Finance Digest for Week of July 2, 2007

FIRST-HALF GLOBAL LIQUIDITY WATCH

Runaway global Credit and liquidity excesses fuelled major global equities indexes to solid – and in some cases spectacular – first-half gains. The German DAX surged 21.4%, France’s CAC40 9.3%, Britain’s FTSE 6.2%, and the Swiss Market Index 4.8%. The Nikkei rose 5.3% and Hong Kong’s Hang Seng jumped 9.1%. Here at home, the Dow Jones Industrials gained 7.6%, the S&P 500 6.0%, the S&P 400 Mid-Cap index 11.3%, the Russell 2000 5.8%, and the NASDAQ100 10.1%.

The emerging markets boom hardly missed a beat throughout the first half. China’s Shanghai Composite index jumped 42.8%, South Korea’s Kospi 21.6%, Taiwan’s Taiex index 13.5%, Brazil Bovespa 22%, Mexico’s Bolsa 17%, and Chile’s Stock Market Select index 29%. Winners in European emerging equities indices included Prague’s major index up 17.0%, Budapest up 16.4%, Poland’s WIG20 14.4%, and Istanbul’s XU100 index 20.4%. Most markets in the Middle East and Africa also posted strong gains. Global (non-U.S.) real estate and art inflation were in full force.

As for global securities issuance and M&A – the fuel for the equities Bubble – the first half was one for the record book. Record total global debt market issuance of $3.7 trillion was up 11% from comparable 2006. Leveraged loans and junk bonds rose to almost a third of total corporate issuance. Announced global M&A jumped 50% to $2.78 trillion. It was certainly a case of global financial players working overtime to reap once-in-a-lifetime bounties, in the process ensuring future financial crisis.

The liquidity theme for most of the first half was one of unprecedented global M&A activity financed by increasingly complex and risky debt structures, all made possible by even more astounding financial sector leveraging. Looking back, February’s subprime implosion provided only a brief setback (respite) for a desperately overheated global credit and speculation infrastructure. The global M&A and securities leveraging booms had already attained critical mass, while Wall Street and the leveraged speculating community had some time back achieved a full head of steam.

Yet late-June’s hedge fund and CDO problems appear more all-encompassing and ominous. February was about U.S. subprime mortgages, while the issue gravitated toward the heart of “contemporary finance” as the second quarter winded down. The story of the historic first half concludes with serious questions with respect to the sustainability of global credit bubble excess. It has “inflection point” written all over it.

Inflating Wall Street balance sheets have directly and, by financing clients, indirectly played a major role in financing the M&A boom. To what degree the leveraged strategies we have seen turn problematic in subprime have been used to lever up corporate credits will be a crucial issue going forward. Importantly, the CDO marketplace is now under the microscope and will likely be so for some time to come.

It is rather ironic that this so-called “golden age of capitalism” has increasingly been financed by obscure “marketable” credit instruments and derivatives that only rarely trade in the marketplace. Moreover, in a marketable securities-based credit system where gains on securities holdings have come to play such a prominent role, there has been a major shift to instruments, structures and strategies specifically to avoid “marking” to actual market prices (in case those prices actually do decline). Or, from another angle, the CDO market represents some of the potentially weakest debt structures imaginable: lend in gross excess to the weakest credits, bundle them in esoteric structures, have these structures be illiquid and difficult to price, sell them for the purpose of speculation/“credit arbitrage”, and then have highly leveraged securities firms financing the speculators enormous leverage.

It is not by happenstance that risk intermediation practices have turned increasingly to gimmicks, obfuscation and worse. By their very nature, credit booms demand progressively more challenging risk “intermediation”. The current global credit bubble requires the transformation of unprecedented amounts of risk into “top-rated” securities. Over the past couple of years, the now arduous intermediation process forced all the major players – investment bankers, rating agencies, leveraged speculators, derivative players, banks, and regulators/policymakers – to push the envelope.

It was really not that difficult back in February for the bulls to proclaim that mortgage problems were isolated to subprime. This will simply no longer suffice, not now that attention has been focused on CDOs, liquidity, pricing, leveraging and unrecognized risks. Is subprime risk in CDOs the proverbial “tip of the iceberg?” Of course it is. The CDO market is the tip of a derivatives iceberg when it comes to risk obfuscation and market pricing issues. Arcane instruments, lack of transparency, and tainted markets can (and did) remain non-issues for quite some time. Yet the longer the period of chicanery the more abruptly greed will inevitably succumb to fear. Today, markets are turning fearful. They are fearful of the quality of assets supporting the massive securitization marketplace, of mispricing, of leverage and liquidity, and – importantly – they are fearful of the ramifications of any meaningful movement away from risk assets. All the fears are justified.

Subprime imploded specifically because of “Ponzi Finance” dynamics. As long as credit was readily available, individuals could borrow and/or refinance to a more accommodating mortgage. But the day the music stops is the day credit losses begin to explode. And when it comes to runaway credit booms, subprime was no anomaly. The perpetuation of the subprime boom was the (only) means for an overheated credit system to finance the marginal borrower – in order to sustain the housing/mortgage finance bubbles. Enormous festering risks were well-concealed by the illusion of perpetually rising asset prices and limitless market liquidity.

I will not attempt to make the case that the global M&A Bubble is (quite) as acutely vulnerable to “Ponzi” dynamics as subprime. But we do know that a proliferation of deals has created a current pipeline of hundreds of $billions of risky corporate loans that will need to be sold into an increasingly risk-challenged marketplace. Additionally, the M&A boom has been instrumental in inflating global equities markets, both by bidding up prices and fostering general liquidity and speculative excess. A reversal of these dynamics is now a distinct possibility. A serious market liquidity problem will commence with any move by the leveraged speculators to aggressively hedge risk and/or place bearish bets.

In “Ponzi” fashion, problems getting debt sold would pierce a susceptible M&A bubble, likely initiating a powerfully recursive cycle of declining equity prices, speculator angst, further debt market stress and the specter of deleveraging. And while the corporate debt bubble may not be “subprime”, there are certainly scores of less than prime borrowers, dangerous speculative dynamics, and latent credit losses vulnerable to any tightening of the credit and liquidity landscape.

Returning briefly to the “distinct irony of the 21st-century financial world ... and the epitome of modern capitalism,” I can comfortably state that capitalism has never generated such a seductively contemptible boom, one financed by a credit system so captivatingly free-market challenged. Global central bank reserves will soon surpass $5.5 trillion. Fannie and Freddie’s combined “books of business” today exceed $4.1 trillion. Untold $trillions of leveraged securities holdings have evolved specifically because the Federal Reserve (and global central bankers) “pegs” short-term interest rates, promises advanced warning of any rate increases, and basically guarantees that markets will remain liquid. Too many guarantees and promises are to blame for securitization and derivatives markets thoroughly perverting global risk markets.

How anyone really could have expected such a system to effectively regulate credit, price risk, and allocate resources is beyond me. Subprime CDOs – yes, the tip of the iceberg. And today’s surging oil prices, widening credit spreads and weak dollar would not appear to portend bullishness. It is official, we are now on Second-Half Liquidity Problem Watch.

ONLY ONE WORD FOR SUBPRIME MESS

It has been several months since the subprime mortgage market started hitting the skids. Whenever the mortgage drama takes a new turn — like a hedge fund blowing up at Bear Stearns, as occurred in late June – some high-level official is rolled out to calm investors. The trouble is, they all seem to have the same scriptwriter. In March, for example, Henry M. Paulson Jr., the Treasury secretary, said the subprime mess was “largely contained.” In April, Richard W. Fisher, president of the Federal Reserve Bank of Dallas, called the situation “mostly contained.” Ben S. Bernanke, the chairman of the Federal Reserve Board, has also used the word to describe the subprime problem.

Now the private sector is weighing in. At a conference in London last week, Timothy Bitsberger, treasurer of Freddie Mac, the home loan financier, called subprime woes “severe, but contained.” Not to be outdone, E. Stanley O’Neal, C.E.O. of Merrill Lynch, said at the same conference that the slump was “reasonably well contained.”

Containment certainly seems to be the consensus. Only question is, how big a container?

The CDO’S Flying Circus

“Merrill Lynch & Co. on Wednesday sold only $100 million of $850 million of highly rated collateral assets it auctioned after seizing them back from the Bear Stearns funds, said a person familiar with the auction. Details about Merrill’s auction and efforts by Bear Stearns to offer $2 billion of CDOs were not immediately clear as possible buyers determine how to value the complex CDOs. Some fund managers speculated the failure to sell the assets as intended indicated the dealers were largely disappointed with what they saw.” ~~ Reuters, June 21, 2007

“Lehman and Credit Suisse held auctions of this collateral before the bailout, and insiders claimed the former sold the assets for half their face value, a development with huge consequences for Wall Street and the stability of the global financial system if true. The pricing is crucial because US financial regulations require banks and hedge funds to value CDOs on their books at market price, but, because of the illiquid nature of the instruments, they usually retain them at the purchase price. ... if Lehman achieved such a low price for the CDOs, it could precipitate a major revaluation of the sector that may, domino-like, devastate related markets. Last week, Merrill Lynch attempted to auction CDOs worth $850m; some traders claim it managed to sell about $100m. No prices were revealed.” ~~ A bet that went wrong, Helen Dunne, The Business, June 30, 2007

“... a lot of hedge funds are now trembling – and I don’t mean because Congress wants to raise the tax rate on general partners’ carried interest. The big hedge fund secret is that, barring credit downgrades, many leveraged and esoteric investments (such as the collateralized debt obligations that inhabited the Bear Stearns hedge fund) aren’t marked to market.” ~~ Hedge funds’ dirty little secret, Doug Kass, TheStreet.com, June 28, 2007

Thanks to lots of discretion in all the right places, the Bear Stearns hedge fund blow up has yet to trigger a financial debacle worthy of a Shakespearean tragedy. With lenders to Bear Stearns’ hedge funds pacified, if not satisfied, and CDO values still under wraps, the event unfolded more like a Monty Python skit ...

