Wealth International, Limited

Finance Digest for Week of September 13, 2004


Worlds apart though they might seem, the difference between the St James’ & Pall Mall Electric Light Company ca. 1898, the then supplier of electricity to the area of London that The Economist now calls home, and the likes of Intel, supplier of chips to the world’s computers, is less than might first appear. A whizzy new technology, quickly adopted, electricity rapidly became commoditized and its price fell sharply -- as, of course, did the profits of companies selling it. In similar fashion, the remains of yesterday’s shock troops of the information revolution are rapidly becoming its weary foot soldiers; and even today’s less elevated prices contain too much hope and hype.

Both Intel and the NASDAQ index, Buttonwood avers, have further to slip, and for much the same reasons: the industry is maturing and there is thus little reason to value technology shares higher than the overall market; quite the contrary, actually. Once a growth industry, electricity companies swiftly metamorphosed into boring utilities. The same is probably true for today’s technology companies. As growth slows and competition pushes down margins, the industry is swiftly becoming commoditized.

In the early 1990s, technology spending was rising swiftly and, to many, the potential of the technology companies seemed almost limitless. Neither is now true, but only gradually and reluctantly are investors coming to realize that while new technologies can be splendid for the economy as a whole, investments in the companies that supply them are often dreadful. As Fred Hickey, editor of the High-Tech Strategist, so memorably put it: “You cannot truly be a long-term technology-stock investor because in the long term almost all the stocks are dead.” Including, alas, the St James’ & Pall Mall Electric Light Company.

Link here.


There are a number of unexploded bombs hidden in the U.S. economy, by no means all of which are George W. Bush’s fault, but all of which will have to be dealt with in the next few years. The bomb for which Bush is most directly responsible, together with the spendthrift and feckless Congress led since 1998 by House Speaker Dennis Hastert, is the Federal budget deficit. Here the problem is only partly the Bush tax cuts, both passed at a time when they looked appropriate to dig the United States out of a mild recession. I would argue that a number of features of those tax cuts, particularly the reduction in dividend taxes, the ending of estate duty and probably the reduction in the top marginal rate of tax, are relatively cheap and so beneficial for the economy that they pay for themselves.

In any case, a greater portion of the deficits has been caused not by tax cuts but by spending increases, partly due to Afghanistan, Iraq and the war on terror, but mostly due to appalling sloppiness and pork-barreling by a nominally Republican controlled Congress, none of which has been vetoed by the President, plus a couple of notoriously expensive boondoggle spending programs instituted by the Bush administration itself. That is about the end of the bombs for which the Bush administration is directly responsible, but there are several others whose ticking has become too loud to ignore. The Bush administration appears to believe that its tax cuts and spending profligacy will be bailed out by economic growth and the rising tax revenues consequent on it; the other bombs will prevent any such happy circumstance occurring.

First, there is the trade deficit, written about warningly by commentators when it hit $400 billion per annum in 2000, and again when it hit $500 billion per annum in 2002, and now apparently approaching $600 billion per annum. The excessive money creation by the U.S. Federal Reserve is also likely to cause a crisis in the near future, this one due to rising inflation. At some point the stock market will drop towards its historical average valuation level, about half where it is now -- more likely in 2005-6 than this year. Finally, there is the impending retirement of the baby boomers, scheduled to begin in 2008, but casting an increasing shadow over the financial markets as we approach that date. Even more fiscally important than reforming social security is reforming Medicare, a problem that the Bush administration has significantly worsened.

So we come to the $64,000 question: how will all these problems play out (in what order will the bombs explode?) and what if any difference will be made by the two candidates’ economic policies? Either way, the Dow Jones Industrial Index on election day 2008 will be below 5000. This is the true choice facing the electorate: between 8% unemployment, a triple dip recession, and resurgent inflation, or 10% unemployment and a damaged world economy. Either way, government will grow and your income will not. Of course, nobody is going to tell the voters that...

Link here.


When Robert Shiller, a Yale economist and bestselling author, told a crowd of finance professors and economics students last spring that only 10% of his money was invested in stocks, they gasped. Managers might suggest anywhere from 50 to 90%. But 10%? This was heresy.

How about 0 percent? That is the share that investors should plow into domestic stocks, according to Ben Inker, director of asset allocation for Grantham, Mayo, and Van Otterloo & Co. (GMO), a money-management firm with some $85 billion in assets. Welcome to a contrarian view of today’s equity markets. A small but vocal band of heretics is calling into question not only the profit potential of stocks but also the foundation for conventional wisdom about investing. Even for those who disagree with them, their arguments serve as a reality check for the market.

The problem with a “long term” buy-and-hold strategy is that investors sometimes have to be extraordinarily patient for the strategy to pay off. In 1981, for example, the S&P 500 Index stood at the same level it first achieved in 1965. Today, the index is about 30% lower than its peak in 2000. Do investors really have to put up with such long periods of losses? No, say a small contingent of money managers. By avoiding the stock market as their primary engine for profit during the past five years, several of these managers have posted good returns.

Most asset classes -- including bonds, commodities, real estate, and US stocks -- are overpriced or offer little profit potential, Inker says. “This is about as tough an environment to find a place to make money as we’ve seen.”

Link here.


With home prices rising at double the rate of wage growth over the past three years -- which many economists say could reflect bubble conditions -- the boom in housing appreciation may be slowing or even receding. It is difficult to say if a bubble is ready to burst or a mild slowdown is imminent, especially in the face of industry predictions that home sales will reach a record high this year. Whatever the case, there is no better time to consider how to prepare for the housing market’s day of reckoning.

The looming possibility of a bubble has inspired a leading financial economist to create a derivative based on home prices. Robert Shiller, a Yale economics professor and author of Irrational Exuberance, has repeatedly warned that bubbles are forming in several markets, mostly concentrated on the east and west coasts. He is also a partner in a firm called Macro Securities Research LLC, which is creating a “Macro” security that will be based on a reference index for home prices in several urban areas. Shiller’s firm will be selling the securities later this year. They will be sold in pairs to offer investors a chance to bet that home prices will increase -- or decline -- in the largest markets.

