Tuesday's Top 10 with NZ Mint: ABACUS blows up in Goldman's face; What China's slowdown really means; The Libor caper; Gold's political edge; Dilbert

Here's my Top 10 links from around the Internet at 10 to 4pm in association with NZ Mint.

I'll pop the extras into the comment stream. See all previous Top 10s here.

I welcome your additions in the comments below or via email to bernard.hickey@interest.co.nz.

I could do with a few more pieces of low hanging fruit...

1. What China's inflation problems might mean for us - The New York Times has a useful piece explaining what China's efforts to reduce its high inflation rate might mean for the global economy.

That means us in a very direct way now that China is the second largest buyer of our exports and the biggest buyer of exports from Australia, which is the largest buyer of our exports.

The issue is particularly acute for us because much of the steel and concrete manufactured to fuel China's infrastructure boom is made from Australia's iron ore, coal and natural gas.

Any slowdown in consumer demand would also affect us directly, given demand for our protein comes from Chinese consumers.

Again, all this is well worth watching in New Zealand. Remember, we don't have a single foreign correspondent there. Yet we have 'em aplenty in London, New York, Sydney and Los Angeles. We'll get great coverage of the Royal Wedding. Not so much on the next 5 year plan from the central committee.

We're doing our best to cover China from afar via interest.co.nz.

Here's the NY Times on the issue.

“China is moving into a new era, a new norm,” said Dong Tao, an economist at Credit Suisse in Hong Kong. “In the previous decade, inflation was about 1.8 percent a year; in the next decade, it may be closer to 5 percent.”

The implications of such a shift are huge, not just for domestic consumers but perhaps even more so for exports. As wages and production costs rise, coastal factories are demanding higher prices for the goods they ship overseas. That means Americans, Europeans and other buyers will have to pay more for those goods or seek lower-cost suppliers elsewhere. In some cases, retailers are bidding for goods at prices the exporters consider too low.

“I hear that many Chinese exporters are rejecting orders from Wal-Mart and other Western retailers,” Mr. Tao said. “I’ve been covering the Chinese economy for a long time, and I’ve never heard that before.”

Many analysts say the government is going to have to do even more to slow the economy, through measures like placing additional restrictions on lending and continuing to raise interest rates, the textbook methods of fighting inflation by tightening the nation’s money supply.

2. Goldman charged with fraud - The Securities and Exchange Commission has charged Goldman Sachs with fraud by misleading investors about toxic mortgage bonds.

Here's the SEC release with these details:

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement. "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

3. Is the People's Bank of China solvent? - Gordon Chang asks this question over at Forbes. He makes a lot of sense.

On Thursday, the People’s Bank of China, the country’s central bank, announced that at the end of March it was holding $3.04 trillion in foreign currency reserves, up a spectacular 24.4% over the last 12 months. No other nation comes close to possessing as large a pile of foreign cash.  Japan, in second place, has about $1.12 trillion.

Thursday’s announcement makes the PBOC, as the People’s Bank is known, appear strong.  Yet the institution is in urgent need of recapitalization.  It is, in all probability, insolvent.  In fact, what makes it look mighty—its mountain of dollars, euros, and yen—is creating its weakness.

How can that be?  The PBOC, to build its reserves, buys foreign exchange entering China.  These purchases are largely financed with the issuance of bills denominated in, of course, renminbi, the local currency.

The purchases create two problems for the central bank.  First, the institution is buying depreciating assets—especially dollars—with an appreciating renminbi.  For instance, the renminbi increased 1.1% against the greenback since the end of last year and 4.5% since the end of 2009.  As the People’s Bank buys ever-greater amounts of foreign cash, its balance sheet necessarily weakens.

Second, Beijing has been forced to raise interest rates to combat now-out-of-control inflation.  For instance, on the 5th of this month the central bank upped the rates for the second time this year and the fourth time in six months.  Every time it pushes rates higher it increases its funding costs for its obligations issued to acquire foreign currency.

4. Politics of a gold standard - Jim Grant from Grant's Interest Rate Observer calls a spade a money printer in this piece courtesy of Zerohedge.

Grant sees inflation getting out of control:

"The Fed is unconscionably complacent about the consequences of what it is doing, and let us not blink at what it is doing: it has imposed the lowest money market interest rates anyone remembers, it has expanded its balance sheet into something grotesque all in the space of a couple of years. These are monetary events that have never before been seen, and indeed, never before imagined...The Fed's policies are certainly great for one class of society: the speculative classes.... We have socialized risk, we have privatized gains, much to the relief of Greenwich, CT where our zillionaires live, and the unconscionable and indefensible fallout of this is that savers get zero on their savings balances, and the speculative classes get to borrow in wholesale markets at zero and get to make their zillions all over again... The Chairman is whistling by the graveyard in this manner of 2% inflation rate being harmless."