A FALSE SENSE OF SECURITY? YOU MUST OWN A HOME

The wonderful world of leverage has lifted homeownership to near-record levels, and we thump our chests with pride at the prosperity and middle-class life that possessing a home implies. Hovering in the background, however, is a glaring statistic: Never before have homeowners actually had such a small ownership stake in the houses they occupy.

The reason is debt. Home prices have gone up a lot, but borrowing against homes has gone up even more in almost all of the last 20 years. “Owners’ equity”, as the Federal Reserve calls the difference, is gradually eroding – a detail that millions of families ignore, focusing instead, perversely, on the rising dollar value of their homes. “People believe their homes will continue to appreciate in value,” said Mark Zandi, chief economist of Moody’s Economy.com, “so that even if they take out money and reduce their equity, it will all come back very quickly.”

When they sell, most still pocket a tidy sum after paying off their loans. But millions of middle-income families do not sell. They take out another loan, which they often spend, surveys show. And then, as the margin of potential profit – aka owners’ equity – shrinks, it becomes a little harder for a family to weather an unexpected hardship, such as an illness, a layoff, a wage cut or a forced early retirement. There is less market value to borrow against in the event of such setbacks and less cash from a forced sale, particularly if the sale comes as home prices are falling, squeezing owners’ equity from the other end.

Just such a squeeze appears to be under way as home prices level off and begin to drop. The stake that families have in their homes fell faster in the 12 months through March than at any time since the early 1990s, the Fed reports. At the end of the first quarter, the nation’s homeowners owned, free of debt, only 52.7% of their dwellings, down from 54.1% a year earlier and 57.5% at the start of the century. The decline occurred even though owners’ equity, measured in dollars, rose by an astonishing $4.3 trillion since 2000. Unfortunately, mortgage debt rose by $5 trillion.

“Basically people are gradually consuming their capital,” said Edward N. Wolff, an economist at New York University who studies household wealth. “It makes the middle class in particular more vulnerable. Their homes are still their biggest saving, and that is the bottom line.” Even now, the illusion of rising equity obscures its erosion. For a family with a $50,000 mortgage and a house valued at $100,000, for example, the owner’s equity is 50 percent.

Even if prices continue to fall, homeowners are likely to cut their borrowing only slowly and reluctantly, if the last year’s behavior is a guide. Using one’s home as an A.T.M., as economists like to say, has become so easy since the 1980s that it is hard to kick the habit. The tax code has played its own special role in all of this. Congress changed the law in 1986, allowing individuals to deduct on their tax returns only those interest payments on loans tied to housing. Interest on other loans no longer qualified. With that big change, borrowing against one’s home to buy a car or an appliance or clothing or a vacation became cheaper, after taxes, than standard consumer credit.

Subprime borrowers are too few to be the major reason for the nationwide decline in owners’ equity. That honor, Mr. Wolff says, goes to a vast number of middle-class families with incomes of up to $150,000 a year and net worth of up to roughly $420,000. The culture of “own your home free of debt as soon as possible” had endured for decades. Through the 1960s and ‘70s, owners’ equity ranged from 65 to 70%. As recently as 1983, some 52% of American homeowners who were 55 to 65 years old owned their homes without any mortgage debt – allowing them to be free of monthly installment payments during their retirement years. By 2004, however, that percentage had dropped to 36%.

The first sharp decline in owners’ equity came in 1990 as home prices dropped while borrowing held strong. The decline then continued, despite the housing boom, although at a slower pace. And then last year, another steep drop in equity kicked in, as home prices weakened but owners kept up their borrowing.

“You might end up without enough pension income to pay off your mortgage, or enough equity to draw on if health costs get out of hand,” said Conrad Egan, president of the National Housing Conference. “But people seem to be saying, “O.K., I’m willing to live in that kind of environment.’”

MIDDLE OF THE ROAD FINANCIAL WOES

We all know that the subprime problem is “contained”. Hank Paulson and Ben Bernanke have both said so. You can contain something while it is still small, localized and manageable. You cannot contain it when it has spread everywhere. It is already too late. In a speech at the Mansion House last month, Mervyn King, governor of the Bank of England, was considerably less sanguine than his American counterparts: “Excessive leverage is the common theme of many financial crises in the past. Are we really so much cleverer than the financiers of the past?” he asked.

The short answer to that question is, of course, no. Subprime mortgages represent a substantial portion of the entire mortgage market. But it is not just the subprime part that poses a threat. The real problem is that American homeowners have too little money. Why do they have too little money? Because they have spent too much. And where did they get too much money to spend? From the equity in their houses.

In the last six years, America’s middle class has run down its balance sheet in a remarkable way. Never before have homeowners owned so little of their own homes. In the ‘60s, homeowners barely mortgaged 30% of the value of their homes. Today, that figure is close to 50%. And it has happened while house prices rose at the fastest pace in at least 80 years. Thanks to rising prices, owners’ equity increased $4.37 trillion since the beginning of this century. But, in a prodigious feat of borrowing, mortgage debt increased even more – $5 trillion.

But now, house prices are falling. The median price of a new home dropped 11% in April from the previous month, to $229,100, the biggest decline since 1970. Homeowners are taking a hit, and these are not just people who live in trailers and watch daytime television. No, they are us! Well, not necessarily us, exactly ... but they are most people.

The rich can lose money in the stock market and no one will particularly care. There are too few of them. The poor, and their problems, will always be with us, but they affect only a miniscule part of the financial system. The problems of the rich and poor can both be “contained”. But middle class troubles are troubles for the whole financial system. And the whole economy.

The rich save money in bonds, art and investment property. The poor save no money at all. But the middle class saves money in its own houses and uses the “savings” (equity) when they are needed – for education, health emergencies, unemployment, and retirement. After a long spree of borrowing and spending, many middle class families have little savings left. And if house prices continue falling, even that sliver of owner’s equity will disappear. In the next downturn, the middle class will be wrung out like a wet mop.

“The housing crisis is different than other crises of the past. In the 1989 crisis, fewer people owned real estate,” writes The Survival Report’s Mish Shedlock. “In the 2000 tech bust, not everybody owned tech stocks. But in both cases, the impact was far reaching. What does that mean now, when most Americans own property AND a mortgage, alongside their stock portfolios? What does it mean when so many of the new jobs in America – as many as 43%, – came from the housing industry?

“Tighter spending. Lost jobs. Troubles for retail, restaurants, car dealers, advertising companies, jewelers, remodeling contractors, furniture manufacturers, banks, electronic retailers, and more. It’s like a virus – it can’t help but spread.”

Then Middle America will be on the same footing as the subprime market today. And the subprime problem will be everybody’s problem.

THE LAST GREAT SOUTHERN CALIFORNIA HOUSING SLUMP

In a series of articles earlier this year, I talked about what living in a housing mania and related bubble was like, but I did not include many details about how living in a market spiraling downwards will psychologically affect the players. As I write this, foreclosure graphs for many areas of the U.S. show rocket-like trajectories. Yet many still insist on calling this a “healthy” cycle correction.

According to some monthly data providers, median prices in Los Angeles County are still chugging upward, despite the steep drop in sales volume evident for over a year. So will prices stay levitated? If not, what will the market participants say and do as the slump progresses? The last time L.A. and much of Southern California experienced a housing downturn that came anywhere near being described as “ugly” started about 1988, and for the most part was a memory by late 1997. A review of local newspaper archives can tell us much, but only if the content is examined with socionomic eyes.

Social mood is endogenously created, but what I read in the archives of the Los Angeles Times blamed many exogenous factors on the housing market downturn. Social mood drives what gets press, and that was the case from 1988 and beyond.

If the media felt bearish about the housing market, then it printed hard-luck housing related stories whether or not they were market related. Fears of job loss (a valid concern), riots, every twist and bump in interest rates, destructive wildfires, earthquakes, and other problems were all “reasons why” the downturn was prolonged. But California has experienced troubling phenomena during housing booms. So it is not natural disasters or riots that trigger booms or slumps. It is the prevailing social mood of the people experiencing them and how they react to them that shape the trend.

Now, let us go back in time and peruse the newspaper archives. You will feel like you are reading Dr. Jekyll and Mr. Hyde. And, if you have been observing the market at all, you will be struck by how much the past is like the present, and you will see that the archives may well serve as a roadmap for what we can expect in the future.

RANDOM WALKING HAND IN HAND

The global equity market surge is nearly four years old. Despite short, sharp swoons in the spring/summer of 2006 and February 2007, the trend is clear. Since 2003 global indexes have surged. Emerging markets – represented by Morgan Stanley Capital International – in Asia, Latin America and Eastern Europe have moved upward in very tight correlation. The S&P 500, Nikkei 225 and Dow Jones Euro Stoxx have moved similarly and in lock step. The last 3-4 years have seen a world wide spike above trend. Markets have been “randomly” walking hand in hand. This reminds us of the recent global run-up in real estate prices. However, the correlation is much greater and price movements are far more rapid.

The last 3-4 years have also been marked by consistently loose credit standards and massive credit and monetary aggregate growth. Steady and low inflation has spread far and wide. Growth has been above trend with no emerging market region performing below 5% in 2006. In the period 2005-2006 the emerging market average GDP growth rate was 7% in constant 2000 Dollars. Across the period 1960-2000 the average growth rate was 4.75%. Emerging market bond spreads have declined by 60% percent measured against the 10 year U.S. Treasury. Basic commodity prices have moved up and stayed elevated. These have been great times for growth and even better times to be invested in emerging markets. Returns in established markets have been Europe led but, strong in the U.S. and Japan. Nearly everyone has been in grand equity price expansion mode.

