The U.S. takes another step towards an all-out trade war with China

Legislation pressing China to raise the value of its currency is set for a vote in the U.S. House next week, as Republicans joined Democrats in expressing frustration that the yuan is appreciating too slowly.

"We cannot wait any longer to level the playing field for U.S. businesses and protect American manufacturing jobs," Democratic Leader Steny Hoyer of Maryland said yesterday after the Ways and Means Committee sent the bill to the full House.

The committee adopted the measure by voice vote after the panel's top Republican, Dave Camp of Michigan, voted with Democrats to back the bill. The full House will vote Sept. 29, said committee Chairman Sander Levin of Michigan, a Democrat.

The measure would let companies petition for higher duties on imports from China to compensate for the effect of a weak currency. President Barack Obama's administration hasn't taken a position on the bill, said Natalie Wyeth, a Treasury Department spokeswoman. A Chinese central bank press official, who prefers not to be identified in accordance with the agency's rule, declined to comment in Beijing today.

The U.S. trade deficit with China widened to $145 billion in the first seven months of this year, from $123 billion for the same period in 2009. The expanding deficit, unemployment lingering at almost 10 percent and polls showing Democrats' seats at risk heading into the election added support for the bill, which has been discussed since 2005.

Flexible Rate

The yuan has strengthened about 2 percent against the dollar since June 19, when China's central bank said it would pursue a more flexible exchange rate. That rate of gain is "inadequate," Treasury Secretary Timothy F. Geithner told the panel last week. Pressure from lawmakers is helping the administration make the case to China to raise the value of the yuan, he said.

Lawmakers such as Camp say they are also frustrated with barriers China has raised to American imports and the piracy of copyrighted American movies, music, and software.

The currency dispute "is a proxy for the state of the overall U.S.-China commercial relationship," William Reinsch, president of the Washington-based National Foreign Trade Council, said Sept. 23 on Bloomberg Television. "I don't think it will have that big of an impact on the American economy."

China Operations

Lawmakers fended off warnings from lobbyists representing companies such as Caterpillar Inc., Wal-Mart Stores Inc., and Citigroup Inc., who said the measure may lead to retaliation against U.S. companies operating in China and curb exports to the country. China may retaliate if the House passes the legislation, said Reinsch, who represents multinational companies such as Caterpillar.

"This could damage our efforts to 'sell American' and compete successfully in the growing China market," Representative Kevin Brady, a Texas Republican who heads the Ways and Means Committee trade panel, said before the vote.

Forcing China to raise the value of its currency may create 500,000 jobs in the U.S., most in manufacturing at above-average wages, according to C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington. China's currency, which is undervalued by as much as 25 percent, is the most important trade issue facing the U.S., he said in testimony last week.

Obama Meeting

Obama pressed China's Premier Wen Jiabao in a two-hour meeting at the United Nations Sept. 23 to increase the yuan's value. Wen said this week that a 20 percent increase in the currency would cause severe job losses and trigger social instability in China.

"We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs," he said in New York on Sept. 22.

"We want to see that any legislation is consistent with our international obligations and consistent with the World Trade Organization and is in our interests," Jeff Bader, Obama's director for Asian affairs, said Sept. 23. He didn't say if this bill meets those tests.

Levin said yesterday the measure was redrawn to be consistent with WTO rules. It would let U.S. makers of products petition the Commerce Department for countervailing duties on Chinese products to compensate for the "subsidy" of a weak currency, according to documents released by the committee.

WTO Rules

The Commerce Department rejected such an argument in cases filed by paper and aluminum makers last month, saying that a weak currency isn't a subsidy to a specific industry, as required under WTO rules. The legislation when introduced by Representative Tim Ryan, an Ohio Democrat, would have required that the Commerce Department find that a weak currency is a subsidy. Revisions crafted by Levin removed that language and instead set out provisions intended to make such a finding more likely.

It's that change that won Camp's backing. "It does not presuppose an outcome," he said.

Forty-four Republicans had already signed on as sponsors of the original bill, and with Camp's support, lobbyists said they expect additional Republicans to vote with Democrats next week. That could help spur the Senate to take it up before lawmakers leave Washington to campaign for election, said Lloyd Wood, spokesman for the group of unions and manufacturers fighting for the bill.

"The bigger the vote in the House, the more pressure it puts on the Senate," Wood said.

Lobbyists for groups representing Wal-Mart and Citigroup faulted the panel for approving the measure.

"Provoking tension with our trading partners doesn't come without costs, and we should choose our battles carefully," Stephanie Lester, vice president of the Retail Industry Leaders Association, which represents Wal-Mart, said in a statement. "It makes little sense to enact harmful policies that will spark a bilateral conflict over currency with one of our largest trading partners and fastest growing markets for American exports."

A BIG NEW DEVELOPMENT FOR THE S&P 500

The message from today's chart is, "We're back in bull mode."

Longtime DailyWealth readers know we check in from time to time with the S&P 500's 200-day moving average to gauge which way the "tide" is flowing for the stock market. A moving average is an indicator that computes the average price of an index over a given time period… In this case, it's the blue line overlaid on the chart below.

There's nothing magical about the 200-day moving average. It's simply the most widely used "marking point" traders use to say if a market is in a bull trend or a bear trend. It's popular because it's popular.

As you can see from today's chart, the S&P spent much of 2009 and 2010 above the 200-day moving average. It then dipped below the average in May and has muddled along ever since. The big rally of the past few weeks, however, has taken the S&P above the average… and back into a bullish trend. Folks are taking Ben Bernanke at his word when he says he'll do anything to support asset prices.

"The U.S. is bankrupt and we don't even know it..."

Let's get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.

What it can and must do is radically simplify its tax, health-care, retirement, and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.

Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: "Directors welcomed the authorities' commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP."

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: "The U.S. fiscal gap associated with today's federal fiscal policy is huge for plausible discount rates." It adds that "closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP."

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It's also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.

Is the IMF bonkers?

No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

'Unofficial' Liabilities

Based on the CBO's data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our "official" debt and our actual net indebtedness isn't surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities "unofficial" to keep them off the books and far in the future.

For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions "loans" and called our future benefits "repayment of these loans less an old age tax," with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.

