Wealth International, Limited

Finance Digest for Week of November 8, 2004


Wall Street is full of “experts” that tell investors sure-fire ways to get rich in the market. Day-trading, buy and hold, trend trading, no-loads mutual funds, buy the dips, blue chip stocks and on and on and on. There are a zillion different ways to make money according to the experts. But few want to tell you what NOT to do. Here are the Top 15 ways we have seen people lose money in the market. Many of these strategies overlap and many investors employ more than one at a time. Of course, they are not guaranteed to lose you money, but I am sure if most investors work at it, they can find a way.

  1. Do nothing.
  2. Change strategies often.
  3. Hold onto losers.
  4. Act with the crowd on news.
  5. Buy hot/trendy/theme stocks.
  6. Ignore fundamentals.
  7. Focus on costs at the expense of quality.
  8. Read everything you can on investing (and suffer information overload).
  9. Chase yield.
  10. Let taxes determine when you to sell.
  11. Don’t know what you own.
  12. Ignore cycles.
  13. Don’t have a bear market strategy.
  14. Try to buy at the bottom, wait to sell at the top.
  15. Avoid professional advice.
Link here.


We have been gleaning facts “brick by brick” in order to write this story on the housing market and what it all means for Wall Street and the economy. The story is simple: While the Federal Reserve is slowly raising interest rates, it is our observation that the housing price bubble is already bursting of its own accord.

The size of the housing bubble should not be underestimated. In middle America, housing prices are up 44% over the past 5 years while in the momentum markets, such as Las Vegas and Southern California, annual “price pops” of 20% to 40% have commonly been recorded until just recently. Housing is big business. In 2004, about 8 million new and used homes will sell with a total transaction value of $1.9 to $2 Trillion. Mortgage debt will rise about $800 billion to $7.5 trillion by the end of this year. The increase in mortgage debt represents the spending that the Bush Administration needed to keep a $12 trillion economy moving forward.

The good news is that home ownership rose 2% to an all time record of 67.2%; the bad news is what had to be done to get it there while the labor force participation rate has dropped 2%! In other words, easy credit and record low interest rates have boosted home sales. In previous economic cycles, the boost to home sales came from rising incomes and more jobs! Long gone are the days when a borrower borrowed what was considered a safe, prudent amount that they could actually pay back. Today, the borrower takes every penny that lenders will lend. In turn, lenders have “gone crazy” because at the end of the day, the lender is not lending “his” money.

President Bush signed the “American Dream Down Payment Act of 2003”. This legislation authorized $200 Million per year in down payment assistance to at least 40,000 low-income families. His goal was to increase the number of minority homeowners by at least 5.5 million before the end of the decade. A first time home buyer whose income is 20% less than the local medium income qualifies for the greater of $10,000, or 6% of the cost of the home, to buy it! Thus, sub-prime borrowers have influenced home ownership rates considerably. Sub-prime mortgages have a terrible record. At least 16% are delinquent or in foreclosure, and 4.6% are actually in foreclosure. With easy money allowing home prices to rise, fraud has become a way of life in the mortgage market because every participant makes a commission or fee if the mortgage closes. The higher the house price, the bigger the mortgage!

Looking back at the facts, it is easy to see that the foundation for housing prices is rotting fast. Buyers have stretched the truth, in every possible way, in order to buy the most expensive house for the lowest possible monthly payment. Given the fraudulent loan underwriting and emphasis on Adjustable Rate mortgages and sub-prime loans, it is clear that any rise in mortgage rates will bury housing. At the high end of the housing market, there are reports of “Yuppie Fatigue”. Super-sizing homes also super-sizes the heating and utility bills, insurance and maintenance costs. Million dollar home foreclosures are picking up.

In the general housing market, 5% to 6% of homes already have more debt than home value, and homeowners are loading up with home equity loans and lines of credit. Currently, wages and salaries have not kept up with inflation despite “economic recovery”; bankruptcies will hit another all time record in 2004; 45% of workers have total net assets of less than $25,000 (including the value of their house) and less than 4 of 10 workers save anything. All of these facts were in place well before oil and natural gas prices headed north for the economic winter.

In Las Vegas there is an unfolding house price debacle. Homes that sold for $750,000 just three months ago are across the street from homes that the same developer is selling today at a nice profit for $550,000. In the U.S., the supply of new homes has risen steadily to a 275 day supply. If home lenders would only read history they would know that from 1975 to 1995, on average home prices rose only 0.4% and with prices sagging now, they should ask for a larger down payment, and fast, or they will be facing big losses. In a market where housing prices are flat, it takes a 15 to 20 percent down payment to protect a lender against loss.

What would a rational down payment mean for housing prices? Today, a buyer who can scrape up $20,000 for a 5% down payment can afford a home priced at $400,000. If you ask him for a 10% down payment, he can suddenly only afford a home costing $200,000! Rational down payments will force housing prices down.

Link here.

Home equity loans double ... again.

Not many people pay attention to bank credit and the money supply, but the Federal Reserve sure does. In fact, if you visit its Web site, you will discover that the Fed tracks enough money and credit data to make your brain explode (unless you are an economist, in which case the damage is already done). Now, the Fed goes to these lengths, because it is supposed to “control” the money supply. Yet this control is simply a means to a greater end for the Fed -- namely, to expand credit. A growing money supply normally means growing deposits for financial institutions, which means -- presto -- more lending and borrowing, i.e. the expansion of credit.

And make no mistake: there has been borrowing aplenty, notwithstanding the slow economy in recent years. Consider home equity. Fed data shows that July 1997 was the first time the total amount of home equity loans reached $100 billion. And it took more than five years for that figure to double, not reaching $200 billion until September 2002. How long do you think it will take to double again? Don’t blink, you might miss it when it happens. The total amount of home equity loans stood at $381 billion on October 20; in other words, homeowners are on pace to convert $400 billion of their assets into debts by the end of this year. What does it mean? Well, it reflects the acceleration of the trend toward reckless levels of debt, as we have often discussed.

Link here.

Same bubble, new indicator.

There is something about a roaring stock market that gets humans so excited that we cannot help but draw up plans to build taller buildings. Maybe it is because businesses is so good. And business is good because we are so smart. And since we are smart today, and will be even smarter tomorrow, business will get better and better. Surely such a great business not only deserves its own skyscraper, it deserves one that is the World’s Tallest. Unfortunately, about the time everyone agrees that building the World’s Tallest Building is a good idea, the stock market crashes. The 1929 stock market crashed about the time plans for the Empire State Building were finalized.

Basil Chapman evidently spent some time researching the Skyscraper Indicator. Mr. Chapman’s examples include the Chicago’s Home Insurance Building in 1885, the Reliance Building in 1894, and New York’s Flatiron Building in 1902. And do not forget that the Sears Tower and the World Trade Center ushered in the worst of the 1970s. Prior to the 2000 market crash, plans were laid to construct Europe’s tallest building in the U.K. Upon further review, the scope of that project has been dramatically downsized. Emerging market investors should note that the latest incarnations of the World’s Tallest Buildings are in the works in China and India. Last summer, ground was broken on New York’s Freedom Tower, which is set to be the World’s Tallest, at least for a while.

Victor Niederhoffer and Laurel Kenner remind us that sticking a 7-story video screen on the side of a building can be just as ostentatious as building the World Tallest Skyscraper, and was just as good an indicator. The Nasdaq’s $37 million video display was unveiled just a few months before the Nasdaq crash.