Our interest centers on the high correlation and the drivers of recent events. We are concerned about correlation as it suggests potential for unusual risk as equity markets eventually return to earth. The drivers are clearly global. To position for rougher sailing in the right direction and the inevitable downdrafts, a basic understanding of the recent global run is required. Past experience has starkly taught that unusual asset prices correlation can cause real trouble when rising tides turn into receding waters. The LTCM saga, e.g., serves as reminder that unusually correlation can carve a swath of destruction through the best of models and assumptions.

To what do so many owe their expanding fortunes? What are the new correlated vulnerabilities taking shape alongside the recent shared run-up? Financial deregulation and integration, exemplified by the merger wave in exchanges and financial firms, is a powerful driver. Capital is far freer to roam in search of returns – or to stay home. Not since the years before WWI, have international capital markets been so wide open. Technological and communication revolutions make the new freedoms far more rapidly actionable. This allows massively greater flows and centralization into larger funds. Sovereign wealth funds have swollen to over $2.5 trillion along side massive pension, insurance, mutual, hedge and private equity funds. Massive asset portfolios and newfound opportunities for leverage and movement buoy spirits and convince leading participants that they are the new masters of the universe. This attitude drips from the actions and speeches of finance personas in London, New York and beyond.

The last decade is defined by large upward redistributions of wealth. The industrialized world, led by the UK and U.S., has seen rising income and wealth accrue to top deciles and percentiles. These are the folks who buy stocks and bonds, allocate to hedge and private equity funds. The more of a growing pie they get, the more they spend on assets. Top marginal tax rates have fallen and capital controls have been removed. Capital gains taxes have been cut and myriad ways around taxation have been found. The shares of national products going to corporate profits are around or above historic record highs. The sheer wealth going to leading institutional and individual asset buyers is flabbergasting. Labor has fared less well.

Money has been super abundant. Central banks have created vast quantities of cash. This cash sloshes around the world. America runs massive deficits with oil and East Asian exporters. We globalize our easy monetary policy as vast export earnings for others. Hundreds of billions of this money enters exporter economies increasing credit and purchasing power. Much ends up in official reserves. Not coincidentally, foreign currency reserves have exploded since 2003. As flows rise, upward pressure is put on asset prices and correlation increases. The same loose credit and low rates driving American consumption steer Chinese investment, Sovereign Wealth Fund placement and world equity markets. Each round of effects acts like one in a line of falling dominoes. Every step sets in motion the next.

High corporate earnings, loose and abundant credit and upward redistribution create bullish conditions for global equities and bonds. Share buy backs have become a juggernaut. As funds, investors and bullish attitudes target foreign companies, share prices rise in tandem. This creates another virtuous cycle. Returns attract inflows to funds that can and do undertake bigger purchases. This generates greater returns that attract more funds, and so it goes. Until, of course, the music stops and some are left dancing.

Private equity has been involved in approximately 50% of merger and acquisition activity in 2007. Concluded deals sum to $406 billion year to date. Buybacks and buyouts require huge stockpiles of cash and cheap credit. The individuals and institutions involved are flush from redistribution. Huge amounts of capital are available. Hopes run high and credit awaits the asking. Regulations are few, global deals are possible and paydays are enormous. Buybacks and private equity buyouts push up share prices and remove shares from markets. This increases demand and lowers supply in the same action. Buyouts and buybacks send flush investors with enlarged holdings into other assets. Activity spills quickly and easily across deregulated markets dominated by multinational firms.

The above factors have combined to move assets into closer correlation. This calls the potency of international diversification into question. The recent uptrend has been wonderfully broad. Many have gleaned impressive returns chasing emerging market assets and buyout/buyback targets. This creates the possibility that the necessary follow on correction will be similarly unusually in correlation and breadth. We would expect a downdraft to be differential in its impact – as the updraft has been. However, would also now expect it to be anomalously correlated by historical standards.

We advise keeping an eye on sovereign bond interest rates differentials, the rate and size of private equity deals, and emerging market equity performance. U.S. housing and asset backed securities are already post boom. We believe that credit conditions will prove more difficult moving forward. The challenge now is to understand and move ahead of a possible correlated, international correction. The likelihood of such an event seems to be growing by the day. We expect some major trouble when our unusually correlated markets fall together.

WORLD’S TOP “MONEY COPS” SET OUT TO BUST CURRENCY MANIPULATORS

Thereby creating an opportunity for forex traders.

I believe China is doing everything it can to keep its currency cheap – despite protests from U.S. politicians. In fact, the politicos in Congress are tired of waiting for the Bush Administration to act. These anxious politicians want to force them to act with new legislation that could alter our foreign exchange policy. Under pressure from the U.S. and others, now the International Monetary Fund (IMF) is jumping into the fray. It could get very interesting as the players get serious about forcing China to act on its artificially weak currency.

The IMF is now set to significantly hike up its exchange rate enforcement efforts. Their obvious goal is to force China to revalue its currency. Everyone involved is hoping this will eventually lead to rebalancing the huge U.S. trade deficit and the massive pool of excess reserves held in Asia. All the gripes and groans about a pathetic yen, or stagnant yuan, might finally be heard.

Addressing overvalued or undervalued currencies has become a touchy subject recently. The countries facing the harshest criticism are the ones that appear to be “manipulating” their currency, using it to boost a positive balance of trade. It is tough to predict exactly what impact this will have on current exchange rate policies. It is even tougher to predict how long such changes will take to inundate global economies. Still, this event is important for both currency traders and regular investors. Here is why.

I personally expect IMF intervention will simmer in traders’ minds for a while before noticeable exchange rate shifts occur. Uncertainty will set in and a more volatile market environment will ensue. Volatility implies uncertainty in the minds of traders and investors. Uncertainty stems from the realization of risk. For longer than I care to recall, risk has been out sick with the flu. It is nowhere to be found in the global markets. Not in any market, not anywhere. Consequently, the amount of money floating around the global financial systems seems to accumulate without end. Not until a true sense of risk finally reemerges will this flood of liquidity finally drain away.

I do not think the markets will be fully ready when the event occurs and risk really finds its groove. But regardless of whether the markets have any clue about what could happen, it is important to be prepared.

Only one bad trade away from another crisis ... and crisis = opportunity.

It is not just me who is thinking about forex volatility. “We are only one bad currency trade away from another Asian financial crisis,” says Nouriel Roubini, expert on the past Asian Financial Crisis. Nouriel says the huge external forex reserve positions and managed currency systems of most of the Asian-block currencies, especially China, is dangerous to the global financial system.

I am not sure how this movie ends, but it will be very interesting to watch it play out now that IMF has entered the picture. At the least, I expect a significant hike up exchange rate volatility during the second half of 2007. This should create some excellent trading opportunities for us.

GOING GREEN WITH SALTWATER

A new method to separate hydrogen and oxygen atoms in water has been discovered by Ohio inventor John Kanzius. This video has been making the rounds, but most who have seen it are skeptics. I think it is worth a look.

Separating hydrogen and oxygen from water economically has been one of the holy grails of energy production for a long time. Such separation has long been achieved, but unfortunately, not in an economical manner. Let is see how this new method does.

How did John Kanzius stumble on his invention? Interestingly enough, he was seeking to cure cancer. His idea was to use radio waves to heat certain metals, like gold. Nano-particles of gold would be injected into cancer patients, and those particles would be attracted to cancerous cells. Next, radio waves would heat those particles and kill only the cancer cells. He did not discover a cure for cancer (not yet, anyway), but he did discover that his radio frequency generator could burn salt water. There are obvious implications, such as powering turbines or engines now running on gasoline, if his solution could work on a scalable basis.

So far, his method fails, as the article “Fire From Salt Water” shows. The old problem was generating electricity cheaply enough to make the process energy efficient. The new problem seems to be inability to produce radio waves cheaply enough to make the process practical for large-scale applications. Can this possibly work in theory? There are tons of Internet articles out there claiming it is impossible. The one common theme in most of them is the idea that Kanzius claims to have invented a perpetual motion device. Burn water (or, rather, oxygen and hydrogen separated by his device) to achieve energy. What do you get when you burn oxygen and hydrogen? Water.

As I see it, he is using radio waves to heat up sodium ions hot enough to cause the hydrogen and oxygen in water to separate. Stop the radio waves and the process stops. That is far from perpetual motion. Can it possibly be that some magic frequency causes salt water to turn into hydrogen and oxygen, producing more energy than it took to generate the microwaves? I am not a physicist, so I simply do not know. But I am convinced that this is both a new method and not a hoax. Proof that it is not a hoax are the patents given to the process. As best as I know, not a single patent has ever been erroneously given to the maker of a perpetual motion device. But that does not mean this process has any practical application unless the process is efficient enough.

The good old formula E=MC² tells us that there is more than enough energy in the universe for us to exploit. All we have to invent are the technologies that can achieve efficient conversion. I cannot say if Kanzius has achieved practical application success or not, but I am willing to say that this is not an outright hoax. I am also willing to suggest that practical application could be theoretically possible. Any physicists out there can feel free to chime in.

For those who think I am perpetually gloomy, I hope this article proves otherwise. I firmly believe that the free market, if left alone, will eventually solve the energy crisis, and most other problems as well. (Now can we please let the free market handle things?!) Running a car on salt water may be impractical (or not), but running turbines to generate electricity is another matter. Regardless of practical application, we can all admire the spirit of John Kanzius. Everyone but the oil companies and oil exporters can wish him the best of luck in solving this problem.

