Wealth International, Limited

Finance Digest for Week of April 12, 2004


Most people understand political disagreement in America through the following prism: One party (the Republicans) believes in free markets and letting the economic chips fall where they may. The other party (the Democrats) believes in taking the rough edges off capitalism and providing insurance against the “creative destruction” of well-functioning national economies. The reality is that both parties, regardless of their rhetorical posturing, want privilege and protection for their political supporters and markets for everyone else.

Politics is the provision of exemptions from market forces. Such policies are wonderful for beneficiaries -- who are few in number -- and not too great a burden on the rest of us. Costs are diffuse and nearly invisible to those of us paying the higher taxes and consumer prices necessary to keep beneficiaries happy. This makes policy reform difficult. Recipients of market privileges are well organized, give lots of money to their political champions, and vote en masse against any politician who proposes change. Prospective winners from reform are rarely aware that they would indeed benefit from changing many of these arcane government interventions and, thus, are unlikely to go out of their way to reward politicians looking out for their interest.

Unfortunately, once everyone is organized and getting market privileges from the government, true reform is almost impossible because it requires everyone to cooperate to give up their privileges at the same time. This requires extraordinary leadership to organize and political trust to keep it from falling apart. The great tax reform of 1986 is a rare example of success. Lower marginal rates for everyone in return for the elimination of loopholes and exemptions was exemplary public policy. But since then the tax code has again become filled with privileges and exemptions; it seems in retrospect to have been hardly worth the trouble.

Link here.


(Part I – Why It Needs To Be Done, covered in last week’s Finance Digest, is here.)

Part II – Cutting the Defense Budget

While the Bush Administration’s fiscal year (fy) 2005 official budget for the Department of Defense (DOD) has estimated outlays of $430 billion, this reportedly excludes money for continuing the U.S. occupation of Iraq, also referred to euphemistically as democracy-building. A conservative estimate of this cost bumps defense outlays up to $455 billion. To that tack on another $16.9 billion that goes for nuclear reactors in Navy submarines and aircraft carriers, the construction and maintenance of the nation’s nuclear weapons stockpile, and the disposal of radioactive waste from nuclear weapons and Naval reactors -- all of which is included in the Energy Department budget. One then can add the nearly $16.6 billion of foreign aid -- money shoveled to foreign countries in order to buy their support and/or buy the support of U.S. voters who have personal fondness or attachments to other countries. This all pushes estimated national security spending to $488.5 billion for fiscal year 2005 compared to the roughly $470 billion being spent this year.

A return to the U.S. of troops and equipment that are deployed overseas would make it safe for the Congress to reduce the size of the U.S. military. Instead of estimating what budget, manpower, and weapons it would take for the U.S. military to win one, two, or however many “major regional conflicts” and associated guerrilla wars that Dick Cheney, Donald Rumsfeld and their associated bunch of Dr. Strangelove’s think we need to win, defense officials and members of Congress would only have to estimate what it would take to deter and/or defeat a country or countries that would attack the U.S. In all, cuts of about 1/3 could be made, without jeopardizing U.S. security, over the next few years. Once the rest of the world was convinced that the United States was no longer going to act like imperial Rome, the number of potential enemies would decrease, making further intermediate- to long-term cuts in defense spending possible.

“Cut-o-meter” savings are figured at: $25 billion (ending the military missions in Iraq and Afghanistan) + $16.6 billion (abolishing foreign aid) + $25 billion (initial cuts in the Army) + $35 billion (initial cuts in the Navy) + $38 billion (initial cuts in the Air Force) + $24 billion (initial cuts in the Pentagon-wide budget) + $10 billion (initial cuts in the Reserves and the Guard). The grand total is an estimated $174 billion annual savings below the proposed fy 2005 level of spending and $155 billion below the level estimated for the current fiscal year. While this only covers only 30% of the current estimated deficit, it is a reasonable start, and given the increasing anger by the public with U.S. overseas military adventures that have nothing to do with defending the nation, these are probably the easiest cuts to achieve. Stay tuned for proposed cuts in domestic programs!!

Link here.

Part III – Cutting Out HUD, NASA and Other Losers

Domestic spending, accounting for about three-fourths of the federal budget, is ripe for cutting. In a previous article, I argued for abolishing the National Aeronautics and Space Administration (NASA). The civilian space program is a 21st century version of Franklin Roosevelt’s Works Progress Administration (WPA) program, a boondoggle that provides employment on useless projects. It is nothing more than high-class welfare for scientists and engineers and the domestic aerospace industry. As several astute readers commented to me after my earlier article on NASA, there are many private ventures that will eventually -- sooner, if not later -- offer manned space flight in a commercially profitable manner, doing a much better job and for a lot less money than NASA.

The Department of Housing and Urban Development (HUD) is a half-baked mixture of political slush funds under the cover of welfare. For fy 2005, HUD’s proposed outlays are $38.9 billion. The Bush Administration actually proposes cuts of over $7 billion in the HUD budget over the current year, in which $46.2 billion will be spent. The HUD budget should be cut at least by one-third, saving about $13 billion per year by fy 2008 from the proposed fy 2005 level and about $12 billion per year from the projected fy 2008 level. Eventually, the whole department should be abolished, saving another $24+ billion per year.

There are loads of independent agencies in the federal government, but here are a few that should be abolished outright. First, abolish the National Science Foundation (NSF), which is nothing more than a sluice-gate for funneling welfare to academics. Academics and universities love to haul in cash from the NSF, as these grants fund the research that keeps big-name academics at their schools. But big-name academics can just as easily gain research funds from private philanthropic foundations instead of looting American taxpayers. Annual savings from abolishing the NSF would be $5.6 billion from fy 2005 estimated levels and $5.7 billion by fy 2008. Actual savings compared to the current 2004 level of spending would be $5.3 billion.

