Kansas City to Close Nearly Half Its Schools!

Dear Friends,

Something must be very wrong if Kansas City is forced to close nearly half of all its schools, in order to improve its financial situation. You can read more about it on MSNBC's website article entitled "Schools to close in Kansas City, Mo., by fall" .

Best wishes,

Ooi

Will Sovereign Debt Default be the Primary Cause of the Next Economic Crisis?

Dear Friends,

I know that the Dow is up 191 points, to 10,099.75 as I email this (2.42am), which, on the surface, would seem to negate my gloomy outlook for the stock market and the US economy, but I am looking at the longer term strategic picture, rather than the day to day market swings. The bears are just starting to make their moves, while the bulls are still very optimistic, and thus, we have to give the market time, before our analysis comes true.

This is the reason why, we should not take Short trades at this early time of the downtrend, unless it is a trade for a very short timeframe. Bear traps are aplenty in the early phase of a downtrend. If anything, you may want to take advantage of this bullish upturn to get out on some of your Long Positions, if you still have them. From a technical analysis perspective, there is still no reason to enter a Long Position even with tonight's bullish move. Of course, this is just my opinion, and you have to take responsibility for your own investment / trading decisions. Ok, let's get down to business.

RISE IN CREDIT DEFAULT SWAP SPREADS FOR SOVEREIGN DEBT

Lately, the spreads on CDS (Credit Default Swaps) on Sovereign Debt have been rising. In layman's terms, the CDS spread is the insurance premium you pay, for protection against the failure of a nation's debt (Sovereign Debt). Even Australia's Sovereign Debt CDS spread has risen. This is because the Australian Government is highly indebted. For an analysis on Sovereign Debt of key countries like USA, UK, Japan, Australia, Germany, China, New Zealand, Russia and Singapore, please refer to my blog article entitled "Forex Fundamental Analysis 081112" which was written on 12th November 2008. Although a little dated on the statistics, it provides a basic but important overview of the strategic picture the world is grappling with today. Luckily for me, I did my homework, a year in advance of the problems today. :-)

http://praesciens.blogspot.com/2008/11/forex-fundamental-analysis-081112.html

Given the current global concerns over the risk of Sovereign Debt Default, the question we are trying to answer today is, "Will Sovereign Debt be the Primary Cause of the Next Economic Crisis?"

The short answer is "NO".


THE RATIONALE FOR THE ANSWER

Sovereign Debt, no matter how large, is not a phenomenon that just happened overnight. The world, and some of the highly indebted, developed countries have survived this situation for decades. So, why should the current levels of Sovereign Debt be the cause of a debt default crisis today?

The risk and fear of Sovereign Debt Default is the symptom of the root cause, not the cause in itself. If it is the root cause of an economic crisis, such a crisis would have happened long ago. In the end, the Sovereign Debts will not default, albeit a few scary moments and one or two Lehman type of collapse, but on the overall, the majority of the Sovereign Debt will stabilize eventually, no matter how indebted some of these countries are.


THE ROOT CAUSE OF THE NEXT ECONOMIC CRISIS - SHORT ANSWER

What makes me come to this conclusion? If so, what is the root cause of the next economic crisis?

The short answer ..... the artificially Low Interest Rates regime today. It is the fear of world interest rates rising that is causing the demand for Sovereign Debt to slowly dry up. Investors who normally would not blink an eye to invest in Sovereign Debt are now starting to question the Reward / Risk Ratio, and therefore, the wisdom of continued investment in Sovereign Debt, in light that they may stand to lose a lot of money, should world interest rates rise.

Why? Let's look at an example.

When an investor first subscribes for a Greek Government Bond at say, $1 per unit, the Interest Rate, called the coupon rate, is set at say, 4% per annum. However, because investors anticipate that interest rates will rise, the price per unit of the Bond may sell for less than $1, say, $0.90, i.e. the price falls by $0.10. This gives a bond yield of 4.4%, i.e. 4% divided by $0.90. In this way, the market is pricing in a rise of 0.4% in Greek Sovereign Debt Interest Rate, in the foreseeable future. Should investors believe that there is a high risk of default, even such a yield may not be sufficiently attractive for investors to lock in their money, for many years, and thus, the price of the Bond drops even further.

In a nutshell, the price of the Sovereign Bond drops if interest rates are expected to rise, or is rising. In this regard, investors lose money, by holding on to the bonds, and thus, less and less investors are willing to invest in bonds today, be it a Sovereign Bond, or a corporate bond, or a municipal bond. Why? Because the world believes that world interest rates will rise soon.

This lack of desire to invest in bonds is causing demand for bonds to dry up, bit by bit.


BASIC ECONOMICS IN ACTION

If supply of money to invest in Bonds is drying up, because of perceived higher risk of loss, whether through default or through drop in price of bonds invested in, then, there are only two ways that this decrease in supply can be countered, i.e. either

• the demand shrinks proportionately, and the price (Interest Rate) is maintained, or,
• Price (Interest Rate) rises to such a level, to induce higher supply, to cope with existing demand.
  

DEMAND IS INELASTIC -GOVERNMENT BUDGET DEFICITS NEED TO BE FUNDED

The problem is, unlike we mortals, Governments have always over spent, and have never practiced any financial self control / discipline. For example, for the year 2009, the US Government earns US$ 3.8 trillion but spends US$ 5.4 trillion. Thus, the US Government needs to borrow US$1.6 trillion to fund its excess expenditure. This excess expenditure is called Government Budget Deficit Spending.

If you and I were to do such things, we would be declared bankrupt within a few years, if not months, but the Governments of the world have been doing such ridiculous things for centuries now.

What is significant today, is that, like a drug addict, the Governments of the world is forced to continue this Budget Deficit Spending, despite being already highly indebted.

The key is that as long as investors with tons of cash are willing to continue lending money to governments to overspend, such governments can continue to borrow indefinitely. So, the governments never think of repaying, i.e. paying down the debt that is already existing, but instead, they borrow more and more. When a debt comes due, the governments just borrow more, to pay for the principal and the interest due, not unlike what you would do, if you were in financial trouble, and attempted to borrow from one credit card, to pay another credit card debt that has become due. Such an activity is called "Rolling over of debt". Most governments practice "rolling over of debt", and thus, government debts keep mounting.


THE IMPLICATION OF INELASTIC DEMAND DUE TO GOVERNMENT BUDGET DEFICIT SPENDING - HIGHER INTEREST RATE

The above discussion has one important implication. It means that DEMAND for investors' money to subscribe for Sovereign Bond is inelastic, i.e. cannot be changed, whatever the price. To understand the term inelastic, think "electricity" for your home. No matter what the price of electricity is, you will still use it. Similarly, demand for petrol is inelastic. You may cut down slightly on joy rides, but for the most part, irrespective of the price of petrol, you will still buy it.

Whenever there is a significant imbalance in demand and supply, as in the current situation on Sovereign Debt, where investors are starting to shy away from subscribing for Sovereign Debt, and thus, Supply of money is drying up, whilst Demand for money is inelastic, Price (Interest Rate being the price of money) will change (rise) to the extent that this imbalance becomes balanced once more, either because Supply is increased once again, because of the attractive interest rate, or because Demand is decreased as those who cannot afford to pay the high interest rates are squeezed out of the market.

Since we are talking about Sovereign Debt, Demand will not be squeezed out, with some minor exceptions. BUT, Price of Money, i.e. Interest Rate offered by the Governments have to rise.


EVIDENCE SUPPORTING A HIGHER WORLD INTEREST RATE REGIME

The recent stock market fall was sparked by a failed bid by the Portuguese Government to borrow Euro 500 million. Only 2/3 of the Government Bond was subscribed, i.e. around Euro 350 million. This is a small sum of money to raise, and yet, the Portuguese Government could not do it. The financial markets took it as a sign of what is to come, when other Governments of the world try to borrow money, in future. It is not that the world doesn't have the money to lend Portugal Euro 500 million, but rather, it is because the world thinks that the Interest Rate (price of money) offered to investors is too low, given the high risk environment for a loss on bonds today. The Portuguese Government Bond yield is around 4.3% per annum currently.

But, the world is more concerned with the Greek Sovereign Debt. What is the current Government Bond Yield for Greece today? It is around 6.6% per annum today, which is quite high for a Sovereign Debt.

