Washington’s Dollar Woes, Gross Examines U.S. Inflation, Oil Really a Bubble?, Second Stimulus Package, and More!

by Addison Wiggin & Ian Mathias

  • “Prop the Dollar Week” in Washington… Bush, Paulson and Bernanke’s mission to save the greenback
  • Bill Gross on the “suspicious” inflation reporting in the U.S…. how proper measures would affect your investments
  • Trade deficit soars to 13-month high… what’s to blame for our $60 billion imbalance
  • Chris Mayer puts speculators’ influence on oil prices in sobering perspective
  • FHA takes giant loss… how the government’s mortgage financer is suddenly facing insolvency
  • Another stimulus package? Which presidential hopeful is calling for a second round o’ rebates

There’s a common cliche: “too little, too late.” Whether this phrase was made for politicians, we don’t know. But they are so freaking good at it:

“A strong dollar is in our nation’s interests,” said President Bush yesterday. The man behind our record government debts and deficits promised to continue “our nation’s commitment to a strong dollar.” You can sleep tight tonight… the White House will be closely “monitoring the situation.”

Hank Paulson added his 2 cents yesterday, saying he, “would never take [monetary] intervention off the table.” In an interview with CNBC, the Treasury secretary hinted that his department is willing to do whatever it takes to prop up the ol’ greenback, including market intrusion.

But of course, that won’t be necessary, as the U.S.’s “long-term fundamentals compare quite favorably with other major industrial nations around the world, and that’s going to be reflected in… the value of our currency.”

Right… long-term fundamentals will soon be reflected in the value of the U.S. dollar. That’s what scares us.

“The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations,” uttered Ben Bernanke, completing the trifecta of Capitol Hill jawboning. Similar to his speeches last week , Bernanke hinted yesterday that inflation is becoming the Fed’s No. 1 concern: “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

Markets reacted quickly to the trio of dollar proppers. In Chicago, bookies and gamblers — ugh, excuse us — futures traders now give 1-in-3 odds that the Fed will raise rates before August. They meet again on June 24-25… we’re not holding our breath.

And currency traders took the bait… The dollar index shot up a full point yesterday. This morning, it’s trading at a one-month high of 73.4. The euro’s down nearly 3 cents from its Monday peak, to $1.55. Same story with the pound, down to $1.95. The yen kept its cool, at 106.

“I’ll tell you an area where we’ve been foolin’ ourselves,” writes Bill Gross in his latest monthly missive, “and that’s the belief that inflation is under control.”

Here’s the cornerstone of Gross’s argument… the averaged inflation rates of 24 global nations versus the U.S. government’s measure of American inflation:

“Looks a mite suspicious,” understates Gross. “Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late ’90s and the U.S. productivity ‘miracle’ may have helped reduce ours a touch, compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors, which should have had an opposite effect, everything else being equal.

“I ask you: Does it make sense that we have a 3-4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized, ‘one price fits all,’ commodity-driven global economy? I suspect not. Somebody’s been foolin’, perhaps foolin’ themselves.

According to Gross, if inflation were measured more accurately, a “readjustment of investor mentality” would push bond, stock and real estate prices down 5-10%.

President Bush’s “strong dollar” policies have garnered the biggest trade deficit in over a year, the Commerce Department announced this morning. In their monthly “trade balance” report, the government reported that trade was… well… rather unbalanced. The April trade deficit widened 7.8%, to $60.9 billion. That’s the biggest gap since March 2007.

Oil imports were largely to blame. The U.S. imported a record $29 billion worth of crude, up $4 billion from last month. Interestingly, the U.S. paid an average price of $96 a barrel in April. We’ll go way out on a limb here and forecast that there’re more crude import records to come.

It’s worth noting that U.S. exports attained a record high of their own. Export sales totaled $155 billion in April, up 3%. Aircraft, farming machinery and medical equipment were the biggest drivers in the latest all-time high.

Oil retreated from record highs yesterday, but remains at $134 a barrel. A good bit of the “pullback” can be attributed to the International Energy Agency… the IEA cut its global demand forecast again yesterday. The global energy watchdog says it still expects demand to increase this year, but by only 0.9%, down from its 1.2% forecast earlier this year.

“I guess traders didn’t bother to read beyond the executive summary,” notes our friend Dave Gonigam. “The IEA cut its supply forecast for non-OPEC countries, too.” Indeed, the report was not as one sided as the market has interpreted… we found this to be the key takeaway in the latest IEA forecast:

“Supply growth so far this year has been poor and higher prices are needed to choke off demand to balance the market… Abnormally high prices are largely explained by fundamentals”.

“I find it remarkable,” opines Chris Mayer, “that so many people seem to refer now to the oil price as being a ‘bubble’ without any reservation. It is as if the oil bubble were a self-evident truth.

“I’m not so sure. A bubble implies that nothing but pure speculation drives the price higher. But it seems to me that plenty of fundamentals underpin a high oil price.” (Two of those fundamentals — U.S. money supply and growing foreign demand — Chris has told you about before… two of our favorite charts .)

“Besides, hedge funds hold about 1.1 billion barrels of oil through futures contracts, according to Goldman Sachs. The world burns through 31 billion barrels per year. Kind of puts the 1.1 billion in perspective, no? In reality, it’s a pretty slender inventory. Maybe people aren’t building up their inventories enough.