The list of other “independent agencies” is lengthy, and while expenditures for each are relatively small, getting rid of all of these 57 independent agencies would save taxpayers $5.9 billion per year. Several large independent agencies -- such as the SEC, the FCC, the Export-Import Bank, and the Tennessee Valley Authority should be abolished, or, in the case of the TVA, privatized. The SEC has failed on so many occasions that it ought to be easy to expose its record and abolish it altogether, recent corporate scandals notwithstanding. The TVA is a model of failure, with electric power production costs being much higher than in comparable privately-owned facilities.

Adding up all the projected additional cuts adds another $41 billion of savings to our previous total of $155 billion, bringing the “Cut-o-meter” total actual annual savings to a bit over $196 billion. Stay tuned for more cuts!

Link here.

Part IV – Abolish the Department of Education

The U.S. Department of Education, created as a political payoff to the National Education Association by former President Jimmy Carter, is a sewer for taxpayers’ money and ought to be abolished outright. Since then, although a few politicians -- notably former President Ronald Reagan -- have paid sporadic lip service to abolishing this useless organization, most have pushed for additions to its budget in order to curry favor with NEA members at election time.

With a budget that was at $35.7 billion in fiscal year 2001, the Bush Administration, in league with Sen. Ted Kennedy, has managed to push up that total to a whopping $64.3 billion proposed for fiscal year (fy) 2005, an increase of over 80% in just four years! Actual spending for the current fy 2004 will total $62.8 billion. Given the hundreds of billions of dollars spent by the Department of Education over the last 25+ years and the dismal results, abolishing it would not harm the quality of education, public or private, in the United States. By abolishing the Education Department, estimated annual savings to the taxpayer would amount to nearly $63 billion over current levels and would raise the “Cut-o-meter” to $259 billion. annually over current spending levels.

More on this story here.

Part V – Abolish the Agriculture Department

The U.S. Department of Agriculture is an anachronism that needs to be abolished. With a budget for fiscal year 2005 of $81.8 billion, it is time for the Congress to get rid of this financial millstone on the body politic. Actual spending for the current fiscal year 2004 should come in at about $77.7 billion. Ostensibly set up to protect small farmers from the vagaries of price fluctuations and crop disasters, the U.S. Department of Agriculture has grown into a multi-faceted bureaucracy that now spends more than half of its budget ($47.3 billion) on the food stamp and related food-type welfare programs. But if the taxpayers ended other farm subsidies, such as the $15.2 billion proposed for price supports, there probably would not be a need for food stamps as food prices would decline, making food affordable to poor people.

Today’s Agriculture Department budget generally reads like a laundry list of welfare programs. The list is lengthy, and it looks ridiculous. One program gets morphed into another, with a new name, but always the same purpose, protecting the farmer from the vagaries of the free market. In the real world, farmers can purchase all the protection they need by executing commodity futures contracts to protect themselves from price fluctuations. The food stamp, school lunch, and other food welfare programs were ostensibly set up to provide subsidized food for the poor or disadvantaged or assuring that school children were not malnourished. The real rationale was to provide back-door support for food prices and assure that no one would ever attempt to abolish such welfare.

One of the more notorious Agriculture Department programs is that of managing the many forests owned by the government. The U.S. Forest Service is responsible for managing the National Forest System, which includes 187 million acres of forests and nearly 4 million acres of grasslands. For fiscal year 2005, the Bush Administration proposes spending $5.1 billion to manage the public forests and grasslands. Given the lengthy track record of mismanagement and losses and the proven stellar track record of the private sector in minimizing fires, losses of wood, damage to private property, and preserving endangered species, federally owned forests and grasslands should be put up for sale to the highest bidder.

Abolishing the Agriculture Department can save taxpayers a fortune cutting the budget by almost $78 billion from the current year. The sale of public forests and grasslands could probably earn another $100–200 billion to pay down the public debt. The “Cut-o-meter” Total is up to .... $337 billion!

Link here.

Part VI – Trimming the Transportation Department

The Department of Transportation (DOT) budget is one that is loaded with pork, and it is ripe for trimming. At a proposed level of nearly $59 billion for fy 2005, it contains loads of useless projects and programs. Among those DOT organizations which often make life miserable for the average American are the Federal Aviation Administration (still running a monopolistic and antiquated system for directing airliners operating in U.S. airspace), the Federal Highway Administration (pork for highway construction along with enforcement of federal pollution control regulations for cars and trucks), the Federal Railroad Administration (which primarily subsidizes Amtrak), and the Federal Transit Administration (it sends pork to local transit authorities).

Proposed cuts from the DOT budget add up to about $24 billion from the proposed fy 2005 level and about $23 billion from the current year’s budget. Adding in the $23 billion in cuts from the current spending level brings the “Cut-o-meter” total up to $360 billion. While there is still a long way to go in eliminating the $500–550 billion deficit, there are still lots more vulnerable departments and programs.

Link here.

Part VII – Privatize the Interior Department

The Department of the Interior is an old-line federal department, with a variety of bureaus -- all with some link to the land or adjacent water -- under its purview. It is a department that has largely outlived its usefulness, except as a vehicle for special interests to get the public to fund their pet programs. Eliminating Interior would save $9.8 billion per year. It would raise the “Cut-o-meter” total to nearly $370 billion.

Link here.