The expected trend for the foreseeable future is that the governments of the world will be competing for investors to lend them money, and this trend is expected to push interest rates up, throughout the world. Thus, the days when the US Federal Reserve can keep its FOMC rate at 0.25%, thus, enabling the US Government Bonds to yield only 2.5%, is almost gone. Sooner or later, and investors are betting on sooner, even the Fed Rate will rise, not by 0.5%, but maybe 1% to 2%.

Imagine a world where Fixed Deposit Rates are up 1% to 2% from current level, and loan rates are up by 3% to 4%.


THE ROOT CAUSE OF THE NEXT ECONOMIC CRISIS - LONG ANSWER

The root cause of the next economic crisis is not Sovereign Debt Defaults. Whilst it is possible and conceivable that there will be two or three countries that will default, (maybe Argentina? But even then, only in conjunction with a currency crisis), the Governments of the world need only raise the Interest Rates they offer, to an attractive level, for investors to continue to lend them, and thus, avoid any debt default crisis.

The problem is, these governments cannot fund their inelastic budget deficit spending without increasing interest rate. This is a unique situation that the world has not experienced since pre-Greenspan era. Alan Greenspan was the Federal Reserve Chairman for the period from 1987 to 2004. He was able to manage the US economy in such a way that he was always in control of the Federal Reserve Interest Rate. Prior to his "reign" at Federal Reserve, there were occasions when countries including the US would go into severe recessions, and then lose control over the Interest Rate mechanism to free market forces.

How do we know that such things happen? Because it is in the interest of every government in the world to keep interest rates low, as long as it doesn't create an excessive asset bubble or high inflationary pressures. Why? Because almost all governments of the world are highly indebted today, and thus, no government wants to pay higher interest rates when it needs to keep borrowing, if it can keep the price of money low.

So, interest rates will always remain low, as long as governments can control it. The only time the governments of the world lose control over interest rate, is when there is an abnormally painful economic crisis, that continues to loom over our heads, like today. Whilst we are assured by the media that an economic recovery is on the way, the people around the world know better, because they are the ones feeling the pain.

So, the only time when governments of the world lose control, is when Supply of Money for Government Bonds shrinks .... like today.

This is what I mean when I said that "The key, the next shoe to drop is the Interest Rate Derivatives", in my blog / email article entitled "Singapore's Economy Shrinks 6.4% in Q4" dated 5th February 2010. I quote -

http://praesciens.blogspot.com/2010/02/singapores-economy-shrinks-68-percent.html

"My point .... no, the world is not falling apart overnight. But, every day, it is getting closer to economic disaster. We don't know exactly when it will happen, but we have a clue in the form of Interest Rates. The Fed has to raise interest rates significantly, at a very fast pace, too fast, and this will catch everyone off guard, and cause massive losses. But the Fed is resisting this move, knowing the next crisis to come, for as long as they can. So, when the Fed does make a move, you know that it is not voluntary in nature."


HOW WILL THE NEXT ECONOMIC CRISIS HAPPEN?

The crisis will come in two parts. First, the imbalance between demand and supply in investor money for bonds will cause the governments of the world, including the Federal Reserve, to lose control over interest rates. Of course, the Fed will give some form of excuse to raise the interest rate, but given the amount of money that the US Government needs to borrow, i.e. US$1.6 trillion per year, in addition to its existing debt of US$14.4 trillion, there is absolutely no reason for the Fed to raise interest rate, unless it has no choice. So, when the Fed raises Interest Rate, you know it has almost lost control, to the free market forces of demand and supply.

This will spark a raising of interest rates throughout the world, to match what the US Government is paying. Thus, world interest rates will rise. When world interest rates rise, this will cause Interest Rate Derivatives spread to widen significantly.

What is this Interest Rate Derivatives? It is made up of many things, but a simplistic understanding would be as follows.

Let's say you borrow money at a certain interest rate, say, 5% per annum. You are satisfied with the cost of borrowing because your business can generate a return on investment of say, 8%, from this money borrowed. However, should the loan interest rate rise, your business profit would be eroded. Thus, you buy insurance with a bank, called an Interest Rate Derivative, so that you fix the loan interest rate at 5%, irrespective of what the prevailing market rate will be in the future.

How can such a simple business strategy turn into an economic crisis, you ask?

Because, the Federal Reserve brought the FOMC rate down to 0.25% per annum in 2008, and loaned the US Banks a trillion dollars, ..... some say, two trillion dollars. The Fed did this to encourage the banks to lend money to spur economic growth in the US.

Borrowing at such low interest rate from the Federal Reserve obviously must be good for the banks, right?

The problem is, the banks did not lend the money out to normal borrowers like consumers or businesses. In fact, if anything, the banks squeezed the consumers and businesses to repay their loans as soon as possible, and curtailed further lending, due to the higher risk environment of debt default.

So, what did the banks do, since they are flushed with cash, not only from the borrowings from the Fed, but also from the loan principal collection?

The banks loaned the money to the US Government. Remember that the US Government needed to borrow US$1.6 trillion a year? The figures jive right? More or less it does.

Why not? After all, if you can borrow at 0.25% per annum and lend to the US Government at 2.25% per annum, why take a risk to lend to Tom, Dick and Harry or XYZ Incorporated?

So what's the problem? Isn't lending to Governments, especially the US Government THE SAFEST loan you can make? After all, the US Government Debt is rated Triple A and the Treasury Secretary, Timothy Geithner, had just recently reiterated that the US Government's triple A rating would stay.

In taking the easy way out, to make easy profits, the banks have committed a basic cardinal sin, that all accountants are taught when taking their accountancy exams ...... never finance a long term investment with a short term debt. For businesses, this translates to ..... never finance the purchase of machineries or land and buildings, with short term debt like bank overdrafts.

Two types of risks arise from such a financing mistake. First, what if interest rates go up? You will then have to pay higher and higher cost of borrowing, but your return on your investment will remain the same. In this case, if the Federal Reserve (FOMC) rate goes up to 2.5% per annum, then, the banks will lose money on the transaction because the Return on Investment is at 2.25%, maximum 2.5%, depending on what instruments they invested in. If the Fed Rate goes up beyond 2.5% p.a., then, the banks will surely lose money, on a long term commitment of between 5 to 10 years.

The second risk stems from a call to return the money loaned. What if the bank withdraws the bank overdraft facility that you used to pay for the machineries? You will have to close down your business because you will not have the cash to repay the bank, and sustain the operations of your business. For businesses, this is the greatest risk, in using short term financing, for long term investments. For the banks, it is possible that the Fed will be more accommodating, and this risk is not as great as in the case of normal businesses.

Given the risk of rising interest rates today, what would you do if you are the CEO of a bank that borrowed money from the Fed at 0.25%, and invested in lending money at 2.25% to the US Government for a tenure of 5 to 10 years?

You cannot unwind the position that you have got the bank into. You can try to sell some of the US Sovereign Debt, but so is everyone trying to do that today. The smarter CEOs bought insurance protection against upward increases in interest rates long time ago. This is called Interest Rate Derivatives .... what we mentioned earlier. Remember?

Here, no matter how smart you are, the risk will always be there. Remember the earlier crisis of the Credit Default Swaps that caused so much arguments over "Mark to Market Accounting", that caused the banks to lose billions of dollars?

At that point in time, some banks bought CDOs (Collaterralized Debt Obligations) i.e. high interest yielding bonds that were risky, but they also bought insurance protection through CDS (Credit Default Swaps), a derivative to protect against failure of payments by the borrowers. But too many borrowers defaulted because the debt was mostly sub-prime and Alt A loans (no documentation evidence loans), and thus, this caused too much losses on the insurers to the extent that Lehman collapsed, amongst the many other financial institutions, whose names have all but disappeared today.

This brings us to the million dollar question. When world interest rates go up, how much losses will the insurers who sold the Interest Rate Derivatives suffer? It is said that the open positions of the Interest Rate Derivatives is around US$140 trillion (US$140,000 billion) today. If the loss is 1%, this would be equivalent to a loss of US$1.4 trillion or US$1,400 billion ..... a lot more than the losses incurred in the Sub-Prime Crisis that started it all.

Which bank has the most Interest Rate Derivatives exposure? Do the banks that have significant exposure have enough capital to pay for the losses? I don't think the current capitalization of all the banks that wrote out the insurance policy on the Interest Rate Derivatives are any where near US$1,400 billion. This means that there will be massive defaults on some very large banks, and here we go again, on a 2nd round of financial and economic crisis, requiring an even bigger government bailout. This is assuming that World Interest Rates rise.