The fiscal gap isn't affected by fiscal labeling. It's the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

$4 Trillion Bill

How can the fiscal gap be so enormous?

Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today's dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.

This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: "Something that can't go on, will stop." True enough. Uncle Sam's Ponzi scheme will stop. But it will stop too late.

And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

Worse Than Greece

Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates, and consumer prices. This is an awful, downhill road to follow, but it's the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won't affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government's credit-card bill and each year's 14 percent of GDP is the interest on that bill. If it doesn't pay this year's interest, it will be added to the balance.

Demand-siders say forgoing this year's 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.

My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no-pain, all-gain "solutions."

A Safe, Easy 45% Profit… Thanks to Bernanke

The people who set short-term interest rates in the U.S. just showed their cards last week…

Thanks to the minutes to the latest Fed meeting, we now know what Fed Chairman Ben Bernanke's playbook is.

Bernanke is making it easy for us to invest… In short, he will keep money as "easy" as possible, for as long as possible – likely beyond 2012.

Today, I'll show you the safest, easiest way to make large profits from Bernanke's easy-money deal. Our target gain is 45% in one year.

To understand what Bernanke is up to, think of it this way… He's trying to light up the U.S. economy like it's a grill. He's dousing it with rocket fuel and pumping away on the "start" button. We're just waiting on the "WOOSH!"… the big flame. He's trying so hard, we're just standing back and waiting for his eyebrows to get burned off.

But chances are, he won't see a "WOOSH." Or more specifically, he won't see the economy light up like he wants. Instead, all Bernanke's rocket fuel will do is light fires elsewhere.

He'll create asset bubbles – like tech stocks in the 1990s or housing in the 2000s – that will eventually result in spectacular busts. But Bernanke won't care about those. All he cares about is igniting the grill in front of him.

According to the minutes to the latest Federal Reserve meeting, the Fed expects the economy will grow a bit slower than it thought… Unemployment will be a bit higher… And core inflation will be lower – only around 1% through 2012.

If those guesses from the Fed are even close to correct, it will keep interest rates near zero for a very long time.

That will make money next-to-free to borrow. The obvious beneficiaries of free money are "virtual banks" like Annaly (NYSE: NLY).

If you've read my writing for any amount of time, you probably know how the story goes with these…

"Virtual banks" are essentially built to take advantage of the government's control of interest rates. These virtual banks borrow money at current (incredibly low) rates, and then buy 100% government-guaranteed mortgage bonds, which yield over 4%. So they take on no credit risk.

They make money off of the interest-rate spread, and they pay high dividends – in the 15% range. And right now, they're cheap! In addition to high dividends, we have room for 30% capital gains in Annaly…

Currently, Annaly is trading near book value. I fully believe it will rise to 1.3 times book value. Why? It's simple…

The dividend yield is just too attractive. I am certain income investors will be willing to bid up the share price of Annaly so high that the dividend yield falls to 11.5%. Think about it. Which would you prefer? Earning less than 1% in the bank? Or earning 11.5% in Annaly for a little bit more risk? An 11.5% dividend would put Annaly at 1.3 times book value.

In short, you'll collect 15% interest while you wait on a 30% capital gain. If it happens within a year, you can make 45% total returns (capital gains plus dividends) – in a totally safe investment.

We have 30% upside in Annaly – and we're getting paid 15% a year in interest. Not a bad deal.

Bernanke and the Fed have shown us their hand, and low interest rates are going to be here for a long time. Take advantage of the Fed and invest in "virtual banks," like Annaly, at today's low price.

Plan on holding for a year or taking profits at 1.3 times book value, whichever comes first.

U.S. stripped of AAA credit rating... By China

Despite repeated warnings going back several years from Moody's, S&P et al that the U.S. could lose its top credit rating with ongoing fiscal deficits and heavy debts, the platinum-plated AAA rating of the United States seems all untouchable.

The top notch rating certainly has helped with continuing debt financing and bolstering the confidence of some government officials. Secretary Geithner, for example, said in a February interview that the U.S. government "will never" lose its credit rating, despite big budget deficits and a newly raised debt ceiling of $14.3 trillion.

Along came a Beijing-based rating agency...

U.S. is headed for one of the worst inflations in history

"It could never happen here"... That's the refrain we hear from our friends and colleagues. They say it after we've gone over all of the numbers involved in the government's financial position and explained our out-of-consensus view that the U.S. is not only heading toward a period of massive inflation, but such an outcome has long since ceased to be avoidable. People respond – "Oh, that could never happen here." – in the same way they repeat a catechism.

We don't think our view is shocking or even surprising. Much like with our GM analysis (we predicted bankruptcy as early as 2005), when you simply look at the numbers, the outcome is unavoidable.

And then there's history. Not a single brand of paper money has ever lasted. Or you might say, in all of recorded human history, gold remains undefeated. We expect that trend to continue. Likewise, we can't recall any nation that ever repaid its debts (in sound money) once they'd grown to 100% of GDP. And watching our neighbors "strategically" defaulting on their mortgages in record numbers, we see no reason to expect Americans will prove to be any more honest about their government's obligations.

Since America isn't the first powerful democracy to default through inflation, it may pay for investors to be familiar with the most famous such event...

In 1915, just after World War I began, you could exchange 4.2 German marks for one U.S. dollar – and that was when the U.S. dollar was still backed by gold. As you know, Germany lost the war. Its people were literally starving by the end, thanks to the British blockade. With no alternative except starvation and annihilation, Germany accepted an armistice that demanded $12.5 billion in reparations. The debt was equal to 100% of Germany's GDP prior to the war. At the time, the exchange rate stood at 65 marks to the dollar, a devaluation of roughly 95%. Most people believe Germany's hyperinflation was caused by this war debt. Not exactly.

After the war, Germany was broke... That's true. But the mark was cheap. It seemed like a terrific investment opportunity. Most people believed Germany would find a way to finance its debts. We imagine foreign investors at the time said, "Oh, hyperinflation could never happen in Germany..." And so speculators pumped another $2 billion of additional credit into Germany. Then came trouble. Germany's main creditor (France) refused to renegotiate the terms of the armistice. And the German people lost confidence in their own government. The people didn't want to pay the debts. Assassinations began to occur, most notably the murder of Walther Rathenau – the foreign minister. Investors lost confidence in the country. They abandoned the mark.

