Wealth International, Limited

Finance Digest for Week of February 9, 2004


On my desk sits a best-selling book that warns of an impending financial catastrophe. Its authors fear that that banks, insurance companies, and even governments are on the edge of insolvency. They argue that for the past decade debt has grown faster than income and has now reached record levels as a percentage of GDP. House prices -- which are currently are record levels -- are set to collapse. Homeowners will be forced to rein in their spending. Following a period of excessive corporate investment, asset price inflation, and credit-fuelled prosperity, deflation is about to stalk the world. Central bankers will be unable to halt this process.

If you are of an excitable temperament you may feel inclined to follow the advice contained in the last chapter of this book. Sell your house, pay off your debts, and build up a pile of cash in order to buy assets which, during the forthcoming crisis, will come to the market at fire-sale prices. However, before you take such rash actions I should tell you that every prediction of these authors will turn out to be false. I write this with complete confidence. Why? Because the book I am referring to, The Great Reckoning by William Rees-Mogg and James Davidson, was published some 13 years ago.

I also have on my desk a more recently published tome of doom and gloom. The Financial Reckoning Day by William Bonner with Addison Wiggin contains an analysis not entirely dissimilar to the similarly titled Rees-Mogg/Davidson effort. Bonner observes that US economic growth in recent years has been driven by credit expansion (roughly $6 of new debt for ever $1 of incremental GDP), etc., etc. I do not know whether Bonner’s predictions will turn out to be as wide of the mark as Rees-Mogg’s. In fact, I do not really disagree with them. Sound economic analysis should recognize the possibility of a variety of outcomes in a world that is both uncertain and imperfectly understood.

Yet I believe his book and similar works at the beginning of the last decade have not been without consequence. The financial community today remembers with complacency the forecasting errors of the Class of 1991 doomsayers. Having received so many false alarms in the past, nothing short of the emergence of an actual crisis could possibly lead them to change their minds.

Link here.

Five signs of financial reckoning day.

The direction of the stock market is difficult, if not impossible, to predict. All you can really try to determine is how likely a given scenario is to come true. Right now, for instance, the financial, or “fictitious”, economy is most likely running out of steam. What, specifically, do I look at to draw these conclusions? There are five major indicators I use. In deference to Bill Bonner and Addison Wiggin’s book, I jokingly call them the “Five Signs of Financial Reckoning Day”. But I am only half joking. What these indicators DO represent is how close we are to a sudden massive shift away from “financial assets” and into hard assets, or out of the dollar and into gold. In other words, they tell me how likely it is that Financial Reckoning Day is close at hand.

Currently these five indicators lead me to believe that the financial economy is on its last legs. There is only so far the combination of low interest rates, easy credit and tax cuts can propel it... sooner or later, as financial debt swells, these stimuli cease to be effective. That the financial economy will soon run out of steam is not certain. But it is highly likely.

Link here (scroll down to Dan Denning piece).


The American and European economies in particular are beginning to look like ill-matched partners on a see-saw: each blames the other for throwing the world economy out of balance. The European economy is too puny and restrained, say the Americans. The Europeans, for their part, complain that they alone are having to bear the consequences of an American economy that is overindulging itself. They are both right.

Link story here.


Any shift in currencies produces winners and losers. And yet the real problem facing the world economy is not a suddenly weak dollar, but a dollar which remains, even after its recent decline, too strong. The drop in the greenback was inevitable and should benefit both America and other countries, because it will help to reduce America’s vast current-account deficit, which is arguably one of the biggest threats to the global recovery. For the same reason the dollar should, and almost certainly will, fall further. But some countries are not prepared to allow the dollar to fall by enough to complete the necessary adjustment to America’s finances.

America’s current-account deficit stands at 5% of GDP, and most economists reckon that this percentage needs to be reduced by at least half. That would stabilize the ratio of America’s foreign liabilities to GDP, which has surged in recent years. So far the dollar has fallen by 15% in trade-weighted terms against a broad basket of currencies. Nevertheless, after adjusting for inflation, its value is still close to its 30-year average. It may need to fall by another 20% over the next few years if the current-account deficit is to be halved.

Link here.

How Main St. and Wall St. will feel as the dollar plunges.

