Commentary

The "Debt Timebomb"

The British Conservative Party's Debt Commission gave it's conclusions during the week. They say that the standard of living of around 15 million people is threatened by the current unsecured personal debt level of £1,920 billion. The Chairman of the commission, Lord Griffiths, a former director of the Bank of England, warned that Britain's personal debt 'timebomb' mountain poses a real financial threat to more than 15 million people or more than 25% of the population.

We are bombarded with so many facts, figures and statistics these days that when confronted with such large figures one's eyes can easily glaze over. When one gets into the realms of such astronomical figures one can easily fail to grasp the enormity of such sums of money or debt and their implications for the wider economy.

£1.92 trillion is £1,920 billion or £1,920,000,000,000 that has to be paid back to lenders plus interest. Much of the debt is in the form of credit card debt which is subject to adjustable rates and in a rising interest rate environment the costs of servicing such debts will increase.

The majority of people should be in a position to maintain their debt repayments. But in an era when many couples are dependent on two salaries in order to pay their mortgages any change in their financial position due to serious illness, family difficulties, loss of a job or any of the many other difficulties which life has a habit of throwing up will create financial distress. There may be a significant minority of borrowers at the margin who will not be able to maintain their debt repayments and their difficulties may have implications for the wider economy with regard to consumer confidence and consumer sales going forward.

Also during the week came the news that in the UK, often held up as a paragon of economic virtue compared to the more lack lustre economies of France and Germany, the banks were forced to write off record levels of debt last year, new figures from the Bank of England have shown. This is in an economy which is meant to be healthy and growing.

Concerns about soaring levels of consumer debt are likely to rise, particularly over the willingness of banks to give large loans to poorer households. Write-offs in the fourth quarter of 2004 are expected to reach a record level of more than £6 billion for the year as whole, according to a report in the Financial Times. The last time bad debt write-offs reached this level was in 1993, when Britain was mired in a recession.

This situation is the same, if not worse, in the U.S. The number of bankruptcy filings is a barometer of the intensifying economic insecurity and ever-rising debt load of American families. Personal bankruptcies have soared from 200,000 a year in 1978 to 1.6 million in 2004. The debt burden carried by the average US household is staggering. In 1946, at the beginning of the post-World War II economic boom, consumer debt amounted to 22 percent of after-tax household income. Now debt is proportionally five times as great, amounting to nearly 110 percent of income.

For much of the postwar boom period, rising consumer debts took the form of home mortgages, car loans and revolving credit balances with department stores or essentials such as shelter, transport and food. Credit card debt (which was generally used for the purchase of less necessary consumer goods but is increasingly being used by distressed citizens in order to buy food and other essentials) only began to become a major factor in the 1970s and 1980s. From 1989 to 2001, according to a recent report by the public policy group Demos, credit card debt nearly tripled, from $238 billion to $692 billion. During the same period, the savings rate plunged and the number of bankruptcy filings jumped 125 percent. While middle-class families saw a 75 percent increase in credit card debt, the more vulnerable were much more likely to plunge over their heads: credit card debt for senior citizens rocketed 149 percent, and for very low-income families, making $10,000 a year or less, the increase was 184 percent.

The explosion in consumer debt is also due to the boom in home mortgage refinancing and the increasing instability of working class and middle class incomes, which has compelled more and more families to rely on credit to offset sudden drops in earnings and sustain consumption. From 2000 to 2003, home mortgage debt soared by more than one-third, from $4.9 trillion in 2000 to $6.8 trillion in 2003. Even though many homeowners refinanced their mortgages to use home equity to pay down debt, non-mortgage consumer credit still climbed by 15 percent, or $300 billion. The proportion of homeowners' equity in their own homes was 86 percent in 1945; by 1990 it had fallen to 61 percent and by 2003 to only 55 percent of the value of their homes.

These huge debt levels in two of the leading economies of the world do not bode well for the long term economic health of the global economy.

Weekly Markets

Precious Metals

Gold futures for April Delivery were down 3.37% for the week. On the New York Mercantile Exchange, gold for April delivery closed at $424.00 an ounce.

Silver was down 6.12% for the week ending at $6.90 an ounce.

Platinum (April) won back a portion of Wednesday's weakness, closing up $6.50 to $862.50 an ounce.

Palladium for June delivery closed the week at $196.15 an ounce.

Some commodity and currency analysts voiced expectations that any further weakness in gold and silver prices could prove temporary. "Gold investors should take heart because if inflation is indeed back, gold is the ultimate hedge against it," strategist and publisher of the Grandich Newsletter, Peter Grandich said.

