Wealth International, Limited

Finance Digest for Week of October 24, 2005

Note:  This week’s Offshore News Digest may be found here.


Tom Barrack, arguably the world’s greatest real estate investor, is methodically selling off his U.S. real estate holdings as prices drive the market to nosebleed levels. He likens the current real estate market to a game of polo. “I feel totally safe playing polo on a field full of pros,” says the bronzed 58-year old. “But when amateurs are all over the field, someone can get killed. They have more guts than brains. They charge after every ball and don’t know when to hold back.” It is the same with U.S. real estate right now. “There’s too much money chasing too few good deals, with too much debt and too few brains.” The amateurs are going to get trampled, he explains, taking seasoned horsemen, who should get off the turf, down with them.

Investors take heed. Barrack may be an amateur at polo, but when it comes to judging markets, he is the ultimate pro. Arguably the best real estate investor on the planet, he runs a $25 billion portfolio of trophy assets, from the Raffles hotel chain in Asia to the Aga Khan’s former resort in Sardinia to Resorts International, the largest private gaming company in the U.S. Barrack’s Colony Capital, one of the largest private equity firms devoted solely to real estate, has racked up returns of 21% annually since 1990, handing investors, chiefly pension funds and college endowments – 17% after all fees. Barrack bought the Fukuoka Dome, Japan’s Yankee Stadium, in part because he calculated that the titanium in the retractable roof was worth as much as the purchase price.

His strategy is to buy classy but neglected properties anywhere in the world where prices are low. Then, he will pour in capital to fix them up, and resell in them in five years of so with their pedigrees fully restored. Says his friend Donald Trump, “Tom has an amazing vision of the future, an ability to see what’s going to happen that no one else can match.” Right now, Barrack’s view of the U.S. market could not be clearer: It is a great time to sell, and a terrible time to buy.

Link here.

A rush to commercial property.

Many real estate executives say they have recently seen a significant uptick in the number of first-time buyers who are entering the commercial market. Many buy small apartment buildings or retailing centers or mixed-use properties that combine apartments with a few stores, real estate professionals say. Some executives say the influx has been large enough to prompt them to try to track these types of buyers more diligently, as well as to reconsider their marketing efforts. “I call it the democratization of commercial real estate – everyone wants to participate, and access to capital is wonderful,” said Gary Gabriel, executive director of the metropolitan area capital markets group at Cushman & Wakefield. At Massey Knakal Realty Services, Robert A. Knakal, the company’s chairman, estimated that there are now six or seven times the number of first-time buyers in the New York area as there were five years ago.

Outside of New York, first-time buyers seem to be increasing as well. In a survey of some 300 institutional and regional commercial real estate investors and brokers, conducted in early September, the Real Estate Research Corporation, a Chicago-based company, found that two-thirds of the respondents said business from first-time buyers had increased since the beginning of the year, with rises in the range of 5 to 25%. These reports may actually underestimate the influx of newcomers, because rookie investors often keep a low profile, for fear that the lack of a track record might jeopardize a deal, according to many commercial real estate executives. “It’s often hard to tell who is a first-time buyer until we get into negotiations,” said Thomas A. Donovan, the executive managing director and partner for the Queens office of Massey Knakal.

Real estate executives in some areas, like Brooklyn and Queens, say that first-time buyers there are buying properties primarily for their own use, rather than for investment purposes, because there is such a large gap in these markets between what buildings sell for and what they might command in rent.

Link here.

Record spending on commercial real estate expected.

Investors will pour a record $200 billion into commercial property in the U.S. this year, according to a survey by a real estate services firm at an industry gathering in San Francisco. Pension funds, private equity firms and foreign investors continue to see real estate as a popular alternative to stocks, bonds and other investment vehicles, even as returns on U.S. real estate are being squeezed by the higher prices paid for buildings, said Bruce Mosler, chief executive of the Cushman & Wakefield services firm.

Over the last five years, Mosler said, the value of the National Association of Real Estate Investment Trusts index has gained more than 20% while the S&P 500 index has lost about 3%. “Capital continues to be reallocated to the real estate market and there is nothing to suggest that the stock market will be less volatile in the near future,” he said.

It has already been a banner year in San Francisco, the second-most-popular market for big investors after New York City, according to Cushman & Wakefield. More than $4 billion in commercial property sales have closed in the city in 2005. But Ken Rosen, a UC Berkeley real estate and economics professor, said stocks of publicly traded real estate investment trusts are due for a fall in the next two years because they have become overvalued. Rosen said REIT prices could drop by 20% after enjoying big gains during the last five years. Still, Rosen said, it is clear that huge amounts of capital are chasing real estate, despite rents in San Francisco and other cities that do not justify the prices being paid for office towers. “A lot of money wants to get into real estate and needs to be satisfied,” he said.

Link here.

Lennar is looking for a few good flippers in Florida.

In red-hot housing markets around the country, most homebuilders have enacted strict anti-flipping clauses to deter speculators from buying in their new communities. Now, Lennar, one of the country’s largest builders, has quietly taken the unusual move of dropping the restrictions at several of its South Florida developments. Local brokers say the decision shows just how much Lennar needs the flippers to keep order numbers up at certain communities.

Over the past year, speculators have been portrayed as the cockroaches of the housing industry. These pesky investors who buy homes with the intent of flipping them for a quick profit have been blamed for much of the supposedly irrational pricing in markets such as Miami, Phoenix and Las Vegas. Much of the speculative activity takes place in the condo market, where investors used risky interest-only mortgages to buy condos before they were constructed.

In the greater Palm Beach, Florida, market, Lennar recently dropped the stringent anti-flipping clauses at several of its townhome communities. The clauses, inserted in sales contracts beginning in August, aimed to deter speculators by requiring owners to pay 10% of the resale price to Lennar if they sold the home within a year of purchase. “When you go from making sales to making no sales, you’ve got a problem,” Mike Morgan, broker-owner of real estate brokerage firm Morgan Florida, says about Lennar’s decision for its Palm Beach properties. “With the investor policy, there was no way they were going to make their next quarter numbers.”

The Palm Beach market, like the rest of South Florida, has seen booming housing prices over the past few years. Port St. Lucie has been one of the fastest-growing cities in America, according to Census Bureau data. But lately, the market has slowed down a bit, local brokers say. Morgan says Lennar recently boosted its commission to outside brokers like himself back to 3%, after dropping it to 2% earlier this year. The company has also been offering more incentives – such as $15,000 off certain new homes – to move product, he says.

With speculators now welcome at the Lennar properties once again, perhaps demand will shoot up. If anything, the move points to how certain areas in South Florida have cooled off compared to 2004 as homebuilders attempted to drive away speculators. “A year ago, this was an order-taking market,” says A.G. Edwards analyst Greg Gieber. “I think things are slowing. Things are not falling out of bed.”

Link here.


There is something disturbing about the cult of personality that has grown up around Federal Reserve Chairman Alan Greenspan. Ben Bernanke, named as his successor, has an opportunity to redefine the role of U.S. central bank governor. Central bankers should be like sports referees: at their most effective if you do not know their names or have not noticed their interventions by the time the game has ended. Instead, handicapping who would replace Greenspan after his Jan. 31 retirement has been one of the hottest games in town. Typing “Next Fed Chairman” into Google last week, for example, produced more than 6 million results in 0.43 seconds.

Bernanke, 51, was the runaway favorite to succeed Greenspan. A betting Web site run by Tradesports.com had him leading with a 36% chance of success at the end of last week. Fed governor and second-favorite Don Kohn was ranked with a 15%t chance of getting the job. By running the Fed as a one-man show since taking charge in 1987, Greenspan has undermined the value of his seminal contributions to the black art of central banking.

When Fed Governor Mark Olson opposed the Sept. 20 decision to raise interest rates for the 11th consecutive time, it was the first instance of dissent since Robert Parry voted for a bigger cut than his peers in June 2003. Anyone who has ever sat through a meeting of any kind trying to reach a consensus knows how incredible that is. More important than the paucity of disagreement is the market reaction – or lack of it – to Olson’s impudence. Traders and investors were comfortable dismissing this hint that the Fed might be poised to pause in its relentless campaign to drive interest rates higher. That is because there is only been one opinion that matters at the Fed, and it is not Olson’s.

The modern equivalent of Fed Kremlinology involves parsing the statements accompanying Fed monetary policy decisions until every noun, verb, comma and semi-colon has been weighed and assayed. That has to end. There is something faintly ridiculous about global financial markets swaying this way or that based on whether a particular sentence construction changes from one meeting to the next. It would be nice if Bernanke could find a way to unshackle the Fed from its self-made linguistic handcuffs. The march of time and the shifting sands of history may yet diminish the Fed chairman’s role. Waiting in the wings is someone with the potential to overshadow Bernanke, wielding even more influence over the global economy than Greenspan ever did. Step forward Zhou Xiaochuan … China’s central bank governor.