Washington’s longstanding support for a strong dollar in favor of a weak dollar has been tacitly but unmistakably abandoned. In so doing, the Bush administration has made a calculated economic and political choice. By condoning and even encouraging a cheap dollar, the administration is providing a big push to American exporters by making their products less expensive in foreign markets. That should encourage more hiring and lower unemployment leading up to the election.

But the long-term risks are substantial. At some point, a weaker dollar will inevitably lead to higher prices for imported goods -- almost all consumer electronics bought by Americans, most of their clothing, many of their cars and much of the oil that provides the fuel to drive them. A much bigger risk is that a plunging dollar could contribute to a rise in interest rates, as foreign investors demand fatter risk premiums before agreeing to buy hundreds of billions of dollars worth of Treasury securities to finance America’s high levels of indebtedness.

Link story here.


As China begins to implement its bold tax reform plan this year, a senior government figure has described the radical reforms, designed to stimulate economic investment, as something akin to “Reaganomics”. While the new regime will relieve the tax burden for many domestic firms, taxes are likely to increase for foreign companies who have previously enjoyed a discretionary discount well below the nominal 33% rate that should, in theory, apply across the board.

Link here.


Most overseas funds decline to run the substantial financial and regulatory burden incurred in offering their services to U.S. investors. Most refuse to do business with U.S. citizens, period, because of the scrutiny and expenses that would involve. This does not mean that offshore mutual funds do not have performance numbers worth noting. On the contrary. And, as explained here, an offshore trust or other entity can invest in offshore investment vehicles unavailable to U.S. persons.

Link here.


It would be hard to deny that the American stock exchanges are in bull markets. Last year the NASDAQ was up over 50% while the Dow 30 and S&P 500 had gains of 25% and it seems that everyone is bullish this year. But is the stock market truly showing signs of prosperity, or is it just BS? I would like to suggest the latter and that it might not be a good time for you to obtain a home equity loan to invest in hot tech stocks. We are going through a housing bubble and stock evaluations as measured by stock price-to-earnings ratios are at bubble levels. The buy low, sell high philosophy would lead you to sell stocks now, not buy them.

I am not suggesting that you sell your house or cash in your retirement funds, only that you do not throw caution into the wind and abandon traditional guidelines. At a minimum, investors should take the time to evaluate their assets and portfolio allocations between stocks, bonds, cash, and gold -- between speculation and safety. What is the case for a BS stock market based on?

Link here.


Not knowing much about Moore except that he is rabidly anti-gun (as evidenced in his movie Bowling for Columbine) I approached his new book Dude, Where’s My Country? gingerly. The first half of the book is very worthwhile, and will reaffirm your faith in the fact America is going to hell in a handbasket under the Republicans. The second half will reaffirm your faith in the fact America will go to hell in an even larger-sized container, maybe a stolen shopping cart, should the Democrats get in.

The investment implications of what Moore says? Pretty much what I have been saying, and in my newsletter for several years. The national debt will continue to grow, and investments in areas such as gold and silver shares -- canaries in the coal mine for what’s coming -- will continue to be very profitable whether we have a Republican police state under Bush, or a Democratic socialist people’s republic under Kerry, Dean, Sharpton, Oprah or whomever.

Link here.


The UK will soon have tax-efficient property investment trusts if the Chancellor of the Exchequer Gordon Brown follows through on industry expectations and announces the new measures in next month’s budget. Should they be modeled on the American Real Estate Investment Trusts, or REITS, then the property trusts will not be charged tax on their income if a high proportion (typically 50% to 60%) of their earnings is distributed to investors. According to the investment bank Morgan Stanley, the UK’s property stocks have already seen a significant boost due to speculation that REITS are about to be introduced.

Link here.


The pact will eliminate duties on more than 99% of US manufacturing exports to Australia, and 97% of Australian exports to the United States. The Australian IT industry expressed concern with regard to several clauses relating to intellectual property protection contained within the pact. Among the points which have raised concern are the extension of copyright, and the alignment of the Australian IP protection regime with the controversial US Digital Millenium Copyright Act (DMCA).

