MACRO ANALYSIS REPORT
ECONOMICS, CENTRAL BANK POLICY
BANKS, BONDS, GEOPOLITICS

* Miscellaneous Morsels
* Banking Policy Caught in a Box
* Compelling Monetization Realities
* Turmoil in USTreasurys on All Fronts
* Many Sides of Damage to USEconomy


HAT TRICK LETTER
Issue #63
Jim Willie CB, 
“the Golden Jackass”
14 June 2009

" It is easy to see green shoots when you are looking at scorched earth." - Doug Dachille (First Principles Capital Mgmt, former managing director at JPMorgan)

" If the Fed examiners were set upon the Fed' s own documents, unlabeled documents, to pass judgment on the Fed' s capacity to survive the difficulties it faces in credit, it would shut this institution down. The Fed is undercapitalized in a way that Citicorp is undercapitalized." - Jim Grant (of Grant' s Interest Rate Observer)

" Regulations are mostly a service to crooks. They create a false sense of security. A lot of the individuals you know personally who have recently suffered huge losses in their investment portfolios are the living proof of it. The shepherds do not work for free, and what starts as the shepherd raising the sheep for their wool, usually ends with the shepherd raising them for their meat." - Richard Maybury (Early Warning Report, also CLICK HERE for interview transcription on mal-investment and crooked regulators)

" A jump in financial speculation is NOT an economic recovery. If the S&P 500 goes to 20,000, but we are drinking $1500 beer and wiping ourselves with $100 bills, we have not gotten richer. Never mind the fact that an S&P 500 of 20,000 DOES NOT create jobs." - Graham Summers

MISCELLANEOUS MORSELS

◄$$$ GIANTS FALL, A SIGN OF THE TIMES $$$. Exit General Motors and Citigroup from the Dow Jones Industrial Index. The Citigroup colossus of financial embarrassment, corruption, supermarkte failure, and Rubin misguidance is gradually being and broken up. One of its parts is the Travelers insurance giant. Replacing these two icons in the DJ Industrial index are Cisco Systems (leading computer network corporation) and Travelers. The changes to the flagship US stock index in my view precede the bankruptcy liquidation of both GM and Citigroup, to come in the next year. They are each doomed and not in the least bit fixable. To put a little reality paint on the GM story, pay note that the new GM Chairman is Edward Whitacre. He is the former AT&T Chairman, hardly a great resume line item, but worse, he admits he knows nothing about cars. Also, the one common theme for the closed Chrysler dealerships apparently is that they all were donors to the Republican National Committee. USGovt management at its best. Hmm!

An aside… A very reliable indicator that financial conditions have not improved much at all, despite the contrived stock market rally is the total dearth of mergers and acquisitions. The stock rally is a pure bear market correction, and bear trap, the direct beneficiary of both accounting rules relaxation (fraud) and huge monetary inflation leakage. Executives have no interest in making big deals and forging new relationships in this climate, which they collectively describe as not good and not really recovering

◄$$$ NATIONAL HIGHWAY TRUST FUND FALLS VICTIM, SURE TO PUT THE AXE TO COUNTLESS CONSTRUCTION JOBS $$$. The falling gasoline price and reduced national driving habits have cut deeply into the US Highway Trust Fund, which provides a huge amount of funding to states for highway and bridge repair and construction, plus more. Frank Holmes of the US Global Fund calls attention to yet another budget crisis. He said, " The US Highway Trust Fund will need an additional $7 billion by August to finance projects already promised to states and keep the fund from going bankrupt." The HTF is the primary source of funding for road and bridge projects across the United States. It is funded through gasoline taxes and taxes on other vehicles like trucks. This is not the first time the HTF has been on the edge of solvency. Just last September, Congress approved a special $8 billion rescue to keep it from vanishing to empty on the gauge. More bailouts are possible. The federal gas tax has been 18.4 cents per gallon since 1993, unlikely to be raised anytime soon, given the struggling economy and the strained political environment. Here is one more acidic wellspring that adversely affects the labor market, as states continue to cut back under horrible insolvency problems. They are making gestures to the USGovt to qualify for TARP funds. So far, the big banks are the hog at that trough.

◄$$$ AIRBUS IS A FLYING PIECE OF COMPOSITE GARBAGE $$$. After the Airbus crashed into the Atlantic Ocean off the Brazilian coast and all 230 Air France passengers perished, the investigation continues. Maybe it does not, since the fault might be with the Airbus vertical fin design, which contains the rudder. The French intelligence agency is working on evidence used possibly to pin the crash on Islamic terrorists, as two suspicious Arab types were on board according to the manifests. In a new age where Bush II is gone from the scene, all evil might no longer be linked to terrorists in mindless displays of authoritarian abuse. The most likely explanation, apart from a possible lightning strike during a powerful electrical storm, is the fracture or separation of the vertical fin stabilizer. The fin was found floating amidst the debris, with no visual damage, which indicates it probably separated at high altitude. The past is scattered with Airbus incidents involving the vertical fin. An Airbus crashed on Rockaway Beach New York City in November 2001, another Airbus A300 model. That crash was blamed on the failure and separation of the vertical fin and rudder, but the official conclusion blamed the crash on pilot error. Sounds like possible political pressure from European power centers.

By comparison, no Boeing 737 aircraft have failed in their vertical fins in many years. Another incident was an Air Transat flight over the Caribbean Sea in March 2005, but was able to return to its Cuban point of departure without any incident or lost lives. The pilot had noticed at high altitude the Airbus A310 rudder had fallen off and tumbled into the sea. Other non-fatal incidents have occurred. One came in 2002 when a FedEx Airbus A300 freighter flight experienced strange ' uncommanded inputs' due to rudder movements without pilot actions. When FedEx conducted its own test on the rudder on the ground, engineers claimed its actuators (the hydraulic system to control the rudder) tore a large hole around its hinges, in exactly the location where the rudders of two previous flights separated from the rest of the aircraft.

The Observer has learned that after one Airbus disaster, more than 20 American Airlines A300 pilots asked to be transferred to Boeings, although this meant extra training and lost earnings. Some of those who contributed to pilot bulletin boards last week expressed anger at the European manufacturer in vehement terms. The National Traffic Safety Bureau is the object of severe criticism in the United States, as they consistently blame tailfin separation on pilot error and ' aggressive pilot inputs' in what seems like mindless conclusions. As BobO says, " Many times ' pilot error' means: the pilot made a big mistake by flying that death trap!"

Airbus is Europe' s biggest manufacturing company, having surpassed Boeing as the leader in the global airliner market. British factories contribute major components, including aircraft wings. The Airbus models rely upon composite synthetic materials that are both lighter (and supposedly stronger) than aluminum or steel. Fins, flaps, and rudders are made of a similar layered composite on the A300 and A310 models. The strength of composites depends upon careful criss-crossed layouts of fiber grains, in anticipation of loads and directional stresses. Gaps and irregularities in the layers can cause extensive de-lamination, and loss of strength. Many government inspection programs depend on visual inspection alone. Many analysts accuse Airbus maintenance procedures of being grossly inadequate. Professor James Williams of the Massachusetts Institute of Technology, one of the world' s leading authorities in this field, said that to rely on visual inspection was a lamentably naive policy, in his words. He and other scientists have stated that composite parts in any aircraft should be tested frequently by methods such as ultrasound, allowing engineers to check beneath their surface with accuracy. His research suggests that repeated trips to and from the sub-zero temperatures common at cruising altitude causes a build-up of moisture condensation inside composite layers, and subsequent separation of the carbon fiber layers from cycles of freezing and thawing. Over time, the gaps grow, and structural weakness develops. Composite experts across the industry advocate state-of-the-art, non-destructive testing of structural parts, yet civil aviation authorities still only require ' naked eye' tests or other basic inspections.

Thanks to CaptainK (former United pilot) and BobO (former Boeing engineer) for the headsup information, which points to yet another government agency cover-up at worst, and incompetence at best. Political pressures seem obvious, since Airbus is not a private firm, but a government subsidized and managed enterprise. Most government agencies are in the pocket of the very groups they are meant to regulate. The Federal Aviation Admin was flawed from the onset, since its charter calls for it to both ' promote & regulate' the aircraft and airline industry. Promotion always wins; that is where the money flows. Yes, Airbus is a flying piece of composite junk. The upcoming Paris Air Show will surely provide some fireworks and freely spoken criticism, which starts on June 15. See the Bloomberg article for a competition playbook preview (CLICK HERE).

BANKING POLICY CAUGHT IN A BOX

◄$$$ USFED SPEAKS WITH TWO VOICES, BERNANKE WITH MOSTLY DENIAL AND NONSENSE, BUT YELLIN WITH SOME WORDS OF WARNING, AS THEY BOTH IGNORE HUGE NEW USTREASURY BOND ISSUANCE AS A FACTOR, LIKE A 20-FOLD RISE $$$. Two weeks ago USFed Chairman Bernanke told a USCongressional committee that the increases in long-term USTreasury yields may reflect rising optimism about the economy and concerns about large federal deficits. Such a comment has one foot in the land of deceit, and one in the land of reality. San Francisco Fed President Janet Yellen has warned that policy makers need to be prepared for ' substantial shocks' and that rising USTreasury yields may be a ' disconcerting' signal of inflation fears. She made reference to the end of an era of relative economic stability in the Western industrial nations for over 20 years. Policy makers next meet June 23-24 at the Fed Open Market Committee to consider whether to increase their planned purchases of $1.45 trillion of mortgage debt and $300 billion of long-term USTreasurys. The next FOMC meeting contains their monetization decision, or denial. The reality is they must monetize! Yellen prefers a stable 2% engineered price inflation rate, but the USFed gaggle had better prepare themselves for much higher inflation in the near future.

USFed officials have begun discussion on how and when they will need to start tightening credit and reduce the unprecedented injections of liquidity into the financial system. They are soon to find themselves totally stuck in continued policy of rapid inflation. If the inflation spigot is turned down, the system will grind to a halt, a systemic failure. They cannot act upon propaganda of phony recovery, and cannot build upon a phony accounting for bank balance sheets. It is like diving onto a broken trampoline, with no lift. She indicates a desire to learn how they created the current disaster and what their policy has produced even in remedy attempts, an interesting concept. They have suddenly become curious enough to calculate the costs and benefits of leaving the benchmark US interest rate near zero percent for many months. Can anyone recall the denials by Bernanke that the US would ever resort to 0% rates, made only two years ago? These people are clowns! See the Bloomberg article (CLICK HERE).

Yellen said, " Recent experience raises the possibility that the Great Moderation is behind us, so we must be prepared for substantial shocks. We do not yet have good estimates of the quantitative impact of such interventions [bond swaps, endless rescues, balance sheet growth]. We simply must understand better, and ultimately develop reliable models of, the extraordinary financial and macro linkages that produced the current crisis. [Near zero rates is certain] to incorporate greater volatility than experienced over the past quarter century. Truly, we are sailing in uncharted waters, marking our maps with every bit of information along the way."