Hedgestreet is also offering trading vehicles based on housing prices, which is slated to become available to investors in October. Trading what it calls “Hedgelets” the retail derivatives exchange company will offer contracts also indexed to regional housing prices in the Chicago, Los Angeles, Miami, New York, San Diego or San Francisco metropolitan areas.

Link here.


Stock analysts and economists have talked all year about corporate America’s “strong earnings”, most of the time to argue that, in turn, stocks will go higher. Though the notion that “earnings drive stocks” is complete fiction, it is true that corporate profits and cash flow have been healthy this year. Yet have you noticed what the talking heads have not talked about when it comes to earnings -- namely, what corporations are actually doing with the money? The economic data makes it clear enough what they are not doing. They are not hiring, or increasing wages, or adding to their productive capacity. Which is to say, the business sector overall reflects none of the growth activities that characterized this stage of previous economic recovery/expansions.

Still, the earnings are going somewhere, and indeed in a very large way: Recent data (for July) shows corporate stock buyback announcements totaled $38.7 billion -- the largest total in 20 years -- and four times the typical monthly amount during the past year. What does it mean? In the view of Steven Roach (one of the few economists worth listening to), it means, “Given the stresses and strains still bearing down on the American consumer, Corporate America has remained justifiably cautious in these uncertain times. With consumers lacking in traction, businesses are in no hurry to go out on the risk curve and fill the void.”

Thus in an economic environment where the usual choices appear too risky, perhaps corporate stock buybacks appear less so. No doubt many decision-makers suppose that, if demand stays constant, reducing the “supply” of stocks will help bump prices higher. Hmmm ... nice logic in Economics 101, except today’s stock market is not a textbook. In truth, nearly all traditional valuation measures show that the market remains historically overvalued. So irony of ironies, if the stock market does what it has always done when it is this far overpriced, what seemed like a conservative means of spending corporate earnings will prove to be most reckless and risky course of all.

Link here.


An Atlanta Journal-Constitution story noted that the woes at Delta Airlines have grown so severe that “Wall Street analysts” are now bearish toward the company. Is this useful news? Can Wall Street help Delta shareholders know what to do? Is this a recommendation that arrived in the nick of time? I could be up all night writing out the answers to these questions, but then again, why use words when the price chart tells all?

This should answer the “nick of time” question. Delta (DAL) closed today at 4.13. If you were a shareholder, at what price level what would YOU have wanted to know that analysts have decided to turn “bearish”? What is more, I actually looked up two separate lists of analysts ratings. In each case the “consensus” had not changed significantly from where it was a month, three months, or a year ago. A clear majority always listed Delta as a “Hold”, “Buy”, or “Strong Buy”. A much smaller percentage listed the stock as a “Sell” or “Strong Sell”.

Do these ratings matter? Well, something persuaded a lot of investors and institutions to buy Delta. During the past three months, shares purchased ran nearly two-to-one ahead of shares sold (34.2 vs. 18.3 million). During this period, Deltaafs shares lost more than one third of their value. If the “analysts” who cover a stock turn “bearish” only after a stock loses most of its value, what is the difference between them and the average investor who throws in the towel long after it is too late? Nothing -- because they are both part of the same psychology. On the other hand, once you understand that psychology, you can put it to work for you.

Link here.


Mary Meeker, the Morgan Stanley research analyst dubbed “Queen of the Net” during the boom years of the late 1990s, has broken her silence, speaking of her regret for the millions of small investors who lost money when the internet boom crashed. Ms. Meeker was one of a handful of analysts including Henry Blodget of Merrill Lynch and Jack Grubman of Salomon Smith Barney who became celebrity cheerleaders for internet and technology firms. As the internet fell out of favour, so did they.

In an interview with Newsweek she said she still feels guilty. “People did lose money on the stocks that I recommended and I’m sensitive to that. I wish we would have downgraded them, and I’ll have to live with that the rest of my life.” Ms. Meeker says the internet remains a good investment long term. “As far as the internet is concerned we’re still in the second inning.”

More on this story here.


Come high water, low water or underwater, anything but hell, Greenspan will raise interest rates by 25 basis points at every meeting for this year -- 2004. Then, he will stop, survey the price deflation his policies have wrought, shrug his shoulders and keep raising rates until the Fed Funds rates are around 4%. Worse, if the economy begins to slow (which it clearly seems to be), expect him not to move slower but faster. This is heresy to the conventional bond/stock portfolio manager. He/she has been conditioned to think (based on the last 10 years) that interest rates rise only due to rising inflationary pressures. He/she associates low interest rates with weak economic growth rates and higher interest rates with higher economic growth rates.

Interest rates though are too low by any measure conceivable other than a deflationary, depression like environment. A 1% (now 1.5%) Fed Funds rate is without precedent in contemporary economic history. The Fed Funds rate is usually at least 1% above the level of recorded inflation, however measured, and should be at least 4% given current inflation of 2.5% to 3%. The Fed is determined to get back to this level in a measured fashion. For now, that means a 25 bps increase in rates at every meeting until it gets to a “neutral” Fed Funds rate which is likely to be between 3% to 4%.

Investors continue to doubt Greenspan. Greenspan has been unequivocal. He has consistently said that rates are too low. They must go up. He has not associated levels of economic growth with the increase in rates. The only ponderous question he has offered us is: At what speed do I raise interest rates? Quickly? In some “measured" fashion? The financial markets have chosen to ignore his unequivocal statements that interest rates are headed higher. Instead, they continue to interpret interest rate moves based on the strong economy/high interest rate weak economy/low interest rate heuristic.