German prices rose fortyfold in 1922. The mark fell from 190 to 7,600 to the dollar. When Germany failed to make a foreign debt payment in 1923, 40,000 French and Belgian troops invaded. To appease its creditors, the German government printed more money. It issued 17 trillion marks in 1923 (compared to 1 trillion in 1922). By August 1923, a dollar was worth 620,000 marks. By early November 1923, the exchange rate hit 630 billion to one.

Could something like this happen in the U.S.? Not exactly. We doubt, for example, China will ever attempt to invade the U.S. to force debt repayment. But we think what will likely happen could easily be worse than Weimar Germany. You see, the mark wasn't the foundation of the world's economy. Today, more than 60% of all bank reserves around the world are U.S. Treasury obligations. As the U.S. continues to run massive annual deficits and as the Fed engages in "quantitative easing," the world's supply of money is growing, by large amounts. Sooner or later, people holding paper money of every variety, not just Uncle Sam's, will come to doubt its most important quality – the stability of its exchange value. The resulting massive inflation will not merely strike the U.S., but the entire world.

U.S. Treasury yields plummet to lowest level since 2009

Treasuries rallied, pushing the yield on the 10-year note to the lowest level since April 2009, on concern the economic recovery will remain slow.

U.S. debt gained as a report indicated inflation was contained last month and economists said the nonfarm payrolls report later this week will show employers eliminated 115,000 jobs in June. Group of 20 leaders said over the weekend that advanced economies plan to cut their deficits in half by 2013, allowing them to curb record bond sales.

“Economic growth for the balance of 2010 is going to be disappointing to a lot of people,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading in New York at Deutsche Bank AG’s private wealth management unit. “At the same time, inflation is benign. With the Fed on hold, maybe 3 percent on 10-year notes is not a bad trade for the next couple of months.”

The yield on the 10-year note decreased seven basis points, or 0.07 percentage point, to 3.04 percent at 2:16 p.m. in New York, according to BGCantor Market Data. It touched 3.03 percent, the lowest level since April 29, 2009. The price of the 3.5 percent security maturing in May 2020 gained 18/32, or $5.63 per $1,000 face amount, to 103 27/32.

Treasuries are the world’s third-best-performing government debt securities this quarter, having returned 4.05 percent, trailing 5.10 percent for Denmark and 4.32 percent for Britain, according to Bloomberg data.

Two-Year Note

The two-year note yield fell two basis points to 0.63 percent after earlier dropping to 0.62 percent, the lowest level since Nov. 27. The yield is approaching the record low of 0.6044 percent set Dec. 17, 2008, after the Federal Reserve cut its target for overnight lending to a range of zero to 0.25 percent.

The yield on the 10-year note will climb to 3.78 percent by year-end, according to the median estimate of 64 economists in a Bloomberg News survey. The yield on the 2-year note should increase to 1.32 percent, according to the median estimate in a separate survey.

The extra yield investors demand to hold 10-year notes over two-year securities, charted on the yield curve, fell today to 2.41 percentage points, the narrowest since May 26, when it touched 2.37 percentage points.

The yield curve plots the rates of bonds at different maturities, with a flatter curve reflecting increased demand for longer maturities from investors expecting lower economic growth and slower inflation.

‘Bull Flattener’

“The curve has gotten a bull flattener,” said Andy Richman, who oversees $10 billion as a strategist in Palm Beach, Florida, for SunTrust Banks Inc.’s private wealth management division. “The economic numbers are looking and coming in weaker than expected.”

Treasuries also rose as U.S. buyers sought longer-term securities to increase the duration of their portfolios to match their benchmarks at the end of the second quarter.

U.S. government debt extension increased by 0.06 years for July 1, compared with 0.09 years for June 1, according to Barclays Plc, one of 18 primary dealers that trade directly with the Fed. Duration measures how sensitive a bond’s price is to changes in yield.

Longer-term government debt was supported as a government report showed muted inflation.

The inflation gauge tied to spending patterns increased 1.9 percent from May 2009 after a 2 percent gain in the 12 months through April, the Commerce Department reported.

‘Room to Play’

“There was nothing in the data to disturb the trend of lower yields,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “The move toward that view has more room to play.”

The Fed said on June 23 at the conclusion of its two-day meeting that the recovery pace is “likely to be moderate for a time” and reiterated its commitment to an “extended period” of low borrowing costs.

A lower-than-expected 431,000 new jobs for the U.S. in May included a 411,000 jump in government hiring of temporary workers for the 2010 census, the Labor Department reported on June 4. The payrolls report for this month is due on July 2.

President Barack Obama said the goal set by the G-20 nations of cutting deficits reflects U.S. targets and takes into account the fiscal and economic needs of each country. The White House projects the U.S. shortfall will be a record of almost $1.6 trillion this year. U.S. marketable debt has climbed to an unprecedented $7.96 trillion.

Global bond returns may have nowhere to go but down after the best first half since 2005.

The benchmark 10-year Treasury note has returned 7.85 percent this year, including reinvested interest, leading global government bonds to a gain of 3.36 percent, according to Bank of America Merrill Lynch indexes. That’s the best start since the firm’s broadest sovereign debt index rose 3.77 percent in the first half of 2005.

Congress passes "diluted" financial reform bill

Legislation to overhaul financial regulation will help curb risk-taking and boost capital buffers. What it won’t do is fundamentally reshape Wall Street’s biggest banks or prevent another crisis, analysts said.

A deal reached by members of a House and Senate conference early this morning diluted provisions from the tougher Senate bill, limiting rather than prohibiting the ability of federally insured banks to trade derivatives and invest in hedge funds or private equity funds.

Banks “dodged a bullet,” said Raj Date, executive director for Cambridge Winter Inc.’s center for financial institutions policy and a former Deutsche Bank AG executive. “This has to be a net positive.”

Hashed out almost two years after the worst financial crisis since the Great Depression, the legislation shepherded by Senate Banking Committee Chairman Christopher Dodd and House Financial Services Chairman Barney Frank places limits on potentially risky activities such as proprietary trading or over-the-counter derivatives and gives regulators new powers to seize and wind down large, complex institutions if needed.

