Welcome to the Weekly Report. A couple of weeks ago one of my subscribers asked me this question:

• "Does your scenario change of how you think things will play out i.e.

  bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation.

  Assuming that Paulson passes the Bail out package as initially presented? Or will your scenario still hold, and we still are heading for eventual deflation. In other words can enough "moral hazard" prevent deflation."
  

$700 Billion dollars have been created to supply liquidity to enable credit to flow once again from the Banks. All the Banks have to do is dump the toxic assets that are killing their balance sheets with the Federal Reserve (as predicted in a tongue in cheek article here) allowing capital reserves to be lowered and releasing funds to enable lending to begin again. By the way capping pay and golden parachutes for Bank executives will not work, a half decent lawyer will find a way around that problem in his lunch hour.

This bail out is not a cure, it's a continuation of a failed, broken and corrupt banking system. I hope everyone noticed that the $700Bn payout was passed after the addition of another $100Bn in new tax breaks so that some of those previously voting nay could vote aye. We also discovered that the situation was so serious and the timing so tight that the US Treasury will move at breakneck speed to set up the auction process, they'll have something cobbled together in a month! Yet a week ago we told that a complete breakdown in the financial system was due within 2 days. Maybe the clocks run differently in Washington?

I digress. So has the scenario I have been following been affected by this bailout, this massive dose of moral hazard?

No, it has not. If anything we have begun to see the first round effects of deflation appear even as the supposed inflationary helicopter drops take place. This is a credit bust, Banks and now large Conglomerates are hoarding cash and cash like assets as they watch the contagion spread. It is the only way they can protect themselves as loans and creditors start to default. This hoarding of cash is apparent in this chart:

Courtesy of Stockcharts.com

FX markets have not reacted as one would expect to a massive injection of $'s into the financial system. The Dollar is now stronger in relation to the Yen and Euro than at any other time over the past year. This at a time when the Fed have done this:

Thanks to Colin Twiggs at Incredible Charts

Why is the dollar stronger? Because there are less of them available in the economy and demand is still high. As I have said more than once, deflation is not just about the destruction of notes or electronic entries or even a reversing of the printing presses. Deflation can (and did) occur when $'s are locked away in vaults and the electronic equivalent of vaults, withdrawn from the economy and removed from the fiscal system.

How is this manifesting itself in financial markets? Here is the outstanding commercial paper (CP):

Asset backed CP has halved since mid 2007, a withdrawal of credit of about.....$650Billion. Add in the recent reduction in financial CP and we are at the $700Billion figure that Paulson/Bernanke quoted but wouldn't explain. It looks to me that the plan is to swap those toxic assets that no one will accept as collateral on short term loans for Government backed debt or, in extremis, cash. The hope is to reinvigorate the "borrow short/lend long" business model, the very model that imploded just over a year ago. It shows a staggering lack of understanding or imagination by the US Fed and Treasury.

This isn't even a bail out, it is a puncture repair patch slapped on the deflating tyre that is credit. What happens when the next layers of MBS/ABS/CDO devalue and become unacceptable as collateral for commercial paper? What happens when Credit Default Swaps fail to pay out on events? Do we just see Paulson bend down on the other knee as he begs for more?

The charts below tell the story of why it is different this time. AAA and BAA Corporate Bonds rates continue to rise as buyers look for a higher risk premium even as Fed Funds price in another cut:

Spreads are now at levels last seen in the aftermath of 9/11, with one very important difference, corporate rates are in a rising trend, unlike the trend into mid 2003. Corporate Bond buyers are no longer pricing in a recession, they now see a real fear of widespread default. We have seen AAA corporate bonds go from risk free when compared to Fed Funds Rates to utter fear in 18 months. Corporate Bond Treasurers held an emergency conference this week as banks continued to tighten and hike rates on borrowing. "Capital is fleeing to safety" said Mr Liebert of Rohm and Haas.

The availability of credit has become scarce in all markets. The Municipal Bond market has all but frozen with activity down 85% from a typical week; college funding was effectively withdrawn by Wachovia.

The simple question is what happens when Corporations attempt to either roll or issue debt? Do they accept punitive rates as they bid for scarce funds or do they just repay what they owe and try to survive on cash flow? Corporations can no longer rely on rolling over debt to put off the payment of the original principal, they will have to build up cash reserves. That will force unemployment higher and investment and expansion lower.

Or do we see "bail out 2" forming on the horizon with the Fed and Treasury issuing cash in exchange for Corporate debt? Is the rest of the world willing to allow the US to "nationalise" Corporations so that they can continue to dominate global markets?

Why would such a bail out be required? Because in July Banks already expressed concern about economic conditions and the situation since then has, as we all know, deteriorated considerably since then. This from the Feds Senior Loan Officer Opinion Survey:

• 3. If your bank has tightened or eased its credit standards or its terms for C&I loans or credit lines over the past three months (as described in questions 1 and 2), how important have been the following possible reasons for the change?

  A. Possible reasons for tightening credit standards or loan terms:

  b. Less favorable or more uncertain economic outlook

  

  
  

So where do I place us in the scenario?

• FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation.

What of gold, the safe haven in troubled times?

Courtesy of Stockcharts.com

We see the tight correlation that began in July to the Dollar continue. More disturbing for gold bulls is the clear downtrend in place. Gold isn't pricing further inflation into the scenario whatever the size of the bail out. Maybe this will change and a premium will be put back into the price but right now I doubt it. Gold is mirroring the moves in the dollar and with a shortage of dollar liquidity as demand increases the situation could last for some time.

I mentioned earlier that I did not believe the bail out was necessary in the form it took. It only buys a little time in a system that has already failed, like throwing your best reserves into a battle that is already lost. What is needed is the ability to see the battle is lost and organise an orderly retreat, acknowledging the failure of the battle plan and the losses it caused. You can then regroup and rebuild using the previous experience to find a new way to fight the cause, re-examining the strategic and tactical approach to the problems.

Bail out or no bail out the first thing we must recognise is that this battle is lost. It will result in much damage and hurt to individuals, corporations, small businesses and banks. It cannot be avoided. Now is the time to organise an orderly retreat, not by throwing resources at the sectors beyond repair but by preserving those areas that can continue.

We have to find a way to wean the economy of the world away from credit, away from leverage and into a mindset that allows savings to exist without the threat of inflation. This has to start with the US (and looking at recent evidence of deteriorating circumstances, Europe, Australia and New Zealand should not be far behind). Debt has to be drawn down, across the whole spectrum; the markets have already begun to do this as mentioned earlier.

This requires some long term planning and radical ideas. Debt has been attractive because inflation allows the debt burden to fall over time. Lenders are recompensed by charging interest on the amount lent.

This has to stop.

Here is the beginning of an idea of how the economy should be run in the future:

All mortgage and secured debt should be centralised and interest accrual suspended for the life of the loan. This would ensure that all underlying derivatives would also be secured. Payment should be made direct from the wages/income of the borrower.

Unsecured debt, including credit cards must be frozen and interest accumulation halted. The capital will be paid down by small payments direct from wages or pensions to the lender or whoever owns the debt if it has been re-packaged and sold on.

Lenders can offset outstanding debt against taxes at a set ratio.

Those who become unable to work or find work should have payments maintained from a Government funded insurance scheme. In exchange the claimant will donate time and effort to government volunteer projects.

If the lender funded the loan by "the borrow short/lend long" model then tangible assets and reserves should be used to pay off the short term borrowing. The long term debt will be serviced by a payment stream from the centralised mortgage pool. Banks would receive staged monthly payments to replace the centralised assets. (debt owed to a bank is an asset) If those mortgages have been sold on in MBS packages then the owner of the MBS receives the payment. If the bank does not have the capability to pay their short term borrowings then the income stream from the centralised fund will be used to make payment. During this period the Bank will be granted a protected status until their borrowings are paid off. During this period the Bank will not be allowed to accept deposits of make loans.

The Federal Reserve will have a remit to ensure that the dollar remains strong by use of deflationary measures. The Federal Reserve will use the reduction in the supply of money, not interest rates to control the dollars strength.

Interest rates will be abolished. The use of credit and leverage will be outlawed. Expansion will only be enabled from the use of savers long term deposits, lending using instant access accounts as collateral will not be allowed. Any lending using deposits must mature at the same time as the lock out to the deposit savings passes. Profits can be used for expansion but 10% of all pre-tax profit made using a loan must be placed in the reserves of the Bank or Corporation. Borrowers of such funds will pay 50% of the pre-tax profit made back to the Bank. If a loss is made then the assets of the company will be liable to recover the outstanding debt.

Depositors will be given a proportional share of the 50% profit made by the Bank on the loan. Taxes on profits will be structured to reward low risk returns for depositors, banks and borrowers. If a company uses profit from previous investment for expansion then tax breaks will be allowed on any further profit made.

What though of those who wish to purchase a home after such changes? With lending severely curtailed houses will have to re-price lower to a level where affordability is within the new lending regimes and the ability of potential buyers to save for and service. These prices will be much lower than current levels.

However the Government holding the centralised mortgages could reduce the outstanding debt, re-pricing it lower in lockstep with the falling prices in the market. This would reduce the income stream to those who previously held the mortgage debt but with the dollar strengthening both domestically and internationally the reduced back payments would have a stronger purchasing power, offsetting the loss of the number of dollars received.

What of exports? Well without the need to constantly expand wage bills and costs of materials exporters will be able to re-adjust prices lower in dollar terms. Wages and costs can be allowed to fall as the purchasing power of each dollar grows. Think of it this way, I would rather have $10 that could purchase Eu30 than $10 that bought Eu10. Of course imports will be cheaper using high value dollars, reducing energy and material costs. It would also attract inward investment.

Remember constant expansion of GDP in the current regime is only required because of inflationary effects. In a deflationary environment such expansion is no longer required, instead wise investment of savings into profitable enterprises would allow a grown of true wealth, measured by appreciation of the currency, the lack of debt and the strength of Government revenues.

Would this cause mass unemployment? I would point out that current levels of unemployment are rising and increasing month on month. This is not due to wise investment and the lack of the use of credit in an economy. Unemployment is rising because business is attempting to save cash and cut costs or the business has failed. This has happened in an inflationary environment. We may be heading for deflation but deflation did not cause this rise in unemployment.

Using deflation to control monetary supply allows current savings to appreciate and allows the dollar to have higher purchasing power. A Corporation would rather have the ability to invest and expand without having to allow for interest payments on debt or inflation affecting its income. Profitable enterprise will be rewarded and expansion will be because of demand for product. Success will attract expansion and increase employment.

This is just an idea based on the premise that to remove credit from an economy (and the leverage it needs in the form of inflation) requires a re-pricing lower of assets and a reduction of currency in circulation. It probably has holes in it as a plan but as I said the current situation requires a radical rethink and a solution that does not include the reasons for the failure of the current financial system.

Whilst the amount required from central funds (and foreign investment) would be far higher than the current $700Bn it would be used to change the way the economy functions, rather than attempting to allow a failed system to stagger forward for another few weeks or months.

Many will read these proto-ideas and dismiss them as unworkable. Whilst the plan is embryonic it cannot be criticised by applying current economic thinking. Keynes, Friedman et al belong in the dustbin of history, their theories are refuted by the results of the experiment.

What we do know and can demonstrate throughout history is that a strong currency and a lack of inflationary expansion does not result in a destruction of wealth. Such conditions encourage savings, investment and responsible expansion to meet a true demand. Profits are achieved through successful business models; investment in such business is rewarded by a share of the profits. However if the business fails then the risk is spread evenly amongst investors and the banks.

Banks must no longer have the ability to falsely inflate monetary supply through leverage; they must once again become custodians of savings and the steady hand on the tiller of investment. All banks must be subject to constant Federal oversight.

Eventually as debt incurred during the inflationary era is paid down or written off the system will stand on it's own without the need for Government intervention. Oversight will become the new buzzword, investment opportunities will be examined in detail with full transparency and excessive risk will be actively discouraged. The study of the financial disasters of the past 400 years will become a mandatory part of the education curriculum, students will be taught why inflation devalues savings and that paying interest on debt enslaves individuals.

If you want intervention then it must be in recognition that the system doesn't work, repeated intervention shows that the system cannot be repaired if it is based on false theories. Intervention can only be justified to change the system, not repair it. A move away from the current credit reliant financial system needs support during the transition; it has to allow time for the new "non credit" system to be set up and the re-education of the public, government and business in the new way money is used.

