Finance Digest for Week of May 3, 2004

INFLATION HITS THE FAMILY DINNER TABLE

Many of life’s necessities are becoming more expensive. Let’s start with breakfast. Eggs: up 5.2% so far this year. Butter for your bread: up 62%. A glass of 2% milk to wash it all down: It may rise as much as 50 cents a gallon next month. Time to head to work: filling up the gas tank now costs 30 cents a gallon more since January. After more than a decade of quiescence, inflation is returning -- eating away at family pocketbooks and rippling through almost every segment of the American economy.

The latest evidence came last week, when the government reported that the first quarter GDP grew at a steady 4.2 percent rate, but inflation virtually doubled: from 1.2% annually at the end of 2003 to 2% now. The rate would have been much higher if it were not for some big-ticket items, such as automobiles and computers, which came down in price. In fact, in the category most families would relate to -- food and gasoline -- prices rose at a 5.3% annual rate. Those numbers echo the more widely watched Consumer Price Index, which shows inflation running at 5.1% annually. Those are the highest numbers since 1990.

The inflationary pressures could well lead to the end of a historically low period of interest rates. Although no immediate rate hike is expected when the Federal Reserve meets next week, analysts believe inflation is reaching the point where the central bank will signal that it will increase rates early this summer. The stock market, anticipating such a move, has already been spooked in recent days.

ORACLE OF ABSOLUTELY EVERYTHING

Warren Buffett has signed on to advise John Kerry. And why not? He is advising everybody else. Buffett, chairman and chief executive of Berkshire Hathaway (NYSE: BRKA) and the second richest man in the world, is as popular as puppies. Tens of thousands flock to his shareholder meetings. Google cites him as an inspiration. His share price is up by 33% on the year and, long term, it continues to leave the indexes in the dust. And, for what its worth, Buffett is, along with Steve Jobs of Apple Computer and Pixar Animation Studios the most popular CEO in America, according to our CEO Approval Ratings.

Google loves Buffett and cited his wisdom on focusing on the long term in its recent pre-IPO filing. But Buffett did not return the favor: “It’s a fabulous business, but my guess is that it comes at a fabulous price. We’d never buy a public offering. The chances of buying something undervalued in a public offering -- it’s not our game,” he says. Indeed, Buffett says IPOs generally are overpriced, and he has never been one for flipping shares for a quick hit. Buffett is equally down on hedge funds, calling the increasingly popular vehicles a “fad” that was more about Wall Street marketing than sound investing.

Buffett also told reporters that he thinks the dollar will decline relative to other major currencies and that Berkshire is adding to its foreign-currency holdings. But other than that, Buffett says he is as confused as anyone: “It gets harder all the time to deploy all the funds that come into Omaha,” Buffett says. The company was sitting on $31 billion in cash at the end of 2003, and even the Oracle of Omaha says he did not know what to do. Unfortunately for Buffett, not many people have experience with this kind of problem.

FOREIGN STOCKS RISE IN DOLLAR TERMS, EVEN AS THE DOLLAR APPRECIATES

The dollar was supposed to have fallen flat on its face by now. It has not. In fact, confounding most currency experts, the dollar has rallied. But most investors would probably fare a lot better this year by betting on foreign stocks than on the faltering American stock market. In most instances, foreign stocks have outpaced domestic ones enough to compensate for the dollar’s rally.

Morgan Stanley Capital International’s All Country Sectors stock index is up 1.5% in dollars this year through April 29, excluding the United States. In local currencies, the index gained 4.8%. Although the climb of the dollar against most currencies sliced that gain by more than half, the foreign performance easily beat the 0.1% dip in MSCI’s index of American stocks. Americans investing in countries using the euro were punished by the dollar. Markets in these countries gained 3.3% in euros; that translated into a loss of 2.2% in dollars.

All prognostications about the dollar should be taken with a dose of skepticism, because some studies have found that such predictions are not much more accurate than flipping a coin. Certainly, forecasts that the dollar would fall as much as 11% against the euro this year and 5% against the Japanese yen have been well off the mark. For the year to date, the dollar is up 5.3% against the euro and 2.2% against the yen. Still, it is likely that the dollar will resume its decline before the end of the year, according to many foreign-exchange analysts.