Chief executive of the Internet Industry Association, Peter Coroneos suggested that the DMCA “is not necessarily a role model for the rest of the world,” observing that: “It has resulted in a lot of litigation, with disclosures of customer information in some cases where people subsequently turned out not to be infringers. We would have concerns about using a system that took away from us the right to manage these issues at an industry level through codes of practice.”

Link here.


The Zero Down-Payment Act of 2004

A new bill was introduced in Congress. “The Zero Down-Payment Act of 2004” would allow the Federal Housing Administration (FHA) to offer a zero-down-payment product for first-time home buyers. 150,000 people who otherwise would not meet current FHA standards would qualify for this type of zero-down-payment mortgage. The legislation will only make taller the mountain of debt consumers are sitting on. But instead of encouraging people to save, the government is making it easier for the public to go deeper into debt. In a debt-driven economy, credit expansion trumps all.

Ironically, in an adjacent article CNN Money says that mortgage defaults are rising: “The market for foreclosed homes has grown in many parts of the country in recent years, thanks to unemployment and less stringent lending practices.” One must ask: Given the uncertainty of job growth, record-high levels of consumer debt, increasing number of mortgage defaults, and pages of other “shaky” economic data, is this the time to relax lending rules even more than they already are?

Last week, a Barron’s article observed a recent brokerage firm’s recommendation that “the housing sector’s potential for appreciation was infinite.” And yes, the story adds, the recommendation was “dead serious.” The same article also displayed a chart showing the highest level of unsold houses -- 380,000 -- in at least 10 years. The author’s suspicion that “the end may truly be nigh” is inspired by the fact that “virtually no one agrees” with his observations. Extreme bullish sentiment is one signal of a market peak. Another one: In recent months, even as the Dow was gaining 1000 points, the homebuilders, a big focal point of the rally of 2003, were running sideways.

Link here.


Bankers, especially those of us in community banks, are guardians of community financial vitality and gatekeepers of individual economic opportunities. We bankers decide who deserves credit and who does not. When we perform this credit rationing function well we fulfill a social good by apportioning scarce credit to those individuals and enterprises which put it to best use. Sound credit decisions result in fewer failures and more successes. Our communities are more likely to thrive when we bankers do our jobs well.

This loan making function, so central to the essence of community banking, has been transformed during recent years. Especially so during the ebullient late 1990’s. The new leniency in credit granting was in keeping with the times, of course. Recall how behavioral standards were stretched and then shattered in government entities, corporations, professional accounting firms, investment advisory businesses and in banks.

During the economic run-up and soaring stock markets of the late 90’s we behaved as though we could spend without compunction and invest without caution. We knew we were in a “New Economy” which no longer respected time honored standards of business practice. New thinking, if it could honestly be called thinking, required us to modify our standards to fit our expectations. We knew the stock markets “always go up in the long run”. Our expectations were soaring. Little did we realize we were replicating behaviors common in earlier periods of economic and market history. These were periods when herd thinking prevailed and they are generally referred to as “manias”. That is, when collective human emotion obliterates rational thinking.

We bankers are sitting on a mountain of consumer debt precariously supported by bubble induced real estate values. This mountain may well crumble during the ensuing declines in the stock markets and the economy. It perplexes me that so few bankers learn so little from history. It is as though collective manias have not previously occurred because we act as though we know so little about them.

Link here.


Last week, a Russian industrialist named Viktor Vekselberg arranged to purchase the entire Faberge collection that was accumulated over many decades by the late Malcolm Forbes. The purchase price was in excess of $90 million in a transaction arranged through Sotheby’s and in lieu of public auction. The new owner plans to exhibit the historic pieces in the city of Yekaterinburg, where members of the Romanov dynasty were executed by the Bolsheviks in 1918.

Thus do the Czars’ Faberge eggs travel full circle. Sold off to foreign interests by the Communists and what few members of the Romanov dynasty who survived, these articles are now returning home, courtesy of a contemporary Russian tycoon. This process also reflects key issues of life under the United States “Dollar-Standard”, an era that was ushered in on August 15, 1971, when President Richard Nixon commenced America’s modern monetary experiment with a purely fiat currency.