The overhaul, which still requires approval from the full Congress, won’t shrink banks deemed “too big to fail,” leaving largely intact a U.S. financial industry dominated by six companies with a combined $9.4 trillion of assets. The changes also do little to solve the danger posed by leveraged companies reliant on fickle markets for funding, which can evaporate in a panic like the one that spread in late 2008.

‘Fig Leaf’

The Standard & Poor’s 500 Financials Index, whose 79 companies include JPMorgan Chase & Co. and Goldman Sachs Group Inc., rose 1.4 percent at 1:02 p.m. in New York.

The legislation is “largely a fig leaf,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. “Given where we were when this got started, I’d have to imagine the Wall Street firms are pretty happy.”

Banks avoided drastic curbs on their highly profitable derivatives businesses. Lenders including JPMorgan and Citigroup Inc. will be required to move less than 10 percent of the derivatives in their deposit-taking banks to a broker-dealer division during the next two years, which may require additional capital.

Goldman Sachs and Morgan Stanley, which were the two biggest U.S. securities firms before converting to banks in September 2008, won’t be as affected because they kept most of their derivatives in their broker-dealer units.

‘Pennies’ of Dilution

“There’s going to be some adaptation, but I don’t think there’s going to be any colossal impact,” said Benjamin Wallace, an analyst at Grimes & Co. in Westborough, Massachusetts, which manages $900 million and holds stakes in Bank of America Corp., JPMorgan and Wells Fargo & Co. Derivatives rules mean “there’s going to be a capital raise, but the analysis we’ve seen suggests we’re talking in the pennies in terms of dilution” of earnings per share.

Senator Blanche Lincoln, a Democrat from Arkansas, had originally advocated forbidding banks that receive federal support such as deposit insurance from trading swaps, a rule that could have required banks to spin off those businesses.

The final agreement provides a number of exemptions: Banks can continue trading derivatives used to hedge their risks and can keep trading interest-rate and foreign-exchange contracts. Banks will have up to two years to move other types of derivatives, such as credit default swaps that aren’t standard enough to be cleared through a central counterparty, into a separately capitalized subsidiary.

97% of Market

U.S. commercial banks held derivatives with a notional value of $216.5 trillion in the first quarter, of which 92 percent were interest-rate or foreign-exchange derivatives, according to the Office of the Comptroller of the Currency. The five U.S. banks with the biggest holdings of derivatives -- JPMorgan, Goldman Sachs, Bank of America, Citigroup and Wells Fargo -- hold $209 trillion, or 97 percent of the total, the OCC said.

The rules are “nowhere as bad as what the banks might have feared as recently as a week ago,” Bill Winters, the London- based former co-chief executive officer of JPMorgan’s investment bank, told Bloomberg Television today. “Banks have pretty much factored in already the idea that most derivatives will have to be cleared through a central clearing counterparty. Not a huge surprise and probably not a huge cost either.”

Volcker Rule

Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather. They include credit-default swaps, which act like insurance for investors in case a debt issuer can’t repay.

Swaps sold by American International Group Inc. that later went sour helped push the insurer to the brink of bankruptcy and triggered a $182 billion federal bailout of the New York-based company during the near collapse of the financial system in 2008.

Another portion of the legislation that was amended in the final conference was the so-called Volcker rule, named after Paul Volcker, the former Federal Reserve chairman who championed it. Originally the rule would have prevented any systemically important bank holding company from engaging in proprietary trading, or bets with its own money, as well as investing its own capital in hedge funds or private-equity funds. Goldman Sachs executives have estimated that about 10 percent of the firm’s annual revenue comes from proprietary trading.

3% Rule

In the final version, the banks will be allowed to provide no more than 3 percent of a fund’s equity, and will be limited to investing up to 3 percent of the bank’s Tier 1 capital in hedge funds or private equity funds. That represents a ceiling of about $3.9 billion for JPMorgan, $3.6 billion for Citigroup and $2.1 billion for Goldman Sachs, according to the companies’ latest quarterly reports.

“I don’t think it will have any impact at all on most banks,” Winters said of the amended Volcker rule. “It’s a pragmatic solution that will result in the banks having no big issues.”

While the rule has been watered down, it still represents an important change in direction for a financial industry that had been allocating a larger and larger portion of capital over the last decade to making bets and investments with their own money, said James Ellman, president of San Francisco-based hedge fund Seacliff Capital LLC, which specializes in financial industry stocks.

‘Casino’ Must Go

“You’re going to be taking out of the banks areas of investing that every 10 years or so, at certain points in the cycle, tend to have dramatic losses,” Ellman said. “Effectively you’re telling the system: We have to take the casino out of the utility.”

While Ellman said the legislation will help to make the financial system safer, he added that “it won’t satisfy anybody who wanted really strict additional regulation of banks.”

The new version of the Volcker rule also incorporates changes proposed by Democratic Senators Jeff Merkley of Oregon and Carl Levin of Michigan that aim to curb conflicts of interest by preventing firms that underwrite an asset-backed security from placing bets against the investment. In April, Levin presided over a hearing in which Goldman Sachs executives were accused of betting against some of the same collateralized debt obligations that they underwrote; the executives responded by saying they were acting as market-makers.

Market-Based Funding

While requirements for an increase in capital will provide banks with a bigger cushion to absorb losses, the legislation does little to reduce banks’ dependence on the markets to finance their balance sheets. It was that market-based funding that made firms like Goldman Sachs and Morgan Stanley vulnerable to the panic that spread in 2008.

“Something has to be put in place to cause banks to have deposit-based liabilities and not market-based liabilities,” Grimes & Co.’s Wallace said.

The effects of the legislation won’t be seen for several years as new regulations are drafted and implemented, analysts said. New international capital requirements under consideration by the Basel Committee on Banking Supervision, which could be implemented by the end of 2011, will also be important.

Investors and analysts including Optique Capital Management’s William Fitzpatrick said bank stock prices have already factored in any likely reduction in revenue from the changes.

