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TAX GAMES; GLOBAL ECONOMY SLOWING

Throughout the morning and into the lunch hour, U.S. asset prices have been higher across the board. The Dow Industrials and NASDAQ are up, bond prices are marginally higher, and the U.S. dollar is appreciating against most major currencies, especially the yen. As I write the dollar is beginning to roll-over and is just about to go negative for the first time in today’s trading. A little later I’ll go back and check the dollar to see if it picks up again to close in positive territory. When I sit back and try to discern what is happening in the big picture, I keep asking myself, “Where is all this money coming from to buy U.S. assets?” I have two answers to the question, but one came as a surprise to me yesterday when I learned of legislation passed last year that gave favorable tax treatment to U.S. corporations with offshore business.

First I’ll cover a few items in the news, then move on to what I believe is providing temporary support for the U.S. dollar and U.S. asset prices overall. Interest rates have been drifting lower ever since the markets overreacted to Greenspan’s tough talk on inflation a couple weeks ago. Some bond analysts are suggesting Greenspan will not deliver on his promised rate increases, and bond market participants are looking at a weaker global economy for the balance of this year. With that, the Mortgage Bankers Association said rates on 30-year fixed mortgages dropped from 6.08% to 5.91% and one-year ARMS fell from 4.39% to 4.29%. The MBA’s application index fell 4.4% with the purchase index declining 5.3% and the re-finance index down 3.1%. This tells me the economic stimulus from a hot housing market has clearly seen its peak. Higher rates will slow demand for housing or at least curtail some of the speculative buying, especially for those that think they need a second, “summer” home. Why do so many people believe real estate prices will continue higher and higher and higher ad infinitum? I just don’t get it.

By far the worst spin I have heard in the markets earlier this morning was all tied to energy prices. Greenspan talked yesterday to calm the energy markets and said rising oil inventories may “damp the current price frenzy.” When the stock and bond markets opened this morning, the newswires were buzzing that stocks were moving higher with oil coming down in price, and also attributed the rise in bond prices (lower interest rates) to lower oil. At the open, energy prices were lower with crude down about fifty cents to $55.50 and unleaded gasoline down about three cents to $1.65 in anticipation of the Energy Department’s release of new inventory data with expectations of increased inventories. Crude posted a gain of 2.4 million barrels and this was the eighth consecutive weekly increase, but the market doesn’t care! Traders were more focused on unleaded gasoline inventories declining by 2.1% while they question whether or not we have the refining capacity to produce enough for the driving season. AAA says gasoline rose to a record $2.228 a gallon yesterday, but it hasn’t deterred motorists, since demand is running 2% ahead of last year.

In a nutshell, both Alan Greenspan and the market spin got it wrong today. They tried to spin the energy data as being bearish, but oil moved higher anyway and is now flattening out for the day. In the big picture energy prices didn’t really change much, but stocks and bonds remain higher nonetheless. So where is all this money coming from to be buying the U.S. dollar, stocks and bonds? The first answer is pretty simple, so I won’t spend a lot of time saying the economies of Europe and Japan appear to be slowing at a faster rate than here in the USA. The following Bloomberg snippets illustrate my point:

Yen Declines on Speculation Japanese Investors Are Shifting Funds Overseas

April 6 (Bloomberg) -- The yen fell against the dollar, approaching a five-month low, on speculation Japanese investors are shifting funds to higher-yielding bonds in the U.S. and Europe at the start of their financial year.

"The main focus during the second quarter of 2005 will be renewed portfolio outflows from Japan," said Samarjit Shankar, director of global strategy in Boston at Mellon Financial Corp., with $707 billion in assets. "This could cause the yen to weaken to 110 to 112 per dollar some time in the second quarter."

Demand for the yen also waned in the past two weeks as reports showed business confidence, factory production and household spending declining in the world's second-biggest economy. Japan's index of leading indicators fell to the lowest since 2001 in February, the government said today.

European Economies: Retail Sales, German Orders Fall on Oil

April 6 (Bloomberg) -- Retail sales in the 12 nations sharing the euro dropped for a third month and factory orders slumped in Germany, Europe's largest economy, adding to evidence unemployment and record oil costs are dimming the region's economic outlook.

An index based on a survey of more than 1,000 retail executives compiled for Bloomberg LP by NTC Research Ltd. stayed below the 50 mark that signals expansion, reaching 48.5 in March after 47.3 in February. German orders fell 2.6 percent from January, when they dropped 3.5 percent, the Economy and Labor Ministry in Berlin said today in a faxed press release.

Investors in Japan are scouring the globe to find a return on investment with Japanese interest rates near zero. Japan’s 10-year government bonds yield about 1.3% compared to 4.4% for the U.S. 10-year rate, so some of the huge savings in Japan could well be finding its way to invest in U.S. dollars and bonds. As indicated above, the Eurozone is showing clear signs of weakness. EU policy makers are meeting tomorrow, and there is a 100% consensus they will not move to raise interest rates. The European economy is slowing and now some of the European manufacturers are voicing their disapproval of imports from China.