But what about the other bubbles? What, for example, might signal the top of the mortgage finance/housing bubble, other than the fact that every waiter, musician, truck driver and scientist have quit their jobs to become either mortgage bankers or realtors? If there is such an emergency flare signaling the peak of the housing bubble, surely it is the Highest Dollar Home Purchase indicator (HDHP), and right now that metric is waving with both hands and screaming. That is because a residence in Palm Beach, Florida just sold for a reported $70 million. “Casa Apava” (Spanish for “Giant Real Estate Commission”) beats the old record by $20 million. The annual property tax payment of $663,971 is based on the pre-sale assessed value of $33 million. The property sold for just $1 million at auction in 1993 because the owner could not keep up payments.

The indicator gets even more indicative. The buyer of Casa Apava is reportedly Dwight Schar, chairman of NVR, a company that happens to be the 8th-largest home builder in the country and a major mortgage banking player. Mr. Schwar ranks 5th on Forbes magazine’s list of top-paid CEOs. The only thing missing is the ghost of Paul Revere on horseback, riding through gated communities yelling, “The top is in, the top is in.”

Link here.

A new reality TV show will follow real estate speculators as they buy, fix and “flip”.

It is one thing to buy a house to call home. It is quite another to buy property with the sole purpose of turning around and reselling for a profit. It is called flipping, and in the coming months, a dozen aspiring real estate investors experience this firsthand -- on camera, no less -- as they attempt to buy, remodel and sell property within a period of six months. Flipping is the subject of an upcoming reality television series with the working title “Property Ladder”, scheduled to appear on The Learning Channel in May 2005.

“Everyone you talk to seems to know someone who has tried to flip property,” said Char Serwa, the sho’qs executive producer. In California, where most of show’s subjects are buying, 2.6% of all houses sold during the month of May were owned for less than six months, according to DataQuick Information Systems, up from 1.9% the previous year.

The homeowners featured on the show are not only footing the bill for the property and the cost of renovations, they are managing the projects on their own. Unlike other TLC makeover shows, seasoned carpenters and designers will not be pitching in to help. What the show’s subjects do get is advice from host Kirsten Kemp, an actress, real estate agent and seasoned property investor. Whether the homeowners actually take that advice is another story. Viewers, meanwhile, may likely learn a few lessons as well, namely that buying, remodeling and selling property is hard work -- particularly when done in a matter of months.

Link here.

Denver area foreclosure rate “scary”.

Almost 10,000 metro-area real estate foreclosures have been filed in the first 10 months of this year, eclipsing last year’s tally. And only a technicality prevented that number from exceeding 10,000. That is because at least two counties -- Denver and Arapahoe -- decided not to hold foreclosure sales during the week before Christmas. Even without every foreclosure being counted, 9,930 foreclosures were opened through October, 28.4% more than the 7,731 in the first 10 months of 2003.

“That’s scary, really scary,” said Anita Dubas, acting chief public trustee for Denver.

Last year’s foreclosures were surpassed only by the 17,122 foreclosures filed in 1988. Foreclosures last year accounted for about 1 percent of the homes on the market, compared with 2.3% of the housing stock in 1988.

Link here.

Commercial real estate deals are hot and heavy, but the talk is of a bubble.

Some real estate investors and analysts say that recent rich deals are a sign that the commercial real estate market is dangerously overpriced. “This feels very much like the last couple of months of the Internet bubble,” said Larry Jay Wyman, the co-chairman of HRO Asset Management, a company that represents a German fund that invests in American real estate. Many investors seem to be making unrealistic assumptions about future market conditions, he said. “People keep saying this is a new paradigm,” said Mr. Wyman, who estimates that he has evaluated about 100 deals in recent months. “As soon as you hear those words, you grab your wallet and get out of the room as fast as possible. A building can only produce as much net rent as its market will allow.”

Despite high vacancy rates, cheaper rents and the pressure on landlords in most markets to make ever-sweeter concessions, the trading frenzy in commercial real estate has continued unabated. Sales of industrial, retail and apartment properties valued at $5 million or more approached $44 billion in the third quarter of this year, reaching a level that was 10 percent higher than any other quarter on record, according to Robert M. White Jr., the president of Real Capital Analytics, a New York research company.

At a time when interest rates remain low and the stock market is performing tepidly, many investors are willing to accept relatively low returns on real estate because they believe they have nowhere else to put their money, investors and analysts say. Expected initial yields, known as capitalization rates, have dropped two percentage points in the last three years, to 7.7%, said Robert O. Bach, the national director of market analysis for Grubb & Ellis. “People are willing to pay more per dollar of income,” he said. “No doubt about it, real estate is expensive, compared to five years ago. Some investors may be overbidding.” But he said there were also signs in many places that the office buildings were slowly beginning to rent empty space.

Fueling the feverish trading is the availability of enormous amounts of capital from both domestic and international sources. Mr. Wyman said his HausInvest Global fund alone had $1.5 billion to invest. “It used to be that if you had a billion dollars to spend, you were a pretty popular guy,” he said. “Now you’re just one of the herd with a billion dollars.”

Link here.

Bank of England predicts house prices will fall.

House prices are set to fall, the Bank of England said in its first acknowledgement that Britain’s overheated property market is finally cooling. Mervyn King, governor, presenting the Bank’s latest Inflation Report, said, “In terms of when it [the decline] might start, I suppose you can say ‘last month’ because you’ve already seen some signs of falls,” adding, “It is the first time we’ve made a statement like this.”

Mr. King said the downward adjustment of house prices relative to incomes might continue for two to three years, although the outlook for prices was “extremely uncertain”. The Bank previously predicted house price growth would slow to zero over the next two years. Economists said the Bank’s comments might bring an even quicker reversal in prices. Estate agents have already blamed milder comments by Mr King in the summer for the sluggish market this autumn.

Mr. King said falling house prices were likely to have little effect on the economy because consumer expenditure growth had not risen over the past five years as house prices had surged. Mr. King also stressed that falling house prices were unlikely to lead to a slump because the three conditions that led to the crash in the early 1990s, large rises in unemployment, sharp increases in interest rates and a deep recession, did not exist. The tone of the Inflation Report convinced analysts and investors that the Bank was less likely to increase interest rates again.

Link here.


At least once a month, a fresh economic number comes out -- and surprises everybody. In the U.S., the just-released October jobs number was “well above most economists’ expectations, as most analysts had predicted yet another monthly slump” (WSJ). Have you ever wondered why these “surprises” are... well, so routine? The obvious answer is, “because we are human, and we all make mistakes,” but could there be more to it? We think so. Economic numbers often catch conventional economists off guard because they forecast future trends based on where those trends have been in the past.

Not even the biggest conventional economic think tanks are immune from this way of thinking. In a recent article titled “Global Financial System is Shock-Proof, Says IMF,” an IMF official told The Guardian, “It would take a major and long-lasting shock to upset a financial system [that is] now capable of riding out the collapse of a hedge fund or even a leading bank. It is hard to see where systemic threats could come from in the short term.” What made the IMF make that “shock-proof” statement? An “upbeat assessment of recent trends,” says The Guardian.

The problem with this approach is that it works only while the “trend is your friend”. But at market turning points, it is useless. Worse than useless, in fact, because the stronger the previous trend has been, the more conventional economists believe it will continue. And the resulting “surprise” takes everyone by storm.

Link here.

Treasuries and the dollar: a pattern of “surprises”?

The two biggest moves in Treasury notes and bonds this year came when most market participants least expected it: The plunge down from the March price high, plus the rally that followed the reversal from the May low. Both moves unfolded contrary to the sentiment among investors and in the financial media.