THE GLOBALIZATION OF AFRICA

“We’re going to become the first African tiger” said Ghana’s President John Kufuor when hearing that a British-U.S. consortium had struck oil. Is that realistic, or is Africa a permanent basket case? And if it is realistic, what would such a development mean for the rest of us?

Ghana, while very poor at an average GDP per capita at purchasing power parity of $2,700, is not particularly corrupt, according to Transparency International, ranking equal 70th on its 2006 Corruption Perception Index, the same level as both China and India, coincidentally. That suggests that corruption may be something of a drag to growth, but cannot possibly be a bar to it. In the Heritage Foundation’s Index of Economic Freedom, Ghana scored relatively poorly at 91st, but is still above both China and India. Economic freedom by the Heritage Foundation definition may be a fairly poor proxy for policies that actually produce growth, but nevertheless that ranking must mean something. In terms of actual economic performance, Ghana had economic growth of 6% in 2006, with inflation around 10%. That was helped somewhat by high food and commodity prices, but prior to the current oil strike Ghana has been a substantial net importer of oil, for example.

Thus Ghana appears well placed to enjoy an economic takeoff, if such a takeoff can be achieved by any African country. Other than possible cultural barriers to a free market society, Ghana’s population growth of almost 2% per annum is the main problem. High population growth hinders economic takeoff because an educated population only becomes fully productive at an average age of 18-20 (the less educated entering the workforce first.) Meanwhile it needs feeding, housing and educating, all of which and the attendant infrastructure impose a huge burden on the economy without any corresponding benefit. Essentially children are a capital investment that does not pay off for two decades. It is not just a coincidence that China only emerged into rapid economic growth after the “one child policy” had been instituted in 1979.

As China showed in the 1980s, India has demonstrated since 1991 and Vietnam has further made apparent since 2000, a “takeoff into rapid economic growth” does not happen at once, with growth rates suddenly shifting to double digits. Instead, a period of economic liberalization accompanied by a reduction in corruption is accompanied by a gradual improvement in the previous growth rate, to perhaps 5-6% per annum, which if population growth is below 2% should give close to a 4% annual improvement in living standards. That appears to be sufficient for the electorate to wish to keep liberalizing policies in place, but it also provides a temptation to the political class, which may react to increased wealth by deciding that the “crisis” is over and so corruption and rent-seeking policies can be restored. Thus the initial period of moderate growth is not necessarily followed by acceleration into rapid growth.

In Bangladesh and Pakistan, for example, no transition into rapid growth has ever occurred and in Brazil the rapid growth of the late-1960s to mid-1970s proved temporary as the transition from military rule to democracy proved a transition to renewed statism, corruption and rent seeking. In India a period of reform after 1991 was succeeded by stasis in the mid-1990s as the corrupt socialists of the Congress party decided that reform had gone far enough. Fortunately in this case reform had been carried out by a center-left government, so an opposition was available that was more committed to reform, which came to power in 1998. Further reform followed rapidly, and after a couple of years delay the economy followed suit, rising to levels of growth not seen before. Unexpectedly, the losers from the initial phase of reform were able to vote out the reformist government in 2004, but the new Congress government appears sufficiently committed to the free market to prevent more than modest backsliding.

In Ghana, the current government appears pretty committed to the free market, and has been stably and democratically elected. The problem will arise when the electorate desires a change, and may not have a reliably reformist alternative. The key to economic takeoff will not be oil discoveries, but the preservation and extension of property rights and above all the nurturing and protection of middle class savings (the seed capital for new businesses) from the triple scourges of inflation, bank collapses, and government expropriation. Thus economic takeoff is certainly possible, and the indicators are that current policies and resources are sufficient to achieve such a takeoff, but dedication to free market policies and against corruption over a decade or more from now is still needed before enough wealth has been created for the process to become self-sustaining.

If Ghana – or some other African country, but Ghana appears among the best candidates – achieves rapid economic takeoff and progresses to middle income status and increasing prosperity, this will be very good news for Africa in general. Only by the example of success can Africans and especially outside aid providers be prevented from reinforcing failure and destroying the market signals that cause success to occur. Once an African country has reached the level of say Thailand – about $10,000 per capita GDP at purchasing power parity, four times Ghana’s level – it can show the rest of Africa both how development can take place and what a wealthy African society should look like.

For the rest of the world, an emerging African country would also be a positive development. It would make it overwhelmingly probable that 50 years from now the great majority of the world’s inhabitants will have at least middle-income status. Nevertheless, however attractive that prospect may be, it raises a serious issue. Can the world economy and the global environment cope with a population of 9 billion (on current projections) nearly all of whom are enjoying a middle-income standard of living, such as an automobile for example, and consuming resources appropriate to that standard of living. The answer may very well be no. There are two problems:

• First, as has been exhaustively promoted in the media, if global warming is indeed a real danger, it will be hugely exacerbated by the extension of the automobile culture to the entire world population, rather than just the wealthy West.
• Second, it is not clear to what extent, at a given level of technology, the world economy is a zero sum game. Automobile production of say 400 million vehicles per annum, the rate implied by a middle income population of most of 9 billion, will not require anything like six times the workforce of the current world automobile production of 67 million. What will everybody else do?

The reality is that human labor at all but the most highly educated and skilled level is potentially in huge glut. The equilibrium world population before industrialization, given decent agricultural techniques and no major epidemics, appears to have been about 1 billion, the population in 1800. The equilibrium population at our current level of technology, at which jobs are adequately filled with people enjoying a decent fraction of current world average living standards, is probably more than 1 billion – but it is almost certainly much lower than the 9 billion. If we enter an era of population glut, we shall enter an era of declining living standards and increasing environmental costs. Our ability to solve such problems will increase much more slowly, because the supply of highly skilled people and scarce energy and other resources is limited, while the problems themselves and their attempted solutions will impose increasing burdens on output. Solving global warming will not be free, and could become very expensive indeed in certain scenarios.

Thus globally as well as in Africa, population control, and in the long term reduction, is key to producing and maintaining decent living standards. However, given the strong inverse relationship between wealth and fertility, a few “African tigers” such as Ghana should be at least some help in addressing even this long term problem.

WHEN POOR COUNTRIES GET RICH

“There is no precedent for such fortunes suddenly finding their way into global financial markets” ~~ The Economist, May 26, 2007

When you hear the phrase, “There is no precedent,” you should sit up and take notice. As this world totters on its way to some veiled future, it is in such small phrases that you will find big clues as to where the trade winds of the market might blow next. In this case, your clue is the massive pool of money building in a way that has never happened before. It is bigger than the hedge fund industry – which makes so much noise and inspires so much comment. In total, these funds run into the trillions of dollars. Yet it is almost like a secret club. Few investors are even aware they exist.

Traditionally, this money has been content to sit on low-risk, low-paying investments – like U.S. Treasuries. That is changing. And where this money is heading next could have a huge impact on market prices. “How and where this massive – and often secretively managed – pool of funds is deployed,” opines the Financial Times, “will be one of the big investment themes of coming years.”

On May 21, China announced its intention to invest in Blackstone, a U.S. buyout firm. China has $1.2 trillion piled up in reserves. It is the flip side of the U.S. trade deficit, you might say. That pile of money grows by about $1 billion every day. Before May 21, China had been content to invest in highly liquid and “safe” investments – such as U.S. Treasury debt. Now, China let the world know that it would set aside about $300 billion this year to invest in things other than Treasuries. Stratfor, a consulting firm, adds this: “That amount represents the single largest pool of cash that any government has thrown at anything, ever. Adjusted for inflation, the U.S.’s largest effort, the Marshall Plan, comes in at just over $100 billion.”

China controls one of the world’s largest stacks of foreign currency reserves. Yet there are other stacks of similar money out there – the excess foreign currency reserves of other foreign nations. Andrew Rozanov, writing in the scintillating journal Central Banking, named them sovereign wealth funds (SWFs). As Rozanov says, “These are neither traditional public pension funds nor reserve assets supporting national currencies, but a different type of entity altogether.”

Sovereign wealth funds control about $2.5 trillion in assets worldwide, compared with about $1.6 trillion in the hedge fund universe. And money continues to pour in. By some estimates, these funds could control $12 trillion in assets by 2015. Where did these enormous funds come from? Many of them were set up decades ago. But they have come on our radar only recently for three reasons, as pointed out by Rozanov: There are a lot of new ones coming online (such as China’s), they are growing rapidly, and they are getting so large – on par with the largest public pension plans.

Governments created many of them with surplus revenues from oil, gas and other natural resources. The UAE and Norway and Russia all got the bulk of their dough from oil. Chile’s funds came from copper revenues. Even Botswana has a $5 billion fund (the Pula Fund) flush with the proceeds of diamond sales. Not all of them are commodity-related, Singapore and Hong Kong, e.g.

So these governments are flush with cash and have set up sovereign wealth funds to invest the money. Today’s unmistakable trend is to invest more and more of that money in private enterprise, stocks and real estate. Norway recently upped the amount it will invest in the stock market. In the past, about 40% was set aside for stocks. As of last month, it became 60%. Norway runs a giant $300 billion fund. That is a lot of buying power. Russia, India and others are also in the process of setting aside more money for riskier assets. As The Economist notes, “Sovereign wealth funds could soon become the most important buyers of such assets, and many others besides.” For China to put even 40% of its staggering fund to work, it “would have to buy more than 10% of the capitalization of the Dow Jones Industrial Average,” says the Financial Times.

