Food Inflation, Pauslon’s New Plan, Gold Forecast, China’s Rare Earth, and More!

Unfortunately, with today’s much ballyhooed announcement, we’re afraid inflation is only going to get worse:

Treasury Secretary Hank Paulson unveiled a 218-page economic reform package equal in scope to the Bush administration’s national intelligence strategy. That legislation brought all of the nation’s 14 intelligence agencies under one office of Homeland Security.

Today, Paulson is suggesting the Federal Reserve should have “the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability.”

Despite its original charter to maintain price stability, the Fed would also be granted the “responsibility and authority to gather appropriate information, disclose information, collaborate with the other regulators on rule writing, and take corrective actions when necessary in the interest of overall financial market stability.”

Paulson also advocated launching a Mortgage Origination Commission to develop standards for the housing industry… he wants the SEC and the Commodity Futures Trading Commission to merge to form one financial community oversight office… and he says the offices of Comptroller of the Currency and Thrift Supervision will merge into an unnamed office whose job it will be to oversee the U.S. dollar. Heh.

We haven’t seen sweeping reforms of this magnitude since the legislation that created the SEC in the first place back in the 1930s. Check this out from today’s WSJ:

Too big to fail? Feds to the rescue

“Housing remains by far the biggest downside risk to our economy,” Mr. Paulson assured his minions at the Treasury. “As we work through this period, our highest priority is limiting its impact on the real economy… We will not seek to implement [the reform proposals] on a pace or in a manner that interferes with our first priority of working through this current period of market difficulty.”

Yeah. So… not only will the federal government be responsible for ensuring price stability, it’ll also remove all risk from the markets too. Not bad for a bunch of hooligans who claim they believe in free markets and a strong dollar. What’s going to happen when the Democrats get ahold of these institutions?

Much of these “reforms,” of course, only confirm in writing what the government has been doing in practice for some time.

“The U.S. Treasury and the Federal Reserve,” counters John Williams, “are effectively broadcasting that they will accept any cost — in terms of money creation and loss of regulatory integrity — in order to save the domestic financial system.

“The alternatives — an imploded financial system, chaos in the citizenry’s daily living, collapse in normal business activity, social and political upheaval — are unthinkable to the powers that be. Unfortunately, their cures will be just as destructive, if not more so, in the slightly longer term.

“The government is only buying some time, which has been traditional practice. Yet the current actions taken to stabilize the financial system have set a course for a [worse] inflation, which eventually will feed upon the U.S. government’s effective long-term insolvency.

“What else could be expected from a system in which the Fed chairman is also the madam of the house of ill repute? Wall Street and most senior politicians have profited heavily from the questionable, but once highly touted business/investing practices that now have turned sour.

“The investing public ignored common sense and fed off the mania hyped in the financial media. Some regulators turned a blind eye to obvious problems. As a result, few in officialdom are in an untainted position to offer honest lectures on the virtue to the bailers or to the crowd being bailed out. Neither the Fed nor the government can afford to become principled at this late date.”

Unfortunately, in the end, it will be you will pay the price… literally.

A footnote: Alphonso Jackson, secretary of Housing and Urban Development, resigned today. You can thank Jackson for his service to the nation… and congratulate him for being one of the regulators who “turned a blind eye.”

The dollar managed to stabilize its plunge over the weekend. The dollar index is now trading tightly at 71. The euro surged again to $1.58.

Consumer inflation in Europe spiked to a record high of 3.5%. That effectively puts the kibosh on an ECB rate cut in the near future. India reported inflation of higher than 6%… Australia more than 4%. Such is life in the twilight of the great dollar standard era — when the paper currency regimes of the world are all in a race to become worthless… ahem, we mean, worth less.

Gold rebounded from its sudden fall on Friday, trading at $940 this morning. But soon after U.S. markets opened, gold fell again, to around $915 as we write. Since its even greater retraction earlier this month, gold has been mostly trading tightly around $900-950.

“My best advice is,” says our friend Doug Casey, “be right and sit tight. And that means staying long until you see a golden bull tearing apart the New York Stock Exchange on the front cover of Newsweek magazine, at which point it will be time to sell.