The federal government is projected to spend $21,671 per household in 2004 -- the most since World War II and $3,500 more than in 2001. Tax revenues will reach $16,981 per household through a combination of the income tax, payroll tax, gas tax, estate tax and assorted business taxes typically passed on through higher prices and smaller investment returns. The remaining $4,690 represents the deficit per household, which will be dumped in the laps of our children. Here is a breakdown of where that $21,671 goes.

Link here.


The Russian government discussed a $10 billion package of tax cuts designed to boost entrepreneurship and help achieve President Vladimir Putin’s goal of doubling the nation’s GDP by 2010. One of the central planks of the tax cut package is a plan to reduce the payroll tax paid by firms from 35.6% to 26%. “This is a substantial sum that will remain at disposal of enterprises, which will lead to an increase in wages and investment,” Prime Minister Mikhail Fradkov observed. However, the government is planning to recoup some of the revenue lost through tax cuts with an increase in levies placed on the nation’s oil and gas sector.

Link here.


A recent survey of US investors has found that only a small minority were fully aware of how the changes in tax legislation enacted in 2003 have affected their investment portfolios. According to the results of the poll, which questioned 500 investors, only 21% said they understood how last year’s tax cuts affected their investments, and only 9% have made adjustments to their portfolios as a result of the tax cuts.

Link here.


China’s rapidly growing numbers of newly rich urbanites prefer investing their money in real estate rather than putting it in bank savings or the stock market, a mainland market research firm has found. Horizon Research, based in Beijing, found that 21.1% of the country’s newly-rich urban citizens favor property investments. Some 11.9% said they prefer bank savings, which is however, still the general population’s most preferred investment tool.

The research defines a newly-rich person as an urban resident with assets worth at least 500,000 yuan (HK$470,949) and an annual income of 200,000 yuan or more. Horizon Research estimated that such newly rich currently account for 5% of China’s urban population. According to government statistics, nearly 300 million people make up China’s urban population -- making the number of newly rich about 15 million.

Shanghai and Beijing are the two cities mostly favoured by the newly rich when they consider investing in real estate. The preference for real estate was probably influenced by the low rates of interest that banks are offering plus the faith in the government’s word that the yuan will not be revalued.

Link here.


Before I went to Las Vegas, I thought I would not like it. After I went, I found that it is a pretty darn good place for a vacation. Because gambling subsidizes everything, eats and sleeps are about as cheap as I have ever seen them. You can stay in a snazzy hotel in Vegas for a lot less money than it would cost you in Florida. You can also find cheap airfares to Bugsy Siegel’s desert dream. And the entertainment is first-class.

I am not a real gambler. For one reason, I do not have the money, and for another, I hate losing. All gamblers lose in the long run (and most lose in the short run) because the odds of all casino games favor the house. I follow the rule my daddy taught me. I decide ahead of time how much I can afford to lose, and when I have lost it, I quit. Should I win, I also quit. That was Rule No. 2: Always quit when you’re ahead.

I guess what I like most about Vegas is its intellectual honesty. Vegas does not run advertisements talking about how it wants to ensure your future. Unlike stock and mutual-fund peddlers, Vegas does not pretend to be interested in your family or your future. It is a tough town, and I like that. Everybody who lays a bet knows what the odds are or can find out easily enough. There is none of this carnie-talk about “keep trying and you’ll get rich.” It is a vacation spot for psychologically mature adults. No bull. No false promises. No mercy. If you cannot control your gambling, you had better be sure to buy a round-trip ticket, because once you are busted, nobody’s going to help you.

Link here.


To most investors, the disappointing stock market performance in the first quarter of 2004 came as a surprise. Despite the vigorous GDP growth numbers, record-low interest rates, huge cash inflows into mutual funds, the Fed’s “firm grip” on inflation, and other “strong fundamentals”, many U.S. stocks are down for the year. Most international stock markets are showing a similar weakness. Economists, bank strategists, and the financial media all claim that the stock market has simply gone “too far, too fast”, and a correction is due. That sounds reasonable, but everyone still wonders: Are we seeing a healthy correction or a return of the bear market?

How does a 220-year trend in stock prices change from up to down without being noticed? Answer: Ever so slowly. The great fooler of the long-term peaking process that began in 1997 has been its longevity. The markets have reversed their trend not because “a correction was due”, or because of a “global terrorism threat”, or whatever else the financial media would have you believe. The classic sign of a tiring trend lately has been the clear extremes in investor psychology. We have been describing them in detail and warning our readers of an impending reversal in stocks.

Globally, the Financials have been one of the leading sectors lately. Historically low interest rates in the U.S, the U.K. and Europe made money “cheap”, stimulating lending and boosting banks’ profits. Where the Internet/tech stock follies characterized the 2000 top, the bank/financial and related sectors will take center stage this time around. The S&P 500 index's current bank weighting is around 22%. That is a record. Same goes for the European bourses. By cutting interest rates 13 times to a 45-year low and keeping them there indefinitely, the U.S. Federal Reserve has opened wide the easy money spigot. Unfortunately, cheap credit (along with associated asset inflation) is one of the few successful American exports. It has created distortions worldwide. So, in this storm, the STOXX bank index will provide an excellent barometer. In his latest Elliott Wave Theorist, Bob Prechter says that “the financial stocks are right now the greatest short on the planet.”

Link here.


Athanasios Orphanides’s recent Fed paper touches on aspects of Japan’s extended economic slump (his basic thesis: the Bank of Japan should have done more). This paper served as a reminder of the inadequacies and limitations of mainstream analysis in explaining Japan’s long economic winter. Fortunately, though long unrecognized and unappreciated by the mainstream, there is a good framework for understanding the Japanese boom and bust. As it happens, that sequence was a classic business cycle as predicted by Austrian theory.