Much the same is true of U.S. Dollar Index. The greenback did not have a friend in the world as 2004 began; yet upon hitting a major low in February, prices took off on a powerful three-month rally. Then, as sentiment turned favorable and prices reached the highs for the year in May, the Dollar Index promptly reversed itself.

And now? In the Treasury market, one sentiment index we follow just registered its second-highest bullish reading on the year. As for the Dollar Index, if anything it has even fewer friends now than it did nine months ago; the U.S. dollar’s lows against the euro have even managed to show up on The Drudge Report. We follow sentiment closely in these and other markets, in concert with the all-important Elliott wave patterns as they unfold on the price charts. Once again, we have strong evidence that Treasuries and the Dollar Index are about to produce another surprise.

Link here.


Charles de Gaulle famously resented America’s paramount position in the global economy of the 1960s. The U.S., he complained, enjoyed an “exorbitant privilege”. Because its currency, the dollar, served as the world’s reserve asset, America could live beyond its means, unconstrained by the periodic shortages of foreign exchange that haunted other, less privileged nations. Nicolas Sarkozy, France’s spirited finance minister, wants to inherit de Gaulle’s mantle as president of the fifth republic. Though somewhat smaller in stature than the great general, both physically and politically, Mr. Sarkozy seems to share his outsized resentment of America’s economic privileges.

Mr. Sarkozy has more to envy than de Gaulle ever had. Today’s America lives beyond its means more flagrantly than ever before. Its government will spend about $427 billion more than it raises in taxes this year. The nation as a whole is running a deficit of $571.9 billion on its current account with the rest of the world. These twin deficits, Mr. Sarkozy points out, weigh heavily on the dollar. The currency’s fall, interrupted in February, has resumed (see chart). On Monday November 8th, it plumbed a new low against the euro of a whisker under $1.30. Only if America restrains its deficits will the markets regain confidence in the dollar, Mr. Sarkozy warned.

Mr. Sarkozy no doubt fears that his American counterparts are quite happy to watch the dollar fall. America’s net overseas liabilities amounted to 23% of GDP at the end of last year, close to the record debts it amassed in 1894. Crucially, the bulk of these debts are denominated in dollars. Thus America may be sorely tempted to dishonour its dollar debts, not by defaulting on them, but by devaluing them.

The immediate casualties of such a policy would be America’s East Asian creditors. To avert a depreciation, Asian central banks would have to amass ever greater holdings of dollars. But this would only expose them to greater capital losses down the road. Alternatively, they might seek to avoid the consequences of a dollar fall, by diversifying into other reserve currencies, such as the euro. But that would only bring the dollar crashing down all the more quickly.

Despite this dilemma, it was Europe’s Jean-Claude Trichet, president of the European Central Bank (ECB), who described the dollar’s fall against the euro as unwelcome and “brutal”, repeating the melodramatic language he adopted in January. But why all the worry? In some ways, the stronger euro will do Mr. Trichet’s job for him. It will contain euro-area inflation, which has remained stubbornly above the ECB’s ceiling of 2%. It will offset the higher dollar price of oil -- last month’s worry du jour. It is true that the dollar has never been weaker against Europe’s single currency since its birth in 1999. But as recently as 1997 it was weaker against a basket of the 12 currencies out of which the euro was fashioned. Back then, no one described the dollar’s movements as brutal. Indeed, at times it seems that European resentment of America’s privileges is a little exorbitant.

Link here.

Can Asia dump Bretton Woods II as dollar falls?

President George W. Bush’s second term may be a challenging time for Asian central bankers. With the dollar hitting an all-time low against the euro, traders are betting that Bush may add to the $412.6 billion U.S. budget deficit, increasing the pressure on the dollar to decline. And unlike during the last three years, the brunt of the dollar’s fall may not be borne by Europe alone. Bank of America says China may allow its currency to fluctuate in a wider range as early as the first quarter of 2005. Together, the two factors -- record current account and budget deficits in the U.S. and a possible appreciation in the yuan --may lead to stronger Asian currencies next year.

The adjustment could mean an end to the current system of semi-fixed Asian exchange rates that has been termed the “Revived Bretton Woods”, or “Bretton Woods II” (BW II). BW II is supposed to be a re-embodiment of the Bretton Woods arrangement, a post World War II system in which the U.S. was obliged to pay gold at $35 an ounce to its official foreign creditors. Other countries pegged their currencies to the dollar. Whereas the original Bretton Woods system collapsed in 1973, its replacement is seen as an ongoing and mutually beneficial agreement between the U.S., which is the world’s financial “core” and Asia, which is its “periphery”. The periphery is allowed to expand its exports by keeping its currencies cheap, as long as it supplies capital to the core to pay for its spending excesses.

At the heart of BW II is China’s 200 million underemployed rural population. And even if this reserve of labor were gone, India is ready to graduate to the periphery with its vast supply of underemployed workers. If it is in the interest of Asian central bankers to keep a lid on their home currencies until every surplus worker in rural China and India has found a job in an export factory, then why should there be a change in Asia’s currency policy in the next four years of Bush’s presidency?

There are strong reasons. On the U.S. side, the issue is political. Jobs are at stake. A weak dollar is “ultimately what the economy needs,” says Bill Gross, the chief investment officer at Pacific Investment Management Co. On the Asian side, the reason why the region must now choose to live with higher currencies is inflation. And another important reason why Bretton Woods II may have to be dumped, is that the current global financial system can be sustained only if Asian central banks act as a cartel and keep their existing and future reserves in U.S. dollars. There is, however, no formal cartel. As a result, every Asian central bank will want to protect itself against an erosion in the value of its assets from a decline in the dollar. All central banks may be better off if no bank tries to diversify its reserve holdings, but as the risks of dollar depreciation grows, each central bank has an incentive to defect and to try to protect itself from losses.

Link here.

Dollar decline gathers momentum.

The U.S. currency has been weakening for much of the past year, pressured by worries over the U.S.’s record $427 billion budget deficit. But the pace of the dollar’s decline has picked up since President George W. Bush -- whose heavy spending has pushed the U.S. finances into the red -- was elected to a second term in office last week.

The weaker dollar will make European and Asian exports more expensive, and hence less competitive, in the U.S. Analysts warned that this could seriously dent the European economy, which relies on exports for much of its growth amid sluggish domestic demand. The euro is now up by 57% from its all-time low of $0.82, recorded in October 2000.

Link here.

Canadian dollar surges past 84 U.S. cents after Bank of Canada Governor comments.

Canada’s dollar rose past 84 U.S. cents for the first time in more than 12 years after David Dodge said export gains have spurred economic growth even as the currency surges. His comments boosted speculation he will keep lifting the target interest rate to cool the economy. Exports comprise 40% of Canada’s economic output, and a rising currency makes exports cost more. The Canadian dollar has risen 10% in the last three months, the most of the 16 major currencies.

Link here.

Weak dollar less of a boost to U.S. exports than in past.

The dollar has been weakening against world currencies recently, a development that usually makes U.S. goods more competitive in global markets and helps sales. But increased global competition, greater reliance on imported raw materials to make U.S. products, China’s continued peg of its currency to the dollar and weak economies abroad may make the recent dollar depreciation less of a boost for U.S. businesses than it has in past periods of dollar declines.

