WillErwin.com

Last week was not kind to stock market participants, as the S&P 500 tumbled 3.0% and the Dow fell to its lowest level since September 2006. Record high crude prices, tumbling financials and less-than-stellar outlooks from tech companies took a toll on market sentiment. Some facts:

* The DJIA down 496, or 4.2%, to 11,347, and is 19.9% from its October peak. The DJIA has seen a -7.8% hit in the last two weeks. Its -10.2% drop so far this month could become its worst monthly loss since Sep 02, and its worst June since 1930.
* Small caps underperformed: last week, the Russell 2000 fell -3.8% and the S&P 600 dropped -4.1%.
* The average S&P 500 stock now has 5.8% of its float sold short — a 45% jump over the past year, according to Bespoke Investment Group (per Barrons).
* At the same time crude-oil futures surged 3.6% on the week, to a record $140.21 a barrel.
* Gold and silver futures also leapt Friday, propelled by record high oil prices and recently renewed weakness in the U.S. dollar. August gold rose $16.20 to settle at $931.30 a troy ounce on the Comex division of the New York Mercantile Exchange. September silver rose 49 cents to $17.71.
* The 19 commodities in the Reuters/Jefferies CRB Index have jumped 29% this year, the most since 1973.

The Wall Street Journal weekly performance graph tells the tale:

The focal point of last week was the FOMC announcement on Wednesday. As expected, the Fed left the fed funds rate unchanged at 2.00%, and its wording largely reiterated the hawkish comments that has led up to the meeting from Fed Chairman Bernanke and other Fed officials. In its FOMC directive, the Fed said overall economic activity continues to expand, partially due to “firming” in household spending. However, the Fed expects economic growth will face the burdens of tight credit conditions, housing contraction and the rise in energy prices.

The Fed said “uncertainty over the inflation outlook remains high, although it expects inflation to “moderate later this year and next year.” The FOMC feels that downside economic risks have somewhat diminished, while inflation risks have increased”.

We think the Fed is likely to keep rates steady for quite a while, as economic growth will remain moderate at best for at least a few more meetings. Credit market conditions are also likely to remain fragile. These factors will inhibit any rate hikes. Addressing any uptick in inflation will not come immediately, particularly as the Fed expects inflation to moderate next year.

As is typical, the stock market traded in choppy fashion following the FOMC announcement, but ended the session largely unchanged from preannouncement levels.

The financial sector took a beating throughout the week, falling -6.6%. Wall Street firms were in downgrade mode, prompting most of the selling. Goldman Sachs sent financials tumbling on Monday after cutting the sector to Underperform from Neutral. Meanwhile, Wachovia downgraded Goldman Sachs (GS) to Market Perform from Outperform. Credit Suisse cut its earnings estimates on Merrill Lynch (MER) and JPMorgan Chase (JPM), citing incremental credit quality deterioration that is largely mortgage-related.

Toward the end of the week, financials continued to tumble. Goldman added Citigroup (C) to its Conviction Sell list, and forecast a $8.9 billion second quarter write-down. Lehman said Merrill Lynch will likely incur a $5.4 billion second quarter write-down, mainly from its exposure to bond insurers.

Nine of the ten sectors posted a decline for the week. The consumer discretionary sector tumbled -4.6%. General Motors (GM) plummeted -16% after Goldman cut its earnings estimates and said the company may be forced to raise capital. Industrials dropped -6.1%, with Boeing (BA) falling -12% after it was added to Goldman’s Conviction Sell list.

Large-cap technology names were under pressure. Shares of Research In Motion (RIMM) tumbled -16% after traders sold-off the stock in response to an earnings miss and tepid outlook. Oracle (ORCL) fell -3.7% after its outlook disappointed investors.

As you might surmise, energy (+1.4%) was the only sector to post a gain, as crude surged 4.5% to all-time closing high of $140.62. A declining dollar, supply concerns, unrest in Nigeria, and Israeli-Iran war scenarios prompted the advance. Traders were overwhelmed, and seemed to ignore an increase in inventory levels and word that Saudi Arabia is increasing output in July.