Since then debt levels at every level of the U.S. economy -- federal, state, local, business and consumer -- have skyrocketed to fund aggregate national consumption. Now portable assets, including Faberge Imperial Easter Eggs acquired over many decades, flow at a single stroke of the pen from weak hands to strong ones. This is a glimpse of the future of an indebted nation.

Link here.


China is touted everywhere as the investment destination of the century. Don’t believe it. My experience tells me that the only people who can really make money in China are the Chinese... or at best those who have real, extensive, on-the-ground experience in the country.

My first journey to China, about ten years ago now, was courtesy of an all-expenses-paid research trip funded by an investment group out of Florida. The outfit wanted me and a gaggle of other editors to give some coverage to the “China” story. Yes, my friends, China was a story ten years ago as well. This was before the Asian Financial Crisis, when Chinese companies were going public in their local markets with the help of some shady Hong Kong business types. Hong Kong, if you were not aware, was born of illicit trade... and it has not changed since birth. It is just cleaner, and you now can say thanks in English before getting ripped off.

If you want to invest in China, be careful and look to experience. It is one of the few countries where I would gladly pay a fund manager a point or two to lead the way.

Link here (scroll down to Karim Rahemtulla piece).


If you are like a lot of investors, you do not sweat the monthly allocations for your 401(k), but when you get a big wad of cash, you panic. Here is some advice. Large sums are mixed blessings for stressed recipients suddenly holding the most money one is likely ever to have in one fell swoop, yet with little time to evaluate the economy and shop among thousands of products. Would it be prudent, then, to just hand the money to a stockbroker and take his advice? Probably not. Even the experts’ experts -- money managers -- seldom have stellar records. According to Morningstar, only one in four domestic equity fund managers beat the S&P 500 over the last ten years.

And here is something else: Even if you find good advice, the price may be such a drag on returns as to render this prudent move almost imprudent. Fees matter: Performance isn’t predictable, but fees are. How, then, to steer through this obstacle course of unreliable human impulses, poor-to-mediocre advice and return-eating fees? Begin by thinking hard about your own needs and how they mesh with what is offered by the sample of providers in the accompanying table.

Link here.


Auric Goldfinger had James Bond tied down while a laser beam advanced toward a tender part of 007’s anatomy. “Do you expect me to talk?” Bond asked as the laser closed in. “No, Mr. Bond,” Goldfinger replied. “I expect you to die.”

In 1964, the year Goldfinger was released, lasers were more lab curiosity than commercial apparatus. You could not make money on them. Since then the devices have found their way out of movie scripts into metal fabricating plants, dentists’ offices, laptops and telephone lines. They can read and write data on those plastic platters known as compact discs. They can do finely detailed cutting work on eyes or metal parts without creating heat. They are making money for a lot of companies.

Link here.


Reading recent articles on fixed-income strategies for 2004, I was struck by how off-base the advice was. The biggest mistake was to treat fixed-income investors as if they were mainly interested in capital gains, not income. Financial writers think such investors panic at the possibility of a rise in interest rates. I find they have a more nuanced view. The value of their portfolio can be damaged by a rise in rates. But the income is not. And future income, from new cash or from reinvestment of interest payments, is helped by a rise in rates.

Typical nonsense from the shortsighted adviser: It is only a matter of time before the Federal Reserve pushes interest rates back up, and that will be a bad thing for fixed-income types. This ignores an important distinction. What the Fed pushes up is short-term rates. But fixed-income investors are more interested in the 10- to 30-year rates. They are worried about inflation, not about the overnight money rate. A Fed tightening of the money supply, aimed at lessening future inflation, will benefit them.

Another piece of bum advice is to avoid high-yield bonds and preferreds because this market is too illiquid. Yes, it is for mutual funds buying in multimillion-dollar increments. Smaller increments are more easily traded, if you need to trade. Then come bond funds. The usual advice is that these are good investment vehicles, since pros manage them and they possess the marketplace heft lacked by small investors. Bond funds do have some virtues. They also have a lot of weaknesses. Take fund fees, which become a real burden when yields drop into the 6% range.

Link here.