There is one sector of the U.S. economy that does seem to be benefiting from the weaker dollar: tourism. And the weak dollar has not dampened Americans’ plans to go to Europe this year, says Neil Martin, who publishes the Trans-Atlantic newsletter. Traffic has risen every month this year from a year ago, although it has not surpassed the record levels seen in 2000, he says. Airline deals -- such as round-trip fares between New York and London of about $200 -- are persuading people to go despite higher prices, he says. Cheap airfares help vacationers justify bigger hotel bills, and many are buying packages to lower their hotel tabs.

Link here.

The dollar’s uncertain cushion.

With sentiment turning decidedly bearish against the dollar, concerns about a rapid meltdown have intensified. But analysts say any precipitous declines are likely to be halted by foreign central banks, and that a steady, orderly selloff is more likely.

While George Bush and Sen. John Kerry both had plans that would have increased the deficit over the next 10 years, analysts said Kerry’s proposals would have faced challenges in a mostly Republican Congress. Bush, on the other hand, has broad support for making his tax cuts permanent and partially privatizing Social Security. Both of these plans would add trillions of dollars to the budget deficit. In addition, analysts say, the Bush administration has pressured the greenback over the past year by adopting a policy of “benign neglect”. “Some think deficits don’t matter,” said Richard Berner, chief U.S. economist at Morgan Stanley. “History indicates that what matters is committing to fiscal restraint, which is hard to find in Washington.”

Former U.S. Treasury Secretary Robert Rubin warned that the dollar’s decline could become more serious and that interest rates could rise sharply if steps are not taken soon to narrow the deficit. Still, Ashraf Laidi, chief currency analyst at MG Financial, said, European and Asian central banks are likely to buy dollars and sell their own currencies, or at least hint that intervention is coming, if the depreciation in the dollar gets materially worse over the coming days and weeks.

In addition, while rumors have swirled that China has been selling dollars recently and is ready to switch to a flexible exchange rate, some say that is not the case. China’s renminbi is pegged to the dollar. “My sources in Beijing were unanimous in underscoring that nothing has changed,” said Stephen Roach, chief global economist at Morgan Stanley. “While Chinese officials may now be preparing the way for a regime change that may come sooner rather than later, nothing imminent appears to be in the cards.”

Link here.


Third-quarter corporate operating earnings are 22% greater than earnings stated according to generally accepted accounting principles (GAAP), according to USA Today, citing data from Standard & Poor’s. That is twice the 11% difference between operating earnings and GAAP earnings during the second quarter, which in turn was more than twice the 5% difference during the first quarter. “Anytime you see the spread getting wider, it should raise a red flag,” said Reuters Research analyst Ashwani Kaul.

Although the gap is the widest it has been in two years, USA Today also pointed out that since 1988, operating earnings have averaged 21% greater than GAAP earnings. In addition, the SEC’s Regulation G, enacted in 2003, makes it more difficult for companies to hide “special charges” that enable them to report higher operating earnings.

Another measure that may deserve a second look concerns “earnings surprises”. The Wall Street Journal reported that 64% of the S&P 500 beat their earnings estimates for the third quarter, but Goldman Sachs chief sector strategist David Kostin is not so impressed. Kostin, in line with common wisdom, believes that companies frequently guide analysts to an earnings number that they feel they could beat -- say, by a penny per share. He prefers to define “earnings surprise” as a result that varies by more than one standard deviation from the analysts’ estimate. After examining 422 of the S&P 500 companies, Kostin found that only 36% had what he defines as a positive surprise in the third quarter. In the second quarter, of the 420 companies that had reported earnings by the same time, 46% had a positive surprise.

Link here.


U.S. regulators stepped up a probe of at least 12 firms including Merrill Lynch & Co. and Charles Schwab Corp., examining whether the brokers profited at customers’ expense when trading Nasdaq stocks. The SEC referred the firms to its enforcement unit for further investigation and possible sanctions after an audit earlier this year found that the brokers may have failed to get customers the best prices, said the people, who asked not to be identified.

“If the brokerage industry would actually quit pretending that they have the client’s interests at heart, maybe they wouldn’t get into trouble,” said John Gavin, president of SEC Insight, a corporate research firm. “Mainstream brokers want you to believe that ‘Buyer, you can trust us,’ but really the sign should say ‘Buyer beware.’” In some cases, the firms themselves took the other side of customers’ trades, rather than offering them to buyers or sellers in the open market, the people said. In other cases, brokers routed trades to firms that paid for a steady flow of orders.

Link here.

S.E.C. warns Amex leaders it may file civil charges.

The S.E.C. has notified the top three executives of the American Stock Exchange that they may face civil charges of failing to properly enforce the exchange’s rules. The commission has warned Salvatore F. Sodano, the exchange’s chairman and chief executive; Peter Quick, the president; and Michael J. Ryan, the general counsel, that it may bring complaints against them. Such a warning, known as a Wells notice, gives an individual the opportunity to defend the actions cited; regulators could still choose not to bring a complaint.

The Amex executives are being investigated in connection with an S.E.C. investigation into the exchange’s regulation of its options trading, an area that has been a persistent thorn in the side of the exchange. Giving notice of pending civil action to executives at the highest levels of an exchange is highly unusual, and it appears to indicate that regulators are concerned about whether the Amex can effectively police itself. One senior trader who has worked on the floor of the Amex for more than 20 years but who asked not to be named because of his long-standing ties to the exchange said many were shocked.

In June 2003, a report by the S.E.C. said that the Amex had routinely overlooked rule violations by its traders and had tried to cover up those regulatory shortcomings by submitting false reports to the commission. Amex’s failure to enforce its own rules violated an earlier settlement struck between the S.E.C., the American Exchange and three other exchanges in 2000 regarding the handling of certain option orders.

Link here.


Pablo is a good man to know. Educated at Stanford and Harvard, he used to travel the world running mining operations for BHP Billiton. No more. Pablo has staked his own future on cheap copper in Argentina. One thing you learn in Argentina is that nearly everything local is really cheap. For example, I had a ham and cheese sandwich and a Coke at Havanna’s, a coffee shop one block from our ritzy Alvear Palace hotel. The sandwich and Coke cost me eight pesos... or less than $3.00. And that was in the fancy part of Buenos Aires. In the town of Posadas, near the good timberland, three bucks will get you a full steak dinner at a nice restaurant.

Natural resources are cheap and plentiful too. Pablo’s Northern Orion is a partner in Alumbrera, a world-class copper mine where copper is mined cheaper than anywhere in the world. Literally, the net cost of production is zero, or (unbelievably) less... thanks to gold being a byproduct of copper production.

I visited a farm, La Adela, which is owned by one of Argentina’s leading agricultural companies. One of the company’s strategies has been to buy up “marginal” farmland and then increase its value many times over by making it productive through modern technology. This business happened to already be positioned in the right place at the right time. Marginal farmland is now booming in Argentina. As an example, they sold two pieces of farmland in the latest quarter, totaling roughly 70,000 acres. It had acquired both within the last 10 years. The combined U.S. dollar profit on the sale of both was roughly 300%. This was not an anomaly... The company also happens to own a “marginal land” farm in the Northwest of Argentina called Los Pozos. This is roughly 600,000 acres, acquired at $4 an acre. They took tumbleweeds and turned it into productive farmland. This company makes a strong case that thousands of the productive acres at Los Pozos could soon be worth 50 times what they paid for it... you would not believe it, unless you were there.

The farmland boom in Argentina is on. What is driving it? There are many factors. You have got higher food/commodity prices worldwide. You have got Argentines who do not want to invest their money in paper assets or put it in the banks. (Remember, their wealth in the banks was frozen for 60 days just a few years ago.) So they are buying farmland, and now shiny new tractors. They are buying real assets. And then there is the new source of demand for what Argentina has... from the Chinese.