The 104% year-over-year spike in crude prices is taking a toll on petroleum intensive companies. UPS (UPS) lowered its second quarter earnings guidance, citing the increase in fuel costs and the sluggish U.S. economy. UAL Corp (UAUA), parent company of United Airlines, is laying off 950, or 15%, of its pilots and reducing its fleet by 100 aircraft. Dow Chemical (DOW) plans to increase prices by as much as 25% in July to combat rising energy costs — its second major price increase in recent months.

On the economic front, the May personal income and spending data showed some decidedly good economic news, indicating the fiscal stimulus is having a beneficial impact. Real PCE — which accounts for 71% of GDP — rose 0.4% in May, and April was revised upward to a 0.2% gain. Real PCE is on track for a 2.5% annual growth rate in the second quarter, and indicates second quarter real GDP will be up close to a 2% rate — well ahead of Wall Street’s expected gain of 0.5%.

* May durable orders were flat, matching expectations, while orders excluding transportation fell by a less-than-expected amount. The data will not alter economic perceptions of a moderately growing economy.
* The decline in new and existing home sales is leveling off after the steep fall in 2007 and early 2008. May new home sales fell -2.5% month-over-month on a seasonally adjusted annualized basis, which follows the upwardly revised 4.8% gain in April. The results are better than the expected drop of -2.7%. Existing home sales rose 2% month-over-month.
* The rate of home price declines is also slowing. The S&P/Case-Shiller Index showed that home prices in 20 major metro areas fell -1.6% compared to last month — the smallest drop since September.

We will be meeting with many of you in the weeks ahead to discuss first half 2008 events and performance. It will be a good opportunity to discuss the current environment, your needs, reconfirm strategy and tactics, and set our future course. In the meantime, here is a quick end of June update from our chief Chief Investment Officer, Orie Dudley in our latest missive entitled: “A Slow, Grinding Recovery.” The salient points are:

* The global economic cycle remains favorable, US exports are strong and impactful.
* Monetary & Fiscal stimulus have been aggressive, and is having an affect.
* Credit markets are repairing.
* The US residential construction drag is beginning to ebb.
* Corporate performance ex-financials is strong – potentially up 10% this year.

Strong headwinds (inflation, financial sector travails, housing price declines) will delay a return to headline growth for several quarters at least, and the market is susceptible to significant volatility as witnessed last week, but negativity is currently quite high, and the above points bear watching.

You can stop reading here, or review our full list of positives and negatives below, thanks to our friends at Bear Sterns…errr JP Morgan.

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Banks as a whole remain under-reserved. From JP’s Vivek Juneja – “Loan loss reserves (LLR) at our bank universe are rising but still below the levels seen in the early 1990s during the credit cycle and also below the 2000-2003 cycle. Reserves were up to 1.7% of loans on average at March 31, 2008, for our banks, but this is below the 2.1% average from 1990-1994”

Capital harder to come by for the financials; so far, loss are outpacing capital raising for the financials. From the WSJ on Mon morning - Banks having trouble raising incremental capital according to the WSJ citing sources; the Journal says that in recent weeks several senior bank executives are receiving reluctance on the part of large investors to pump more capital into the space given that many large recent raises are significantly underwater and the financial sector’s fundamental outlook doesn’t appear to have hit bottom. If investors demand improved terms, it could make each incremental raise increasingly dilutive. WSJ.

According to Bloomberg, there has been ~$399B worth of write-downs taken and only ~$322B of capital raised on a worldwide basis (the discrepancy is largest in Europe, where losses have totaled ~$202B but only $146B in capital has been raised).

Stimulus checks are almost done - So far, the Treasury has sent out 94.849MM checks totaling $78B; the payments started in late Apr and will pretty much wrap up in mid-Jul (the gov’t is due to send out $107B worth of stimulus - they are ~73% of the way through).

No panic yet? The VIX, despite rising 13% Thur, remains ~23% under the ‘08 highs, suggesting investors aren’t as “panicked” as they were back in Mar. indeed, after talking to our desk, there continues to be real buyers strike with no liquidity on the desk (no rush for the exits…yet).