These folks at the US Federal Reserve are flying blind, repeating their errors, and showing their confusion, if not utter fear. They learned nothing from the identical chapter in monetary history from years 2002 and 2003, when sustained ridiculously low interest rates spawned bubbles and financial fraud. Yellen warns about systemic shocks. She should. The list of potential shocks includes bank system collapse or relapse, a burst of price inflation, bond vigilantes riding on horseback kicking up long-term rates, the Chinese pushing the US fraud king bankers off the stage, a sequence of Black Hole USTreasury Bond incidents attracting available capital, housing endless decline acting like 2-ton wrecking ball on the USEconomy, even gold default events coming to the COMEX. One should tend to agree with her growing concern, if not alarm.

◄$$$ THE TRAGEDY IS THAT THE USFED HAS NO EXIT STRATEGY, AND CAN HAVE NO EXIT STRATEGY, CONDITIONS NOT OFFERING ONE $$$. The USEconomy is in recession. Arguments of ' less bad' data do not work. The ultimate problem is that banks remain insolvent (lies do not produce solvency), households remain insolvent (foreclosures ramp up as house prices continue down), the USGovt finances remain horrendously insolvent (deficits are worsening), and US industry is slowly collapsing (with General Motors the latest example). Bank lending remains stuck, as lenders do not trust the viability of borrowers (job losses are constant). Banks are being induced not to lend, since the USFed offers them interest on reserves held by the USFed itself. Why lend, when a small return is guaranteed? The options left to the USFed are terrible. They can hike interest rates during the most powerful recession the USEconomy has faced in 70 years. That will not work, a surefire disaster! They can slowly drain excess liquidity, when available credit to households (home equity) and businesses (corp bonds) and states (municipal bonds) are under tremendous strain. That will not work, a surefire disaster! They can continue the course and permit the bond market to raise long-term rates and assure that the housing decline actually accelerates downward in a worse fashion. That will not work, a surefire disaster!

TRAGICALLY, THE USFED HAS NO OPTIONS AT ALL, AND HAS EXHAUSTED ALL ITS AMMUNITION. A RATE HIKE WOULD POP THE BIGGEST BUBBLE IN MODERN HISTORY, THE USTREASURYS. SUCH A DECISION WOULD BREAK THE ENTIRE INFLATION MACHINERY AND ELIMINATE ALL OFFICIAL RESPONSE MECHANISMS. Their only option left is quarterly $1 trillion monetization, to produce powerful price inflation, and to risk the fury of foreign creditors. It is the coward' s back door escape, used to attempt to inflate debts away and betray creditors. IN THIS CASE, ITS USAGE WILL DRIVE CREDITORS AWAY. The US bankers will be forced to embark on a publicity campaign in China, the Arab nations, and elsewhere to sell their inflation plan. The harsh reality that the face right now is that foreign creditors have much smaller trade surpluses, and cannot finance the USGovt deficits transformed into bond securities. The monetization option stares at them directly. Refusal will force a USTreasury auction breakdown, and death of its primary bond dealers.

Take a quick examination of Exit Strategy options, to quickly realize no viable options exist, period! If the USFed does nothing, and continues the present course, then a horrendous situation arises where the USTreasurys remain the only investment around and the USDollar declines to the point of lifting the entire cost structure of the USEconomy. That is the Black Hole option. Easy money and free money for the financial sector (a veritable syndicate) would enable more bubbles to form, the primary location being the magnificent USTreasury bubble. When the real cost of money, over and above price inflation, is negative, huge risks arise for asset bubbles, especially when the near 0% nominal cost persists for up to a year and even more. Such very accommodative monetary condition caused the current credit crisis. Its continuation assures similar crisis, but most likely of a parallel type and not exactly the same type, whose result would create new cancers. Furthermore, a continued 0% policy assures the long-term rates will rise from fear of price inflation and lost control, being seen right now. The housing market would face further destruction, being seen right now. On the other hand… If the USFed begins to raise interest rates and to drain excess liquidity in the banking system, then a horrendous situation arises where the fragile USEconomy cannot even remotely withstand the added stress. The credit derivatives would suffer terrible powerful destruction, at first hidden, then in full view. The recession underway would worsen with acceleration. A powerful feedback mechanism is at work. If and when any recovery arrives, interest rates would rise slowly at first, enough to trip the recovery and interrupt it, if not derail it. With high likelihood the rising interest rates would accelerate upward, due to Interest Rate Swap control fixtures that unwind to wreck havoc.

The ultimate source of the systemic breakdown into widespread insolvency was the housing crash and related mortgage defaults. Here is the dilemma as it pertains to the all important housing. A continued easy monetary policy would accelerate the terrible housing market from a mortgage rate standpoint. A new tighter monetary policy would accelerate the terrible housing market from an economic standpoint from worse job loss. Bankers have great challenges finding worthy borrowers now, and with tighter monetary conditions, even fewer borrowers would qualify for the most basic of loans. Tightening monetary conditions would more assuredly kill the USEconomy and US banking system in rapid fashion. The mere talk of monetary tightening is lunatic. It is motivated by knowledge of the extreme growing risk right now presented by 0% rates, growing worse with each passing month. Doing nothing, continuing monetary ease, assures price inflation soon, and eventually powerful price inflation, forcing upward the entire cost structure for the USEconomy and housing. Tightening monetary policy, raising rates and draining the system, assures the gradual death of USEconomy by means of the strangle of urgently needed credit lines. The USFed is truly between a rock and hard place, with no viable options, and it must know it!!! The continued USEconomic recession absolutely ties the hands of the USFed. THEY CAN DO NOTHING EXCEPT MONETIZE!!! The USGovt and USFed are trying to reproduce the Good Ole Times, to restore conditions back a few years ago. This is utterly and irrefutably impossible!!!

◄$$$ GRANT CALLS THE USFED GROSSLY UNDER-CAPITALIZED, EXPECTS PRICE INFLATION TO ARRIVE SOON, AND IMPLIES THE USFED WILL AGAIN BE LATE IN TIGHTENING $$$. Jim Grant of the Grant' s Interest Rate Observer is an elite credit market analyst with a solid background and great track record, an undisputed authority. He should be listened to. Grant opens by calling the US Federal Reserve grossly under-capitalized, with $45 billion in capital, but $2100 billion in assets, for a 47:1 ratio. He does not believe the USFed could withstand a true audit, even though a most unusual bank. Grant believes that 0% is the wrong rate for any economy, no exceptions. It caused enormous problems and is a sign of desperation, if not failure. He calls ' Quantitative Easing' money printing on a wholesale level. He believes the monetary policy enacted by the USFed represents a vast experiment in moral hazard, one that usually results in far bigger problems eventually. He expects price inflation will arrive sooner than expected, since $830 billion in tinder lies around, even though it is ' soaking wet' as he called it. Either economic recovery or passage of time will dry the tinder. At the same time, he anticipates the output gap to remain a big problem, meaning under-utilized industrial capacity, as in prolonged recession. He claimed several examples of a weak economy producing strong price inflation, a clear slap at the prevalent stupid economist belief that strong growth causes inflation (PURE HERESY). Despite a growing chorus that expects the USFed to begin tightening its monetary policy soon, Grant pointed out that the USFed has a long history of reacting in late manner to all crises and bubbles. He cited 15 of 16 primary official bond dealers who do not see any tightening before the end of the year. They must see the predicament and lack of options facing the USFed. This view is repeated by ex-Harvard and now PIMCO co-executive Mohammed El-Erian, who expects no USFed change by yearend.

Grant sharply disputes the notion that an institution is too big to fail, calling it one of our nation' s greatest weaknesses. Saving what is too big and far too unmanageable will be the ruin of the nation, in my view. Not trying to be humorous, he cited the principle that there is no such thing as a bad bond, only bad bond (wrong) prices. His examples were the 2.1% USTreasury 10-year Note in December 2008, and certain mortgage bonds selling at 50 cents to par value a year ago. One should listen to his comments carefully and take his warnings seriously. One can quickly infer that something very unique and very ugly comes. The thermometer for the fever, whether from either policy driven scenarios, is a skyrocketing gold & silver price. Either price inflation or systemic ruin with desperation actions will drive the precious metals prices skyward. See his CNBC interview with Ariana Huffington (CLICK HERE).

◄$$$ THE USFED IS USING ITS INTERNAL LEVERS TO KEEP FOREIGNERS FROM ABANDONMENT $$$. Greg Weldon provides a great glimpse inside the USFed inner workings, although some will scratch their heads. USFed Chairman Bernanke is motivated to maintain what Weldon calls ' fiscal sovereign credibility' in order to satisfy foreign creditors and their demands for US$ risk compensation. The USFed pays foreigner central banks to hold USTreasurys in USFed accounts. As the USTreasury Yield Curve tilts more steeply, the USFed reacts by paying out more on deposits held into the future. The graph below includes the USTreasury yield spread of 5-year versus 2-year (in blue) and the Forward 2-year US Deposit Rate (in red), each hardly household concepts, surely a bit abstruse and technical. They are closely linked. Weldon wrote, " The rise in rates is being DRIVEN by concern over fiscal sovereign credibility, NOT anything linked to Fed ' action.' [This is] a theme that is clearly evident in the overlay chart below which reveals that the US Treasury Yield Curve has LED the move in the (more Fed sensitive) Deposit Rate spread (inverted), breaking out on May-21st, two weeks prior to the move to new ' highs' in the strip."

◄$$$ ECONOMIC & POLITICAL DEAD ENDS ARISE $$$. The United States policy makers, both monetary and fiscal, are at deep odds, great opposition. They both subscribe completely to the benefits of printed paper money as solutions directed at problems. But they have little concept or appreciation, let alone fear, of the aftermath. The Rubin Directive is to put off problems until tomorrow. IT IS NOW TOMORROW. Policy is being repeated that caused the current crisis. The harsh reality is that abuse of paper money is a powerful addiction, an elixir with a two-sided sword when applied. Most bailouts to date have ensured that economic mal-investments remain, toxic assets stuck on bank balance sheets, as failure and fraud continue to attract huge funds. A high volume of money continues to be wasted propping dead banks, restructuring failed car companies and sustaining other ruined ventures like AIG and Fannie Mae. The hundreds of billion$ devoted to rescues, bailouts, and stimulus are the official protective actions to prevent the monster of deflation from hitting, something Bernanke pledges never to let happen. The result will be bank constipation, commodity price increases, further economic liquidation, endless housing decline and foreclosures, and a rancid acidic sickness much like a deadly bacteria lodged in the body economic.

Deflation advocates direct attention to the velocity of money in circulation. It has broken down badly, during a time when unemployment is rising. The USFed official Monetary Multiplier ended last week at 0.867, half its average of 1.70 over the last decade. Thus one can easily conclude that the credit mechanism is still broken. This is what happened in Japan in its Lost Decade. Consumer borrowing in April fell by $15.7 billion, now at a $2520 billion total level. Revolving credit card debt fell by 11% annualized in March and April. The USGovt and USFed preach avoidance of the Japan swamp but are doing exactly what Japan did, only with more gusto, more volume, and more power. They proceed down the only path they know, pushed by political forces. The conclusion to the casual observer should be that the US will earn not a Lost Decade, but a calamitous path to a lost nation, a systemic failure with all the lethal trimmings that come with prolonged insolvency. The US operates without the benefit of trade surplus or industrial output that Japan had. The Japanese enacted numerous stimulus packages, each to sustain a wounded patient. So is the United States. The Japanese refused to liquidate the largest dead banks, but to prop them up as zombies instead. So is the United States. The Japanese distributed funds in huge volume through structures of dubious health. So is the United States. Sadly, the United States should prepare for something much less benign as a Lost Decade like suffered in Japan, a sure agony. In their struggle to provide exactly the wrong solution, the monetary elite in the United States, who control Wall Street, the US Federal Reserve, Regulators, the USDept Treasury, and the USCongress itself, will eventually doom the nation to ongoing stagflation at best, and an devastating inflationary recession at worst. They are going down the same Japanese road, only ours is dead end since no trade surplus and little viable industry.