Remember with China’s growth rate of 9.5%, they haven’t simply taken jobs from the U.S., but rather from all parts of the globe. Europe and Japan have both been forced to outsourcing less expensive labor from China just to remain competitive in the global economy. Most recently the European textile industry is demanding curbs on Chinese imports that it says surged more than 46% in January after a global quota system ended on December 31^st. China’s textile exports have been limited by a global quota system that has been in place for 40 years…the global economy is changing dramatically right in front of our eyes!! How will the rest of the world compete with China longer-term? In the meantime, slowing economies overseas could well be causing money to move into dollars because our economic growth rate is perceived to be better than that of Japan and Europe….but is it?

My read on the situation says the biggest part of our “growth” is coming from inflation. Remember that understated inflation means overstated GDP growth! It calls to mind a testimonial I remember coming from an owner of a lumber yard. The long story made short…the owner was talking of his business being up by more than 10% year over year, but when he studied the actual number of board-feet sold, it was lower than the prior year. With fewer units sold, but more dollars through the system, he can only attribute his gains to higher prices, or what most folks call inflation. Soon enough the markets will realize it’s not true growth, but growth through inflation. For now, it’s enough to move money into dollars, but I’m not so sure on how long this will last. While mentioning the slowdown of global economic growth, it’s timely to point out a Bloomberg article with some interesting comments from the World Bank

Global Economic Growth Is at a `Turning Point,' World Bank Says

April 6 (Bloomberg) -- Global economic expansion is at a "turning point" with growth slowing to 3.1 percent this year after the fastest increases in four years, the World Bank said.

Rising interest rates, led by the U.S., higher oil prices, the weakening of the dollar and increasingly lopsided trade balances between countries such as the U.S. and China, are contributing to the erosion, the bank said in a report made public today. The world economy expanded 3.8 percent in 2004.

"Global growth momentum has peaked," the World Bank said in a statement accompanying its Global Development Finance Report. "Developing country gains are vulnerable to risks associated with adjustments to ballooning global imbalances."

The likelihood of slower growth means policy makers must move quickly to reduce budget deficits, and developing counties must prepare for rising interest rates and reduce debt levels. Countries that haven't taken advantage of recent economic growth to reduce their debt will likely face financial difficulties as economic conditions worsen, the World Bank said.

"There is a tendency for financial markets and policymakers to miss the warning signs and overshoot making the necessary adjustment larger when it does occur," said Uri Dadush, director of the World Bank's Development Prospects Group.

The article goes on to detail adjusted growth rates for many key countries for the balance of 2005. If you are invested in emerging markets, Japan or Europe, here’s the link if you want to see the rest of the article.

Favorable Tax Treatment Supports Dollar

Reason number two for money moving into U.S. dollars and supporting U.S. asset prices has to do with a tax change made last October. I’ll give you my two-cent nutshell version, but you really should read Mr. Bell’s explanation to get the full scope of what is happening. When a U.S. corporation has profits from conducting business overseas, to bring the money home (repatriate) they would sell the local currency and buy dollars, then pay a 35% tax on the repatriated profits. In October 2004 President Bush signed legislation that drops the tax rate to 5.25% until October this year. Money has been parked in tax haven countries such as Ireland and Singapore, but with the tax change it is now finding its way home. Nobody knows how much money will be repatriated to U.S. dollars, but two investment banks estimate the amount to be around $100 billion. We get a double-pop here in the U.S. because first the foreign currency is sold for dollars, then the dollars are invested in U.S. stocks and bonds. At a time when our Federal deficits are hitting all-time records, the government decides to walk away from $30 billion in tax revenues for one year. It looks like the powers that be are expecting U.S. corporations to do the heavy lifting in support of the dollar, at least until October this year…then what?

I also found it noteworthy to see that the repatriate funds are to be used for specific purposes. Two that I know of are shoring-up under-funded pension programs. Wall Street likes this because once the money goes into the pension funds, it will most assuredly find its way to the U.S. stock and bond markets. Another item the companies can use the money for is acquisitions, or corporate takeovers. I wonder how many billions of dollars ChevronTexaco has stashed offshore…was this tax break the incentive Chevron needed when the headline came out, “ChevronTexaco to Buy Unocal for $16.4 Billion?” The Wall Street insiders really like this one because it pumps-up the profits for investment banks with M&A activity and supports the dollar in the process.

At the risk of being redundant, I’m posting an excerpt from this most excellent article that appeared on Financial Sense just three days ago. Please note the author’s credentials. Robert Bell is Chairman of the Economics Department, Brooklyn College, New York. The article is laced with literally 30 footnotes substantiating his claims. Here’s the excerpt that really caught my attention along with the link to the full article, “The Invisible Hand (of the U.S. Government) in Financial Markets.”