“Strictly gazing through a crystal ball, I think it’s going over $1,200, no problem. Just to reach its previous high in purchasing power, gold will have to go over $2,500 — probably more like $3,000 after you discount the phoniness in the government’s CPI numbers.

“But because this crisis is much more serious than the one in the late 1970s and early ’80s, and much more far-ranging, $3,000 is actually a fairly conservative number. I’ll say it again: Gold is not just going through the roof, it’s going to the moon.”

Doug uttered those exact words to huge applause at our Vancouver Investment Symposium last July. Gold, at the time, was trading at $680. Given current events, you won’t want to miss Mr. Casey this year as he joins the independent investment world’s most audacious thinkers in Vancouver, July 21-25… details here.

And while we’ve got you thinking about buying gold, keep this in mind: Friday marked the 75th anniversary of FDR’s executive order to nationalize all gold holdings in the United States.

Operating under the authority of a “War Time Powers Act,” Roosevelt illegalized gold ownership and confiscated all privately held bullion “to provide relief in the existing national emergency in banking, and for other purposes.”

U.S. stock markets suffered more losses on Friday, as the Dow and S&P fell about 0.7%. The Nasdaq fared a mite worse, down 0.8%. After today’s trading, we’ll bid bon voyage to a tumultuous first quarter.

Look for a recap of the bloody start to 2008 tomorrow. Here’s a taste:

Global investors yanked $100 billion out of hedge funds in the first quarter of 2008 — the biggest quarterly outflow in the history of the hedge fund business.

For perspective, by this time last year, hedge funds had added $19 billion to their frothy pools. In 2006, they pulled in $49 billion in the first quarter. These stats all come courtesy of Emerging Portfolio Fund Research.

Meanwhile, sovereign wealth funds (SWFs) grew a staggering 18% in 2007, to $3.3 trillion. The firm International Fund Services attributed this impressive growth amid dodgy market conditions to surging commodity prices.

Coupled with the Morgan Stanley report we cited earlier this month, researchers estimate SWFs will control $10-12 trillion by 2015 — a sum equivalent the entire annual GDP of China.

Oil traded back down to $101 today. Consumer consumption slowed for the seventh straight week last week.

“China currently produces nearly 95% of the world’s supply of rare earths,” writes Byron King, exhaustively covering the resource beat and alerting us to another area of immense global competition.

“Rare earths, scientifically known as lanthanides, comprise 15 different basic elements — the kind that even veteran hard asset investors have never heard of: neodymium, cerium and lanthanum, for example. They help make all sorts of things… batteries, X-ray film, lasers, televisions, hard disk drives, magnets and a slew of other things.

“Without the rare earth lanthanum, the global petroleum refining industry would need 10% more crude oil to produce the same amount of finished product. Imagine that.

“China’s dominance of rare earth output gives that nation an overwhelming advantage in developing many forms of technology. The Chinese clearly understand the strategic value of rare earths, and they have begun to take advantage of the situation. They now control much of the research and development work going on.”

But they don’t control everything. In Energy & Scarcity Investor, Byron recently recommended an Australian rare earth play with “remarkable potential going forward.” If you’re interested in mining this deep, subscribe to ESI here.

“KPMG’s pockets are not as deep as you state,” writes a reader in reference to our warning on Friday. “KPMG is an LLP entity and is set up as an affiliation of member firms at the country level (in effect, independent accounting firms licensed to use the KPMG name and methodology). So if one practice were to fall, the rest are legally distinct and separate. Only the U.S. firm has liability here. The 123,000 employees you cite are all member firms combined.

“The Americas region (U.S. plus North and South America) generates a paltry $6.59 billion in revenue, the U.S. being the bulk of it. All Americas firms combined amount to less than one-third of the total, at 35,500 employees.”

The 5 responds: We stand corrected. KPMG still makes a nice target for class action lawyers on the prowl.

Thanks for reading,

Addison Wiggin
The 5 Min. Forecast

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