Interest rates are headed up at a faster pace and to higher levels than what the bond/equity markets are currently anticipating. Portfolio managers and investors have forgotten that the rate cuts of 2002-03 were made in an environment when (it seemed as if) the real economy and financial markets were entering a deflationary/illiquidity death spiral. Unless those conditions are replicated, rates will go up at every single Federal Reserve committee meeting until they are 1%-2% above inflation indicators. I have been saying this for some time now and now other people are echoing some of these arguments. Do investors truly believe that a 4% Fed Funds rate for next year is implausible? For those wrapped in such serene clouds of implausibility, an implausible market decline wiping out the gains of 2003 and 2004 beckons.

Link here.


Back in 2000, I wrote an article for The International Economy titled “The Great Experiment.” The focus of the analysis was the nuances of contemporary finance, in particular the ramifications for unchecked growth from the government-sponsored enterprises (GSEs). Four years later, sufficient data and observations from this “experiment” warrant an update and further analytical examination. From January 2000 through May of this year, Fannie Mae and Freddie Mac’s combined “books of business” (retained portfolios and guaranteed mortgage-backed securities sold into the marketplace) have ballooned 77% to $3.66 trillion. According to Federal Reserve “flow of funds” data, total mortgage debt has increased 93% to $9.62 trillion, jumping from 61% to 84% of GDP in seven years.

Total mortgage borrowings expanded $1.0 trillion or 12 percent last year, with 2004 on track to surpass 2003’s record. For comparison, mortgage debt increased on average about $200 billion annually during the first eight “pre-bubble” years of the 1990s. The nation’s average price of existing homes sold has increased 28% over three years and 48% over the past six years. In California, median home prices were up an astonishing $97,530 during the past twelve months (through May) to $465,160. Golden State home prices have surged 46% over two years, and 129% over six years, in what has developed into one of history’s spectacular asset inflations.

The GSEs have played the instrumental role in the development of a historic mortgage finance bubble. And while the GSE debate tends to concentrate narrowly on the values of the federal subsidy and the implicit government backing of agency debt, the broader -- and crucial -- issue of the consequences of a momentous expansion of mortgage finance is neglected, if at all recognized. Reminiscent of the late-1990s manic stock market environment, the issue “Is housing a bubble?” has become a hot topic for the media, investment analysts, economists, and policymakers. Federal Reserve Bank of New York economists Jonathan McCarthy and Richard W. Peach recently concluded that “there is little evidence to support the existence of a national home price bubble.” Yet, their article -- and Federal Reserve research generally -- ignores what should be the focal points of bubble analysis: credit growth, speculative finance, marketplace liquidity, and various financial and economic distortions.

Analyses of the GSEs and mortgage finance should begin with an appreciation for the extraordinary capacity of key lenders these days to issue unlimited quantities of new liabilities (chiefly, agency and asset/mortgage-backed securities) with no impact on the market’s perception of these instrument’s “Triple-A” quality status. Indeed, it is a defining characteristic of contemporary Wall Street “structured finance” that virtually inexhaustible quantities of risky loans can be transformed into perceived top-quality, safe and liquid securities. This alchemy is dependent upon a daisy-chain of explicit and implicit guarantees, credit insurance, liquidity agreements, and the expansive derivatives marketplace.

The GSEs are very much the nucleus, while the market’s faith in the Fed and Treasury to stand behind Fannie, Freddie, and the FHLB provides the backbone of this peculiar market structure. These days, GSE and Wall Street securities fabrication has supplanted the government printing press as the paramount source of monetary inflation. Examining the nature of lending, it should be clear that contemporary “money” is today increasingly comprised of agency securities and agency-related instruments, along with Wall Street structured products. To ignore asset inflation, speculative finance, and bubble dynamics is really to disregard the very essence of contemporary finance and economics. In reality if not by statute, the GSEs evolved to attain the all-powerful status of quasi-central banks.

Above all, abundant and unabated credit and liquidity creation fueled home price inflation. Furthermore, the GSE’s aggressive securities purchases have played a definitive, yet surreptitious, role in the explosion of derivative positions. Mushrooming derivatives markets have, in turn, played an instrumental role in the historic ballooning of GSE and mortgage debt generally. The major problem is that the larger GSE balance sheets, mortgage debt, speculative leverage, and derivative positions balloon, the less viable the entire hedging (“portfolio insurance”) mechanism becomes. I am therefore left with the disconcerting view that the GSEs have evolved into the linchpin for a massive mortgage finance bubble encompassing endemic -- and eventually untenable -- financial sector leveraging, speculating, and derivative trading.

Yet the ramifications of the mortgage finance bubble are anything but confined to the financial arena. Indeed, the bubble’s effects on the real economy may very well prove the most intractable. Mortgage credit excess and asset inflation today foster household over-borrowing and over-consumption. Investment decisions are similarly distorted. Regrettably, we are witnessing a replay of the late-1990s telecommunications and technology boom-and-bust experience, where a surfeit of speculative finance fosters destabilizing over-spending in the “hot” sectors. No less an authority than Alan Greenspan proclaims confidence that the market pricing mechanism will function over time to innocuously rectify U.S. imbalances. Analysis of the nature of bubble dynamics, however, leaves one anything but complacent.

I made the case four years ago that uncontrolled GSE excess posed a threat to our policymakers’ strong dollar policy. I today advise that the U.S. mortgage finance bubble creates a clear and present danger to the stability of our financial system and economy, as well as the soundness of our currency.

Link here.


It is amazing how things can change in just a few decades. Take 1934. Back then people did not buy the idea that stocks would always go up, even though real-live Academic Research said they would. At least Benjamin Graham was not buying it. In fact, he blamed the exceptional enthusiasm for stocks in the late ‘20s on all that research that showed that, “It was only necessary to buy ‘good’ stocks, regardless of price, and then to let nature take her upward course.” In his 1934 classic, Security Analysis, Graham examined this line of reasoning with the patience of a science teacher explaining why people used to think the sun revolved around the earth.