DON’T HAVE $1 MILLION? SOME MANAGED ACCOUNTS WILL TAKE $25,000 NOW

Financial firms are having an easy time selling a new breed of managed accounts, which previously required $1 million minimums, for as little as $25,000 to $100,000. For that sum, a financial adviser can now invest a client’s assets in a program that provides access to money managers who typically cater to people with seven-digit portfolios, at a minimum. The big allure of these accounts is that rather than pooling your money with other investors in the classic mutual fund setup, you own securities directly, allowing greater control of your tax bill. Investors in these accounts can also instruct managers to exclude certain stocks and even entire sectors. There is also professional allocation and rebalancing advice.

While the level of customization available on a low-minimum managed account may not match the white-glove treatment of a multimillion-dollar account, there is still more control than in a mutual fund. Combine that with the fact that many disappointed do-it-yourself investors are turning to advisers -- and that those advisers are actively looking for alternatives to the scandal-tainted world of mutual funds -- and you have one hot product.

The Financial Research Corporation reported that assets in separate accounts rose 29 percent last year to more than $500 billion. While that is just a rounding error for the $7.5 trillion mutual fund industry, Michael Evans, an analyst at the research company, forecasts that total assets could surpass $1.5 trillion within the next five years.

THE CASE FOR A GENUINE GOLD DOLLAR

by Murray Rothbard

For nearly a half-century the United States and the rest of the world have experienced an unprecedented continuous and severe inflation. It has dawned on an increasing number of economists that the fact that over the same half-century the world has been on an equally unprecedented fiat paper standard is no mere coincidence. Never have the world’s moneys been so long cut off from their metallic roots. During the century of the gold standard from the end of the Napoleonic wars until World War I, on the other hand, prices generally fell year after year, except for such brief wartime interludes as the Civil War.

During wartime, the central governments engaged in massive expansion of the money supply to finance the war effort. In peacetime, on the other hand, monetary expansion was small compared to the outpouring of goods and services attendant upon rapid industrial and economic development. Prices, therefore, were normally allowed to fall. The enormous expenditures of World War I forced all the warring governments to go off the gold standard, and unwillingness to return to a genuine gold standard eventually led to a radical shift to fiat paper money during the financial crisis of 1931-33.

It is my contention that there should be no mystery about the unusual chronic inflation plaguing the world since the 1930s. The dollar is the American currency unit (and the pound sterling, the franc, the mark, and the like, are equivalent national currency units), and since 1933, there have been no effective restrictions on the issue of these currencies by the various nation-states. In effect, each nation-state, since 1933, and especially since the end of all gold redemption in 1971, has had the unlimited right and power to create paper currency which will be legal tender in its own geographic area.

It is my contention that if any person or organization ever obtains the monopoly right to create money, that person or organization will tend to use this right to the hilt. The reason is simple: Anyone or any group empowered to manufacture money virtually out of thin air will tend to exercise that right, and with considerable enthusiasm. For the power to create money is a heady and profitable privilege indeed.

ECONOMIC PARASITISM

An interesting but somewhat lengthy article entitled “Fractional Reserve Banking As Economic Parasitism”, by a guy named Vladimir Z. Nuri, cleverly notes some eerie parallels between physics and economics, and how many of their formulas resemble each other, which fascinates me for two reasons... Firstly, they are both concerned with physical things, like money and gases, and how they operate in the real world, and secondly because the current crop of mainstream economic theorists and THEIR theories and equations have done such a poor job that it apparently amounts to mere hocus-pocus, and we should be on the lookout for something better.

Mr. Nuri wisely instructs us that one can be led to enlightenment by always remembering a Latin phrase, cui bono? which translates as “who benefits?” And then he caps that off with caveat emptor, or “let the buyer beware”. This is an adaptation of that other timeless credo, which is “follow the money”. He uses this transcendent insight to ask some very interesting questions, such as concerning “Spending and circulating new dollars... the key question is, who owns those dollars?”

His conclusion, and my conclusion -- and your conclusion if you have correctly used your Mogambo Decoder Ring -- is that the bankers own the dollars because they are the ones who created the dollars in the first place, and that is why he writes “Whoever has or is given the authority to create credit has the authority to extract wealth from the economy by that same mechanism.” And these people are, as they always are, the bankers. The bankers are, in other words, extracting the wealth of the USA to enrich themselves.