Either way, hyper-inflation is the real risk. The best indicators of deflation not taking the upper hand in price structures in my view are the crude oil price and copper price. The USEconomic structure cannot take prices down if its foundation of energy and metal costs are rising from USDollar concerns, and protective measures. The cost of living will surely rise for most American businesses and households, along with unemployment and loss of homes. The officials in charge, the financial crime syndicate, will opt for more power after they created the crisis. The biggest risk is the gradual collapse toward the governmental center, for both economic reliance and financial sustenance. This trend is already clear. The result could become a Black Hole, ending up in systemic failure and USTreasury Bond default. Watch for both a concentration of banks via consolidation and a concentration of power politically. The former creates a Mussolini Fascist Business Model that cannot remedy itself. The latter usually delivers a Fascist state in its fully glory, eradicating liberty.

The immediate consequence is that enormous USGovt federal deficits will result in unspeakable pressure at USTreasury Bond auctions. So far, the stress has been handled by steadily rising bond yields. The federal deficits will continually be revised upward, as tax revenue drops but spending plans rise. The threat to the USTreasury Bond ' AAA' rating is entirely unjustified, kept as a global expedient. The largest bubble in the world right now is the USTreasurys. The principal creditors are fast losing confidence in it, led by China and its consistently surly attitude. The pattern of debt liquidation has a long way to go before completion, and IT IS NECESSARY. Households and individuals should avoid both debt and leverage. The onset of price inflation is a certainty. Great lengths will be required of the USGovt stat lab rats to falsify the rising price inflation phenomenon.

◄$$$ THE INTEREST RATE SWAP NIGHTMARE CHAPTER IS SOON TO UNFOLD, AS LOST CONTROL OF THE BOND MARKET BECOMES LIKE WILD HORSES TRAMPLING THE FIELDS OF GRAIN, SETTING OFF LAND MINE EXPLOSIVES $$$. Not only has the housing market stalled, with new mortgages and refinanced loans hitting a brick wall. The other major threat is to the Interest Rate Swap, those powerful credit derivative contracts that tie together the bond world in complex knitting. The IRSwap actually controls the USTBond market. The instability of USTreasurys on the long maturity (10-year & 30-year) and on the short maturity (so far just the 2-year) will surely soon unleash great firestorms of disruption, heavy losses, and raging fires for the big banks. A greater second chapter to the Credit Default Swap opening salvo comes, with unclear timing. Twice as many IRSwaps exist than CDSwaps, a story that bankers refuse to discuss. Over 65% of credit derivatives are Interest Rate Swaps, which link long-term bonds to the short-term LIBOR rate. They enable floating bonds of different types to benefit from a lower short-term rate. For over a year, the Credit Default Swaps (insurance contracts for asset backed bonds) have garnered most attention from this unregulated zone of darkness where financial nuclear bombs are hidden with criss-crossed fuses. During the many months when USTreasurys have had bond yields under 1%, the long-term USTreasurys have also been absurdly low. No longer are long-term rates low, as they have risen very quickly, too quickly. The IRSwap contracts have been under tremendous strain, but have received almost no attention. When short-term interest rates are near 0%, and are used as the basis for powerful leverage in IRSwap contracts, nearly infinite strain is applied. It is akin to dividing by a number near zero in mathematics, like a point of singularity in a discontinuous function in calculus.

The IRSwap contract has enabled for 15 years the long-term rates to remain well below actual price inflation, kept down by force from the control originated from USFed short-term dictated rates. The astute forensic bond analyst Rob Kirby calls the artificially low long-term interest rate the ultimate source of financial market bubbles in the last two decades, ' a pox on humanity' in his words. The falsification for 15 years of the Consumer Price Index goes hand in hand with falsification of interest rates, both long-term and short-term. Interest Rate Swaps form a powerful hidden leverage device, put at great risk with 0% conditions due to excessive force applied. The supposedly easy money comes with a heavy hidden price, that being shocks to the structural foundation and its gradual hidden weakness to the entire bond lifeblood to the banking system. Next come explosions large and small in the Interest Rate Swap arena. It will be the greater second chapter to the CDSwap opening salvo. The IRSwap contracts have been suffering growing tremendous strain. They assure tremendous and possibly catastrophic losses, whose attention will come in the next few months. The instability of USTreasurys in general will light a fire that rages inside the big banks. Some competent analysts, who were not fooled by the growing dangers that erupted into crisis last year, believe that a volatile USTreasury Bond could destroy the US banking system, delivering it final blows after the mortgage crisis rendered it insolvent. The destructive mechanism is the Interest Rate Swap contracts. The commercial mortgage losses, the Option ARM mortgage losses, the credit card losses, these will add to bank distress and in more cases failures. But the Interest Rate Swap disaster looms close with heavily leveraged sledge hammer blows, with sudden enormous catastrophic losses.

See Rob Kirby' s illuminating article entitled " Theater of the Absurd: A View From the Inside" (CLICK HERE). He provides excellent arguments to make the case of profound market interference, with diverse and profound damage to the entire nation. In the article, Kirby travels through the bond world to offer evidence that Credit Default Swaps lie at the epicenter of the derivatives crisis. AIG is its most visible victim of those insurance contracts. The Office of the Comptroller of the Currency issues a quarterly report, which unfortunately is lagged badly in its data provision. The four major villains, all protected from prosecution despite a bank system failure, are JPMorgan Chase, Goldman Sachs, Citigroup, and Bank of America. Notice that a mountain of IRSwaps are traded, even though no counter-party could possibly exist, given the huge volume. The reason for grandiose IRSwap deployment is simple: to keep interest rates low in strong-arm fashion. Now their usage has begun to backfire, and danger rises for major credit derivative accidents twice as great as the CDSwap accidents that killed AIG. The victims list also includes Bear Stearns and Lehman Brothers. A second list of dead financial firms is very likely to be written before long.

◄$$$ CREDIT DERIVATIVES REPRESENT AN UPSIDE PYRAMID, WITH UNSTABLE APEX RESTING ON AN UNSTABLE PLATE, WITH SLIGHT WINDS AND PUSHES CAPABLE OF DISRUPTING ITS BALANCE, RESULTING IN LARGE ACCIDENTS $$$. One should begin by realizing that the credit derivative pyramid controls the USTreasury complex, and not the reverse as it commonly thought. For a good primmer on IRSwaps, their background and application, go to the PIMCO website (CLICK HERE).

PIMCO explains, " At the time a swap contract is put into place, it is typically considered ' at the money,' meaning that the total value of fixed interest rate cash flows over the life of the swap is exactly equal to the expected value of floating interest rate cash flows. In the example shown in the graph above, an investor has elected to receive fixed in a swap contract. If the forward LIBOR curve, or floating rate curve, is correct, the 5.5% he receives will initially be better than the current floating 4% LIBOR rate, but after some time, his fixed 5.5% will be lower than the floating rate. At the inception of the swap, the ' net present value,' or sum of expected profits and losses, should add up to zero."

JPMorgan alone has $66 trillion in notional value of Interest Rate Swaps. They must constantly balance this load, in what is called dynamic hedging. Risk must be managed when bond conditions change in different locations within the bond maturity curve. The dynamic hedging task has been rendered very difficult, if not impossible, since so large. The entire hedged position in IRSwaps greatly exceeds the value of the entire USTreasury Bond market, a fact kept quiet by bank officials. With most IRSwap contracts, fixed net payments are made on a quarterly basis. So the hot fires that burn in big bank basements must be dealt with each quarter, as loss damages are assessed and paid for promptly. JPMorgan in all likelihood is every bit as insolvent and possibly bankrupt as Citigroup. Toss in the US Federal Reserve as likely insolvent. The threat of a second fire in the credit derivatives arena directly affects USFed policy. Any policy change would directly affect the Interest Rate Swaps, and light fuses.

The USFed has no Exit Strategy available to it, since raising interest rates would exacerbate a trend that has begun without any direct active decision on the official rate. In fact, the USFed typically telegraphs its change in policy direction, mainly because the vast IRSwap control devices must change course in ultra-slow movements. They cannot change quickly or in big strides, since sudden movement is poison to the credit derivative control structures. Recent talk of USFed potential strategy changes serves as a trial balloon, which in my view appears to be shot down to the dismay of the cogniscenti, but ignorance of the investment community. The bond market is shifting weights inside the JPMorgan rowboat, and dangerously. The IRSwap represents a major obstacle to reversing the easy accommodative monetary policy of near 0% rates, but also serves as a coffin nail final blow to the US banks. They are not recovering; they remain insolvent; they face further losses; they are toast and destined for the dustbin. Next comes the unraveling and Christmas Tree of explosions in the credit derivative arena. The challenge will be for the USFed and USDept Treasury and Wall Street to hide the fires and damage. Given their quarterly feature of reconciliation, the smoke (if not fires) will be easily seen, except at JPMorgan which is exempt from all accounting.

The US car industry has traditionally been a big user of variable rate debt and interest rate swaps. The losses racked up by General Motors and Ford Motors are horrific. The carmakers were able to offer low finance rates or zero percent car financing from heavy usage of variable rate debt and Interest Rate Swaps. Low car sales is a major part of their financial woes, but widespread usage of credit derivatives provided an income stream. Bondholders were truly bagholders. The other side for Detroit carmakers is their active swap trade, where they traded their bond yields (often over 6%) in return for the low short-term rates, and collected quarterly income in the process. An Interest Rate Swap disaster looms close, with the big banks lined up for a kill. But now that GM is bankrupt, many such swap contracts have been torn up, and many future payments no longer have to be made by some big banks that traded with GM.

Market Skeptics arrives at a conclusion. They wrote, " A dollar collapse will drive interest rates to infinity. Right now the financial institutions around the world are sitting on trillions of toxic US debt, hoping it will recover some of its value. However, a dollar collapse makes the ' hold to maturity' strategy a losing proposition. As the world realizes this, all manner of toxic US debt will be sold as everyone tries to escape the dollar' s devaluation. Bailing out the interest rate swap market will be impossible. Fear of inflation will be the biggest factor driving interest higher and causing stress in the interest rate swap market. So printing money to help banks/companies pay their swap obligations would just feed this fear and make things worse. Potential damage from interest rates swaps is INSANE… The notional amount of interest rate derivatives outstanding in the second half of 2008 was $418.7 trillion… There will be few survivors of this interest rate swap apocalypse." See the Market Skeptics article (CLICK HERE).