Putting that kind of money to work could be politically impossible. After all, when China’s CNOOC, a partially state-owned oil company, tried to buy Unocal, an American-based oil company, there was such resistance that CNOOC called it off. That may be why China’s first purchase is in a private firm that does not own any “strategic” assets. The Blackstone deal was just the first little spoonful behind an enormous appetite. Look for more headlines as China and these other giant sovereign wealth funds put their money to work in a history-making buying spree.

JIM ROGERS SAYS HE HAS SOLD EMERGING MARKETS, EXCEPT CHINA

Jim Rogers, who predicted the start of the global commodities rally in 1999, said he has sold out of all emerging markets with the exception of China because they are “over-exploited”. “I’m hoping when the next big correction comes I am smart enough to buy some of them back,” Rogers, chairman of New York based Beeland Interests Inc., said in an interview in Singapore. “They are all over-exploited, so I’ve sold out.”

The Morgan Stanley Capital International Emerging Markets Index has risen twice as fast as a measure of developed countries this year – jumping 17%, compared with the 8.2% gain in the MSCI World Index of developed economies – as investors bet sustained global economic growth will bolster profits. Shares in developing countries have outperformed every year since 2001, with benchmarks in Brazil, China, India and Malaysia all touching records this year. “I’ve sold out of nearly all the emerging markets,” Rogers said, without naming them. “Right now, there are probably 10,000 young MBAs on airplanes flying around from one emerging market to another.”

“The only one I didn’t sell was China,” said Rogers. “I don’t ever want to sell China, but if China doubles again this year, then it’s a full-fledged bubble and I’ll have to sell.” China’s benchmark CSI 300 Index fell 4.2% last month, the first monthly decline since July 2006. Still, the index almost doubled in the first five months of this year, building on a 121% advance in 2006. Those gains have helped make China the world’s most expensive major stock market. The CSI 300 is valued at about 41 times earnings, about twice as much as the MSCI Asia Pacific Index. The S&P 500 Index is worth 18 times earnings, while Europe’s Dow Jones Stoxx 600 Index is valued at about 15 times.

Concerns that emerging markets are overvalued may be slowing investors’ enthusiasm. Global emerging market funds drew $696.4 million in the first half of 2007, according to estimates by Boston-based Emerging Portfolio Research Inc. That has slowed from $6.53 billion a year earlier.

“I’m long nearly all agricultural commodities, about 20 of them, because that’s the place to be,” said Rogers. “It’s better than the stock market, the bond market or any other market that I know of right now.”

SATIRICAL DICTIONARY SLAMS HAMPTONS

The rich and famous who summer in the Hamptons are about to get skewered once again. Miles Jaffe, the industrial designer cum satirist who rocked the summer denizens of the swanky East End towns in 2001 with his NukeTheHamptons.com site, has penned The Hamptons Dictionary: The Essential Guide to Class Warfare.

Jaffe, 49, fills the 170-page dictionary with acerbic nicknames for the spoiled kids of the wealthy vacationers and phrases that poke fun at the large mansions that dot the coastline and the lifestyles of the folks who appear very full of themselves. “America is supposed to be a classless society where all men are equal, but we have replaced it with a financial-class system,” said Jaffe. Jaffe calls the book a critique of America’s non-class class system.

Playstation, Jaffe writes, is nothing more than a vacation house in the Hamptons, while a “sprick” is a spoiled, rich kid. He adds that privilege and entitlement are two separate things and that money does not buy class and is no longer even that special anymore – especially in the Hamptons. One of his terms is “false authority syndrome”, which he uses to describe a belief that people with money are better educated, more socially conscious and more highly evolved when “that is just an illusion,” Jaffe said.

The social satire started off as an essay with the new words defined in a glossary, a vernacular of the East End’s colorful terms, like weekend warriors, along with new ones he coined. But the glossary kept getting bigger and bigger. “That became the project,” said Jaffe, an industrial designer who grew up in the Hamptons, and worked construction sites and drafting tables growing up.

“It’s a perfect spoof on how pompous the Hamptons has become,” said Angela Stump-Boyer, a Hamptons real estate broker. “It’s also a fun beach read.”

TO HIM THAT HATH

Behold, there it is – Waterloo Bridge. Right outside our office window. It is almost the same bridge depicted in a painting by Claude Monet that became famous last week – a new one was put up after Monet left for Giverny. While we get to see the real thing for nothing, the version preserved on canvas sold at auction for an extraordinary amount, reported as £17.9 million pounds by one source and £18.5 million by another – about twice what experts had expected.

The sale of Monet’s painting last week triggered a rush of reflections and questions in us – on aesthetics, on real value, and on history’s first worldwide credit bubble. Meanwhile, The Daily Telegraph rushed to succor the poor – not with bread, but with art. It offered readers a glossy reproduction of said painting for free. This gave rise to a question. We did not know whether it was an existential question, or a financial one, or a grammatical one, but it haunted our sleep: What is the difference between a genuine work of art and an ersatz copy? So deep and troubling were the resulting cogitations that we spent all of last week in prayer, meditation and inebriation, trying to make sense of it all.

We tossed. We turned. We stewed. We simmered. Finally, we saw a beggar on Blackfriar’s Bridge, and pointing up-river, we asked: “What is the difference between a picture of that bridge up there given out for free from the Telegraph and painting of it that just sold for $35 million?”

“Ah ... 35 million dollars?” came the reply. We rewarded the man with half a shilling and continued on our way. It was true. Mr. Market has spoken. Who are we to question his judgment?

The big buyers in the art market come from the financial industry, we are told. But what do they know about spending money? The typical hedge fund manager knows all about making money. He is an expert at separating others from it. But when he has made it, he is completely unprepared for getting rid of it by himself. Instead, it weighs him down, like a heavy mink coat on a rap star. It makes him look sweaty and ridiculous. What is a rich man to do but buy a Warhol or build a monstrosity in Greenwich?

When you make $1 billion per year, you can buy the most expensive house in the world every year and still have $900 million in change. So, you have to buy bigger and ever gaudier accouterments. Finally, your yacht becomes so big it gets stuck in the East River and your friends laugh at you. That is the problem with parting with big bucks to get status. You are always in danger that it will backfire.

The hidden appeal of art, on the other hand, is that you can spend as much money as you want without obviously looking like an upstart. Instead of wearing a diamond-encrusted watch that chimes “nouveau riche” on the hour, you buy a $100 million diamond-encrusted plaster skull, created by Damien Hirst. It is not a silly prestige item, you tell yourself; it’s art! Buy one of these absurd concoctions ... then buy another ... and another. And now you are an art collector! When you die, you can leave the whole foul lot of it to a museum.

What is this art really worth? If you wanted to look at Monet’s painting of Waterloo Bridge you could get a print for nothing. Or, you could pay $35 million for the real thing. From a distance, you can barely tell the difference. You have to get up close. The closer you get, the more you can appreciate the artist’s genius. As you approach the painting you see the texture, brush strokes, and subtle colors. And there, at maybe a range of two feet, you can appreciate the master’s skill at rendering the view from our office window into a work of genuine art. Maybe that is worth $35 million. Maybe it isn’t.

This little analysis might have rested comfortably in our stomachs, had it not been for an earlier art auction, in which a print by Andy Warhol was deemed worth $71.5 million. And here we are getting a little queasy. For Warhol never lifted a paintbrush at all. You can get as close as you want. Stick your nose into the canvas. You will not find any greater detail. You could print up a million copies. Each one could be as faithful to the original, and as readily passed off for the real thing, as a dollar in your wallet to the next crisp new bill to leave the U.S. Bureau of Printing and Engraving.

“Green Car Burning” is not a painting at all – but a print. The “original” is a reproduction of a newspaper photo. The only thing that might be considered the faintest bit authentic or original about it is that Warhol put a green cast over the image and broke up the picture a bit. So, if authenticity, originality, or painterly talent were the only source of the high prices, we cannot explain the Warhol phenomenon. The visual difference between a print and a print of a print is almost undetectable. Both give exactly the same satisfaction at any range. If the print of the print has zero value, the print itself should have approximately the same. Why then would anyone in his right mind pay so much for it?

“Because it will go up in value,” you say? We can practically read your lips. “It’s a good investment.”

The previous record for a Warhol was set last November, when a portrait of Mao, reproduced from a picture in Newsweek, sold for $17.4 million. In just six months, Warhol oeuvres increased in value by 100%. But the increase in prices merely increases our puzzlement. The price of a copy, established by the Telegraph at zero, is still zero. But the price of an “original” Warhol has soared to $35 million. The elusive, non-visual, almost undetectable difference between a copy and the real thing is actually doubling every half a year. How to explain it?

It was here that we began our heaving fits. What are these strange objects of contemporary art, we wondered? They have no real value. Are they anything more than a way for very rich people to part with their money on amicable terms? Are they not the perfect way to do it? The answer came to us. Yes. Like the dotcoms of the tech bubble era, contemporary works of art are held down by so little down-to-earth real value that their prices can go up straight to the moon.

FASTER GAINS FROM “MATURE” BULLETIN BOARD STOCKS

I am sure you have heard stories about stereotypical penny stock day traders. You probably think they are all chartists, frantically analyzing every sub-penny share they come across to make the right move. When the momentum is in their favor, they strike, making money when these ultra-tiny stocks move one-tenth of a cent.

Sure, some skilled traders make money. Others can even make a living with these momentum plays. But it can be a disaster for beginners. Even the “pros” can lose big money making these risky bets. If you do not know what you are doing, you could wipe out your savings in a matter of minutes with one bad trade.

Thankfully, you do not have to be a day trader to make money on the bulletin boards. In fact, you actually have a better chance of seeing gains on your over-the-counter trades if you look toward stocks that trade for a little more than a few cents a share. I call these “mature” bulletin board stocks (MBBSs). They are not the blue chips of the OTC, but rather are bulletin board stocks that trade in the sweet spot – just creeping over $1 per share. Statistically, these MBBSs have shown more gainers than their smaller counterparts.