He dissects Greenspan’s famous 1967 essay entitled Gold and Economic Freedom, and notes that Greenspan was correct when he described how, when the supply of money increases, that the “earnings of the productive members of society lose value in terms of goods,” but that Greenspan was wrong when he immediately followed that up with, “When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes.” In truth, says Nuri, the bankers created the credit, therefore the bankers created the money, therefore the bankers owned the money, and therefore the value went into the pockets of -- and I am sure that you have already connected the dots here -- the bankers themselves. What everybody else ends up with is, predictably, pure price inflation, making them all worse off. See how simple this stuff is? It makes you wonder why Alan Greenspan doesn’t comprehend it.

Nuri also posits the concept of economics as an ecosystem, and, as he says, “building on it, an important additional theme proposed and explored here is that of economic parasitism.” His perspective is that parasites survive by utilizing various techniques to remain unnoticed, they use their anonymity to feed on their hosts, and, in many cases, actually alter the behavior of their hosts toward suicidal actions so that the next phase of their parasitical lifecycles can proceed. Politicians, bankers, overpaid CEO’s and lawyers immediately come to mind, and the term “parasite” is probably a lot more descriptive than “vampires”, which is another apt metaphor that is often used to describe these groups of people.

The short executive summary is that Mr. Nuri validates, through rigorous mathematical process, everything that the Austrian school of economics has been saying all this time. And the mathematical conclusion shows that deflation is actually a good thing! Nuri says “deflation can be a natural and beneficial redistribution of increased GDP or efficiency,” although Alan Greenspan thinks otherwise, and that is why he is trying to kill us all with inflation.

The obvious way to make money on the deal is to buy a bank. If you cannot get one of them, then buy gold. Nuri says “Price inflation is a precise, mathematical measure of the macroscopic energy dynamics of a system which adheres to physical laws.” And where does this energy come from? Exactly where you thought it comes from: fractional reserve banking. It is one of the world’s greater evils, my grasshopper, and if you do not watch out, Mr. Greenspan and his banker cronies will use it to steal the value of your money from under your very nose.

THE SUZERAIN

Capital as a financial concept is defined by the price of money. Monetary calculus takes place in dollars, or yen, or euros, amongst a myriad of other monetary symbols. When that money price no longer reflects the realities of supply and demand, becoming distorted -- as is often the case when the political mixes with the economic -- you have the ingredients for a crisis. Currency manipulation is effectively a cloaking device, where political ambition seeks to change the natural pattern of the market. Today, it is frequently in the news, as America continues to suffer job losses to nations that can produce the same for less. Chief among the new habitats for these migrating jobs is China.

The Chinese yuan is linked to the dollar, as are other Asian currencies -- the Hong Kong dollar, and the Malaysian ringgit. Japan, while not officially pegging the yen to the dollar, has joined its Asian neighbors as a large purchaser of U.S. dollars. As James Grant has noted, “The pell-mell purchase of dollars for yen, renminbi and other Asian currencies constitutes the largest exchange-rate manipulation in the history of the world.” The Asian countries follow this path to keep their own currencies from appreciating against the dollar, thereby protecting what they perceive to be the key to their own prosperity -- namely, exports.

This will end, as all manipulations end, in disaster. It will end in devaluation, as tremendous purchases of dollars cannot be sustained. That is the way of all unsustainable trends. They go on for longer than most people think likely, eliciting elegant theories to rationalize them... and then the trends stop, usually to the surprise of many and to the detriment of their portfolios. Ludwig von Mises observed that the monetary policy of one nation voluntarily becomes a satellite of a foreign power when it pegs its own country’s currency rigidly to the currency of a monetary “suzerain-country”. Under such an arrangement, the pegged-currency country is bound to follow all the changes the “suzerain” brings about in its own currency, against other currencies and against gold. Today the U.S. is the suzerain. China, for as long as she cares to link her currency at a fixed rate with the dollar, is at the mercy of U.S. dollar policy.

China sells its exports for dollars. These dollars have gotten cheaper and will likely get cheaper still. China sells, and in return receives notes that, in a sense, will never be repaid at par value. But the cycle does not stop there. Devaluations are often followed by more devaluations, as each nation is deluded into thinking that the way to prosperity is to destroy the native currency to stimulate exports and to preserve jobs. Whatever the advantages put forth by advocates of devaluation, they are at best temporary, resting entirely on the fact that adjustments to currency changes take time. But ultimately, devaluation simply means that those bound by the currency must work that much harder to purchase the same quantity of foreign goods that they were able to purchase before for less work. Devaluations make one poorer, not richer.