But we have already made a case, in explaining why the demand is inelastic, while supply is drying up, slowly but surely. Is it a sure thing to happen? Is it a Predetermined Element? No. But the probability of it happening is getting higher by the day.

I have explained the disastrous consequences of higher world interest rates from the Derivatives point of view. I have not even mentioned the devastation that a high interest rate regime will do to already cash strapped consumers and businesses, what more, the even more massive retrenchments to come, as a result of further cost cutting measures to cope with higher financing cost. I have also not bothered to complicate the analysis with the potential risk of currency devaluation crisis, which would aggravate matters to an almost inconceivable level of economic disaster.

This is why I say that the KEY, and the root cause of the next economic crisis will be the rising of World Interest Rates. This is why, I say that the Federal Reserve will not raise interest rates, until and unless they have no further option, i.e. they are on the verge of losing control of the situation to free market forces at work. When the world (governments especially) is consuming tons of cash, and supply of cash from investors (not central banks) is stagnant, as is the case today, price, the cost of money in the form of interest rate, has to rise. This is THE RARE HISTORICAL MOMENT in time, when governments of the world lose control over interest rate, the price of money, they have to borrow. This is why it is possible for the Dow to fall to 4,800 +/- 300, as stated in my blog article, "How Low will the Dow Go?"

http://praesciens.blogspot.com/2010/02/how-low-will-dow-go.html

In Malaysia, we experienced such a rare historical moment of uncontrollably high interest rate regime in 1986, when Fixed Deposit rates were at 12%, and bank overdraft rates were at 18% per annum. Federal Reserve Rate went to a high of 12.5% in the late 1970s, just after the Oil Price rose above US$100 per barrel, in 1974. That was when the Fed lost control of the interest rate mechanism, although they will never admit to such a hypothesis. Sounds like history repeating itself doesn't it?

I hope you enjoyed this analysis as much as I did, writing it.

Best wishes,

Ooi

Singapore's economy shrinks 6.8 percent in Q4

Dear Friends,

I wrote two email articles (edited for better accuracy) that I forgot to post on my blog, so for record keeping purposes, I will do so now.

As usual, please reminded that you are responsible for your own investment decisions. I am here to share my opinions and information, but you enjoy the gains, and suffer the losses. So, make your own decisions, for better or for worse.

http://sg.news.yahoo.com/ap/20100104/tbs-as-singapore-economy-3c8dc0d.html

Singapore's economy shrinks 6.8 percent in Q4

THIS is what I am talking about, when I said that the Long Term Outlook of the Dow should be below 6,500. This news is fresh from the oven. Singapore is the first country to report its GDP data for 4th Quarter 2009, i.e. within 5 days AFTER 31st December. US GDP data will only come out on 29th January 2010.

The significance of this news is not that there is a relapse into economic recession, but rather the fact that it is 6.8% negative, which is comparable in pain to some really bad recessions. In short, there was a lot of economic and financial pain experienced in Singapore between October to December 2009. So much for a happy Christmas.

You cannot use the rubbish media definition of an economic recession of 2 negative quarters because it is biased. It takes one quarter to get out of recession, and when the GDP was 0.1% positive, the media announced to the world that a country is OUT of recession, and then, it takes two quarters to announce another recession. Just stick to positive and negative GDP growth to get a feel for the economic pain. Also, pay attention to the numbers to understand how much pain is being experienced.

Don't forget that if you were once earning $10,000, and your earnings drop significantly to $7,000 in the recession, it is little consolation, nor any news to celebrate when your boss announces a salary increment of $100 for you. The $100 increment amounts to a raise of 1.4% on the low base of $7,000, and does nothing much to bring your salary back to normal of $10,000. This is the TRUTH of the economic pains in the world right now.

Worst, the world is about to experience further income cuts, even from the low base of $7,000, and what you just saw from the news is like your salary being cut another $483, from $7,100 to $6,617. Can you feel the pain? So much for the $100 increment a few months ago.

Most businesses are suffering from significant drop in sales turnover and profitability, and there is nothing to suggest that this trend will not persist for the foreseeable future, without any significant changes for the better. If anything, the future looks even bleaker with time, and there is an increasing possibility of even further drops in turnover and profitability in the next one to two years.

The funny thing was, I kept analyzing the economic data, trying to remain unbiased as I searched for signs of positive or negative Economic Growth in the future, and my Economic Growth Forecasting model could not give me any positive results, even though EVERYONE in the world kept talking about an economic recovery. Now, I know that my Economic Model didn't lie to me, and it was the commentators who were biased in their assumptions. Some actually used the wrong model to make their forecast, and this was evident from the way they talked.

For your information, what is Foreseeable Future is defined by me as "AS FAR AS I CAN SEE, until new information changes the outlook".

This is THE MAIN WAVE of the ECONOMIC TSUNAMI, and it is almost upon us. I expect the economy of US and Singapore to also experience bad results for 1st Quarter 2010.

The first economic recession of 2008 was like a fall from a 3 storey building. You end up half dead in hospital's Intensive Care Unit (ICU). You slowly recover, and the champagne bottles start to open in the view that you will be back on your feet in a few months' time. NOW, the doctor suddenly finds you have some symptoms of a relapse. Complications have arisen. You are not out of danger yet. You are still recovering from your bone breaking fall, but because of your low immune system, you have caught other diseases. You are in danger of becoming very ill.

How ill? What is this illness? What medicine to prescribe?

All these questions cannot be answered at this stage because at present, only the negative symptoms are appearing, while the cause is less certain. COMPLICATIONS, not an accident, is the cause of this Main Wave of the Economic Tsunami.

The facts we know are clear. There is a hell of a lot of economic and financial pains being experienced, and the world economy is extremely fragile. It only takes a snap of a single match, to light up the bonfire.

From our perspective, this is about businesses and consumers having to suffer too long from low income compared to the hey days, while prices of everything remain higher than the income fall. Without a relative fall in prices, People and businesses are still tightening their belts on the overall, and despite whatever any Government or media has to say, the people know the pain is there, with nothing in sight to change that view, for the foreseeable future.

There are some pretty bad economic storms out there, and it is brewing into another major Financial Tsunami. It is coming, my friends. You might want to consider getting out of your stock positions if you have any, and wait for a more opportune time to reinvest.

I quote from an email I wrote on 29th December 2009 in response to a very interesting article per website link below, of the growing income gap between the rich and the poor, i.e. before the Singapore GDP announcement: -

http://silverbearcafe.com/private/11.09/unraveling.html

In the last few months, I came to the conclusion that there is no point lamenting about the gap between the rich and the poor because that is exactly what capitalism is about. The only thing we have to worry about, is

"Which side of the fence are you on?"

I think there is no solution to this economic problem. The prophecies of George Orwell's "Animal Farm" will keep repeating itself, whoever is in power, and the world will cycle through great eras, down to bad economic eras, and we are seeing the movement towards worser and worser economic conditions, in the economic super cycle.

Economic Depressions cause a change in wealth on a massive scale. It provides the necessary earthquake to break the existing economic structure and its foundations to the core, leaving behind vast devastation for all. And from the ashes of disaster, a new economic era is born. This was how economic history has been, and this is how it will be.

America had it great for a long time, not because of capitalism, but because they had plenty of land, and was the industrial might of the world. Next, the US$ became the world reserve currency, and this allowed Americans to spend 750 times more than they should have, if the US$ were not the reserve currency. There is no way America can repay the debt it owes the world.

The mound of sand is looking like it is about to topple. We do not know exactly when the last grain of sand will do the whole mound in, i.e. cause it all to fall down, but it's a question of WHEN, not IF. Debts have to be repaid. Full stop.

The grain of sand is actually the US Treasury issues, whether short, medium or long term notes. The over subscription for such notes are falling, and is down to 2.1 times now, from a high of 3.6 times. It was only a couple of months ago, that it was 2.9 times.

The key, the next shoe to drop is the Interest Rate Derivatives. It is said that there are around US$140 trillion in Interest Rate Derivatives, and the horror story is .... what will happen if the US Interest Rates rise significantly? Some are expecting the IRD to cause major losses on those who have underwritten the assurance of continued low rates regime.

