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Thursday, 5 June 2008

Global Financial Meltdown Ahead

By James West

The third phase of the "mortgage meltdown" or "real estate bubble" or "credit crunch", or whatever you prefer to think of it is, will be nothing short of a re-ordering of the financial universe. We will one day (hopefully) look back on this time and shake our heads in awe at the depression-era hardships many are on the verge of suffering.

Lehman Brothers (NYSE:LEH) is the institution in the spotlight today, as the frightening prospect of a Bear Stearns-style demise looms for the U.S.’s fourth largest securities firm. I created a "Google Alert" for the term "Lehman Brothers Collapse" a couple of weeks ago, and the number of stories being delivered with that phrase included has today peaked at 10.

Previously, the stories included in the daily alert were from blogs and commentaries, what most of us would consider "fringe" sources. Today, the stories are in Forbes, Bloomberg, Associated Press, New York Times, and Fox Business, among others.

Shares of Lehman fell $3.22, or 9.52 percent, to $30.61, despite the company’s assurances that the investment bank had enough liquidity and was not borrowing from the Federal Reserve’s discount window.

Meanwhile, in a speech Fed Chairman Ben Bernanke re-iterated his position that the U.S. economy would rebound in the second half of this year on the stimulus of interest rate cuts, Fed loans to banks and tax rebates.

Poor Ben. Under siege and mostly on his own, he’s left with nothing but platitudes in his arsenal to defend against the dark hordes gathering at the gate.

The complete meltdown scenario referenced in the title of this article envisions a scenario whereby Lehman Brothers and a few other major investment banks find themselves so starved for cash as a result of illiquid holdings that continue to plummet in value, that the Fed can’t print money fast enough, the banks can’t help them simply because the sums required to stave off collapse are too great, and the entire sector is left to its own devices for survival.

Closely following on the heels of one then two then three or more institutional implosions, the U.S. dollar will resume its dead weight drop, which will in turn drive the prices of energy and raw materials up so high that farmers won’t be able to afford to bake bread from their own wheat. The nation will become, on a broad scale, impoverished. Crime will skyrocket. I’ll be up north.

The bright side to all this doom and gloom is for investors in gold. The complete meltdown scenario would see gold take off in a northerly trajectory just as fast as the dollar goes south.

The effect would, however, be the opposite for oil. While the dollar value for gas at the pump would certainly rise due to the diminished purchasing power of the greenback, U.S. demand for hydrocarbon energy would ease as the un-affordability of gasoline would see huge shifts to alternative transportation methods. Already, bicycle sales are on fire throughout the United States.

But the big kicker that is going to make the recession a global depression is the sudden slowdown in growth in India and China.

I was horizontal in the dentist’s chair yesterday when BBC’s World News reported a slowdown in the rate of growth in India. I had an hour of construction going on in my mouth to ponder on that before the good ole BBC news loop came round again, and I heard it repeated. The drill’s vibration was insufficient to thwart the bells ringing in my head.

The entire bull market in base and industrial metals is, according to many institutional investors and economic theologians, based on the fact of India and China’s unstoppable growth. Admittedly, one quarter’s statistic indicating a deceleration in the rate of growth is hardly cause for alarm. However, should this pan out to be the first iteration of a change in the pattern we’ve grown accustomed (actually…more like addicted) to, we could be in for some serious trouble.

The world over, observers have been watching the ripple effect initiated by the real estate and credit bubble implosions comfortable in the knowledge that the Asian growth machine was proceeding seemingly unaffected by the carnage in London, New York and Berlin. So if India is now to fall victim to higher capital, energy and raw material costs, is China right on its heels? What is the greater implication for the United States and the rest of the G8 nations if this last bastion of economic fortitude is also to crumble?

According to the BBC (and yes I was taking notes while the dental crew was unleashing its own economic expansion in my yarp), “Growth is expected to continue to slow this year, but will remain higher than most other economies in the world.

"There will be deceleration this year coming from industry and high interest rates," said economist Saugata Bhattacharya, from the Mumbai-based Axis Bank.

"Industrial impulses will be curtailed. However, there will be a partial offsetting if agriculture and monsoons will be good," he said.

If agriculture and the monsoons are good?!

Isn’t this the nation where 17,500 farmers commit suicide in their fields each year precisely because agriculture and the monsoons are not good?

That’s right. 17,500 farmers every year between 2003 and 2006 took their own lives standing in their fields because they owed, on average, US$1,000 or less. If I committed suicide every time I owed somebody a thousand dollars, it would be a most disagreeable movie version of Groundhog Day.

At least 160,000 farmers have committed suicide since 1997, said K. Nagaraj of the Madras Institute of Development Studies.

The BBC's Karishma Vaswani in Mumbai said the rising cost of living had had a negative impact on consumer spending and the situation was likely to get worse before it got better.

India’s main growth slowdown occurred in the manufacturing sector. As it turns out, the same thing is happening in China. A Reuters story crossed the wire at 1:05 a.m. Eastern stating that "China's manufacturing sector slowed last month for the first time since January as export orders and domestic investment both weakened”.

And why should we be surprised?

China has essentially become the world’s manufacturer. If the G8 nations are in a pinch because the credit they’ve been “spending” for the last 10 years has in fact turned out to be play-dough, and the dismantling of the Betty Crocker Easy Bake credit oven has eliminated the clay ducats we’ve been using to acquire overpriced bricks and mortar, the obviously the world’s manufacturer is going to experience a reduction in demand, and by extension, Gross National Product.

Dare I say it? Is this the onset of global recession?

Do you ever feel like you’re on the Titanic, and you’re looking over the rail at the icebergs thinking, "Shouldn’t we be proceeding a little bit more cautiously?", while the men in uniform keep shouting, "Full speed ahead!"?

Alas, that is the world we live in. If our elected officials declare "Full Speed Ahead", then full speed ahead it is. Democracy’s Achilles heel, apparently.

So now what? Is it time to sell base metals, precious metals and all the juniors exploring for same? What about the big boys – the producers? As I said, this is the first news of diminished growth in Chindia (no disrespect intended), and so a knee jerk reaction would be just that, at this point.

But it’s a nervous eye watching the data today on my part. If the Asian juggernaut has exhausted its momentum, all the gold, silver, oil and metals stocks in the world won’t feed a planet torn by food riots and civil warfare.

James West
Publisher

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