Holy cow!, how things have changed. Just this morning a perfectly reasonable looking gentleman was explaining to CNBC viewers how academic studies have proven that stocks go up over the long term, and if you do not buy stocks then you might as well admit that you are an anti-academic Luddite, who probably still uses spray-on deodorant so you might as well just go back to asking your Ouija board to look for lottery numbers. This difference in sentiment is especially striking when you consider that Graham’s book was published about the same time past his market peak as the CNBC guest was speaking after our market peak.

Of course, this very comparison is not exactly academically rigid since we do not know if anyone other than Graham (and maybe his good buddy Dodd) scoffed at the investing (at any price) for the long-term mantra. But for the purposes of this article, we will assume that after getting crushed like bugs in the stock market crash, investors in the early to mid-‘30s were at least somewhat gun shy. Not so today. Investors enjoy running out and buying stocks, comforted that they will provide fine performance eventually. We do not even need academic research to know this. We know this because retirement plan providers are launching a new product with this sentiment as its very premise.

The product is called an “autopilot 401(k)”: employees will automatically be enrolled in the company 401(k) when they become eligible, unless they sign a form to “opt out” of the plan. However, it is not the automatic contributions, but the way promoters are talking about how investments can be handled that reminds us just how warm and fuzzy stocks still seem. That is because some plans will not only take the money, they will fix the asset allocation. The “appropriate” asset allocation, of course, will include stocks. The plan can “...automatically put the participant into the appropriate lifestyle funds as he or she gets older.” A lifestyle fund, as all cutting edge investors know, is a fund of funds that allocates bond and stock exposure based on the age of the participant, i.e., how long his/her “long term” is. The problem, of course, is that not all long terms are equal. This chart shows how some long term periods, when it comes to the stock market, are better than others. Whether or not automatic lifestyle investing turns out to be profitable for investors, the lifestyles of 401(k) providers should improve since they will have more money under management -- automatically.

Link here.


A good book tells a good story, and I especially admire writers who can tackle a complex subject and still tell a compelling tale. Roger Lowenstein’s When Genius Failed: The Rise and Fall of Long-Term Capital Management comes to mind, as does J.K. Galbraith’s The Great Crash 1929 (though I disagree with Dr. Galbraith’s general view of government). In these books, and a relative few others like them, the authors cut through a jungle of facts and keep the reader caught up in the narrative instead of excessive details.

Yet I wonder if any one mortal will have the time and wisdom to make sense of the stupendous financial web that has spun out of all forms of debt and credit in the U.S. economy in recent years. Who will be gifted enough to tell the story, should the markets and the economy all go wrong in an epic debacle?

Did you know that even credit card debt is now “pooled” into securities (usually bonds) and sold to investors? So are second mortgages, car and student loans, etc. etc. Sales of these consumer bonds “this year through early September totaled $324 billion, compared with $306 billion is corporate bonds,” according to the Wall Street Journal. Yes, “‘consumer bonds’ this year are on a pace to outsell U.S. corporate bonds.”

Imagine: unsecured debt sold as a “security” -- a security! -- with institutions and individuals now holding billions of dollars of these “investments”. What happens to these “securities” for second mortgages if the real estate bubble bursts? No one knows; there is no precedent for the scenario in history. What happens to them if interest rates skyrocket? No one knows; there is no precedent.

Link here.


The traditional “defined-benefit” pensions, in which employees have a passive role, contrasts with the more recent “defined-contribution” plans, such as the 401(k), which give employees an active role. “Active” in theory, anyway. The conventional wisdom assumed that more control over more choices would produce bigger nest eggs and a more prosperous retirement for millions of households, which explains the great migration into 401(k) accounts that began during the 1980s. Some 115,000 U.S. firms had traditional pension plans in 1985; about 31,000 did as of 2003. In contrast, “only a tiny fraction of households had 401(k) accounts” in 1983, but “by 2001, about 62 percent of older households had one,” according to The New York Times.

The story continues: “Retirement benefits today, particularly the 401(k) account, simply are not worth as much as the older kind of benefits.... The sweeping change in employee compensation appears to be the reason, according to new research by Edward N. Wolff, an economist at New York University who analyzed 18 years [1983-2001] of household financial data collected by the Federal Reserve.

“When Mr. Wolff looked at the net worth of the median older household the ... figure declined by 2.2 percent, or $4,000, during the period.... For a generation to emerge from two bullish decades with less wealth than its parents had ‘is remarkable,’ Mr. Wolff said. Based on economic growth and market returns over those 18 years, he said, their wealth ‘should be up around 30 or 40 percent.’”

What is more, there is no evidence that people took more “active control” of their retirement funds even during the three-year bear market (2000-2002); if anything, the data suggests the opposite. The average contribution from employees into their 401(k) was 7.8% in 2002; in 2003 it was 8.1%. Only 17% of employees made any change in their asset allocation in 2002; in 2003 the percentage was about the same.

Link here.


Property prices in Hong Kong have risen faster than in any other country featured in the global house price survey undertaken by the Economist magazine, it has emerged. According to the publication’s quarterly survey, which studied property market data in 20 countries, house prices in Hong Kong recorded an annual gain of 28.7% last year. South Africa and New Zealand recorded the next highest gains at 25.5% and 22.1% respectively.

The study found that house price growth was in double digits in eleven of the 20 countries examined, with prices now at record levels relative to average income in several, including: the US, the UK, Australia, France, Ireland, the Netherlands, New Zealand and Spain. Nonetheless, three of the countries featured, namely Germany, Singapore and Japan, managed to buck last year’s global trend and record declines in average house prices.

For Hong Kong however, the figures represent a dramatic comeback for the territory’s property market, which has undergone a sustained slump for almost a decade -- including a 17% decline in the year previous to the study -- and overall values in the city are today on average 55% beneath their 1997 levels.

Link here.


