Wealth International, Limited

Finance Digest for Week of November 28, 2005

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


November’s French riots seemed to bring together everything that should make investors shy off western Europe: intractable unemployment, ethnic conflict, sputtering growth rates, aging populations and vertiginous taxes. But Robert Lyon, a charmingly irreverent money manager based in Chicago, sees beyond all that. It is not just that this has been a banner year for European stocks. The MSCI Europe index is up 16.6% this year in local currency terms (and 1.8% in dollars) versus 1.6% for the S&P 500. The 55-year-old head of Institutional Capital Corp. and manager of its $125 million International Fund says Europe offers well-run companies with good earnings growth – but at lower prices than their U.S. counterparts.

Lyon’s trick is to find European stocks (and a few Japanese ones) that are not as well covered by analysts as are their U.S. peers. He has found a sufficient number with market caps of at least $2 billion on which his International Fund has returned 9.2% a year over the last five years, six points better than the MSCI EAFE index (which blends Europe with Asia).

Link here.


This year’s run-up in the oil and gas prices may have backed off a bit, but energy costs are still high and will stay up for a long time. The situation prefigures what will happen to most natural resource commodities in coming years. The demand is unabated given the rise of China and India as global economic powers with huge populations. These nations’ expanding middle classes have gotten beyond wanting to eat better; they now want better housing, transportation and consumer goods. Aside from oil and natural gas, the prices of copper, iron ore and coal have seen dramatic increases. Look for price surges in lesser-known raw materials, such as chromium, nickel, tungsten, cobalt, titanium and vanadium, to name a few.

The good news for investors is that the accelerating demand for raw materials will make this sector grow much more rapidly than the world economy as a whole. So put money into raw materials producers beyond the obvious oil and natural gas companies. Unfortunately, there are no exchange-traded funds (ETFs) or closed-end funds that adequately cover nonenergy natural resources. Since many of the good ones are overseas, I do not advise buying their bonds because you get no upside beyond their coupon yields. Go for equities with strong dividend yields, or the prospect of rising payouts.

Southern Peru Copper (61, PCU) is a Phoenix-headquartered copper miner with operations in Peru and Mexico. The 10% dividend yield makes this very rewarding to own. I also like Fording Canadian Coal Trust (35, FDG), a Canadian producer of metallurgical coal – the stuff used to fire steel blast furnaces. Like the Canadian energy trusts I have written about, Fording has a high current yield – 17%. The fears are that the dividend rate, which was just recently increased, cannot be sustained. The stock has fallen 21% from its 2005 high in September. If there is a dividend cut, it already is priced into the stock.

Link here.


Mutual fund companies should be turned into not-for-profit organizations. At least, that is what David F. Swensen thinks. In his new book, Unconventional Success: A Fundamental Approach to Personal Investment, the head of Yale’s endowment lambastes the entire mutual fund industry for failing the American investor. Its sins, he says, are funds with trailing performance, excessive portfolio turnover and high management fees. He points to recent fund scandals, in which some managers benefited at the expense of ordinary investors, as another indictment of all that is wrong in the industry.

Strangely, Swensen argues, the root of all these issues is the profit motive. To him, fund managers are just looking out for themselves, not customers. If fund firms are turned into virtuous nonprofits, he writes, “No profit margin interferes with investor returns.” In condemning mutual funds, Swensen omits large parts of the story. While there have been problems in some corners of the fund universe, the vast majority of funds remain an extremely effective wealth-building tool. Fund investors get professional management, diversification and low investment minimums (as little as $50 a month).

Following are a few of my favorites in the fund arena, all wonderful, ethical businesses thriving because of their commitment to shareholders and free enterprise.

Link here.


Too much of good thing spells trouble. this summer companies recorded a record level of cash. And bondholders had nary a creditworthiness worry. Ever since the bull market went south, corporate America has shored up its balance sheets, refinancing debt at lower rates or paying it down. Sure enough, we saw a lot of credit upgrades. It looks as if those happy days are numbered. Now the sacred cash on these replenished balance sheets is in jeopardy of being squandered on shareholders – agitated shareholders who are fed up with 2005’s sideways equity market movement. Corporate shakedown activists are stirring investor ire and demanding action. Corporations, toadying to these appetites, are engaged in a relentless surge of share buyback programs and outsize dividend payouts.

Creditworthiness is disappearing before our very eyes. Bondholders hate when that happens. We want the cash used to make coupon payments, to lower debt or, if neither of those, at least to expand business in the expectation of bringing in new cash later. The use of cash to pay dividends or buy in shares is bad news for corporate bondholders. The early signs of a credit downgrade cycle are here. Act accordingly. Scrutinize your portfolio to make sure you do not own bonds in companies with growing debt loads. In particular, beware of companies that are announcing monstrous repurchases or special dividends.