As Wednesday's trading in the Nymex metals pits got under way, financial markets already had a case of the jitters brought on by Federal Reserve policymakers saying Tuesday afternoon that inflation has become a concern for the U.S. economy. Compounding this, fresh signs of inflation emerged in the consumer price index for February released by the Labor Department earlier Wednesday.

Rightly, there has been much talk recently of Asian Central Banks and particularly the Central Bank of China diversifying their reserves out of dollar denominated assets and into the euro, other currencies and gold.

China has less than 2% of its reserves in gold. China and Japan hold a lot of US debt, but they may not want to hold U.S. dollar-denominated debt for the long term. They are starting to look at diversifying and one of the time-honoured and traditional ways of diversifying one's assets is to buy gold.

The Chinese recently deregulated and liberalised their gold market which allows private companies to sell gold bullion to Chinese citizens and Chinese citizens to invest, save and own gold. This was illegal for most of the 20th Century due to the Chinese Communist governments monopolisation and strict control and suppression of the gold market. An exchange for the sale of bullion in larger quantities have been set up in Shanghai.

Tyrannical and authoritarian governments do not like their citizens to own gold as gold confers economic and financial independence and means that citizens are not dependent on the State and therefore do not adhere to 'the Party' line. Thus there is likely to be a lot of pent-up demand which will have ramifications for the gold price going forward. Like the people of India the Chinese have a strong cultural affinity for gold and there is strong physical buying out of China in recent months.

Chart courtesy of Break Point Trades

Gold's 200 day moving average is at $418.70 and this should provide support. It's 65 week moving average as shown in the chart above is at $414. Were it to fall through these levels it may test it's February low at $411.50. On the upside resistance is at $429.80 and then $436.10 and the March 11 peak of $448 which if it takes out and closes above could result in gold heading to new bull market highs.

Silver found support at the 200-day moving average (680.90) and looks to be consolidating at these levels. Look for mild resistance from 705.00 up to 710.80 the 100-day moving average and then resistance at $7.50.

Oil

Light, sweet crude ended this shortened week mixed as investors considered the impact of the deadly explosion at a BP refinery in Texas late Wednesday. Oil ended Thursday gaining $1.03 to $54.84, but is down by the week by $1.88 or 3.31% and down from it's intraday record high of $57.60 on the previous Thursday.

It seems that China has not even begun to begin to build it's muted strategic oil reserve. Some analysts believe it should start impacting the market in the second half of 2005 with implications for the price of oil.

More regarding Chinese and Asian demand for commodities in the 'Other Commodities' section.

Other Commodities

Reuters Commodities Research Bureau's Index sank 3.9% to 306.88 from 320.15 last Friday. The CRB is up 8.1% already this year but the index has now lost 5.5 percent since reaching a high of 323.33 on Mar. 16, the highest price seen since December 1980. Since hitting a low of 182.83 in October 2001 it is up more than 68%.

There should be support at the psychologically important 300 level and strong support at the 291 to 292 level, which had capped the CRB until the Mar. 22 breakout and at the 200-day simple moving average line comes in between 280 and 285. It is usual in a multi year bull market to test support at the 200 day moving average.

The Reuters CRB Index ( the 17 basic components include hard tangible assets such as Metals, Textiles and Fibers, Livestock and Products, Fats and Oils, Raw Industrials, Foodstuffs). One of the CRB index's greatest strengths is the fact that there is an equal weighting of all of its 17 components. This weighting assures that no price increase in any single commodity, like oil, can significantly skew the entire index. Significant moves in the CRB are only possible when the majority of its component commodities are moving in unison with a particular primary trend. The most important commodities - gold, oil, and silver only account for 3/17th of the entire index.

The Goldman Sachs Commodities Index dropped 2.7%. The GSCI is a world production-weighted commodity index which next year will be composed of 24 liquid exchange traded futures contracts. The GSCI includes energy, industrial metals, precious metals, agricultural and livestock products.

CLSA Asia-Pacific Markets, a leader in brokerage and investment banking services in Asia, said in a report China will continue to drive global demand growth for almost all commodities. China's consumption of steel, iron ore, nickel, copper, aluminum and oil will grow at double-digit annual rates for the next five years. "For investors concerned with commodity prices over the coming five years, the focus should be on how much supply will be coming on line and not the sustainability of Chinese demand."