Plunge Protection’s New Cash

In late October 2004, the U.S. public was looking the other way when the tax cut was passed. Most people were obsessing over who would win the presidential election.  Few were paying much attention to what the Republicans in Congress were doing, which was giving billions in tax cuts to U.S. corporations which had profits parked in tax havens around the world, such as in Ireland or Singapore. Bush signed the law enabling this tax giveaway on 22 October 2004. The tax changes were noted by a few at the time, even before the law changed. But the general level of financial journalism is so bad that they got no real echo in the press. Most people speculating against the dollar had no idea they were about to get stung. Obviously a few knew what the implications of the tax law were. They made out, more or less literally, like bandits. But one cannot legitimately claim insider trading since the tax law changes were publicly available knowledge, and even made it to the internet on various accountant websites in October. But they don’t seem to have gone much beyond these specialists. On 15 January 2005, I had a long talk in Paris with a top European stock market guru. Well connected and with a devoted following which he obviously did not want to burn, he had in all sincerity advocated buying gold to a gathering of thousands of his devotees a couple of months earlier, in November, after the passage of the U.S. tax law.

Most speculators were caught unaware on this source of currency pumping money, so it is unreasonable to assume that there will not be other surprises, which will be announced in due course.

The law Bush signed in late October 2004 goes by the obscenely false name, the American Jobs Creation Act. If there is one thing it will not do is to create jobs. It will instead create takeovers, which nearly always produce losses in jobs—in the name of synergy. Takeovers are on the limited menu of activities companies are permitted to do with the money they can “repatriate” under this law. Not that the limited menu makes much difference, since the money brought in does not have to be fenced off in any way. So if $10 billion were spent by a company on takeovers, that frees up another $10 billion to do whatever was prohibited under the law, such as paying dividends, buying back stock, or filling the pockets of executives with extra bonuses.  Normally such profits earned in foreign subsidiaries of U.S. companies would be subject to a tax rate of 35% if they were brought home, which is why the money had stayed parked in the tax havens. But the law gives companies a one-year window for the “repatriation” of this cash at a tax rate of only 5.25%. Nobody knows how much will be brought in. When the law was passed in October, the general expectation reportedly was that the figure would be about $135 billion. But one player has estimated it at $319 billion. “This has some investment bankers salivating,” wrote David Wells in the Financial Times. But how much would be converted into dollars from other currencies? According to two different investment banks, the figure is somewhere around $100 billion. That would be the minimum available from this source to pump the dollar for one year. Recall that the Exchange Stabilization Fund has less than half that for eternity.

The Bush administration’s use of repatriated foreign profits to pump domestic markets shows that they are not going to let “thin ice” signs stifle their version of the economy, at least not without a fight. However, the underlying weakness of the economy because of the twin deficits remains, so basically all that Bush and his Plunge Protection team are doing is moving the “thin ice” sign out onto thinner and thinner ice. The weight of the Bush team will eventually crash through that ice into exceedingly cold water.

Back to the Closing Numbers

By the end of today’s trading session the dollar remained in positive territory with a gain of .08 on the U.S. Dollar Index to 84.68. Though the dollar was higher, gold and silver were also higher with spot gold up $2.60 to $426.70 and spot silver higher by eight cents to $7.10 per ounce. Most of you know that I am quite bullish on silver. I would throw in my two-cents once again, but Ted Butler already did all the work for me. In his most recent report he said it all, touching on the Commitment of Traders Report, basic fundamentals, COMEX inventories, physical tightness of supplies, and silver’s potential once it gets on the radar screens of some powerful investment houses. Here’s the link to Mr. Butler’s analysis. I’m glad you’re back in the saddle this week, Ted!

I think the bond market got it right with slight gains in today’s trading. The bond market is sniffing-out economic weakness ahead. We’re already seeing many companies issue earnings warnings for the first quarter and lower guidance for the balance of the year. We will probably see slightly higher rates as the year progresses, but I sure don’t see any significant increases; there’s just too much debt in government, business, and in America’s households to significantly increase the cost of money.

The Dow Industrials gained 27 points to 10,486, the NASDAQ Composite had no change for the day closing at 1,999, and the S&P 500 added two points to 1,184. Not much to write home about the stock market today. Just when it looked like some of the financial stocks were looking ready to fall off the proverbial cliff, they are now getting a small bounce with interest rates falling over the last week. It looks like the bleeding may have temporarily stopped for AIG, Fanny Mae, Citicorp, J.P. Morgan and others, but they will still have a big hill to climb since they have NO CLUE how to spell the word L-E-G-A-L…much less e-t-h-i-c-s. Give me a break…why don’t they send these crooks to jail for the incredible damage they are doing to our financial system and to our country with announcements of fraud on what seems like a daily basis!!! This is absolutely shameful for what is supposed to be the most powerful country in the world. Is this how we sell freedom and democracy to the rest of the world? Guess what folks…Rome fell for very similar reasons. If our leaders keep up all the antics, we will surely follow the footsteps of Rome! Oh well, time to go.

Have a Great Evening!

Mike Hartman

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