Corporate credit has started to deteriorate, but trends are still very strong on historical basis - what if deterioration moves to historical average or overshoots to the upside? according to S&P, through June 11, 33 firms have defaulted (debt worth $38.3B) vs 22 in all of ‘07 and 30 in ‘06. The spec default rate was 1.45% in May vs 1.29% in Apr. S&P’s mean baseline U.S. speculative-grade default rate forecast is unchanged at 4.7%…..”This is a sharp increase from a 25-year low of 0.97% recorded at the end of 2007.” To reach 4.7%, 74 entities must default in the next 12 months (S&P press release)

S&P has a report that showed corporates in the United States could face downgrades at a faster pace than the last recession in 2001. The number of companies at risk for a downgrade has risen 24 per cent since June 2007, compared with a 10 per cent increase between June 2000 and June 2001 (FT); S&P says Rising Star Potential Lowest In 5 Yrs (this is amount of credits poised to move up the credit quality spectrum)….only 12 issues in June qualified, lowest since Mar 03.

Moody’s warns on junk loans - Moody’s said that the recovery rates in junk loans this credit cycle could be sig. less than prior ones b/c of the explosion in this type of debt. First-lien junk loans will prob. only recover 68c on the dollar this time around vs. a historical average of 87c (WSJ). The combination of worsening recovery rates, combined w/deteriorating overall credit, suggests a dark outlook.

Commercial real estate sales pace is showing signs of softness, the first step before pricing starts to drop - PPS, an apartment REIT, announced this week that it has ended the process of trying to sell the company after five months of trying due to difficult market conditions. “We conducted an open and thorough sales process, but conditions in the economy and the financial markets combined to produce a difficult transaction environment.”. PPS talked to several potential parties, offered to sell parts (instead of the whole company), and even was offering up prospective financing from Freddie, Fannie. Despite all this, PPS failed to find any buyers. Meanwhile, CMBS sales could fall to just $20B this year, dwn from $237B in ‘07, and the lowest in 12 years. Some think sales might total only $15B. In Europe, 3.6 billion euros ($5.63 billion) of the securities were sold this year, a tenth of the 33 billion euros issued in the same period a year earlier - Bloomberg. Manhattan office rents fell 2.2% in Q2, the first decline since 2005, according to real estate broker Studley Inc.

Credit card debt - Fitch issued a negative report on Friday June 27 - says that card losses are hovering around or have exceeded 5-year averages and issuers have increased their loss expectations. “The deterioration in credit cards is accelerating faster than many had expected…..The message we are trying to deliver is that things are going to get worse before they get better. Thus far, credit card businesses have been profitable but that could change.” (Fitch).

Eco growth outlook (from JP Morgan) - With the cushion of tax rebates still at work, US economic indicators have fared better than those of the Euro area or Japan. On the back of a string of better than expected demand indicators, the US economy is now tracking a 2% growth pace in the current quarter vs our previous forecast of 1%. However, key high frequency momentum indicators (claims, regional surveys), coupled with higher oil prices and mortgage rates, are now pointing to a weaker 1% pace in Q3.

European data showing signs of softness - a lot of talk in the last couple days about weak eco growth numbers that have come from the Eurozone, just as the ECB gears up for a rate hike at its meeting coming up in Jul. The FT says there are fears re “stagflation” in Europe following Mon’s round of data, inc. a weak eurozone purchasing managers index and a sluggish German IFO reading. The WSJ says European data has taken a “turn for the worse”. Ireland’s economy will fall into a recession this year for the first time in more than two decades, the Economic and Social Research Institute said (Bloomberg). Spanish Finance Minister Pedro Solbes said Tuesday Spain’s gross domestic product growth will likely fall to less than 2% in 2008 and could fall still further in 2009 (DJ). From the London Telegraph - (Ambrose Evans-Pritchard) - “Eurozone waits in dread for the ECB’s next move”.