The Austrian analysis begins with the boom. Unsustainable booms begin with the creation of money and credit not supported by underlying capital. It begins with interventions in the world of money. In older days, it was easier to see that money creation beyond what was covered by specie was false capital, but in the modern anchorless and credit-soaked economy, the distinction is theoretical and much harder to detect. Nonetheless, this false capital does not create wealth. However, its creation does impact interest rates and influences the pattern of production away from what it otherwise would have been -- hence the creation of instability and of an underlying tension.

Monetary expansion cannot go on indefinitely or without consequence. The bust, then, is the period where market forces tack back toward where they would have gone without the fog of monetary intervention leading them astray. This requires liquidation of projects and businesses that no longer appear profitable. Workers and capital are redeployed to more profitable lines. This is a painful process, no doubt, but inevitable and salutary. The economy cannot grow again on a firm sustainable base until the old bad investments are liquidated. Each bust or recovery has its own unique features, but the essential characteristic is that the bust is curative and necessary to get the economy back on track.

Any delay or prevention of the necessary spadework of the bust only promotes further unsustainable circumstances and will aggravate the downturn. As we will see below, the Bank of Japan and the Japanese government did everything but let the market self-correct. The monstrous malaise suffered by Japan was entirely of its own making. And consistent with Austrian theory, these interventions have only slowed the recovery and hampered the market’s self-corrective process.

Link here.


Twice in just the last few weeks developments occurred which have much deeper implications for the U.S. economy and markets. In fact, the eventual effect of these for Americans particularly will translate into a drastically different standing in the world economically than what we have all been long accustomed to. It can truly be said that, for us, the world will be turned upside down over the next several years. None of us alive today has ever dealt with an economic and market environment that did not have at its core somehow one important anchor. And that was that -- though there were transient occasions since World War 2 when there were some interruptions -- the world, in the end, has revolved around the United States of America.

In a military sense, it has been American might and muscle that, for the most part, have kept most of the world a safer place. America’s economy has for several decades been the world’s largest. U.S. consumers, though they have dangerously built their seeming prosperity on mountains of debt, have nevertheless contributed to economic activity elsewhere by consuming so much. It can truly be said that, especially in recent years, Americans have virtually carried the entire world on their backs. Part and parcel of the world being “tilted” toward the U.S. has been the establishment of U.S. capital markets as the largest and most liquid in the world. People and even governments the world over have shoveled endless amounts of money into U.S. financial assets, giving an even greater aura to the United States as the great engine of wealth creation in the world.

As one sage once put it, though, “Whatever can’t last, won’t.” As the above scenario and America’s being the consumptive center of the universe has endured, major imbalances have been built up. For years, pundits of all stripes have speculated as to when the “tipping point” would come, where America could no longer accumulate such massive internal and external debts; and, further, when others in the world would smell trouble -- or greater opportunity elsewhere -- and begin to change their behavior towards America.

Early answers to these questions -- and warnings to the wise -- are starting to come in. A few weeks ago, Japanese officials surprised currency traders by suggesting that their long and heavy intervention in the currency markets designed to keep the yen from appreciating too drastically was coming to an end. No longer as dependent on America’s consumers, Japan has begun the process of a “readjustment” of sorts away from an economic model that has worked well in recent years. As Japan’s resurgent economy increases its appetite for imported raw materials, it will need a strong currency to keep those commodities-- all of which are priced in the U.S. dollar-- from getting overly expensive in their yen. I predict that China will not be far behind in following the same course as Japan. Such a move will demonstrate China’s belief that the previously insatiable American consumer is finally about “full,” and that the best days of exporting gobs of cheap goods to America are over. The Japan/China moves will translate into soaring costs for everything priced in U.S. dollars which will, of course, most acutely affect Americans.

The second watershed event of recent days: OPEC’s refusal to cancel planned production cuts, thereby keeping upward pressure on oil prices. With the U.S. by far being the world’s largest importer and consumer of oil, OPEC has had to consider at times what its major customer could “bear” as far as prices were concerned. Simply put, the U.S. has on many occasions been able to browbeat the cartel into pushing prices down to make already (relatively) cheap oil in America even cheaper. The threat was that if Americans were asked to spend a rising percentage of their incomes for energy, the U.S. economy would stagnate or go into reverse; and future sales at any price would thus suffer. That was a point that President Bush argued forcefully in recent weeks; but a point which the OPEC cartel, led by Saudi Arabia, rejected.

That reality is that the world has begun to turn upside down for America. We no longer dictate every element of the global economy and prices as we once did in order to maintain our own advantage (in this case, much cheaper costs for oil than in the rest of the world.) The real issue here is that, due in great part to exponential growth in China and elsewhere, demand for oil is so great that prices have to rise. With other buyers increasingly demanding their product and willing to pay its price, why in the world would OPEC continue to kowtow to America, when it is no longer necessary? The implications for America are clear: Continuing records for gasoline and other energy products, with their attendant drags on corporate profits and spending, not to mention their own inflationary pressures. As evidenced by both the Japanese and OPEC developments in recent weeks, America will no longer be the author of its own destiny. The implications are enormous; yet the handwriting now on the wall is being ignored by almost everyone else.

Link here.