Look, there is China hype, and China reality. There is dumb money and smart money. There is what China knows Americans are willing to pay any price for, and there is what China is willing to pay any price for. We want to make sure we are invested in the second half of each of those sentences above, and avoid the first half. I don’t want to get caught on the wrong side of investor whims. And I don’t really want to put my money in China, as if history is any guide, chances are I will get out less than I put in. I do want to buy a cheap asset with extraordinary intrinsic value, waiting to be unlocked... when nobody else in the world is buying it.

Link here (scroll down to piece by Steve Sjuggerud).


Merck has lost its coveted AAA long-term debt rating, amid growing concerns over the likely costs from the withdrawal of Vioxx, a best-selling painkiller. The move is a blow to Merck, long regarded as a blue-chip that prides itself on scientific research, eschews acquisitions and rigorously reports unadjusted net earnings every quarter. It also underscores the growing credit risk posed by litigation and regulatory investigations. Only six non-financial U.S. companies now hold AAA ratings.

Vioxx, an anti-inflammatory drug often used for arthritis, was withdrawn from the market on September 30. An internal study had found the painkiller doubled the risk of heart attacks and strokes after 18 months use. Merck’s record of contesting adverse clinical data, even as Vioxx was being enthusiastically marketed, have made the company the target of a federal criminal investigation by the U.S. Justice Department and an informal inquiry by SEC.

Although the creditworthiness of U.S. companies has generally been improving this year, the number that have seen their credit ratings cut as a result of litigation risks is also on the rise. Some 13% of all U.S. downgrades this year by Moody’s are linked to legal or regulatory concerns, more than double last year’s 6 percent.

Link here.


According to the Office of Federal Housing Enterprise Oversight report on Fannie Mae, the company has for the last several years followed a policy of choosing the accounting treatment of their huge portfolio of derivatives trades only after a few weeks, when it knows which way interest rates have moved in the interim -- thereby either recording a profit or deferring a loss. In 1998, $200 million of derivatives losses diverted out of the profit and loss account by this means increased that year’s Fannie Mae profits just enough to hit the earnings per share target set by the Board of Directors, and move top management’s bonus pool from no bonuses to maximum bonuses. Further investigation will show whether the similar distortions of proper accounting in 1999-2003 had similar effects on those years’ management bonuses. Since bonuses in Fannie Mae are a substantial multiple of base salary, this was not insignificant. I leave it to your own judgment and that of the SEC as to whether it was outright fraud.

Fannie Mae is important because if there is indeed $15 billion of water in its capital base, about a third of its stated capital, the U.S. taxpayer is seriously at risk in a housing downturn. There would seem no good reason why a company whose sole rationale is to place a quasi-Federal guarantee on home mortgages should be part of the private sector at all, certainly not accumulating a $900 billion portfolio of home mortgages in its balance sheet, capitalizing itself three times as aggressively as any commercial bank would be allowed to, and rolling the dice.

Entrepreneurship in performing Fannie Mae’s core function is simply encouraging a taxpayer rip-off; the company should be set up not to permit it. CEO Raines, paid $12 million last year, could be replaced with a member of the Government’s Senior Executive Service, whose maximum basic pay in 2004 is $158,100. The saving, as Fannie Mae’s advertising nauseatingly re-iterates, could provide cheaper mortgages for America’s Homeowners.

The Fannie Mae problem is symptomatic of a wider ailment in the U.S. corporate system, the excessive remuneration of top management, and its over-dependence on achieving earnings numbers that can be and are manipulated. Professor Michael Jensen of the Harvard Business School propounded in his seminal 1979 paper “Theory of the Firm: managerial behavior, ownership costs and agency structure” and in a number of other writings during the 1980s the thesis that management remuneration needed to be tied more closely to achievement of earnings goals and increase in shareholder value. Since this thesis promised to lead to more money for top management, it was eagerly accepted by U.S. business, and has led to a spiraling in management remuneration, all of it justified by apparent achievement of shareholder goals.

The increase in management remuneration has taken two forms. One is an explosion in the use of stock options, which gained rocket fuel in 1995 from the U.S. Senate, led by Senator Joseph Lieberman (D.-Conn), successfully preventing the FASB from bringing their cost onto the income statement, where it should properly be counted. The other remuneration explosion has taken the form of cash bonuses, frequently a large multiple of base salary, awarded on the basis of achieving budgeted earnings targets for the year. Both budgets and earnings results are accordingly manipulated by management, and the result has been a catastrophic decline in the quality of U.S. corporate accounting. Fannie Mae is just one example of this.

Jensen himself has been appalled by the results of the revolution he caused, has spoken out against excessive stock options, and in 2001 issued a research paper “Paying people to lie: The truth about the budgeting process” which claimed that abolition of counterproductive budgeting behavior could increase productivity and shareholder value by as much as 50-100 percent. Sorry, Professor, it may well be too late; you should have thought of this problem the first time, and not placed excessive reliance on the questionable integrity of U.S. top management.

Link here.


The Federal Reserve defines the trade-weighted dollar as “a weighted average of the foreign exchange value of the U.S. dollar measured against a subset of the broad index currencies that circulate widely outside the country of issue.” What that means, is they look at the countries with which we trade and create an index based upon the average of their currencies. The more we trade with a specific currency, the more “weight” it has in the index. That is why the euro can rise 50% and the dollar only fall some 25%. The currencies of Japan, Mexico and Canada are in the index, as well as that of China. The dollar has risen recently against the peso, is flat with China and has not moved all that much in terms of many of our Asian partners. The euro has taken the brunt of the declining dollar.

I am still bearish on the dollar and will explain why in a few paragraphs. But before we start, let us take a deep breath. The dollar falling is not the end of Western civilization. It is not some calamitous event that will shake the United States to its core. A drop of over 40% went unnoticed by most of America in the late 80’s and 90’s. Unless you were traveling overseas, you did not see much difference. The economy grew fairly well throughout the period. Inflation continued to fall. It will have consequences, of course, but it is far less important than the problems a secular bear market will have upon our portfolios. It is, however, a trading opportunity. The valuation of the dollar is a symptom, not the problem.

Secondly, we should take note that currencies are the one market in the world where profit is not the end game. In stocks, bonds, commodities, real estate and anything else that moves, the object is to make a profit. Currencies are a manipulated market. They are manipulated by the central banks of sovereign nations, who make decisions about what the level their own currency should be for the own economic and political purposes. That makes them volatile and very difficult to predict in the short term. In the long term, the markets work. But it can be much longer than most people think. Now, with those caveats let us proceed.

There are many reasons to be concerned about the dollar, but the number one reason is the trade deficit. A Fed study shows that any time a country gets to a 5% trade deficit, there follows a sharp correction (usually 20-30% or more) in the value of its currency. We have been there for some time, and are going higher. The rising price of oil almost guarantees the deficit will rise. Why have we not seen such a correction? As noted above, governments for their own benefit, manipulate currencies. There are governments who believe it is in their best interest, at least for now, to keep the dollar propped up.

If the Fed raises rates too far, too fast, it will slow the economy and bring on a recession. If it keeps rates low, it risks inflation and a falling dollar. Members of the Fed have let it be known that a little inflation buffer is not a bad thing if it is the price of protecting us from deflation during a future recession. Inflation, however, is not good for a currency. But the Fed does not care about the dollar. They will not willingly watch the economy wilt in an effort to protect the dollar. The only central banks interested in protecting the dollar are across the Pacific Ocean.