Preannouncement season hasn’t been too active, but there have been some notable red flags so far heading into the June Q reporting period. UPS warned Mon night, raising more worries about broader US slowdown (UPS’s disappointment follows the weaker guidance from FDX). ROK lowered its numbers Wed morning - “Revenue for the month of April was consistent with original expectations. However, for the past several weeks, the Company has experienced slower than expected growth in the U.S. and Europe”. AXP was cautious on the outlook Wed - “Business conditions continue to weaken in the U.S. and so far this month we have seen credit indicators deteriorate beyond our expectations”. Several banks have come out w/neg. updates on credit trends for the June Q (inc. KEY and FITB). On the tech sides of things, Negative data points for wireless handsets continue to pile up, inc: TXN’s mid-Q update (said it saw weakness in low/mid-range handsets), Compal lowering its full year unit outlook, Foxconn said seeing weakness from one of its largest customers, IFX lowering its outlook b/c of weakness from communications, and on Friday Sony-Ericsson reporting very weak margins during the Q. China handset sell-through grew by 8.7% YoY in the month of May (compared to 18.4% in the first four months), the lowest since 2004. RIMM’s results missed forecasts for the May Q and Aug guidance was a bit disappointing on the earnings front b/c of higher-than-expected spending levels; that stock has declined ~16%+ over two days.

Homebuilders - despite all that’s happened w/the homebuilders in the last few years, like trends continue to surprise on the downside. LEN and KBH both sold off hard this week following earnings and the broader builder index is closing in on fresh lows. Some comments from the LEN conf call this week - “The housing market has continued to deteriorate throughout the first half of 2008…..we expect that this trend is going to continue for at least the remainder of the year. The deterioration that unfolded so quickly in the housing market over the past years has now spread to the overall economy. And while there are some who still suggest that we might avoid a recession and believe the economy will continue to grow though at a slower pace, their case is becoming more and more difficult to make in the face of rising unemployment data. I am asked regularly as to whether or not we are at the bottom. And I feel overall that we are not there yet. A little over a week ago our senior management team visited with each of our divisions as we did our reviews. We reviewed each of our divisions in detail and evaluated the dynamics of each market in which they operate. Generally speaking, there are not yet signs of stabilization in the field. an increasing flow of foreclosures that are maintaining downward pressure on prices and appraisals. And in many markets, it is apparent that the flow of foreclosed homes is expanding rather than subsiding”

Auto markets imploding - auto sales have been running at a very depressed rate over the last few months, impacting not only the auto OEMs, but also auto parts suppliers and auto finance companies. Expectations aren’t high for a sig. rebound in sales - on June 26, Edmunds lowered its ‘08 outlook - “There is still uncertainty in the marketplace, and we have no reason to believe gas prices will decrease in the short term….Due to these conditions, we’ve lowered our 2008 sales forecast from 15.5 million units to 14.9 million units.”. GM and Ford have both lowered their sales forecast and the ratings agencies (Fitch, S&P, Moody’s) have come out negative on the group. This week, Progressive Moulded Products Ltd, one of the largest auto parts suppliers in Canada, filed for bankruptcy protection (Progressive follows several other filings from the group, most recently, Plastech Engineered Products Inc). Chrysler this week drew down on a $2B credit line from its two owners (Cerberus and Daimler) and Fitch downgraded the co’s debt (a headline from the Detroit Free Press Thurs morning read “Chrysler cash crunch feared”; Chrysler this week fended off speculation about an imminent bankruptcy filing). The weak sales pace is hitting note only the major OEMs but also their finance subsidiaries - some fear that Ford Credit, which has posted a profit every year since ‘89 (and which doesn’t many much mortgage exposure) could post a loss in ‘08 (and not pay a dividend to its parent Ford Corp). GMAC, already suffering from its Residential Cap exposure, is now being hit on the auto side (WSJ Heard on the Street was negative on GMAC Thurs morning). From Vivek Juneja - 30-day delinquencies on indirect auto loans are at the highest level seen since 1972 and above the peaks seen in all recessions since then. Delinquencies on subprime auto loans are up very sharply and also rising quickly on prime loans from extremely low levels.Credit markets showing signs of strain again – on several different metrics, credit markets are showing renewed signs of strain. Treasuries are enjoying a strong bid on a flight-to-quality trade while corporate spreads widen (Risk premiums on corporate debt widened, with the leading credit derivatives index close to its record wides at 143 basis points on Friday). High-yield bond spreads widened 57 basis points to 727 basis points, the biggest weekly rise since Jan. 4. The TED spread has risen north of 100bp.