Credit analyst Felix Salmon describes great distortions already evident. He wrote, " The market in interest rate swaps is enormous, orders of magnitude greater than the market in credit default swaps, and like most markets, it is done some pretty crazy things over the past year, with long-dated swap spreads going negative for most of that time. Because there are not any systemic implications of things like negative long-dated swap spreads, and because the swaps market is a zero-sum game where for every winner there is an equal and opposite loser, policymakers and bloggers and pundits have not paid much attention to it." DeCarbonnel recognizes it as the threat which could bring down the US financial system.

COMPELLING MONETIZATION REALITIES

◄$$$ MONETIZING THE USGOVT DEBT VIA USTREASURYS SERVES AS A TECHNICAL DEFAULT, MOST ASSUREDLY TO BECOME A REGULAR QUARTERLY $1 TRILLION MONETIZATION PLEDGE, DESPITE UNPROFESSIONAL INCOMPETENT VACANT PLEDGES TO THE CONTRARY $$$. USFed Chairman Bernanke attempted to satisfy Chinese need for assurance, and mollify their fears of currency debasement, by actually claiming that the United States is not at risk of monetizing the federal debt. Denial of monetization is preposterous, an extraordinarily dangerous message and urgent message of either incompetence of deceit, probably both. This absurd message comes almost two months after a public pronouncement of monetizing $300 billion in USTreasurys and $750 billion in USAgency Mortgage Bonds. The Chinese must think the American bankers are not only crooked but lousy liars, or worse, take their creditors as fools and suckers. Monetization of the USGovt debt and deliberate deep USDollar debasement continue apace. Desperate and manifest need dictate its loud continuance in great volume. Ongoing bank losses, households running on empty, ruined icon industries, primary bond dealers put at risk, and larger than expected declines in tax revenues assure without any doubt whatsoever that federal deficits will be monumental, bigger than what most words can indicate, and the object of monetization. At the same time, USTreasury auctions are reaching a crisis stage, as primary USFed bond dealers are under great distress, suffering losses at yields rise in their intermediary role. The monetization will not only occur again, but my forecast is for a quarterly commitment of $1 trillion or more, each and every quarter to come. If not, then the system will endure seizure on the bond size and the system will drain like a Black Hole on the financial market side apart from bonds. See my article entitled " Quarterly $1 Trillion Monetization" (CLICK HERE).

The group of 20 to 22 bond dealers with contracts to sell USGovt debt securities is under siege, suffering a grand new plight. The USFed primary bond dealers are being squeezed, and word has spread like a nasty rumor, like wild fire. Curiously, they have some power to respond, and can inform the USFed that they monetize or else bonds go unsold, auctions fail very visibly, with full embarrassment, and full harmful impact to the USTBonds and USDollar simultaneously, tarnishing badly their image. The bond dealers are at risk from rapid loss, and face a possible sudden extinction, or basic resignation. Despite the rising long-term USTBond yield, money going into USTBond purchases in general is growing like a powerful torrent. Demand for USTBonds is growing fast, very fast, a little understood phenomenon. Bond supply is rising faster than demand though!!

The role of primary bond dealers is to hold inventory as intermediaries, a prospect that makes those dealers LOSERS right away as bond yields rise. They turn around and sell the same bonds as quickly as possible. Auction sizes one or two years ago used to be $5 billion, $10 billion, even $15 billion on a given month. Two weeks ago the official auction was for $110 billion, a 10-fold increase. The pushback comes from these primary bond dealers, who collectively possess the power to tell their issuer (USDept Treasury) and their agent (USFed) that buyers fail to arrive as bidders in sufficient volume to absorb such huge regular supply. Buyers are big financial institutions (like pension funds, bond funds) as well as foreign central banks. Pressure is rising quickly for the Dept Treasury and the USFed to monetize USTBonds again in order to lighten the supply load, to take pressure off the primary bond dealers, or else face a renewed crisis is created that could easily grow out of control and force at least a temporary default. The $300 billion monetization commitment in March appeared to be a big amount, but it was not. That amounts to two or three months in supply, if the $1800 billion in USGovt deficits is to be financed. The $1 trillion monetization MUST BE REPEATED, and even become a quarterly event. Refusal by the Dept Treasury and USFed to monetize could result in failed auctions, crushing losses by the primary dealers, and their possible disappearance.

Three key points deserve mention, together contributing as strong motives for quarterly $1 trillion monetization. 1) First, for years the USFed and its Wall Street agents have succeeded in creating a phony USTBond rally prior to and during official Treasury auctions. They did so by using many devices, such as forcing stock indexes down, stressing news stories of peak corporate earnings, citing economist pronouncements of a likely slowing USEconomy, aided by Plunge Protection Team entrances at technical chart spots. The result was a bond rally that gave powerful tailwind assistance to the primary bond dealers (NOW GONE). During their holding period as intermediaries of USTBonds, they profited slightly, and with volume, they profited heavily. That convenient tailwind has turned suddenly into a headwind of hindrance, that now leads to losses. The result will be a gradual ruin of primary bond dealers. Watch in the next year for some to vanish and remove themselves from this insider gravy train of former profits, turned into current nightmare. 2) Second, a hidden bidder in JPMorgan is extremely likely to come forth, but sure to remain hidden. The bid to cover ratio on USTBond auctions must remain over the 1.0 ratio, or else a bond auction failure is the case, with huge shame and painful declines to the USDollar. As word leaks that JPMorgan serves as a hidden bidder to tarnish the integrity of the auction process, the credit market will paint a big billboard sign that HIDDEN MONETIZATION is occurring. The Dept Treasury issues USTBonds and the USFed brings them to the credit market. But JPMorgan conducts the brokerage market activity in the credit market. A gradual undermine should be seen in the USDollar exchange rates, with or without monetization being out in the open with full disclosure. Currency traders despise monetization, and hate it even more when it is hidden, as in with deceit. 3) Third, foreign producers (both energy products and finished industrial products) have much less trade surplus to recycle into USTBonds, their usual destination. So the usual bidders will either not show up at bond auctions, or they will bid much smaller amounts when much larger bond volume come to auction blocks. The USTreasury will be isolated in a powerfully damaging manner. These three factors will force the Dept Treasury and USFed to monetize and monetize and monetize, each quarter after quarter after quarter. Eventually the financial markets will realize the $1 trillion monetization must be a fixed quarterly event. The effect on the USDollar will be enormous, enough for it to plumb much lower lows than have been seen to date.

The trend is clear for those with open eyes. The official bond auctions will continue relentlessly, probably well over $100 billion per month, for perhaps twenty months at least. Worse, the USGovt federal deficits will be much bigger than estimated. Most assuredly, foreigners will have less money to purchase the USTBonds. Here is an astonishing unprecedented fact, during a time when shock is eclipsed regularly. The USGovt tax revenues are down 35% year over year. For the first time in US history, the tax collection month of April 2009 was a net negative month. Expect the USTBond supply pressures to build, not reduce. A certain USTBond monetization commitment forestalls its official default at a later date. The job losses continue in huge numbers. The home foreclosures continue in accelerating numbers. The national home prices continue in steady declines. The USEconomic recovery began in 2001-2002. It was built upon a housing bubble as a foundation, whose bust is absolutely not a completed process. The national insolvency will take its toll on USTreasurys as a certain reflection. The debt downgrade (imminent, scheduled, expected) of the UKGilts three weeks ago awakened the world to the perception of the USGovt debt as Third World debt paper as well. The fiasco is tied to the USGovt committed debt being transformed into debt securities, the USTreasury Bonds. It is a gigantic hairball. It is like a rattlesnake swallowing a goat.

◄$$$ MONETIZATION NOT ONLY CONTINUES, BUT IT HERALDS STRONG PRICE INFLATION IN FUTURE MONTHS $$$. Do not listen to the Deflation Knuckleheads, some of whom are very bright analysts. They are simply wrong, cannot anticipate the spillover, cannot anticipate the GO signal given to banks to lend again, and cannot even properly measure money anymore. Sure, pockets of failed asset prices will occur. But in a strong inflationary recession, losers and winners are in diametric opposition. The setting has never been seen before, except briefly in the 1970 decade. That was a quick sudden fever permitted to rage. Today we observe powerful sustained events that are not responding to any remedy, because the ultimate problem is systemic insolvency. Banks are busted; households are busted; USGovt finances are busted; much US industry is busted. The rest is just a charade and shell game. Spending home equity was actually an integral part of the grand liquidation that has reached a new level.

Despite Mr. Bernanke' s recent protestations that the Fed would not monetize federal debt, and despite misplaced market expectations that the ' strengthening' economy will cause the Fed to tighten, draining liquidity from the system, the prospect of amplified monetization seems certain. In the two weeks ended June 3rd, the USFed adjusted monetary base was up 107.7% from a year ago, down slightly from the 113.4% annual growth in the previous two-week period. The USFed can only affect the monetary base, its primary tool for affecting the money supply in the form of circulating currency and bank reserves. Bank reserves are exploding. What is normally 4% allocated in bank reserves has become 96%, in a giant constipation episode. The annual growth in excess reserves is at 1813%, as evidence. Despite all the hype of return to normalcy, banks refuse to lend funds into the normal flow of commerce. The Shadow Govt Statistics outfit provides an Ongoing M3 estimate of 7.3% annual growth. The ultimate problem is insolvent banks, which cannot proceed with expansion of loan portfolios or credit market assets since they are broke. Their principal activity is shoveling badly impaired toxic assets of miniscule value into reserves after exchanging them for USTreasurys in the numerous USFed liquidity facilities. Erratic money supply growth figures testify to a continued bank crisis. The system cannot properly absorb the orchestrated surge in bank reserves any more than a dead man can process a meal shoved down his throat!

The USFed and USDept Treasury have embarked upon a highly destructive course. Cheap money and easy credit contributed heavily to destroying the US banking system and USEconomy. Its acceleration is set to destroy a large swath of capital. That is what excessive monetary inflation and uncontrolled debt do. They destroy capital. In no way has the nation benefited from broad capital formation and job creation. Since the USGovt and banking authorities do not properly diagnose the problem behind the crisis, they have ordered more of the same ruinous cost-free money, and signed on for amplified debt. The destruction phase will continue.

◄$$$ PRICE INFLATION WILL COME SINCE CHANGE WILL COME $$$. John Hussman makes two great points on the important matter of price inflation development. He claims that price levels can remain under control only if the money velocity is held down permanently. To maintain low money velocity, the banks must keep their bank reserves over the current 95% level, something difficult to do as they gradually find qualified borrowers and approve new loans. He claims that price levels can remain under control only if the value of goods & services is perceived as less than the value of USGovt liabilities packaged in debt securities. As USTreasury Bonds lose value, the mainstream goods & services appear to have relatively higher value. The process kicks into gear. To maintain the USTreasury bubble will be difficult, especially when supply is overwhelming, especially when price inflation is seen as a growing future risk, and especially when foreigners have less trade surplus and diversify out of US$-based securities. Hussman makes the strong point that bank losses will continue, as new categories like commercial mortgages and formerly pristine prime mortgages add to big losses, a parallel point to mine. He concludes that the USEconomy must experience a 100% price inflation in the next decade, in order to bring back into line the debt ratio to the US Gross Domestic Product. That angle of reasoning makes perfect sense for a price inflation long range target. A double in consumer prices and the GDP price component would result in a gold price of $3000 per ounce, and a silver price of nearly $100 per ounce. See the excellent article by John Hussman entitled " Anything But Academic" on this important subject (CLICK HERE).