Link here (scroll down to piece by John Mauldin).

How high can the euro rise?

The euro was launched Jan. 1, 1999 at 1.21 to the dollar. It “promptly” (over a few years) fell to a low of $0.82. Today it is at $1.27 and change. The British pound and the Swiss franc have traded roughly in concert with the euro. I have been in London, Paris and Geneva this past year. I am amazed at the prices of ordinary items in terms of dollars. I wonder: How can people afford to live? $25 to take a family of four to McDonalds? $2 cokes in the stores and $6 cokes in the hotels in Geneva? Yet, the “locals” do not think much about it. In terms of their currencies, there has been little inflation. Things roughly cost the same as they did a few years ago. While we have seen gold go on a tear in dollar terms, there is no bull market in gold in Europe.

Our trade deficit is far higher than it was almost three years ago when the euro started to rise. Can the euro rise another 50%? I seriously doubt it. Such an imbalance in the world would reap a harvest of trouble. It could rise another 20% to above $1.50. While a long way from $0.82, in one sense, this would not be far from the value of $1.21 that the European Central Bank originally placed on the euro.

Long-term currency moves are not one-way, and they can be quite volatile. While I am still reasonably confident that the dollar drops over the next few years, there will be more years like 2004 in front of us. I would not be surprised to see the euro go back to $1.20 before it gets to $1.40. These things ebb and flow. Speaking of ebb and flow, the dollar is not on some permanent downward path. It will find a bottom, probably ridiculously low, the trade deficit thing will get sorted out and then the dollar will start to rise. As an example, I think Europe has more long-term structural problems than the U.S. (I am speaking in terms of decades, not years) and would not be surprised to see the dollar and the euro at parity in 10-15-20 years. The more things change...

Link here.

Short view 105

Where is George Soros when you need him? With talk emerging of European Central Bank intervention to drive down the euro, and Asian central banks trying to maintain their pegs against the dollar, the stage seems set for a battle between the authorities and the markets. But in 1992, Soros took on the Bank of England which was trying to hold up the value of a currency. Currently, central banks are trying to hold their currencies down.

When a central bank is trying to support its currency, it relies on its stock of foreign exchange reserves. Eventually, these will run out. That gives speculators a target. But in theory, the central banks have infinite ammunition to force their exchange rate down. They can simply issue more and more of their currency in order to buy dollars. The infinite capacity of central banks depends on the intervention being unsterilized, in other words the extra currency is added to the nation’s money supply. That has inflationary implications.

Sometimes, merely the threat of intervention can help to stop a currency from rising, and this may be the game Europe’s central bankers are playing at the moment. Eventually, however, markets will be unimpressed by such threats if they are not backed by action.

Europe has benefited from strong export growth but has suffered from sluggish global demand. If a strong currency enables eurozone interest rates to be kept low, boosting consumer demand, that is quite a sensible policy mix. So, even though central banks are still trying to “buck the market”, their task is not so onerous or their aims so ambitious, as the Bank of England in 1992. The chances of speculators making a Soros-style killing are consequently reduced.

Link here.


In a steamy corner of the derivatives kitchen, the chefs are reheating a dish called the collateralized debt obligation, seasoning it with equities and commodities instead of the usual corporate bond extracts. The market for these securities, known as CDOs, is booming as investors seek ever-more complex bond structures to deliver benchmark-beating returns. To make the new specials on the menu palatable, banks pay Moody’s Investors Service and Standard & Poor’s for the financial equivalent of a Michelin star. You would not trust a restaurant that paid for its Zagat Survey rating; you should treat these CDO ratings with similar distaste.

At the heart of the CDO market is a dirty little secret. Its purpose is to turn lead into gold and water into wine. In the same way that Liverpudlians disguised overripe meat and vegetables by cooking them to mush in a stew called scouse, CDOs turn scary bits of the financial markets into digestible chunks for a pension fund’s trustees. Instead of telling their overseers, “We punted a chunk of your pension-fund money on the derivatives market in a structured transaction that depends on what happens to the stock market, which way commodity prices go and whether the wind blows on Sunday,” buying a CDO allows money managers to tell trustees, “We bought a AA rated bond issued by Hokey-Cokey Bank.”

Link here.


For months, financial talking heads have tried to explain the day’s action in stocks by the opposite action in oil prices. On those days when both stocks and oil moved in the same direction, the media either kept quiet or used the word “despite” in the headlines. (Incidentally, don’t you find it strange that the price of Crude fell 15% in the past 10 days despite the recent news? The Suez Canal blockage interrupted oil shipments for a few days; the duration and outcome of the Fallujah battle has been uncertain; the U.S. daily oil production has slipped to its lowest level since 1950. Given all that, should Crude not be going up, not down?)

Well, now that Crude is off its highs and off most media outlets’ radar screens, a new contender for the “indicator dujour” has just emerged. Today, the euro briefly touched the 1.30 level, marking a new historic high against the U.S. dollar. Will the financial media now latch on to the “rising euro” story and pull it out of the hat every time stocks have a bad day?

The truth is, neither the price of oil, nor the valuation of euro against the dollar, nor the “good” or the “bad” news has any effect on the dominant stock market trend. Markets have a mind of their own, and the recent price action in Crude is another proof. What moves markets, then? Sentiment. Social mood. Collective psychology. All successful traders know that.

Link here.


Everyone who surfs the evening TV channels knows that gambling has become popular over the past few years. If you are wondering just how popular, the reply is, “A lot more than you thought”. Consider, for instance, California’s 1.4 million state and government employees, who may soon double down on the amount of retirement money they put into hedge funds.

The “double-down” is a blackjack strategy. You use it when you have a two-card hand, before getting the third (and final) card. It doubles the size of your bet, and actually does improve your odds of a higher payoff in certain card combinations: for example, if you have got a 4 and a 7 when the dealer’s face-up card is a 6, the odds favor a double down. But the odds almost never favor the double down if the dealer’s face-up card is an ace or 10. Of course, most amateur card players are oblivious to the dealer’s hand, and use the double down simply because they were dealt a face card, or, worse, to try and recoup their losses.

As for the retirement funds of California’s state and government employees, reports this week say they will double their “investments in hedge funds to $2 billion to generate higher returns as stock markets stagnate.” What is more, many of those 1.4 million individuals may not even know about their double down, since the fund manager in charge of their pension fund (“Calpers”) makes the decision to do so.

Question: if boosting investments in hedge funds will “generate higher returns”, why not put ALL the money in hedge funds to capture this “higher return”? If the answer is that the increased risk is too great, then is it not necessarily true that doubling down a hedge fund investment could generate lower returns? Has anyone checked the dealer’s hand?

Link here.


You typically that the Chinese have over-invested in fixed capital. More specifically, China has “imported” inflation from the United States by fixing its currency to the U.S. dollar. Credit excesses in the U.S. lead to rising asset prices and consumption. In China, they lead, so the theory goes, to reckless bank lending and over production. First, let us look at the numbers. China’s fixed capital spending is equal to about 43% of its GDP. According to the CIA world fact book, that is the 7th highest percentage of 145 nations surveyed. You might be interested to know that Equatorial Guinea is first, with a percentage of 63.6%. The U.S. comes in at 122nd, with about 15% of GDP going to fixed capital investment.