We have been reading that virtually every sentiment indicator for the U.S. economy and its stock market is showing optimism far in excess of what happened in early 2000, at the height of the stock market bubble. This euphoria, by the way, is unique to the United States. Apparently, it was the burst in U.S. real GDP growth during the third quarter of 2003, hitting an annual rate of 8.2%, that has played a key role in kindling the new growth euphoria. A forecast of 4-4.5% of real GDP growth in 2004 quickly became the consensus.

It is our long-held opinion that the American practice to annualize many figures confuses many people in the markets. America’s growth performance from quarter to quarter during 2003 reads as follows: 0.35%, 0.8% and 2.05%. There was an economic upturn, for sure, but a very weak one in comparison to the postwar cyclical norm. Far more important, though, is the staying power and the dynamics inherent to the current U.S. economic upturn. In principle, economic growth can have two flagrantly different sources: first, sound fundamentals making for self-sustaining and self-accelerating economic growth; and second, artificial monetary and fiscal stimulus.

To quote economic theorist Joseph A. Schumpeter: “Our analysis leads us to believe that recovery is sound only if it does come from itself. For any revival which is merely due to artificial stimulus leaves part of the work of depression undone and adds, to an undigested remnant of maladjustments, new maladjustments of its own.” In this respect, the sluggish recovery of the past few years clearly has nothing in common with past postwar cyclical recoveries. In those cases, the economy promptly jump-started when the Fed eased. This time, the most aggressive monetary and fiscal pump priming of all time, now in its fourth year, is showing just mediocre economic effects. The familiar self-accelerating recovery remains elusive.

Link here.

Unemployment Rate: True or False?

Last Friday, the Department of Labor (DOL) reported the January unemployment rate at 5.6%, “down from recent highs of 6.3% in June 2003.” Let’s take a closer look at these labor statistics. A New York Times column observed: “Since the recovery officially began in November 2001, [payroll survey] employment has actually fallen by 0.5%, while the working-age population has increased about 2.4%. The only seemingly favorable statistic is the unemployment rate, which has recently fallen to 5.6%... But how is that possible, when employment has grown more slowly than the population, or even declined? The answer is that people aren’t counted as unemployed unless they’re looking for work, and a growing fraction of the population isn’t even looking.”


But let’s not dwell on the DOL’s fuzzy math. The real question is, why, oh why, are companies not hiring if the economy is doing so well? They aren’t hiring because despite the rosy facade of the official reports, deep down something is holding employers back. But what?

Link here.


It is one thing not to learn from your mistakes. But what sort of behavior goes beyond ignoring past mistakes, and almost revels in trying to duplicate the foolishness of others? I pose this question regarding the week’s big business story: the $54 billion attempt by Comcast Corp. to take over/merge with the Walt Disney Company.

Mergers on this scale invariably inspire clichés about “synergy”, “content”, “distribution”, and the like. Read the whole press release and you will probably come across phrases like “shareholder value”. Value? Were Vivendi/Seagram shareholders not promised “value” from the creation of that media giant? That was Dec. 8, 2000, and Vivendi’s share price was around 80. The stock fell as low as 9 in August 2002, and now trades near 22.

Then there is the entire book that someone should write about the creation of the AOL Time-Warner behemoth. Oh wait, someone did: It is titled, Fools Rush In: Steve Case, Jerry Levin, and the Unmaking of AOL Time Warner. Around the time of the merger, share prices traded in the 70s; it fell below 10 in 2002. Call it what you will, from “irrational exuberance” to “bubble psychology”. The more important issue is that you understand the behavior for what it is.

Link here.


Normally, you might sweat off the piles of debt that have been accumulated in the preceding boom, as you might work off a big meal. Recessions and busts are usually what do this, but this last downturn seems to have been mild and its work not yet finished. The current federal debt outstanding according to the Bureau of Public Debt stands at $6.9 trillion. Consumers are no better off, having kept on borrowing and spending through the bust. The ratio of household liabilities to net worth hit an all-time high of 22.6% in the first quarter of 2003 (the most recent data available). Outstanding consumer credit, mortgage debt and other debt hit $9.3 trillion by April 2003: “A lot of people are dangerously close to the edge and any minor setback could push them over,” said Amelia Warren Tygai, co-author of The Two-Income Trap: Why Middle-Class Mothers and Fathers are Going Broke.