On Grant's expectations for inflation rates: "there will be a lot of suddenly - 4 or 5% let us say...So much of our speculative apparatus is powered on these zero percent interest rates... Think how hard it is to hold back a cash reserve in this economy... Your stupid neighbor who is watching this program is making a lot of money in the stock market: how hard is it not to participate? You can't do it..."

"But 4% inflation would mean that the party is over... Everything would fall out of bed... Gold and silver would right themselves, because they are money that would come into their own at the end of the cycle of disillusionment but for a time there would be terrific chaos in investment markets."

As for the gold standard: "If I am right about the dynamics of the Federal debt, not only is the mathematics for a gold standard compelling but so are the politics."

5. No worries - It's just hysteria. US economist and author Clyde Prestowitz tells Radio Live's Andrew Patterson on Sunday Business that America doesn't have a problem with debt or its budget deficit. People are still buying Treasuries and the US dollar. Don't worry -- be happy, he says

On the face of it, he's right. Amazingly, after Standard and Poor's threatened to downgrade America overnight, US Treasury prices rose and yields fell.

However, Prestowitz does see the need for the United States to give up its 'cocaine' of the US dollar being reserve currency. He also points out the Chinese are also addicted to the 'cocaine' of US over-consumption and over-borrowing.

He's also right: when will the bond vigilantes actually wake up? Or will foreign central banks of surplus countries have no choice but to buy US Treasuries while they run surpluses.

6. Two tiered justice system - Glenn Greenwald writes at Salon about America's two tiered justice system. The indictment against Goldman referred to above is only a civil one, not a criminal one.

The evidence of rampant criminality that led to the 2008 financial crisis is overwhelming, but perhaps the clearest and most compelling such evidence comes from long-time Wall-Street-servant Alan Greenspan; even he was forced to acknowledge that much of the precipitating conduct was "certainly illegal and clearly criminal" and that "a lot of that stuff was just plain fraud."

Despite that clarity and abundance of the evidence proving pervasive criminality, it's entirely unsurprising that there have been no real criminal investigations or prosecutions. That's because the overarching "principle" of our justice system is that criminal prosecutions are only for ordinary rabble, not for those who are most politically and financially empowered. We have thus created precisely the two-tiered justice system against which the Founders most stridently warned and which contemporary legal scholars all agree is the hallmark of a lawless political culture.

7. Where US house prices are headed - Robert Shiller is America's foremost statistician on house prices and was vocal in predicting the bursting of the US housing bubble that caused the Global Financial Crisis.

Here's his chart of US house prices going back to 1890 with a prediction at the end by Barry Ritholz from The Big Picture.

8. How China really works - John Garnaut writes for the Sydney Morning Herald from Beijing and often has some interesting insights into how the middle kingdom really operates, particularly as it tries to take the heat out of inflation and slow the economy.

Only in the past fortnight has the campaign against inflation become a big political project. "The [tightening] trend will continue for some time," said People's Bank of China governor Zhou Xiaochuan, adding that there was no "absolute" limit to how high reserve requirements could go.

Typically, this political phase of the monetary policy cycle is accompanied by a steep rise in corruption prosecutions, as officials reach for non-conventional levers to control activity.

The Propaganda Department has already begun a campaign to talk down the real estate market and publicly threaten non-compliant officials. And the industry associations have been mobilised into displaying their price-fixing chastity.

9. The great Libor caper - Bloomberg reports Bank of America, JP Morgan Chase, Barclays, Citigroup and HSBC are being accused by three European fund managers of deliberately manipulating the Libor (London Interbank Offer Rate) to avoid having to pay high interest rates. Mais non...

The banks sold Libor-based futures, options, swaps and derivative instruments “at artificial prices that defendants caused,” harming investors, FTC Capital GmbH of Vienna, FTC Futures Fund SICAV of Luxembourg and FTC Futures Fund PCC Ltd. of Gibraltar said in an April 15 complaint in New York federal court.

From 2006 to 2009, the banks “collectively agreed to artificially suppress the Libor rate,” and in early 2008, “during the most significant financial crisis since the Great Depression,” the rate remained steady when it “should have increased significantly,” the funds contend.

10. Totally How To Be a Media Pundit - I follow all these rules...