“Out of debt out of danger” is an old proverb that says it all. It applies to personal debt as well as to the liabilities of business and government. It may even pertain to the world monetary order and the U.S. dollar standard that rests on mountains of debt. They cast dark shadows not only on the dollar itself but also on American economic conditions. The world monetary order consists of a large assortment of national currencies all of which are fiat money. They are made legal tender by the decree, or fiat, of their governments. The U.S. dollars we know are money because the courts say they are legal tender and we accept them. Internationally, they have no legal status but are readily used because of their relative prominence and good repute. As the world’s most popular money, they have become “standard” money. Unfortunately, it is a precarious standard that may soon sink in the quicksand of debt.

The Federal Reserve manages the standard in utter disregard of basic principles and laws of economics. It blithely and routinely ignores market rates of interest that limit the demand for loan funds to the supply of savings. It prints money and creates credit at will, allowing member banks to borrow new funds at one percent and then relend them happily at 4, 5 or even 6 percent. Its bargain rate induces financial institutions to extend new credits not only to the federal government itself but also to business and consumers. Guided by popular notions of the benefits of money creation and driven by political concerns, Federal Reserve governors take pleasure in keeping their interest rates far below market rates in order to stimulate and activate the economy, thereby creating bubbles of debt.

During the great stock market bubble of the 1990s, growing current-account trade deficits signaled a rapid flow of American funds abroad. Between 1992 and the first quarter of 2002 they moved in payment of the annual excess of imports over exports of goods and services actually rose to some $500 billion or 5% of GNP.

A world economy that labors under such chronic imbalances with goods and services flowing to the biggest and richest economy and its fiat money drifting to poorer countries is highly unstable. Some foreign observers even call it “perverse”; for this reason, they are searching for new ways to sustain global activity that does not rest on a growing mountain of U.S. debt. But they need not search far; inexorable economic principles are bound to force a correction.

Link here.


Gold and Economic Freedom, by Alan Greenspan ... ca. 1966

Since the beginning of World War I, gold has been virtually the sole international standard of exchange. Gold, having both artistic and functional uses and being relatively scarce, has always been considered a luxury good. It is durable, portable, homogeneous, divisible and, therefore, has significant advantages over all other media of exchange.

But if all goods and services were to be paid for in gold, large payments would be difficult to execute, and this would tend to limit the extent of a society’s division of labor and specialization. Thus, a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) that act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend and thus to create bank notes (currency) and deposits, according to the production of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security for his deposits). But the amount of loans which he can afford to make is not arbitrary: He has to gauge it in relation to his reserves and to the status of his investments.


It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly re-established a sound basis to resume expansion. But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline -- argued economic interventionists -- why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely -- it was claimed -- there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of 12 regional Federal Reserve banks nominally owned by private bankers, but, in fact, government sponsored, controlled and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. [And the rest is history ...]

Link here.

The Liberty Dollar

We all know that the dollar does not buy what it used to. But few people know that in 2001, the purchasing power of the U.S. dollar was only 4 cents compared to the 1913 dollar -- the year the Federal Reserve was created. This fact is not election year hot air; it comes from the U.S. Department of Labor Statistics. Few people also know that the U.S. federal debt was “only” $6 trillion in 2001, according to the U.S. Department of the Treasury. Fewer people know that at the beginning of this year -- in only three short years -- the national debt was over $7 trillion dollars and the purchasing power of the dollar had dropped to about 2 cents. And worse, in the past three months, the U.S. government has added an alarming half a trillion dollars to our money supply.

A half of a trillion dollars, from where? Based on what? Of course, based on debt, as that is the sole basis of the U.S. dollar. In a world where our government has no monetary discipline, are they free to create money out of nothing? No, they create it out of debt, by further indebting the people -- you and me. So how much is the U.S. dollar worth today? Who knows? But it has got to be less than the proverbial “two cents”. The real concern is what happens as the purchasing power nears zero. And if that is too esoteric for you, then at least the speed of the dollar’s decline should be a major concern.

I know we can trust history, because neither man nor his government has changed -- I know we need to protect ourselves because the government will not protect us. How can I be so absolutely sure? Because they cannot. They and their undisciplined money are the problem. Of course, buying silver like Buffett, Gates and Soros is good for everyone, just like it was in Weimar Germany. Silver’s bull market will be much, much better than gold’s, just as it was in 1979-80 when it appreciated 10 times, while gold only doubled.

So what is the solution to the very real prospect of a monetary meltdown? How in the world can we head off such a climatic end to the American Experiment? While consumers should protect themselves with silver, that will do nothing for our great country or the rest of the world that now holds U.S. dollars as its “reserve” currency. We, the people of America, need to think of protecting our constitutional government from itself as much as protecting our money. Enter the American Liberty Dollar. ...

Link here (scroll down to piece by Bernard von NotHaus).

A 1-Ounce “Libertad” silver coin minted by Mexican mint is proposed.

The last Mexican economic debacle of 1994-1995 prompted my search for monetary stability. Intuitively, I first thought of gold, but I reached the conclusion that the enmity of the United States and of the IMF toward the monetization of gold would make that avenue a dead end. Therefore, I took the alternate route, a plan to monetize silver, a metal of which Mexico is the world’s No. 1 producer. Mexico’s history is inextricably linked to silver money, since silver minted in Mexico was the world’s most important money for centuries. I should point out that the U.S. silver dollar, as defined in the Constitution, is based precisely on the characteristics of the “Ocho Reales” coin minted in Mexico.

The Mexican audiences that I have addressed in the last nine years have enthusiastically received my idea regarding the introduction of silver into circulation. It is too early to say whether or not my plan will come to fruition, but there are hopeful signs.

I believe that the only road to a monetary system that permits the survival of industrial civilization is one that retraces the steps that carried us to our present state. Paper money was introduced after real money already existed. For a time, paper, gold and silver money circulated together, side by side. Overextending and mismatching credit finally resulted in the creation of such large amounts of paper money that real money became an obstacle to further creation of paper money. I believe that we must go back the way we came, by reintroducing real money to circulate in parallel with paper money.