“Profitability is indeed going to take a hit and we’re going to see more stringent capital requirements,” said Fitzpatrick at Milwaukee-based Optique, which oversees about $800 million including stock in Bank of America, Goldman Sachs and JPMorgan. “The changes are most certainly necessary. They can certainly lead to a more stable and predictable earnings stream.”

Still, he added, “this doesn’t remove all of the elements of financial distress that could lead to some of the challenges we had in 2008.”

Gulf DISASTER: Federal agency says BP spill could cost over $1 trillion

Bad news concerning the Gulf oil disaster continues to come from WMR's federal government sources in the Federal Emergency Management Agency (FEMA) and the US Army Corps of Engineers. Emergency planners are dealing with a prospective "dead zone" within a 200 mile radius from the Deepwater Horizon disaster datum in the Gulf.

A looming environmental and population displacement disaster is brewing in the Gulf.

New home sales plunge to lowest level on record

Purchases of new homes in the U.S. fell in May to a record low as a tax credit expired, showing the market remains dependent on government support.

Sales collapsed a record 33 percent to an annual pace of 300,000 last month from April, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down.

Stocks dropped and Treasuries rose as the report added to signs of weakness in the economy after a decline in retail sales and a slowdown in private job growth. A lack of inflation and concern over jobs and housing are among reasons Federal Reserve policy makers today are likely to renew a pledge to keep interest rates near zero for an “extended period.”

“May was a bad month for the economy,” J. Alfred Broaddus, former Richmond Fed president, said in an interview on Bloomberg Television’s “In Business With Margaret Brennan.” When the Fed releases its policy statement today, its language on the economy will be “markedly more pessimistic,” he said.

The Standard & Poor’s 500 Index fell 0.6 percent to 1,089.27 at 10:39 a.m. in New York. The S&P Supercomposite Homebuilder Index decreased 0.4 percent. The yield on the 10- year Treasury note fell to 3.11 percent from 3.17 percent late yesterday.

Exceeds Drop Projected

Sales were projected to drop 19 percent to a 410,000 annual pace, according to median estimate of 76 economists surveyed by Bloomberg News. Forecasts ranged from 300,000 to 530,000. The government revised April’s purchase rate down to 446,000 from a previously reported 504,000.

The median sales price decreased 9.6 percent from the same month last year, to $200,900, today’s report showed.

Purchases dropped in all four U.S. regions last month, led by a record 53 percent drop in the West.

The supply of homes at the current sales rate jumped to 8.5 month’s worth, from 5.8 months in April. There were 213,000 new houses on the market at the end of May, the fewest since 1970.

A report yesterday showed sales of previously owned homes unexpectedly fell in May, adding to concern the retrenchment following the end of the tax incentive will be deeper than anticipated. Existing house purchases, calculated when a contract closes, dropped to a 5.66 million annual rate, the National Association of Realtors said.

New-home sales are considered a more timely barometer of the market than purchases of previously owned homes, which account for about 90 percent of the housing market.

Housing Slump

Other data show the market is starting to stumble. Housing starts in May declined by the most since March 2009, and building permits, a sign of future construction, fell to a one- year low, data from the Commerce Department showed. The National Association of Home Builders/Wells Fargo confidence index for June fell by the most since November 2008.

The number of mortgage applications filed to purchase houses dropped this month to the lowest level since 1997, according to data from the Mortgage Bankers Association.

The Standard & Poor’s Supercomposite Homebuilder Index, which includes Toll Brothers Inc. and Lennar Corp., has dropped 28 percent since reaching a 19-month high on May 3. The broader S&P 500 Index is down 10 percent from April 23’s 19-month peak.

Builders are also concerned that the Gulf oil spill and European debt crisis are hurting buyer confidence. Toll, the largest U.S. luxury homebuilder, said deposits have been running 20 percent behind the year-earlier period the past three weeks.

Consumer Outlook

“Concerns about the financial crisis in Europe and escalating regional political tensions, coupled with worries about the oil spill in the Gulf of Mexico and its effects on the economy and the environment have negatively impacted the outlook of American consumers,” Joel H. Rassman, chief financial officer at Horsham, Pennsylvania-based Toll, said in a June 16 statement.

Hovnanian Enterprises Inc., the largest homebuilder in New Jersey, said orders fell 17 percent in the quarter ended April 30 from a year earlier, and contract signings slowed in May, indicating the tax credit helped pull some sales forward.

This startling announcement could have huge implications on your taxes

Yesterday in the UK, something happened that has significant implications for us all.

Old western economies are clearly losing their dominance. Particularly in Europe, the costs of broken pension plans and entitlement programs are bankrupting entire economies.

Yet, national governments continue to perversely borrow and consume; politicians have been acting like degenerate gamblers, borrowing money from anyone they could, blowing it all on terrible bets, borrowing more money to make even worse bets, and actually expecting different results.

Something needs to change... and it appears that Britain is the first major western government to face the music. As such, British Chancellor of the Exchequer George Osborne unveiled yesterday what has been touted as 'emergency' budget austerity.

Osborne's budget cuts deep. It hits the elderly, it hits low income workers, it hits single mothers, it hits business owners and investors... it even hits the Queen, who will see her multimillion pound salary frozen for several years.

To give credit where credit is due, Osborne should be commended for looking his nation in the face, speaking about a very grim reality, and being candid about the tough sacrifices that everyone will have to make.

But here's the scary part, and what we need to learn from:

While there was significant talk in Osborne's speech about spending cuts, most line items have yet to be fully determined. What they are absolutely clear about, though, are the tax changes.

Britain's VAT, for example, will increase from 17.5% to 20%. Many personal income tax rates will rise as well, particularly for high income earners. These changes will be phased in gradually... except for one.

Osborne announced that Britain's capital gains tax will increase from 18% to 28% for higher income earners. Yet unlike the other changes which are phased in over time, capital gains tax change occurs IMMEDIATELY.

There is a serious lesson here: governments have the power and willingness to make major changes overnight. With the stroke of a pen, they can impose capital controls, higher taxes, gold forfeiture, confiscation of retirement savings, or anything else they can dream up.

Britain's emergency budget underscores this point even more, and reminds those of us who aren't in the UK that we need to prepare NOW. Why? Because other countries won't be far behind, including the United States.