Link here. Profile of new Fed chief Ben Bernanke – link. At the Fed, an unknown became a safe choice – link.

Maestro Redux?

It is easy to celebrate the man and his pedigree. We all know that Ben Bernanke is a solid economist, with impeccable credentials from many of America’s greatest universities. Leading academic journals are filled with his contributions. But that background begs the most important question of all: What we do not know is Bernanke’s ability to provide institutional leadership for a central bank that is facing a unique confluence of domestic and international imbalances – the asset-bubble-current-account nexus.

Every Fed chairman that I ever worked with or observed over the past 33 years has had to face circumstances that he was unprepared for. Arthur Burns was a business cycle expert ill-equipped to cope with inflation. G. William Miller was a businessman untrained for the vicissitudes of financial markets. Paul Volcker was a financial expert who struggled with a wrenching recession. Alan Greenspan was a business consultant who was quickly thrust into the thicket of financial crisis management. Ultimately, Volcker and Greenspan learned to adapt and cope – but not without initially going through wrenching financial market corrections. Volcker quickly faced a wrenching sell-off in the bond market and Greenspan had to cope with the stock market crash of 1987.

Investors are thrilled that Bernanke is precisely the right man for the right moment. After all, he is America’s most renowned expert on “inflation targeting” – the need for the Fed to be explicit in linking its policy instrument (the federal funds rate) to some stylized goal of price stability. And, of course, everybody’s worried about inflation again. The energy shock of 2005, which has taken retail energy prices up some 35% over the 12 months ending this past September, has financial markets in a tizzy. Inflation-phobic central bankers at the Fed are now chomping at the bit to rush back into battle against inflation.

After all, we have all been to this movie before in the stagflationary 1970s. Never mind, the striking dichotomy that has opened between energy prices and well-behaved “core” inflation rates in the non-energy segments of the economy. Never mind, the powerful forces of globalization that seem to explain this dichotomy quite nicely – especially the breakdown of the once critical linkage between input costs (like labor, energy and other raw materials) and underlying prices. The warrior central banker wants to ride into battle again. And who would be better suited to lead the charge than the world’s most prominent inflation targeter – Ben Bernanke? It is a great Hollywood script, but it’s so yesterday.

Why should we presume that Bernanke would be spared the same test that his predecessors faced? Financial markets have had an uncanny knack of finding the weak link in the new guy’s chain. The history of modern day macro, to say nothing of the experience of the Fed and its various chairmen over the last several decades, warns of extrapolation. But why should we also presume that Bernanke would be the one Fed chairman who will be challenged by the problem that falls neatly in his comfort zone – namely, inflation? The past is a poor guide for what to expect in the future. Talented and well-trained central bankers are invariably tested by something new and different. America has far more serious problems on its plate than inflation that a new Fed chairman will quickly have to confront.

Two of them are especially worrisome – a monstrous current account gap and the Mother of all asset bubbles. And it turns out that the external deficit and the housing bubble are joined at the hip – thanks to the policy strategies of the man who is about to pass the baton to Bernanke – Alan Greenspan. The escape act from this conundrum – the modern-day Fed’s favorite word – has yet to be written. Bernanke has opined on the circumstances in a rather disingenuous way – suggestion that a profligate America is actually doing the world a favor by consuming a global saving glut. If that is his starting point on the bubble-current-account conundrum, watch out below. A saving-short U.S. economy is hooked on asset bubbles and debt as the sustenance for economic growth. Weaning America from this dangerous recipe could likely be the defining challenge for the Fed and its new chairman. The great irony for the Fed is that Alan Greenspan’s legacy may well be Ben Bernanke’s albatross.

Links here and here.

Bernanke: There is no housing bubble.

Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve. U.S. house prices have risen by nearly 25% over the past two years, noted Bernanke, currently chairman of the president’s Council of Economic Advisers, in testimony to Congress. But these increases, he said, “largely reflect strong economic fundamentals,” such as strong growth in jobs, incomes and the number of new households.

Bernanke’s thinking on the housing market did not attract much attention before Bush tapped him for the Fed job Monday but will likely be among the key topics explored by members of the Senate Banking Committee during upcoming hearings on his nomination. Many economists argue that house prices have risen too far too fast in many markets, forming a bubble that could rapidly collapse and trigger an economic downturn, as overinflated stock prices did at the turn of the century. Some analysts have warned that even a flattening of house prices might cause a slump – posing the first serious challenge to whoever succeeds Fed Chairman Alan Greenspan after he steps down Jan. 31.

Bernanke’s testimony suggests that he does not share such concerns, and that he believes the economy could weather a housing slowdown. “House prices are unlikely to continue rising at current rates,” said Bernanke, who served on the Fed board from 2002 until June. However, he added, “a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year.”

Greenspan has said recently that he sees no national bubble in home prices, but rather “froth” in some local markets. Prices may fall in some areas, he indicated. And he warned in a speech last month that some borrowers and lenders may suffer “significant losses” if cooling house prices make it difficult to repay new types of riskier home loans – such as interest-only adjustable-rate mortgages. Bernanke did not address the possibility of local housing bubbles or the risks faced by individual borrowers or lenders in a slowing market. But if Bernanke is confirmed as Fed chief, and if the housing market slows more than he expects, he would be unlikely to use the central bank’s power over short-term interest rates to prop up falling housing prices for the sake of individual homeowners, according to comments he has made in numerous speeches and statements in academic papers. Bernanke believes “the Fed’s job is to protect the economy, not to protect individual asset prices,” said William Dudley, chief economist for Goldman Sachs U.S. Economics Research.

Link here. U.S. Treasury Secretary John Snow sees no housing bubble – link.

Listening, but never learning …

Chairmanship of the Federal Reserve is to Wall Street and the media what the golden calf was to the ancient Israelites: a vulgar idol produced by the hopeful imagination of people who know better. They believe the Chairman anticipates what is ahead for the economy, and adjusts the Fed’s policy accordingly. This notion is a crock and it stinketh, but to say this to folks who need to hear it will change few minds, if any. Idolatry will not suddenly stop simply because you call it what it is.

Mind you, the powers-that-be who can approve Ben Bernanke’s nomination will soon show that they too embrace the Fed-Chairman-as-deity fiction. Tune in to the hearings and watch for yourself. Whenever Mr. Greenspan has appeared before the Senate Banking Committee, 90% of the questions put to him are about the trade and budget deficits, oil prices, tax and fiscal policy, etc. – topics he exercises about as much “control” over as he does over which two teams will appear in the 2006 Super Bowl. Of course there is always a token inquiry or two about the one measly lever the Fed Chairman can pull – namely the Fed funds rate – but why waste the golden calf’s time on something as mundane as a one-dimensional reality?

Recent months have seen a steady flow of accolades heaped on Mr. Greenspan, and the flow will increase as his retirement nears. But read and listen carefully, and the praise will be about how he “managed” the 1987 stock market crash, two recessions, the LTCM debacle, the Asian currency crisis, the bursting of the dotcom bubble, etc. Yet, what ALL these examples serve to show is not what the man anticipated, but instead how he reacted.

Central bankers are economists. Their “forecasts” do NOT anticipate real events and trends in the future; instead they habitually make linear projections of today into tomorrow. This cannot possibly help you as much as you can help yourself.

Link here.

We just got “Bernanke’d”.

The big news this week: President Bush disappointed the wags by refusing to appoint his personal tax accountant to the Federal Reserve. Instead he chose Ben Bernanke, the renowned Princeton man. With a cheery glint in his eye, a pleasing teddy-bear persona, and solid real-world experience under his belt, Bernanke is well-respected on both sides of the aisle. He is a John Roberts, not a Harriet Miers. Thank goodness for that at least. What shall we say of the future fed head? It is probably easiest to let Mr. Bernanke speak for himself, as he did in this November 21st, 2002 speech:

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

That sums things up nicely, no? As the late-night infomercials say: “But wait, there’s more!” In off-the-cuff email discussion of the Bernanke appointment, my colleague Chris Mayer called attention to this quote from a 2004 Bernanke speech: “We believe that our findings go some way to refuting the strong hypothesis that nonstandard policy actions, including quantitative easing and targeted asset purchases, cannot be successful in a modern industrial economy.”

In everyday language, “targeted asset purchases” translates to state-sanctioned purchase of private assets in the event of a crisis. Such action would not be unprecedented, even for a modern, democratic, free-market economy. Hong Kong, that bastion of bootstrap capitalism, did it openly and brazenly in 1998. (Type “Hong Kong market intervention” into Google and you will get some interesting hits.) So in Bernanke we have a man who is well respected in economic circles, readily accepted by the political establishment, and almost universally hailed by the cognoscenti as the next steady hand on the tiller. And yet this same man has talked openly of letting the printing presses rip, Latin-American style … and if that fails, letting the 8,000 pound gorilla of government wade into the private sector, nationalizing assets for the public good. I do not say this mockingly: God help us.