It is time for change but not the "change" politicians talk about. The world can and will prosper and improve the life of its inhabitants without the use of credit and leverage. Capitalism can function without credit, it is not a requirement of capitalism to have unbounded leverage. However capitalism does require savings, investment and a sharing of profits. It also requires failure and the results of such failure to function, clearing out poor business models and allowing others to try by applying new approaches and true innovation.

Finally and most importantly the public must ensure that those they elect to govern them and the appointees they make are answerable at all times for the good governance of the Country. To aid this all forms of paid lobbying must be outlawed and all the investments of public officials must be placed in a blind trust whilst they hold office.

Welcome to the Weekly Report. This week we use the words of Ben Shalom Bernanke to describe why the $700Billion bailout will fail. I am going to assume the Bailout is enacted in one form or another and is probably announced around the Far East market opening times. However, there is a possibility that if Congress has not agreed then no soothing words will be forthcoming and a crash in share prices is used to "galvanise" action. We shall see.

What does Ben see as the biggest problem in the markets, be it shares, assets, commodities, bonds or derivatives?

Where better to find out than by examining his paper "Long term commitments, dynamic optimization and the business cycle" submitted in May 1979 as part of his Doctor of Philosophy degree at MIT.

Ben divided the work into 3 short essays, each a"theoretical study of some form of long term commitment made by economic agents". As Ben is an academic he has belief in his own pre-dispositions, his work stands as an interpretation of what he thinks happens in the world, in this case the world of investment. This week I want to concentrate on his analysis in Chapter 1, the problem of making "irreversible investment decisions when there is uncertainty about the true parameters of the stochastic economy" entitled "On the timing of irreversible investments"

I think it is most apt considering where we are in financial history. I shall quote his work as we go along.

Basically Ben is stating that the timing of an irreversible investment is based on incomplete information and as the timescale shortens the lack of information makes the irreversible decision harder. Add into the mix a period of uncertainty and high volatility and the investor is left with 2 decisions.

If the investor decides to enter a position in such conditions then the position is likely to be irreversible and takes away the ability to "react flexibly" on receipt of new information.

However the investor can make a different decision (an echo from Jessie Livermore?) and that is not to commit to a position, instead waiting to "find out the long term implications before they act."

This reaches deeply into the thought processes of Ben Bernanke, the paper studies the "making of durable, irreversible investments." Could anything written by Bernanke be more apt to the current situation? I think not. Ben goes on to explain an irreversible investment:

"Once a machine tool is made......it cannot be transformed into anything very unlike a machine tool without prohibitive loss of economic value - this is what we mean by irreversibility"

We shall come back to that remark later.

Ben goes on to explain why irreversibility creates an "a-symmetry" between the acts of "investing and not-investing", something I would read whilst thinking "short selling ban". He goes on "if an agent invests and new information reveals that he should not have, then he cannot undo his mistake; his loss accrues over the life of the investment. If an agent fails to invest, when he should have, he can still make up most of the loss by investing in the next period (Ben is referring to the business cycle)"

This has major implications for the bailout. Even Ben has to admit that the pricing of toxic debt, all those securities he is willing to swap for cash is incomplete to the extent that he cannot do anything other than offer a ball park figure, a guess.

What we have is an irreversible investment being touted on behalf of the US taxpayer. We have a lack of transparency, a lack of pricing, a refusal to acknowledge if the trade is of suitable size to reach the desired investment target and most importantly a lack of new information to decide whether we should "go in" or "stand aside".

Bernanke and Paulson have shortened the time horizon, through the constant referral to "urgent action is required or face meltdown". This ensures that Congress have to make a decision on incomplete information. They are forcing Congress to disallow the ability to stand aside by not allowing them to wait for new information. It is manipulation of the highest order and in Bernanke's own words "an a-symmetric" situation between "investing and non-investing".

Even Ben knows that forcing this issue is wrong, as he states:

".....when the environment is in a state of flux or uncertainty, a wait-and-see approach is most profitable and investment is low."

So why is Bernanke ignoring his own thesis, the building blocks of his own academic house, to allow what he knows is a bad investment? Because he believes it can be changed into a good investment.

Bernanke and Paulson are as much in the dark about what the toxic debt is worth as everyone else. To say that the buyers have left the room is an understatement; no one trusts an instrument that cannot be priced.

So during the week Bernanke said it would be a good idea to buy these assets at either a higher price that quoted, for those that have a quote or pay full price on the hope that by maturity they will have recovered to original face value. This is an attempt to force the buyers to recognise that a high bidder has entered the fray, not so much to ensure a higher price is fixed but to provide a quality boost, a government assurance, if you like.

Thus even at low current prices the toxic debt has a measure of quality it did not possess at the beginning of last week, almost like it has had an upgrade from a Credit Rating Agency. Was this a not so subtle attempt to try and remove some of the uncertainty and flux from the markets?

Either way the decision for Congress should be to adopt a "wait and see" approach and not to invest on behalf of the Taxpayer whilst the information is incomplete in current market conditions. For Bernanke to go against his own advice must surely place doubt upon his credentials and integrity as Chairman of the Federal Reserve.

The bailout will fail because it is a bad investment and it is Bernanke who told you that that "If an agent invests, and new information reveals he should not have, then he cannot undo his mistake; his loss accrues over the life of the investment." Remember a machine tool once made cannot be changed without major economic outlay. Bad debt, repackaged and sold as an investment is subject to the same forces, it cannot be changed without incurring a high cost.
This deleveraging, the unwinding of the greatest credit based bubble in history is not over, the losses are not finalised; the information is incomplete.

Whilst all of this gives us an insight into the thinking behind the bailout, or rather the apparent haste in which it has been conducted I have uncovered something else that would also add to the doubt about Bernanke's thinking.

In his book "Nonmonetary effects of the financial crisis in the propagation of the Great Depression" Bernanke worried (correctly, in my view) that the lack of credit and credit facilities and the higher price of credit had a greater effect that the decrease of money stock. However he thought such effects would have the biggest effect on smaller rather than larger firms.

However as quoted in "The banking panics of the great depression" by Elmus Wicker, Temin devised a test of Bernanke's hypothesis. In his simulations "he found that all of the coefficients of the Bernanke regressions have the wrong sign; that is, in the more concentrated industries, the fifty largest firms suffered the largest decline in production."

Now whilst this might seem to be nit-picking it does raise a very serious and important point. Bernanke is turning away from his own work and thoughts to support the bailout. Worse he may very well be doing so on very incorrect assumptions.

I have to ask is he capable of doing the job entrusted to him? Is he the academic weak link?

More importantly The Collection Agency comes up with a viable plan on how we stop the credit crunch, depression and the end of the Western World.

In other words you, the taxpayer are going to pay for the mistakes, the pitiful delusions of those that thought they could overrule markets by thinking "innovative". It's obscene and worse it does not address the problem.

The problem remains because Paulson et al do not understand what has happened, how the system has been so abused that it no longer functions. Ben Bernanke knows why, he studied in depth what caused the last failure of the Keynesian dream. His attempts to bypass the inevitable outcome were summed up by this writer in a series called the Eggertsson Theory, available for free at An Occasional Letter. However the Monetarist approach adopted by the Fed is struggling to survive as a viable option as the whole financial system does what any Ponzi scheme does and collapses in on itself.

The latest plan is for a Government "Bad Bank" to be set up, funded by Treasury Debt converted to cash by the Fed and used to "buy" (without a pricing mechanism?) poorly performing or defaulted privately invented securitised assets. It is being touted as the cleansing of the financial world to achieve nothing more that the ability to re-create the same conditions that existed over the past 80 years. Again this is no surprise to this writer, I suggested some time ago that the moves made to shore up Fannie and Freddie would not mean the survival of these GSE's and that it was more likely that a new Institution would appear. All that Paulson has done is to revive the M-LEC idea, a Government held and controlled Super SIV, moving the debt of Banks and Nationalised Assets to an off balance investment vehicle. Although some in Congress are warning about the possible long term risks and damage such a scheme could cause, I expect Congress to do what it has always done after its members see the damage done to their own investment portfolios.

What happens to these asset back instruments once they have been placed under the control of the State Politburo, sorry, government is unclear. Is the debt forgiven, is it traded out in the future during the next boom and scramble for investment returns or is it encased in glass and dropped into the deepest part of the Atlantic to lay forgotten?

No wonder my Moral Hazard Outrage Indicator melted. The taxpayer sees an increase in debt that makes anything ever done by the US in the name of financial stability look like small change. This will cost over a Trillion dollars (where have we heard that figure before?) to bailout a failed Financial System. This has nothing to do with "keeping house prices high" it has no benefit for those already in or entering the process of default.

Let us be blunt, if you make money by ignoring risk and applying ridiculous modelling to financial assets you should suffer the losses too. For those who decry such a stance, saying that it would cause the financial system to implode, face facts - the system doesn't work.

If you allow the unfettered use of credit and leverage then without exception the unwinding will be catastrophic. Joe Public doesn't care anymore, his access to new credit has become restricted to non-existent and he is already suffering the fallout of this stupidity. We allowed the use of credit to build the economy which allowed failed business models to continue to function long after their natural life expectancy.

Still it hasn't stopped Paulson in his attempts to move beyond the law and spread the idea to the rest of the world:

• Sept. 21 (Bloomberg) -- Treasury Secretary Henry Paulson said he's confident several countries will take steps comparable to the $700 billion plan he proposed to buy bad mortgage-related securities to address the global financial crisis.

  ``We are talking very aggressively with other countries around the world and encouraging them to do similar things, and I believe a number of them will,'' Paulson said on ABC News' ``This Week'' program.

• By Alison Fitzgerald and John Brinsley

  Sept. 21 (Bloomberg) -- The Bush administration sought unchecked power from Congress to buy $700 billion in bad mortgage investments from financial companies in what would be an unprecedented government intrusion into the markets.

  Through his plan, Treasury Secretary Henry Paulson aims to avert a credit freeze that would bring the financial system and the world's largest economy to a standstill. The bill would prevent courts from reviewing actions taken under its authority.

  ``He's asking for a huge amount of power,'' said Nouriel Roubini, an economist at New York University. ``He's saying, `Trust me, I'm going to do it right if you give me absolute control.' This is not a monarchy.''

  As congressional aides and officials scrutinized the proposal, the Treasury late yesterday clarified the types of assets it would purchase. Paulson would have authority to buy home loans, mortgage-backed securities, commercial mortgage- related assets and, after consultation with the Federal Reserve chairman, ``other assets, as deemed necessary to effectively stabilize financial markets,'' the Treasury said in a statement.

  The Treasury would also have discretion, after discussions with the Fed, to make non-U.S. financial institutions eligible under the program.

These assets are toxic for a very good reason. Too much money was looking for a return and that allowed lending to happen at very lax standards. Then some bunch of merchant bankers decided whilst munching through a Chinese takeaway to bundle the debt into packages and sell it on, freeing up the capital to allow the process to continue. All that risk was introduced into the financial system without a single $ to back it up. If you wanted to insure yourself against loss you agreed a Credit Default Swap with a third party. They wrote the insurance for a fee and you got your cover. Unfortunately as we have seen with AIG and others, they didn't have the money to pay out when a triggering event happened, the insurance was worthless.

Now we have Paulson touting another insurance scam, where the Taxpayer has to allow a devaluation of the dollar without an increase in spending power. Worse still the Taxpayer now has to watch as the Treasury and the Fed securitize the debt and give cash to the very Institutions that caused this to happen, for the second time in less that 80 years! Does anyone not see what happens next? The new cash is used to start the same process all over again. This no cure, this is no bailout. This is a continuation of the same broken, corrupt and unworkable system that has been used since the inception of the Fed.

Its time for the system to change. The pain is already coming as the availability of credit for business and consumers comes to a halt. This new cash isn't going to help them, it'll just be directed to the next "big thing". So what can be done to alleviate the problems and set up a new way of running and living in an economy?

Firstly the new cash must not be given to the Institutions; they will only blow it again causing an even bigger mess. By all means take the liability away from the Institutions and transfer it to the Taxpayer, let the Institutions clear the books and purge the debt. Then place them in a regulatory hell which refuses them access to leverage or the ability to create money without very large reserves. They will think much more carefully about where to invest if their assets are rarer. The word "risk" will be the first thing anyone mentions when an investment plan is put forward. Limit their take on returns to a maximum of 4% a year, anything over this has to go back into the "Bad Bank" SIV without any relaxation of regulation. Place oversight into the back offices so that the Institutions cannot limit their gains to 4%. Increase the levels of taxation upon profits. In effect make the flash world of finance revert to the dull world of traditional banking.