China’s investment in fixed assets for the first eight months of the year, according to official government statistics, was at an annual rate of about $600 billion, or roughly 40% of China’s GDP. Is it too much? Or more specifically, can a government efficiently and productively manage the task of investing $600 billion a year in fixed capital projects? Or is it inevitably going to lead to bubbles and over investment in certain sectors (hint, the ones that favor the bankers or government officials)?

Again going to the data, we see that 25% of China’s investment in fixed assets is in manufacturing. No surprise there. But that does not, ipso facto, constitute a bubble. If you look at the growth rates of investment in particular sectors, you get an idea of where China’s planners think China’s needs lie. Investment in ferrous metal mining grew 256% in the first eight months of this year compared to last. Oil processing, coking plant, and nuclear material processing grew by 127.5%. Wood processing investment was up 71%, furniture manufacturing investment up 52%, and general metal products investment up 57.4%. These are the investment priorities of a nation that is industrializing. There is really nothing shocking to any of the numbers you see here. In fact, the deeper you dig, the more you will see signs that China is using its $54 billion in annual foreign direct investment deliberately and pragmatically. It is building itself an industrial base on the back of Western capital. Not bad for a nation that did not have a lot of capital to begin with.

When you can leverage your one single indigenous economic advantage -- abundant labor, create a currency policy that makes your goods perpetually cheap to the world’s most voracious consumers, AND manage to get Western investors to build you factories for you, you have either been lucky, clever, or both. Once the base is built, it will be China’s. The State, after all, is the largest landowner. And there is no private property.

The fixed capital investment numbers show more of the same the deeper you dig. Investment in transportation was 11.5% of all fixed asset spending. Road construction made up 7.6% of all investment. New water projects, like the Three Gorges Dam, made up 8.2%. These are simple needs for a massive country. More water. More energy. More roads. More iron. More steel. If there IS a bubble caused by easy credit and bad bank lending, it is in commercial real estate, which constitutes 25% of all fixed capital investment. This explains why Shanghai’s skyline looks so much like Hong Kong’s.

The longer-term question for China is how long it will take the capital markets to mature. Will China’s equity markets grow? Will there be a bond market? Will the commodities and futures exchanges take root? These questions are important ones about China’s financial system. But in the meantime, there is the present reality. And for now, investment in fixed capital -- even if it is 40% of GDP -- does not seem like a grotesque economic problem for the Chinese to have. Though there will surely be some mistakes and some corruption, they will end up with real assets capable of producing a large variety of goods and services. Whatever short-term busts the Chinese reap from over-investing in productive capacity, the long-term benefit is that they have migrated the productive capacity of the world to their shores. It should stay there for a long, long time.

Link here.


I must admit that, on election night, I was hoping one of two things would happen: Either no one would turn out to vote, thereby de-legitimizing our rulers in D.C., or, more realistically, that one party would dominate the Congress, while the other took the Presidency. The latter would, ideally, have resulted in gridlock for the next four years, thereby limiting the damage the government could do to the country. At least a Democratic sweep would have put an end to the reign of the neocons. And since most votes for Kerry were really just votes against Bush, it would not have given the socialist from Massachusetts much of a mandate.

But the Republicans won the Presidency, and increased their majorities in both houses of Congress. Unless you attribute the Republican victory to a vote fraud of unprecedented magnitude, the reality is that Americans thoroughly endorsed what Baby Bush stands for. So let us play the cards the way they have been dealt. And, perpetual optimist that I am, I think the next four years stand to be among the most profitable of a lifetime for a minority of properly positioned investors and speculators.

I am not talking about the average American. Having sown the wind, Boobus americanus is going to reap the whirlwind. As Patriot 2 becomes law, what little is left of civil liberties and the Bill of Rights is going to disappear. The gigantic deficits the government will run to fund both the war and domestic programs will take interest rates to levels we have not seen for a generation. That will crush the current mania in real estate, and likely cause the stock market collapse, that began in 2000, to resume. Unemployment will rise. The dollar will accelerate its collapse, as foreigners, from Central Banks to the man on the street, unload their dollars, causing the price of imports to skyrocket. The American standard of living will nosedive. I expect we are looking at what will amount to a much more severe version of what happened to Americans in the 1970’s. And that is only if the current adventure in Iraq does not mutate into World War III.

But, as I said earlier, I prefer to look at the bright side. Higher levels of inflation will not only drive capital from the dollar and conventional investments; it will drive capital into gold. Bush believes that it does not matter what foreigners think about the United States. But, he will find that once countries start holding their reserves in euros and gold, the dollar will become a hot potato. The way I see it, the dollar is on the way to reaching its intrinsic value. This is a catastrophe for the average American, but boon for those who follow the trend. I fully expect to see gold trading well over $1000 before Bush’s term is over. But the really big gains will be in mining exploration stocks. The gold stocks will go into a bull run wilder than anything we saw with the Internet issues.

There will be an immense transfer of wealth in the years to come from those who do not own gold, to those who do. A lot of that is almost guaranteed by Bush’s profligate foreign and domestic policies. Best of all, the gains in store for us will be subject to the low capital gains taxes Bush is promising -- one part of his policies I agree with. What is to be done about the problems in the U.S.? Don’t look to Bush for a solution. But you should be able to insulate yourself from most of them with the money you make in the incipient gold and commodities bull market.

Link here (scroll down to piece by Doug Casey).


According to Alan Greenspan, the U.S. economy’s slowdown in the second quarter was just a “soft patch” caused by the sharp rise of the oil price and “geopolitical” uncertainties. After all, the economy’s growth is built on excellent fundamentals. That the bullish consensus in the U.S. readily swallowed this message is hardly astonishing. But it was also fully shared by the OECD and the IMF. Both are forecasting continuously robust U.S. economic growth. At issue remains the familiar question of whether or not the prodigious fiscal and monetary stimuli of the past have been successful in launching a protracted, self-sustaining economic recovery in the U.S.

What, exactly, does “self-sustaining” expansion mean? We would say it describes two key conditions: first, the complete absence of any artificial monetary and fiscal stimuli; and second, a change in the economy’s pattern of growth from debt and bubble-driven, to employment-and income-driven. Both conditions are not at all fulfilled. Tax cuts have ended. Individual tax refunds heavily bolstered consumer incomes during 2004’s first half. Although the Fed is gradually raising its federal funds rate, it remains artificially low. Investors have been stunned in recent months by the quick, sharp drop in 10-year Treasury yields from 4.9% to barely 4%. Business spending on high-tech investment has picked up, but there is reason to assume that investment projects have been pulled forward to benefit from the 50% accelerated depreciation, expiring at year-end and to be followed again by new weakness.

Mr. Greenspan likes to claim that, thanks to his brilliant policy, the U.S. economy experienced its mildest recession during the whole postwar period in 2001. If this was an achievement, it was more than offset, however, by the following unusually sluggish recovery. It was, in fact, the U.S. economy’s weakest recovery by far in the whole postwar period. Worst of all, though, was its badly skewed composition. In the past, personal consumption has on average accounted for 67% of real GDP growth. This time, its share was 109% of GDP growth. The other unusually large contributor was government spending, with a share of 33%.

It has, meanwhile, been recognized that the economy’s transition from subpar growth toward self-sustaining expansion requires strong capital spending and hiring by businesses. The consensus is convinced that both are definitely on the way. A supposedly splendid corporate profit performance and highly liquid corporate balance sheets are the main arguments. Careful scrutiny of the relevant facts leads us to a radically opposite assessment.

Link here.