It is easy to become agitated over the words of a single politician (and make no mistake, the supposedly “neutral” federal reserve is packed with political animals), but the reality is more complex. Greenspan presented the image of a powerful wizard, but he was always more of a showman. The same will be true of Fed Chairman Bernanke, only more so. The new Fed Head will wield immense rhetorical power, much as the old one did, but at the end of the day he is just a bagman. Fund Manager John Hussman makes a powerful argument in his piece entitled “Why the Federal Reserve is Irrelevant”. One of Hussman’s key points is that the Federal Reserve essentially shifts assets around, employing an elaborate charade of smoke and mirrors in the process.The fed attempts to manage and massage the supply of money and credit, but does not control it in any real way.

At the same time, the Chairman’s rhetoric and stature have obvious psychological weight, the force of which is very real, and Fed positioning can strongly influence short-term market movements. In the past I have compared the Chairman of the Fed to a jockey riding a docile elephant. The key thing is maintaining the illusion of confidence and control; much of the game is psychological, for elephant and observers alike. Under normal situations, the jockey is genuinely capable of directing the pachyderm this way and that. But when real panic breaks loose? Forget it.

When it comes to America’s financial situation, Mr. Bernanke knows he will be weaponless at the extremes, tossed about on the wind and the waves like any mere mortal. Perhaps this is why his past speeches have talked openly of such extreme measures. Anointed as Chairman, Mr. Bernanke cannot turn down his shot at greatness … but he knows in his heart of hearts where the dark road may lead.

Link here (scroll down to piece by Justice Litle).

Helicopter Ben is no Paul Volcker.

Never has a changing of the monetary guard taken place with the U.S. economy in so precarious a position. When Paul Volcker arrived, everyone knew the economy was a mess. Volcker’s obvious job was to clean it up. Today, the general perception is that Alan Greenspan will leave the economy in great shape, and that Bernanke’s job will be to keep it that way. However, nothing could be the further from the truth. Wall Street’s positive reaction to the appointment of Ben Bernanke is yet another example of how completely clueless most investors are when it comes to the Fed and the precipice over which America’s economy now teeters.

Historically, the markets have always found a way to test the resolve of an incoming Fed Chairman. For Bernanke, that test is likely to come in the form of his commitment to maintain the purchasing power of the dollar, in direct contrast to his previous statements with respect to his willingness to sacrifice it. That aim can only be achieved by aggressively raising interest rates, even in the face of falling asset prices and recession.

In an apparent attempt to reassure the markets, Bernanke pledged to continue both Greenspan’s agenda and America’s prosperity. The reality however, is that we need a Fed chairman willing and capable to do the opposite – to clean up Greenspan’s mess, not make it bigger. America’s apparent prosperity is nothing but an illusion built on the phony foundation of inflated asset values and consumer debt. Greenspan’s strategy to delay America’s return to economic viability for the sake of political expediency has come at great cost to the nation’s future standard of living. What we need is a Fed Chairman willing to take away the Greenspan punch bowl before Americans drink themselves to death.

Then there is the problem of propping up the dollar. With few exportable products creating demand for U.S. currency, the trillions of dollars now in global circulation maintain their value only as a consequence of faith. For the last several years, that faith has in large part resulted from the near deification of Alan Greenspan. Whether justified or not, such faith will not simply transfer like a baton to Bernanke; it will have to be earned. Given the statements that Bernanke has already made with respect to the use of the invention of the printing press to create unlimited amounts of money at virtually no cost, his advocacy of the Fed doing whatever it takes to combat deflation, including the buying of long-term government bonds, stocks, real estate, and even consumer goods, such as automobiles, as well as his reference to dropping dollar bills from helicopters, which earned him the nickname “Helicopter Ben”, gaining the world’s confidence will not be easy.

When the Federal Reserve was first established, its function was to provide an “elastic money supply,” one that grew as the economy expanded, and shrank as it contracted. However, modern central bankers grow the money supply during economic expansions, and then grow it even faster during contractions. As a result the Fed has become nothing more than an engine of inflation, growing the money supply indefinitely, in direct contradiction to its original mission. Had such a hair-brained scheme been proposed during its inception, the Federal Reserve never would have been established in the first place.

Link here.


Corroboration was seen in particular in recent job gains that were fast enough to lower the unemployment rate to a four-year low of 4.9%. In our view, the plethora of statistical data was overwhelmingly pointing to slowing economic growth. Consumer spending may have remained surprisingly resilient, but considering its feeble underpinnings in the housing bubble, the time before a marked pullback is, in any case, rather limited. All that is needed to stop the consumer borrowing-and-spending spree in its tracks is a halt to the rise in house prices, implicitly finishing the provision of increasing collateral for higher borrowing.

With great interest and attention, we are pursuing the struggle in the U.S. bond market between a large bearish community apparently betting on an impending recession or a period of slow growth triggering the accustomed “Greenspan put” – and a Federal Reserve displaying unprecedented determination to enforce higher long-term rates, so as to slow the housing bubble, increasingly fueled by speculative fervor. In our view, the bond bulls are right about the economy’s weakness. The U.S. recovery is grossly ill-natured, depending fatally on continuous strong support from “asset-driven” consumer spending. Stopping the housing bubble is sure to stop the mortgage refinancing bubble.

To us, this seems like pulling the rug from under the table. While the bond bulls appear perfectly right in their dire assessment of the economy, we think they are playing a dangerous game. Under apparently tremendous pressure to produce profits, they risk a clash with the Fed. For the Fed people, on the other hand, their credibility is at stake. This might well force them to go further with their rate hikes than they intended. Further, it has to be realized that today’s U.S. bond market is a house of cards. Maintaining long-term interest rates at their present level needs a steady, huge stream of carry trade creating artificial demand for assets. If the Fed cracks this trade by inverting the yield curve, this would send long- term rates steeply up. A fire sale of unimaginable proportions could begin, with bond prices crashing. Comparing the credit explosion with the savings implosion and also with a consumer inflation rate now up 3.6% year over year, U.S. interest rates are, in any case, ridiculously low.

Lately, another conundrum has caught our attention: the unprecedented huge and growing wedge between soaring credit growth and dwindling money growth. Our investigations identified two main culprits: the U.S. trade deficit and escalating Ponzi financing of unpaid interest. The 2001 recession already had a totally unusual pattern. Unlike all prior experience, the economic downturn that developed in 2001 clearly had its cause not in tight money and credit. What followed the unique 2001 recession pattern was an equally unique pattern of economic recovery. Still, the unusually fast and aggressive easing had its spectacular immediate and widely trumpeted success in the mildest postwar recession. Consumer spending never paused, increasing by 2.5% in 2001 and 2.7% in 2002. Its largely credit-financed component of spending on durable consumer goods raced ahead by 4.3% in 2001 and 11.7% in 2002. Equally exceptional was the behavior of residential building. After a slow start, it took off into the famous housing bubble.

Business fixed investment, normally a main driver of recoveries, refused to respond at all. Rather, it accelerated its decline during 2002. And this, in fact, has become and remains America’s central structural problem. Though it has recovered from its lows, it is no higher than in 2000. As the recovery developed, American publicity kept hammering into people’s heads that the U.S. economy is greatly outperforming Japan and Europe. This conveniently diverted attention from the fact that in reality America had its most anemic recovery in the whole postwar period by any measure. By the reported productivity growth, this recovery resembles a “new paradigm” miracle. By the real GDP numbers, the economy appeared to be doing quite well, though much worse than in past cycles. But in terms of employment and wage and salary growth, this recovery has been and remains a disaster.

Link here (scroll down to piece by Dr. Kurt Richebächer).

No Way Out

Your editor began his recent half-day discussion with Dr. Richebacher in Cannes, France. “And I accept your grim diagnosis for the U.S. economy. But I don’t want to accept your equally grim prognosis. I understand, for example, that our economic imbalances are considerable. But I don’t want to believe that they are insurmountable. Isn’t there some way for us Americans to tip-toe away from the precipice of disaster?”

“No,” Dr. Kurt answered bluntly. “That’s not possible. The imbalances are simply too great.” During the next six hours, your editor learned all the gritty details of America’s economic predicament…

Richebacher: One has to realize that all the increase in American consumer spending is borrowed. And it is borrowed against rising house prices. In 2001, Greenspan replaced the bursting stock market bubble with the housing bubble. But soon he’ll be faced with a bursting housing bubble. The only question is when. But it comes suddenly, yah. Asset prices are the key to the U.S. economy. As long as asset prices are high, there seems to be ample liquidity in the economy. But as asset prices fall, the liquidity disappears. Americans think they are liquid. They aren’t liquid. Liquid is a person who has savings. We must realize that the appearance of great liquidity is merely the result of highly leveraged asset prices. And those can collapse.

Can we hope that asset prices merely deflate gracefully, rather than collapse?