Secondly, the new cash should be directly used to lessen the debt burden of the Taxpayer. Either the mortgages or loans should be reduced by a one off payment and/or the amount of interest paid should be subsidised. This has the bonus that a reduction in the amount owed allows a re-pricing of the debt within the Bad Bank SIV to a realistic level, it also allows a lower income stream to be feasible in servicing the toxic debt. As the new owners of the debt the Treasury can set the expected level of return, in effect quoting its own mortgage rate.

By reducing the amount owed and the interest paid the housing market can settle into a realistic pricing mechanism which will result in lower, achievable prices that can be attained by new buyers without resorting to financial innovation (lying and cheating about income). Those in possession of mortgages can see a worthwhile reason to continue servicing a lower debt burden, slowing and stopping the defaults and keeping the asset backed bundled debt viable.

This is not price inflationary for consumer goods. We already know consumers are tapped out and unable to purchase staple goods, let alone luxuries. The freeing up of a part of the previously non-disposable income to the disposal side of the accounts will not cause a buying frenzy, without access to free and cheap credit the consumer will have to save to buy goods.

Finally, we never allow the current form of economics to rule over the financial system and the people ever again. Get Congress to ban it.

The punishment will be served upon the Institutions who rightly deserve it; the relief will come to the Taxpayer that bailed them out.

Welcome to the Weekly Report. This week we look at Gold. I am not a gold-bug, I do not believe much that it written by the gold traders, fund managers, bloggers and other assorted gold related doomsters. Subscribers were warned some weeks ago to be very careful of what they read in the gold community, it has a habit of trotting out far fetched scenarios when gold drops. Indeed when technically based (charts) writers start to trot out lines as to why they are going to ignore what the chart is telling them it reminds me of the Dot.com commentary as the Nasdaq collapsed.

I own physical gold and have done for years but in the first Quarter of '08 I hedged those holdings by going short gold in my trading account. That hedge remains in place and will only be removed if gold goes above $1000 area or drops back to the support at $328.

The hedge was placed by observing that gold had gone parabolic. As most TA practitioners know, parabolic rises usually end in tears and huge heart rending sobs of despair. Now whilst the gold community tell you not to sell and to use the drop in price to accumulate more gold, I advised subscribers and others to look to the short side. This resulted in a fair number of rather nasty emails from those who read my stance on gold at sites like Safehaven and Market Oracle. I know many in the gold community truly believed gold would bottom out at each and every bounce on the way down and who knows, they may be right on the next bounce but so far gold is doing exactly what all charts do after a parabolic rise.

Here is a monthly chart of gold going back to 1998 with some simple support and resistance levels:

I haven't bothered with trendlines, my chart doesn't go back that far in history.

Without doubt the $729 area looks important for gold and a break would trigger further downside moves. However I use a very simple maxim (not mine) that support is support and resistance is resistance. Most times they do what they are meant to do. So I will watch the chart and see what happens, rather than try to second guess the tape.

Here is a monthly chart of the RTS Index (Moscow):

Have Russian stocks found support? Would you be buying stocks in the Motherland on Monday opening? Maybe support has been found but right now, just like gold, it's in a downtrend and buying could be compared to trying to catch a falling knife.

Here is a monthly chart of the S&P 500 again with simple support and resistance:

Of course gold is not the S&P 500 and nothing in the books say it has to act the same way but I constantly remind subscribers that the words "it's different this time" should send a shiver down an investors spine. Yet it's a phrase that constantly comes to mind when I read various gold bias articles, as if deleveraging and a withdrawal of liquidity from financial markets and assets somehow bypasses gold or other commodities. The following monthly chart is Euro/Dollar:

So a fall in gold as the dollar rises would be perfectly natural, notice the rise in gold and the Euro have many similarities, gold cannot be seen as a standalone entity. Gold commentators used the weakness of the dollar to justify the rise in gold, the flip side of that argument cannot be dismissed or hidden behind rumours of a delay in physical delivery. Maybe the delay is for suppliers to charge at a higher quote and deliver at a cheaper future price to themselves, rather than a shortage caused by mysterious motives.

As for calls that the US Fed and Treasury are devaluing the dollar by their delivery of liquidity measures the charts tell a different story. The fall in the Euro, Pound and Yen may well be due to Central Bank coordinated intervention but so what? The market has moved and no one knows when the strengthening of the dollar will stop. Ignoring the move or believing in theories as to why it won't continue hasn't protected gold buyers since late October '07.

I am not saying gold will follow the same path as the Nasdaq but no one out there can tell me it will not. We all read calls for the bottom of the housing market with a large degree of cynicism:

Why not apply that same cynicism to calls for gold to rebound?

Gold topped in March at $1031 and dropped to $736 last week, about a 30% loss. I do not view a fall like that as a buying opportunity on the way down, I'd much rather wait for a sign that gold has bottomed and then begun to move higher before adding to my position. What the future holds for gold is not known, all I see is that gold is suffering from the downside of a parabolic rise. How long that downside lasts for is a question no one can answer, it could finish tomorrow or it could last for years:

Keep your hard earned capital safe, wait for the bottom to have been and gone and go with the new uptrend, do not try and catch falling knives. The examples above cost many a trader and investor more than they could afford.

Welcome to the Weekly Report. This week we look at the end of Fannie and Freddie and ponder why PIMCO are screaming for help.

Regular readers may have noticed that the Weekly Report hasn't been available on the excellent Safehaven.com or The Market Oracle since July. Nothing sinister to report, I just thought that subscribers deserved a bit of added value and some excellent TA on the direction of gold.

By the way, I see John Mauldin is beginning to see the problem that some of us saw coming over the past 2 years and a situation I reiterated in this article. (About half way down.) I mention this because I believe it may be related to the PIMCO poser mentioned in the headline. For now, let's just say that I believe there is a major problem in the bond markets and those Fund Managers that have supported (and partied) with each other are not adverse to a bit of supportive cheerleading. It's an example of why traders and investors should be very careful about divining the future from the readings of some writers.

Speaking of taking care about what someone says and then does, Bloomberg reports that Treasury Secretary Hank Paulson is yet again doing overtime on a Saturday, announcing the end of Freddie and Fannie:

• "Sept. 6 (Bloomberg) -- Treasury Secretary Henry Paulson is preparing to announce plans to bring Fannie Mae and Freddie Mac under government control, seeking to halt the crisis of confidence in the companies that make up almost half the U.S. mortgage market.

  The decision follows the Treasury chief's repeated comments to lawmakers in July that he wasn't likely to use taxpayer funds to prop up the federally chartered, shareholder-owned firms.

  
  Pacific Investment Management Co., manager of the world's biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, said Newport Beach, California-based Pimco fund manager Bill Gross, in a Bloomberg Television interview.

  Washington-based Fannie and Freddie dropped in after-hours trading. Fannie fell $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70."

This wasn't difficult to see coming since the turn of the year, as I have mentioned before the "borrow short and lend long" business model, funded by selling debt into the marketplace is dead and has been for sometime. However the taking of F&F into "conservatorship" reopens the debate about moral hazard, the moving of the liabilities from the private sector, the bond holders and investors to the Tax Payer. Simply put the US financial system is being socialised, the capitalist responsibility to losses abrogated and those that bought F&F debt are being bailed out. The problem is no one wants to buy F&F bonds unless it has an actual guarantee from the US Government, implicit was no longer enough in these days of deleveraging and liquidity tightening.

Yet again, just like Bear Stearns, we see the markets bypassed as the bailout is implemented after hours on a Friday. How long will investors being willing to hold stocks over a weekend in any company that has a weakened capital position? It is more than possible that this bailout may well trigger another, that of investors heading for the exit. No wonder the Dow had a week like this:

Looks to me that some have already tip toed out of the theatre but there may still be an opportunity for those watching banks and financials:

Note the resistance around 75.

Note the resistance at, errrrr, 75. No recommendations of course, just an observation. So here we are faced with another bailout, another acceptance of moral hazard only this time the Fed and the Treasury ensured the rules, regulations, laws and mandates, not forgetting to mention the funding, being pre-approved (remember that phrase?) by the lawmakers and the President in the summer.

However will the nationalisation of F&F be enough to placate the bond holders? If I held the debt I would be wondering whether the next move might be a debt swap, devaluing the worth of the debt I own as the US Government attempts to re-negotiate its position. This whole mess is very far from over, if you want to recap my thoughts on this, click here to visit my free 21 month update which included a resume of F&F's problems.

Bill Gross at PIMCO is looking more nervous each time I see him.

• "And now, while some will compare current government bailouts to Slick Willie, citing moral hazard, near criminal regulatory neglect, and further bailouts for Wall Street and the rich, common sense can lead to no other conclusion: if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the US Treasury - not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A., via subsidised home loans issued by the FHA and other government institutions. A 21st century housing-related version of the RTC such as advocated by Larry Summers amongst others could be another example of the government wallet or balance sheet that is required during rare periods when the private sector is unable or unwilling to step forward."(PIMCO)
  

• "Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for "they are all underwater." We, as well as our SWF and central bank counterparts, are reluctant to make additional commitments."
  

Its no wonder PIMCO and anyone holding PIMCO Funds are screaming for intervention to help prop up the price of Agency debt, for PIMCO this is the second shoe falling, not the first. As I said back in March:

• "Mr Gross is saying, quite rightly, that his job is to avoid any potentially toxic assets leaking into his pond. Unfortunately sometimes a previously healthy asset already in the pool begins to decay, leaking toxins into the pond. In a small pond its easy to fish out the decaying matter, in a large lake, filled with cumbersome assets it can be much more difficult.

  Has PIMCO found an Old Maid hidden in its hand?

  Consider this, from Bloomberg :

  • "Ross, chairman of WL Ross & Co., and Gross, chief investment officer of Pacific Investment Management Co., said they jumped at the chance to buy $1 billion of municipals each. Their interest helped to drive last week's rally in fixed-rate debt. Investors remain concerned that a flood of new issues from borrowers refinancing auction-rate debt will overwhelm demand while hedge funds and banks pare their purchases, analysts at New York-based Citigroup Inc. said in a March 7 report."
    

• Now this could be viewed as an attempt to capture some cheap assets with high yields. It could be viewed as an attempt to catch a falling knife. I don't think the reasoning behind such a move is either of these options. Mr Gross has no qualms about causing a moral hazard which in financial markets means intervention. I suspect the intervention, an attempt to restore confidence, has more to do with PIMCOs own position than it does with the Municipal Bond market.
  

For those who think I might be off the mark, have a look around at the collateral damage over the past 14 months and remember Governments have the ability to re-price their debt in their own favour. PIMCO, Russia and the Chinese are not immune from the fallout and they will have to take major losses.

That's it for this week. If you are interested in a long term, unbiased view of the economic conditions we are facing visit the Collection Agency.

Welcome to the Weekly Report. This week we concentrate on the other economy attempting to use the work of G B Eggertsson to avoid depression, the UK. In particular we study the interview Chancellor Alistair Darling had with the Guardian newspaper as it reveals, possibly unintentionally, his mindset and that of the UK Treasury. I shall only quote small parts of the Darling interview, all rights belong to the Guardian, therefore you should visit the link and read the interview in full.

We should remember that this interview, with a man who shuns the limelight, may be a case of Darling's hand being forced in the discussion of the state of the UK (and implicitly the World) economy by the remarks of Mervyn King at the Bank of England and the need to be seen to do something effective, rather than displaying the bunker mentality of PM Brown.

Mr King has held a pessimistic view of the UK and World economy since the second credit crunch bite hit in January, his speeches have been at odds with both PM Brown and Chancellor Darling, pointing out the downside risks greatly overshadowed any upside optimism the Government concentrated on. As time has passed it is Mr King who has been shown to be closer to the mark than the Government and I suspect the lack of noise from PM Brown and this interview with Chancellor Darling are the result. Further it should be remembered that even in the current difficult times the politicians have kept to their summer vacation schedules, ensuring that any change in policy did not happen through the summer months.

So what is the mindset of the UK Chancellor? He took the job after Brown vacated the seat to take over as Prime Minister. It was possibly one of the worst timed promotions in political history. Within 3 months it was apparent that a liquidity squeeze was creating real trouble in the short term credit markets. Or rather it was apparent to some banks, lenders, borrowers and a handful of bloggers, writers and the odd "maverick".

Here is Chancellor Darling's view of the events last year:

• "When times are far from easy, it's even more difficult. And we knew the economy was going to slow down." But he hadn't the faintest inkling of the financial crisis about to unfold before him. "No, no one did. No one had any idea."