At a certain point, President Obama will be forced by circumstance to look the American people in the eye and ask them to sacrifice... and pay higher taxes effective immediately.

Also, it's likely that the US government will get its hands on private retirement savings some day soon... there's about $5 trillion out there, and at some point that they'll mandate a portion of all managed retirement accounts to be held in the 'safety' of US Treasuries.

I can't stress this enough-- proper financial planning should be an integral part of your multiple flag strategy.

To protect yourself from overnight tax hikes, this means using existing, legitimate tax shelters. US tax code, for example, provides a means for people to set aside tax-deferred savings for retirement through an IRA or 401(k).

Most of these entities, though, are unfortunately engineered to generate profits for the financial institution who manages the account, rather than the individual who is busting his butt every day to save for retirement.

The best solution that protects your savings from rising tax rates and government confiscation is to hold your investments in an Open Opportunity IRA structure.

Similar to a regular IRA, an Open Opportunity IRA allows you to generate tax-deferred (or tax-free) returns on your savings. Unlike a regular IRA, this structure gives you complete control and flexibility to do what you want with your retirement savings-- like planting multiple flags overseas.

With an Open Opportunity IRA structure, you can buy foreign property, store gold overseas, establish an offshore bank account... as well as invest in all the other instruments that you might already be investing in right now with your retirements savings.

The big difference? It's nearly impossible for the government to get their hands on it. And if you start investing through this tax deferred structure, you won't wake up one morning to higher tax rates that will pummel your investment returns... which is exactly what happened in the UK this morning.

This is one of the biggest no-brainers for US taxpayers... even if you're just starting out, establishing one of these structures provides a long-term solution to generate tax-deferred or tax-free savings as you make contributions over time.

Terry Coxon is a leading expert in this industry; he's authored numerous books on tax and personal finance issues, and his latest e-book is one that you should absolutely own.

In Unleash Your IRA, Terry explains the real magic behind these structures-- how to set one up, how to protect yourself and your assets, and all the amazing things you can do while still following the tax rules.

I strongly urge you to take action now... continuing to kick the can down the road is a very dangerous course of action given all the warning signs around us.

Former Fed chief Alan Greenspan: U.S. debt crisis coming soon

The aging economist argued recently that the US is about to run out of its ability to raise debt at low rates to finance its growing deficits.

His disagrees with most economists who worry about the effects of the US debt in a few years, but believe that very low borrowing costs will help American fund its government spending in the meantime.

Why the world's best investors own a small group of gov't-backed banks

Anyone who doubts the big banks will succeed in the new regulatory environment by quickly jumping into bed with government is already wrong. To secure its place in the Treasury-financial complex, Bank of America has come out in full support of Komrade Obama's sweeping overhaul of financial services regulation. As Bloomberg put it, "The Obama administration has found a banker it can do business with: Bank of America Corp.'s Brian Moynihan."

Moynihan, Bank of America's CEO, has wined and dined the likes of Treasury Secretary Tim Geithner and economic advisor Lawrence Summers. He's in. He's one of them now. And Bank of America will remain competitive because of it.

Jamie Dimon, CEO of JPMorgan Chase, is coming around, too. Back in June 2009, Dimon warned in a Wall Street Journal op-ed piece about "the danger of the pendulum swinging too far," meaning too much government intervention in the economy. A month ago in a Chicago speech, according to Bloomberg, Dimon expressed support for 80% of the overhaul plan. Goldman Sachs has already settled with the SEC in the mortgage trading scandal. Big bankers make big money not in spite of the government, but with its substantial assistance. Whether they admit it or not, government support is one of the most important reasons investors like John Paulson and Bruce Berkowitz own stocks like Bank of America, Goldman Sachs, and Citigroup.

Steve Sjuggerud: It's time to be fearful of stocks

"Be fearful when others are greedy, and be greedy when others are fearful."

– Legendary investor Warren Buffett, one of the world's richest men

Now, my friend, is a time to be fearful.

It is the opposite of a year ago. Back then, it was time to be greedy – and we were...

Almost exactly a year ago in DailyWealth, I wrote an extremely bullish story, called "The Great Rally Before the Great Inflation."

At that time, investors were downright scared. But I said stocks would have one of the greatest bull runs in history. What I wrote turned out to be exactly right. But today, things have changed...

Goldman scandal: Firm may have known about charges for 9 months

Goldman Sachs Group Inc (NYSE: GS) was warned about pending charges against it as early as nine months before the SEC charges were brought.

SEC rules apparently do not require a public company to disclose the receipt of a Wells Notice from the agency. The notice is an indication that charges will be filed and a chance for the firm in question to make an argument for why it should not be.

The Most Important U.S. Oil Discovery in 40 Years

"They've ringed fenced me," Cactus said.

I am not an oil and gas analyst.

I know very little – nothing, really – about the engineering or the geology of hydrocarbon discovery and extraction. Fortunately, my good friend Cactus Schroeder has been discovering oilfields and pumping them dry for more than 30 years. His father was a wildcat Texas oilman, too. If I didn't know better, I'd wager the liquid in Cactus' veins was light crude instead of blood.

I recently spent the better part of a week with Cactus, fishing for giant blue and black marlin off the coast of the Darien jungle in Panama. With very little else to do on the boat (neither of us caught a big marlin), we had plenty of time to talk. And Cactus had a lot to say – far more than usual…

He told me he has found what he expects will be the largest oil discovery of his entire career. It lies in the middle of a huge new oil and gas discovery called Eagle Ford. It is a field so large, Cactus says he believes it will become the largest oilfield in the history of the United States.

Still… I had no idea what a "ringed fence" was. Or why it mattered. Cactus explained:

They've been drilling all around my land – on all sides. And every well they drill is a well I don't have to drill to prove the value of my land. I've got working rigs surrounding my property now. And they're producing a lot more than just gas. They're full of condensate…

Slowly, over four or five days, I came to understand what Cactus was talking about and why it is so important. You need to understand one critical thing about the Eagle Ford play in South Texas: It holds liquid hydrocarbons, not just gas. And there's a lot of liquid in it, not just a little.

So-called "condensate" is the holy grail of the natural gas business. It refers to the amount of liquid (think butane) that's mixed in with the gas that's trapped in "tight" shales.