Stock buybacks – from The Economist – according to data from The Fed, corporations have been easily the biggest buyers of shares since 2005; indeed households have been net sellers almost ever since the dotcom bubble burst in 2000. But the annualized pace of share repurchases by companies fell from around $1 trillion last year to $200 billion in the first quarter of 2008”. The Economist.

Crude markets seem to be shrugging off this past weekend’s Saudi meeting and a negative Barron’s article - so far, oil doesn’t show any signs of cracking and instead surged to fresh highs this week.

Reasons to be positive –

Jul 4 falls on a Friday, meaning US investors will have 3.5 days off to contemplate Q2 earnings season.

TAF – the Fed will hold the final TAF for June on Monday June 30. We should hear about the Jul auction terms sometime next week (they should unveil something on Jul 1-3 based on past practices). There has been growing speculation that the Fed might extend the terms of the TAFs and could up the auction amount (the June auctions were 3 $75B offerings w/terms of 28 days – some think the length could be extended and the size increased).

Financials & Capital - the Fed is considering changing certain rules and making it easier for private equity firms to inject capital into ailing financials. Some banks/brokers have been able to raise capital, but the Fed is worried that the pool of cash could be drying up. As a result, officials are considering more lenient rules when it comes to PE firms taking large stakes in financial firms. As it is now, any firm that purchases a large stake is subject to intense regulations and rules - the Fed may relax some of these to encourage more capital to flow into the sector. WSJ

Financials & Capital – while the WSJ has said capital raising is getting tougher for financials, the sector is still able to find money (although the terms are becoming more stringent). This week, there were several large raises out of Europe. Also in Europe this week – Resolution, an investment group, announced that it has been developing plans for a consolidation of the smaller banks and lenders in the UK banking sector, intended to create: 1) a new, larger and stronger bank, targeting an AA rating, through the consolidation of the current fragmented sector; 2) a better balanced business model, with a strong emphasis on attracting retail savings and potential for growth; 3) the opportunity for investors to benefit from consolidation gains, lower costs and better access to wholesale funding.

Financials have taken an immense beating - The XLF financial index has declined by $1.2 trillion in market value (44%) over the past year, equal to the more pessimistic forecasts of the extent of the write-downs to come.

Sentiment readings (and stock prices) are at/lower than the Mar lows - The latest weekly AAII (American Association of Individual Investors) Survey reading came in at a -22% (% bulls less % bears); The latest survey of -22% is basically the third lowest reading this year, with worse readings during the March lows (T Lee). Merrill’s latest portfolio manager survey out this week reveals very high levels of bearish sentiment - highest in the past 10 years (more than ‘00 and ‘03) according to the FT. US consumer sentiment is at 28-yr lows.

Remittance #s showing some signs of hope? More a mixed bag – “The delinquency velocity is definitely slowing, which is a critical turning point. (However, the delinquency trend now in place must slow further in the coming months; it is not enough that velocity is slowing when new delinquencies remain so high)” (Chris Flanagan)

End-of-Q action - Q2 comes to an end this Mon June 30; some of the recent weakness (puking anything financial related) might abate a bit starting Jul 1.

Hedge fund redemptions - how much of the selling now is HFs raising capital for end-of-Q redemption requests? The WSJ reported on June 12 that HFs were bracing for a wave of defaults this year…….some of the recent selling could be funds raising cash in anticipation of this event. On Wed night, a holder of NSM shares disclosed a share sale and said it “sold these shares to satisfy contractual obligations related to certain client redemptions”.

Deal volumes are off Y/Y during the first half of the year in aggregate, but strategic M&A is picking up. Global M&A volumes are off 30% in the first half of ‘08, but most of this is b/c of an 88% fall in PE transactions. Strategic buying is off only 2% Y/Y.