“I don’t know where oil is headed. I know we will have gut-wrenching pullbacks. But it seems to be that $100-plus oil is here to stay for at least several years.”

Chris has advised his Special Situations readers pick up a few select oil and gas exploration and production companies. He tells us there are a few lesser-known domestic “E&Ps” with big acreage and even bigger potential for meaningful finds. You can get the details by signing up, here.

Gasoline prices reached another all-time high today. The national average “price at the pump” is up to $4.04 for the cheap stuff.

Grain prices are still on the rise, as well. Corn contracts in Chicago found another record high, $6.73 a bushel, as today’s planting progress report was worse than expected. The U.S. Department of Agriculture said only 60% of the American corn crop is in “good or excellent condition.” Last week, they said 63% was in similar shape; a year ago, 77% was in the same condition.

What’s more, only 77% of the nation’s soybean crop has been planted. This time last year, 92% was in the dirt.

“The U.S.’s ‘strategic grain reserve’ is almost empty, too,” adds Kevin Kerr. “It’s not really a formal ‘strategic reserve’ like the Petroleum Reserve, but it is an indicator of how much grain we have on hand, should we have a major domestic crop failure, such as we are witnessing now.

“According to published reports, there are only 24.1 million bushels of wheat in inventory. With recent sales for humanitarian relief, that leaves only 2.7 million bushels in the entire inventory. To put that number in perspective, it’s about enough wheat to make only half a loaf of bread for every family in the U.S. In addition, the reserve shows there is no cheese, no butter, no dry milk powder, no additional grains. The cupboard is bare, that’s for sure.”

As food and energy costs soar — get this — Washingtonites are already clamoring for a second “stimulus package.” Barack “I’m a free-market guy” Obama said yesterday that Washington should inject another $50 billion into the ailing U.S. economy.

Stunned by Friday’s jobs report, Obama called for the extension of unemployment benefits and another round of stimulus checks. The bill he proposed would add at least another 13 weeks of unemployment benefits to the current 26-week federal cap. The rebate checks, well, he hasn’t figured out how that will work yet… just an idea.


Bush’s influence spreading… in more ways than one

Elsewhere in Washington, the Federal Housing Administration quietly admitted yesterday a $4.6 billion loss. The FHA, the government’s mortgage financer and insurer, is suffering unexpectedly high default rates on home loans. Gasp! Can you believe it?!

The FHA has found its own special way to put its business in jeopardy: the seller-financed down payment mortgage. That’s when the seller covers the buyer’s down payment and then adds the payment to the total price of the loan… an awesome way for people with zero capital and horrible credit to own a home.

Who would have thought these wouldn’t pan out? Not the FHA… seller-financed down payment mortgages account for over 30% of their loan portfolio.

FHA officials announced that it had to extract over $4 billion from its measly $21 billion capital cushion to cover the losses. “No insurance company can sustain that amount of additional costs year after year and still survive,” admitted FHA chief Brian Montgomery. “Unless we take action to mitigate these losses, FHA will soon either have to shut down or rely on appropriations to operate.”

The U.S. stock market is having a hard time digesting all this drama. Traders suffered a volatile day yesterday, and when the dust settled, major indexes were all over the place. The Nasdaq fell 0.6%, the S&P 500 finished unchanged, and the Dow rallied 0.5%.

Investors in China, however, had no such dilemma. The Shanghai Composite plunged 7.7% as we slept last night. Chinese markets were closed the day before, so this morning’s session was the first chance to react to Friday’s bloodbath on Wall Street.

Plus, the Chinese central bank announced it would be raising the required reserve ratio for banks yet again. The People’s Bank of China has moved the RRR 15 times in the last year and a half. That may be a welcome relief for those watching Chinese growth and inflation… but for Shanghai Composite investors, already down 42% this year, it was just another reason to sell.

Other Asian nations felt the pain too… Hong Kong’s market fell 4.2%. Taiwan fell around 2.5%. India, Japan, Indonesia and South Korea all fell over 1%, too.

“Since the beginning of history, it has been very difficult to hold onto your money,” writes a reader. “If members of your own clan didn’t try to take it, then rival clans would, and even if you could defend your wealth from them, you could always trust that your own king or priest or army would come after it.

“The only thing that has changed is that they now use the law to get your money. If you want to keep some of your wealth, in addition to a good lawyer, diversification can help…

“But perhaps I’m just paranoid… growing up, my father used to remind me about how after the civil war (in Nigeria) all the Igbos (the loosing side) who had more than £10 had their bank balances reset to £10 (about $100, adjusting for inflation.) All their shares were confiscated and all their real estate in major cities was classified as ‘abandoned’ and confiscated by the state.

“I’m not saying it would ever happen in America (after all, Americans love the rich and don’t see currency speculators, oil executives and other rich people as their enemies), but I really wonder what percentage of voters own gold and how many of them would care if confiscating people’s gold was sold as ‘a solution’ to inflation and unemployment?”

The 5: Now you’re thinkin’.

Best,

Ian Mathias
The 5 Min. Forecast

P.S. We’ve got our own “solution” for skyrocketing prices: The Agora Financial Reserve. This exclusive group of investors is privy to every investment idea we’ve ever unearthed. Reserve Members get our all-out effort to preserve their wealth… from options trading to value stocks, commodities to tech… everything we have to offer. If you’re interested, we’re now accepting applications for membership: See if you qualify, here.

rspertzel

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