My point .... no, the world is not falling apart overnight. But, every day, it is getting closer to economic disaster. We don't know exactly when it will happen, but we have a clue in the form of Interest Rates. The Fed has to raise interest rates significantly, at a very fast pace, too fast, and this will catch everyone off guard, and cause massive losses. But the Fed is resisting this move, knowing the next crisis to come, for as long as they can. So, when the Fed does make a move, you know that it is not voluntary in nature.

This is the current situation. Of course, the danger may pass, if they reach a good agreement with PBOC (People's Bank of China), to continue to support the US Treasuries, so ... this is not an imminent disaster, but a real danger that needs to be accounted for. The key is in the future Fed Interest Rate .... not the normal moves, but the ones that seem very unlike a normal Fed policy. That's when we know something has gone terribly wrong.

As for the alarm bells on capitalism, the current situation in US is nowhere near as bad as the Great Depression, not to mention the times of Industrial Revolution. To understand the Great Depression, see the movie, "The Grapes of Wrath". For life in the Industrial Revolution era, see Les Miserables.

My outlook for the world economic and financial markets for 2010?

I am too busy to write blog articles nowadays, so I will just requote what I wrote to a friend earlier today in response to his recommendation of an Elliott Wave Theory blog, and before the Singapore GDP number was known to me.

Thank you for sharing. I went to the website and his chart on the Rising Wedge, with falling RSI seems to confirm my opinion that the US Stock Market liquidity driven run up is almost over. I actually sent an email to Victor, over the weekend, to get out of any positions if he can, but I am too busy to write any articles on the outlook.

If you look back into my April and August Outlooks, the only two times I wrote Dow Outlooks since April 2009, I set a target for 10,500 to 11,000 as the maximum peak potential. We are in that critical zone, and there is no reason nor price behavior evidence for me to change my outlook set then. Of course, I was wrong on the duration of the run up .... but hey, I'm no God. Hahahahahahaha. Forecasting is a probability game, and I won't get it right the next time, but sometimes, it does work.

The big strategic picture is usually quite reliable, compared to the short term forecast due to noise from news and short term fear and greed sentiment.

My long term forecast is still one of extreme pessimism, i.e. below 6,500 on the Dow, before the economic challenges are all over. BUT, we will have to reassess the situation at the 8,900 to 9,200 region, and depending on the news and price behavior, we will need to make a decision whether THIS new downturn is the 1st wave of a 5 wave Long Term Bear Market (my macro economic view), or merely a Downward Correction in a Long Term Uptrend (the general consensus macro economic view).

You will note that I do not believe in ALL of Elliott Wave methodology, i.e. too much wave counting. Instead, I believe in what I think is quite reliable, the wave structures that can arise, and try to assess the various scenarios, as they unfold, .... with a view to making money.

In other words, don't get lost in the details of EWT. Be flexible. Stick to the simple principles, and make money from it. Of course, the making money part is the tough part, but, it all starts with the thought right?

In short, this is going to be hell of a year, to find opportunities to make money, because the world economy and financial markets are going to experience one heck of a roller coaster ride this year. Meantime, go easy. Smell the roses, enjoy the fresh air, and just stay out of trouble. Life will be great if you can do just that.

Best wishes,

Ooi

Realty Trac Outlook - More Foreclosures Ahead

Dear Friends,

Wondering what is the current Home Foreclosures' situation now that the economy is supposed to be in the "economic recovery phase" as some have claimed?

On 13th January 2010, Wall Street Journal's Dawn Wotapka interviewed Realty Trac's Rick Sharga for his opinion. Realty Trac is the key body in the US that tracks foreclosure statistics. Rick's outlook in a nutshell - More Foreclosures Ahead.

Best wishes,

Ooi

Peter Schiff's CNBC Fast Money Interview

Dear Friends,

Here is a really interesting debate between Peter Schiff and CNBC's Fast Money Panel on 4th January 2010, about whether the economy is recovering. View it and make up your own mind on the future of the economy.

Peter Schiff foresees taxes on profits that is happening right now.

In my view, one is talking about statistics, while the other is talking about the big strategic picture of the realities of life. You decide - rely on the statistics or look at the big, long term strategic picture.

Best wishes,

Ooi

Marc Faber's -"The Gravy is Out of the Markets" 2010 Outlook

Dear Friends,

Marc Faber's outlook for 2010 - the "gravy is out of the markets".

Best wishes,

Ooi

Jim Rogers Interview with CNCB's Maria Bartiromo

Dear Friends,

Here is a hard talking interview of Jim Rogers by Maria Bartiromo of CNBC on the World Economy. What is interesting is that he is long the US Dollar, whilst he mentions usual issues like "printing money" and "currency turmoil".

Best wishes,

Ooi

Soros on World Economy (Financial Times Interview)

Dear Friends,

Here is the interview of George Soros with Financial Times on 23rd October 2009. Slightly into 3 minutes, he talks about the "hope" of a V Recovery, and he thinks that it may not happen, and questions what would be the impact, when people realize they are wrong.

Overall, Soros' opinion is worth listening to, because he summarizes the world economic situation quite succinctly.

Best wishes,

Ooi

Part 1 of the Video



Part 2 of the Video

US Dollar to Weaken?

Dear Friends,

This news article from Bloomberg today, entitled "Pimco Says Dollar to Weaken as Reserve Status Erodes is one of the most significant information on the US Dollar, that I have seen for quite some time.

Why? Because PIMCO is the largest Bond Fund investor in the US, and Bill Gross is the Bond King of the world. So, when PIMCO or Bill Gross makes a statement, I listen.

The message bears an extremely high significance in my mind because it is very rare that PIMCO or Bill Gross comes out speaking negatively against the US Economy, its Government, or its Currency. PIMCO and Bill Gross tend to be politically correct, and is more diplomatic than most other fund managers in their public views. So, when they say something so negative, it is actually quite alarming.

Nevertheless, don't panic, and rush to sell all your US Dollars straight away. This is a Long Term Structural Issue for the US Economy, and I agree with their opinion. BUT, there is time to do the necessary, i.e. to hedge against such a High Impact Uncertainty.

Currently, the US and the World Economy is still in Asset Deflation Mode, with the exception of the stock market, which is in a Strong Bear Market Rally, albeit a potential downward correction in the short term.

Property Prices will continue to fall, and Consumer Demand will remain lethargic at best, and is more likely to drop further, with time. Thus, Commodities Prices in general, will fall lower, in the longer term, albeit swings to the upside, due to Bear Market Rallies.

What is becoming clearer, and will become even clearer, is that Consumer Price Deflation will also be experienced, at least in the Short to Medium Term. Until and unless the US Dollar weakens significantly, the US and World Economies are slipping deeper into the Great Recession, and possibly into an Economic Depression.

I am not talking about the Technical Statistical Positive Growth of 0.3% achieved after the economy has fallen off the cliff which economists call an "Economic Recovery".

It is really amazing how it takes two quarters of negative GDP growth to officially confirm a Recession, but a mere 0.3% positive growth in a single quarter to announce an Economic Recovery.

The real truth is that the Pains of the people will continue, irrespective of what the statistics say. Business conditions will remain lethargic at best, and Consumers remain cash strapped, and heavy losses will persist in the housing market.

Job Losses are slowing down in momentum, which is good news, but ..... job losses persist, even if less people are losing their jobs compared to a few months ago. A reduction in the momentum of job losses does not equate to a turnaround in the economy. It does have the potential, but it is way too early to make such audacious claims.

Worst, when analyzed as a total economic system, the signs are still very unhealthy.

In conclusion, I stand by my view that for the Short to Medium Term, the Economic Outlook is one of Asset Deflation and Great Recession bordering on Economic Depression.

However, I do agree that there will come a time when the US Dollar will face some form of Currency Devaluation Crisis, due to excessive printing of money, and when this happens, then the Stagflation Scenario will materialize.

The challenge is in getting the timing right. To hedge against Stagflation, we need to invest in Precious Metals like Gold and Silver, and even buy some stocks that are commodities / mineral resources based.

However, in an Asset Deflation Environment, like the current Great Recession, which can easily plunge into an Economic Depression, holding any Assets, be they Precious Metals or Stocks or Properties, will result in Losses from Dimunition in Asset Value.

This is why we have to be extremely careful in ascertaining the right market timing.

Frankly, I need to warn that it is indeed audacious to suggest that we can time our Portfolio Management Strategy so well. Economic Statistics tend to be conflicting, and if anything, tend to confuse us more than illuminate our understanding.