Owing to the public’s fear of radiation, abetted by the nuclear protection industry and the media, nuclear power in the United States is at a standstill, just when we most need it. Construction on all nuclear power plants ordered after 1974 has stopped, and no orders have been placed for any since 1978. In the last 15 years, 8 nuclear power plants in the U.S. have been shut down because of escalating regulatory costs and public fears about radiation (103 remain). The U.S. uses fossil fuels, mainly coal and natural gas, to produce 70% of its electricity. Nuclear power generates 19% and hydroelectric dams the other 11%. (Energy obtained directly from the sun, gathered by mirrors or photovoltaic cells, and from wind turbines generates less than one-tenth of one percent of our electricity.) Production of electricity consumes 36% of the energy we use.

Overall, the U.S. obtains 85% of its energy from fossil fuels -- about half from oil and the other half equally from coal and natural gas. Compared to coal and hydroelectric dams, nuclear power is the safest and cleanest way, from an environmental standpoint, to produce electricity. And the fuel it uses, uranium, is more abundant than fossil fuels (or rivers left to be dammed). In contrast to the U.S., other countries do recognize the advantages of nuclear power. France uses nuclear power to generate 77% of its electricity, and 35 nuclear power plants are currently under construction around the world, 24 of them in Asia.

All the nuclear power plants in the U.S. are second-generation reactors, based on designs derived from those made for naval use. Third generation reactors, with an output of 600 MW, are simpler, smaller, more rugged, and reduce substantially the possibility of a core meltdown accident, from a likelihood of 1 in 20,000 to 1 in 800,000 per reactor year. (Third generation reactors have, for example, 80% fewer control cables and 60% less piping.) They are standardized to expedite licensing and reduce construction time. Fourth generation fusion reactors are being developed that should be in operation fairly soon.

Per amount of electricity produced, hydropower causes 110 fold, coal, 45 fold, and natural gas, 10 fold more deaths than nuclear power. As Petr Beckmann, founding editor of Access to Energy, shows in his book The Health Hazards of Not Going Nuclear, nuclear power is the safest source of energy in all aspects, not excluding terrorism and sabotage, major accidents, and waste disposal. From an environmental standpoint, nuclear power is far superior to coal or hydropower.

Our country needs to bring the troops home and start building third (and fourth) generation nuclear power plants, like China and other Asian nations are doing. The War on Terror will not be won, with our adversary employing fourth-generation-warfare suicide attacks on civilians in one’s homeland, until our country pulls its stick out of the hornet’s nest. This is perhaps the greatest advantage of nuclear power, coupled with new technologies like thermal depolymerization. It will better enable our country to follow the advice its first President gave us in his Farewell Address -- to conduct dealings with other nations in the marketplace, not on the battlefield. Building nuclear power plants can help end the War on Terror, in addition to keeping our lights and computers on.

Link here.


“Buy and hold” investing is Wall Street’s most cherished dogma, the foundation that the church of mutual funds was built upon. Individual stocks are too volatile for most individual investors -- or so the keepers of this faith would have you believe. Mutual funds are their more stable and less risky solution. This way you simply turn your money over to a professional. This way you can “diversify” and still enjoy stock market gains. This way you -- the little-guy investor -- won’t do dumb stuff.

What kind of dumb stuff, you ask?

Well, like buying and selling stocks at a pace that turns over half your portfolio in a year’s time. That is not “more stable” -- it is the opposite of buy and hold investing. And, of course, you would never imagine that stock mutual funds generally had average annual turnover rates of 50% -- would you? Truth is, anyone who does imagine that actually needs a bigger imagination: Stock funds have had annual turnover rates higher than 50% for some 20 years. ICI data shows a 55% turnover in 2003; 62% the year before; 73% the year before that.

It might be possible to overlook the “do as I say, not as I do” approach, IF the fund industry could show superior performance. But they cannot. Most managers underperform the S&P 500, and/or the average index return in their industry category. If buy and hold is Wall Street’s most cherished dogma, “market timing” is the heresy they most often condemn. Yet the facts clearly show that is exactly what they try to do. It is also true that a large percentage of individual investors try to time the market anyway, by chasing after performance. The fund business simply helps them do a poor job of it.

Link here.

Wall Street’s 2nd-most cherished dogma

If there is a second-most cherished, I would say it is the supposed need for the individual investor to “diversify”. These two dogmas both flow from the same flawed premise, namely that financial markets are “efficient”. Stock prices are on a “random walk” that does not follow patterns or trends. This is demonstrably false, yet random walk theory is still widely embraced by much of academia and Wall Street. Its logic dictates that your portfolio should be “balanced” -- if one part suffers heavy losses, some other part should enjoy strong gains. This “protects” your portfolio.

Conventional wisdom of this sort does not die easily; it can live on long after the facts & evidence refute it. And “refute” is a good word to describe the results of a study published this past February, which speaks directly to the strategy of diversification. It evaluated the performance of “diversified” vs. “concentrated” stock mutual fund portfolios -- nearly 1800 funds in all -- from 1984 to 1999. Two finance professors and a PhD student at the University of Michigan did the research; their scholarship and methodology appear sound. Their conclusion?

“We find that funds with concentrated portfolios perform better than funds with diversified portfolios.... Analyzing the buy and sell decisions of mutual funds, we find additional evidence that the trades of concentrated portfolios add more value than the trades of diversified portfolios.”

“Diversification” is recycled nonsense. It does nothing to control risk. At best, it is a guarantee of mediocrity.

Link here.