I don’t think that’s possible. Excess credit is the only thing supporting asset prices… Greenspan recently observed that American consumers have weathered the energy price hikes very well. But that’s only because they borrowed crazier and crazier. That’s not the kind of resilience you should applaud. It’s as if he said, “We succeeded in helping the consumer to borrow more and more.” It would be desirable, of course, if the consumer would retrench a bit. Not that he would continue to increase his borrowing.

… The thing to realize, of course, is that the housing bubble is many times more dangerous than the stock market bubble, because it involves the whole banking system. Greenspan has replaced one bubble with an even bigger and more dangerous bubble. It’s insane. American monetary policy is out of control. Greenspan has created a debt Colossus. This debt Colossus needs permanent new credit. In an economy that needs four dollars in credit to produce one dollar of GDP, simply reducing credit could be disastrous. Even a slight reduction of credit could create enormous negative repercussions in the asset markets and financial markets. The level of credit excess in America has reached such a level of absurdity that no return to normalcy is possible without a disastrous effect on the economy.

America has become what Hyman Minsky calls a “Ponzi unit”. In other words, there sometimes comes a point where an economic unit has to rely upon asset sales to satisfy its interest payments and debt repayment. That’s America!

What the Americans have done is that they have simply abolished savings. And that means that more and more of GDP goes into consumption at the expense of investment and at the expense of the trade balance. … What I often hear is that there’s so much liquidity in the U.S. economy and U.S. financial markets. But this liquidity is not from cash. It is credit. There is huge liquidity in the asset markets that could turn into a savage deflation tomorrow. This is an illusion, this liquidity argument. It works as long as the system of inflating asset prices functions. But when it stops, liquidity is gone. If there is a lot of leverage in the market, it can collapse. But people say to me, “It has notyet happened.” Yes, that’s right it has not yet happened. … But it will, as soon as credit becomes more expensive or difficult to obtain.

The crucial support for the American financial infrastructure is the massive purchases of U.S. Treasury bonds by foreign central banks. The Americans think that this is to their advantage. But this only means that they have a longer rope with which to hang themselves. To have too much credit is never good, not for a country and not for an individual and not for a company. … Central banks are the marginal key influence. And therefore, when you consider the American fundamentals, America is certainly the most backward country in the world, among industrialized nations. From a fundamental point of view, the American economy is in incomparably worst condition today than in 2000. Income growth for the individual is stagnating. It is negative. And there is no savings. America has no reserves to protect itself against the next recession.

The fact is, you Americans are trapped. And worse, there comes a point where you’re unable to sell any assets to raise capital, a point where the markets become completely illiquid … because there’s no buyer left. The buyers of today are all leveraged buyers. They need new credit. But when you get declining prices, there is no buyer left. America’s super-liquidity all comes from borrowing. Credit has played a major role in all U.S. financial markets. There are many who say that deficit spending by the government is bad. But they don’t say that deficit spending by the consumer is equally bad, or worse. The American idea that everything good comes from consumer spending is preposterous. And that is the key fallacy in America today.

But the key question is whether America has finally reached the inflection point where its disastrous economic policies will begin to undermine its prosperity. I think she has. … There is no way out. The excesses are much too big to be treated with conventional methods.

Link here (scroll down to piece by Eric J. Fry).

Meet the Doctor – Part II

You Anglo-Saxons know no limits at all! And no one complains about it. We Europeans impose fiscal limits on ourselves and have difficulty keeping them under control, which is understandable. But when Americans double and treble their deficits, that is okay, because there are not limits. The Anglo-Saxons have two different sets of rules: One for the Europeans and one for the Anglo-Saxons. The Anglo-Saxons can do whatever they like. The normal economic condition for a developed industrial country is to have an export surplus, and this surplus becomes the basis of its capital formation. That was basic macroeconomics, yah. All of a sudden, the virtue of an industrial country is not to export, but to over-consume … to save the world through over-consumption.

The European economies, for example, always had investment and export as a key driver of growth. And that is what you would expect from an industrialized economy, that is invests and that it exports. … But Americans just borrow and consume. … [B]ecause your consumption has grown so far out of proportion to production, capitalist America relies on the generosity of communist China. The Americans don’t even realize how ridiculous and absurd this is. It’s so absurd I can’t believe it. I think this is the worst sign that I could imagine. It means that net investment is collapsing.

Consumption produces the least desirable kind of growth. And the simple thing to know is that it is unsustainable. It is unsustainable because real incomes are not growing. In America you’re having a fiasco in employment and income growth. The average income of the American middle-class is declining in real terms. And they have debts and debts and debts and zero savings. They have no reserves. In America, it is no secret, the manufacturing sector is shrinking. That’s THE big problem. In every economy, the manufacturing sector has the biggest multiplier effect.

[M]anufacturing is a sector that uses all the intermediate goods. That’s part of its multiplying effect. The growth of financial services is fine, but not when the manufacturing sector is disappearing at the same time. When you look at capital goods production in the United States, you can see what has collapsed is investment. And with the collapse of investment you have a collapse of employment in the manufacturing sector.

There are two kinds of assets; those that you produce, and those that you simply trade. In America today, you have an inflated service sector trading inflated assets. The assets that you trade do not produce any widespread wealth. They simply produce wealth for the individuals who trade them. The great failure in America is in investment, employment and income growth … and that is tied to manufacturing. … Greenspan and his associates have told the world that all of America’s massive imbalances do not matter. But for any economist who has a little something in his head, the structure of the American economy is one of the most alarming of all time. For a developed economy it is scandalous.

The American economists think this is perfectly acceptable. But I find it unbelievable. Like Ben Bernanke blaming the rest of the world for what he calls a “savings glut”. This is crazy. Why isn’t he, instead, urging Americans to save and to invest? Are the Fed governors really as stupid as they appear? Or are they deliberately stupid? … There are, of course, people in America, including many of my readers, who are old-fashioned, economically speaking. Paul Volcker, for example, who is an old friend of mine. But he held these basic economic concepts that I write about in his gut. All these things that I write about used to be in the gut of every economist.

The Americans I knew thirty years ago saved money. They didn’t save as much as the Europeans, but they held the same attitude, at least. The fundamentals were never questioned. No economist questioned the idea that a nation needs savings. … But all of a sudden, the Americans have rewritten economics … because it suits them. Saving money used to be instinctive in people, even without any economic theories. Classic economic theory is absent in America. It does not exist. … And so I wonder, is it possible that next year we will see the great denouement of the American economy?

Link here (scroll down to piece by Eric J. Fry).


Not surprisingly, an unbalanced global economy is struggling under the weight of the energy shock of 2005. This has not been lost on world financial markets. Stock markets have sagged on the fear of demand risk and bond markets have backed up as central banks sound the alarm over incipient inflation. This underscores the inherent risks of the fabled four-engine global airplane. This gigantic 747 is now flying on just two engines, fueled by the American consumer on the demand side and the Chinese producer on the supply side. If the demand engine sputters, added thrust from the supply engine may be destabilizing. That is a legitimate concern in late 2005. If U.S. consumption falters in the face of ongoing vigor from Chinese production, it may be difficult for an already wobbly plane to maintain its altitude.

In the end, it may all hinge on the stability of a two-engine 747. The supply engine is going at full throttle while the demand engine is at risk of sputtering. An unbalanced global economy has long been lacking the internal stabilizers to cope with such a mismatch between supply and demand. As long as the American consumer keeps spending, this enormous airplane will keep flying. However, the energy shock of 2005 and the likely end of America’s housing bubble draw that key presumption into serious question. The supply engine will have a tough time keeping the 747 aloft if the demand engine runs out of fuel.

Investors need to pay greater attention to the downside risks to global growth in 2006. Such an outcome will put pressure on the earnings underpinnings of equity markets, provide support to bonds by drawing inflation worries into question, and pose a serious challenge for dollar bulls. The 747 is about to enter turbulent skies.

Link here.


Last week’s blockbuster earnings reports from Citibank, J.P. Morgan and Merrill Lynch set the tone for firms to hand out an estimated $17.5 billion in bonuses to more than 150,000 traders, brokers and bankers, according to executive search firm Options Group. Tom Angello, managing partner of executive search firm Horizon Group, said he expected this year’s round of bonuses to be at their highest level in many markets with some on Wall Street likely to take home up to 15 times their base salary. “Last year was a good year for everybody but I would expect the compensation to be up to 30 percent higher this time around,” he said. “Some traders and bankers and people in hedge funds will exceed 12 times their base salary. Bonuses of $5 million or more would not be surprising.”

For many, flashy cars are the favored way to splash their bonus cash. The real estate market is already showing signs of being another popular choice for bonus-inspired spenders this year. For others partying in style is definitely the first preference. Tatiana Byron, president of premier New York event planner 4pm Events, says she knows of one Wall Street man who is spending about $200,000 to rent a yacht to cruise the Caribbean with 20 of his closest pals, finishing up with a round of golf at a luxury Barbados course. For another young Wall Street trader, post-bonus plans are to take a dozen friends on a 5-star, 10-day safari to Kenya – at a cost of about $12,000 a head.

Link here.