China, by continuing to allow for the cheap accumulation of yuan with overpriced dollars, is doing U.S. consumers a favor that cannot last. When China stops, and when the rest of Asia follows suit, the end result ought to be higher interest rates and a cheaper dollar... not to mention painful economic adjustments.

P.S. The end of Asia’s vendor-financing scheme will herald unhappy times for the holders of many U.S. financial assets, but it will likely reward those that have hedged or sold their dollars for assets likely to rise against the dollar. The biggest casualty will likely be the U.S. housing market.

HOW RICH ARE THE ENGLISH ROYALS?

I have spent the past six months making a program with an absolutely obvious conclusion: how rich are the Royals? The answer, ladies and gentlemen, is -- wait for it -- very rich indeed. Surprised? It should be absolutely transparent how much money they are given and how much they have. They say there is all the transparency you could want in the civil list. But the civil list is set on the basis of need and it is impossible to assess how much they actually need if you do not know how much they have. And, trust me, it is impossible to find how much they have because they are just not telling.

The most obvious example is the Queen’s share portfolio. It could be worth nothing. It could be worth billions. But we will never know because she holds shares anonymously in a company called the Bank of England Nominees -- the logic being that it could destabilize the market if we knew what the Queen was buying and selling. However, if the chairman of BT sells off all his personal shares in the company that will certainly affect sentiment. And his transactions, like yours and mine, would almost certainly have to be in the public domain.

CHINA AND THE FED: TWIN PIQUES

Few people can hold a candle to Alan Greenspan when it comes to opaque utterances on monetary policy. The language following this week’s Fed meeting will be parsed in agonizing detail for the merest scintilla of a whisper of a hint of a change in the Fed’s ultra-accommodative interest-rate policy. But if Mr. Greenspan plays his cards close to his chest, the good folk at the People’s Bank of China, that country’s central bank, make the Fed chairman look the very model of openness. Possibly, the uncharitable thought occurs, because they do not know what is going on. Yet no matter how little Mr. Greenspan or his counterparts in Beijing say, or how opaquely they say it, one thing is clear: monetary policy in both America and China is tightening. Since many an investor is fleeing low interest rates by placing bets on global reflation, these trades will be sorely tested in coming months.

Which will have the greater effect -- tightening by the Fed or the People’s Bank -- is a moot point (another way of saying that your columnist does not have the foggiest). Undeniable is the fact that the combined impact has already been big. Most obvious has been the effect on government bonds, and especially those issued by the United States government. In a few weeks, the yield on ten-year Treasuries has risen from a low of 3.65% to 4.5%.

If the attractions of Treasuries have waned, investors have started to look in horror at emerging-market bonds. Last year’s poster children have become this year’s street urchins. Bonds issued by the likes of Brazil, Turkey and Russia have, to quote one normally sober investment bank, suffered “violent re-pricing”. Down, that is. Stockmarkets have stumbled everywhere, caught between the joys of heady economic growth and the potential pain of higher interest rates. The riskiest are among the hardest hit.

In America, the fretful will tell you, there are striking similarities to 1994, when inflationary pressures were rising, the Fed was forced to double interest rates (to 6%) and there was widespread carnage in the bond market. The sanguine reply is that the Fed will move rates much more cautiously than last time -- and telegraph every move to a market that is all too aware of those similarities. But returns are far lower than in 1994, and leverage in the financial system is far higher.

China has also been here before, at about the same time. In 1993-94, investment grew at over 60%, GDP growth rose to over 15% and inflation peaked at 28%. Things did not turn out too well after that. Back then, though, China did not play such a big part in either global growth (of which the country has accounted for a full quarter over the past five years, on a purchasing-power-parity basis). One cannot help worrying that two of the most important economies in the world are about to start tightening monetary policy at the same time. And no one knows how fast or how far they will have to go.

PREPPING FOR THE GOOGLE IPO AFTERMATH

Theoretically speaking, there ought to be no greater morale boost for hard-working entrepreneurs and startup employees than the prospect of a very successful initial stock offering. In reality, however, a lucrative IPO, while beneficial for employees’ bank accounts, also creates a certain degree of havoc within the workplace, experts in workplace psychology say. With Google poised for a multibillion-dollar IPO, and demand for technology stock offerings out of deep freeze, tech executives are once again grappling with issues last faced during the boom years of 1999 and 2000.