However, the KEY to the Golden Doors between the two Conflicting Investment Scenarios, i.e. Asset Deflation vs Stagflation is the World Interest Rates. Before a US Dollar Devaluation Crisis, which usually precedes a Stagflation Scenario, the Major Governments of the World will do its best to avert such a crisis.

The Key Tool available to fight a Currency Devaluation Crisis is the Central Bank Interest Rate. By raising Interest Rate, a Central Bank hopes to attract investors into buying its currency, and thus, stem the tide that would otherwise have been disastrous.

I would highlight that by the time a Currency Crisis is about to happen, such an effort is unlikely to work. Nevertheless, I have not seen a Government that will not try, using this policy, to fight off the crisis.

Thus, I stand by my earlier analysis that World Interest Rates have to rise first, before a US Dollar Devaluation Crisis leading to Stagflation will materialize. Nevertheless, it is important to note that by the time World Interest Rates rises, the US Dollar could have, and in all likeliness, would already have devalued to some extent.

BUT, there is a major difference between the normal fluctuations of a currency, strengthening at certain times, weakening at other times, as opposed to the whole world deciding with a single minded view, that the currency is in deep trouble. Right now, the world views are still quite divided.

If and when the World Views are starting to converge in one direction, the US Dollar Devaluation will start to gather momentum, and the Federal Reserve will provide us with the first sign of trouble, i.e. a raise in Interest Rate. Whether the raising of the Interest Rate is explained as due to an improvement in economic conditions is immaterial.

What is significant is that Interest Rates are being raised, for fear of Stagflation, which is just another way of saying the Federal Reserve is starting to show concerns for a Currency Devaluation.

If there is no concern for Currency Devaluation, most Governments will persist with a Low Interest Regime, because it lowers the Government Budget Deficits Funding Cost, and thus, the Government has more money to spend.

In conclusion, my opinion is to persist in holding cash, but be nimble enough to protect ourselves, at the first sign of trouble, i.e. when US Interest Rate starts to rise, or is likely to rise.

Best wishes,

Ooi

Economic Recovery with Pain

Dear Friends,

This Wall Street Journal video suggests that the US Economic Recovery will happen, but the Pain will remain, making it feel like there is no recovery at all.

David Wessel, Economics Editor of the Wall Street Journal explains why. I think that this is a very balanced and objective summary of the US Economic Situation.

Best wishes,

Ooi

California Hotels Are in Financial Trouble

Dear Friends,

This Wall Street Journal Video reports that even luxury hotels are in trouble. 32 hotels have been foreclosed in California, with another 218 in distress. Even the famous St. Regis in California has closed down.

With a number of loans coming due for repayment, occupancy rates having fallen from 80% to 40%, and hotel property valuations down by as much as 40%, there seems to be little hope of a good solution to their financial problems, and ultimately, the banking losses problems.

Best wishes,

Ooi

Is the US Dollar About to Weaken?

Dear Friends,

In my previous blog article entitled "Rise of the 30 Year Treasury Bond Yield", I highlighted that the China Government has already started selling Treasury Bonds. The situation is further clouded by the fact that Gross External Debt amounting in the range of US$4.4 Trillion to US$ 6.2 Trillion is already due for repayment.

These are facts, and if the current trend is to persist, which is a key assumption, then in my opinion, the US Dollar will have to weaken.

We look at the US Dollar Index to assess the Probability of such a phenomenon happening.

Chart is reproduced Courtesy of StockCharts.Com.

From the Weekly Chart, we note that the USD Index had formed a Double Top between the period of November 2008 to March 2009, making a Pivot High at 89.62 before falling to a Pivot Low of 78.33 as at early June 2009. In the past few weeks, the Index has been moving sideways.

This Price Pattern seems to be supportive of our Global Macro Analysis that the US Dollar should weaken, especially when the Index has already breached below its Weekly SMA200 (Simple Moving Average for 200 Weeks).

Two Scenarios can arise from the current Price Pattern, i.e. either the Index goes into a WSTR (Wide Sideways Trading Range), where it whipsaws to and fro its SMA200, or it will resume its fall, after the present Sideways Consolidation.

Either way, it would seem that the Probability of the US Dollar Index moving forward in a Primary Uptrend and making new Pivot Highs is low. This is despite the Gross Oversold Position of the Slow Stochastics.

We move on to the Daily Chart for a closer look at the price behavior.

Chart is reproduced Courtesy of StockCharts.Com.

It is clearer here, that the Probability is High that Price is in a Primary Downtrend, but currently experiencing a Sideways Consolidation. We can expect the Downtrend to resume successfully, once Price breaks below both the SMA50 and the Key Horizontal Support Level.

The Primary Downtrend is confirmed once the Index breaks below 77.69.

The current Daily Chart Price Pattern of the USD Index reminds me of the Daily Chart of the Dow Jones Industrial Average (DJIA) afrer it broke below its SMA200.

Can you see how the DJIA Bulls made one last gasp of effort to climb above the SMA200? In this case, it failed, and the Dow eventually fell from 13,000 to the 6,500 level, with a few Bear Market Rallies in between.

History does not always repeat itself, but it is possible for history to repeat itself. What strikes me, is the uncanny resemblance of the 3 Peaks before it went below the SMA200 in both cases.

Please be reminded on the Liability Exclusion Clause, which is at the top of my blog page, i.e. that the final trading decision is yours, and I will not be responsible or liable for any losses you may incur from whatsoever reason. :)

Best wishes,

Ooi

© Copyright 2009 of Praesciens.Blogspot.Com.

Rise of the 30 Year Treasury Bond Yield

Dear Friends,

As mentioned in my earlier blog regarding the potential rise in World Interest Rates, it is interesting to note from this Chart that the Yield of the 30 Year Treasury Bond has risen back to the levels experienced at the beginning of the year 2008. This is despite the fact that the Federal Reserve Interest Rate is still kept at 0.25% per annum, having fallen from 5.25% since July 2007.

Chart is reproduced, Courtesy of StockCharts. Com.

In July 2007, the 30 Year Treasury Bond Yield reached a peak of 5.408%. It then fell to a low of 2.518 % in December 2008. However, since the beginning of Year 2009, the 30 Year T-Bond Yield has risen steadily, to a high of 5.066 % before correcting to 4.308 %, which is still relatively high, compared to the Fed Interest Rate.

The Daily Chart provides a more detailed view of the bottoming out, and the subsequent rise since the beginning of year 2009.

Chart is reproduced, Courtesy of StockCharts. Com.

What does all this mean? In my opinion, it is evidence of a dislocation between the Interest Rate Policy of the Federal Reserve, who want to keep Interest Rates artificially low, to stimulate economic growth, and the Real World Situation, which is fast reflecting a fast weakening demand for US Government Treasury Bonds, in the wake of fast increasing Supply of such Government Bonds.

Will the US Government relent to Higher Fed Interest Rate by end of 2009? To me, the answer lies in the Supply & Demand for US Treasury Bonds, particularly those held by Foreign Investors, rather than Domestic American Investors.

We note that based on US Government Statistics as at 31st March 2009, there is a total of US$ 4.4 Trillion due to be repaid by 30th June 2009, unless it is successfully rolled over.

Furthermore, there is a total of US$ 1.8 Trillion where the Debt Service is Unknown. I am not sure why the US Treasury Department is unable to classify its own Debt Obligations properly, but that's what it has declared to the world, i.e. the classification of this US$1.8 Trillion is UNKNOWN. In my opinion, any Debt that cannot be classified as Long Term, has to be classified as DUE IMMEDIATELY, since, if there were no repayment terms discussed, theoretically, the Debt could be recalled at any time.

Thus, the total Debt that is already due as at 30th June 2009, stands at US$ 6.2 Trillion. Exactly how this Gross External Debt which is already due for repayment will be settled, is unclear.

What seems clear is that if the Lenders are not happy to roll over the Debt, then, the US Government will have no choice but to repay this amount immediately. This should result in a devaluation of the US Dollar, as the US Government does not hold sufficient International Reserves or Gold Reserves to repay the Loans that have come due.

Should the Lenders agree to roll over the repayment, then, there will not be a Currency Devaluation Issue.

Given that the risk of default has risen, and the fact that the US Government has ignored International Investor Community concerns that it is printing Excessive Amounts of Money, I would agree to a Rollover on only a portion of the Debt, and only if the Interest Rate is much higher than what it is currently prevailing.