Peter F. James had been working at Refco less than two months when he noticed something this summer that teams of accountants had apparently missed for years. Mr. James, a recently hired employee in the controller’s office, wondered why a larger-than-normal interest payment had been made to Refco on an outstanding loan made by the company. In August he started to ask questions, eventually taking his concerns to the chief financial officer, Gerald M. Sherer. The answers would lead to the departure of the chief executive and the rapid unraveling of the company that prompted its filing for bankruptcy protection last week. The oversize interest payment that Mr. James noticed had its roots in a bad receivable – money due to Refco – from clients adversely affected by the Asian financial crisis of the late 1990’s, according to a person briefed on the investigation.

“He’s the hero in discovering this,” a person close to the investigation said of Mr. James. “He just kept pushing.” Mr. James declined to comment for this article. Mr. James had been hired by Mr. Sherer, who himself came to Refco only in January, to help bolster the firm’s financial operations. Mr. Sherer had alerted the board to problems with Refco’s internal controls – the practices or systems for keeping records and preventing abuse or fraud. That weakness was disclosed in Refco’s regulatory filings before its initial public offering in August. Now, questions are mounting over why others – among them, the company’s auditor and the underwriters that took Refco public in August – never discovered what Mr. James did.

The collapse of Refco has been a black eye particularly for Thomas H. Lee Partners, the private equity firm that bought a majority stake in Refco in August 2004. Before Oct. 10, when Refco disclosed that its chief executive had hidden $430 million in debt for years, the Refco investment seemed like another quick, bold and successful bet by the Lee firm, perhaps best known for buying Snapple for $135 million in 1992 and selling it two years later to Quaker Oats for $1.7 billion. When Refco went public this summer, its shares surged 25% on the first day of trading. Now Refco’s collapse has come at an awkward time for Lee. The firm, based in Boston and one of the oldest in the buyout business, has been making a transition from the leadership of its founder, Thomas H. Lee, to three handpicked successors: Scott A. Schoen, Scott M. Sperling and Anthony J. DiNovi. At the same time, it has begun trying to woo some of the nation’s largest pension funds, among other investors, to take part in a new $7.5 billion buyout fund it plans to raise early next year.

Link here.


The past four years will likely be remembered as a gilded age for anyone in real estate, especially mortgage bankers. But with interest rates rising, the industry is preparing for a slowdown that may prompt some lenders to merge with their competitors. Consumers may be winners from the mortgage banking industry’s scramble for customers in the months ahead of this anticipated consolidation. Homebuyers are already seeing lenders cutting loan fees, and some lenders are willing to offer lower mortgage rates even if it takes away from their profits./

Last week, the chief executive officer of Washington Mutual, Kerry Killinger, also said that the mortgage industry may be headed for a shake-out, and he ticked off measures WaMu has taken to reduce its exposure, including selling a larger portion of its mortgages than in the past. “Companies are losing money to keep market share,” said Douglas Duncan, chief economist at the Mortgage Bankers Association (MBA). “The consumer is being subsidized because the competition is so fierce. For the short run, the consumer is getting a better deal.”

Once that period of consolidation and mergers is over, consumers are unlikely to get such a good deal. There will not be price gouging after a merger wave, but fees probably will not be slashed as much as they are today, Duncan said. At a mortgage-banking-industry convention in Orlando this week, many executives were clearly worried, with rising interest rates eating away at demand from consumers looking to buy homes or refinance existing mortgages. Some said companies will need to make themselves leaner by cutting staff – or find merger partners. More than one executive voiced concerns about shrinking profit margins.

Lenders expect to process $2.26 trillion of home loans next year, down from this year’s expected $2.78 trillion and sharply lower than 2003’s record of nearly $4 trillion worth of loans processed.

Link here.

FDIC chief weighs in on high-risk home loans.

Increasingly popular high-risk mortgages could imperil both borrowers and banks if the hot housing market cools off, the head of the Federal Deposit Insurance Corp. said last week. With home prices breaking records, FDIC Chairman Donald Powell became the latest regulator to voice concern over people who took out interest-only or option adjustable-rate mortgages to buy homes they otherwise could not afford. Borrowers and mortgage lenders could be at risk if housing prices drop or interest rates rise. “Credit losses are very low now, but mortgage lenders need to be prepared for higher losses,” Powell said in a speech to a gathering of community bankers in Orlando, Florida. “Homeowners taking on these types of mortgage products need to understand how their obligation may grow when their low introductory interest rates expire.”

The FDIC and other federal agencies that regulate banks are evaluating the risks to lenders and examining banks’ lending policies and will issue guidelines for banks where needed, Powell said. The regulators do not seek to stanch innovation by banks, but to encourage sound banking principles, he said.

Link here.

More home buyers get interest-only loans.

U.S. home buyers chose interest-only loans, which initially require no repayment of principal, for almost a quarter of all mortgages in the first half of 2005. The share of interest-only loans grew to 23% of all home mortgages from 17% a year earlier, according to a report issued by the Mortgage Bankers Assn.

Link here.

More homeowners with good credit getting stuck with higher-rate loans.

Low interest rates and aggressive marketing campaigns have driven home lending to record levels. But increasingly Americans with good credit are being saddled with loans designed for high-risk borrowers. These higher-cost loans have been the fastest-growing segment of the mortgage market– accounting for 20% of the home loans issued last year, up from 10% a decade ago. Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20% of people who get these so-called sub-prime loans could have qualified for more-conventional prime loans.

Consumer advocates say it is a “borrower beware” market. Companies and independent brokers generally are not legally required to tell customers that they might get a better deal elsewhere, and regulations have not kept pace with the booming mortgage refinancing market and skyrocketing home prices. “The reality is, if you happen to walk into the wrong door, you can be trapped,” said Kathleen Keest, senior policy counsel at the Center for Responsible Lending, a nonprofit advocacy group in Durham, N.C. The National Home Equity Mortgage Assn., which represents sub-prime lenders, disputes the notion that large numbers of their customers could find better loans elsewhere. There are legitimate reasons, the association says, why lenders make sub-prime loans to borrowers with good credit. Self-employed people, for example, do not have regular paychecks to document their income.

Used properly, sub-prime loans can help people with spotty credit and a large amount of debt, or others who simply want to tap their equity to pay off expensive credit cards. But they also can allow loan agents and brokers to earn high commissions at the expense of people with solid credit. Loren and Rebecca Oldham say they thought they were getting a good deal when they refinanced their mortgage at 5.25% interest, cutting their monthly payment by $150 a month. But when they sold their house outside Louisville, Kentucky, less than a year later, they discovered a clause that forced them to surrender nearly $16,000 as a penalty for paying off the loan early. Prepayment penalties are usually for borrowers with bad credit, not folks like the Oldhams, who say their high credit score should have landed them a loan without the provision. They plan to seek a refund, and are kicking themselves for not taking enough time to spot the penalty.

Link here.

The real estate industry strives to keep the commission rates high. Here is how.

You save by buying prescriptions and contacts via the Internet. You can now trade stocks for just $10. You purchase airline tickets, rent cars, and book hotel rooms with no transaction fees on the Web. Yet sell your house and you still pay a 6% commission – a whopping $12,000 or so on an average U.S. house. Why has the Internet age not ushered in lower real-estate costs?

In other countries, commission rates are about 1.5% points lower, according to the American Homeowners Grassroots Alliance. In the UK, says University of California professor of economics Chang-Tai Hsieh, commissions average just 2%. Brokers, the National Association of Realtors, and many critics came together in Washington to discuss industry competition and address why the 6% commission has proved so durable. The Federal Trade Commission and the Department of Justice antitrust division, which have spearheaded an assault on NAR practices that they consider against consumers’ interests, organized the conference.

Critics maintain that the industry has systematically fought off innovative business models that would introduce efficiencies and save consumers billions of dollars. The FTC outlined serveral of the methods, including traditional brokers “boycotting” discount-brokers’ listings, state laws that restrain trade, and making it difficult for discounters to get on the Multimple Listing Service.

But, says Hsieh, all these machinations do not ultimately serve the broker, much less the public. He suggests that the NAR abandon its attempts to prop up commissions. “Price protection,” he says, “ultimately does not benefit the price protectors. The efforts are self defeating.” Hsieh says brokers spend more time prospecting for clients – handing out business cards, cold calling, knocking on doors – than they spend selling and marketing homes. That is just waste, of no actual value to their clients. He does not necessarily have a solution. But, he says, “We should try to think of ways to create structure to channel competition that will translate into better efficiency and better prices – not waste.”

Link here.


General Motors, already hobbled this year by $3.8 billion in losses and a non-investment credit rating, is being investigated over its pension accounting and transactions with bankrupt auto-parts maker Delphi Corp. GM is cooperating with the SEC after receiving subpoenas. The Detroit-based automaker’s finance unit, General Motors Acceptance Corp., is also being probed as part of an SEC and grand jury investigation of insurers, the company said. The agency is studying whether companies inflate profit or minimize earnings swings by using unreasonable assumptions to value pension assets and liabilities. In the last two years, the SEC has asked Boeing, Northwest Airlines, Navistar International and others for similar information.