One of the chief concerns is retaining key staff members who have already made enough from stock options not to have to work. Another is convincing employees fixated on the company’s stock performance to go back to concentrating on their jobs. Granted, these are far better problems to have than the ones tech firms face during a downturn. For much of 2001 and 2002, employers were more worried about handing out pink slips to workers who actually needed a paycheck. But sudden wealth is still a disruptive force that must be reckoned with.

Google IPO mania slows SEC Web site.

Intense interest in Google’s initial public offering slowed the performance of the Securities and Exchange Commission’s Web site, which hosted the search company’s financial documents.

HOW VENTURE CAPITALISTS EARN THEIR KEEP

In the minds of entrepreneurs working to expand their fledgling technology companies, the intangibles brought to the table by their investors -- experience and contacts -- often are worth a lot more than money itself, David Hsu, a Wharton management professor, writes in a paper scheduled for publication in the August issue of the Journal of Finance. The paper is titled, “What Do Entrepreneurs Pay for Venture Capital Affiliation?”

If a company borrows from a bank and the terms are similar, it does not matter what bank it gets the money from. In seeking venture capital investment, however, a company is hungry not just for cash but also for the venture firm’s “reputation and access to a network of relationships -- with customers, suppliers, investments bankers and other important constituents in the universe that the entrepreneur cares about,” Hsu says.

This may not be a startling insight to technology entrepreneurs who are familiar with venture capitalists. What Hsu’s paper does, however, is provide a scientific measurement of the magnitude of this phenomenon. He found that offers from more reputable venture capitalists are three times more likely to be accepted by entrepreneurial companies and that, on average, these favored investors acquire start-up equity in the companies at a discount of between 10% and 14%.

PERVASIVE STUPIDITY

A friend, Pat, is a civil engineer. He designs buildings and bridges and the like. He is the principal of his own company, which is now 11 years old. He has had a great run, too: he estimates that his business has grown at a rate of at least 50% a year for all 11 years. Business is really booming. Recently Pat took on some partners. In doing so, he had to price the business to decide what they should each contribute in exchange for their portion of the profits.

The 50% growth rate Pat cited is a ballpark figure. Believe it or not, most businessmen are not obsessed with the price of their business every minute of every day. Pricing the business is a subject that only occasionally comes up for the vast majority of businesses in existence. The idea of selling the business for the sole purpose of realizing a capital gain seems, as often as not, just... well... stupid. So what price did Pat, this successful entrepreneur, assign to his business, to his 50%-a-year money machine, his crowning achievement? 20-times earnings? 30-times earnings?

Peter Lynch says that if you find a 25%-a-year growth business selling for less than 20 times earnings, you should “back up the truck”, meaning buy as many shares as you can afford. We are led to believe that 20 times earnings is a bargain for a business growing at half the rate of Pat’s design firm. And what about the wunderkinder of the new era? Should Pat charge E-Bay prices for his business, or Yahoo prices? 50-times earnings? 100-times? He has made a growing profit every year for 11 years. Amazon has not made a dime, and it is “worth” $18 billion.

Pat charged his partners 5 times earnings. I heard that and nodded, unfazed. It is a rather typical, reasonable private market valuation for a good business. Five times earnings. Pat did not think this was a bargain-basement price. He thought it was reasonable, a win/win situation, for both himself and his new partners. Here is a guy who has never studied a thing about finance or investing. But he is smart. Most people just do not ever look at the stock market as a place where businesses trade hands.

As Pat asked a series of rhetorical questions about the high prices big corporations are paying for big mergers and acquisitions or that the public is paying for traded stocks, I realized how rare it is to find anyone who understands how absolutely efficient the stock market is at reflecting the pervasive lack of plain business sense that characterizes the average person’s approach to investing.

What would you call a place where the buying and selling is literally worth more than that which is bought and sold? A circus? A casino? Suckers Alley? It has already got a name: Wall Street. And more than 50% of all Americans think they are going to get rich buying its perpetually, systematically, purposely overpriced offerings -- which they think they will quickly sell to someone who will pay even more. That is just... well... stupid.

THE PENDING BEAR MARKET IN CENTRAL PLANNING

There is only one financial history and, despite this, there are a myriad of ideas about it. What is most readily apparent is also critical in our current era. These are the linked great asset speculations, with the first one in tangible assets blowing out with the subsequent financial asset mania blowing out nine years later. As focused in the world’s financial center, the first financial bubble climaxed in London in 1720. Generally occurring twice per century, the example that ended in Q1 2000 was the sixth such “new financial era”, as they have been described by each generation of enthusiasts.