I do not believe that the world’s monetary and financial system can be reformed; any attempt at reform would decimate the world’s economic activity instantly. There is no alternative: We have to let the world’s monetary and financial system proceed to its own destruction; we cannot “go back to gold”. What we must therefore strive for, as much as possible, is the reintroduction of silver or gold -- or even both -- into parallel circulation with the fiat paper money we presently use everywhere. Eventually, the world fiat money system will destroy itself through its inherent defects.

Link here (scroll down to piece by Hugo Salinas Price).


The unusual strategy adopted by the Federal Reserve in the summer of 2003 for stoking the U.S. economy without cutting interest rates was a clear success, researchers at the U.S. central bank have concluded in a new study. The study, led by Fed Governor Ben Bernanke, says the central bank managed to exert powerful effects on interest rates merely by promising to keep the key short-term federal funds rate low for a “considerable period”. Those influences were at least five times stronger than the average effect of actual interest-rate changes since 1991.

By July of 2003, the Fed had dropped the federal funds rate to a 45-year low of 1 percent without generating what it could consider a “sustainable” economic recovery. The policy makers decided at that point to stop cutting interest rates. They switched instead to a strategy that Bernanke and his colleagues call “policymaking by thesaurus”. For the first time in its history, the Fed began to make public statements about how it might change interest rates over a horizon beyond six to eight weeks. On Aug 12, 2003, the Fed’s monetary-policy committee announced that it believed “the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.”

For the next five months, the committee retained the “considerable-period” promise. Then it began to tinker with the language, making subtle changes that slowly altered the meaning of the promise. In late January 2004, the Fed’s Open Market Committee dropped the phrase “considerable period” and replace it with an assurance that the Fed could be “patient in removing its policy accommodation”. In May, the language shifted again -- the committee said it believed policy accommodation could be removed “at a pace that is likely to be measured.”

In their study, Bernanke and his co-authors provide hard evidence that the Fed’s ability to steer the economy often depends far more on what it says than on what it does with interest rates. Moreover, they say, the Fed’s “considerable-period” maneuvers had an even bigger effect on longer-term interest rates than previous statements of the FOMC. “Shaping investor expectations through communication does appear to be a viable strategy,” Bernanke and his co-authors, Vincent Reinhart and Brian Sack, concluded. The maneuvers had other salutary effects as well, the study says. They “reduced the volatility” of public expectations of Fed policy, allowing investors to make more accurate guesses about the timing and magnitude of Fed interest-rate changes. They even taught investors how to accurately adjust their expectations in response to new economic data.

Link here.


Mark Twain, in an unverified quote, once described a mine as “a hole in the ground owned by a liar.” Using that definition, a horde of liars were in Las Vegas last week to pitch their projects and bright prospects to hundreds of gold geeks who attended the Gold & Precious Metals Conference. While most mining company pitchmen and women were putting attendees to sleep with talk of drill samples, stripping ratios, and proven-and-probable reserves, investors perked to rapt attention to hear gold newsletter writers and prognosticators tell them which of these liars were worth investing in and where the economy is heading.

The star of the conference was day two’s keynote speaker, James Grant. Grant, perhaps the finest wordsmith in financial journalism, is the editor of Grant’s Interest Rate Observer and author of four books on finance and financial history. Grant is a devotee of the Austrian school of economics and often refers to the work of Mises, Rothbard, Menger, and Ropke in his books and newsletter. Grant told the standing room audience that he is a “gold believer” and though he thinks the price of the metal will go up he is an “expert at not knowing when.”

Gold competes against other currencies, Grant reminded the crowd, “with one arm tied behind its back.” While investments in other currencies pay interest, gold pays none, a huge disadvantage. “Every time I look at a compound interest table I am startled anew,” Grant deadpanned. While not paying interest, gold is an “investment in historical truth.” Being long the yellow metal is essentially being short Alan Greenspan and the Federal Reserve. The most powerful central bank in the world has never been more revered than it is currently. But, when Grant hears central banker, he thinks government employee. When he hears rate setting, he thinks, price fixing. “How could the Fed know what the interest rate should be?” Grant asks.

Despite a hesitant Fed, Grant believes that a generational bear market in bonds began in January of 2003. All bond bull and bear markets are generational, Grant says, and coincide with the life cycles of monetary systems. But as far as what the bond market will do next week, next month or next year, Grant is an agnostic. America’s trade, current account and budget deficits will ultimately undo the dollar’s credibility. The only collateral for the dollar is the American persona. The dollar is only “supported by an idea,” Grant told the crowd, “but will the idea hold up in the face of adverse arithmetic?” Grant is betting no.

Link here.


January saw this year’s highest price levels in the stock market, because from there the trend has been mostly lower. Apart from the past month, April and June saw the highs of the only notable rallies in 2004. The rise into the April peak lasted only two weeks, while the decline that followed took back all of those gains and more. The June highs concluded a climb that lasted some five weeks -- yet from there, the major indexes once more fell to new lows on the year.

And along with gains that gave way to steep declines, these two failed rallies have one more thing in common: A rapid rise in bullish sentiment. In each case, a sentiment index that we watch closely spiked upward even more vigorously than the market itself did, which indicates just how quickly market psychology can still turn bullish.

Which brings us to the rally that began just over a month ago. It is the third real rally of 2004; and, like its two predecessors, it has seen the same rapid climb in this sentiment index, yet to an even higher level. What does this mean?

Link here.


Calling the consumer a “miracle worker” might be a bit much, especially when compared to a human genome decoder or people who understand the coffee menu at Starbucks. But we consumers, if not miraculous, have hardly exhibited normal behavior by keeping spending going longer than the noon line at the post office. This chart is just one illustration of the mighty consumer. Normally you would expect the year-over-year change in consumer spending to decline now and then. In fact, before the New Financial Era (B-NFE) consumer spending actually faltered in economic downturns. These days, the economy, whatever that is, can do whatever it wants, but we consumers are going to keep spending. And so far, we have been increasing spending longer than in any period on the chart. Hooray for us!