Check out this price-to-gains comparison – statistics pulled form last Thursday’s trading session. As you can see, when it came to the smallest of the small stocks, the losers outpaced the gainers for the day, while most of these tiny shares remained unchanged or simply did not trade at all that day. But as you move up in price, the percentage of gainers over losers increases.

But do not think you will be sacrificing big gains for consistency. These MBBSs can show you huge short-term profits just like the sub-penny momentum stocks can. Just look at the big gainers from that same day. These top five gainers show us that making the big money is still possible with the “big” penny stocks. If we apply our same stock-picking criteria to these bulletin board stocks as we do with companies that trade on major exchanges, we can look forward to big gains – and a newfound sense of security.

THE MOST DANGEROUS RELIGION

Revisiting water stocks.

“Thinking the guy up ahead knows what he’s doing is the most dangerous religion there is.” ~~ Kurt Vonnegut, Brief Encounters on the Inland Waterway

I like this Vonnegut quote. It reminds me of Wall Street research. And it reminds me of the investors who trust in Wall Street research. I do not like the dangerous religion of blind faith in Wall Street. Instead, I prefer to operate where many professional investors fear to tread – in the small cap sectors where Wall Street analysts rarely venture.

Needless to say, it is pretty hard to follow Wall Street advice when there is none. That is the area of the market we have been investing in of late. I plan to continue exploring for opportunities in this sector. You should know that I pursue every single investment idea as if it were entirely my own money. My own family invests in this stuff. Even my in-laws! Therefore, you know I gotta pay attention here!

My investment approach hangs heavily on the fundamentals of the business involved. The fact is, they do not change all that much, even though the stock prices bounce all over the place. Water stocks are a perfect example. One year ago today, I issued a special report on water stocks, dubbed “Blue Gold”. The recommended stocks in this report are up an average of 60% over the last 12 months! Very likely, these names are due for a bit of a pullback, but when to get back in?

I plan to hold the Blue Gold Portfolio stocks for years, barring some fundamental change in the businesses. I have no interest in trading these stocks. If you want to ride along with me on them, do it with patient money. Right now, there are three Blue Gold stocks to think about. Gorman-Rupp (GRC: AMEX), Hyflux (HYFXF: Pink Sheets) and Lindsay (LNN: NYSE) are the only stocks below my buy-up-to prices. Hyflux is the most appealing, as it has the most upside – but it is also the most risky. I do not think you need to rush into the other two, though I like both long term. I would put Hyflux at the top of the Blue Gold heap and the other two about even behind it.

The big news in our portfolio last week was Lindsay’s sterling earnings report, which sent the stock flying. Lindsay’s main business is in irrigation equipment. In our new water-constrained world, modern irrigation equipment is one good way to use water more efficiently. Lindsay also benefits from the agricultural boom under way. Higher prices for corn and wheat and other staples mean farmers’ incomes are up. That means they have a little more money to spend on things such as farm equipment. Agriculture is the largest user of water resources.

You can see the rapid increase in water use relative to population growth. The Financial Times reports, “Annual world water use has risen sixfold during the past century, more than double the rate of population growth.” It seems to me water conservation will only become more important as the years roll on – and Lindsay’s irrigation equipment is part of that solution. The trends backing Lindsay’s business are powerful and long term. Ride the wave.

I hope that gives you some ideas. As to market timing, your guess is as good as mine. I thought it looked scary toward the end of the year. But instead, the market rallied hard. I just try to pick up good stuff that I can hang onto even in the face of a market decline.

Everyone’s tolerance for that sort of thing is different. You can hedge by using options - buying puts on the market, for example. Or you can lighten up on your stock holdings. Those are personal decisions based on your own stomach for volatility. In my own account, I do not use stop losses and I do not use options to hedge. I ride it out and accept the volatility. As an individual investor, I view my tolerance for volatility and low liquidity as one of my advantages against the big boys.

Oh, and the best lifeboat is cash. In the rising tide of market volatility, the sinking level of worldwide water supply provides a fundamentally sound investment theme.

GLOBAL EXODUS FROM THE U.S. DOLLAR IN MOTION

World’s central banks engage in a game of “Who can inflate their currency fastest?”

The trick to profitable foreign exchange trading is to pick the least ugly currency. Nearly all fiat or paper currencies are ugly, because the 18 of the world’s top-20 central banks are inflating the money supply at double digit rates. At the moment, the world’s two ugliest currencies are the Japanese yen and the U.S. dollar.

The Bank of Japan pegs its overnight loan rate at just 0.50%, in a brazen effort to devalue the yen, to boost exports abroad, and prevent an abrupt unwinding of the mushrooming yen “carry trade”. Meanwhile the Federal Reserve is inflating its M3 money supply at a 13.7% annualized clip, according to private economists, which if correct, would be the fastest rate of expansion in more than 30-years.

U.S. Treasury chief Henry Paulson, and former chairman of Goldman Sachs, “monitors the financial markets closely,” and has reinvigorated the infamous “Plunge Protection Team” (PPT), which comes to the rescue of the U.S. stock market whenever nasty revelations come to the surface. At the moment, Paulson’s grand strategy is to offset losses in the U.S. housing sector with big gains in the stock market, to prevent the U.S. economy from sliding into recession.

A key PPT player is none other than Fed chief Ben “helicopter” Bernanke. Since the Bernanke Fed discontinued the decades-old reporting of the broad M3 money supply in March of 2006, the growth rate of M3 has accelerated from 8% to a sizzling 13.7%. The Bernanke Fed is preventing borrowing rates from rising at a time of explosive loan demand for U.S. corporate mergers and takeovers, by rapidly increasing the U.S. money supply. Global mergers and takeovers soared to an astronomical $2.78 trillion during the first six months of this year, up 51% from 2006, led by $1.05 trillion in the U.S. alone.

But one sector of the U.S. stock market which has not responded positively to the Fed’s heavy injections of monetary steroids has been the home builders, a top bull-market leader from 2003 thru August 2005. The Dow Jones Home Construction Index is off 25% this year, and is flirting with key support at the 525 level. On July 2nd, Paulson sent a discreet signal to Wall Street power-brokers to avoid dumping the home builders: “In terms of housing, it has had a significant impact on the economy. No one is forecasting when, with any degree of clarity, that the upturn in housing is going to come, other than it’s at or near the bottom.”

The Fed has obscured its money printing operations by discontinuing the reporting of M3, in order to limit the damage to the fixed income markets. But word of the explosive growth of the M3 money supply is slowly leaking out, and taking its toll on the U.S. Treasury Note market, which briefly tumbled to its lowest level in five years in June, lifting 10-year yields as high as 5.30%, before receding back to 5.00%, on a “flight to safety” from the riskiest of the sub-prime home loan market. Because the U.S. credit markets are swimming in a tidal wave of rising liquidity, there will always be bargain hunters who are happy to park excess cash into the bond market whenever yields surge higher. Asian central banks and Arab Oil kingdoms in particular, have been big buyers of T-bonds over the past four years, and hold roughly $1.3 trillion of the IOU’s, but even this massive intervention could not turn the tide of the 4-year bear market.

But now there are indications that China’s insatiable appetite for U.S. T-bonds is waning. Since Beijing unhinged the dollar from a fixed peg of 8.27 yuan in July 2005, the value of the 10-year T-note, when converted into yuan, has declined by 15%. The dollar has slipped 8.9% lower since the yuan was freed from the dollar peg. Beijing is almost guaranteed to take further losses on its massive $900 billion U.S. bond portfolio, with its secret agreement with Paulson, limiting the dollar’s annual devaluation against the Chinese yuan to 5%, to avoid the U.S. Treasury’s label of a currency manipulator. China’s old guard is finally waking up to reality, and looking for new ways to invest its bulging foreign currency reserves. The Ministry of Finance has been authorized to invest $200 billion of the country’s FX stash into publicly listed companies, real estate, or private deals around the globe.

China’s parliament also authorized the State Council to abolish or reduce the 20% withholding tax levied on interest income. The measure is aimed at staunching the flow of cash into the surging stock market by making bank deposits more attractive. Already, China’s 7-year bond yield has climbed 120 basis points to 4.22% since April 2nd, and now the central bank has new tools to drain liquidity from the money markets. Higher Chinese interest rates have put a roadblock before the powerful Shanghai red-chip index, which has found stiff resistance at the 4,300 level, but finding support at 3,700. With higher after-tax interest rates on Chinese bonds, and pressure on the Fed to lower the fed funds rate due to the sub-prime home loan meltdown, hot money from abroad should continue to flow into the Chinese yuan, greasing the skids for the U.S. dollar’s slide against other Asian currencies, such as the Korean won.

The Bank of England – “Asset Targeting” Pioneer

Just about every major central bank has a big credibility problem, when it comes to maintaining the purchasing power of its currency. The BoE, for instance, has tolerated double-digit growth of its M4 money supply for the past two years. The BoE is the “Group of Seven’s” original pioneer in “asset targeting”, or guiding the stock and real estate markets to higher levels, by injecting excess liquidity into the markets, until asset prices reach the bank’s targeted levels. The BoE has guided the Footsie-100 from a low of 3,500 in Q1 2003 to a 7-year high above 6,600 this month. But the BoE’s monetary abuse is taking its toll on the British debt markets, where the benchmark 10-year gilt fell to a 7-year low in June, lifting its yield to as high as 5.55%, before bargain hunters came out of the woodwork.

“Investors are likely to take advantage of this ample liquidity and the associated easy credit to purchase other assets, driving risk premia down and asset prices up,” the BoE said in a February 20th report for parliament’s Treasury Committee. “In due course, those higher asset prices may be expected to feed through into higher demand for goods and prices, putting upward pressure on the general price level.”