Anyone who reviews financial history would note that the period between the two asset manias has, in each case, been nine years. The next observation would be that whether the senior central bank’s ambition was tempered by sound money or given free reign (the examples of 1720 and 2000 were the most egregious), the duration has not been shorter nor longer than 9 years. All have been followed by a long period of financial and economic contraction that eventually healed the abuse of the credit and currency markets otherwise celebrated as a “new financial era”. In some examples, including ours, the third year out from the bubble peak has recorded a cyclical business recovery and bull market.

One irresistible conclusion is that the financial forces engaged in the paired great asset speculations have been so powerful as to overwhelm policymakers’ attempts to materially alter the basic pattern (This would include the old propaganda about “curbing inflation”, which reached unprecedented levels in 1980, or then vainly trying to extend the 1990s financial bubble). Another is that financial history itself is a profound due diligence, not just on the wild promotions integral to every great market speculation, but also on every theory of intervention and its application.

Without appropriate due diligence, the consensus ardently believed that the fabulous prosperity of the 1920s and 1990s, for example, was the result of brilliant policy and that the “new era” was a lasting condition. While Q1 2000 indelibly recorded furious convictions that the tech bubble would continue, Q1 2004 recorded similarly intense convictions that U.S. policymakers would depreciate the dollar well into the foreseeable future and that China would continue to buy commodities for the equivalent duration. These were ideal conditions for the biggest “full-court press” on silver since the delusions that drove silver to $48/oz. in 1980.

Beginning with nickel in early January, there has been a series of speculative spikes and severe plunges. These sudden losses of speculative abilities are serious, but this seems not to have daunted the convictions that a senior central bank can depreciate its currency at will. History suggests that without soaring asset prices, this prerogative can be denied and this typically has occurred following a bubble.

The last one hundred years has seen the greatest attempt by government or their agencies to alter financial history in, well, financial history. This brief review is limited to the most obvious series of blunders and does not cover the excesses committed by the Fed in the 1920s. (That blunder, as many know, was concisely covered by Alan Greenspan in his essays of 1966.) Instead, these pages are limited to the attempts to alter the natural course of interest rates. The only thing that central bankers can do and have done is to depreciate their currency -- and that has been limited or prevented in previous post-mania contractions, as it is being now with the rising dollar, so far.

As the last of the manias fail, it will leave only one conviction remaining and that is that policymakers managed the recovery and that it can be maintained. Or, to be blunt, that they can continue to trash the dollar. Instead, and as in Communist countries in the 1980s, the impracticality of the theories and practice of central planning will come under critical scrutiny. Some are expecting a disaster for the senior currency. Quite likely, rather than the dollar being repudiated, the management of it will be repudiated.

FELIX ROHATYN’S WARNING ON AMERICA’S INDEBTEDNESS

Three decades ago, New York City was facing bankruptcy. The Federal Government refused to bail out the city. This led to a famous headline in the New York Daily News: “Ford to New York: Drop Dead!” The man who was called in to restructure the city’s debt was Felix Rohatyn. He was a bond expert. He earned his keep that time. The city did not officially have to declare bankruptcy.

Recently, he wrote an article for London’s Financial Times. The article is not on-line except to subscribers, but Bill Fleckenstein has provided some choice extracts. His comments are good, too. Rohatyn’s article was titled “America: Like New York in the 1970s but worse.” It reads:

“Indebtedness spinning out of control, fueled by an unchecked increase in the deficit. An accounting system that indiscriminately mixes expenses with capital assets, ignores contingent liabilities, and makes Enron look conservative. A social structure sharply divided between ‘haves’ and ‘have nots.’ An administration locked into denial on the assumption that ‘the markets will always be there for us.’ A political system paralyzed as public finances careen toward catastrophe. That was New York City in the early 1970s; it could be America tomorrow. America’s out-of-control federal budget deficit, rapidly growing domestic and foreign debt, and off-the-books Social Security and Medicare liabilities look eerily similar to the fiscal situation that faced New York nearly 30 years ago. ...”

He then explained how we have been able to live so far beyond our means (European and Asian central bankers financing U.S. deficits, etc.) and how that may not be able to last forever, and he rebutted Alan Greenspan’s contentions that basically all is well. The Fed’s efforts to stave off recession and consequent massive debt defaults leads it create more money, which leads to asset bubbles.