  He can clearly recall the day last summer when alarm bells first began to sound. The chancellor was on holiday with his wife and their two teenage children in Majorca. "I remember I picked up the FT in the supermarket, as you do, and it had the European central bank starting to put money into the economy. I phoned the office to ask why they were doing quite so much. It didn't surprise me that money was going in - there was concern going around - but it was the sheer scale of it. I said, what about our institutions? This was when Northern Rock started to figure."

Clearly neither Darling, the Treasury nor PM Brown were prepared for the events that had and were to unfold. Yet the year before, in June 2006 at Mr Kings traditional speech at the Lord Mayors Banquet, attended by the then Chancellor Brown King delivered a very clear and detailed warning about micro and macro credit risks:

• "Financial stability more generally is a topical concern in financial markets. More than one banker and merchant in the City has said to me recently, "I cannot recall a time when credit was more easily available". How worried should we be? Let me begin with the implications for the stability of markets and institutions before turning to monetary policy.

  Securitisation is transforming banking from the traditional model in which banks originate and retain credit risk on their balance sheets into a new model in which credit risk is distributed around a much wider range of investors. As a result, risks are no longer so concentrated in a small number of regulated institutions but are spread across the financial system.

  That is a positive development because it has reduced the market failure associated with traditional banking - the mismatch between illiquid assets and liquid liabilities - that led Henry Thornton and, later, Walter Bagehot to promote the role of the Bank of England as the "lender of last resort" in a financial crisis.

  But the historical model is only a partial description of banking today. New and ever more complex financial instruments create different risks. Exotic instruments are now issued for which the distribution of returns is considerably more complicated than that on the basic loans underlying them. A standard collateralised debt obligation divides the risk and return of a portfolio of bonds, or credit default swaps, into tranches.

  But what is known as a CDO-squared instrument invests in tranches of CDOs. It has a distribution of returns which is highly sensitive to small changes in the correlations of underlying returns which we do not understand with any great precision. The risk of the entire return being wiped out can be much greater than on simpler instruments. Higher returns come at the expense of higher risk.

  Whether in banking, reinsurance or portfolio management, risk assessment is a matter of judgement as much as quantitative analysis. Ever more complex instruments are designed almost every day. Some of the important risks that could affect all instruments - from terrorist attacks, invasion of computer systems, or even the consequences of a flu pandemic - are almost impossible to quantify, and past experience offers little guide.

  Be cautious about how much you borrow is not a bad maxim for each and every one of us here tonight. Ignore the unsolicited emails that rain down on us offering unwanted credit. I received one last week that began, "We have the solution, Mervyn, for your bankruptcy".

  The development of complex financial instruments and the spate of loan arrangements without traditional covenants suggest another maxim: be cautious about how much you lend, especially when you know rather little about the activities of the borrower.

  It may say champagne - AAA - on the label of an increasing number of structured credit instruments. But by the time investors get to what's left in the bottle, it could taste rather flat. Assessing the effective degree of leverage in an ever-changing financial system is far from straightforward, and the liquidity of the markets in complex instruments, especially in conditions when many players would be trying to reduce the leverage of their portfolios at the same time, is unpredictable. Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the financiers of the past?"

If Darling et al thought what was unfolding in August 07 was a Minsky moment, think again. Merv King implicitly warned the Government, in public, over a year before what the risks were. Can we truly believe he was briefing differently behind closed doors? I suspect Mr King is now the "brains" behind the operation to avoid a depression in the UK, he need only point to his 2006 speech to deflect any Government intervention in the affairs of the Bank of England. However with public support for the current government at an all time low Darling and Brown can no longer wait for things to "settle down".

Yet this isn't the only problem the UK populace has with the Chancellor. His failure to comprehend the events that have unfolded is bad enough but he is incapable of realizing the difference between an economic and a political crisis:

• "Even then, the gravity of the credit crunch was still not fully clear. "No one knew how serious it was yet." Then he received the second catastrophic phone call of last summer, from his private secretary - and this time the head of Her Majesty's Revenue & Customs was also on the line, with news of a major blunder.

  "I just thought," Darling says, "this is a disaster. This is terrible. I said, We have to search the place from top to bottom. One of them said, We'll start Monday. I said, No, we start today. I phoned Gordon up. I said, We appear to have lost two disks containing the personal details of just about every family in the country. We knew it was bad." What did Brown say? "He said it was bad.""
  

• "Darling's life, in his wife's words, has been "a crisis a week" ever since. The economic times we are facing "are arguably the worst they've been in 60 years," he says bluntly. "And I think it's going to be more profound and long-lasting than people thought.""
  

• "When I've got something to say about housing," he retorts stiffly, "then I need to deal with a whole range of things." If I was trying to sell my house right now, I would wish he'd hurry up. "Yes, all right, but if you're going to announce anything in the housing market, you don't do it in the middle of August. It's just a silly time to do it." Does he feel no sense of urgency? "I'll do it when I'm ready to do it."
  

This brings us to the central question, why, after shunning the limelight throughout his career, does Darling now allow the press into his life? Why now is he using the press to warn the country that it's going to get worse (much worse if you take his 60 years quote seriously)?

The UK parliament operates on the same schedule as Public Schools (which are private in the UK), they take the same holidays and have many of the rules and traditions. As the children return to their learned institutions the politicians begin to make the moves they think are required to ensure continued power.

For Darling and Brown that means trying to invigorate the UK economy by implementing the Monetarist / Eggertsson ideals.

We have a clue as to what these new policies and initiatives will contain:

I shall go out on a limb here and say the Mr King will lag cuts in rates behind economic indicators, he will be reactive, not proactive. This will be a conscious decision in reaction to the Treasury's actions.

Already it has been leaked that a major initiative to socialise private housing, by allowing local councils to take part (or full) ownership of unsold homes and the homes of dwellers who cannot meet or are struggling to meet mortgage payments. This is truly "New Deal" territory, requiring a massive expansion of Government debt to effectively underwrite mortgage lenders (banks) liabilities. It is being sold as a housing initiative. If that were so, why not just buy the mortgage and place it in a Government Sponsored Enter...... you follow me?

No, this is about ensuring that the payments continue to flow into the banks coffers, either as interest income or as a lump sum to pay down the capital borrowed.

It also ensures that councils have a need to spend on the infrastructure required to oversee such a project, an expansion of public spending. This will also be backed by the Government probably in the form of higher spending limits, budgets and of course allowing higher taxation at a local level.

It is the socialisation of private bank debt and liabilities using taxes and public debt. No wonder the £ is headed south for the duration. This plan must have been drawn up in consultation with the banks who as we know are not adverse to using "private" knowledge for their own advantage.

Darling had only one reason to use the Press, he is preparing the way for the Governments fiscal rules to be set aside. Brown's so called prudent approach and economic golden rules are about to be torn up and thrown out the window, justified by the emergence of the worst economic crisis for 60 years and the political need to be seen to "do something". I suspect the expansion of public debt will only be starting with the implementation of the housing/bank bailout.

To misquote Mr King:

Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the politicians of the past?

Firstly I have to apologise to my subscribers, illness ravaged the family this past week or so and it's been all hands to the pumps, this has led to a less than acceptable output from the Agency.

We have to dive right into the meat of the subject, namely Eggertsson Theory has failed, or rather the bailout plan devised by the Fed based on the work of GB Eggertsson is not providing the results expected.

Let me recap and keep it short. Eggertsson wrote a paper that I believe the Fed used as a blueprint for the plan to avoid a deflationary depression last seen since 1930's. In essence the idea is to directly inject cash or US Treasury Bonds (almost cash when yield is near or at inflation levels) into the banking system and the consumer's pockets. By bypassing the traditional route that an expanded monetary base would take, i.e. through pricing mechanisms, the policy would be non-inflationary but had to be carried out under the threat of a retraction in growth and the expectations of future higher inflation. This would cause banks, business and consumers to act in a way that would be expected in an inflationary environment, loans would be taken and spending would increase in the near term to avoid the inflationary losses that would be incurred in the longer term to currently held reserves. This would provide the antidote that Japan did not apply to its deflationary cycle, where spending was put off as cash appreciated in strength as an asset.

However, the bailout is utterly dependant on a perceived continuing increase in inflation by those who spend. If the inflationary expectations are undermined then any cash or nominal cash fed into the economy will not be spent, it will be hoarded or saved, firstly as a capital reserve increase and later as an appreciating asset as inflation levels reverse.

As G B Eggertsson put it:

• "Inflation expectations increase because higher nominal debt gives the government an incentive to inflate to reduce the real value of the debt. To eliminate deflation the government simply cuts taxes until the private sector expects inflation instead of deflation. At zero nominal interest rates higher inflation expectations reduce the real rate of return, and thereby raise aggregate demand and the price level. The two main assumptions underlying this result is that there is some cost of taxation which makes this policy credible and that (2) monetary and fiscal policies are coordinated."
  

This raised inflation expectations amongst consumers and business as the creating and releasing of cash assets flooded into the markets. However, the next expected stage did not take place.

Banks are in trouble and it's a much deeper problem that the authorities imagined even 6 months ago. With the Likes of Freddie and Fannie now finding the "borrow short/lend long" model failing, it isn't just a matter of fresh capital injections being used to bolster reserves. Now it's about assuming that the US Government will stand ready to cover the liabilities of any "too big to fail" financial company.

The expectation that the US Government will stand as guarantor should raise inflation expectations through the roof. The assumption that government debt will increase massively and therefore make it attractive for the US to increase inflation to devalue that debt should be the guiding principle in current markets. As Eggertsson explained:

• "The government, however, can increase its debt in several ways. Cutting taxes and dropping money from helicopters are only two examples. The government can also increase debt by printing money (or issuing nominal bonds) and buying private assets, such as stocks, or foreign exchange. In a Markov equilibrium, these operations increase prices and output because they change the inflation incentive of the government by increasing government debt (money & bonds). Hence, when the short-term nominal interest rate is zero, open market operations in real assets and/or foreign exchange increase prices through the same mechanism as deficit spending in a Markov equilibrium."

So we should have a good idea of what to expect in the future, right? Well if the bailout was going to plan yes we would, unfortunately the bailout appears to be failing, not so much in execution but in the results it is engendering.
The problem is globalization. If the rest of the world could be isolated from what is happening in the US the bailout would probably work. The globalization of finance and debt, the freeing of markets and exchange rates has ensured that what occurred in the US in the 1920's and 30's is now going to play out on a much grander scale. Basically the US of the '30's is now the World of the 00's. Whereas Global Wealth Funds, Private Equity and Hedge Funds swung into action to provide cash in exchange for assets, much as the bailout of Wall St in Oct '29 did back then, the follow on result has been the same:

• "William C. Durant joined with members of the Rockefeller family and other financial giants to buy large quantities of stocks in order to demonstrate to the public their confidence in the market, but their efforts failed to stop the slide. The DJIA lost another 12% that day."

• "It is hard to overstate how radical the regime change was. "This is the end of Western civilization," declared Lewis Douglas, Director of the Budget"

• August 22 - Bloomberg (Kevin Hamlin): "A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank. 'If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,' Yu said... 'If it is not the end of the world, it is the end of the current international financial system.'" (Thank you Doug Noland)

So we have a reduction in capital and a willingness for foreign Central Banks to realise large scale mark downs in the face of a possible complete loss. This is reminiscent of the '30s US Banks closing the door to new business and calling in the loans they had made, regardless of the loss.

What though of the expectations of inflation? Are consumers upping current spending in the face of future, higher inflation? Are they expecting higher inflation?

Not according to this chart from the St Louis Fed. The University of Michigan inflation expectations have levelled off followed by a dip in total retail services (excluding food services). Is more disposable income being diverted into food purchases?

This chart should be sending a big warning out to the consumer reliant parts of the economy. Tax rebates and tax breaks, helicopter drops of cash and cash assets, are not having the desired effect of increasing inflation expectations. Indeed the drop in real retail and food service sales in 2008 coincides with the delivery of the tax rebate cheques.

The chart above is gold over the past year. Without a doubt gold led inflation expectations to the upside, as it should and to the delight of the gold community. Now we see gold telling a different story (linked, as ever, to the $). Gold is not looking for high/hyper-inflation, either it is ignoring current fiscal and monetary policy (which would be a first) or gold is pricing in a fall in inflationary forces. We should remember that the $ volume of sales in the charts above include the effects of higher prices.

If consumers are not buying now to avoid higher prices later then they are either saving or paying off debt. Consumers are expecting a deflation of income, probably as a result of a contraction in employment compensation and are acting accordingly.