Possibly this explains why the 30 Year T-Bond Bill has been rising so rapidly, despite the stagnant Fed Rate remaining at a ridiculously low level of 0.25% per annum. How the Fed intends to attract Bond Investors to buy Short Term T-Bonds at such a low rate on a sustainable basis, is a real wonder.

In any case, it looks like we are on the right track for Higher Interest Rates Worldwide, within the next two years.

Best wishes,

Ooi

Note: - Interest Rate Yield goes up when the Demand for the Bond goes down, or alternatively, when the Supply of the Bond goes up, which causes the Price to fall, as investors are more motivated to sell than to buy. When Price of the Bonds goes down, the Yield of the Bond goes up.

In the current situation, China is starting to sell down on its Treasury Bonds, and thus, the US Government is facing a double whammy of higher supply (US Government printing more money), and lower demand (Foreign Investors selling). This situation cannot persist for long without some significant negative consequences, of either rapidly rising interest rates, or a currency devaluation, or even both.

In this regard, it would be advisable for the US Government to exercise much more stringent fiscal prudence, instead of thinking of spending even more, with a 2nd Stimulus Package. Whenever the US Government proposes to spend, the Lenders face an even greater risk of a Currency Devaluation, and thus, this policy discourages a stable currency exchange rate.

The Right Investment Strategy in Today's Economic Environment

Dear Friends,

Quite a number of you have been asking me how to make your money work for you in a more effective way. Obviously, many of you are not happy to just put your money in the bank, and earn very low income due to the ridiculously low interest rate era that we are experiencing today.

My answer has always been that this is an Asset Deflation Economic Environment, and thus, if you hold assets, you will lose money in terms of capital devaluation. Alternatively, for the more sophisticated traders, I suggested taking Short Positions, especially in ETFs (Exchange Traded Funds) like DOG (Dow Jones Industrial Average SHORT ETF) and SH (S&P500 SHORT ETF), at the appropriate moments in time.

However, most of you are not comfortable with a SHORT Strategy, and thus, are left unsatisfied with the alternative .... the low fixed deposit returns.

So, I have decided to do a bit of research to empirically substantiate my thesis that doing nothing, i.e. not invested in Assets (other than Cash Instruments) is better than being invested.

Of course, you can always quote to me, with hindsight, that so and so made money going in Long, at the right time. Yes, there will always be exceptions to any generalization.

However, I am interested in being on the right side of the fence, i.e. to take positions that give me a Higher Probability of Winning, and thus, I want to be in the two Standard Deviations of a Normal Distribution Curve. In other words, I want to be in the same Strategic Direction as the Market and thus, have a better chance to make money.

What is the Strategic Direction of the Market?

American Household (including NonProfit Organizations) Wealth (Net Worth) peaked at the end of the 2nd Quarter of 2007 (30 June 2007), at US$64.4 trillion. The Total Assets held then was US$78.3 trillion supported by Total Liabilities of US$13.9 trillion.

However, US Government Statistics showed that American Households' Wealth have dwindled to US$ 51.5 trillion as at 31st December 2008. The Total Assets have been reduced to US$65.7 trillion, while Total Liabilities actually went up, to US$14.2 trillion. This is despite the fact that Americans have been complaining that they cannot get Mortgage Loans to buy Housing Properties.

Whilst Total Liabilities grew by US$300 billion, Home Mortgages Loans grew from US$10.2 trillion as at 30th June 2007, to US$10.5 trillion as at 31st December 2008, thus, accounting for practically 100% of the total increase in Liabilities in the 1.5 years.

Nevertheless, it is true that Home Mortgages Loans peaked in the 1st Quarter of 2008 at US$10.6 trillion, and thus, the US Banks have collected repayments more than they have loaned out, by US$100 billion.

The statistics above show that Americans have lost US$12.9 trillion or 20% of their overall wealth, in the 1.5 years between the start of the Sub-Prime & CDOs Crisis, to the end of last year. The year 2008 was clearly a period of significant Asset Deflation .

A Basis for Comparison of Your Own Fund Management Performance

You now have a basis to compare how well you have performed, in managing your money, compared to the Average American with Wealth. If you had left all your money on cash, earning a fixed deposit interest of say, 1.0% per annum, you would be 21% better off, than 300 million Americans, and possibly, 2 billion more people around the world.

But, just how badly, or how well did you fare against the Wealthy, who can afford to employ the best Fund Managers in the world, to make their money work harder and more profitably for them?

The CapGemini Merrill Lynch World Wealth Report for 2009 stated that -

"At the end of 2008, the world's population of High Net Worth Individuals (HNWIs) was down 14.9% from the year before to 8.6 million, and their wealth had dropped 19.5% to US$32.8 trillion. The declines were unprecedented, and wiped out two robust years of growth in 2006 and 2007."

HNWIs are defined by the CapGemini Merrill Lynch World Wealth Report as "those having investable assets of US$1 million or more, excluding primary residence, collectibles, consumables, and consumer durables." while Ultra HNWIs are "those having investable assets of US$30 million or more, excluding primary residence, collectibles, consumables, and consumer durables."

The Report also defines Mid-tier millionaires as "HNWIs having US$5 million to US$30 million in investable assets."

Did the Ultra HNWIs do any better?

The Report stated that, "Ultra-HNWIs suffered more extensive losses in financial wealth than the HNWI population as a whole. The Ultra-HNWI population fell 24.6%, as the group’s wealth dropped 23.9%, pushing many down into the Mid-Tier Millionaire pool."

The Importance of Getting the Strategic Economic Direction Right

The above shows exactly how important it is, to get the Strategic Picture right. When an economy is in a Positive Sum Game, you can buy and hold good fundamental stocks, and even adopt a Dollar Averaging Periodic Timing Strategy.

However, once the economy moves into the rare, Negative Sum Game Climate of Asset Deflation, where High Uncertainties prevail, buying and holding assets can be very, very costly to your Overall Wealth. I have mentioned this way back in my emails in July 2007, and also in my previous blog article, but it is so important that it is worth mentioning again.

So, if you had left your money on fixed deposits, and was having a dissatisfied feeling that you have not optimized the ROI (Return on Investment), let it be known that your actual ROI for the year 2008, was 21%, assuming the Fixed Deposit Rate was 1%. Actually, it is less than that, because some of the Net Worth Losses were in 2nd Half of 2007, but hey, who's really counting?

Congratulations, you have managed to get ahead of 2 billion people with wealth, and have sneaked a march on the HNWIs, by getting a little richer compared to them.

Wealth is relative to what others own. If you had US$100,000 in 1930s, you would be a very, very rich man then. Today, you need to have US$1 million of Investable Assets, excluding your primary residence which you call home, to join the ranks of 8.6 million, Millionaires around the world. But, at least you are getting closer, by the day. :)

Where did the money go? How did Americans lose US$12.9 trillion?

As Property Prices fell, the value of Real Estate Assets held by Americans, dropped 15% or US$3.6 trillion, from US$24.1 trillion as at end of June 2007, to US$20.5 trillion as at end 2008.

The Stock Market wiped out a substantial portion of the Corporate Equities Assets held, with a decrease of US$ 5.9 trillion or 40%, from US$14.7 trillion as at 30 June 2007, to only US$ 8.8 trillion as at 31st December 2008.

The sad part is that many prudent, soon to be retired baby boomers are going to face a financial crisis, upon retirement in the next few years. Why? Because, their Pension Funds lost 22.6% or US$3 trillion, down from US$13.3 trillion as at 30th June 2007, to US$10.3 trillion as at 31st December 2008.

Were there Smart People who sold down their assets and moved their money into cash instruments? Yes. There was an increase of about US$600 billion, i.e. US$0.6 trillion, in Cash Instruments, since 30/6/07 (US$7.1 trillion) to 31/12/08 (US$7.7 trillion).

Is the American Financial System still Flushed with Cash?

Some people have argued that the American Financial System is still flushed with cash. Yes, this is true, and the amount as at the latest US Government statistics of 31st December 2008, is US7.7 trillion. This means that on average, Americans held 11.7 % (US$ 7.7 trillion divided by US$65.7 trillion) of their Total Assets in Cash as at 31st December 2008.

The problem is, the Wealthy holds a disproportionate amount of that cash, whilst the average American holds very little cash.

Another challenge is in getting the Americans with the cash, to spend. In the first place, these people are flushed with cash precisely because they don't need to spend this money. Secondly, there is a dislocation between asset demand and asset supply.