The Tet Offensive began late on the night of January 30, 1968. It was the beginning of Tet Nguyen Dan, or the Lunar New Year’s Day. The “Tet Offensive” consisted of a series of forty major attacks and dozens of other minor attacks all over the south by the North Vietnamese Army (NVA) and the Viet Cong (VC). Militarily, the Tet was a disaster for the NVA. Military historian Victor Davis Hanson estimates the kill ratio for U.S. forces was over 50-1. The NVA were beaten back nearly everywhere they attacked. But even the fact that they attacked everywhere sparked political shockwaves in America.

1968 was an election year. The offensive took place only two months before the New Hampshire primary. Prior to the offensive that took its name, Tet had been a traditional truce day during the war. And in fact, the NVA made a point of saying in public it would observe a seven day cease-fire beginning on the 31st -- a promise it fully intended on breaking. The NVA was looking for some kind of tactical surprise to compensate for its lack of firepower. It got the surprise it wanted. The campaign -- in military terms -- failed... but its strategic success was astounding. Why?

The biggest problem was that the American public had been led to believe the war was going well and victory was in sight. And in that sense, the strategy behind the attacks was brilliant. It did not aim at American military might, but American public opinion -- by far the weakest element of the American campaign. It was a well-aimed psychological blow at the morale of the American people. The campaign by NVA general Vo Nguyen Giap was a textbook example of using shock and awe to undermine public support for the war through media images.

Tet turned out to be a sell signal for the stock market even though, in military terms, it was a victory. It is a testament to the psychological fragility of investor. But then again, maybe people felt bearish already... bearish on Johnson, bearish on Vietnam... and when they came to their senses, bearish on stocks. Maybe Tet was just the emotional reason investors used to sell. In that respect, today’s situation in Iraq bears looking at. The market is overbought. The economy gives conflicting signs of its fundamental health. America finds itself in the midst of another contentious election and another contentious war. Is Fallujah a sell signal? The real target in this uprising is the U.S. voter. Show him images of dead Americans being mutilated, and you can drive the Americans out of the country, or at least Bush out of office. That is the strategic goal in Iraq. Undermine the morale of America. It could work. But even if it does not, it’s a sell signal for investors. No use panicking later when you can sell now and avoid the rush.

Link here.


The OECD says the US economic rebound is gathering steam as business investment picks up, but it has warned that the huge US current account and budget deficits are clouding the economy’s long-term prospects. It said a recovery which started in mid-2003 was growing broader, fuelled by household and government spending but increasingly including business investment. The OECD nonetheless urged the US government to take measures to tackle the current account and budget deficits to avoid stunting future growth.

Link here.

Figures show tax burden falling for US taxpayers.

The total effective federal tax rate in the United States fell to an average of 21.5% in 2001, the lowest level since 1992, according to statistics released by the Congressional Budget Office recently. The figures, which measure the burden of income, payroll and excise taxes, show that on a percentage basis, the tax rate declined for the lowest fifth of incomes by 19% to 5.4% in 2001 compared to the previous year. The overall figure of 21.5 % was 7% lower than in 2000.

The decline in the tax burden for those nearer the top end of the income scale was ascribed to factors such as a declining stock market accounting for a fall in capital gains tax.

Link here.


Take a break as you fill out your 1040 form, and play this game: suppose you could choose which government entities your tax dollars support -- and in what proportion. Since it is a thought experiment, let’s assume that local and state government functions are part of the list. What percentages will you assign to which departments, agencies and programs?

Polling data tells us enough about the government services people value to permit reasonably confident predictions about how the national results would average out. Police, fire, water and sewage, courts and prisons and national defense will get far more money than they would ever have the nerve to request. The allocations for national parks, environmental protection, air-traffic control and highways will probably be many times their current budgets. But my first point (match my prediction against your own choices) is that almost all the choices will be for tangible services. Most of them will be for services that fall under the classic understanding of a “public good” -- something that individuals cannot easily provide on their own and that is shared by all (police protection, clean air).

My second point is that allowing taxpayers to name where their tax dollars go would put large segments of local, state and federal government out of business. Much of the apparatus of government does nothing that ordinary people, making sensible judgments, would willingly pay government to do. But say that those apparently departments can advertise -- but that the advertisements must meet the same standards of truthfulness as the advertisements for, say, antacids. What a delicious prospect: a government office having to explain itself in order to persuade taxpayers to support its existence. The elements within the government that can make a persuasive case will do fine. Americans are not stingy or shortsighted. We will still have plenty of mine inspectors and curators. But who will voluntarily pay for the layers of bureaucratic barnacles that make up so much of the organization charts? Who will pay for the billions in subsidies that are doled out to agricultural, corporate and nonprofit special interests? Who will pay for the enormous pork-barrel projects?

Link here.


America’s complicated tax system needs a complete overhaul, not minor fixes. The large role that system plays in many of the political dramas dominating the daily headlines shows why. Republicans and Democrats, for instance, are fighting over the “outsourcing” of jobs to foreign countries. But with our 35% corporate tax rate -- higher even than the rate in socialist countries such as France and Sweden -- should we be surprised that some jobs leave America when the tax code punishes investors for creating jobs here?

Another issue is corporate “inversions”, which take place when a company defends the interests of its workers and shareholders by moving its charter from the United States to a jurisdiction with better tax law. Some politicians call these companies traitors, even though they are keeping their factories and headquarters in America. Others want to blame Bermuda and the Cayman Islands for having better tax laws than us. But would it not be a better idea if politicians fixed the problems in the tax code -- such as the fact that the IRS imposes a second layer of tax on companies trying to compete in global markets?