Without an expectation of higher inflation the US Fed and Treasury have been caught in a trap of their own making. They are unable to ignite further inflation to devalue the fiscal and monetary debt created to help the banks/brokers and GSE's survive, placing the burden of servicing that debt onto the tax payer.
The Fed and US Treasury have created cash and cash assets, in a low interest rate environment to engender the belief that a highly inflationary path was being followed. Whilst that part of the bailout plan was successful, the reaction to it, from banks, consumers and business has not had the desired effect.
Rather than "spend now to save later" the ethos seems to be stop spending, stop lending, stop borrowing and repay what debt you can. It is a monetary tightening beyond the control of the US Fed and Treasury.

Milton Friedman and Anna Schwartz concluded that the monetary tightening and political interference that occurred under FDR (price controls etc) turned what should have been a recession into a depression. Ben Bernanke acknowledged this and said it wouldn't happen again. He was correct, the US Fed/Tsy have done all they can to ensure liquidity was available for all that needed it and directly injected cash into the wallets of consumers.

However the plan has failed, not at government level but instead the financial sector, businesses and the consumer have initiated the tightening as they recapitalise, save and pay down debt.

Here is the conclusion to Does The Consumer Truly Believe? Written back in April, I see nothing happening to change it:

• "Consumers have been fed a diet of higher inflation expectations and are reflecting as such but there seems to be resistance to actually commit to higher spending. That resistance will grow if signs of further moderation in inflation appear and spending will be suspended until prices fall to acceptable levels.
  If spending does not increase business may decide that the Feds inflationary expectations are misplaced when compared to what their till receipts tell them. If business then decides to cut overheads and raise productivity by cost savings, allowing prices to fall to attract sales, the Fed will have failed and a deflationary environment will be established."

The Danish Central Bank will take over Roskilde Bank after no buyers were found for the regional operator. After Nothern Rock/BOE this is the second time in Europe that a central bank has to step in for a bailed out bank during the current mortgage crisis.(Saxo)

• "A recap of the scenario:

  bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation."
  

The evidence seemed to be pointing toward a move beyond "FEAR" and the beginning of the withdrawal of speculative funds. This week certainly supported this thought and I would like to share some charts that fly in the face of the events that recently unfolded.

We have been watching the 30yr T-Bond yield closely over the past few weeks, watching for an upside breakout. It looks like the breakout is failing which then had me examining some charts with a bit more urgency, especially given the geo-political events unfolding.

Markets are fickle at the best of times but to ignore the events in Georgia and Ossetia, where Georgia went on the offensive against separatists now actively supported by Russian troops, tanks and aircraft beggar's belief.For instance, after reading the comment below what would you expect to happen to the price of crude oil?

• "The Georgian foreign ministry in Tbilisi said the Black Sea port of Poti, the site of a major oil shipment facility, had also been "devastated" by a Russian air raid."

The map is from 1998 (so this hasn't come as a surprise!) and in April 2006 NPR reported:

• "The tiny former Soviet Republic of Azerbaijan is on the verge of an oil boom. This summer, a 1,000-mile pipeline is expected to begin pumping oil from Azerbaijan's Caspian Sea coast, through neighboring Georgia, to a Turkish port on the Mediterranean Sea.

  Industry experts say this pipeline will allow Azerbaijan to eventually quadruple its oil exports, but political opponents in Azerbaijan worry that the oil money will help the government of the former Soviet republic stifle pro-democracy efforts.

  The $4 billion project is backed by the United States, in part because it gets Caspian Sea oil wealth out to the international market, without going through Azerbaijan's much larger neighbors, Russia and Iran."
  

This is not a fight in some dustbowl that no one is interested in, this is has the ability to morph into an extremely serious situation that might end up with the US and Russians throwing more than insults at each other.

You would have thought the stampede to hold gold would have been heard on the Moon! So what did we get last week (hourly chart):

We tested the 848 area, massively important support. Major Powers could go head to head, NATO involvement is not out of the question and gold drops??
This isn't bad news being painted as good, the usual market machinations. This is a complete breakdown between risk protection and events and can only be caused by something much, much larger. Are we seeing a re-allocation of resources, a removal of leveraged speculation?

Above is a Dollar/Yen weekly chart, again something we have been watching for sometime because of this (Dow weekly):

A significant move, a rebound by the dollar against the Yen has been in progress since early March and it looks like a new wave of carry trades have been placed in US stocks over the past month. Does this explain the attempted rally by the Dow? Remember, we have support for the 30yr T-Bills too over a similar 4 week period, hence the stalling and falling of yield.

Is this rotation of dollars out of commodities (too many falling charts to publish here) and into cash, US Treasuries and large cap stocks confirmation of last weeks thoughts? If it is then the amounts must be enormous to kill off any effect that should have happened with the Georgia situation. Are we seeing the Hedge Fund sector finally deciding to unwind as the rolling of debt and the unavailability of leverage forces a withdrawal of speculative funds?

What we do know is that right now the money flows are so large that an Oil War can be ignored. That tells me its time to be very cautious about investing or trading and puts me on alert that something else; something that has a potentially bigger impact may have started.

This article will be subscriber only until mid week.

A shortened version for this week, the Collection Agency needs a little timeout to recharge. This weeks report is also subscriber only.

"A recap of the scenario:

bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation."

We have reached an interesting situation for the Dow as you can see on the chart above. The head and shoulders pattern shown is a classic, well defined, a downward sloping neckline and most importantly it formed at the top of the market. In mid-July I added the yellow highlighted box to show what I thought was an important area. It has now become critical to future direction.

Even though the indicator has turned up I take no solace, it is designed for spotting market tops, not rebounds. What this looks like to me is a bull trap. The move back above the neckline on the close of the candle 3 weeks back, especially with the impressive bounce from support at 10828 may well have got the market participants excited, especially as the move continued into the following week. However, the important resistance at 11700 proved to be a considerable obstacle and the market backed away, not one but twice. It looks to me that someone is happy to sell the rallies.

If you look back at the scenario I think we now have to watch for the "withdrawal of speculative funds" from the stock (and other) markets. I shall use the action from now as a clue to what is in store. If the neckline holds as resistance and we start to head lower we have a target of circa 9300. However if we break back above the neckline and close next week above it, I shall maintain a cautious stance toward shorting the index and watch the reaction to a move up to 11700.

It is noticeable that talk of the Hamptons and holidays, or desks being manned by the "second string" traders (not my description) is quite rare this summer. I would be interested in any anecdotal evidence that suggests it's a quiet season east of Long Island. I would also tie this in with Doug Noland's latest here, especially his concluding paragraph.

Finally, here is a chart that I like to look at. It's the Daily Dow, all the purple support / resistance lines are from such areas that formed on the rise from 2003 to 2007. I have found it very useful since November last year. However no guarantees it will continue to be so:

It is an interesting exercise. If we breakdown below the 15 / 16 July lows, I will update the lower bands.

On a connected theme, I have been asked to give a more detailed explanation of the Trend Indicator (TI). Firstly the chart, posted last Sunday with the weeks price action:

So what do we have, other than a lot of wiggly lines? The pink line is the median, below is bearish and above is bullish. The other lines act like bands, offset from the median, but they do have subtle differences in their calculation than the standard type you get with a chart package.

The idea is to show how in up and down trends the moves follow a symmetry that reflects the distance price is from the median, the "bands" act like mobile support and resistance.

Secondly (and not surprisingly considering the chart above the Trend Indicator) we have support and resistance levels, usually in purple but occasionally in red, if I consider it to be of major importance. These are from levels seen on the daily (not weekly) chart.

Occasionally a yellow highlighted area will appear showing an important zone of support and resistance.

Finally the arrows, green are active, red are old calls (my record). They do not call direction, they point to the support and resistance levels I think will be in use in the week ahead, both the traditional variety and the Trend Indicator type. Last week I was looking for:

Resistance at the green TI line and at 11743 / the yellow band.

Support at 11249 and the red TI line.

The idea is to keep it simple and wait for the reaction rather than pre-empt a failure or success of the support/resistance, although more aggressive traders may want to place trades differently. Basically, I expect support to be support and resistance to be resistance.

I use candles simply to show the wicks, they display confirmation of support or resistance at certain levels. A good example of this is the lower red arrow at the blue band in mid July.

The Williams % indicator is to help identify overbought/oversold conditions but is not part of the TI.

The combination of 2 differently calculated support and resistance techniques and candle wicks show a high probability of where the trend is going as can be demonstrated by the clustering of arrows around the consequent price moves, remember the arrows are placed on the chart ahead of the price action for the coming week:

There are 3 red arrows I consider to be misses, all 3 were in the direction of the trend but looking for larger moves. Here is the chart for the week ahead:

Again but zoomed in:

The green arrow at 11743 from last week remains active. There are signs that we maybe settling into a large sideways consolidation, that's just my interpretation though. For trading I will be looking for the reaction at either 11249 or the green TI resistance "band".

I hope this answered the questions some people had about the TI.

Have a good week all.

It has been a rather busy time for The Collection Agency, picking up assets in lieu of cash. Anyone need a badly treated, surplus to requirements, Bank customer desk or ten? I can do job lots.

We start off with an excerpt from The Bernanke Conundrum written on 8th May 08:

• "You see, For Ben Bernanke the current situation isn't "news"

  Bernanke has already studied the conundrum. I quote from "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression" as used in "New Keynesian Economics"(Mankiw and Romer Ch 29):

  "An interesting aspect of the general financial crises - most clearly, of the bank failures-was their coincidence in timing with adverse developments in the macro-economy"

  "The present paper builds on the Friedman-Schwartz work by considering a third way in which the financial crises (in which we include debtor bankruptcies as well as failures of banks and other lenders) may have affected output" .".....because markets for financial claims are incomplete, intermediation between...borrowers and....lenders required nontrivial market making and information gathering".

  Bernanke then goes on to state that as the real costs of intermediation rose some borrowers found credit to be expensive and difficult to obtain. He then states:

  "The effect of this credit squeeze on aggregate demand helped convert the severe.....downturn of 1929-1930 into a protracted depression"

  Bernanke goes on to identify various problems from the '20s that made the 29-30 downturn, which included the expansion of debt and in 1930 the move by banks out of the loan markets into more liquid instruments. Indeed the 1932 National Industrial Conference Board survey of credit conditions reported that the shrinkage of commercial loans in 1931 and the first half of 1932 represented pressure from the banks on customers for repayment and refusal by banks to grant new loans. The worry is that the Fed Chairman saw no cure better than the one used in the '30s New Deal and the large scale intervention of the federal Govt:

  "home mortgage market...function....was largely due to the direct involvement of the federal government....establishing ...FSLIC...federally chartered savings and loans....government "readjusted" existing debts....and substituted for recalcitrant private institutions in the provision of direct credit. In 1934.....Home Owners' Loan Corporation made 71 percent of all mortgage loans extended"

  It looks to me that Bernanke has already instituted the measures he believes will help avoid a repeat of '29-'33 by delivering the medicine now rather than later. As we have seen earlier in this article, the medicine does not seem to be affecting the patient. Credit availability continues to contract due to the policies of banks. Ben Bernanke now finds himself in a situation where he has delivered all he can to no avail. Does he sit back and wait for a change in credit conditions to become apparent or is there more that he can do?

  Whatever he does, unless lending conditions change markedly and rapidly in this quarter, it will be ineffective. Bernanke will no longer have to refer to history to see a deflationary depression, he will be living it."

Well lending conditions certainly changed markedly and rapidly in this quarter and not the way Ben Bernanke would have wanted. Fannie and Freddie, set up in past decades to solve the same problems we face today are defunct, broke, ripe for a knock on the door from yours truly.

Bluntly, you cannot expect to borrow short to fund long and survive. We have seen all those who went out on mega-leverage with this business model either fold or become unable to fund current positions, igniting a de-leveraging frenzy as a desperate attempt was made to try and save some of the capital that was used to make the positions.

We are now living the very scenario Bernanke studied; yes I am saying we are at the beginning of a Depression the likes of which the World has never seen. Of course those readers who read the excerpt from The Bernanke Conundrum can see what is different this time.

In '29-'37 the Government stepped up to the plate when the private sector stopped lending and originating mortgages by creating FSLIC et al. Now we don't have that option, instead we have the prospect of watching the destruction of the descendants of that '30s bailout.

Bernanke also pinpointed the other great problem of that era:

• "because markets for financial claims are incomplete, intermediation between...borrowers and....lenders required nontrivial market making and information gathering".
  

