Thursday, April 26, 2012 – Everybody Loves Free Money

Everybody Loves Free Money
– by Sinclair Noe

DOW +211 = 12,887
SPX + 22 = 1360
NAS + 39 = 2893
10 YR YLD +.02 = 1.43%
OIL +.02 = 89.41
GOLD + 11.30 = 1617.10
SILV + .20 = 27.64
PLAT + 5.00 = 1411.00

Pop Quiz: What do Wall Street bankers love? Free money. They swoon at the prospect of  money being redistributed from taxpayers to bankers. You might say they are socialists, in this regard; if redistribution of wealth is your definition of socialism. This morning European Central Bank President Mario Draghi declared “the ECB is ready to do whatever it takes to preserve the euro…and believe me, it will be enough.”

We don’t know the details. Draghi wasn’t actually handing out euros to the bankers, but the idea is that there will be a European version of Quantitative Easing, possibly a direct bond purchase program.

The euro rallied against the dollar. European stock exchanges jumped. Commodity prices jumped. The Yield on Spanish and Italian bonds dropped. Yields on German and US bonds rose as prices dropped. And US stocks moved higher. The ECB announcement was a put, a floor under the markets. For bankers and traders, the announcement flicked the switch to “risk on”, because even if they lose money, the ECB will just print more. Draghi opening the door to a Bernanke-style monetary policy in Europe is a big deal — at least for the financial markets. This sort of stimulative policy does a poor job of circulating money through the broader economy. 

Still, the market was excited about the prospect of “whatever it takes” even though various Euro-technocrats have been saying “whatever it takes” for three years now, and apparently it takes more and more with less and less results. Draghi’s comments today could be a signal of more action; the ECB meets next week. Maybe Draghi has something else up his sleeve. He said: “believe me, it will be enough”; we’ll see. 

Treasury Secretary Tim Geithner testified before the House Financial Services Committee yesterday. Representatives mentioned the fact that  Geithner had four years, and meeting after meeting, to bring the Libor issue to Congress’ attention and it just wasn’t done. When Geithner ran the New York Federal Reserve Board, they failed to inform US regulators that they had an admission of guilt from a Barclays employee that the Libor was being rigged. The Commodity Futures Trading Commission and the Justice Department had to build their case without the direct evidence of rigging that Geithner and his staff knew all about.

Geithner claimed in testimony that he did everything he could, saying: “We took the initiative to bring those concerns to the attention of the broader U.S. regulatory community, including all the agencies that have responsibility for market manipulation and abuse.” Time will tell but right now somebody’s story isn’t matching up with the facts. 

Also, it is worth noting that the House of Representatives yesterday voted to pass a bill that would audit the Federal Reserve. The House passed similar legislation from Representative Ron Paul back in 2009; then as now the bill couldn’t and won’t make it past the Senate. Dr. Paul’s website states: “The Fed was created by Congress and remains subject to full oversight and regulation by Congress — up to and including abolishing it altogether!” No question the Congress has the authority. It’s a shame there isn’t much enthusiasm for real transparency. 

In the early spring this year, US farmers were on their way to planting some 96 million acres in corn, the most in 75 years. A warm early spring got the crop off to a great start. We were on track for one of the largest corn harvests on record, but the corn plant is sensitive to heat and dehydration. As spring turned to summer the temperatures increased and the corn crop decreased. Drought afflicts 86% of the Midwest; and the drought is worsening in the South, which was just recovering from last year’s drought – the worst Texas had seen in a century. Almost 30 percent of the Midwest was suffering extreme drought, nearly triple from the previous week. More than 53 percent of the United States are in moderate or extreme drought or worse –  the worst in five decades. 

The US Department of Agriculture says the drought will push food prices 3 to 4 percent  higher next year. Milk, eggs, beef, pork, and poultry prices will all be affected as the drought has already pushed feed prices higher. Farmers started out the season anticipating a record 14 billion bushel corn crop. The drought is expected to cut production by roughly 3 billion bushels. Corn and soybean futures hit record highs last week on the Chicago Board of Trade. Prices fluctuate with every passing rain shower, if there is one, but corn prices are up 20% from March 1; soybeans are up 22% and wheat is up 36%.

Normal grocery price inflation is about 2.8 percent a year. The USDA kept its projected food price increase for 2012 steady at 2.5 percent to 3.5 percent, saying average retail food prices were flat for the first half of 2012 thanks to unusually low fruit and vegetable prices as well as lower prices for milk and pork. Poultry prices are expected to increase quickly. Beef and dairy prices will likely increase next year as farmers start to cull herds. Milk prices might climb by as much as 10%. The new forecasts are the agency’s first food price projections to factor in the drought.

Feedlots are the second largest consumer of corn. The Department of Agriculture estimates that forty percent of the corn grown last year was used to produce ethanol, a result of a federal mandate to increase the amount of corn-based ethanol used in the nation’s gasoline supply. So, the cost of the drought will be felt at the grocery store and also probably at the gas pump. 

Farmland values are ultimately correlated with population growth and the growing demand for grains, meats and other foodstuffs. Farmland has turned into a hot alternative vehicle among institutional investors like Harvard University and TIAA-CREF. The reason is simple; the Federal Reserve, or the ECB, can print more money, but there’s a diminishing supply of farmland. It’s a stable source of value and usually a stable source of income. 

Despite the farming boom and growing concerns there may be a farmland bubble in the Midwest, there has been less attention paid to the escalating cost of inputs that have become part and parcel in conventional agriculture—fertilizer, herbicides, pesticides, GMOs and fuel. According to the USDA’s Economic Research Service, yields increased 30% between l989 and 2009. Meanwhile, the cost of inputs tripled during the same 20-year period.  And then there is the giant problem – the drought. 

While you might think drought related crop failure would be catastrophic for crop farmers, the truth is that most are not going to be affected or may even profit as a result of taxpayer subsidized insurance. When the last major drought hit in 1988, 25 percent of farmers had crop insurance, while this year 85 percent do And the program is designed so that the larger the losses for insurers, the greater the share of the payouts the government will pick up. And as prices go up, the payout to farmers goes up, so a complete crop failure means a big payday. 

In 2011, with a drought in Texas and other weather woes, government-run crop-insurance programs paid out a record $10.8 billion. Of premiums paid in 2011, farmers chipped in $4.5 billion, while the government paid $7.4 billion. Because of the program’s reinsurance rules, insurers made a $1.7 billion profit even with those record payouts, while the government took an underwriting loss of about $500 million. Despite the insurance, there are still losses associated with the drought, but most farmers will still have seed money for next year. 

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