Felix Rohatyn went through New York City’s crisis and made his reputation. There will be other Rohatyns in days to come. But the best way to take advantage of a popped bubble is with cash. He who bought a condo in New York City in 1969 probably lost. If he bought it in 1975, he won. When we hear that Rohatyn is worried, Templeton is worried (he predicts that 20% of home owners will lose their homes in the next downturn), and Buffett is building cash, I think we should not get pulled into a mania. You will be able to buy cheaper later.

NOT SO FUNNY MONEY

Of all the government’s criminal activities, probably none is more egregious, but less apprehended by the general public, than its handling of our money, or what passes for it. The Constitution, of recent memory, assigns Congress the task of coining money, while prohibiting that power to the states, which are bound, by that selfsame Constitution, to make nothing but gold and silver coin a legal tender in payment of debts. If the officials who swore an oath to obey the Constitution actually did so, the mints would be coining gold and silver coins, and the people of the states would be using them to pay their debts. Inflation would be non-existent, prices would be stable or gradually falling, and savings would retain their value, or appreciate. Worthwhile, don’t you think?

These very advantages of a precious-metal currency were extolled by none other than Alan Greenspan, before he succumbed to the siren song of insider fame and power. They are, after all, simply common sense. But the failure of government officials, both federal and state, to obey these strictures of the Constitution means that inflation is a more or less conscious government policy. Inflation favors the borrower, and Uncle is a big borrower indeed. And without the power of the printing press, government could never have achieved its present size and scope.

When the redesigned $20 was introduced, the Bureau of Engraving and Printing launched a “large, consumer-focused marketing campaign to explain the redesign to the public. The government spent about $12 million in advertising---.” At first blush, spending $12 million to advertise money is absurd. But remember: the outfit that is spending $12 million to advertise money gets money for nothing -- they print it. (And don’t tell me that they at least have to pay for paper and ink! How do you think they pay for those?) What of the oft-repeated assertions that the tinkering with our paper monetary devices is to discourage counterfeiting? Federal Reserve Board governor Mark Olson said that fighting forgery “is a job that’s never finished.” What an honest person would have said is that fighting competition is the job that is never finished! All counterfeiters are equal, but some are more equal than others. Mr. Olson’s gang finances the government, and that grateful organization has bestowed “legal tender” status upon his outfit’s output. Talk about equal protection of the law! The Fed has the monopoly on Monopoly money.

The Fed Is Lifeblood to the Root of Evil

Central banking is perhaps the most brilliant scam ever perpetrated, and the U.S. Federal Reserve stands as the most successful of all central banks in history. The Fed is able to transfer wealth away from the people who earned it, and into the hands of the Federal Government and member banks, relentlessly, stealthily, year after year, and all the while maintaining the preposterous claim of social benefit in the form of “managing the economy.” The method of this theft is sophisticated and disguised enough as to escape the attention of most, and when combined with propaganda, leads most people to the conclusion that we would be in trouble without it. Yet I wish to show here that central banking can be well understood by most people for exactly what it is -- the fraudulent theft of trillions of dollars via the monopolization of money. In the companion article, “The Origin of Money, and How It Was Stolen from You,” I will show that the usual justifications given for central banking are dubious.

STRANGE GOINGS-ON WITH THE YIELD CURVE

Lately the market has lacked a “natura”q yield curve, as this most reliable of indicators seems to be in limbo. This problem is more than an academic debate, and goes to the heart of the current debate about Fed policy. It also affects your investment portfolio big time. In June of 1996, Fed economists Arturo Estrella and Frederic S. Mishkin published quite an important paper, entitled “The Yield Curve as a Predictor of U.S. Recessions”. Essentially, Estrella and Mishkin showed how every U.S. recession in the post-WW2 era has been preceded by a negative yield curve. By a negative yield curve, we mean that short-term rates are higher than long-term rates, which is not the natural order of the world. Normally, you should be paid more interest for holding longer-term bonds and taking more risk. When long-term rates are higher, the yield curve is referred to as positive sloping. That is the case today, and in fact, right now the positive-sloping curve is rather steep.

In subsequent papers, Estrella and Mishkin have noted that out of 26 different indicators, only a negative yield curve was a truly reliable predictor of recessions. In August of 2000, the 90-day average yield curve was negative and the lowest it had been since 1989, prior to the 1990 recession. Based upon the Fed study, it was not hard to predict a recession beginning in the summer of 2001, or to begin to call for the Fed to preemptively lower rates at the end of 2000. Thus it was also not hard to suggest to readers that they get out of the stock market. Since rates would be going down in a recession, neither was it hard to suggest that investors load up on long-term bonds. At the end of 2000, these were profitable trades to make.