The rising M3 growth signals price inflation, surely made much worse by severe signals of price pressures generated by renewed weakness in the USDollar. The propaganda party line from Wall Street, through its Dept Treasury control room, is that rising interest rates have come from the early stage of USEconomic revival and recovery. This is patent nonsense. Crude oil prices and copper prices are reliable price indicators of a weak USDollar in direct response. The US financial leaders, who presided over a disaster, cannot admit that the weakness in the USDollar comes as a market response to gargantuan bond monetization and outsized federal deficits. They have contributed to a price inflation threat, precisely when it is unwanted. What comes is a staggering stagflation, actually worse, a powerful inflationary recession.

Focus has been directed upon the USFed balance sheet. Not only is it huge, but it is loaded with toxic assets. The usual scenario is for them to sell their balance sheet to the credit markets, and thus drain excess money from the system. This time around, that process has a huge obstacle. They cannot easily sell off these toxic assets in order to drain the excess liquidity from the credit markets, enough to prevent a spillover into the USEconomy. Most of those assets are worthless, and many of them have small depleted markets where values have come down enormously. Such a big drain would permanently cripple the housing market anyway, which in turn would kill the banks. Drainage as policy would cause a USTreasury bear market of monstrous proportions, which would kill the USDollar. Therefore, price inflation is coming for another simple reason that the USFed cannot unload the plentiful garbage assets on its balance sheet, cannot drain the excess liquidity in the banking system, and cannot prevent a certain eventual spillover into the USEconomy. In this sense, the only change to come will be spillover at the top of the vast barrel. When price inflation arrives without welcome, or even with welcome, the impact on the gold & silver prices will be very big and very positive. The impact on USTreasurys is uncertain. Holding the line on USTreasurys will assure a powerful negative blow to the USDollar. Look for both the USTreasurys and USDollar to suffer simultaneously, in a perfect storm!

◄$$$ JULIAN ROBERTSON MAKES A BIG BET AGAINST USTREASURYS $$$. Julian Robertson is a bonafide hedge fund legend. He has generated stellar returns at his famous Tiger Management fund. He has pioneered a successful investment methodology, which has spawned several successful modern day hedge funds, the ' Tiger Cubs' as they are known. Robertson is recently acclaimed for his prediction of the financial crisis over two years ago. He takes a macro approach, finds a promising idea, researches it extensively, and places a large investment position. Now comes news that Robertson has ' bet the farm' on his next idea. His next big bet is on rising price inflation. He recently said in eFinancialNews, " Steepeners are a type of interest rate swap, where one party agrees to pay the other a fixed rate in exchange for a floating rate, which is derived from the difference between long and short term rates. Many of these products also use high leverage, where the difference between the two rates is multiplied by up to 50 times to produce a higher return." He has built a position akin to an Interest Rate Swap that profits from rising price inflation. He anticipates that interest rates could reach 7% rather soon on the long-term USTreasury Bonds, and in future years could go as high as 18%. He first went public with his Curve Steepener play in January 2008 in Forbes magazine. That article described how Robertson was " long the price of two-year Treasuries and short the price of the ten-year Treasury, betting that the difference, or curve, in the yield between the two will increase." Such a play is negative on the US economy. Robertson executed it because he felt the US Federal Reserve would continue to flood the economy with money. He was dead on, exactly right, a forecast position extremely consistent with the Hat Trick Letter. See the Seeking Alpha article (CLICK HERE).

Robertson maintains very pessimistic forecast view concerning the USDollar. He believes it will become so weak that it leads the central banks of China and Japan to stop purchasing USTreasurys altogether. Deep isolation would come to the United States on a financial level, exactly my forecast for several months. In such a scenario, 10-year bond prices would move down as bond yields rise quickly. That is exactly what we have seen. Back in January of 2008, Robertson told Fortune, " I have made a big bet on it. I really think I am going to make 20 or 30 times on my money." He has taken a great firm stand on a thoroughly frightening scenario. He is clear in his belief that the USGovt and USFed and Wall Street have not solved the current problems. He expects conditions could go from bad to much worse. He likened the current situation of the US to that of Japan in 1990, except the US is in far worse shape.

In his recent interview with Value Investor Insight, two years after his original interview, Robertson further describes his rationale for the large investor stake. He says, " I am amazed at the amount of money the government is throwing at this thing. You do not even react anymore unless somebody' s talking about $1 trillion. I genuinely admire the administration' s courage in doing what it is doing, but not the wisdom of it. I look at the TALF (Term Asset-Backed Securities Loan Facility) program, for example, and it is almost a bribe to get people to put on more leverage... I ask anyone to give me an example of an economy beefed up by huge amounts of quantitative easing that did not inflate tremendously when or if the economy improved. I think what we are doing now will either fail, or it will result in unbelievably high inflation, and tragically, maybe both. That would mean a depression and explosive inflation, which is frightening."

Robertson is definitely not alone in his outlook. Numerous other prominent investors and hedge fund legends share his disdain for USTreasurys, which clearly have accepted much of the financial market risk. Michael Steinhardt called USTreasurys a foolish play over the long stretch. He labeled them as risky, stuck with the low yields in danger of rising. The Steinhardt Mgmt fund was one of the first truly successful hedge funds, collecting a 24% annual return for almost thirty years. See that Seeking Alpha article (CLICK HERE). Steinhardt believes that the current market rally will not last and that the United States has large fundamental problems still unsolved. He said, " The economy is still a scary place. My net feeling is that this rally does not have all that much more to go and the dangers out there remain consequential." He clearly sees the current rally as a temporary bear market rally.

TURMOIL IN USTREASURYS ON ALL FRONTS

◄$$$ TURMOIL IN THE USTREASURYS, AS LONG-TERM RATES RISE, BUT A SPIKE OCCURS IN THE 2-YEAR RATE RISE $$$. The main factor that Interest Rate Swaps CANNOT handle is volatility, the absence of linear movement in interest rates that form the underlying basis for these credit derivatives. Unfortunately, instability has arrived and IRSwap risk is behind it. Distractions are many from official sources. Blame it on the Chinese for rebalancing, and seeking the safety of shorter time horizons for redemption. Blame it on rising concern of extended moral hazard with low low rates near 0%. Blame it on bond vigilantes who foresee the rise of price inflation and the specter of a whipsaw hitting the USEconomy. Blame it on at least one announced huge monetization exercise by the USFed, and a likely series of such exercises, enough to tarnish its own debt rating. Blame it on growing lack of faith & confidence in the USGovt finance, with federal deficits in the trillion$ for a few years, or as they say, as far as the eye can see. My expectation is for the USEconomy to suffer from an inflationary recession, where both price inflation rages and the recession drags on as endlessly as the housing decline. The stock market rally since the spring has transferred hazard to the USTreasury market in a direct handoff of risk. My other conclusion is that defense of the USTreasurys will be seen and noticed, but unfortunately, the risk will transfer to the USDollar. The buck will fall harder when the credit derivatives continue to take their toll, and burn through banker walls.

The initial reaction to the US banking system collapse last autumn was to hunker down into the perceived safe haven of the USTreasury Bond. It rallied enough to send the 10-year bond yield from 4.0% down to 2.1% insanely. The parade was engineered by JPMorgan using bond futures contract purchases, and the US Federal Reserve which opened global swap facilities for foreign usage. As we see now, no such safe haven exists, since the USTreasurys are an inferno of acidic debt and depleted grease from the monetization printing presses. The 10-year USTreasury yield (TNX) finally reached the 4.0% mark, and like hitting any psychological point, backed off slightly. It has worked through a two-step runup from 2.1% to 3.0%, and then to 4.0% in completion. Look for the TNX to consolidate in the 3.8% to 4.0% range, much like a person digests a bad meal, complete with a bout of nausea, more indigestion, and a visit to the bathroom for relief. Later on, the TNX will march higher still, in unison with a great many more outsized USTreasury auctions. The TNX will next pursue 5.0% after consolidation. A burst upward is possible after the 20-week moving average (in red) crosses above the more stable 50-wk MA (in red), an imminent event.

Losses discourage investors, especially auction purchasers at the cusp. USTreasury 30-year Bonds have handed investors a 28% loss this year versus 11% for the 10-year security and 0.4% for two-year security, according to indices compiled by Merrill Lynch. USTreasurys of collective maturities have fallen 6.2% this year. The convention conclusions have missed the mark on systemic instability, as rising rates are not from newfound USEconomic growth, or even the prospect of such growth. Focus on price inflation, cost structures, creditworthiness, foreign creditor relations, flight by foreigners, and future debt issuance. These factors are relevant. However, the bond market volatility takes a big toll on Interest Rate Swaps. They require dynamic balancing. Like a man with his family on a large rowboat, the sudden shift of weight leads often to the boat capsizing. Such risk exists with the credit derivatives, except they are an armada of huge river barges loaded with bond ore.

As if that is not enough, the 2-year USTreasury Note has suffered even greater volatility. If the Chinese rebalanced in May by moving more from long-term USTBonds to the 2-year USTNote, then they have experienced sudden losses. Their resentment, already strong, will turn acute. The upward movement by 50 to 60 basis points is sure to cause turmoil. IRSwaps hate sudden movements and turmoil! Again, IRSwaps most likely caused the turmoil. They did not suffer consequences of the turmoil. The obvious conclusion is that official USTreasury auctions of magnificent size have forced up bond yields and disrupted credit derivatives. Huge upcoming auction supply could force the 2-year USTNote yield to 3.0% quickly, enough to cause very large and very public problems. The 2-year is not known to be the midterm bond, but it is fast becoming the battleground. Finally, the reality of USGovt deficits have smacked the credit markets like a hurricane. The rise in bond yields is natural when supply arrives by the truckload, after decades when it arrived in wheelbarrows. The rise seen in the chart below is not normal. Nothing about the USTreasury Bond market has been normal in the last several months, from naked shorting of USTreasurys to gigantic USDollar Swap facilities for foreign central bank usage.

◄$$$ USTREASURY AUCTIONS WILL CONTINUE LIKE A NIGHTMARE, EVEN AS TAX REVENUE SHORTFALLS CONTINUE LIKE A PARALLEL NIGHTMARE $$$. The official auctions have continued, a veritable parade of debt securities for the financial markets to absorb. It cannot absorb such huge supply. My unflinching expectation is that the USFed and USDept Treasury will relieve the stress to the system, stress on full display, by announcing another monetization of $1 trillion for bond purchase, and do so on a quarterly basis. In the last week, $35 billion in 3-year USTreasurys were auctioned at 1.960% on June 9th, and $19 billion in 10-year USTreasurys were auctioned at 3.990% on June 10th. Recall that just one month ago, auctions sold the same 10-year USTreasury at 3.19%, which is unprecedented and the source of sudden loss. The last week also had $11 billion in 30-year USTreasurys auctioned at 4.720% on June 11th, in a more successful auction. But a huge indirect bid came, usually with fingerprints connected to central banks. They probably were called in to remedy the tarnished image of the USTreasurys in general. The week ended with some repair to damaged psychology, thanks to central banks. They are not the real market, but rather artificial and a type of monetization too. Federal tax revenue is on the sharp decline, at a time when some foreign central banks had been reducing their USTreasury exposure.