It said that domestic demand, rather than foreign investment, is driving the commodity boom, making China less susceptible to downturns in other markets. The strength of this demand for resources underpins CLSA's forecast of 8-9 pct GDP growth for the Chinese economy this year and 7-9 pct annual growth through 2010, the report said

CLSA said the main threats to these forecasts are the high proportion of fixed asset investments in China that are government funded, plus the continued dependence on the banking system for almost all financial intermediation in China.

Demand for copper will also continue to grow at annual rates of 10 pct or above, feeding China's growing power network and construction boom. The report said China also has room for substantial increase in demand for steel, with per capita consumption rates still at relatively low levels. On aluminum, China is likely to overtake US as top consumer of the commodity within two years.

On oil, the report notes that the International Energy Association estimated in the late 1990s that China would need 7.1 mbd of oil in 2010, "but it now looks like demand will hit that mark this year." "Consumption has far outpaced domestic oil production, leaving China with a rapidly growing appetite for imported oil," the report said. Liquefied natural gas is the only commodity where China was not driving demand, but that is about to change "in a big way", it predicted. It cited industry sources in Australia as saying China could import 40 to 60 metric tons per year of liquefied natural gas by 2020. About half the demand is coming from power plants

"When it comes to energy and commodities, China already punches above its weight-class," the report said. That hunger for resources is likely to translate into more overseas acquisitions by Chinese companies in the mining sector, it said, noting such investment is still in its early stage.

Currencies

The U.S. Dollar index gained 0.14 points to 84.18 on Thursday and is higher by 2.06 points or 0.8% on the week.

The U.S. dollar index closed at new 5 week highs, the euro index closed at new 5 week lows, the yen closed at new 4 month lows, gold closed at new 5 and ½ week lows.

The euro index lost for its sixth straight day and lost 0.18 points to 129.54 to further its five week lows. For the week, the euro index is down by 3.54 points or 2.66%. The yen lost 0.18 points to 94.06 to further its four month lows and is down by 1.38 points or 1.45% on the week.

Nearly all currencies were down against the dollar for the week. The Icelandic krona dropped 4%, the New Zealand and Australian dollars 3%, the Norwegian krone 2.25%, and the Swiss franc 1.8%.

The Latin American currencies generally outperformed their global counterparts.

Bonds

The 10-Year Treasury note yield fell in a relatively tight range Thursday and lost 0.016 points to 4.591% as the June 2005 US Treasury bond gained 7/32 to 110 5/32. For the week, the yield is higher by 0.18% as the new bond for the quarter started.

Corporate bonds: At the moment, investors consider corporate bonds to be relatively safe and so have been willing to accept yields that are closer than normal to what rock-solid Treasury bonds produce. Unhappy with skimpy returns on Treasurys, investors have bought riskier bonds in search of additional yield, figuring that because corporations have reasonably good cash flows, the risk of default is low.

But last week's earnings warning from General Motors Corp., one of the three largest corporate bond issuers in the U.S. (along with Ford Motor Co. and General Electric Co.), raised the prospect of its bonds being downgraded to high yield, or junk, status, shaking up the corporate-bond market.

The corporate-bond market has been transformed by so-called credit-default swaps - derivatives that are designed to protect lenders from a borrower's default but that increasingly are used by hedge funds and others speculating on corporate financial health and the stock market. The value of corporate debt covered by these swaps is roughly equal to the entire value of all corporate bonds outstanding world-wide - about $5 trillion.

Jim Bianco, president of Bianco Research LLC in Chicago, says complex strategies involving credit-default swaps on multiple companies create the risk of a single company's troubles spilling over to the debt of seemingly unrelated borrowers. Moreover, he adds, many investors in credit-default swaps hedge themselves against losing too much money on them by betting on stock options, thereby linking the corporate-bond and stock markets.

Stocks

For the week, the Dow Jones Industrial Average was down 1.76% to 10,442.87. It was it's biggest weekly fall in six weeks.
On a weekly basis the S&P 500 Index was also down 1.53%, to 1,171.42 after last weeks drop of nearly 1%.
The Nasdaq was down 0.83% for the week and closed at 1191.06 following last weeks 1.66% drop.
The Nasdaq has now closed below the psychologically important 2000 mark and closed below it's 200 moving day average and at it's lowest level of the year so far.

While General Motors GM and Fannie Mae FNM, or the Federal National Mortgage Association, did not continue their terrible stock market performance of the previous week neither experienced a rally.

American International Group (AIG), the world's largest insurer, continued it's poor share performance and was down from $58.90 to close at $55.60 or a loss of some 6% for the week following last week's 7% drop.