Quite a number of the properties for sale, (about 19 million properties actually) are in less desirable places, including Sub Prime Properties. The people with cash would not be drawn to buy such properties.

Even if the properties are in desirable locations, and look very attractive, as have been seen on Media Interviews, the Market Sentiment (Investor Confidence) and the Price still has to be right, to get the transaction done. However, this is not the case today, as 50% of the Property Transactions concluded are foreclosure sales. Furthermore, New Home Sales by Property Developers are competing with existing Home Sales for the limited investment capital.

If we value the average property at US$100,000, then, the value of the 19 million Existing Homes for Sale would require an Investment Capital of US$1.9 trillion. This is before New Home Sales for development projects to be launched.

Will this Cash be the Key Driving Force for America to grow out of this Economic Recession?

Since there is enough cash, i.e. US$7.7 trillion in the American Financial System, compared the value of properties in stock to be sold, it is possible for this Segment of Society to be the key driving force pushing America out of the current economic recession.

In fact, in most economic recessions, it is not those that are affected by the recession, i.e. the Unemployed, that will drive the economy; rather, it is the Unaffected that will eventually invest in New Home Sales, that moves the economic conditions out of its Vicious Cycle of Failure, into a more positive environment.

However, please note that it is Investments in NEW Home Sales, and not Existing Home Sales that is the driving force for an economic recovery. Why? Because Existing Homes are already built, and thus, has very minimal effect on Job Creation.

On the other hand, New Home Sales require construction workers to build the homes, and thus, is a key factor in driving the economy forward. Sustainable levels of New Home Sales is the Key to future Economic Recovery. This is the key economic indicator we will need to monitor, in ascertaining whether an Economic Recovery is really underway.

Is A Sustainable Economic Recovery Underway?

In the latest US Government Statistics published, American Household Wealth decreased another US$1.3 trillion in the 1st Quarter 0f 2009. The 2nd Quarter of 2009 may show a slight improvement in the Wealth of Americans, as there is a stock market rebound, off its lows set in February 2009, but this positive wealth effect is somewhat negated by the continued fall in property prices throughout the country.

Economic Activity did pick up in the 2nd Quarter of 2009, leading some Optimistic Analysts to argue that possibly an Economic Recovery is already underway. However, this phenomenon is merely due to a replenishment of business inventories, which were running low, and not due to increase in Consumer Demand.

New Home Sales did pick up for about two months, but then, it seemed to have fizzled out, and does not look SUSTAINABLE, which is the key to a Sustainable Economic Recovery.

In any case, the banking sector doesn't look like its about to go on a massive Credit Expansion Plan any time soon, and without Credit Expansion, there is limited upside to Economic Growth. Thus, any recovery will be lethargic at best; at least for the foreseeable future, until the recapitalization of the banks are resolved.

It is my belief that there are still a lot of banking losses to come. Credit Card Delinquencies and Home Mortgage Defaults are still rising rapidly, even as Home Prices continues to decline. The massive Job Losses, which is expected to persist till mid 2010, do not augur well for Investor Confidence as well.

Even if Investor Confidence is somewhat restored in the future, the market still lacks a very good reason to go out and buy properties. There may be a few occasional bump ups in prices, but the Property Market isn't going anywhere any time soon, when the economy continues to be lethargic at best, and the huge overhang in Property Inventories, coupled with increasing supply due to further Home Mortgage Defaults, with mean a stagnation of prices at best, and possibly, a further depression of prices.

It is obvious that this time around, the Supply of Properties far exceeds Demand. Also, with increasing pressure to sell due to the increasing inability to maintain mortgage installment payments, it is possible, and in fact, likely, in my opinion, that Distress Selling will depress prices significantly from current levels.

Can the US Government Policy Help Alleviate the Crisis of those in Financial Difficulty?

Here, it should be noted that the US Government's policy to help those in financial difficulties and in danger of losing their homes, have been criticized. Whilst everyone can understand why the Government would want to give a helping hand, more and more people are beginning to question whether this is a wise policy.

What is the Alternative? Some argue that perhaps the Government should be giving incentives to those that can afford the properties, to buy, rather than trying to help those that cannot afford it, to persist in keeping what they cannot pay for.

It is always sad to see someone losing their home. However, if one has overstretched one's finances, any Government help to pay a few months' mortgage installments, will not solve the longer term problem of continuing to pay for the next 10 to 20 years. Of course, in some cases, one may be able to tide over the few months, till one can find a job, but let's face it, the Trend is a Negative Sum Game, of even more, and more job losses to come, and for every job created, a number are lost. Thus, this is a losing battle where some question the wisdom to continue fighting.

Rather, if there is sufficient incentives for the Unaffected to buy properties, this may help to create demand, which will at least soften the persistent fall in prices, if not maintain the current level.

From a rational perspective, this makes sense. From an emotional perspective, how can you not help those in trouble? The key question is whether the US Government is throwing good money after a lost cause.

The Impact of Government Spending

The US Government has proposed to spend unprecedented amounts of money, and is expected to incur US$2 trillion in deficit. However, to date, there has been no noticeable traction effect from the Spending.

In a normal economic situation, Government Spending is supposed to result in a Multiplier Effect, i.e. US$1 of Government Spending will generate more than US$1 in economic growth. This is because the money flows from Government hands, into Businesses, which in turn, passes it on to Employees, who spend on Consumption Goods, and this in turn, stimulates job creation and employment income growth.

However, it has been argued that for the US, which has lost its Industrial Might, and is now Services and Consumer Spending Dependent, will require US$4 to generate US$1 of economic growth. If this is true, and so far, it looks like the case, then, it is extremely expensive economic growth; so expensive that some, including myself, would argue that it shouldn't be done.

High Impact Uncertainties of the Future

Nothing is working; at least not the real world stuff. Jobs continue to be lost; credit delinquencies continue to rise, banking loans are not forthcoming, asset prices continue to fall, and businesses continue to fail.

Adding to these woes, are the High Impact Uncertainties of Higher World Interest Rates and Devaluation of the US Dollar. By Uncertainties, I mean that the phenomenon may, or may not happen.

What is the Current Economic Situation?

Right now, we are in the midst of a GREAT RECESSION. Whether this Asset Deflation Environment will deteriorate into a much deeper economic crisis, i.e. an Economic Depression, will depend on whether the economy can recover before Unemployment hits 20%. As is, the official number is 9.5%, but if we take into account those that want to get a job but have given up looking for one, then, the figure is closer to 15%.

Can The Great Recession Worsen into an Economic Depression?

It is not difficult to see how the current Great Recession can turn into something worse. In fact, it is much harder to see a way out of the Unemployment Problem, as the trend of Job Losses is likely to persist in the foreseeable future, albeit, lower levels of losses with each passing month, after the 3rd Quarter.

I could be wrong, but my instincts and business judgment tells me that after the inventory build up, without an equal increase in consumer demand, businesses are bound to reduce their workforce even further. Thus, I expect 3rd Quarter of 2009, to experience significant job losses in the US.

Most people who are sharing their opinions that there will be an economic recovery at the end of 2009, or early 2010, is relying on mathematical economic growth, due to US Government Spending, i.e. one based on the Formula,

GDP = Consumption + Investment + Government Spending + Net Exports

Although Consumption and Investments are falling rapidly, if the Government Spending is large enough, it will increase the GDP, offsetting the fall in the other two areas. This is possible, and some people have called it a Jobless Economic Recovery.

However, Government Spending is not sustainable, if Unemployment persists, at least not, without increasingly higher funding costs to raise money to cover the Excess between Government Income and Expenditure.

In a normal economic recession situation, I would argue that Government Spending may work. However, in the present climate, with the banks languishing from a lack of capital adequacy, it is not likely to work, and job losses will persist.

Thus, it is not only probable but very likely that the current Great Recession will worsen into an Economic Depression.

What About Stagflation? Which is a More Likely Scenario, Depression or Stagflation?

If there is no further action from the US Government, then, I really believe that the US Economy will worsen into an Economic Depression. However, it is also clear that the US Government will do everything in its power (translated into more Government Spending), to bring forth an inflationary environment, rather than a Deflationary Environment, as will be encountered in an Economic Depression.

In an Economic Depression, Asset Prices will not only fall, but actually fall significantly. Why? Because Unemployment would have risen to levels that is extreme economic hardship to the majority of the population. Also, those with money would have lost a large portion of their wealth because they went in and bought assets thinking they were cheap, and the asset prices have deteriorated significantly since then.