Before the Friday intervention, William Buckler of The Privateer wrote, " Foreign central banks are trying to slowly slip away from the USDollar and USTreasury paper, mainly by lowering their holdings of foreign exchange reserves. Smaller Asian central banks ran down foreign exchange reserves by more than $US 300 billion in the 12 months to April 30. Russia' s reserves slid by $US 213 billion in the eight months to March 31, the latest central bank data shows. If this exodus by the smaller central banks is joined by many more, the global run of USTreasurys is on. If even one of the main central banks, China' s perhaps, were to join in the sell-off, USTreasurys would be devastated. US corporate tax receipts fell to $US 69.4 billion through May versus $US 178.2 billion a year earlier, a decline of 61 percent, the USTreasury' s budget statement said on June 10. Individual income taxes received were down by 23 percent so far this fiscal year to $US 592.6 billion compared with $US 769.2 billion in 2008. These falls of 61 percent and 23 percent in tax revenue are a mirror image of the actual state of the real US economy. But Washington DC is ignoring it. Instead, Washington is trying to ' stimulate' the US economy with one of the most amazing rescue packages in economic history. The US government and the Fed have spent, lent or committed $US 12.8 TRILLION. That is almost the value of everything produced in the US last year, trying to stem the longest American recession since the 1930s."

◄$$$ MAINSTREAM MEDIA SHOWS HINT OF BANK RUIN REALITY, CONCEALED BY ACCOUNTING RULES ABANDONMENT $$$. Give some credit to Bloomberg, although they are late in their warning, that the Q1 stock rally was founded on phony accounting. In an article entitled " Bank Profits From Accounting Rules Masking Looming Loan Losses" by Yalman Onaran dated June 5th (CLICK HERE), they publish news that we in the Hat Trick Letter read about in the April issue, how accounting rules abandonment permitted dead banks to appear to book profits on the quarter from supposed ' improvements' to their balance sheet. This is far more than just permitting full value on credit assets, assuming the banks hold until maturity. Martin Weiss of Weiss Research in Jupiter Florida begs to differ, offering a splash of harsh reality. He said (quoted in April also), " The big banks profits were totally bogus. The new accounting rules, the stress tests, they are all part of a major effort to put lipstick on a pig." Banks look stronger than they really are, even though Treasury Secy Geithner claims the Stress Tests show the big banks capable to withstand a somewhat worse USEconomy. They cannot and will not. Onaran wrote, " The government probably wants to win time for the banks, keeping them alive as they struggle to earn their way out of the mess, says economist Joseph Stiglitz of Columbia University in New York. The danger is that weak banks will remain reluctant to lend, hobbling President Barack Obama' s efforts to pull the economy out of recession."

The charade permitted the big banks to raise $43 billion in capital, when they are essential insolvent and teetering toward death. Confidence is a tenuous slippery concept, which can be stolen, but can be lost quickly. The stolen quarterly profits are derived from accounting rules relaxation, which permit the banks to declare the value they choose on dead assets. A worsening USEconomy will reveal the phony patchwork on these derelict vessels. Janet Tavakoli is president of Tavakoli Structured Finance in Chicago. She claims the government stress scenarios underestimate how bad the economy may become. For example, the USFed designed the Stress Tests with easy low fence thresholds, such as the 21% to 28% loss rate for subprime mortgages as a worst-case assumption. Already, almost 40% of such loans are 30 days or more overdue, according to Tavakoli, who forecasts the defaults on these toxic assets to reach 55% easily. Almost no major news syndication published contradictory news on the bank rally from death. These banks are true zombies. Occasionally Bloomberg puts a stick in Wall Street' s eye, and this is such a time. It takes courage. If we had more like Bloomberg, the US would be a far better place.

◄$$$ GEITHNER ELICITED LAUGHTER IN MOCKERY DURING A BEIJING VISIT, AS THEY PUT HIM IN A SMALL SEAT AT THEIR GROWING TABLE. $$$. The disrespect and embarrassment is acute, worthy of a Saturday Night Live episode on NBC television, complete with derision. Geithner told the audience of students that their national savings in US$ denomination was safe. They erupted in immediate laughter, probably being much better informed than even the US public. The US press did not report on or photograph the reaction by Geithner, replete with certain embarrassment. Bear in mind that Chinese students are extremely obedient, rarely to embark on spontaneous displays in official gatherings. They were most likely instructed to show some disrespect to the American Banking Witchdoctor at any appropriate time.

The Chinese clearly do not take American bankers seriously anymore. They are fed up with childish irresponsible accusations of yuan currency manipulation by USGovt officials, when the biggest manipulators on the planet are the US-UK fraud kings, who have rigged the USTBond, USDollar, and gold markets for twenty years. Geithner angered the Chinese credit masters in his first week in office, with currency manipulation charges. The Chinese officials called Treasury Secy Geithner to Beijing to warn and scold him about monetization and ruinous US$ risk. In private meetings, they might have forced yet another grand concession, like the Eminent Domain possibly granted to Secy State Hillary Clinton a couple months ago. One should anticipate that the Chinese will continue their support of USTreasury debt only if given very large bargained agreements in return. They will demand it. We as people will not learn what they are until much later. Watch who travels where. If USGovt officials continue to travel to Beijing, and with greater frequency, then China is pulling on a tight leash.

THE CHINESE REACTION TO FURTHER MONETIZATION WILL BE INTERESTING TO WATCH. MY PERSONAL BELIEF IS THAT THEY INSTRUCTED GEITHNER THAT ALTHOUGH THE USGOVT MUST MONETIZE ITS USTREASURY SALES, THE CHINESE MUST ACCUMULATE GOLD AND GIVE IT MUCH GREATER LEGITIMACY IN THE GLOBAL CURRENCY SYSTEM. CHINA WILL NOT BE DENIED THEIR SEAT AT THE GLOBAL FINANCE MINISTER TABLE.

The Chinese have begun to take protective measures on their vast $2.2 trillion US$-based holdings. They are clearly diversifying toward the short-term maturity, selling some long-term maturity. They might be selling some USAgency Mortgage Bonds. They might be purchasing gold with proceeds. They might plan to exit the 2-year USTreasurys traded down after two years, and not roll over. That would cause big problems for USGovt forced redemptions at a future time, and lead to extremely large monetization. The Chinese clearly are working a plan. They take action on reserves management. They make complaints about US$ risk. They publish news openly on US financial matters. They call to Beijing their indebted serfs. They are extremely patient. They read the works of Sun Tzu on the art of war, and have turned the tables in the financial wars. They want respect and a major seat at the global finance table. In time, they will become the world' s foremost and most important bankers, eclipsing the Arabs.

Bloomberg made the following statement two weeks ago. " Seventeen of 23 Chinese economists polled in connection with Geithner' s visit said holdings of Treasurys are a ' great risk' for the nation' s economy, according to a Chinese state media report. Still, the majority argued against quickly cutting them, the Beijing-based Global Times reported."

MANY SIDES OF DAMAGE TO USECONOMY

◄$$$ NBER WARNS OF CONTINUED RECESSION RISK $$$. The National Bureau of Economic Research is the designated official economic analyst group in the United States. They are charged with declaring the beginning and end of recessions. They pitched in an opinion recently of legitimate warning, but unfortunately it contains swallowed propaganda. They stated while the USEconomy is showing signs of stabilizing from a recession that started in December 2007, it is ' way too early' to say the contraction is over, according to Robert Hall, the head of the NBER and Stanford University professor. He said the Gross Domestic Product estimated on a monthly basis " had a trough earlier this year, but it is way too early to say that it is a true trough rather than a pause in a longer decline. We waited a long time to declare the 2001 trough [end of last recession] because of the disagreement among indicators, and we probably will have to wait a long time in this cycle as well." The GDP had no low point whatsoever. My opinion of US university economics professors is only a little more positive than for USGovt economists, after numerous private debates with PhD Economists in the last 15 years, even Ivy League PhD Economists. They have alarming blind spots, stick with ruinous dogma that has earned the nation a crisis likely to end in tragedy, and cannot see anything but benefits from paper money and all the freedom it offers financially.

The NBER relies upon several key indicators, worthy of listing in order to properly observe how misdirected and poorly focused this elite economic agency is. They rely upon job payrolls, which have fallacious lifts from the Birth-Death Model and constantly changing seasonal adjustments. They rely upon existing home sales, whose numbers are rising from foreclosure bank sales. They rely upon consumer confidence measures, which are as ethereal as they are useless in my view, but reflect retail sales, a big downer lately. They rely upon manufacturing, which has slowed in the pace of its decline. The ISM Manufacturing index for May was 42.8, versus 40.1 in April, a move in the right direction, but still under the important 50 level that marks a recession in progress. The National Purchasing Manager index for May was 34.9, versus 40.1 in May, a move in the wrong direction. The NBER relies heavily upon the Leading Economic Indicator, a composite of several indexes like these cited. Unfortunately, heavy weight on the LEI is given to the S&P stock index, whose rise was engineered by the Plunge Protection Team, and whose foundation was phony bank accounting, which permits asset losses to be called gains for profit. See the Bloomberg article (CLICK HERE).

My best economic indicator is something difficult to fudge in falsification, the capital expenditure for business. It is the rate of change for non-defense, non-transportation business equipment purchases, otherwise called capital expenditures, or Capex. It is the durable goods order rate, excluding the Boeing aircrafts and military defense contracts, which are both irregular and very large. The Capex is stuck on the negative side, at minus 1.5% in April after minus 1.4% in March. It is also never discussed by leading economists, for some odd reason, probably because it is so accurate a forecast tool and often contradicts their stupid forecasts that are proven consistently wrong. As a group, they are wrong about 80% of the time. The Capex is very simple to monitor and interpret, as businesses that plan to expand purchase equipment in order to do so. Almost no business expansion goes without some equipment, like computers, cash registers, air conditioners, industrial machinery, telecommunications gear, monitor scopes, air conditioners, and so on.

◄$$$ PERMANENT STAGNATION & DECLINE COME, WITH SHOCKS TO PREVENT OUTRIGHT COLLAPSE $$$. When the engrained problem is insolvent, a great stagnation arrives. When the solution is more of the same medicine that produced the problems, a great stagnation arrives. André Pinheiro de Lara Resende is a noted Brazilian economist who makes some excellent points. His preface hit hard, as he wrote " Given that a large part of the assets acquired by the Fed, financed by the expansion of its monetary liabilities, are irrecoverable, it results in the transformation of private debt into public debt. The justification to commit public funds in such a scale is to try to avoid the collapse of the banking system and to make it resume lending. So far with no success; and it will probably remain unsuccessful, as long as the private sector remains over-indebted, classic monetary policy is incapable of stimulating the economy in the present circumstances. The economy, however, almost two years after the beginning of the crisis, continues to be overwhelmed by unredeemable debts. As long as households and firms continue to bear the brunt of excessive debt, they will try to reduce expenditures and increase savings. Until debt is reduced to levels which are perceived as reasonable, the private sector expenditure will be exceptionally low." He recognizes the problem as insolvency and a crippled central bank.