However in the world of financial innovation, counterparty isn't required, you draw up a contract with another trader and set some parameters. You pay an income stream to maintain the contract and the other trader pays out if a pre-determined default position is reached. The other trader decides whether or not to lay off some or all of the risk, there can be no implicit acceptance by the market or any other participants that this has been done. Unlike a traditional derivative market (i.e. exchange traded) there may well be no "winner".

Financial innovation is based upon the premise that risk is more evenly distributed and less likely to cause a choke point. Clearly the failure to price these obligations (like an exchange, not mark to market) has led to today's problems. Although some debt derivatives do now have a pricing structure, eg Markit.com it is still reliant on participant disclosure, without which the contract remains hidden. There is a very good reason to hide the details of these agreements. If you, as the "other trader" did not spread some risk to the rest of the market, you are fully exposed to a default event. If the position is disclosed others may decide to take advantage of triggering a default, causing the concentration of risk that was to be avoided.

During the good times, those heady days of massive leverage and cheap debt, where massive income streams could be gained for agreeing to cover some improbable event it must have felt too good to be true. Why bother laying off the risk of some event that the risk models said was a 1-10,000 year event?

The only time a credit contraction is not deflationary is when no leverage has been used. Without leverage, the money lent is spent and re-circulated in the economy, ending up (or passing through) the lenders books (or some other bank) as new income. The loan, if defaulted upon, has no direct impact on the amount of money in the system - it is still circulating but belongs to someone else.

However with leverage you are playing the margin game. If $1million is put up as the collateral to a $10million loan, the leverage is 9-1. You supply the 1 and the lender supplies the 9. All is well and good as long as you service the $9million debt and its value is unchanged. If you can borrow short term at low rates and lend the $10million long at high rates, it's a lovely day for all. You keep rolling the short term debt for as long as it takes for the long term loan to be serviced and paid off.

It's stunningly simple and very lucrative. Until it isn't.

If the collateral (cash, assets, derivatives it doesn't matter, its all created, borrowed - none of it has an intrinsic value, other than confidence) is suddenly viewed as being risky, then the value of the collateral is downgraded and becomes lower in value.

So what happened to the value that was removed? It disappeared, it doesn't get re-circulated and it doesn't re-appear on the borrowers books. It has gone unless the value of the asset (including "money") goes up. The lender sees (or instigates) the fall in value and demand more assets to make the value back up on the collateral so that it matches the original nominal worth of the borrowed amount.

Some might say that the devaluing of the asset resulted in a transfer of wealth from the borrower using leverage to the lender. This didn't happen because the collateral is used to secure a 9-1 proportion of the lent amount. In effect the $9million lent was also devalued; the requirement to add to the original collateral of the $1million was to cover the losses in the $9million. If the asset was devalued 10% then the $9million would lose $900k. The collateral is said to be worth only $100k as the losses are borne by the borrower, not the lender. To make the collateral back up the lender needs to add $900k to match the original amount, even though the lenders asset has dropped below $9million (to $8.1million) if the borrower wishes to maintain the position.

To maintain the original worth of the position, a deflation of $900k is required from the capital of the borrower. That capital cannot be recovered unless the asset used as collateral is valued higher. It is this drawdown of capital from the borrower that causes a deflation in available assets because of the leverage involved.

As I have said more than a few times it is not a lack of printing that causes a deflationary environment but the lack of circulation of cash (asset) through the economy. The hoarding of cash to increase capital is the same as the Fed removing banknotes and not replacing them or the raising of taxation without a commensurate increase in Govt spending.

You do not have to stop or reverse the printing presses to cause deflation and any student of the '29-'37 period should know this. The House market in a large part of the western world is a stunning example of this un-leveraging deflation.

House prices have collapsed because the funds used to extend mortgages to borrowers have been withdrawn. The reasons do not matter, capital is being withheld and the lending process has almost stopped. If you bought a house worth $10million and used a $1million deposit, you borrowed $9million. If the house is now only worth $9 million (asset write-down?) then if you sell you will lose $1million. That's $1million of your capital gone, disappeared, not re-circulating in the economy or reappearing on a banks book.

You have had a deflation of $1million, the bank received back the original $9million amount lent. If you faced a loss bigger than your deposit you either have to raise capital to pay more to the bank or the bank takes a loss on the $9million and if the asset is priced correctly on its books, suffers a deflation too.

Has Hank Paulson achieved what he set out to do when he left Goldman Sachs? During his time at GS the Daily Telegraph suggested Paulson had made 70 trips to China and had/s an intimate relationship with the Chinese elite.

It was China that re-circulated all those surplus dollars from trade with the US back into asset backed securities, including buying a huge amount of Fannie and Freddie securitized debt. Yet again we see the bankers moving into key government positions prior to the "crisis" unfolding, another pointer that the "Minsky moment" was anything but.

Now we see the usurping of Government by an official to save the very organizations that China(and others) bought an enormous amount of debt from:

• July 25 (Bloomberg) -- In October 2003, Treasury Secretary John Snow told Congress ``we need to be on guard'' against the ``perception'' that the U.S. government stood behind the stocks and bonds of Fannie Mae and Freddie Mac.

  This week his successor, Henry Paulson, has seen a plan to make such a guarantee explicit to the brink of passage, getting a presidential veto threat withdrawn and reversing years of Republican-led efforts to unhook the companies' fortunes from the government's finances.

  The Fannie-Freddie legislation -- it cleared the House July 23 and the Senate may vote as soon as today -- is the result of circumstances and personality. A lame-duck White House is struggling to revive the economy and prevent a further meltdown in the housing market that would demolish the centerpiece of President George W. Bush's ``ownership society.'' Meanwhile, Paulson's desire to get a deal through the Democratic-majority Congress outweighed the administration's free-market orthodoxy.

  ``Paulson has been able to use a lot of leverage on the White House,'' said Vince Reinhart, who used to head the Federal Reserve's monetary-affairs division and is now at the American Enterprise Institute in Washington. The former chairman of Goldman Sachs Group Inc. ``has authority associated with his previous job, and events are such that if policy makers have to do something, they ultimately do it.''

  Stock Purchases

  Once Bush signs the legislation into law, the Treasury will have the right to buy unlimited stock in Fannie Mae and Freddie Mac, the government-chartered corporations that account for almost half of the U.S.'s $12 trillion mortgage market. The measures give a government backstop for their $5.2 trillion of debt outstanding, allowing them to borrow at a cheaper rate than private companies.

  Largely missing from the bill are provisions the Bush administration and other Republicans have pursued for years: powers comparable to those over commercial banks that would limit the mortgage giants' lines of new business and their investment portfolios.
  

I view the Freddie and Fannie mess with a jaundiced eye, I do not see an attempt to save the US mortgage market by the Administration. What I do see is an attempt to save China and possibly others, such as the Russians, from an enormous $ related loss and to save the US economy from the effects of China et al dumping $ assets wholesale into a distressed system. How much needs to be covered?

This from the Daily Reckoning:

• "The prospect for every GSE bond clearly states that it is not backed by the United States government," says Matt Kibbe, president of FreedomWorks. "That's why investors holding agency bonds already receive a significant risk premium over Treasuries."

  The Russians ignored the warnings and grabbed the risk premium. Today, fully 21% of Russia's monetary reserves are invested in the obligations of Fannie, Freddie and the Home Loan Banks. And the largest holder of Fannie and Freddie debt is another friendly foreigner, China. The middle kingdom, according to the FreedomWorks organization, owns $376 billion worth of U.S. agency bonds. Altogether, foreigners hold $1.3 trillion of them.
  

The moral hazard of this bailout or to be more specific, nationalization, is enormous. To stay alive F&F need to continue to attract income, buying pools of mortgages and using the income streams to pay off the previous buyers of F&F securitized debt. The only hope is to pay off the debt servicing costs averaging at around 4% by having an income stream at around 6-8% until maturity of the 2002-2007 issuance or until the debt can be bought back. That means mortgage users, Joe "bleed me dry" Public, faces a depressed housing market and higher interest rates for at least a decade.

Marty Chenard has spotted this; here is an excerpt from his Friday Stock Timing letter:

• Note that two weeks ago, the yields bottomed out and started moving higher. That set a "higher/low" in place where the yields should start moving up more aggressively. The 53 yield target should have mortgage rates move up to approximately 6.78% to 7% in the coming weeks or months. (Rates were 6.125% to 6.25% when we first posted this warning.)

(Chart courtesy of StockChart.com)

Note the similarities to H1 2007. The difference this time is that the Fed has already cut Fed Funds from 5.25% to 2% since January 2007. It looks to me that the Fed has either lost control of the long end of the bond market or it is happy to let the curve steepen.

Bearing in mind what you have just read, you can already guess that I think the Fed will be happy to see the long end go higher.

That's it for this week; keep an eye on the 30 year T-Bond yield.

Welcome to the Weekly Report and a bit of housekeeping. I forgot to enable the link to the bulk of last weeks (free) Report, click here to read the rest of the article.

This week I was going to look at why we suddenly have threats and warnings being issued from the SEC and backed up by utterances from Paulson and Bernanke about short selling but Doug Wakefield and Ben Hill beat me to it. I recommend the article as it raises some very good questions about the motives behind this latest blast of hot air.

So what on earth am I going to write about? Well, rather than get into the fundamentals I am going to look at a few charts, specifically some of those on this list:

• The securities identified in the Commission's order:

  
  BNP Paribas Securities Corp.BNPQF or BNPQY

  Bank of America Corporation BAC

  Barclays PLC BCS

  Citigroup Inc. C

  Credit Suisse Group CS

  Daiwa Securities Group Inc. DSECY

  Deutsche Bank Group AG DB

  Allianz SE AZ

  Goldman, Sachs Group Inc GS

  Royal Bank ADS RBS

  HSBC Holdings PLC ADS HBC and HSI

  J. P. Morgan Chase & Co. JPM

  Lehman Brothers Holdings Inc. LEH

  Merrill Lynch & Co., Inc. MER

  Mizuho Financial Group, Inc. MFG

  Morgan Stanley MS

  
  UBS AG UBS

  Freddie Mac FRE

  Fannie Mae FNM

We see a clear bounce which gives us a new support level at 48.5, albeit from a level lower than the 1998 low of 54.5. I suspect it was the loss of the 1998 support that caused last week machinations and we were right to look at this as an important level. Of more interest was the move and hold above the 2002 support at 60.3, although Fridays candle shows me that some indecision now exists.

Citi:

Stopped at the 50DMA. You have to go back some time before you see a sustained rally in Citi that did not result in renewed selling. However, if Citi moves above the 50DMA next week then it has room to go higher in the short term.

Bank of America:

A similar story to that of Citi but without the retest of the 50DMA. What we begin to see is that a nice set of parameters are in place to help judge the next move.

Goldman:

GS has been favoured throughout the credit crash and has closed above its 50DMA again. As you can see from February and June, this is no guarantee of further advancement. Notice the last attempt at a sustained move above the 50MDA in April was with the help of a gap up open. I am not convinced yet of a further sustained medium term rally, I would want the 200DMA to be breached too.

HSBC:

HSBC has a more promising bullish outlook, if it can take out the 50 and 200DMA. However as it has shown recently, it is not immune from bearish sector sentiment, even with a large exposure to the Asian markets.

JPM:

This chart has me nervously eyeing a reversal although the 50DMA has held as support. For me I would need to see the 200DMA breached and a new high established before giving it further consideration.

Lehman:

So much for the SEC supporting an orderly market and routing out false rumours. Has previous support at $20 become resistance? Like Bear Stearns last year there are some gaps higher up that look attractive but it doesn't necessarily mean it will happen.

Merrill Lynch:

We begin to see who is favoured and who isn't in this latest rally. Notice how Fridays high couldn't equal Thursdays?

Morgan Stanley:

The 50DMA acts as resistance at $40 which was also the support in February. Suddenly the charts don't look as promising as the earlier examples.

UBS:

$22.5 and the 50DMA may prove difficult to breach for UBS. (Remember if these charts do make bullish moves, then don't get over-complicated, either view them as a bull or leave them alone. Don't pee into the wind)

With that last comment in mind we look at the the chart for Mizuho:

A higher high (than June) would look constructive.

Barclays:

I don't like the candle action on Thursday and Friday. It joins the list of the unfavoured.

Credit Suisse:

CS found resistance at $45. A lot needs to happen on this chart before I would go long.

Deutsche Bank:

DB is similar to CS but if it did decide to continue higher it has obvious targets at the 50DMA and resistance near $105.

Allianz:

With those large gaps down and up last week doesn't exactly look like true investor movement. If the bank was so hated on the Tuesday, what has changed to its fundamentals to now make it attractive?