Given the large amount of debt outstanding, it is easy to see that creditors are not likely to win any votes in deciding the future monetary policy of the country. Repudiation of debt is the familiar song in history, the favored path used to extinguish debt. It seems likely that it will be no different this time.

With all the debt still saddled on the US, it is an irony that the rising stock market and happy statistics have given most Americans the hope that things have turned and the boom is on. But what sort of prosperity is this? Commenting in the 1930s, Albert Jay Nock wrote, “Reports seem to show the regular pre-election effort to start a boom in the stock market is on. Americans have a strange notion that the ordinary laws of economics do not apply to them. So doubtless they will think they are prosperous if the boom starts, and that deficits and indebtedness are merely signs of how prosperous they are.”

How easily could that paragraph be lifted and put in today’s Wall Street Journal?

The repeated debt repudiations found throughout history led Freeman Tilden to conclude “at least half of all economic history is concerned with the tragi-comedy of governments getting into debt by extravagance and trying to get out by fraud.” Though, he would wisely add, “the other half is concerned with individuals attempting to do the same thing.” The forces that led to these earlier repudiations and swindles are converging now on a debt-laden America.

Link here.


One of the biggest beefs that liberals have against conservatives is that the latter are reflexively pro-business. That is, whatever the business community wants, conservatives will bend over backward to give them. This is untrue for principled conservatives. But, sadly, the Bush administration and the Republican Congress keep giving liberals ample reason to believe that the stereotype is fact.

Principled conservatives believe in the free market. While this may seem to equate with a pro-business viewpoint, in fact it often does not. The last thing most businessmen want is a free market, where they must compete, slash prices, continuously innovate, suffer narrow profit margins, and live constantly on the edge of bankruptcy. They would much rather have assured profits, monopoly positions, price supports, trade protection, and the other trappings of a corporate welfare state. The dichotomy results from the fact that the business community necessarily is made up of existing businesses. By definition, therefore, it does not include those that have yet to be formed. Moreover, the business community is comprised of large businesses with significant political clout and many-times more small businesses that individually have no political influence whatsoever.

Big businesses are much more inclined to support governmental solutions to the problems they face because they have the muscle to get them. Government bailouts and trade protection are seldom, if ever, granted to small businesses, only to big ones with high profiles and many employees. Thus those who expect big businesses to support the free market are constantly betrayed. Those who support the free market and truly want to help consumers often must labor alone and battle big corporate interests. But without some grounding in the intellectual tradition of the conservative movement, it is very easy to assume that the conservative position and the business position are one and the same.

Link story here.


Since President Bush won his campaign to slash the tax rate on dividend income to 15% last year, reports show that a significant number of firms have both increased their dividend payouts and issued “special” one-off payments to shareholders in recent months. According to Standard & Poor’s, a total of 229 companies increased their dividends last year by an average of 26%. Of these, 14 firms actually doubled their dividend payouts, and 33 companies increased their dividends on more than one occasion.

Link here.


Why do investors pay no attention to Greenspan’s warnings about budget deficits? Because they know these warnings are based on archaic theoretical conventions that have recently been well tested and found false. Greenspan described deficits, for example, as making “demands on national savings.” The idea is that government borrowing must be subtracted from an otherwise fixed amount of saving. In reality, recessions cause budget deficits and also shrink the sources of savings (profits and jobs). Savings rates are always lower in the wake of recessions -- 14.7% in 1993, for example, and 14.6% rate of 2002.

Greenspan still claims, “The current account deficit and the federal budget deficit are related.” If we would get rid of the budget deficits, Greenspan and others promised in the early 1990s, then the current account deficits would vanish too. What happened? In 1991, the budget deficit was 4.7% of GDP, but the current account was in surplus. Trade warriors should beware of getting what they ask for: The reason imports fell more than exports was that the U.S. recession was worse than abroad. After that bad start in 1991, twin deficits predictions became worse and worse. Every year the budget deficit grew smaller and smaller, before turning into rising surpluses. Yet the current account deficit grew larger and larger.