“The accounting rules for pensions allow people to do things you wouldn’t believe,” said Ron Ryan, chief executive of New York-based Ryan ALM, an asset management company. “The rules are the problem.” GM’s statement was prompted by DaimlerChrysler’s disclosure in an SEC filing two days ago that the agency was seeking information about the methods the company uses to determine its pension obligations “as part of its investigation of accounting issues involving such benefits at GM.” GM and Ford Motor were asked to provide data on their pension assumption in October 2004.

SEC staff asked for similar clarity from Sysco Corp. and Walt Disney in 2003. U.S. accounting rules let a company assume a positive annual return on pension-fund assets such as stocks even if the assets lost value that year. GM’s obligations of as much as $12 billion in additional retirement costs for workers from Delphi, a former GM unit, are also an issue, said Argus Research analyst Kevin Tynan. As part of the 1999 spinoff of Delphi, GM agreed to cover some retirement costs for Delphi workers if parts maker could not pay them.

Link here.


If you plan on visiting some big-name metropolitan art museum anytime soon, let us warn you: It may be difficult to plumb the depth of works by the likes of Picasso and Pollack – what with the giant red “SOLD” sticker obstructing the view. No joke. According to an October 26 New York Times, art institutions across the country are taking some of the greatest contemporary works off their walls and putting them on the bidding block at famous auction houses.

Maybe you have heard of a few of them: 1.) The New York Metropolitan Museum of Art (MoMa): Planned sale at Christie’s in November of 13 famous works, one of which is estimated to fetch $1.5 to $2 million alone. January and February: sale at Sotheby’s to raise a projected $4 to $6 million. 2.) Los Angeles County Museum of Art: Planned auction of 43 works (expected value: $10.4 to $15.4 million) at Sotheby’s in November in the “biggest sale by the museum in over” two decades.

In the words of an October 16 New York Daily News: “The art market is hot and prices are rising through the roof. In fact, art can be a better investment than stocks,” literally. To wit: “The annual rate of return on art sold at big auction houses in the last five years was 7.2%. Over the same period, the S&P rose just 2.4%.” As it were, museums are sitting on their very own gold mines. They just happened to wake up to this reality long AFTER the art craze took Wall Street by storm. Case in point, back in May 2004, Picasso’s “Boy With A Pipe” fetched $104.2 million, shattering all sales records for a single painting ever in history. At the time, a May 10 Barron’s observed: “Collecting art is the new cocaine.”

But no matter if the only art hanging on your walls is a swimsuit calendar, you have to admit – for a museum such as the Metropolitan to give into the, well, drug, is nothing short of incredible. After all, it is curator, not PROCURATOR and those opposed to these institutions capitalizing on their collections are anything but mum. “History will make a fool of these museums.” – AND – “Museums shouldn’t part with their legacy.” – AND – The matter “reflects the influence of an impatient new generation of financially astute trustees who fail to grasp the role that museums play as cultural guardians.”

MoMa? Try, MoMa-ney – no matter IF the purpose of the auction is to raise money for other acquisitions. Call us crazy, but last time we checked, the Met was not the New York Mets. Institutions of fine art ordinarily DO NOT trade old masters for new ones. This, though, is no ordinary time. As the June 2004 Elliott Wave Financial Forecast explained: “The obsession with paintings is an extension of the panic for stuff… art prices are not strictly commodities. Their prices are also influenced by social mood as reflected by stock prices and regulated by the Wave Principle.”

In short, the bullish optimism that propels stock prices up also propels the price of art, sending everyone from traders to fund managers to private collectors into the sector with hopes of getting rich quick. For museums to join the bandwagon – well, that kind of story sends a clear socionomic clue to the impending swing in stocks. This kind of picture does indeed send a thousand words.

Elliott Wave International October 26 lead article.


Listen to a stockbroker or financial planner hawk their services and you will almost certainly hear words to this effect: You can expect the stock market to return an average of 10 percent a year over the long term. That statistic is trotted out with such certitude that most investors accept it as financial gospel. But can investors who start buying stocks today actually expect that kind of return over the next 10, 20 and 30 years? “From 2005, guess the length of time that is needed to assure the long-term average,” said Ed Easterling, president of Crestmont Research, a Dallas investment research firm. “The answer – probably never.”

Mr. Easterling is not alone in his effort to lower investor expectations. An increasing number of academics and financial experts believe market returns over the next few decades will not match previous decades. A more realistic return – or, as Mr. Easterling puts it, a return that a rational investor can expect – is somewhere between 6% and 7%. The respected Leuthold Group, a Minneapolis research firm, also estimates long-term market returns in that range. “It’s unreasonable for investors to expect double-digit returns,” said Eric Bjorgen, senior research analyst at Leuthold. “Too many investors tether their expectations to what happened in the last 20 years, but that’s not likely to happen again in our lifetime.”

A look back at stock market history will show why. The average compounded annual return of the Standard & Poor’s 500 index from 1926 to 2004 is 10.4%, according to Ibbotson Associates Inc., a Chicago research firm. Many people just assume those same returns over the next few decades and project from that how much they will accumulate for their retirement. But what they are actually doing is betting that another market bubble will push stock valuations to the limit as they did in the late 1990s, Mr. Bjorgen said. “That period was a statistical outlier, an aberration, that comes around maybe every 75 years,” he said. “Rational people shouldn’t base their financial expectations on the madness of crowds.”

Link here.


Is Wal-Mart going wobbly? Over the past couple of weeks, America’s largest company – linchpin of the low-wage, no-benefit economy that is increasingly the norm in America – has announced some surprising reversals of course. In a series of speeches and interviews, chief executive H. Lee Scott unveiled four initiatives that he clearly hopes will polish the company’s increasingly tarnished image. Wal-Mart, he said, will shift to more environmentally responsible practices – demanding greater mileage of its truck fleet and better packaging of its products. It will offer more affordable health insurance to its employees, cutting the monthly premium in some cases to just $11. It will monitor the environmental and health and safety practices of its foreign suppliers. And it will lobby for a higher federal minimum wage.

Scott’s timing is anything but accidental. The sweatshop conditions in which thousands of employees of Wal-Mart’s suppliers routinely work, and the depressive effect that Wal-Mart has on working-class living standards here in the U.S., are receiving increasing scrutiny – enough to impede the company’s growth. Wal-Mart’s attempts to open stores in the major cities of the Northeast and West Coast have been largely checked by a coalition of fearful and indignant unions, smaller retailers, churches and liberal activists. Wal-Mart’s stock is down 13% this year. And worse is still to come. In November filmmaker Robert Greenwald will release Wal-Mart: The High Cost of Low Price, a scathing documentation of the company’s business practices at home and abroad.

So the leopard realized it was time to change its spots – up to a point. Only 44% of Wal-Mart’s nearly 1.3 million U.S. employees are covered under its health insurance plan; indeed, as any state government can attest, many thousands of Wal-Mart employees qualify for and routinely use the Medicaid program for the indigent. Now the company says it will make its insurance more affordable – though it still comes with a $1,000 annual deductible, a hefty chunk of change considering that the average Wal-Mart employee makes less than $19,000 a year.

Scott’s announcement that Wal-Mart wants better environmental and workplace practices from its foreign suppliers raises many more questions than it answers. To demand that Wal-Mart’s foreign suppliers clean up their act is to demand that Wal-Mart alter its own zealous low-wage culture. Which is why Scott’s pledges merit a healthy dose of skepticism. Scott’s out-of-the-blue declaration of support for a higher minimum wage does merit belief. For Wal-Mart is bumping up against a serious problem at least partly of its own making: Because it pitches its products to a disproportionately low-income clientele, its revenue rises and falls with the fortunes of the lower end of the American working class.

Those fortunes these days are anything but bright. The coming crunch in heating oil prices, the decimation of American manufacturing, the steady decline of median family incomes over the past several years, the failure to raise the federal minimum wage since 1997 and the fact that Wal-Mart is setting the pay standards for millions of American workers – all these are combining to limit the ability of Wal-Mart shoppers to buy as much as they used to. While sales at the Neiman Marcus end of retailing have been doing just fine, the working-class money crunch is taking a real toll in Wal-Mart-land. Wal-Mart, could, of course, raise its workers’ wages, but Scott has dismissed that out of hand. So now it is the feds’ responsibility to rescue Wal-Mart from the consequences of the low-wage, low-consumption economy that Wal-Mart, with such fanatical devotion, has created. For, in Wal-Mart’s America, it is not clear that even Wal-Mart can thrive.

Link here.

Wal-Mart warms to the state.

H. Lee Scott, Jr., the CEO of Wal-Mart, surprised many by calling for an increase in the minimum wage. And what accolades were heaped on him! The company was even cast in a new role, from the exploiter of workers to the responsible advocate of pro-worker policies. And how selfless, for who has to pay such higher wages but companies like Wal-Mart? And thus do we see a corporation set aside its business interests on behalf of the long-term interests of society.