The problem is not just with business taxation. There are plenty of disputes about personal income taxes as well. Republicans and Democrats love to argue about whether the “rich” pay their fair share. Much of this debate is nonsensical, especially since supporters of big government frequently assert that any household making more than $80,000 is “rich”. In any event, there is little doubt that our tax code is grossly unfair. We do not want America to be like France, an envy-ridden nation that punishes people for being successful. But we also do not want rich people to dodge their taxes simply because they can hire lots of lawyers, lobbyists and accountants.

This is why the flat tax makes so much sense. Every household would get a deduction based on family size, but then every dollar of income above that level would be subject to tax. Such a system would ensure that the rich paid their “fair share”, but it would avoid the punitive tax rates that have caused so much economic misery in Europe. Sound too good to be true? Well, it is already working in many other nations. Hong Kong has had a flat tax for a long time and has boasted the world’s fastest growing economy for the past 50 years. Estonia, Lithuania and Latvia implemented flat taxes in the 1990s after getting their independence from the Soviet Union. They have been growing so fast that Russia decided to implement a 13% flat tax in 2001. Now Russia is booming, and Slovakia and Ukraine just adopted flat tax systems as well.

It is frustrating to see former communist nations adopt the flat tax while the United States struggles with an unfair tax system that combines the worst of class-warfare ideology and the worst of special-interest deal-making.

Link here.


More than 650,000 Brits are estimated to have bought property in the Spanish Costas, while France and Greece are also popular with people looking for a holiday home or even a new life abroad. But many people buying their dream home abroad are paying far more than they need to, by failing to take into account the effect of currency fluctuations between sterling and the euro.

When you buy a home in Europe the deposit, typically between 20% to 50% of the overall purchase price, must be be paid in euros. Rather than exchanging the entire cost of the property from sterling into euros at the same time, a large number of people take out only the deposit in euros, leaving themselves open to currency swings when the transaction has to be completed. As a result, the property that seemed such a bargain at the time could end up costing you far more than you had budgeted.

That is the message from offshore savings bank, Alliance & Leicester International, which is advising buyers who have the property price available in cash to take steps to protect themselves against swings in euro exchange rates.

Link here.


Expectations of a rise in US interest rates this summer grew on Wednesday after stronger inflation figures helped lay to rest any lingering fears of deflation. Consumer prices rose by 0.5% in March, higher than the 0.3% forecast by the market. Excluding volatile food and energy prices, inflation rose by 0.4% on the month and 1.6% compared to March last year -- a significant increase on the 1.2% reported last month. Coming on the heels of robust retail sales and employment figures, Wednesday’s data reinforced market confidence that the Federal Reserve will soon start to edge interest rates higher.

Federal Reserve officials are increasingly confident that inflation has stabilized, after a long period during which the rate of inflation declined, and are no longer seriously concerned about the risk of further substantial disinflation. The pick-up in inflation was led by the rising cost of medical care, apparel and hotel and lodging costs.

Link here.


In a devastating and brilliant lecture at the Austrian Scholars Conference, Sean Corrigan chronicles the failings of growth-driven government policies that impoverish in the long run. He foresees that the West is already displaying symptoms of the eradication of the middle class in favor of the governing military-political elite, and at the cost of buying off its feckless urban proletariat with a higher dole and more spectacular circuses.

Link here.


Debt is an institution in American government, long established and widespread. A cursory glance at debt statistics will quickly show that there has been a lull in the truth about debt, namely, that it cannot grow indefinitely at the rate at which it has been growing -- at least, not without a serious revaluation of the dollar, something we are already in the midst of seeing. The current federal debt outstanding according to the Bureau of Public Debt stands at nearly $7.2 trillion. It was only in 1981 that the legal debt ceiling was $1 trillion.

Though it may be surprising to some, particularly those who believed in the supposed fiscal responsibility of the Clinton years, the public debt has risen without interruption since 1956. Incredibly, the $7.2 billion is conservative; if you add in all the off-balance-sheet contingencies and guarantees (implicit and otherwise), you probably triple that figure, at least. This also excludes debts incurred by states, municipalities, etc.

Thomas Cahill, in his latest book, Sailing the Wine-Dark Sea, called 7th-6th centuries BC lawgiver of Athens Solon “a sort of Athenian Franklin D. Roosevelt”. Indeed, both men led famous swindles on the citizens they governed. It was Solon, according to the historian Plutarch, who lightened the debt burdens of Athenians by “raising the value of their money; for he made a pound, which before had passed for seventy-three drachmas, go for a hundred; so that, though the number of pieces in the payment was equal, the value was less; which proved a considerable benefit to those that were to discharge debts.” In fine Athenian fashion, and very much like our own modern age, treachery was given a pretty name. The Greeks called Solon’s act a “seisacthea”, meaning a relief or a disencumberance. Solon forced a revaluation, in effect transferring wealth from creditors to debtors. His financial alchemy would not be unique.

It was probably not Cahill’s intent, but his linking Solon with FDR is most apropos in this respect, because FDR too pursued a similar policy of debt relief in the 1930s -- by breaking contracts. Faced with paying for the extravagance of the “New Deal” and also grappling with a severe crisis, Roosevelt chose the tried old hand of repudiation. In 1933, the incoming Roosevelt administration assaulted the monetary order of the country, forcing it off the old gold standard, confiscating the gold of American citizens and putting it under the ownership of the Federal Reserve. The Roosevelt administration also brazenly stepped in and repudiated private and public contracts that required payment in gold -- if you had signed a contract stating that you promised to pay in gold, you no longer had to do so. A promise was not a promise anymore. The Supreme Court upheld the government’s repudiation of private and public contracts to pay in gold by a 5-4 majority. The court reasoned that these contracts interfered with the government’s ability to control the supply of money -- which they did, and which was precisely the point of such clauses.