The only theory that proved even more bogus than twin deficits was the theory that predicted long-term interest rates must have gone up in 2001-2003 when surpluses turned into deficits. Yet Greenspan’s testimony nonetheless tried to resuscitate this tiresome fraud that someday, somehow budget deficits are finally going to raise interest rates. No sensible bondholder expects “an appreciable backup in long-term interest rates” unless and until Greenspan decides to cause an appreciable backup in short-term interest rates, pushing the fed funds rate 3 or 4 percentage points above the inflation rate. But the last time the Fed did that was in 2000, when the budget was in surplus.

Projected federal spending is indeed a huge threat to future prosperity, particularly the unpayable future promises of Social Security and Medicare. But the essence of that threat -- which Greenspan described very well -- is “debilitating increases in tax rates”. Politicians and their advisors who promise to "fix" some future budget forecast by imposing debilitating tax rates as soon as they can are just threatening to turn a possible future risk into an immediate and debilitating economic infirmity.

Link here.


The cleanup after a storm will generate economic activity and employment, as will the repair of smashed windows; critically, however, the cleaning and repairs will also extinguish development and jobs. This is because the resources used to repair damaged and destroyed property are resources that cannot simultaneously be used to produce other goods and services. Hence the “broken window” fallacy exposed by the French economist Frédéric Bastiat (1801-1850) in his essay What Is Seen and What Is Not Seen. Bastiat demonstrated brilliantly that what economics can teach (but what, alas, relatively few economists actually do teach) is an understanding of the principles that underlie the often-mundane details of everyday life.

Bastiat’s tale exposes an elementary fallacy that most schoolchildren can quickly recognize. Yet it is also much more. Indeed, prominent people occupying powerful positions are presently succumbing to a vastly larger and more disturbing variant of the broken window fallacy. Although they denounce small, localized and individual acts of vandalism with all of the rhetorical ferocity they can muster, they impute rather modest negative consequences -- and potentially appreciable benefits -- to massive, extensive and state-supported acts of vandalism.

Immediately after September 11, 2001, pundits propounded their views about the impact of the government’s response to the attacks upon economic activity in the U.S. Among these views: the destruction of the World Trade Center and all the wealth embodied therein would ultimately augment rather than erode American standards of living. E.g., according to Larry Kudlow “we may lose money and wealth in one way but we gain it back many times over when the rebuilding is done.” It would follow that the widespread destruction of valuable property ultimately begets prosperity. From this statement it is but a small step to infer that the greatest destroyer of property, war, creates wealth and increase living standards.

Most government expenditure has the same effect. Taxpayers, if allowed to keep their earnings, would either buy consumption goods or save and invest (i.e., buy production goods). It is false to posit that if a government does not commandeer this money then people would bury it in the back garden. The ultimate absurdity revealed by the broken window fallacy is that if it were true, then governments could easily create and fructify wealth: they need only (and repeatedly) erect pyramids and monuments, dynamite them and immediately rebuild them. Succumbing to the broken window fallacy has wider and more insidious implications. What was lost in the 9/11 and other attacks was not just physical capital, like tall office buildings, but immeasurable talent and tacit information. Kudlow’s assessment of the situation utterly discounts the creativity and productivity of the lives lost that day and the lives that will be lost in any resultant wars.

Link here.


John Templeton was 88 years old. He had been active in the stock market his entire life. But now he thought it was time to sell. At first glance, there was nothing unusual about this. Most 88-year olds do not own too many stocks. And, at the time he decided to sell, in January 2000, stocks were obviously expensive and therefore risky for conservative investors. Selling a few stocks was only prudent. But it was not prudence that motivated John. It was profit.

It is one thing to have an idea about where the market ought to be heading. It is another thing altogether to bet an entire $180 million fortune on your hypothesis, but that is exactly what John did, beginning in January 2000. He sold short 84 different Nasdaq stocks, putting an even amount of his fortune against each position -- roughly $2.2 million on each stock. He told his brokers: “This is the only time in my 88 years I’ve seen technology stocks go to 100 times earnings; or, when there were no earnings, 20 times sales. It is insane, and I am going to take advantage of the temporary insanity.” On average, he made over $1 million per position, increasing his fortune by 50% in just a few months.