Resende compares rightfully the American economic condition with the Japanese economy after the real estate and banking crisis of the nineties. He points out that excess debt and deep insolvency cannot be treated in conventional rescue and stimulus fashion. Neither monetary policy nor fiscal policy can bring life to the USEconomy. Since the savings rate rises, since much of stimulus is devoted to payment of debt (like credit cards with heavy interest charges), and since basic living expenses are the destination for most government assistance, no business expansion occurs. No chain reaction economic activity is remotely likely, and no pent-up demand exists. As he said, " The virtuous circle of the Keynesian expenditure multiplier is thus interrupted." Resende grasps the importance of the housing sector for USEconomic growth as a perverse foundation, and the whipsaw for its reversal. He assessed, " Since the rise of asset prices is fueled by rising indebtedness, from a certain point onwards, the process acquires a pure speculative character. When the rise in asset prices is interrupted, the private sector discovers it is insolvent. Real estate bubbles, especially residential real estate bubbles, being a speculative process based on assets of a wider ownership, are the ones that more damage cause when exhausted." He connects the futility of monetary policy during a period when private household insolvency abounds. He purports that usage of monetary policy to keep an insolvent economy alive actually renders fiscal policy as useless for economic stimulation. In other words, low interest rates become useless to those suffering from too much debt, from which it follows that government programs (read: handouts) become useless in generating new spending or forming new businesses. Capital formation does not occur, thus no remedy.

Resende offers no alternative for remedy for the US situation. Either permit a collapse to rid the indebted condition, or suffer the agony of an endless quagmire. The USGovt has already chosen endless quagmire due to its chosen debt solution. He wrote, " There is not much of an alternative. Either to let the economy collapse, in order to reduce debts, and then use fiscal policy to revive it, or inundate the insolvent economy with public credit, to avoid the collapse, and lose the ability of fiscal policy to pull it out of a prolonged lethargy. Either a horrible end or an endless horror. The US will most likely face a long period of stagnation." The option of profound monetary inflation, and in my view chronic monetization, carries with it a very heavy price. He believes the US will lose its credibility as issuer of global reserve currency debt securities, namely USTreasury Bonds in USDollar denomination. He correctly gives strong possibility to the outcome of strong price inflation and sudden devaluation of the USDollar. However, an excess of monetary inflation and federal deficits risk exactly these, eventual price inflation and gradual devaluation of the USDollar. He advocates some monetary inflation and some federal deficits, as long as they can be kept under control. THAT IS NEXT TO IMPOSSIBLE, in my view, but an approach that must be politically attempted. He advocates at the same time for indirect reduction of debt burden via inflation during simultaneous stimulus actions. The creditor nations pay the price in hidden fashion, likely with resentment. He concedes, " It is thus understandable that China, the largest withholder of American public debt bonds, does not feel comfortable and proposes the creation of a supra-national reserve currency." He sees China as actively working to de-throne the crippled USDollar, as is my perception.

Resende calls for a supra-national reserve currency, a global basket. Actually no new currency would be involved. He plays down the hyper-inflation risk from printing presses gone haywire and the associated USDollar devaluation. But he does give such a threat some credence. He believes a new supra-national reserve currency would work to solve some incredible large imbalances that strain the global economy. Almost alone in the world outside China and Russia, where the view is growing in acceptance, he cannot envision any solution within the current framework. He calls for action with urgency. That is shared vigorously by my view. He concludes, " The creation of a true supra-national reserve-currency would reduce the impact of an eventual devaluation of the dollar. It would also be a fundamental tool to reverse the asymmetry behind the large macroeconomic imbalances of the last decades. A world currency would require a credible supra-national issuer... The comprehension that the macro imbalances that brought us to the present crisis, and also hamper its resolution, can only be corrected within a new global institutional framework should give a sense of urgency to the agenda." A true solution only can come from a new global currency, at minimum a basket of existing currencies, at best a gold-backed new currency.

Graham Summers has a way with words. The economic analyst, market strategist, and contributor to Seeking Alpha, offered an opinion on the Coming Economic Collapse. He expects this autumn will prove the ' worst is over' crowd wrong yet again. He wrote:

" To give you an idea of how big a problem these deficits are, consider that the US government could tax its citizens 100% of their earnings and NOT have a balanced budget. In light of these issues, the government' s $787 billion stimulus package does not exactly breed confidence in an economic turnaround. Incomes have lagged inflation in this country for over 30 years. Creating a bunch of temporary positions related to construction and the like is NOT going to alter this in any significant way. Moreover, most of the job growth in the last 10 years has come from bubbles: two out of five jobs created between 2002 and 2007 came from the housing industry. The irony here, of course, is that the Stimulus Plan is merely following this trend, creating jobs from our latest (relatively unreported) bubble: the bubble in government spending and employment. Bottomline: the US needs to create sustained job growth involving skilled professionals with high wage earning potential, NOT more guys laying concrete. We need fundamental structural changes to the US economy, NOT temporary positions resulting from one-time government projects. And with a $9 trillion deficit in the works, $787 billion does not really mean much in terms of increased tax receipts. Also, and this is bit of a personal aside, it is hard to believe that throwing $787 billion towards creating jobs really shifts our economy away from financial services when we have thrown over $2 trillion towards Wall Street and the banks (via direct loans and lending windows)." An excellent final point, that the solution so far has been to direct funds at the very sector that must be shrunk or exterminated, the Wall Street firms that caused the crisis and national failure in progress.

◄$$$ MAY JOBS REPORT ONLY SLIGHTLY LESS HORRENDOUS LOSSES $$$. The official figure is for a May loss of 345k jobs, with the jobless rate up to 9.4% (collecting state jobless insurance benefits) but at 16.4% in the U-6 broader jobless rate (that counts people actually without jobs). The official doctored jobless rate rose from 8.9% in the previous month, for a still hefty rise. The April job loss figure was revised to the positive side by 35k jobs. However, the villain in the room is again the Birth-Death Model, that work of fiction that rises to the occasion to help on the propaganda front. The B-D Model added 220k mythical jobs in May after adding 226k mythical jobs in April, at a time when small business is in fast retreat. Free of such nonsensical adjustments, April lost 730k jobs, while May lost only 565k jobs. While a reduction, it is better described as a less horrendous situation, and not a cause for either celebration or herald of recovery. For instance, check the Bureau of Labor Statistics smoking gun in the B-D Model details (CLICK HERE) on construction jobs. It adds 43k such jobs in May and 38k in April, when the official aggregate reported 110k lost construction jobs in April and another 59k in May. The two sources are in direct conflict. More dissection is in order to expose big sleight of hand, pure deception.

John Williams of the Shadow Govt Statistics points out another perversion to the May Jobs Report. In his words, " Accordingly, I have estimated a monthly upside bias for May of 60,000 (the monthly average in place after seasonal adjustment) plus 44,000 (the added bias for May 2009, which likely has not been redistributed over all the months with appropriate seasonal adjustment), for a total of 104,000. I have no argument with those looking to net out the total 220,000 monthly bias; the only issue is seasonal adjustment, and those monthly factors are being played with and revised every month." Hence, remove the Birth-Death Model fictional addition to jobs, and remove the constantly changing seasonal adjustment, and this would add another 100k to 110k jobs lost. That would put the adjusted May Job loss in the 638k to 648k range. THIS IS PURE DATA CORRUPTION AT ITS WORST.

Compare this fully unadjusted job loss number with the April 730k job loss figure, and not much change at all. The seasonal adjustment mechanism is being altered every month, when it should be constant throughout the entire year and only experience changes every several years. That was our policy at Staples when the Jackass was solely in charge of seasonal adjustment analysis, calculations, and index management. In other words, it no longer is a stable seasonal adjustment, but rather a political propaganda adjustment factor. The constant alteration in this adjustment is testament to the still accelerating corruption of US economic statistics.

The official nonsense and propaganda, more like cheerleader role for a team losing badly on the field, is stark. Richard Yamarone, an economist at Argus Research, said " This tide is turning. We expect this trend of slower job loss to continue throughout the year." He must be impressed by the Birth-Death Model and seasonal adjustment chronic rejiggering, blind to the USEconomy with foreclosures, housing price decline, and real bank losses. Believers of USGovt statistics proceed at their own peril. The jump in official jobless rate from 8.9% to 9.4% contradicts the so-called less bad scenario they claim is unfolding. At 9.4%, unemployment in May is the highest rate since August 1983. Some economists actually claim that hundreds of thousands of people, perhaps feeling more confident about their job prospects, streamed back into the labor force last month looking for work. Thus the rise in the jobless rate. In other words, they admit the broader U-6 jobless rate is more the reality. Including laid-off workers discouraged and no longer looking for new jobs or who have settled for part-time work, arrives at the so-called underemployment rate, labeled the U-6. At 16.4% in May, it is the highest on record dating to 1994. Lastly, the number of people out of work six months or more rose to nearly 4 million in May, a record, and triple the total from when the recession began back in December 2007. Labor Secretary Hilda Solis called the uptick in unemployment ' unacceptable' and pledged to bring it down by helping the unemployed get new skills or training. Does she mean high school and college mathematics and science, like student across Asia have, but which are minimally required in US schools?

Bear in mind that nine months after the Lehman Brothers collapse, the USGovt is trying to put in a favorable light job loss data that is at double the pre-Lehman levels. A closer granular look at the May Jobs report reveals that businesses continue to reduce work hours. The workweek hit a new record low of 33.1 hours, compared to 33.2 hours in April. The three-month trend in workweek is at a minus 8.6% annual rate. Regard this as the ugly side of salvaged productivity during a falling GDP. Job loss data would be a few hundred thousand worse if companies cut workers instead of work hours. Lastly, consider the jobless claims, the weekly measure of new cases of people who lost their job applying for state unemployment insurance. In the week of June 6th, another 601k claims were made to log 621,750 as a 4-week moving average. The better statistic in this regard is the continuing claims, at 6.816 million, the 19th consecutive record week. This is the tragedy. The continuing claims net out those who find new jobs. It cannot be fudged. It is impossible to claim any good news when this net figure sets records, and easy to refute the doctored overall May job loss figure.

◄$$$ RETAIL SALES ACCELERATE TO THE DOWNSIDE $$$. Again, hardly a green shoot, but more like a green dagger extending worse into the heart of the USEconomy. May retail sales fell by 5.9%, a very negative sign. As CreditSights wrote, " Reversing the true course of consumer spending is likely to be a long, sustained, and difficult effort, and one which will remain burdened by an employment (and, by association, a personal income) environment which has only recently begun to slow its fiery descent, leaving in its path a collective job loss that dwarfs any seen in recent economic downturns." The percentages presented in the graph are monthly changes in retail sales. Perhaps the May decline is a reaction after tax payments in April. More likely it is the beginning of a second phase in USEconomic decline.