The whole thing befuddled Wal-Mart haters as much as it disgusted its free-market defenders. Ted Kennedy would not go so far as to praise the company, but he did say that “If the CEO of Walmart can call for an increase in the minimum wage, the Republicans should follow suit on behalf of the millions of working men and women living in poverty.” Other lefties just would not believe it. The spokesman for Wal-Mart Watch said that Scott’s call for a higher wage floor was “disingenuous and laughable”. And yet, let us think this through. Might there be another reason Wal-Mart would advocate a higher minimum wage?

Before looking at the evidence, let us do some a priori theorizing based on the history of US corporate regulation. Historians such as Robert Higgs, Butler Shaffer, Dominick Armentano, and Gabriel Kolko have chronicled how the rise of business regulation, including intervention in market wages, was pushed by large companies for one main reason: to impose higher costs on smaller competitors. This is how child labor legislation, mandated pensions, labor union impositions, health and safety regulations, and the entire panoply of business regimentation came about. It was pushed by big businesses that had already absorbed the costs of these practices into their profit margins so as to burden smaller businesses that did not have these practices. Regulation is thus a violent method of competition.

Moving from theory to reality, we find that this is precisely what Wal-Mart is up to. The hint comes from the news stories: “Wal-Mart maintains that it pays above the current $5.15 an hour minimum wage to its employees.” The current minimum is $5.15. According to studies, Wal-Mart pays between $8.23 and $9.68 as its national average. That means that the minimum wage could be raised 50% and still not impose higher costs on the company. So who would it affect if not Wal-Mart? All of its main competition. And the truth is that there are millions of businesses that compete with it every day. There are many ways to compete with Wal-Mart. Not all shoppers like sprawling stores. Others like better service with more experts on the floor. Others just hate crowds. But a main way to compete is to hire lower-priced labor. Now, if Wal-Mart can successfully lobby the government to abolish lower-wage firms, it has taken a huge step toward running out its competition.

Now here is the great irony. The left has long been in a total frenzy about how Wal-Mart saunters into small towns and outcompetes long-established local retailers. Wal-Mart’s opponents have whipped themselves into a frenzy about the company’s success, claiming that it always comes at a huge social cost. Now, most of this rhetoric is overblown and ignorant. The left’s claims of unfair practices would be valid if Wal-Mart did indeed work to impose legal disabilities on its competitors – in effect making it illegal to outcompete the company. And yet that is precisely what raising the minimum wage would do.

Thus has our CEO friend Mr. Scott discovered a viciously devious tactic. He sees a way to drive out the competition by doing precisely what Wal-Mart’s biggest critics are advocating! And what will be the result? Wal-Mart’s share of the market will go up, and its degree of cartelization over the mass consumer market will increase, not by market means but through government intervention. Then we can expect the left to once again fly into another hysteria about the size and growth of the company – totally oblivious to how they worked to bring it about. Free-market advocates who have long defended Wal-Mart can only be disgusted at this shift in the company’s methods from competing on market grounds to calling for the state to crush its competition. Even more disgusting is how the company can count on the economic ignorance of its critics to help do it.

Link here.


Unfortunately for the U.S., history has never been kind to empires. They rise from the ashes, flourish and eventually decay. The past is dotted with glorious states, which ultimately faced the inevitable – the eventual decline! The 16th century belonged to the Spanish, the 19th century was dominated by the British and the 20th century saw the growth of America. So, who will take charge of the 21st century? I am of the opinion that China will dominate our planet in the future. You may think I am crazy. But, if someone had told you in 1900 that the U.S. would replace Britain as the world leader in the 20th century, you would have pronounced him crazy too! So why am I so sure that the dragon will rule?

Remember, the People’s Republic of China is a massive market with 1.3 billion people. When the Chinese leaders unleashed capitalism 20 years ago, they changed our world forever. The Chinese economy has been gradually opening its doors and the effects are being felt today in several sectors. The most profound impact has been felt in the commodities arena. China is in the early stages of its industrialization and per-capita consumption is still depressed. Yet, China has already replaced the United States as the largest consumer nation in the world! China is now the largest consumer of copper, zinc, tin, rubber, raw wool, cotton, coal and major oil seeds. Furthermore, it is already the second largest consumer of oil (despite a ridiculously low per-capita consumption of 1.7 barrels when compared to 25 barrels in the U.S.!), aluminum, nickel and lead.

The point I am making is that China’s hunger for raw materials is going to increase in the future. As more and more jobs are transferred to Asia, the standard of living will rise. Wealthier people consume more things – period. Multiply any small increases in consumption by the 1.3 billion Chinese and you get a gigantic figure! This thought must have businesses dreaming all around the world! China is now the 7th largest economy in the world and worth US$1.4 trillion dollars. However, adjusted for differences in purchasing power, the Chinese economy is already the 2nd largest and over 60% of the size of the U.S. economy.

What will happen to domestic demand (and commodity prices) when the 371.6 million Chinese households start consuming more? You do not have to be a rocket-scientist to figure out that the price of raw materials will go through the roof! In addition to this, what about China’s neighbor, the second most populated nation in the world? India. It is home to 1.1 billion people and has 199.4 million households. India, with a GDP of $600 billion comes in as the 12th biggest economy in the world. But, adjusted for differences in purchasing power, it is already the 4th largest economy in the world after the U.S., China and Japan!

India has 6 cars per thousand people and China’s number comes in at a shockingly low 6.7 cars per thousand people. Compare these figures with the developed nations: France – 491 cars, United States – 481 cars, Japan – 428 cars, U.K. – 384 cars. Even Cambodia has 312 cars per thousand people! I am convinced that India and China’s car ownership will not remain so low forever. It is no wonder that car manufacturers all over the world are drooling at the future! Oil demand is another story altogether. Those who believe that this is just a temporary spike in prices are living in a dream world!

Over the past 200 years, commodities had five secular bull markets. The shortest bull market lasted 15 years while the biggest commodity boom (1878-1918) went on for a monstrous 40 years! The current bull market is only 4-5 years old. If history is any guide, the current commodity bull still has a long way to go.

Link here (scroll down to piece by Puru Saxena).


Tell me if you think this is odd. A report by University of British Columbia says that while the public feels that “war is becoming more common and deadlier, that genocide is rising and that terrorism poses the greatest threat to humanity … not one of these claims is based on reliable data. All are suspect; some are demonstrably false.” The study goes on to show that “the number of conflicts between nations, civil wars, battle deaths, coups and genocides has been falling steeply for more than a decade.” This “disconnect” between reality and the public’s perception rings a bell. A few months ago, we noticed a similar phenomenon in people’s assessment of crime and immigration. Crime is down, but fear of crime is up. Migration is flat, but fear of immigration is up.

What is wrong with us? Some say, blame the media: Too much violence on TV and elsewhere. But we at EWI think that the roots of these false beliefs are deeper than pop culture. The declines in the world’s major stock markets back in 2000 signaled a shift in global social mood that began to unfold that year. Notice that since then, international feelings of fear, opposition and separatism have grown strongly. Social mood is a powerful force that can and does overtake people’s rational thinking. Its best indicator is the stock market – and that is why, by knowing where stocks are going, not only can you manage your investments better, you can also anticipate many cultural trends.

Link here.


If Wall Street hosted a Halloween costume party, the most popular get-up might be Fred and Wilma Flintstone. After all, if you believe the mainstream take on where the energy market is headed in the coming weeks – we will all be feet-powering our cars and rubbing two sticks together to heat our homes this winter. And nothing raises these kinds of concerns like the October 26 weather forecast calling for “lower-than-normal temperatures” in the northeastern U.S. On this, the following news stories speak volumes: “The cool weather is a warning sign of colder weather ahead and Consumers will have to dig deep to pay for winter heating oil bills.” (Reuters)

Factor in the popular notion that Hurricane Katrina and Rita have caused irreversible damage to oil refineries in the Gulf Coast region, impairing production and freezing output – and you may as well go drown your sorrows at Bedrock’s “Water Buffalo” Lodge. Problem is – the psychology surrounding the bullish energy prices has been in force for the past two years, from the very onset of the uptrend in prices. Those who choose to see only what is in front of them right now are truly living in the Stone Age – in a time when animal instincts dominate cold hard facts.

As it were, the facts paint a very different picture. Here, an October 28 Bloomberg hits the wooden club on the head: 1.) Crude oil inventories are 12% above year ago levels; 2.) Energy Department reports that demand for fuels in the four weeks ending October 21 was 1.4% lower than a year earlier, while consumption was 4% lower over the same period; 3.) Imports of gasoline into the U.S. have surged to records three of the past four weeks, compensating for reduced productions. In the week ending October 14, imports rose to the highest level ever in history; 4.) As of October 28, crude oil prices have plunged 14% since hitting an all-time record on August 30. Bottom line: “There is no real shortage of capacity in the upstream and on a global basis. There is no shortage of refining capacity.” And last time we checked, “cold” weather forecasts for winter were pretty par for course.