Even for Sir John Templeton, one of the world’s all-time best investors, this stock market operation was the trade of a lifetime. He is famous because he made fortunes for long-term holders of his emerging market mutual funds, which profited by investing in dirt cheap foreign growth markets, like Japan in the 1970s and Peru in the 1980s.

Today Sir John Templeton lives on Lyford Cay, in the Bahamas. He is still -- now at 91 -- active in the markets. He granted an interview to Forbes magazine earlier this year, and offered a warning to investors, telling them it is difficult to find reasonably priced stocks anywhere in the world. “You can always find bargains somewhere but it is difficult now. My advice is to own government bonds.” He is not recommending U.S. bonds, but bonds from countries that do not have huge fiscal and trade deficits -- like Hong Kong, Singapore and South Korea.

Now, for the first time since January 2000, you will find Nasdaq 100 stocks trading at the same kind of absurd valuations as they did at the top of the bubble. And The Wall Street Journal is once again reporting on the lives of 20-something financial whiz kids who have been mistaken for geniuses in the midst of a raging bull market. Within the S&P 500 there are only 10 stocks that have P/E ratios below 10. That is the lowest tally of cheap stocks ever, according to Barron’s.

Link here (scroll down to piece by Porter Stansberry).


For 2003, the U.S. posted a record trade deficit of $489.4 billion, up 17.1% from the previous record set in 2002. The U.S. imported a record amount of food, industrial supplies, autos and auto parts and consumer goods. Wasn’t the weak dollar was supposed to have boosted exports? In fact, the dollar has been falling continuously for the last 2.5 years, but the trade deficit in 2002 and 2003 has only gotten bigger. How come? Well, maybe because there really is no correlation between the two. Check out the accompanying chart.

Link here.


If ever there were a field in which machine intelligence seemed destined to replace human brainpower, the stock market would have to be it. Investing is the ultimate numbers game, after all, and when it comes to crunching numbers, silicon beats gray matter every time. Nevertheless, the world has yet to see anything like a Wall Street version of Deep Blue, the artificially intelligent machine that defeated chess grand master Gary Kasparov in 1997.

Far from it, in fact. When artificial-intelligence-enhanced investment funds made their debut a decade or so ago, they generated plenty of media fanfare but only uneven results. Today those early adopters of AI refuse to even talk about the technology. Still, artificial intelligence has steadily improved in sophistication and quietly made itself indispensable on Wall Street.

Before the hype machine cranks up this time, however, it would be smart to figure out just what AI can and cannot do for investors. True AI software is designed to model human decision-making and, like humans, to “learn” from experience. That is far more ambitious -- and potentially more useful -- than standard data-crunching and stock-screening programs. But how do you model the mind of a Warren Buffett or a Peter Lynch?

Andrew Lo, director of the Laboratory for Financial Engineering at MIT, found that feelings are another extremely important input for professional investors. “Unless you can put an emotional value on certain events and actions,” he explains, “you can’t get the job done.”

Link here.


In a hearing before the House Financial Services committee, Congressman Ron Paul took the opportunity to ask Federal Reserve Chairman Alan Greenspan several pointed questions. Greenspan’s normal evasiveness was tested when Paul asked him directly whether Fed actions represent a threat to freedom and prosperity. Mr. Greenspan’s startling response: The Fed does indeed have “inordinate power” over the American economy.

“I certainly appreciate Mr. Greenspan’s candor,” Paul stated after the hearing. “The Fed does have a tremendous impact on the economy and our lives, but its board members generally escape any political scrutiny for their actions. I want to make the public and Congress more aware of just how powerful -- and destructive -- the Fed really is. The unbridled expansion of the money supply will hurt all of us in the long run, in the form of price inflation, destruction of personal savings, and higher interest rates.”

Paul also cited economist Friedrich Hayek’s “pretense of knowledge” principle during the hearing, arguing that no amount of Fed “wisdom” can substitute for the discipline and price setting of the free market. He pressed Greenspan to admit that no government planner can know the “correct” interest rate for the economy, but the Chairman again sidestepped this central question. Paul is well known for his opposition to inflationist Fed policies and his support for a stable, commodity-based currency system. True capitalism requires a free market for money and interest rates, just as surely as it requires a free market for wages and prices.

Link here.
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