There are regulatory probes into unusual and possibly illegal insurance contracts and signed by AIG in 2000 and 2001 and more importantly an investigation into whether American International Group distorted its results by using insurance deals to bolster it's financial position. The Wall Street Journal reported that up to 12 of the insurer's executives had received subpoenas from federal financial regulators. A probe into AIG's accounting practices has rocked the world's largest insurer and cost Hank Greenberg, its former chief executive, his job.

A cursory glance of GM's long term stock performance is sobering and not a pretty sight.

General Motors 2000-2005

http://finance.yahoo.com/q/bc?s=GM&t=5y&l=on&z=m&q=l&c=

General Motors 1962-2005

http://finance.yahoo.com/q/bc?s=GM&t=my&l=on&z=m&q=l&c=

GM's market capitalisation is $15 billion and it has debt of some $300 billion.

GM's debt of some $300 billion is estimated to be some 5 times the value of all the gold in the United States Bullion Depository at Fort Knox in Kentucky or some 147.3 million ounces of gold bullion worth some $62 billion. However, this is just an estimate as unlike other U.S. government assets which are audited on an annual basis by the General Accounting Office or GAO there has not been a proper audit of the U.S. bullion reserves since the Eisenhower Administration.

Interest must be paid on GM's debt and on average interest payments of around 5% per annum would equate to payments of $15 billion per annum. This is the entire market capitalisation of GM being paid in debt repayments per annum. This does not bode well for workers, bondholders and shareholders and pension funds which hold GM bonds and or shares.

Quotes of the Week

"Britons are facing a $1.92 trillion personal debt timebomb. The sheer scale of consumer debt has made millions of households extremely vulnerable to shocks in the economy, both from fiscal mismanagement and external factors such as oil price rises, acts of terrorism and wars. A downturn in the economy would create serious economic and social problems for the 15 million people who struggle with debt repayments. Debt is a time-bomb which could be triggered by any number of shocks to the economy, at any time."
British Conservative Party Commissioned Report on Debt in the UK

"There are some signs which might indicate a housing bubble; increased private buying of housing for letting with the expectation of capital gain, and parents using equity from their own homes to assist children with deposits. But it is not clear how far these changes may have contributed to higher prices. It is also not clear what scale of adjustment in house prices monetary policy should seek to achieve.... Home values are at historically high levels at present in relation to personal incomes.... Low nominal interest rates may have encouraged consumers to boost debt levels to unsustainable levels amid unrealistic expectations about future incomes. There are a number of low income households whose debt levels pose real problems."
Kate Barker, Bank of England's Property Analyst and Policy Maker

"When the Federal Reserve raises interest rates, as it continued to do Tuesday, trouble usually follows. In 1987, the stock market crashed. In 1994, Orange County went bankrupt and Mexico devalued its peso, ravaging its economy. In 2000, the Nasdaq Stock Market bubble burst.... Are markets due for some kind of crisis? "It seems likely," concludes a report from ISI Group, a New York economic-research firm. Even with the boost in the Fed's target for the federal-funds rate, charged on overnight loans between banks, to 2.75 percent from 2.5 percent Tuesday, rates remain historically low. But whenever the Fed tightens, borrowing costs rise and the economy slows. "If a company or country is a weak link, that combination of higher interest rates and reduced economic activity just tips them over," says ISI economist Nancy Lazar. What are the likeliest candidates for a crisis? Some analysts say the record U.S. trade deficit could trigger a disruptive further decline in the dollar's value and a jump in interest rates as buyers of American bonds demand more yield to compensate for their risk. Other possibilities listed by ISI are oil; developing countries, which could be vulnerable if investors stopped pouring significant capital into them at low interest rates; or the financially strapped airline and auto industries. Still, ISI says, "Often, a financial crisis is something that's not on anybody's list."
Greg Ip, Financial Columnist, Wall Street Journal

"Since manias are rare occurrences, gracing us with their presence every 30 or 40 years, how can a crowd delude itself twice in just five years?" His answer was that there are actually two crowds at work. "The tech mania, it seems, was primarily driven by testosterone - Ferrari driving CEOs of dotcom ventures and hyperactive day traders. The present day mania appears to have more balance, with women playing a greater role. Men are more prone to think in terms of abstractions and do things like chase technology stocks into the stratosphere, while a house is tangible and appeals to both sexes." Should this be the case, then both sexes are to blame for what is to follow."
Kevin Duffy, Principle, Bearing Asset Management