Shale gas plays have been the driving force in the onshore oil and gas business for the last decade. You might even have heard of some of the big fields by now: Barnett, Fayetteville, Haynesville, and Marcellus.

Shale plays are big, rich resources… but they normally hold only a little condensate. Eagle Ford is proving to be a notable exception – it is rich in condensate. More information about the size of the field and the volumes of condensate and gas is coming out almost every day now, and the numbers get better and better. A year ago, only a dozen drilling rigs were working across the entire play, which stretches across more than 30 counties. Today, more than 50 rigs are drilling well after well.

Judging by the pace of the drilling and the production rates of each new well, these 50 drilling rigs should allow production to grow to nearly 40,000 barrels of oil per day within the next 24 months. That's roughly $1 billion worth of oil per year at current prices.

Keep in mind… this is just from the handful of rigs working Eagle Ford in 2009. Those estimates don't include the value of the gas that will also be produced. And those estimates don't take into account the hundreds of additional rigs that will be put to work. Oil production is going to ramp up quickly.

I expect Eagle Ford to yield more than $2 billion in oil and gas by 2013 and to increase steadily for at least 20 years. These numbers mean Eagle Ford will probably produce hundreds of billions worth of oil and gas over the next 30-40 years.

I know these numbers must sound like pie in the sky. After all, U.S. oil production fell every year from 1991 until 2009. The decline led some pretty smart folks to declare we'd reached "peak oil." They believed onshore oil production would continue to decline until there was literally no oil left. I never believed any of that nonsense. I knew eventually prices would rise enough to support the development of new technologies for finding more oil and extracting it more efficiently. Not surprisingly, that's exactly what has happened.

New seismic technologies allowed prospectors to find liquid hydrocarbons in shales, even though the plays are deep and narrow – 12,000 feet down and usually only a few hundred feet thick. To efficiently drill these finds requires so-called "horizontal drilling," where rigs first must bore down to the oilfield and then veer sideways through it. The combination of these new technologies is releasing huge amounts of liquid hydrocarbons in the Eagle Ford.

Consider just one company's recent results. On April 7, EOG Resources announced drilling results from 16 test wells drilled across a 120-mile trend. Yes, that's right – a 120-mile trend. Based on the initial results and a core analysis, EOG believes it will produce 900 million barrels of crude from these wells over the next decade.

Mark Papa, EOG's CEO, says of the discovery: "We believe the South Texas Eagle Ford horizontal crude oil play will prove to one of the most significant United States oil discoveries in the past 40 years."

After talking to Cactus, I think he's right. And in tomorrow's essay, I'm going to show you how such a large oilfield went untapped for decades… exactly how big it is… and a list of publicly traded companies involved in the Eagle Ford.

Protecting Your Wealth from Your Government

At DailyWealth, our major focus is on helping you grow your wealth as quickly and safely as possible…

For ideas on how to protect your wealth once you have it, I don't know anyone better than asset-protection attorney Joel Nagel.

I've known Joel for a long time. He's one of the nicest guys in the business… and he's spent over a decade helping some of the world's richest people protect their wealth from disasters.

As I mentioned yesterday, we're in a crazy situation right now in America. Instead of making the future brighter for our children, the government is making things worse.

That's why my publisher, Stansberry Research, recently held a private conference call with Joel… and he shared some great ideas. Given the problems I've written about recently, I wanted to share some of them with you today…

Stansberry Research: Joel, could you give us an overview of what you recommend folks do to protect themselves from the things we see happening in the next few years… whether they have $5 million in the bank or $50,000?

Joel: It really does come down to the level of financial wherewithal a person has and what they're trying to protect. The strategies are very different for somebody who has, say, $50,000 that they want to protect as opposed to somebody who has millions of dollars.

We advise our clients to consider opening up a foreign bank account based outside the United States. This will give you the ability to open CDs in foreign currencies. It'll provide you with insurance should something happen to the dollar or the U.S. banking system. And as you mentioned, in the event of future currency controls, you'll already have a nest egg outside the United States from which to operate.

Secondly, along the same lines, foreign currencies – most of our clients look to have some portion of their net worth held outside the U.S. dollar. And again, you don't have to be a millionaire to hold an account with some Swiss francs, New Zealand dollars, Canadian dollars, Australian dollars…

There are plenty of currencies that aren't based on the huge debt model the U.S. dollar has taken on, and therefore aren't as susceptible to the kinds of crashes the U.S. dollar is going to face.

Stansberry Research: How about gold and other precious metals?

Joel: You don't have to be that wealthy to consider owning precious metals. We recommend clients hold at least 10% of their net worth in gold, silver, platinum, palladium. And the precious metals should be located outside the United States.

Along with metals, physical metals, you have metal certificates, often referred to as "foldable gold" that you can quickly and easily move from one location to another and redeem either for physical metal or for cash later.

Stansberry Research: How about another idea?

Joel: Foreign real estate rounds out the bottom category – again, having not only foreign real estate as an investment, but also as a physical safe haven where you can go not only for vacation, retirement, or any other reason that you wish to leave the United States.

Steve here again… Joel outlined several easy steps you can take to safeguard your wealth. It doesn't take millions in the bank to make it worthwhile. So even though you might not have considered these before, you ought to now. 

George Soros: U.S. is creating a massive new bubble

At an event hosted by The Economist magazine last night, George Soros warned investors that the methods used to resolve the 2008 financial crisis are no different than the methods that helped cause the crisis to begin with. Soros says we are blowing inevitable bubbles that will have similar dire results:

“The success in bailing out the system on the previous occasion led to a superbubble, except that in 2008 we used the same methods….Unless we learn the lessons..."

The Potential Death of the American Dream

When I was a kid, the world was my oyster…

Some days, my buddies and I would go exploring in the woods. Other days, we'd play wiffle ball in Wade Welch's yard… or we'd play "kill the man with the ball" in Mike Bruner's yard.

I always had a secret mission, though: I was going to be a "pro" at something. Fortunately, I had the work ethic to get there…

When I wanted to be a pro basketball player, I'd shoot baskets in the driveway until late at night. And when I wanted to be a professional musician, I'd practice for hours a day… in the garage… in Florida. I didn't mind sweating in the garage, I didn't even think about it. Remember, I was on a mission.