The BoE is well aware of the inflationary consequences of double-digit money supply growth, but it must still overcome stiff political opposition to higher borrowing costs, namely from newly installed prime-minister Gordon Brown. “Rigid monetary rules that assume a fixed relationship between money and inflation do not produce reliable targets or policy,” Brown argued on June 14th. Such reckless comments by Mr. Brown, are reminiscent of his decision to sell off more than half of the UK’s centuries-old gold reserves in May 1999. Brown offloaded the gold at a 20-year low in 17-auctions at an average of $275/oz. Since then gold has risen sharply and stands around $650/oz.

The BoE is still far behind the monetary inflation curve, and would have to hike its base rate by 100 basis points to 6.50% or higher, to rein-in M4 growth into single digits. Ultimately though, the pressure on the BoE to hike interest rates further will come from the gilt market, which is in danger of a nasty meltdown, unless the central bank lives up to expectations of future rate hikes. Mitigating some of the pressure for higher rates is the strength of the British pound, which climbed above the psychological $2 mark last week, for only the second time since 1980. The British pound is being driven higher by widening interest rate differentials moving in its favor, with the Fed handcuffed by a weakening housing market and a sub-prime loan debacle.

Both the British pound and U.S. dollar are heavily inflated currencies. Both offer large external trade deficits and big budget deficits. While the Fed is inflating its M3 money supply at a 13.7% clip, the BoE is inflating its M4 at a 13.9% annualized clip. But the U.S. economy is roughly six times the size of England’s, so in absolute terms, the increase in supply of U.S. dollars is much larger. And with the BoE expected to lift its lending rates to 75 basis points above the US$ rate, the pound is winning this “reverse beauty” contest.

Aussie dollar shines with yield-hungry investors.

After breaking thru the long held psychological barrier of 80 U.S. cents in March, one has to go back 18 years to find the last time the Aussie dollar traded as high as 86 U.S. cents. There are several reasons why the Aussie dollar is climbing sharply higher against the greenback, but the most commonly cited is higher yields. The yield on Australia’s 10-year T-bond was +122 basis points higher than comparable yields on the U.S. T-Note early this week, up from +56 bp in April 2006.

Interest rate differentials play a big role in the FX “reverse beauty” contest, and the Aussie has been underpinned by its relatively attractive yield. Yet why are Aussie bond yields rising relative to U.S. yields? Flush with cash after a string of budget surpluses, the Australian government issues barely enough new paper to cover rolling maturities, keeping bonds outstanding at just A$60 billion, and down from around A$94 billion when Prime Minister John Howard came to power in 1996. The U.S. total public debt has ballooned by 50% since the turn of the century to reach $8.8 trillion. Aussie T-bonds offer the same AAA rating, and with an appreciating currency, one might have expected Aussie yields to shrink relative to US yields. This Aussie yield spread is one of the market’s great mysteries.

The Reserve Bank of Australia (RBA) is not thrilled about the sharply higher Aussie dollar, which is bound to hurt exporters and widen the current account deficit, which jumped 20% to A$15.1 billion in Q4, the largest quarterly shortfall on record, with the 12-month rolling total equal to 5.9% of the country’s GDP. The RBA intervenes every month to sell Aussie dollars and slow its upside gains.

In the game of competitive currency devaluation with other central banks, the RBA has allowed its M3 money supply to expand at a 14.1% annualized rate, pumping up the local stock market but undermining confidence in the Treasury bond market. Aussie 10-year bond yields rose above the psychological 6% level in June, for the first time in five years. To rein in the explosive M3 growth, the RBA would probably be required to hike its cash rate by 100 basis points to 7.25%. But that could send the Aussie dollar soaring into orbit against the Japanese yen, its top trading partner. Thus, the RBA’s anti-inflation fighting capability is held hostage by the Bank of Japan, which will not lift its interest rates into alignment with the rest of the world.

Indirectly, the BoJ is exporting inflationary pressures into the Australian economy, with its super-low interest rate, and cheap yen policy. In turn, Aussie 10-year bond yields are rising faster than Japanese bond yields, lifting the spread to +430 bp over JGB’s, and catapulting the Aussie dollar to a 16-year high of 105-yen.

Japanese fixed income investors have become an integral part of the infamous “yen carry” trade, purchasing a large block of Australia’s outstanding A$521 billion of foreign debt, seeking to profit from the yen’s devaluation. But should the BoJ start to lift its interest rates to narrow the gap with the rest of the world, the carry trade could unwind, perhaps in a violent fashion.

The Bank for International Settlements (BIS) pointed out on June 24th, that “there is clearly something anomalous in the ongoing decline in the external value of the yen. Tighter monetary policies would help to redress this situation, but the underlying problem seems to be a too firm conviction on the part of investors that the yen will not be allowed to strengthen in any significant way,” adding the yen could rise sharply once market sentiment shifts. But traders have heard these empty warnings for years, and the yen has stayed weak, in large part due to a gentleman’s agreement between the U.S. Treasury and Japan’s ministry of finance.

BIS chief calls for responsible monetary policies.

Central bankers are playing a game of “Smoke and Mirrors” inching up interest rates at a snail’s pace, but not high enough to curb explosive loan demand nor the growth of the money supply. But BIS General Manager Malcolm Knight is now calling on the world’s top central bankers to slow down the printing presses, and allow borrowing rates to rise, to start draining the “Global Liquidity Glut”, in earnest.

“Financial conditions are still accommodative, access to credit remains easy and credit spreads are at record lows. Containing inflationary pressures seems to require further tightening in most jurisdictions, as is expected by financial markets,” Knight said. “The credibility of central banks around the world may hinge on their response to surging money and credit growth, which is helping fuel asset bubbles. Some central banks need to ask soul-searching questions about the appropriate policy response. Ultimately, the credibility of central banks lies in the balance.”

Central banks in Australia, Canada, China, England, the Euro zone, Korea, South Africa, and Switzerland are expected to heed the call of the BIS chief, by lifting short-term rates 0.5% higher, albeit at a baby-step pace in the second half of 2007. Even the radical inflationist Bank of Japan is laying the groundwork for a long overdue quarter-point rate hike to 0.75% this summer.

Forex market expects an easier Fed, setting another global exodus from the U.S. dollar in motion.

One central bank that cannot contemplate higher interest rates however, is the Bernanke Fed, which is hamstrung by the sub-prime mortgage loan market. The benchmark ABX 07-1 BBB index, which is tied to sub-prime mortgage loans, fell to 53.16 cents on the dollar, and has tumbled 43% since January. ABX’s are sub-prime loan mortgages which are bundled in securities.

The fallout from the slide in sub-prime ABX’s is uncertain, but if left unchecked, tighter lending standards could sink the U.S. home building sector and housing prices. Foreign currency traders are already upping their bets that the Bernanke Fed will continue its clandestine policy of injecting more U.S. dollars into the banking system, and eventually lower the fed funds rate in a crisis situation. Coupled with the likelihood higher rates overseas, yet another global exodus from the U.S. dollar has been set in motion.

In retrospect, it was Bernanke’s infamous comments in a letter to California Rep Brad Sherman, dated February 15th, 2006 which began the dollar’s latest 18-month descent. “A precipitous decline in the dollar, should not necessarily disrupt financial markets, production or employment,” Bernanke wrote, portending the central bank’s rapid increase in the growth rate of the U.S. money supply.

Two months later, Russian finance chief Alexei Kudrin put the knife into the dollar, by telling the IMF that Moscow could not consider the dollar as a reliable reserve currency because of its instability. “The U.S. dollar is not the world’s absolute reserve currency. The unsustainable U.S. trade deficit is causing concern and that the international community can hardly be satisfied with this instability,” Kudrin told a stunned audience of the world’s top central bankers in April 2006. On November 24th, 2006, Chinese deputy central bank governor Wu Xiaoling warned “The exchange rate of the U.S. dollar, which is the major reserve currency, is going lower, increasing the depreciation risk for east Asian reserve assets.”

Russian Bear aligned with “Axis of Oil” meets President Bush.

Russian kingpin Vladimir Putin has been a notorious bear on the U.S. dollar for the past few years, and is a key member of the “Axis of Oil” including American foes Iran’s Mahmoud Ahmadinejad and Venezuela’s Hugo Chavez. All three members of the “Axis of Oil” have been switching their FX reserves away from the U.S. dollar and switching into Euros.

At a two-day meeting, Bush called Putin, “solid partner”, and added that “Russia has made amazing progress in such a short period of time,” since Soviet Union collapsed in 1991. “Russia is a country with no debt, and it’s a significant international player. Is it perfect in the eyes of America? Not necessarily. Is the change real? Absolutely,” Bush said. Putin responded by saying, “The deck’s been dealt and we are here to play. I would very much hope that we are playing one and the same game.”

At the core of their disputes however, is Putin’s alignment with Iran’s Ayatollah Khamenei, his support for Iran’s nuclear program, and Moscow’s opposition to further UN sanctions on Tehran, which could wreak havoc on Iran’s economy. Putin also opposes Bush’s plan to create a European-based missile-defense system with radar based in the Czech Republic and interceptors based in Poland.

Russia is the world’s largest natural gas producer, and is second to Saudi Arabia as the world’s top crude oil exporter. Rising oil and base metal prices have enabled Russia to amass foreign currency reserves of $405 billion, the 3rd largest after China and Japan. Russia’s economy expanded at a 7.7% annualized rate in the first five months of this year, while the U.S. economy grew at only 0.7% in Q1. On April 6th, Russian central bank chief Sergei Ignatyev said the approximate structure of Russia’s foreign exchange reserves was 50% in U.S. dollars, 40% Euros, and 10% in British pounds. Last year, Putin ordered payments for Russia’s Ural oil exports in rubles, abandoning the U.S. dollar as a medium of payment. Iran’s Ahmadinejad has ordered payment for Iranian oil exports in Euros.