Earnings estimates are being cut – Reuters reported this week that the Q2 earnings outlook is deteriorating “rapidly” as analysts slash forecasts. Second quarter profits are expected to fall at a rate of 10.2 percent. While Q2 numbers probably won’t be too pretty, analysts may already be baking this in. Some of the largest cuts this week came to Merrill and Citigroup earnings forecasts.

Consumer companies had some decent numbers this week, inc. DRI, KR, BBBY (although NKE was a notable disappointment). While its hard to extrapolate results from these three companies to the entire consumer space, they do offer some hope that trends in the group aren’t falling off a cliff.

Negativity around financials could actually help reported earnings for banks/brokers - there is a perverse relationship between the perception of a bank’s health and the benefit that bank receives to its reported earnings from changes in the value of its debt. During a Q if the value of a bank’s debt declines, then the company is able to book the change in value as income (rough description). So some financials in the upcoming June Q might receive some benefit out of this accounting rule.

Housing Bill getting through Congress - it appears as if the long-awaited FHA-based housing bailout bill is trying to work its way through Congress and has overcome some meaningful hurdles. The Senate failed to get it through on a final vote this week due to certain members of Congress trying to attach energy tax credit legislation, but it doesn’t appear as if this is an insurmountable issue. While the legislation might slip past the Jul 4 recess, both the White House and Treasury appear to have come around and could support the bill. Even if they don’t, some think Congress could get a veto-proof majority.

U.S. credit card and auto ABS could withstand significant increases in unemployment from current levels before ‘BBB’ or ‘AAA’ bonds default according to Fitch. However, downgrade risk persists, particularly at the subordinate level as unemployment levels have increase substantially over the past 12 months

Good afternoon,

To say the least, June of 2008 will not be a month we remember fondly with respect to the equity markets. With oil prices reaching new highs frequently throughout the month, equities have found new lows for the year. While the equity market weakness in late 2007 and early 2008 was focused primarily on the financial sector’s troubles, this month’s decline has been almost solely a function of inflation concerns. There is much concern about the Federal Reserve’s ability to effectively manage the delicate balance between a very soft economy and keeping a lid on inflation. The interesting thing about that relationship is that the former may be the best solution for the latter, and that may be what the Fed is looking for. When the Fed’s Open Market Committee met last week, they left rates unchanged. They slightly reduced their risk assessment for economic growth while modestly increasing inflation risks. Our expectations for future Fed Funds rate moves are for higher rates but not until the fourth quarter.

As the domestic economy remains weak and stagnant while many developed and emerging international economies begin to weaken, inflation pressures (including oil prices) are expected to fall. According to Francois Trahan, portfolio strategist at International Strategy and Investment (ISI), we only have to look back to the summer of 2006 to see slowing global economies, especially developing economies such as China and India, having a significant effect on oil prices. Just before the last correction in oil prices there was: 1) a correction in emerging market equities; 2) slow or slowing economic growth, especially in developing economies; and 3) sentiment for oil at very bullish levels. We are currently seeing these same trends develop. The second half of 2006 saw a 30% reduction in oil prices leading to a 11.6% increase in the S&P 500 (ISI: Portfolio Strategy Report, 6/30/08). We cannot guarantee the same outcome, but the comparison and similarities are definitely worth noting. That said, risks remain such as the current situation with Israel and Iran and continued financial sector turbulence that will keep uncertainty and volatility in the commodity and equity markets at high levels.

I recommend a neutral weighting to equities with a focus on high quality (large cap) domestic and international stocks. There are increased risks in all asset classes at this point (cash included), so we do not recommend making moves outside of one’s investment plan or objective in an effort to chase higher yields and/or returns. Ensuring proper asset allocation and diversification in line with your investment objective is of prime importance at this time.

Have a good holiday weekend.

The Chinese government announced June 19 that it will raise the price ceiling on a number of energy products by 5 percent to 25 percent. However tentatively, the Chinese are thus beginning to accept the challenge of running the gauntlet between unemployment and inflation.

Yesterday China announced that it would raise diesel & gasoline prices by 1000 yuan/ton, equivalent to around $0.48/gallon. With current prices around $2.70/gallon, this amounts to an increase of +18%. In addition China is expected to raise jet-fuel prices by 1,500 yuan/ton, or +25% today. On July 1, China will also increase electricity prices by an average 0.025 yuan/kilowatt-hour, or +4.7%.