Clearly the Banking Sector and the Primary Dealers are at a crossroad. Will the rally continue or have the "naked shorts" now bought enough stock to allow the short positions to remain open? Will the rally in banks spill over into other sectors?

As I try to concentrate on capital preservation (unlike the SEC) maybe the Banking/Broker sector should be avoided or only dabble with funds you can lose without worry.

My first public post on a financial site was 21 months ago so the timing is right. Unfortunately for the readers of my eco-babble I cannot do a 6 month resume, so here it is, a 21 month review of my work.  We start off with a quick update to last week and a quirky question and then into the meat of the review.

Last week I opened by saying even I was worried about my own bearishness, using my own thoughts to make me think about possible supports (highlighting LTCM levels as possibly the area to watch for banks and financials).  I am still watching this level. If support doesn't hold we are on our way down to the 9300 area on the Dow, eventually.

I have very little to sell, my little website was set up using the Austrian School of Economics as a guideline, it ticks along at a minimal cost to members because I didn't incur any debt or debt servicing costs to set it up. The capital I use is from savings and is repaid by the small subscription I charge, it even makes a small profit which when saved over a period of time may allow me expand the facility.  If all my subscribers left tomorrow I could close the site down and walk away without having incurred any loss and move on to something new.

Now apply that line of thought to every single company in the S&P500. Can you find a single company that would be able to follow the same path? If you can, let me know because it would be nice to find a well run, properly capitalised Large Cap to put on the "long" watch-list. Remember, no debt. That includes bond issuance.  If you wanted to be really at the cutting edge of investment in the new era of capitalism that will rise from the ashes of this Monetarist/Keynesian credit/debt orientated fiasco, check out the Funds in your portfolio, any leverage being used? The expression that "cash is king" is going to become the"new" catchphrase in the near future.

It is here that I have to do a recap of my previous remarks and comments about the economy. Unlike many bloggers and writers who are looking at the next Quarter or the second half of '08 and recounting what they said in March, my view has to go back much further than that to see if what I wrote about last year or earlier is coming to fruition. It is the only way I can help readers understand how my poor befuddled brain works. Now I cannot re-create each article here but what I can do is give you a link and a couple of key words or a phrase with the date of the article.

Is this an ego trip, a boost to my already self enhanced view of my abilities? Not really, it's just a way of showing you my timespan, how my thought processes work, you will find the odd wrong call too. So here we go:

A First Sighting  originally written in November 2006:

• "A lack of cash, driven down by tighter, more expensive credit, a lack of liquidity that starts at the bottom and works its way higher up the food chain, until even those, referred to in whispered tones as daz boyz, see that the health of the US economy is going to require a donation of wealth from everyone. Even them.

  
  Can you see what I have caught a first sighting of?

  
  And out there, somewhere in Hedgeland, someone is finding it more and more difficult to sleep at night, thinking about all those CDO's sitting on the books. No one to lay it off to, a one way bet on liquidity."
   
  

Gone in Sixty Seconds originally written in June 2007:

• "If you have debt you are bending over and picking up the soap.

  
  Straightforward, no nonsense, in the prison block showers, soap collecting. Hopefully coffee has been spat at screens, wives/delicate husbands have been offended and stopped reading within 60 seconds. Because what I'm about to impart to you should make you feel this way. You, Joe Public, are about to be ridden into the oblivion. No one can save you, no one really cares. Big boyz, from companies like mine are going to take your possessions away. Faceless corporations are going to take your home away. All because you have debt."
  
   
  

The Second Sighting originally written in September 2007:

• "This leads us back to a rather large problem. In fact its huge problem and its not being talked about out there in Media land. What happens to a tapped out consumer, loaded with debt, trying to roll a teaser/innovative (thanks AliG) mortgage if rates are going up? It's not going to happen, it's a train crash. Borrowers are already operating under tighter credit controls so the ability to re-fi is curtailed for many. Add in much higher rates and the situation becomes impossible. Banks are going to suffer from a curtailed income stream, as debt default rises, just as the teaser rates for the Banks' borrowings come to an end and reset much higher. Can you see the irony?

  Banks are no better off than over stretched sub-prime mortgage borrowers. They need an income stream from lending to ensure they can pay the liabilities they owe to savers, savers that will demand higher yields. It's unsustainable and it's going to stop, soon.

  Banks are hit with a double blow, as a lack of income leaves them either unable to service their own debt and default or forces them into repaying the debt using capital holdings or returns from assets sold in the markets. Either way, credit for business and consumers becomes impossible to provide. A massive contraction of activity is a given.

  It's been noticeable of late to see the recession word crop up, even in the mainstream media. I think they are wrong. I think the future contains a scenario much worse than a recession.

  So, my forewarned reader, will you be leaving your money in a "sub-prime" bank?"
  

• I want to walk you through why I see deflation in the future.

  At this point I have to make something clear, whilst the traditional view of deflation is less money in the economy, I do not see cash as the current driver of inflation/deflation. The mover is credit. Allowing an unfettered increase of credit to replace the traditional over printing of notes to sustain a bubble(s) or ponzi scheme (if banks have, as a % of loans, effectively no reserves, what else can the system be based on?) then a reduction in credit must be deflationary.

  The importance of this cannot be under-estimated. Credit itself has/is being used as an asset to beget more credit. This explains the exponential rise in credit; it feeds on itself as credit notes become the asset to allow further credit to be lent out. By allowing credit to underwrite itself to form other types of credit the whole system becomes reliant on the confidence of lenders and borrowers having the means to eventually repay. If that confidence is put under pressure, the system stops. If confidence cannot be restored in a very short timescale (Central Bank / Tsy intervention) then the system begins to reverse, as credit is redeemed. The reversal will be at the same pace as the initial rise in credit growth. Although painful, the reversal would be orderly, as long as all the borrowers have the ability to repay. If that ability to repay is impaired then the redemption becomes disorderly.
  

• "So is Mr Bernanke getting undeserved criticism? I think he is and I think I know why. There is a war on Wall St right now and it's viscous. There are interests that need protecting, accounts that need to be kept hidden and rescues that have to be carried out. All of this has to happen in conjunction with falling rates. If it doesn't happen quickly, with the full cooperation of the Regulators, Fed and USTsy, then whole ponzi  scheme comes crashing down. Someone though isn't giving out enough covering fire. Mr Bernanke is keeping some of his powder dry by not telegraphing further rate cuts, in fact you could easily see a case for rate rises if some of the downside risks become too big to ignore.

  Wall St doesn't like it. The last thing the Cabal expected was that they would have to use their own money to sort out their own mess.

  Is Mr Bernanke getting bad press at the behest of Wall St?"
  

• "You can now see why, as a result of a flat to falling monetary base coupled with a contraction of credit, I see the risks of a deflationary recession as a very high probability. A depression is not as remote as many think.

  Is this just a US-centric problem? Not according to Esteban Duarte and Steve Rothwell at Bloomberg, who unearthed this:"

• Europe Suspends Mortgage Bond Trading Between Banks

  Nov. 21 (Bloomberg) -- European banks agreed to suspend trading in the $2.8 trillion market for mortgage debt known as covered bonds to halt a slump that has closed the region's main source of financing for home lenders.

  The European Covered Bond Council, an industry group that represents securities firms and borrowers, recommended banks withdraw from trades for the first time in its three-year history until Nov. 26. Banks are still obliged to provide prices to investors, according to the statement today.

  Banks including Barclays Capital, HSBC Holdings Plc and UniCredit SpA took the step as investors shun bank debt on concern lenders face more mortgage-related losses than the $50 billion disclosed. Abbey National Plc, the U.K. lender owned by Banco Santander SA, became the third financial company to cancel a sale of covered bonds in a week as investors demanded banks pay the highest interest premiums on covered bonds in five years.

  ``We are in a deteriorating situation,'' Patrick Amat, chairman of the Brussels-based ECBC and chief financial officer of mortgage lender Credit Immobilier de France, said in a telephone interview. ``A single sale can be like a hot potato. If repeated, this can lead to an unacceptable spread widening and you end up with an absurd situation.''
  

• 
  "You can find more about Covered Bonds at: http://ecbc.hypo.org/Content/Default.asp - if you can spot the difference between a CB and the MBS, ABCP or ABX derivatives then you have a keen eye.

  Oh, and yes, you read that correctly - that is a $2.8 Trillion lending market that has been closed. No wonder LIBOR has been climbing to new 2 month highs and above and reaching new all time high in spreads from the Fed Funds Rate.
  

Edwin Coppock, Fed Fund Rates and The Dow

• The next chart shows 2 things. The first is my dire attempt to display what I consider to be the best chart of the year. If only I was better at this graphics stuff eh? Ah well readers, you can't have everything..... The second is the chart itself. I have overlaid a chart of the Fed Fund Rates from 1986 to present with a monthly chart of the Dow from 1986 with its Coppock Indicator. It's clear to see the CI before 1996 did indeed lag and post '96 it's a much better tool. Although the CI is used to indicate a bull market on a rise through zero it can be seen that in either half of the chart CI did give a lower high before stocks broke lower (marked by faint red lines). What's more those lower highs were divergent when compared to the Dow which made higher highs: 
  

• So, what are the Coppock, Fed Fund Rates and the Dow trying to tell us now? Firstly a rider. Although Fed Fund Rates are falling, other rates, especially LIBOR are not. We should keep this in mind. Firstly, we have a falling CI, with a divergent lower high when compared to the Dow. The Dow itself is beginning to resemble the 1999/2000 top, without a lower low as yet. Fed Funds are dropping and if consensus (a warning in itself) is correct, FFR will be much lower next year.

  With the CI acting in a much more timely fashion, the minimum we can expect is for a flat return on stocks whilst FFR has ongoing cuts and the downward direction of the CI is maintained. A lower low on the Dow would make the flat return scenario seem less likely and open up expectations of a larger fall in 2008.
  

Are you thinking I may not be specific enough? Well I don't like to mention specific calls on individual shares, that's not really what I am about but this one had reached an important level:

Citigroup - Opportunity or Death Rattle? Originally published in January 2008:

•   "The current low is different, a sustained period of selling continues whilst the oversold condition persists. It is the opposite condition of continued buying whilst in an overbought condition as seen in 1999/2000. Unless a financial miracle occurs Citigroup is going lower, 1998 anyone? If my suspicions come to fruition then the price may well end up quoted in cents."
  

Automobile Wreckage. It Isn't just Ford and GM

• "We see the same deterioration in price and the widening of spread that has become so familiar in the CDO/MBS indexes. As with housing, the inability to create further derivative structures due to rising spreads (risk premium) will curtail the lenders ability to clear the balance sheets and facilitate further lending.
  

  It isn't just the Markit.com index which is dropping. TRR (Total Rate of Return) CLOs are struggling too as Fitch Rating Agency has noted, downgrading 28 tranches and also placed an additional 37 tranches on Rating Watch Negative. Unsurprisingly TRR CLOs are a mixture of derivatives of loan portfolios that according to Fitch are now at risk for intensified spread/credit risks. Market values on the SMi U.S. 100 have fallen 6% since mid '07. Considering the type of asset and its potential lack of worth in a flooded market (unlike housing) I expect spreads to widen considerably.
  
  It seems to me that a combination of tightening credit for the consumer, caused by the inability of lenders to clear balance sheets due to derivative markets pricing in higher risks which is stifling new issuance, will cause a real fall in spending on Autos. It should not be forgotten that other unsecured debt will have the same problems.
  
  The possibility of widespread damage in the US domestic Auto industry beyond GM and Ford seems much greater today than at any other time."

AIG Get Caught By The Auditors originally written in February 2008:

•   "Support at the $50 seems bust and the threat is a monthly close below the '03 low. It's yet another chart that flags up the lows from 1998. I'm not saying it's a short (or a long) that's not my job. I just want you too see something that looks worse than me in the mornings.

  By the way, be careful of who you listen to. This was one of the comments I saw on Bloomberg about the AIG drop:

  "Investors eventually will look back at yesterday's announcement and conclude they overreacted, said David Katz, chief investment officer for New York-based Matrix Asset Advisors, who supports Sullivan (the CEO)." Must be a coincidence......

  Then again we are at point in the markets were hope is being ladled out to the hungry and despondent. As I write this little snippet appears:

  "U.S. Industry: Uber-investor Warren Buffett on tv making remarks about the monoline insurance industry, apparently has offered a reinsurance plan to those firms. Talk has boosted the recently ailing monolines and is said to be behind the solid bounce in US stock futures in recent trading. Provided by: Market News International"

  I have some bad news for Mr. Buffett. This isn't the bottom even for the better quality debt. As I have maintained for some time contagion in the derivative bond market is deeper than anyone realises and it has spread beyond investment and traditional banks. AIG know that only too well.