Just how impressive are we? We’re so good that according to the Wall Street Journal consumer-oriented asset-backed bonds will probably outsell corporate bonds for the first time in world history [also see You Call That a “Security”?? above]. If you include mortgage backed debt, all consumer related debt now accounts for almost one-third of the entire bond market’s outstanding value -- vs. 29% for government and agency debt.

Of course, we cannot take all the credit. The refi-boom helped a little. Okay, it helped a lot, at least according to this chart which shows retail sales going up in Olympian fashion during the multi-year refi wave. The refinancing boom, of course lowered everyone’s interest rates so we could use all that money we saved to pay our mortgages off early, and prudently reshape our personal finances ... or buy TVs the size of garage doors. And the great thing about the NFE is that we do not have to wait, wait, wait while until we save up enough to waltz into Best Buy and say “That one.”

Curiously, both the change in retail sales and overall consumer spending have peaked now that the best of the refi-boom is behind us. This may be less of a coincidence than our Fed Super Chairman wants to believe. When you think about, as banking expert Sarel Oberholster obviously did when wrote this piece, we consumers can take out the Really Big Cash Out Loan only once. But after the Really Big Loan, bad things happen, at least if you are a Fed Chairman’s pulling for eternal GDP growth. 1) We have start paying back the Really Big Loan. 2) Our spending falls off a cliff the next year. So with the refi boom and the new kitchen behind so many of us, could the growth lines on the retail and consumption charts dart below the zero line? After all, that would be normal. But in an economy that relies on consumer spending, normal might be a problem.

Link here.


Florida, which has lured more retirees and vacation homeowners than anywhere else, might be losing some appeal for the same reason it is so beautiful: its place in the tropics. Florida’s hurricane-prone geography might be a growing liability. The poundings it has taken recently from hurricanes Charley, Frances and Ivan -- with millions evacuated and millions left without power -- are making some people think twice about buying property or retiring in a state so vulnerable. If government meteorologists are right, significant weather changes mean Florida will be seeing more hurricanes and more destructive hurricanes in decades to come.

Tony DosSantos, 54, a federal employee in New York, is reconsidering plans to retire to the Sunshine State. Florida was high on his list of dream places to move to with wife RoseMaria. But Arizona, with its dry heat and quiet desert, now tops his list. Recent hurricanes convinced him he does not want to spend his golden years fleeing life-threatening storms.

Aside from the fear factor, shoppers are finding that real estate in much of Florida is no longer so cheap to buy and own. Florida has no state income tax, a big draw for prospective buyers. But in some areas, home and condominium prices last year jumped 20% or more amid record-low mortgage interest rates, strong housing demand and investor speculation. Past hurricanes already have roughly doubled insurance premiums statewide. In southeast Florida, premiums have at least tripled since Hurricane Andrew, the nation’s costliest natural disaster, damaged or destroyed 130,000 homes 12 years ago.

John Talbott, author of The Coming Crash in the Housing Market, notes that baby boomers buying vacation and retirement homes are helping drive up prices, but he thinks the hurricanes might give some pause. “Such a devastating natural disaster would have to make some of them rethink their choice of location,” he says. State officials are quick to point out that Florida has weathered numerous hurricanes in the past and continued to prosper.

Hurricane Andrew was followed by a decade of spectacular growth in southeast Florida, fueled in part by billions of dollars in insurance payouts. But during that decade, southeast Florida was repeatedly spared a direct hit from a major hurricane. Southeast Florida became the glamorous address of choice for sports, film and music stars. Miami Beach enjoyed a renaissance, with condo towers reaching new heights and “South Beach” becoming a metaphor for everything hot. But the nation’s top meteorologists say this season’s storms are not a fluke. Scientists say subtle changes in ocean temperatures and winds are likely to make Florida’s annual hurricane season -- from June through November -- worse in coming years.

Florida, with a vulnerable coast increasingly packed with homes, hotels and condominiums, could be at risk of much greater property damage and loss of life in the next two decades. Frances and Charley together have done about $11 billion in insured damage so far this season. Ivan’s damage is yet to be tallied, and hurricane season is not over. More hurricanes would surely raise the price of paradise: higher building costs due to stricter building codes, higher insurance costs and more storm evacuations.

Link here.

Insured losses from Hurricane Ivan could hit $7 billion.

Insured losses in the United States from Hurricane Ivan’s assault on the Gulf Coast could run from $2 billion to $7 billion, a risk assessment company said Thursday as it slightly reduced its estimate of the cost of the deadly storm. Risk Management Solutions said maximum winds of 110 mph to 130 mph at landfall were lower than expected and the hurricane’s track limited the worst damage from storm surge to barrier islands southwest of Pensacola, Florida. RMS, which markets catastrophe risk management products and services to insurers, reinsurers, trading firms and financial institutions, estimated before Ivan made landfall that insured damages could range from $4 billion to $10 billion.

Link here.


In the parched desert of dismal prospective returns around the world, Japanese stocks have stood out as a veritable oasis. And, unlike just about every other rich-country market, the Japanese market has actually gone up this year. But some of the recent numbers coming out of the country, which have been dreadful, have necessitated the sort of questioning that in times past would have called for a packet of fags. To be blunt: is the oasis in fact a mirage?

Recent numbers provided yet more ammunition to those who think Japan’s recovery is unsustainable. There are still lots of them, and they wield arguments aplenty: the high price of oil, a lack of domestic demand and the consequent reliance for growth on exports to China and America, two countries that are not without problems of their own. And, in the background, a sclerotic, corrupt and pitifully ineffectual political system, which has failed Japan so spectacularly in the long years since the popping of the bubble. The bond market, which has been right for all of that time, is again registering its despair. The 1.5% yield on the 263rd issue of ten-year bonds, though triple what it was in June of last year, is still a lot less than almost all of its predecessors, and down from 1.9% a few weeks back.