While several other Asian nations have already reduced fuel subsidies, we had expected China to hold off until after the Olympics, so this news comes as a surprise. Before today’s news, we had forecasted China’s demand growth to be 4.7% in 2008, or an addition of 350,000 barrels/day. Based on our analysis of Indonesia’s response to its price increases, we believe that the annualized impact on demand could be 50-80,000 barrels/day, or 15-20% of China’s expected growth. As a result, China’s annual oil demand growth is now expected to be lower at circa 4%.

As a result of this earlier than expected increase in pricing (and the expectations of a further hike after the Olympics) and increases in Malaysia, India, Indonesia and Taiwan, we forecast non-OECD demand to slow from 2Q08 to year end. Coupled with an acceleration of the decline in OECD consumption we continue to believe demand is highly likely to be negative by 4Q08.

Analysis

The Chinese government announced at 10 p.m. local time (9 a.m. CDT) that beginning in two hours it will raise the price ceiling on a number of energy products by 5 percent to 20 percent. Runaway Chinese energy demand has both skewed international commodity markets and presented China with an increasingly distorted energy market as the government, refiners and retailers attempt to pass the buck to someone else.

A 25 percent increase is not a major step, and the increases only incompletely impact gasoline, diesel, jet fuel and electricity. The Chinese already have indicated that there will be several exceptions — public transport fares, for example, will not be adjusted — and any partial price increase that allows for large loopholes will only have a limited impact. And so far the changes seem to impact only the price caps in place — actual subsides, for example to the rural poor, have not been mentioned.

This effort is halfhearted by design. The Chinese system runs on cheap capital, the idea being that if firms have constant access to below market-rate loans, then they can maximize employment and keep disgruntled citizens from going on long marches. It is a system that purchases social stability, but at the cost of a mountain of nonperforming loans. Eventually that mountain has to be dealt with, and past economic crises in Japan and Indonesia — states that use a similar system — are proof positive that the Chinese are proving cannier than the Japanese and Indonesians, however, and are attempting to reform their system piecemeal and break their addiction to cheap capital. One of the first steps in doing this is introducing the concept of rates of return on capital to Chinese businesses, thereby getting firms to recognize that a high debt-to-income ratio is something not to be celebrated. In the early — and even middle — stages of this process this means firms ought to begin to understand that loans should not be used for funding everything. Firms thus begin to think about profit, and shift from being loss-making enterprises that employ gobs of people to leaner firms that operate at a thin profit. In theory, as the transition occurs, newer, financially healthy firms are born to absorb any excess labor.

Jacking up energy prices will be enough to push most of these partially reformed firms back into the red, and risk making them formally bankrupt (again). Unless, that is, the government feels forced to roll back what advances it has made and make cheap credit available en masse once more.
But China is in a double bind. The very capital system that gave rise to its financial problems has generated a second problem: inflation. When everyone has access to unlimited cheap money, they can bid up the price of anything of which there is a less-than-infinite supply: land, buildings and oil. A primary factor behind oil at $130 a barrel has been the lack of Chinese price sensitivity — they can just take out (another) loan to pay the import bill.

We have now reached the point where the Chinese face dire pressure whatever they do, whether that involves leaving the system as is and watching inflation overcome their financial reform efforts, vastly accelerating efforts to curtail inefficient capital use by gutting loans and risking massive unemployment as firms close by the thousands, or freeing energy prices and facing public wrath as inflation injects social instability (and perhaps have higher prices push those same vulnerable firms over the edge anyway). Beijing thus faces a choice between death by unemployment or death by inflation. The two deaths are intimately related; their cause is the same: ridiculously cheap credit.

With today’s increased price caps the Chinese government is attempting to feel out which option will generate less opposition: cracking down on the loan system or raising energy prices. The one (very) bright spot in all this is that the Chinese have chosen to do this before the Olympics, an event that all Chinese see as their day in the sun. Beijing must be sufficiently confident in the system’s stability to take this risk — and after all, it is a very small step laden with exceptions. (After all, fuel riots outside Olympic stadiums would not exactly promote the vision of strength and unity Beijing is aiming for.) That said, there is no doubt the government is fully aware of how few options it really has. However tentatively, the Chinese are beginning to bite the bullet.