"Welcome to the Bubble Economy, 2005. There's the housing bubble and the commercial office space bubble. There's the bond-market bubble and its two progeny, the junk-market bubble and the emerging-market-debt bubble. That $2.50-a-gallon price you see at the pump has all the markings of an oil bubble. And the premiums being paid for all those corporate mergers and acquisitions is a pretty good indication of a stock-market bubble. In fact, nearly every asset market you can think of is showing signs of bubble like behaviour. The reason is pretty clear: The global economy is awash in free cash. "There is an excess of liquidity around, and it is proving very hard to get rid of it," said John Makin of the American Enterprise Institute, using the term preferred by economists."The possibility of a liquidity bubble around the world concerns me," Citigroup Chairman Charles Prince told the Financial Times last week."
Steven Pearlstein, Bubbles Abound In a World of Ready Cash, Washington Post

"The popular notion that an increase in the stock of money is socially and economically beneficial and desirable is one of the great fallacies of our time. It has lived on throughout the centuries, embraced by kings and presidents, politicians and businessmen. It has shattered numerous currencies, inflicted incalculable harm, and caused social and political upheavals. It springs forth, again and again, no matter how often economists may refute it.... American statisticians and economists want to make us believe that America is a new-paradigm exception in this respect, being miraculously able to generate unprecedented productivity growth with zero savings and record-low fixed business investment. The consensus readily believes it. For us, this is macroeconomic rubbish."
Hans Sennholz, Consultant, Author, Lecturer and Austrian Economist

"The U.S. economy has been treated with the most opulent monetary and fiscal stimulus in its own history and also in comparison to the rest of the world. And what did people in America get out of all that artificial stimulus? It is, actually, America's worst recovery by far in jobs and income since World War II or the Great Depression."
Kurt Richebacher, Banker, Economist and Author, Contributor to Wall Street Journal, Barron's, Le Figaro & other publications

"America has become more of a debt 'junkie' than ever before with total debt of $40 trillion, or $136,479 per man, woman and child. 66% ($27 trillion) of this debt was created since 1990, a period primarily driven by debt instead of by productive activity. The seriousness of the problem cannot be overstated. A steep rise in interest rates at this juncture would be the horror of horrors. Normally higher interest rates would strengthen the value of the currency as they attracted foreign investors. Not this time. Apart from the problem of pricking all the bubbles in the economy starting with the housing bubble, and ballooning the budget deficit into outer space, there is an even larger and more immediate problem. And that is the effect that steeply rising interest rates have on the value of bonds, widely held at home and abroad. The effect is inevitable and instantaneous. Higher interest rates make bond values collapse."
Michael Hodges, Grandfather Economic Report

"The economic situation today is reminiscent of the 1970s. The economic malaise of that era resulted from the profligacy of the 1960s, when Congress wildly expanded the welfare state and fought an expensive war in southeast Asia. Large federal deficits led to stagflation -- a combination of high price inflation, high interest rates, high unemployment, and stagnant economic growth.... I fear that today's economic fundamentals are worse than the 1970s: federal deficits are higher, the supply of fiat dollars is much greater, and personal savings rates are much lower. If the federal government won't stop spending, borrowing, printing, and taxing, we may find ourselves in far worse shape than 30 years ago."
Dr. Ron Paul, U.S. Congressman, Member of the House Financial Services Committee

"From the beginning of 2001 to the end of 2003, the economy added $1.317 trillion in gross domestic product and $4.2 trillion in debt. That means that each new dollar of economic output was accompanied by $3.19 in new debt. So now, for the first time, the debt-to-G.D.P. ratio stands at more than two to one. Higher collective leverage, in turn, means that we're more susceptible to external shocks. "The bigger the debt, the smaller the margin for error," said Austan D. Goolsbee, a University of Chicago economist. Companies with no debt can weather several lean quarters; companies with piles of debt often find that a single bad quarter spells disaster.

The same holds for consumers. All kinds of wild cards that are scary even in placid times - another spike in gas prices, a rupture of the housing bubble, fresh job losses, a period of sustained inflation - become nightmares during times of greater leverage. So as we go to bed with our suppers and our home-equity lines of credit, Professor Goolsbee says: "I think we should be a little nervous."
Daniel Gross, Journalist, Editor and New York Times best selling author, New York Times

Key Events in the Week Ahead

The key event of the week is the March employment report on Friday and April Fool's Day.

Wednesday brings a revised read on gross domestic product growth in the fourth quarter. GDP is expected to have grown at a 4.0 percent annualized rate, versus an earlier 3.8 percent reading.

Oil markets nervously await Wednesday's weekly oil inventory report.

Personal income and spending figures Thursday.

February factory orders due Thursday.

Besides the jobs report on Friday also due is the revised University of Michigan March sentiment reading and the Institute for Supply Management's manufacturing index.