According to the BBC, UK consumers have grown “extremely comfortable” in using credit cards over the recent years. So comfortable, in fact, that last year the number of credit cards in circulation surpassed the number of UK citizens. So comfortable that this summer, the amount of money owed by consumers for the first time ever topped £1 trillion. Britain remains the “most developed card market in Europe” -- and globally, it is second only to the U.S. Despite these already staggering statistics, British credit card companies are very optimistic about their prospects. They see a steady uptrend in credit card use for the years ahead, expecting the number of cards in use to jump 40% by 2008.

On the flip side, the number of UK consumers filing for bankruptcy has been rising just as fast, hitting a new all-time record last quarter. Almost a third more people are filing this year than in 2003. Problem is, many consumers have been expecting to pay off their credit card debts by cashing out their “home equity”, but with house prices falling across England, this plan is backfiring.

Contrary to the conventional wisdom, record-setting credit card debt and insolvency numbers are signs of good times, not bad. Bob Prechter wrote this in Conquer The Crash: “Near the end of every major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely.” Willingness to lend and borrow money, just like willingness to buy or sell stocks, is determined by the health of social mood. And nothing reflects its health better than the direction of the stock market. The British FTSE has been climbing since early 2003, reflecting improving sentiment, and UK consumers’ willingness to borrow has been climbing with it.

Link here.


Financial history and libraries are never as dull as they may seem. In my experience a couple of decades ago, it was like prospecting for gold, but within the relative comfort of dusty library stacks. The discoveries ranged from Eureka! to the vignettes of life. The highlight of today is the struggle between those compelled to bring us yet more intrusive government and those who have had enough. Over the past 2000 years, this intense struggle has occurred before and freedom eventually won. Such immense conflicts and reforms were not only features of the period but, I would suggest, the political highlights. The most straightforward way to convey the observations is by asking and answering a few key questions.

One is -- When did the senior economy suffer a great and chronic inflation? Over the past 2,000 years, there have only been three. Each lasted for almost one hundred years and the increase in the basic cost of living was horrendous and, in its most rampant phases, destructive to the social fabric. As calculated by Emperor Diocletian’s administration, prices in Rome soared by a factor of 40 times through the Third Century. The next great inflation brewed up and ran through the 1500s and, after some 400 years of a relatively quiet price history, the third great inflation began very early in the Twentieth Century when the U.K. was the senior economy, with the world’s financial center in London. With the three distinctive centuries of inflation being so consistent in character and duration, it is possible to consider that the third one is unwinding, which brings us to the next big question.

What periods suffered the greatest experiments in authoritarian government? This one jumps out at you. Rome, which had been a republic, did not relinquish in peace the prerogatives of power assumed during a couple of great wars. This, combined with unrelenting taxation and currency depreciation during the Third Century AD, culminated in a murderous police state. Another question -- Beyond rampant inflation and political bullying, what else was common to the three monstrous centuries? It has been the lust for unearned money.

With its vast empire of conquest and tribute, Rome had accumulated the greatest amount of wealth in history. Then, once limitations upon government ambition were corrupted, even this great treasure became inadequate to fund bureaucratic ambition. Thus the resort to confiscatory taxation and horrendous debasement of the currency. These two evils are the big sign that bureaucracy has become more important than the common wealth. Over the centuries, there has been inquiry about collapsing empires and why Rome failed. Rome, as with the Soviet Union, was an uneconomic model that, without a steady flow of tribute, failed. The “Dark Ages” that followed could be more appropriately be considered as a “silent age” of political reform, agrarian expansion, and innovation. Rome, as a police state, was the real Dark Age.

The second extraordinary accumulation of wealth started in 1500 with the transfer of gold and particularly silver from the new to the old world. Much of this was coined and the increase in circulation was associated with some rise in prices that was exacerbated by deliberate and frequent currency depreciation. During the 16th Century, Spain became the dominant power and, despite controlling most of the greatest windfall in history, the treasure was insufficient to fund state ambition. Windfall and confiscatory taxation notwithstanding, Spain defaulted to its creditors three times. This drained Spain’s vitality and the collapse of Europe’s greatest power in the 1500s was similar to that of Rome’s some 1,200 years earlier. Proponents of political correctness in the 16th Century supported the divine right of kings and, by extension, of bureaucrats. Today it is the insidious theocracy of 20th Century liberalism that needs reformation.

The second century of inflation ended as a massive speculation in tangible assets blew out in 1609 and a severe credit crunch was followed by nine years of stagnation. And with the end of the “old” era of inflation, politics took a turn away from authoritarianism and back towards the sovereignty of the individual. The end of absolutist kings was ensured by the “Glorious Revolution” of 1688. The establishment’s bullying combination of high church and big state slowly but inevitably diminished until around 1900. Productivity soared.

One new thing in financial history was the voluntary development of the stock market in the late 1600s. The first tech mania erupted in the 1670s, which was in Turn Pike roads with an outstanding increase in productivity. The next steps to modern finance were the advent of independent research with Houghton’s market letter in 1692 and the Bank of England in 1694. The latter, when its notes were convertible, provided the innovation of a sound and efficient paper currency. The abandonment of this benefit permanently in 1931 returned the monetary corruption that has always been the temptation and hazard since coinage was developed more than 2,500 years ago.

In the Western world, a hundred years of interest rate and foreign exchange manipulations enabled one of the greatest examples of state theft in 2000 years as well as one of the greatest losses of individual freedom. Moreover, this did not materially change the basic patterns of financial history. In a developing age of privatization, it seems reasonable to look forward to the public figuring out the main impracticality of Western central planning and then demanding monetary reform with the restoration of a convertible currency.

There is little doubt that this would be resisted by the establishment and, if the old and notorious Vancouver Stock Exchange has a parable, it would be the definition of a promotion: “In the beginning, the promoter has the vision and the public has the money. At the end, the promoter has the money and the public has the vision.” In 1900, all levels of government were taking only 10% of GDP and the public was sceptical about big government. In the last part of the 20th Century, the government take was approaching 50% and the public had visions of government as a wish machine. The concept of big government and its absurd currency is close to being discovered as a rank promotion.

Link here.


We live in an age when a lot of promises regarding retirement are going to be broken. Just how they are broken, and what replaces them, will have profound effects on the future of the industrial nations that have dominated the world economy in the last century. What is at stake is a reversal of perhaps the most important economic trend in developed countries since World War II, that of guaranteeing financial security for their citizens. In most major countries, governments came to provide health care and an assured pension. In the U.S., some of that came from employer-financed health care and pension plans, but the results were often similar.

Now, increased competition stemming from globalization has left many companies scrambling for ways to cut costs. And many pension and health care plans are pay-as-you-go systems whose generous benefits while the baby boomers were working now seem unsustainable as that huge population group begins to retire.

Pension plans seemed to hold their own in the late 1990’s, when a soaring stock market allowed companies to assume that they did not need to put money in. But the bubble burst, and now the S.E.C. is looking into the numbers at some companies that may be using generous assumptions to make their pension picture look prettier than it would otherwise appear. Workers without traditional pension plans generally have defined contribution plans like 401(k)’s, but these leave the risk of market losses with the employee.

Link here.


Gold futures logged a gain of $4 an ounce for the week to close Friday at $438.30 an ounce on the New York Mercantile Exchange, a level the market has not seen since July of 1988, boosted by a drop in the U.S. dollar and continued violence in Iraq. The CBOE Gold Index (GOX) closed at 98.4 -- its highest ending level since March 1997. The Philadelphia Gold and Silver Index (XAU) rose 2.4%to close at 108.59, a level not seen since mid-February.

Link here.
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