So can we conclude that because of today’s steep yield curve, there are no recessions in the foreseeable future? Unfortunately not. The current yield curve has been unnaturally distorted; the Fed is holding short rates down to 1%, and it would be nigh on to impossible for a negative yield curve to emerge, even if there were a recession in our future. Many economists are calling for the Fed to raise rates in June, allowing them to rise to a more “natura” rate of 3-3.5% -- at least 1% above inflation. Today, 10-year rates are 4.57%. Thus, if rates were “natural”, we would be seeing a yield curve that was much flatter. That means we should be paying attention... for before the yield curve goes negative, it first becomes flat. But until you see that first flicker of a negative yield curve, you do not need to worry a great deal about a recession in the near future.

In the real world, however, holding rates down below the “natural” rate will eventually cause inflation. At some point, the market forces rates up in spite of the Fed. And that is the cause of so much angst among economists and investors. But before they start to raise rates, the Fed will want to see actual evidence of inflation. What if the Fed does not raise rates until November? Could the “natural” yield curve sometime later this year be negative, suggesting a recession 12 months later? Would we be seeing a “false” positive curve because of the Fed holding rates down. The answer is that we would be in completely uncharted territory with little historical precedent. The twin deficits, record oil prices, richly valued stocks and a soaring real estate make for an interesting, if unpredictable, future.

THE HISTORY OF A CENTRAL BANKER’S SPECTACULAR FALL FROM GRACE

When John Law was faced with crippling sovereign debts in eighteenth century France he raised a mountain of successful paper money and made an entire country feel rich. He was clever, brave, charming, honest and -- for a while -- extraordinarily popular. Unfortunately he also caused virtually everyone who had any money in France to lose it, which tends to overshadow those other qualities. How it happened is worth understanding; never more so than now.

KERRY IS SEEKING BAD ECONOMIC ADVICE

Sen. John Kerry recruited two famous businessmen to what The New York Times described as his “motley team” of economic advisers. Kerry turned to Steve Jobs of Apple Computer and Warren Buffet of Berkshire Hathaway. (When Kerry said he was fighting for Jobs, we did not realize he meant Steve.) Buffett is the second wealthiest man in the world. Steve Jobs just received America’s second largest executive pay package. Both are amazingly talented at what they do. But what they do not do is economics. Until now, nobody imagined Steve Jobs had any interest in economics. Buffett, on the other hand, has sounded off on numerous topics. Unfortunately, Buffet’s paper trail makes it reasonable to conclude that Kerry approves of his views. And that could prove embarrassing.

The trouble with politicians using naysayers like Buffett as economic advisers is that such people cannot resist peddling gloom to voters who can read the headlines and see for themselves that it is utter nonsense. If Kerry is really looking for sound economic guidance, it would be best to ask a real economist. One of the best, and a self-described Clinton Democrat, is Robert Hall of Stanford. But Kerry might not grasp his enlightened Harvard-bred views on tax policy. Bob Hall, you see, is the co-author of the Hall-Rabushka flat tax.

THE MIGHTY METAL: WHY JOHN MEYERS IS CONFIDENT THAT GOLD IS SET TO SOAR

Two reasons -- or really two certainties... first of all, Washington refuses to accept a crushing deflation. Second, vast numbers of people are generating new wealth -- wealth that they will no doubt spend but also save... some of it in the form of gold bullion. With so little confidence in the dollar these days, it seems certain that some of the world’s new bourgeoisie will look for other instruments in which to stash their savings. If even just a fraction of the world’s new wealth is invested in gold, it will have an explosive impact on bullion’s price.

Meanwhile, the gold price is now hovering around the $400 level. It has also broken below what some feel is an important psychological level several times, perhaps signaling trouble. Don’t believe it. The great gold bull market of the 1970s had several corrections, one of which was of a far greater magnitude than this hiccup. Newmont Gold President Pierre Lassonde agrees with us. He also points to the 1970s to demonstrate why gold could soar in an era of what he calls a “manic-depressive dollar”. “We haven’t even started to correct the U.S. financial imbalance of the last three years,” said Lassonde. “Don’t tell me that the gold bull market is over. It has hardly even started.”