◄$$$ CREDIT CARD DISTRESS POINTS TO USAGE FOR DAILY EXPENSES ON AN ONGOING BASIS, HARDLY EVIDENCE OF RECOVERY $$$. This data refutes any USEconomic recovery. People are depending upon revolving credit in desperation, no longer able to draw cash from their home ATMs, the home equity line of credit and second mortgages. Credit card delinquencies jumped 11% in the latest quarter versus a year ago, and jumped by 9.1% over the previous quarter, according to a credit reporting agency TransUnion. The delinquency rate is defined as the ratio of borrowers 90 days or more delinquent on at least one credit card. The DQ rate increased to 1.32% in 1Q2009. The average credit card debt balance rose 4.09% from the previous year to $5729, a figure calculated by TransUnion from 27 million individual credit files. In a gradually tightening vise, households turn to credit cards, as banks have tightened lending standards. They do so because of a heightened default risk, as job losses mount, foreclosures continue, and job pay cuts become common.

The state by state data reflects the ' GoGo' housing bubble state locations. Delinquency rates were highest in Nevada at 2.44%, then Florida at 1.9%, then Arizona at 1.68%. Rates were lowest in North Dakota at 0.73%, then South Dakota at 0.77% and Alaska at 0.77%. TransUnion provides an outlook, actually more like an agency forecast. They expect the 90-day delinquency rate will continue rising toward 1.7% by the end of 2009, from the 1.32% in the first quarter. TransUnion expects Nevada at 2.95% will have the highest delinquency rate by the end of 2009. Peak DQ rates could be seen in late 2010 or early 2010. They cite the USEconomy' s response to stimulus and remedy as very uncertain and problematic. In my view, the USGovt measures are way off the mark for effectiveness. Outside influences could have unforeseen effects from policy and legal changes, the report cautioned. " The impact the changes to credit card regulations and associated legislation, and the response of card lenders to those changes, will have on consumer behavior and hence delinquency rates, is still unknown." See the Money CNN article (CLICK HERE). At the end of 2008, credit card debt stood at $972.73 billion, up by 1.12% from the end of year 2007. Expect it to rise much further.

◄$$$ HOUSING SECTOR & MORTGAGE FINANCE WERE CRIPPLED IN THE LAST MONTH, AS MORTGAGE RATES ROSE ALMOST 100 BASIS POINTS $$$. Mark Hanson, aka Mr Mortgage, has provided a shocking graphic. It shows that for California foreclosed properties, exactly half the amount on the loan equals the amount in deficit. In other words, exactly half on average of the current California home values equal the original mortgage loan balance, for a shocking 50% value to loan ratio. Put yet another way, properties are worth half the amount of the loans held against them! Mortgage rates shot upward along with long-term USTreasury Bond yields in the last few weeks. Typically, the mortgage rates track the 10-year USTNote bond yield. The difference addresses loan risk and profit margin for lenders. The housing market just hit a brick wall, again, for the fifth or sixth time. See his expert Field Check Group website on mortgages (CLICK HERE).

Hanson wrote after the first week in June, " Make no mistake about it. New mortgage market loan production died this week. I am already hearing analyst and press chatter about how the renewed optimism surrounding a macro economic recovery will outshine the 100bps rise in rates experienced in the past few weeks. Put it this way, when rates rose sharply to 6% on various occasions in 2004-2006, fixed-rate business dried up immediately. People were much more positive about their prospects in 2005 than they are today. For that matter, rates are not much better today then in 2008, which was one of the lowest volume years on record. Rates in the high 5%' s are a killer for this mortgage and housing market, period. The consumer stabilization thesis that has become consensus over the past few months in part relies upon cheap mortgage money and the refinancing and modifying of America. At today' s interest rate levels, that thesis is out of the window. With rates comfortably in the mid-to-high 5%' s, refinance rate locks are down 80% from a few weeks ago. In order for a loan to fund, it must be locked. Therefore, at least a couple hundred billion [dollars] in unlocked mortgages presently submitted and in process at lenders around the nation are in jeopardy of dying. Obama' s 105% refinance that was suppose to benefit up to 5 million homeowners, 15% of all GSE [Fannie Mae & Freddie Mac] loans is also a non-starter with rates this high. Can the economic rebound that is also now consensus and pushing bond yields through the roof really be enough (soon enough) to help millions of underwater, over-levered homeowners around the nation? Without low rates, homeowners will have to earn their way out of the deepening housing, mortgage, and negative-equity hole." In clear terms, Hanson explains the short-circuit in home mortgages, which cannot be relied upon to power a USEconomic recovery.

See the mortgage comparison chart showing 100% negative equity. When one calculates the shortfall in the home equity versus the entire set of mortgage balances, including both 2nd and 3rd mortgage liens, the average negative equity across all properties foreclosed upon in May reaches the 100% level !!! In May, the average current value of California properties at the foreclosure stage was $232k and the average total debt was $418k. This leaves an average negative equity of $186k, or 80% deficit (' upside down' ) relative to average current values. The second mortgages make the ratios worse.

◄$$$ HOUSING PRICE DECLINE REMAINS THE KEY ALBATROSS, THE MILLSTONE, THE CEMENT SHOES FOR THE USECONOMY AND US BANKING SYSTEM $$$. Despite all talk of a housing market stabilizing, it is pure nonsense. Any increase before in mortgage applications and home sales came from foreclosure sales and forced negative equity (short) sales. That is a horrible trend. Now, refinances are more difficult and new mortgages are at a halt. A housing market in decline by 15% to 20% annually in price is a disastrous, plainly stated. The price decline is stuck in the high end of that range. Robert Shiller is a finance professor at Yale University, and author of the S&P Case Shiller housing price index. It contains traded futures contracts. Shiller believes US housing prices are in the midst of a decline that may last for years. He cites land prices in Japan' s major cities, which fell for 15 straight years after a 1980 housing bubble burst. Based upon data compiled by the Japanese Real Estate Institute, prices in the Tokyo area and in five other cities (Kobe, Kyoto, Nagoya, Osaka, Yokohama) sank 76% from 1990 through 2005. Almost three years have passed since the S&P Case Shiller index of US home prices peaked, having fallen 32% from a high in the second quarter of 2006. Shiller expects prices may continue to fall, or stagnate, in 2010 and 2011.

An estimate by the hedge fund T2 Partners LLC calls for the national index to hit bottom in mid- 2010 after dropping 40% to 50% from its high. Their co-founders Whitney Tilson and Glenn Tongue regard indications that the housing market has stabilized to be ' the mother of all head fakes' in their words. See the Bloomberg article (CLICK HERE). Mortgage rates have moved from 4.78% in April to over 5.5% last week. Mark Hanson estimates that 70% of all refinance activity has been cut off totally. The volume of refinance loans fell by 11.8% in May. With less refinance of troubled loans comes more foreclosures and lower housing prices, as supply continues to overwhelm demand.

Here is my unconventional housing market view that makes great sense. Home prices will continue to fall until they reach the cost of construction, and possibly a little lower, simply stated. They are near the 1990 price level now, a Hat Trick Letter forecast made over a year ago when a double cycle correction was stated. Worse, home prices might go slightly below construction costs in an overshoot, hardly uncommon. Stability in home prices should come at a level marked both construction cost combined with the added force of rising commodity prices used in that construction. Homes require lumber, copper, and cement as a foundation on costs. They are generally rising. Foreclosures and tight credit are real factors, but the cost angle should force a long scraping process at a bottom.

◄$$$ OPTION ARMS BEGIN TO INFLICT SEVERE DAMAGE, PRODUCING A WAVE OF ADDITIONAL FORECLOSURES, SURE TO KEEP HOUSING PRICES ON THE DOWNWARD SLIDE $$$. For two years, the Hat Trick Letter has warned of a powerful wave of Option ARM defaults as a second blow after the subprime wave. They are insane ridiculous time bombs. They have begun to explode. The loan was designed to offer a ridiculously low initial interest rate for a period of three to five years, like 2% to 3% typically. The monthly payment, again by design, is less than the interest, resulting in a growth in the unpaid loan balance and a shrinkage of home equity over time. That is called ' Negative Amortization' and only in America. Falling home values make it all a worse bomb. The loan triggers an alarm when the loan balance reaches a threshold like 110% or 125% or 140% of the original loan. At that time, payments escalate sharply to make up for lost time on repayment of principal and interest. The Option ARM loans are the most perfect device for removing homeowners from their homes after bankrupting them, when the housing market enters a decline. The entire concept of negative amortization seems as destructive and idiotic as it does predatory, with a common outcome being home loss to bankers. The decline is now in its third year. The loans have exited the teaser rate periods with rate resets, and the loans are hitting principal triggers. The bombs are going off! California lies at the epicenter of this particular chain reaction of explosions. Option ARM recasts will exacerbate the pain for California, the state already with the most foreclosures in the nation. The state has also suffered massive price declines. In California, the median existing single family home price dropped 37% in April to $256.7k from a year ago, according to the California Assn of Realtors.

About one million Option ARM loans are estimated to reset higher in the next four years, according to real estate data firm First American CoreLogic. Three quarters of these Option ARM loans will adjust in 2010 and in 2011. The peak reset will come in August 2011 when about 54 thousand loans will recast. Over $750 billion of Option ARMs were originated in the United States between 2004 and 2008. California accounts for 58% of Option ARMs, according to a report by T2 Partners. Cameron Pannabecker is the owner of Cal-Pro Mortgage and the Mortgage Modification Center in Stockton California. Pannabecker said. " This [Option ARM] loan is a perfect example front to back, bottom to top, of everything that has gone wrong over the last five to seven years. The consumer had a product pushed on them that they had no hope of understanding." Worse, it is predatory and results in home loss. Susan Wachter is a professor of real estate finance at the Wharton School of Business. She regards the Option ARM as another threat to the housing recovery and the USEconomy. Owners who surrender properties to the bank rather than make higher payments for homes (which have plummeted in value) will further depress real estate prices and further flood the housing inventory on the market. She said, " The option ARM recasts will drive up the foreclosure supply, undermining the recovery in the housing market. The option ARMs will be part of the reason that the path to recovery will be long and slow."

Refinancing is impossible in many cases, given the nationwide drop in prices and tighter lending standards. Underwater loans (where home value is less than the loan balance) do not happen at all. Under Fannie Mae and USGovt directives, refinance of underwater loans has been executed when the deficit is 5% or less. Mortgage rates are relentlessly rising. The average 30-year rate jumped to 5.59% in the week ended June 11th from 5.29% a week earlier, according to Freddie Mac. The delinquency rate for Pay Option ARMs originated in 2006 and bundled into securities is soaring, with a repeat in the 2007 vintage. The lending institutions continued underwriting them even though they were exposed as time bombs long ago! Over the past twelve months, payments 60 days delinquent on Option ARM loans originated in 2006 nationwide have almost doubled to 42.44% from 23.26%, Deutsche Bank said. For 2007 loans, the DQ rate has leaped from 10.1% to 35.25% for a quick disaster. The mortgage portfolio managers are already seeing much higher levels of delinquencies on Option ARM loans even before they reach the point of the recast with higher rates. See the Bloomberg article (CLICK HERE).

Thanks to the following for charts StockCharts, Financial Times, Wall Street Journal, Northern Trust, Business Week, CIBC Bank, Merrill Lynch, Shadow Govt Statistics.