Truthfully, if you want to know whether the rally in energy prices is set to continue through the thatched roof, there is no better place to look than the October 26 Short Term Update. In that issue, we devote a special section to the sector starting with two labeled charts of one exchange-traded fund comprised of oil and natural gas stocks. In our words: “There’s no doubt that many view the current situation as a buying opportunity. [And], when you look at the Elliott Wave pattern of the decline from the September 22 top the scenario that emerges leans strongly to one side.”

Elliott Wave International October 27 lead article.


A few not entirely random observations: 1.) The three major U.S. stock averages (Dow, S&P 500, NASDAQ) are lower over the past month, six months, and year-to-date. 2.) More than any other factor, energy prices have contributed to “inflation fears” in recent months. Yet from the highs of late August to the lows last week, crude oil prices DECLINED some 17%. 3.) An index of energy sector stocks fell strongly from Sept. 22 to Oct. 20, and then bounced back a bit. This down-up action has formed a textbook Elliott wave pattern. 4.) The Commerce Department this morning released the latest housing numbers. I did a late-afternoon survey of Google News and saw 22 “related articles”, 18 of which had headlines with variants of “new home sales rise”. Only one headline took the trouble to say “New home sales rise more slowly than expected.” None of the headlines/articles even tried to spell out what you can see in this chart.

Facts like these (and many more) are vital to an informed understanding of where the markets and economy are now, and where they will go next. But the usual suspects do not (and cannot) provide you with most of what you need to know.

Link here.


One of London’s most successful hedge fund managers has told investors that October is shaping up to be the worst month in its history. The warning is likely to be read as a harbinger of bad news from other hedge funds. Roger Guy and Guillaume Rambourg, co-managers of the $1.5 billion AlphaGen Capella hedge fund for Gartmore, told investors in a letter dated October 21 that the 6-year-old fund was down 3.5% for the first three weeks of the month.

Link here (subscribers only).


Back-to-back 100-point swings in the Dow show how much the markets are driven by human psychology. Humans behave in certain ways, and these behaviors are patterned. In the case of financial markets, these patterns are perfectly recorded for all to see in a price chart. Anybody can see these patterns of behavior if they know what to look for. In the beginning, Bob Prechter tried many forms of technical analysis before he struck on the Elliott Wave Principle, because he could see the patterns. For anyone interested in why it sparked him intellectually, here is an excerpt from his question-and-answer book, called Prechter’s Perspective.

Link here.


Gold has been irrelevant for so long that most investors ignore it completely. That is unfortunate. The precious metal’s 3-year advance from $265 an ounce to $470 is no accident. The price of gold is rising because its main competition, the U.S. dollar, is proving to be a very poor store of value. In other words, the gold bull market is just beginning. According to the conventional wisdom, there are only a few ways for the bull market in gold to play out. Option #1: The yellow metal’s dollar price will violently launch into orbit at some point, arc into a near vertical crescendo and ultimately burn itself out supernova style. Option #2: The gold price will grind higher over the next few years, punctuated by sharp rallies and swift sell offs (just to keep us on our toes). But in either case, the gains will not endure. The gold price will eventually return to earth … where it belongs.

Gold will return to normalcy, which in gold’s case equates to dormancy. After all, what goes up must come down. Right? That is what everyone expects. Yet what if, this time, the future does not look like the past? What if gold were to climb to new highs, breaking the $1,000-an- ounce barrier, and never return from whence it came? Now that would be something. To understand the bullish outlook for gold, we must first examine the bearish influences operating against the U.S. dollar.

It arguably took two world wars and a global depression to dislodge the British pound as the king of world currencies. That is a fairly tall order; no wonder the consensus belief is that king dollar will maintain his throne. But for all the elements working in its favor, the reign of America’s world-beating currency has a large strike against it: The profligate policies of America itself. While it took a series of extraordinary events over the space of decades to dislodge the pound, Britain never spent others’ money with the wild abandon America has shown. To put it bluntly, the U.S. has taken a jackhammer to its financial credibility. The U.S. consumer is happily in hock up to his eyeballs, betting on further housing appreciation to bail him out, while the accelerating pace of U.S. government spending boggles the mind.

Link here.

Deflation and Gold Bugs

Some things never go out of style, including good interviews. Let us look back one year in time to Bob Prechter’s Theorist of October 2004. In it, he published an interesting interview he did with Chris Oliver, the Money Editor of The South China Post. Here is an excerpt.

Q: Can the Federal Reserve prevent deflation?

Bob Prechter: No. We have a huge bond market of $30 trillion, which is debt already created. If bond investors came to believe that the Fed would begin printing money and throwing it around, what would they do? They would sell every bond they have got, which would lead to a decrease in the supply of credit because bond prices would fall and interest rates would rise. So there are not any alternatives to deflation. … The ultimate result is going to be a worldwide depression. There were deep depressions in the 1790s, the 1840s and the 1930s, and I think the next one is already under way. It started in 2001. We have had one or two every century, and we are headed into one now.

Q: Gold bugs say we are in an inflationary era and that this is backed by the rapid rise in the price of the yellow metal from $250 an ounce in 2001 to above $400 recently.

Bob Prechter: They did not say it at the low in February 2001, when gold was a buy at $250. The fundamentals were all bearish then, and even gold mines were hedging for further decline, which never came. Fundamentalist arguments do not get you in at a bottom or out at a top. They often set traps so you will do the wrong thing.

… Think about this: Gold is trading exactly where it was in 1996 despite massive credit inflation over the past eight years. Why is that? I think the gold market understands the difference between credit inflation and currency inflation. A reversal in credit expansion – which is inevitable – will crush prices for everything, and the gold market knows it. The gold bugs’ theory is that an increasing money – actually credit – supply should be bullish for gold and silver. But it has not been bullish for 24 years, so why is it bullish now? Look, I might be wrong on my current outlook for gold. In 1995, in At the Crest, I called for the bear market to end about New Year’s Day of 2001, and it ended that February. So I am somewhat conflicted. But that does not mean that the bulls’ arguments are any good. We have heard them at every gold top since 1980 and opposite arguments at the lows. People have a psychological imperative to come up with reasons to be bullish at tops and bearish at bottoms. Market analysis is a subtle and difficult craft. You cannot just look out your window and assume the obvious. That is not to say the obvious never happens, but when it does, it’s luck.

Link here.


Why do we write about money … and about markets … every day? We do it because the markets are a source of amusement, but also because they hate humbug in all its forms. No matter what people say or think, the markets eventually have their say, and their say is final.

“There’s no housing bubble,” says Ben “Printing Press” Bernanke. “[U.S. Treasury Secretary] Snow sees no housing bubble,” either, says Reuters.

Is there really a housing bubble? Two of the most powerful and knowledgeable financial officials in the world say “no”. Does that settle the issue? Nope. The markets still have not spoken. If there is a “bubble” in housing, it will burst. That is what markets always do to bubbles. If no bubble bursts, well … Bernanke and Snow will be proved right. We will see.

Link here.


(Found in Old Saint Paul’s Church in Baltimore, Dated 1692 … we have merely updated it.)


Remember that there is a fool on every corner and a sucker born every minute; be on good terms with all of them. Speak your truth quietly and clearly; listen to others, even the dull and ignorant, for they too have money to spend.

Avoid loud and aggressive persons; they are vexations to the spirit. If you compare yourself with others, you may become vain or bitter – especially if you check out their balance sheets – for always there will be greater and lesser persons than yourself.

Ask not what you can do for your country, but what your country can do for you … before it goes broke.

Keep interested in your career, however humble; you will probably need the money.

Exercise caution in your business affairs … for the world is full of trickery. But let this not blind you to what virtue there is: many persons strive for high ideals, though everywhere life is full of private heroism, as well as public humbug.

Be yourself, but only if you can’t do better than that. Especially, do not feign affection, for what is the point? Neither be cynical about love; for in the face of all aridity and disenchantment, it is perennial as the grass … or at least as cyclical as presidential elections.

Take kindly the counsel of years, gracefully surrendering the things of youth; the old codgers might know something. Nurture strength of spirit to shield you in sudden misfortune; misfortune is practically guaranteed, especially after 18 years of Alan Greenspan at the Fed. But do not distress yourself with imaginings; there is no need … things are worse than you could ever imagine anyway. Beyond a wholesome disciple, be gentle with yourself. But do not forget to kick a man when he is down; he would do the same to you.

You are a child of the universe, no less than the trees, the stars, and bathtub rings; you have a right to be here. And whether or not it is clear to you, no doubt the universe is unfolding as it should, whether you like it or not.

Therefore be at peace with God and on even terms with bookies and barkeeps. With all its shame, drudgery, claptrap & broken dreams, it is still a beautiful world.

Link here (scroll down to piece by Bill Bonner).
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