Now we wait to see if the bullet bites back.

I’m so glad it’s summer. I’ve been getting to really enjoy the things that I love the most — such as water-skiing, having the “challenge” of working on some C++ and website projects. I really feel free, like there is no weight on my shoulders, and it is such a great feeling to have!

Two of my most recent website designs are:
TJON INTERNATIONAL
BuySomeDrank.Com

So, eventually, this website will get updated with some cool look, instead of the default theme.
I hope everyone is having a great summer!

I wanted to give everyone a status update as to what I’ve been doing, since I’ve been MIA for the past few weeks/months. I’ve been in and out of the hospital (total time in hospital = weeks) for severe migraine headaches, that even narcotics would not respond to. I have a brilliant neurologist and we’re trying out some other options that seem to be helping.

So, I’ve been quite busy or ill (hopefully no more of the latter) and just wanted to give any readers a status update on the crazy life of Will Erwin.

I wanted to take a second to call a time-out in your busy day. I know we’ve all heard and know that donating blood is a good thing to do. However, the majority of us don’t do it for a variety of reasons from it taking up time to being scared of needles. I donated blood a few months ago when my grandfather was in the hospital, shortly before he passed away. I recently got a phone call from the mother of a 10-year old child, thanking me for my donation of blood and that it helped save her child’s life. That really hits you at home when you hear that. Taking 30 minutes out of your day a couple times a year to donate blood and you’re helping save lives.

This is something physically you can do. One thing that you can do on you’re computer is to run Folding@Home.

Dear Will Erwin,

Your next eligible blood donation date is 04/01/2008,

Thank you for saving lives. Your last donation helped save the lives of
three people. You will be eligible to donate and save three more lives on
the date listed above. Please make the time to donate again. Patients need
you.

St. Luke’s Episcopal Hospital Blood Center

So, please. Take an hour out of your day or weekend and help save a life. It’s easier than you think.

I’m happy to report that the ISP, Comcast, who has been throttling BitTorrent downloads have reached an agreement that they will upgrade their network capacity and also no longer throttle [BitTorrent] Internet traffic.

This is welcomed news as the US broadband infrastructure needs an upgrade along with BitTorrent becoming a more and more acceptable protocol and practice. The US used to lead the world in broadband capacity but in the past few years has been slipping further and further down the international list.

Below is a synopsis of the information that I received regarding the upcoming Cyber Storm II exercise.

The Cyber Storm II (CS II) will commence on Monday, March 10, and continue through Friday, March 14, 2008. This will prove to be the largest cyber security exercise of its kind and will reach across the globe. Four other countries are involved with “playing” in the exercise: Canada, United Kingdom, New Zealand and Australia. The Secret Service Criminal Investigative Division will be hosting CS II at it’s Headquarters in Washington, DC. We anticipate up to one hundred fifty
(150) players will be participating in cyber attack scenarios for a 24hr period over four days.

Boose/Allen/Hamilton, a private firm contracted by DHS, will be injecting cyber attack scenarios on private industries, federal and local government entities, and financial institutions throughout the week. It is possible that your office may receive one of these injects and contact you regarding a cyber attack, network intrusion, etc. All electronic injects will state *** EXERCISE ***. When you receive these cyber scenarios, follow your normal course of action as far as notifying your partners (private industry, law enforcement, academic, etc) and discussing the best way to solve the problem.”

SecurityFocus has an interesting article on a new $30 billion US government project, called Cyber Initiative. It is intended to secure the nations [United States] infrastructure, but some worry that it may be too little, too late. I think the skeptics may be right on this one.

Read it here

Just because two people argue, it doesn’t mean they don’t love each other. And just because they don’t argue, it doesn’t mean they do.

We don’t have to change friends if we understand that friends change.

No matter how good a friend is, they’re going to hurt you every once in a while and you must forgive them for that.

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