The problem was, my mission changed about every year. But this fact never changed: I believed I could succeed at whatever I wanted if I tried hard enough.

I had no burdens in front of me… I had no impediments to my potential success. If I put my mind to it, I could make it happen. And thankfully, succeed I did. I'm living proof of the American dream –the idea that you could set out to make your own success and achieve it.

Today? I'm not so sure about things.

When I was a kid, we didn't have money. But that was OK. We were starting from scratch.

Unfortunately, my son will not even have the "luxury" of starting from scratch. Instead, he will start out in the hole…

According to public awareness firm the Peterson Foundation, the government's debt was $184,000 per person in 2008. For my little family of four, that's $736,000 of government debt. And it keeps growing.

By the time my son grows up, the federal government will have already "mortgaged" his household earnings by hundreds of thousands of dollars, by spending more than it takes in before he was born. Even worse, the government will force him (with the threat of jail time) to pay its debt.

Instead of improving the outlook for my son, the federal government is making the situation much worse… Consider these facts:

For 2009's taxes, 47% of tax filers will pay $0, according to the Tax Policy Center, a Washington think tank. This is an alarming trend. As recently as the 1980s, just 10%-15% of Americans had no tax bill. And in 2000, around 22% paid no taxes, according to www.taxfoundation.org.

To say it another way, a family of four with a household income of $50,000 will have a federal income tax bill of $0… Actually it will receive a "refundable tax credit" –a check from the government! A full 40% of tax filers will receive a check.

It astounds me that nearly half of the tax-filing population will have the benefit of government services… and pay none of the costs.

I hope my son has the ability, like I did, to start with a clean slate… with the world as his oyster… with no shackles holding him back… so he can be successful.

But I shouldn't hold out hope.

We're facing the potential death of the American Dream –the thought that if you work hard and try hard, you can be as successful as you want.

We're quickly replacing the American Dream with the European Politician's Dream –that if you're lazy and don't try hard, the government will take from those who do try hard and give their money to you. That is not the America I was raised in. And that's not the America I want to live in.

So what can we do?

We can protect ourselves from the government taking more from us in future taxes. One of the best ways for most people right now is to convert your traditional IRA to a Roth IRA. I'm doing this now.

The other things I will do are: 1) hold my politicians accountable for their actions and 2) give my son the tools to succeed… an education and a work ethic. That way he is best equipped to succeed in whatever world he inherits. 

How to Protect Yourself from a Bank Run

An elderly woman was panicking…

"It's my life savings we're talking about, my pension. I'll have nothing left if they go under," she said.

A rich couple nearby was panicking, too. They weren't just sobbing like the old lady, though. They had nearly $2 million in the bank. This was the fruit of a life's work… and they were about to lose it all. They'd barricaded a bank manager in his office and were threatening him.

Can you imagine how you would feel with your life savings trapped inside a bank… with hundreds of people in line ahead of you and the police telling you to go home?

In September 2007, Britain's eighth-largest bank, Northern Rock, announced to the public that it was running out of cash and would have problems honoring customers' deposits. A run on the bank developed. Lines formed at bank branches all over the country. Violence broke out in some instances. The police were called. Branches were suddenly closed down. Few people were able to get their money…

Fortunately for the Northern Rock depositors, the British government guaranteed all Northern Rock's deposits… and the panic dissipated after a few hours. No one lost money.

As I reported earlier this month, thousands of banks in America are going to fail over the next three years. Most Americans believe the U.S. government is safely insuring their bank deposits. But it's impossible to predict what havoc this wave of bank failures will create. Although it seems unlikely right now, some depositors could lose their savings and we could even see bank runs again…

The FDIC is the institution in charge of protecting bank deposits. The FDIC is supposed to maintain a pool of funds to insure America's banking deposits. This pool is empty. In fact, according to the FDIC's latest report, the pool had sunk to a negative $21 billion as at the end of 2009. Forty-one banks have collapsed so far this year, so the deficit must now be nearing $25 billion.

The head of the FDIC, Sheila Bair, has said the FDIC's insolvency is possible and she's assessed a one-time fee on every bank the FDIC insures in an attempt to cover the deficit. For some small banks, this onetime fee could consume an entire year's profits. Paradoxically, this fee could end up causing even more bank collapses.

So what can you do to protect yourself?

First, get as much money as you are comfortable with out of the banking system. I only keep a few thousand dollars in the bank, for convenience. I keep the rest of my savings in Treasury bills. T-bills are the safest financial instruments in the world. They don't pay any interest, but neither does your bank, so you don't have anything to lose by investing in T-bills. To buy T-bills direct, go to www.treasurydirect.gov and open an account with the Treasury.

Second, keep a stash of physical cash. Make sure you secure it from fire and theft. I recommend you store at least three months of living expenses. I count gold and silver as cash, too. At the least, you should own a small bag of silver coins. You can trade these in small denominations if you need cash. Asset Strategies International offers the most competitive prices I've found on bags of silver coins. Three, if you already have deposits in a troubled bank, don't panic. Remove your money and deposit it in a safer bank. If withdrawing your funds will incur a fee, wait for your deposits to mature and then withdraw your money.

Finally, if you must hold significant sums of money on deposit in the banking system, choose only the safest banks. How do you judge which banks are safe and which are risky? They're quite easy to spot. Did your bank expand aggressively from 2002 through 2007? Did it offer higher than average CD yields? Did it expand its loan portfolios aggressively? Is it based in South Florida, Atlanta, Las Vegas, Southern California?

If you answered yes to any of these questions, there's a good chance your bank has taken some big risks. It's probably not safe.

Is your bank trying to participate in the FDIC's auction process? If so, then it's a safe bank. The FDIC only allows well-capitalized banks to participate in its auctions.

In America's modern economy, the idea you could lose your money in a bank failure seems farfetched. The fact is, thousands of banks are about to fail and the FDIC's deposit insurance fund is showing a deficit. Besides, banks pay almost no interest right now, so apart from the convenience of a small checking account balance, what's the point in keeping your money in the banking system? There isn't one.