The laws of economics never cease. Debts must be dealt with; they cannot grow indefinitely at their current rates. Furthermore, history tells us that these debts are not usually repaid as agreed. In a world of fiat currency, debt relief takes a subtler path than the overt aggression of a Roosevelt. Inflation (an expansion of the money supply), or legalized counterfeiting, is the modern spin on an old idea. The forces that led to these earlier swindles are converging now on a debt-laden America. From Solon, to Roosevelt, to Nixon’s closing of the gold window, the tradition of fraud is evident. In today’s world, all you need is a printing press. My guess is that Bernanke’s printing press will be busy.

Link here (scroll down to Christopher Mayer piece).


For us, Mr. Greenspan is the great deluder of the American public, flatly deceiving it about the economy’s true situation and prospects. His speeches always convey the impression of extraordinary sophistication, but the reality is that elementary knowledge of macroeconomic aggregates or processes, such as saving or wealth creation, obviously eludes him. It keeps amazing us how little critical response he finds. One reason for this generally silent complacency, we presume, is an overwhelming desire among economists not to upset the prevailing bullishness of public opinion. Bear in mind that Wall Street economists dominate economic discussion in the United States. Their main concern is the stock market.

But we also note a widespread lack of knowledge or interest in macroeconomic matters even of crucial importance. Nobody cares about savings, nobody cares about a credit expansion that has gone completely out of control and nobody seems to realize that the huge trade deficit has been the greatest profit-killer in the U.S. economy for years. Rather, it is hailed as an emblem of economic strength.

The other looming danger in addition to the trade deficit, is, of course, the immense risk it poses to the dollar and in its wake to the whole financial system, both having become heavily hooked on incessant, immense capital inflows. It seems to us that this horrendous danger, too, is in general not at all appreciated.

The credit excesses of the late 1990s bubble economy implicitly disrupted its underlying structures of demand, output, relative prices and profits in many ways. The thing to realize is that these bubble-related maladjustments depress the economy of their own accord, as happened in the United States in 2000-01. In the same vein, restoring sustainable economic growth requires liquidation of the distortions that have accumulated in the economy and its financial system. We see absolutely no evidence of this having happened. Instead, Mr. Greenspan has merely diverted these distortions, turning them into even greater maladjustments elsewhere in the economy.

In our view, America’s Great Deluder has done a miserable job: he has papered over existing maladjustments from the boom through even bigger, new bubbles and macroeconomic maladjustments, heralding much worse to come in the future. The structural damage to the economy has become far too big to lend itself to a mild correction. The next downturn will not be pleasant.

Link here (scroll down to Kurt Richebächer piece).


If you really want to get rich by investing in stocks, you will sit down right now and list every losing stock you have ever bought on a piece of paper. Then you will write out a detailed explanation of everything you did wrong, every decision you made, and why you made it. You will write out everything in as much detail as you can recall. If you do this every time you make an investment mistake, I promise you will become wealthier than your neighbors who do not examine their mistakes in intimate detail.

This idea did not come out of thin air. The writings of the great value-oriented investment managers of our time are much more focused on what can go wrong than what can go right. Warren Buffett is the world’s most successful investor, according to the only yardstick that means anything: he has made more money investing than anybody else. In his 1991 letter to shareholders, Buffett explained why he often recounts errors in minute detail: “I will occasionally unburden myself in these pages in the hope that public confession may deter further bumblings. (Post-mortems prove useful for hospitals and football teams; why not for businesses and investors?)” When value managers are not recounting past mistakes in detail, they remind investors regularly that bad things can happen. And when good things happen, they should not necessarily get the credit.

The preoccupation with post-mortems and caution is something you do not generally hear among momentum-oriented investors, or among those who are trying to cash in on the latest technology craze. Warren Buffett’s partner, Charlie Munger, says you learn more from mistakes than from successes. That is because Munger knows that, before you can make money, you have to learn how not to lose it. Hint: The lack of sex appeal in that proposition is one of the reasons why most investors will lose money on stocks over time.

Link here.


Total shareholder assets managed by the mutual fund industry is $7.4 trillion. A sum that large gets spread around (to some 8100 funds), yet the spread is not even: The largest 25 fund companies manage 72% of industry assets. Coming in at no. 6 on the list of behemoths is Putnam Investments, a name you should recognize if you have kept up with the so-called market timing scandal in recent months. Indeed, the story has plenty of sordid details. Top executives allegedly knew for years that Putnam fund managers engaged in the improper trading, but did nothing to stop it. In fact those managers were paid fantastic sums. In general the firm had a reputation for “charging high fees even though its funds’ performance often lagged their peers.” The price of the scandal -- literal and otherwise -- has been high. It cost the Putnam CEO his job; the fund managers in question face civil charges; huge accounts like the Florida and Massachusetts state pensions have pulled out.

Putnam shareholders withdrew some $61 billion in 2003, with most of the redemptions coming after the scandal broke in October. Media reports of the outflows have led much of the coverage, emphasizing the 25% reduction in Putnam’s assets. Far be it from me to suggest that $61 billion ain’t a lot of money. But let us think about that 25% figure -- one in four of Putnam’s shareholders pulled out. A fact that I find far MORE astonishing, which was overlooked in every story I have read: Three of four shareholders left their money in Putnam’s hands.

So what is the real story about “investor confidence”, about the “faith” the average mutual fund shareholder has in the system? The question answers itself, even if the establishment does not know the right question OR answer.

More on this story here.
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