As Arnold Schwarzenegger might say, the present lot of Japanese government debt traders are a bunch of economic girly-men. Yes, Japan has its problems, but its economy is on the mend. Odd though this may sound to those hardened in the Japanese school of disappointment, the surprises for investors in the country’s stockmarket are more likely to be of the good sort, not the bad. The Japanese establishment, as one economist put it rather neatly, has run out of stupid things to do to wreck its economy, and the “problems” that Japan has -- huge and growing exports -- are problems of which the likes of America can only dream.

Which is partly why the GDP figures look so odd. Perhaps they can be safely ignored: after all, Japanese economic statistics tend to be dodgy. Depending on what numbers you look at, profit margins are either higher than at any time since the bubble burst, or their highest of modern times. ompanies have used a lot of this money to pay off all of those debts they piled up in the bubble years. Japanese corporate balance sheets are now in their best shape in decades, and at some stage in the none-too-distant future companies will have the confidence to start investing a lot more than they have done in recent years. That is when the virtuous circle could really kick in -- when companies start to invest and hire again in earnest, consumers will start to spend again.

True, by the standards of other countries’ stockmarkets, Japanese equities are not a giveaway: Topix, the broad stockmarket index, trades at a price-earnings ratio of some 19 times this year’s earnings. But by the country’s own standards, they are mouth-wateringly cheap: in each of the rallies of the 1990s, the p/e was four times that.

Link here.


Howard Bensema, 74, is paying the price for years of prudence. He does not like debt, and for more than three decades he has managed to live without it. He has not had a mortgage since the 1970s. He paid cash for his last two houses. He also paid cash for his cars, including the 1902 Oldsmobile he restored and displays at auto shows. Bensema has a spotless driving record, too, and is meticulous in paying bills. “I have paid on time or ahead of time for more than 50 years,” he says.

While Mr. Bensema’s habits are laudable, even inspiring, in our debt-laden times, in the eyes of his insurance company, they make him a credit risk. Since the first of the year, he has been wrangling with his insurer and the state insurance commission. Given his history, he feels he deserves the lowest possible rate, but he is not getting it. The problem is that he has no recent history of borrowing money and paying it back. That means he has no verifiable credit and a minuscule credit score. In citing its reason for denying him a better rate, his insurer listed the reason as “total credit less than optimum.” So because his debt is zero, Bensema pays more for insurance than those in hock.

Most credit scores are compiled from a scoring model known as FICO, which was developed in the 1980s by the rating company Fair Isaac. FICO scores range on a point scale from 300 to 850, with higher scores indicating lower credit risk. But here is the problem for Bensema: To generate a score, a person must have at least one account that has been open for six months or more and at least one account that has been updated in the past six months. For people like Bensema who live outside the credit nation in which so many of use are mired, scoring amounts to an unfair penalty. It imposes rules of a game they have refused to play.

Now those ratings are affecting not only our ability to go further into debt but to get basic services such as telephones and electricity. In some cases, employers use them to evaluate job applicants. Credit bureaus say scoring has created a impartial numerical guide for granting credit by removing human error from the process. Actually, it removes all humanity from the process. It creates a veil behind which companies can hide without taking responsibility.

Link here.


One has to appreciate, in theory and in practice, Alan Greenspan’s genius, at least in the Machiavellian sense, and how it has been used in the financial markets to drive the real economy. Indeed, many notable economists, financial market participants and the press, are now acknowledging how the Fed has used asset bubbles in stocks, bonds, and housing to facilitate the continued household spending of borrowed money. This has created a false sense of wealth and has kept the economy rolling with no savings.

What is becoming crystal clear is that if the United States’ bond and stock markets suddenly “re-priced to fair value”, the world would witness a crash in stocks, bonds, housing prices and the dollar. This inevitable re-pricing, caused by unsustainable Treasury and Trade deficits, will be fiercely and politically delayed, at all costs, until after the November election. Also, the extent to which the Treasury and Fed can use legal but undisclosed Exchange Stabilization Policies is not widely understood by the financial markets. More importantly, while the magnitude of aid -- amounting to $1.3 Trillion -- given to America’s financial markets by foreign central banks has been disclosed, it is not appreciated that these holdings will most likely keep US Treasury rates 3% lower than they would be if the Treasury needed to fund its deficits within the US.

Evidence of the government’s “active hands” in the markets continues to grow. First, there is the manipulation of the gold market that has been solidly documented but not widely disseminated in the press. Beginning under the Clinton Administration, the dollar has been made to look strong by holding down the price of gold. Second, evidence also appears in the stock market’s strange but predictable behavior. Whenever the markets look like they are about to crash, major buying suddenly appears at the regular scheduled times during the day to keep the stock indexes from breaking down below major psychological barriers. We do know that Greenspan understands and uses psychology to try and create a self-fulfilling prophecy when it comes to the markets. He understands that if he is telling the world one day that the economic recovery has “traction” and the next day the stock market goes south, any economic recovery would suddenly be history.

You might wonder where the really big market manipulation is. Simply look at the Federal Reserve’s Foreign Custodial Account. Since 2001, it has risen by $700 billion to $1.3 Trillion today. This is a record! All this money has been printed up out of thin air by foreign central banks to buy United States’ Treasury debt and support the dollar at a far higher level, and hold US longer term interest rates at a lower level than they would be without this direct and unprecedented market manipulation. (When it comes to central banks, the polite word for manipulation is intervention). This intervention, which holds the value of the dollar up and interest rates down, also makes bond and stock prices artificially high. In turn, artificially high asset prices encourage consumers to spend and not save.

From the perspective of a prudent investor who is interested in the preservation of capital, two choices seem obvious. The first choice is to use the foreign central bank intervention as a window to get out of US stocks, bonds and the dollar. The second choice is to study with Navajo Indians to learn the secrets of their “rain dance for money” and perform it for the foreign central banks.

Link here.
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