Higher oil prices would increase the wealth the “Axis of Oil” and the clout of the Arab Oil kingdoms in the Persian Gulf, which control an estimated $1.6 trillion of FX reserves, outstripping the Chinese dragon. One has to wonder what impact a possible military confrontation over Iran’s nuclear weapons program would have on the foreign exchange market.

A LACK OF FINANCIAL INDEPENDENCE

Wednesday of this week is America’s national holiday. On this day, 232 years ago, a sweaty group of rich lawyers and planters gathered in Philadelphia, plotting mischief. They were determined, they announced, to overthrow the lawful government of the American colonies and replace it with something more to their liking. They acted, not in the name of their own self interest, they said, but on behalf of liberty and independence, which they all claimed to cherish more highly than life itself.

What they wished to do was to give up one George in London in favor of another George in Virginia. This was no sure thing. George III was not going to give up without a fight. George Washington would have to raise an army and boot him out ... or else the signers of the Declaration of Independence would probably hang. “We must hang together,” remarked Franklin, “or we will surely all hang separately.”

Luck was with them. None of them hung. Instead, Franklin himself went to Paris and convinced the French to help. They gave them money to buy war materiel. More importantly, a French squadron blockaded the entrance to the Chesapeake Bay, cutting off the British troops from their lines of supply. The British commander had no choice. He had to capitulate. And so, America became independent of England.

But there is nothing like a long stretch of good luck to ruin a nation. Americans went from strength to strength, victory to victory, coast to coast – always struggling to preserve and extend their precious independence. And now, here we are, more than two centuries later. We have a new George in the White House, and Americans have never been more dependent on others. But now it is not to the English that they are bound, but to their creditors.

On Monday, the dollar fell near to a 26-year low against the English pound. Against the euro, it dropped to near its lowest level ever. Why this should be happening is both a long story and a short one. The short story is that currencies go up and down all the time. The long story is the subject of so many of these Daily Reckonings that readers are getting bored with them.

Dollars are losing their appeal, generally, because there are so many of them. Each paper dollar represents an I.O.U. from the U.S.A. As the United States increases the quantity of dollars, their credit quality comes into question. Logically, each new dollar is worth less than the last one. This little insight has not been particularly useful to dollar bears. Many have lost their shirts, their girlfriends and their minds waiting for the laws of economics to be enforced. Today, we are not predicting when or how law and order will be restored to the world’s markets. But in the last couple of weeks, at least it looked as though the sheriff was back in town.

What also makes the dollar suspect is that Americans, themselves, seem to be in such a hurry to get rid of them. Mountains of them are building up overseas. China may have almost a trillion dollars in its reserves. At the present rate, Russia will accumulate additional reserves of more than $200 billion in 2007. These I.O.U.’s are stacking up outside of the U.S. because Americans cannot keep them at home. Every day, U.S. consumers spend $2 billion more on overseas products and services than they receive in payment for their own exports. This leaves the typical American household a little short of cash. It has to borrow to fill the gap between income and outflow. Since it saves almost nothing, it depends on the savings of foreigners.

The balance of investment income – the difference between what U.S. investors receive from overseas and what the U.S. pays out in interest and dividends to foreigners – also turned negative last year, for the first time since 1915. Warren Buffett explained, “In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest.”

Whole books have been written on this subject – at least one of them by your author (with Addison Wiggin). They all tell the same story – that there are not many people on the planet who can afford Americans’ luxury lifestyle ... not even Americans themselves! Debt and dependence stalk young and old. Back in the late 1970s the cost of college began to rise sharply. Lenders rushed to provide credit to help the masses pay tuition. Educational debt exploded, rising more in the 1990s than it had in the three previous decades, and three times faster than college costs. By 2007 the average student graduates with about $19,000 worth of student debt, and $2,000 in credit card debt. Credit card debt almost tripled between 1985 and 2005. Now, the average family owes about $9,000 on its plastic “safety net”.

But the biggest increase has come in mortgage debt. It has been increasing at a half-trillion dollars per year. Never have so many homeowners owned so little of their own homes. Even during the biggest boom in housing prices in history, Americans took money out of their equity so fast that the ratio of mortgage debt to housing value dropped – from 70% in the early 1990s to 52% in 2007.

Meanwhile, U.S. government debt has grown at a sprinter’s pace too. By our calculation each and every American household has the weight of $500,000 in extra debt on its back – its share of the U.S. “financing gap”, an amount that includes not only the official debt, but also the present value of future commitments less anticipated revenues.

All of which is to say, that this Independence Day finds Americans less independent than ever before. They count on the Arabs for energy. And they depend on the Asians for money to pay for it. Soon, they will not be able to go to the bathroom without out asking permission from their Chinese creditors.

Happy 4th of July!

Land of the Free

“This is a society of true believers. The belief in democracy, market economics and the importance of religion is far more pervasive here than Marxism ever was in Russia.” ~~ Michael Ignatieff, in The Daily Telegraph

It is the Fourth of July. Should we hang out the red, white, and blue bunting from our office balcony, or the black crepe? Should we whine about the America we have lost, or give a whoop for what we have left of it? That star-spangled banner still waves, but does it still fly over the land of the free, we ask? Or over a country with a spy camera on every street corner ... a nation so deeply in debt that freedom has become a luxury it can no longer afford?

Whatever direction we take, we trip over a contradiction. Things always seem to be black and white at the same time. That is why we took up tango, dear reader. As far as we know, no serious tango dancer has ever committed suicide. It is the mathematicians and engineers who blow their brains out. An ideologue or a mathematician cannot tolerate contradiction. His little world has to fit together neatly, like a crossword puzzle. Each intersection has to work perfectly.

But that is not the way real life or real people work. A healthy woman loves her husband, but often hates him too. She has two eyes, and sees a slightly different view of him with each of them. What is wrong with that? Likewise, even a man with only a single eye cannot help but notice that the world is menaced by inflation and deflation at the same time, and that America is both free and un-free at exactly the same moment.

What we have come to dislike about the neo-conservatives is not that their view of the world is right or wrong – for how could we know? – but that it is so small. They are true believers in a very tiny world ... one with no room for mystery, contradiction, ignorance or humility. It has to be small, otherwise they could not understand it.

Neo-cons think they can see what no mortal has ever seen: the future. That is the twisted genius of the “preemptive attack”. They stop the criminal before he has committed his crime! They think they can know what no mortal has ever known: not only what is good for himself and his country, but what is good for the entire world. And they intend to give it to them, whether they want it or not.

In today’s email box, for example, George W. Bush himself sends us the following message: “... liberty is God’s gift to humanity, the birthright of every individual. The American creed remains powerful today because it represents the universal hope of all mankind.” Here we will take a wild guess: there are probably more than a few bipeds hobbling around the planet for whom the “American creed” is not so much a hope as a dread. But the president continues, “We are winning the war against enemies of freedom, yet more work remains. We will prevail in this noble mission. Liberty has the power to turn hatred into hope.”

“America is a force for good in the world,” continues the leader of the world’s only super-duper power, “and the compassionate spirit of America remains a living faith. Drawing on the courage of our Founding Fathers and the resolve of our citizens, we willingly embrace the challenges before us.”

America’s citizens, meanwhile, are deeply in debt. They see little choice but to back the system, such as it is. Free or un-free, they could care less. Just keep the money flowing. They have come to rely on government. They need Fannie Mae, and unemployment insurance, and social security, and jobs, and the Fed, and fiscal stimulus. Or, at least, they think they do.

After 50 years of the Dollar Standard boom, the average American finds himself less free than ever. He is a slave to the highest government spending and biggest public debt burden in history. And to the heaviest mortgage and other private debt load ever. He has mortgaged up his house. He has taken the bait of credit-card lenders. Now he has no freedom left. He must keep a job. He must pay attention to the Fed’s rates. He must have an interest in George Bush’s government (for now he depends on it)!

“July 4 should be about celebrating freedom and independence,” wrote Richard Benson, published in this week’s Barron’s, “yet the bankers are the only people jumping for joy. Never have Americans owed so much in terms of their total debt, the ratio of total debt to income and the amount of cash flow the debt needs to serve it. Americans used to believe that if they were debt-free, they were free. Today, Americans just want the freedom to borrow more, even if it means they are on the way to becoming enslaved by their debt.”

The average citizen is only a few paychecks from getting put out of his house. He no longer has the freedom to step back, to reflect, to think, to wonder about things, or enjoy the contradictions. Instead, he must bow before the politicians who control his livelihood, and place himself at the beck and call of every government agency with a dollar to spend.

The message from George W. Bush concludes with an endearing personal note, in which “Laura joins me in sending our best wishes for a safe and joyous Independence Day ...” How we got to be on a first-name basis with the First Lady, we do not know. We have never even met her. Why she should wish us a happy day, we do not understand. But these are the peculiar, baroque eccentricities of America that make it such an endearing place to its citizens and such a rich treasure for contemporary ethnologists and stand-up comics.

They, too, will wonder about the contradictions. Why do Americans celebrate “freedom” ever more loudly, while becoming ever less free? How can they crow about the “home of the brave” when they attack pitiful, third world nations that cannot defend themselves? How can they ballyhoo their own independence when their armies occupy two foreign nations?

Most people will ignore the contradictions altogether. Many will see them as hypocrisy. Some will be outraged. And a few will hear the off-tempo tango beat, and enjoy the holiday anyway.