By now I was producing the Weekly Report and this particular issue got a huge number of hits:

The Weekly Report 25 February 2008:

• "Now, I am not going to give you advice on what to do about your cash on deposit and I don't want you to think I am being overly bearish but…….I have called this whole fiat credit collapse correctly from the beginning. No, I don't want a pat on the back. I just want to read the next line carefully.

  If I had money in a US bank today, I would be worried. So worried I would withdraw the cash before new regulations are passed restricting account activity. I know it sounds alarmist but then the first warnings always do." 
  

This from CNN Money:

• "Customers with uninsured deposits will get at least half that money back, and they could get more back, depending on what the FDIC gets when it sells the bank, said FDIC Chairman Sheila Bair. IndyMac customers will have their funds transferred to a new entity - IndyMac Federal FSB - controlled by the FDIC. They will have uninterrupted customer service and access to their funds by ATM, debit cards and checks.
  

  However, customers will have no access to online and phone banking services this weekend, according to the FDIC. Service will resume on Monday. Loan customers were advised to continue making loan payments as usual."
   
  

On the 3rd March in the Weekly Report I wrote this:

• For those who think a run on the $ would be inflationary, think again. The pressures placed upon the financial system would be overpowering. It would collapse, within hours. A fiat system without access to credit would result in instant depression. It doesn't matter how "expensive" assets are if you cannot buy them. For instance, taking account of Fed Pres Poole remarks, the opportunity has arisen were speculators can start to look at shorting GSE's and the $.
  

  The Fed is playing an incredibly dangerous game and I suspect it is about to be called after going "all in".
  

But what of the future you say? Get another coffee and we will look forward to what I think maybe in store for us all.

How close is the Federal Reserve to a margin call? Well, anecdotal evidence is pointing to a need for the Fed to open the discount window to bailout Fannie and Freddie.  In an article published on the 12th March, Pre-emptive Warning of a Major Banking Crisis I highlighted this snippet:

• "Right now the Primary Dealers are purely a front, emperors without clothes. Ben Bernanke is literally behind the curtain, pulling the levers. The problem for the Bernanke is the lack of levers, the SOMA is a finite resource, which I estimate to have $600Bn (ish) of usable collateral available."
  

• "Collateral for U.S. currency in circulation and other reserve factors that show up as liabilities on the Federal Reserve System's balance sheet "
  

Of course the real risk is to the Banks, Brokers and Insurers. All that GSE debt is AAA rated, as good as cash, and is classed as Tier 1 type assets - or it was until this week.

The problem? This:

• "GSE securities are booked as risk-free investments by banks owing to an "implicit guarantee" assumption attributed to the GSE's. This relief is theoretical and changes in regulation may affect this assumption."
  

If you think this is far-fetched then have a chat with Merv King over at the Bank of England who made sure the restrictions below were included in the terms and conditions of the Special Liquidity Scheme, as quoted in the Weekly Report for the 27th April 2008:

• "The main category of assets will be securities backed by residential mortgages. Securities backed by credit card debt will also be eligible. These assets will be high quality - rated as AAA. If the assets were to be down-rated, banks would need to replace them with AAA assets. The facility will not accept raw mortgages and none of the underlying assets can be derivative products. The Bank of England routinely accepts assets denominated in currencies other than sterling. It will not accept securities backed by US mortgages."

Either more reserves will have to raised to cover the loss of value to these Tier 1 assets or the banks may decide that marking to market is "difficult" and enact the recently passed legislation, moving the assets down to tier 2, or 3. Either way, the liability for banks will go up. Basel 2 once more comes to the fore.

 Some are relying on the possibility that this:

• " The Senate measure would create a new $300 billion government-backed foreclosure prevention program and strengthen oversight of Fannie Mae and Freddie Mac."CNN Money.
  

• "Trone in a research note estimates that JPMorgan Chase's total exposure -- holdings of GSE debt, mortgage-backed securities and counterparty risk -- is $87 billion, or 69 percent of its equity.
  

  Citigroup has exposure of $51 billion, or 40 percent, while Goldman Sachs has the largest total exposure among investment banks at $14.2 billion, or 32 percent of equity.

  In addition, GSE bonds and mortgage securities generate underwriting and trading business that have fueled Wall Street profits for years."

• "As we work through this tough housing market, we are maintaining a strong capital base, building reserves for our credit losses,"
  

Freddie Mac on the other hand took a slightly different approach, after the usual bluster, easily summed up as everything is okay, Freddie then went on to say this:

• "Beyond that, there are a number of options to manage our capital position. The average rate of run-off on our retained portfolio is currently about $10 billion per month, and not replacing that run-off would free up approximately $250 million of capital per month. Over the course of a year, this would free up approximately $2.5 to $3 billion of additional capital if this run-off rate remains constant. We also could consider reducing our common stock dividend. Our current annual common stock dividend is approximately $650 million.
  

  Currently, Freddie Mac's liquidity position remains strong. This is a result of the combination of two factors: access to the debt markets at attractive spreads and an unencumbered agency MBS portfolio of approximately $550 billion which could serve as collateral for short-term borrowings. "
  

Who is left to lend to the GSE's? I don't see the Banks rushing in - do you? The answer is the Lender of Last Resort, the tax payer.  What of the moral hazard that grows daily as the US Fed and Gov't commit more and more dollars to this expanding mess? I wrote a warning in the 25th May 2008 Weekly Report of the need to keep tight control:

• "To avoid moral hazard arising, strict controls have to be placed upon the facilities that are created and the use of the assets supplied from those facilities. A failure to control the results of centralist intervention will encourage the very behaviour that caused the original problem.

  Let me be blunt. There is no risk to the financial sector that is so great that could justify invoking a moral hazard. If a bunch of banks and investment houses collapsed under the strain of unserviceable debt or losses so great that creditors required compensation, so be it. The pain would be enormous and the recession deep but the US economy and importantly the US financial sector would re-emerge stronger, leaner and fitter than at any time since WW2.

  As we know such an event will not be allowed to happen, the Fed and the US Gov't are working together to ensure that credit markets at least allow maturing debt to be rolled over, giving time to the banks and investment houses to rebuild their capital reserves. It is a 2 pronged attack, the Fed keeps the banks functioning and the US Gov't drops money directly onto consumers in an effort to encourage spending or re-finance mortgages that have become too burdensome. These measures have no time limit, they can be repeated and increased until the day occurs when banks tell the regulators "all is well".

  The groundwork for an episode of moral hazard is laid out but not yet constructed as long as the facilities are controlled and the assets applied to the task at hand."

To give you some idea of the attempt to increase inflationary expectations, read this excerpt from someone we have already quoted today:

• "US HOUSING: Federal Deposit Insurance Corporation Chairman Sheila Bair outlined in an Op-Ed piece in today's Financial Times a proposal that would assist one million homeowners who are facing foreclosure. The plan proposes that Congress authorize the U.S. Treasury to use $50 billion to make loans to borrowers with unaffordable mortgages to pay down up to 20 percent of their principal. The repayment and financing costs for these Home Ownership Preservation (HOP) loans would be borne by mortgage investors and borrowers. This approach is scaleable, administratively simple, and will avoid unnecessary foreclosures to help stabilize mortgage and housing prices."
  

And what of the future, are we going to continue to stagger from one financial implosion to another, constantly increasing liabilities in an effort to keep the system going? Without a doubt the Governments and Central Banks will attempt to follow this path, sacrificing your future to preserve the present for a corrupt, failed and illegitimate financial system based on a branch of economics discredited not once, or twice ('30s and '70s) but now for a third time.

Yet I see a different outcome, one that is reaching towards its final conclusion:

• " A recap of the scenario: bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation."
  

After the deflationary experiences of the '20s and '30s the Fed embarked on a strategy to eradicate deflation and to control inflation using interest rates.

Yet today we see Fed Fund Rates at 2% whilst price inflation, caused by the pass though effect of the rising costs in the production of goods, remain stubbornly high. The Fed isn't fighting inflation, it is fighting deflation as it attempts to divert the effects of the great credit crash and de-leveraging of the financial system.  The Fed understands that current price inflation is the legacy of loose credit availability, the feed though effects of the massive expansion of credit used to escape the deflation scare in 2002.

Yet despite the Feds every move, credit is being wiped out as losses and de-leveraging reduce cash reserves and banks tighten their lending standards to the extent that many are avoiding the market.

The situation is a copy of that in '29-'32 and similar to '37. Banks are unwilling to lend and are doing all they can to raise capital, cash is king. Prices of goods and commodities are reaching levels that are causing buyers to stop and think, not just consumers but Governments too:

•   "BANGKOK (Thomson Financial) - Japan has turned down 60,000 tons of rice from Thailand after the asking price nearly doubled in the space of a month, the Thai Rice Exporters Association said Wednesday.

  Chookiat Ophaswongse, president of the association, said Thailand on Tuesday offered the Japanese government 100 percent white rice at $1,300 per ton -- up from the $720 it paid in March.

  "This time, Japan turned it down, saying that the price was too high for their budget," Chookiat said, adding that Japan did not want to be seen as a country pushing up global rice prices."
  

A consumer retrenchment of proportions never before seen approaches. The temporary relief of tax rebates for US consumers has passed; it was noticeable that the main beneficiary was Wal-Mart, not the specialist or high end part the retail sector. The rebate was spent on essential or near essential goods.

It will be the inability of consumers and business to buy assets or services that will force prices down as the suppliers seek to keep market share. Are there signs that the availability of credit is going negative coupled with a reluctance of banks to do business?
 

Credit is contracting along with borrowing. The banks are deleveraging and unwinding positions at an accelerating pace. Banks continue to keep credit standards high and discourage borrowing by charging higher rates, or in the UK by not passing on Central Bank base rate cuts.

When will we know the process is finished?

We have a way to go. At a rough guess, US Banks and Institutions need to unwind $200Bn of capital. At a leverage of say 10, that's $2Trillion of positions, minimum.

Is there any sign of relief for the stock markets in the near future? The following chart (Dow weekly) shows the Dow since 2004 along with an important moving average, traditional support and resistance and a proprietary indicator. The vertical red lines identify turn points as flagged by the indicator.

I have had to compress the chart but it does show the change from low to high volatility. The head and shoulders, with a downward sloping neckline is textbook. The yellow highlight shows the retest of the neckline that took place over the past 2 weeks. If that neckline holds then the target for the Dow is 9305 (the lower thick purple line) minimum. The neckline is my line in the sand, circa 11430.

The diagram below is the Armstrong Economic Confidence Model:

 Is the attempt by Governments and Central Banks to avoid the fallout from the credit crash and the horrendous damage being caused to the global economy doomed to failure?

My thanks to you all if you managed to stay with me to the end of this article. I firmly believe that this is how eco-bloggers, writers, analysts and fund shills should recap their calls on the markets. I do not believe a 6 month timespan is an effective window for investors to base their investment decisions on. What happened in the past does influence the future, the present is just those events unfolding.

Choices made over 10 years ago have influenced current events, those that dismissed the writers back then who warned of the possible outcomes will never be called to account, the memory of the market participants is too short. Those who did warn of the eventual outcome will get no recognition, unless they are one of the handful who managed to survive the snide comments and muffled laughter sent their way over the past decade.

I have no doubt we are in a bear market, a bear that will devour ALL asset types and not be restricted to stocks. A 20% fall in stock markets does not signal the onset of a bear, that was just a figure used by fund managers et al to keep you long in the market so you could absorb 20% losses. If that Head and Shoulders plays out a 20% loss will seem like a lucky escape.

During the last bear in stocks the advice from the vast majority of "advisors" was to stay in the markets, for many that meant unrecoverable losses. The advice back in 1929-30 was the same, most people only sold after they had taken enormous losses on their portfolios. Has it changed with the advent of the internet, satellite TV and mobile phones? No, it hasn't. All that happens now is the bad advice is delivered quicker that previously.
 
Bear markets are viscous, dangerous periods designed to make everyone hurt, including bears. Some of the biggest rallies in stock markets happen in bear markets. I do not expect markets to go straight down, you only need to look at 1998-2003 to see why.

Protect yourself, use stops, use only spare capital, be able to carry on with life if you lose your pot and stand back from the market, take a wider, longer term view. Finally be very careful who you listen to and what you read. When the overall pot shrinks those who need your funds to survive will do and say almost anything to try and make your wallet lighter.