At that point in time, most people, including the Rich, are cash strapped. What this means is that the Rich can still be owning quite a number of assets like properties and stocks, but most of these assets would have lost 50% to 80% of their values, and worst, they can't be sold because there are no buyers in this Cash Liquidity Crisis.

This Depression Scenario is not acceptable to the US Government, and it prefers, as far as I can see, to pump prime the economy with more and more Government Spending, at the risk of Inflation, possibly due to US Dollar Devaluation. This will bring forth a different Scenario, i.e. the Stagflation Scenario where Interest Rates and Inflation are high, but the economy is lethargic at best, and recessionary in nature.

However, due to the Inflationary Environment, Asset Prices may not fall as significantly as compared to a Depression Scenario. Nevertheless, in my previous blog article, it has been pointed out that a Stagflation Environment does not necessarily mean that Asset Prices will not fall.

What is worse is that Consumer Inflation will rise significantly, and this will give rise to more hardship for the People.

If this is the case, why should the US Government choose a Stagflation Environment compared to a Depression Environment?

The Lesser of Two Evils - Stagflation or Depression?

In my opinion, Stagflation is worse than a Depression. Why? Because the already hard hit Consumers will have less Purchasing Power for their Dollar. An Inflationary Environment does not necessarily mean that Job Creation will rise. If Job Creation does not rise, while Inflation erodes away at Declining Employment Income, the situation will be a lot worse than if the US Government had not done anything at all.

So why does the US Government persist on this choice?

Because it is trying to stimulate economic growth, in the hope that it can contain the Stagflation Pressures should it rear its ugly head.

We are in a poker game folks. If nothing is done, we are likely to face an Economic Depression. If something is done, it depends on the effectiveness of two subsequent events / activities First, whether the Government Spending will generate some economic growth and create some jobs. If these goals are achieved, then, we are on the way to an economic recovery.

On the other hand, if the current situation persist, i.e. where the Government Spending does not seem to produce any noticeable results, then, the US Government would have spent for nothing, but now face all the downside risks.

The 2nd Event / Activity is the effectiveness of the US Government in reigning in the excessive money supply, when inflationary pressures start to show. Theoretically, this is easy to say, but practically, the potential results to reign in Inflationary Pressures is unconvincing.

If the US Government is not able to reign in the Excessive Money Supply on time, then, a much more painful economic situation will arise, and it would be fair at that point in time to say, with hindsight, that the US Government had gambled big time and erred, and now the people must suffer the consequences.

Should the US Government Gamble for Stagflation?

Despite some opinions to the contrary, the degrees of freedom are limited. Interest Rate is already at 0.25%, and yet, it is not working. US$3.8 trillion is being thrown at the problem, and yet, there is no noticeable result.

It is also obvious that no US President can tell Americans that they just have to grit their teeth and take the pain like a man.

It is one of the greatest economic myths of all time that the public believes a competent Government can manage an economy in such a way, that there is no major economic recession. It is an even greater myth that the public believes that a Government, any Government, however competent, is capable of going against the Forces of Nature, and thus, is able to lead a country quickly out of a major economic recession.

"To be, or not to be, that is the question." If you want to be the US President, you have to show the Americans that you are doing something to alleviate their pain. This is despite the fact that you are human after all.

To be fair to President Obama, no US President would do any less than what he has done. My key issue with his policy is that he may have taken America a bridge too far, i.e. he has spent too much, too early.

I know that he argues that the earlier he spends, the earlier the economy will resume its path of positive growth. However, this is based on the Assumption that Government Spending will stimulate REAL Economic Growth and Create Jobs. Whether this premise is flawed, only time will tell.

In any case, for a Stagflation Environment, I would recommend buying enough shares in key consumer spending areas like Utilities, Transport, Telecommunications, Food & Beverages, to hedge against the increase in prices of consumer goods and services. However, I would maintain most of my Portfolio Capital in Cash Instruments, as the Interest Rate could be quite high.

What about the Hyper Inflation Scenario?

Yes, I have discussed the risks of the Hyper Inflation Scenario a number of times in my blog and email articles.

It is possible that the US Government fails to reign in the Excessive Money Supply when Stagflation Pressures set in. This will lead into a runaway inflation environment, where the US Dollar Devaluation will turn into a severe crisis of mammoth proportions, and then, we will know what it is like to experience Hell on Earth.

However, I believe that the Stagflation Scenario must arise first, before the Hyper Inflation Scenario can set in, and thus, we still have time to prepare and act, when necessary.

The Challenge is that the Hyper Inflation Scenario requires a completely opposite Investment Strategy to the Depression Scenario.

In the Depression Scenario, Cash is King. Hold cash, and earn at high interest rates, whilst enjoying great purchasing power because everything is cheap, due to a nationwide / worldwide cash liquidity squeeze.

On the other hand, in a Hyper Inflation Scenario, cash is the worst thing you can hold. When Purchasing Power is eroding at the rate of 50% per month, it is not enough to earn interest at 30% per annum. The way to hedge against Hyper Inflation is to buy Commodities, possibly in the form of Commodity ETFs (ETCs) or to own Plantation or Mining Stocks.

As you can see, it is very dicey / risky as the current economic situation is so uncertain, that either one of the scenarios, i.e. Depression or Hyper Inflation can happen in the future, and there is no way to ascertain which scenario will become the reality of tomorrow.

Thus, one way to hedge is to keep at least one property where you will stay, should either scenarios happen. In this case, in the event that Hyper Inflation sets in before you can do anything, you are at least hedged against one property.

The Window of Opportunity to hedge against Hyper Inflation will be very small, as it will occur like a Financial Tsunami, without much warning. By the time we realize what is happening, prices would have gone up by 30% to 50%, and then, we would be very hesitant to hedge because we could incur substantial losses should it turn out to be a false alarm.

It is easy to formulate a strategy to hedge, but in reality, the margin of error is so small that a slight mistake in timing could be fatal. Thus, it would be advisable to put on some defensive positions and risk some asset devaluation should the Hyper Inflation Risk rise from hereon.

CONCLUSION

At present, I see the Economic Environment as one of Negative Sum Game, i.e. Asset Deflation, although a continued Bear Market Rally is not only possible but likely in the Medium Term. However, in my opinion, in the Long Term of one or two years, the most likely scenario is an Economic Depression.

Depending on the subsequent action of the US Government and the ultimate impact of persistent massive Government Spending, there is a possibility that a Stagflation Scenario can play out in the later stages of the Depression.

Whether this leads to the Hyper Inflation Scenario will depend very much on the effectiveness of the US Government's efforts to reign in the Stagflationary Pressures when it rears its ugly head. Given that a Government, any Government, is more likely to fail than succeed in such a quest, it would be advisable to be hedged to a certain extent, through one or two properties, and exposure to Commodity ETFs and Commodity Related Stocks, when the Stagflation Scenario is underway.

Should the Hyper Inflation Scenario become a reality, it will be necessary to even borrow money rather than hold cash, to invest in Assets for Hedging, e.g. Physical Silver ETF or Physical Gold ETF.

In the meantime, hang in there. The Year 2009 might not result in such a great relative fund performance as was experienced in the year 2008, but I believe that it is still very much an Asset Deflation Environment, albeit a Prolonged Bear Market Rally before another big economic and financial markets crash.

Can you imagine what would happen if World Interest Rates were to soar significantly in the next two years? If the economy is in such a bad shape when World Interest Rate is so low, the World will be in a very desperate situation in a High Interest Regime. Can you imagine what Asset Prices would look like at that time?

Will this Scenario definitely come true? No. However, there is still time to jump on the bandwagon, should there be positive traction from the US Government Spending, and the US Economy unexpectedly turnaround into a Positive Economic Growth that is sustainable.

After all, if it is sustainable, it will last a few years, and thus, you can't miss a boat that will go on a journey for such a long time. This is why we don't focus much on the Positive Sum Game Scenario. It is the easiest to invest in, and doesn't require that much skill as the rest of the Scenarios, because the investment risk is reduced significantly, as the climate becomes much more predictable and manageable than the period experienced in the last two years. In a Positive Sum Game Scenario, the Warren Buffett Buy & Hold + Dollar Averaging Strategy would work well over the long term.

In the meantime, hang in there. Keep your investment capital safe.

In conclusion, "Not doing anything, is still doing something."

Best wishes,

Ooi