If you are in the bond market to buy today, look for names and industries that are the least likely to be downgraded. High on the good-to-buy list are financial institutions. Banks and brokerages need pristine balance sheets and credit ratings, so there is no nonsense.

Link here.


It is like buying a gift for the guy who has everything: What can you do to impress the boss for whom you have already been pulling all-nighters and all-weekenders? That is the dilemma faced by thousands of investment bankers in New York every fall, when bonus season gets under way. Starting sometime after Labor Day and ending before Christmas, everybody in the financial industry is on their best, most obsequious behavior, hoping to curry the favor of those who divvy up the spoils. And what spoils there are this year – the 2005 bonus season looks to be Wall Street’s biggest haul in five years. Last year, the New York State Comptroller’s office estimated the average bonus on Wall Street to be a clean $100,600 (or $15.9 billion split among 158,000 employees). Early estimates of the 2005 bonus pool reach as high as $19 billion.

Typically, Goldman Sachs’s announcement of its third-quarter results kicks the bonus season into high gear. Long revered for being where the serious money gets made, the firm has had a blowout year even by its own standards. Announcing a record profit in the third quarter, Goldman also noted that it had set aside $9.25 billion, almost $420,000 per employee, in compensation. When fourth-quarter results are factored in, that total could swell to an $11 billion pool, or $500,000 per employee. Naturally, money on Wall Street is not shared equally, not even close. …

Link here.

Wall Street celebrates doing a good job of separating people from their money.

Bonuses at Goldman are said to total $40 million this year. “In every war the victors get the spoils,” writes Paul Farrell. “Same here, as Wall Street doles out more than $20 billion in bonus money to its army. Huge bonuses: $105,000 to first-year associates right out of business school. Imagine some 25-year-old with an MBA gets a bonus three times bigger than the average American’s income.”

“Worse yet, Wall Street’s top generals get one-time bonuses bigger than most Americans make in their lifetime, $6 million or more from the Wall Street Greed Machine. How do they justify those huge bonuses? By being greedy all year long, playing with your money while secretly siphoning big bucks off the top. Look at Wall Street’s rotten performance since the 2000 crash. Wall Street’s a big loser. Seriously, have you checked the Wilshire 5000 or the S&P 500 indexes lately? Both are in negative territory, below where they were five years ago.”

Farrell is indignant. He needs to step back, take a deep breath and smile. Wall Street is a business, just like any other. It offers a service: separating people from their money. This year it has done a good job of it. Why should it not celebrate? Wall Street offers to help people make money without working. It is such an attractive bamboozle, few people can resist. Google at $400? Gimme some right away … before it goes to $500!

We take the bonuses on Wall Street, and high salaries throughout corporate America (G.M. may have cut 30,000 employees, but it still spreads good cheer through the ranks of top management), as more evidence that we have reached a late, degenerate stage of our imperial economy. The sun has not set yet, but the decaying serenity of late afternoon hangs in the air, like the perfume of an old woman. The companies that make the most money are those that shuffle money – not those that make things people want to buy. And throughout the entire society, everyone participates in what has become an orgy of swindle and delusion. Consumers earn less and less each year (for the last two years), but they spend more anyway. Average wages are expected to rise 3.5% this year. But after increases in energy and health care, the typical wage earner is likely to have less money in his pocket in 2006 than he did in 2005, or 2004, or 2003.

The U.S. government jiggles and jives the figures so no one knows what is really going on. Poor householders don’t have a clue. They think they really can get rich by buying and selling each other’s houses, or by putting their money with Wall Street. They really believe you can have a yin without a yang, and that after the sun rises, it stays up forever. We shall see…

Link here.


Herein, we will argue why we believe that Dr. Ben Bernanke is ill-suited for the Chairmanship of the Federal Reserve System – especially for residential property and other investor’s, homeowners, the general public, both domestic and international markets, and, sadly, for his own historical legacy. By all accounts Dr. Bernanke is a “nice” guy, and some wonder why he would have placed himself in the position of coming on stage following the Maestro. We believe that as events unravel, as the true history of the unprecedented Credit Bubble is exposed, Mr. Greenspan will be appropriately discredited. Why would Dr. Bernanke place himself in harm’s way? Hubris comes to mind. (Webster’s Online: Hubris: “hyü-bris, noun: exaggerated pride or self-confidence.”)

Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.” ~ Andrew W. Mellon, Secretary of the Treasury, ca. 1932

Bulls of 1929 – like their 1990s counterparts – had their eyes glued on improving profits and stock valuations. Not a thought was given to the fact that the rising tide of money deluging the stock market came from financial leverage and not from savings.” ~ Dr. Kurt Richebächer, ca. recent

This quote from a good doctor is one that we highly agree with. Substitute the word “housing” or the word “stock” and you will be up-to-date. Then loosely substitute the words “Bull Ben” for the words “Bulls of 1929”, and you will see our position at the outset. And while we are not nearly as severely austere as the former Secretary of the Treasury, Andrew W. Mellon, he does make a point. A planned debacle, an all hand’s-on-board public winding down, would be less painful to the investing public and all Americans than if it comes out of nowhere. However, a well-thought-through program would be communist-like central planning that will never and should never fly in a Capitalist Society. Unless of course the Federal Reserve System does it in secret, like so much of what they actually do. Could they be planning it now?!?!

We argue that Dr. Bernanke is a Bull, not an inflation dove or hawk. The later are terms bantered about in the press, terms that merely obscure for the investing public his real role as Fed Head. He must be a bull. He must create a wide perception that everything is just fine, and that we do not stand on the brink of deep recession, if not, depression. He is no Alan Greenspan, but, moreover, he is no Paul Volker, just when we need him. Need Paul Volker? Yes. We argue that in order to maintain the confidence of foreign governments and their central banks who fund our Current Account Deficit, our Government, our War, the Fed must tighten (raise interest rates) and be less accommodative (stop freely enabling the creation of massive amounts of dollars through liquidity growth) than has been the case. Not through Greenspan-like baby steps, but firmly and decisively in order to maintain the slightly diminishing flow of recycled dollars back to the U.S. that buy our Treasuries, Mortgage Backed Securities, Asset Backed Securities, and the like. The inflow of more than $2 billion per business day, to keep us solvent.

A bit of the historical record is in order. In November of 2002, newly appointed Federal Reserve Governor, Ben Bernanke, gave a historic speech, which gave him the nickname, Helicopter Ben. The speech, entitled: “Deflation: Making Sure ‘It’ Doesn’t Happen Here” was thought by some to be much more than Dr. Bernanke’s personal opinions given to a major group of economists in Washington D.C. That, some have opined, he was speaking for and with (his boss) Mr. Greenspan’s approval. But, of course! “As I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation. 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 US dollars as it wishes to at essentially no cost.” At the bottom line, among other things, he said it would be appropriate to “shovel money from helicopters” if deflation were at hand.

What is the Fed? Simply put, the Fed is not a federal entity or agency, it is owned and operated (through a special U.S. Charter) by a cartel of major banks, who obviously see to their own best interest first. The books of the Fed are not open for public scrutiny. We do not know what they own, what they buy, or when they do it. Why? The American people would not stand for it! We do not know the amounts and names of academic economists who receive generous monetary grants (taxpayer money) from the Fed for sweet-heart skewed research supporting Inflationism. Why the secrecy? At its inception a function of the Fed was to maintain and control an “elastic money supply”. This is not necessarily a bad idea … in good times shrink the money supply, and, in bad times grow the money supply. What has happened is that Greenspan always grew the money supply, and, moreover, created an accommodative policy which enabled easy creation of liquidity – debt … thus creating the huge Credit Bubble. Structured finance (Wall Street), which rarely has had such easy money, began creating exotic Securities products, such as mortgage backed securities, asset backed securities, etc.

They then began making crazy (leveraged by more credit, liquidity) bets (hedging, derivatives) on those products. This newly created debt, easy money, inflated and created a Credit Bubble, which, first, inflated the stock market (late ‘90s), and, now the mortgage bubble. (The same easy leveraged money conditions that created the Crash of 1929, and the ensuing Great Depression. The record shows that history does repeat itself occasionally, and always when self-interested central bankers call the shots.) The consequences for the American public are indeed frightening, and again we suggest preparing yourself in advance for the possibility of another Great Depression, which may be world wide in scope.

Greenspan came to the job with a much more resilient situation than Dr. Bernanke finds. Any number of issues give Dr. Bernanke, very little wiggle room. Does Dr. Bernanke have it? Or, is it merely a claim based on formidable academic credentials. Can the new guy in town, the oncoming new sheriff convince the markets, the investing public, moreover, the America people that a recession is necessary – to safeguard the economy – from a depression. This is not deflation, this is the big one. He claims credentials as a foremost student of the Great Depression. But, are his analyses correct? Does he correctly understand what happened, and thereby know how to avoid a 75 year old trap? He may, or may not. Notably, the formidable annalist, Doug Noland, does not seem to believe that the highly regarded scholar of the Great Depression, Dr. Bernanke, actually understands the history of the Depression. He has also identified what we consider a Bernanke trait. Blame foreigners. Blame others. “Take an hour or so and carefully read his April 2005 speech, ‘The Global Savings Glut and the U.S. Current Account Deficit’. I can honestly say – with a conscious effort to avoid hyperbole – that it is one of the most flawed and suspect pieces of analysis I have ever read by a respected economist. And the subject matter is one of the most pressing issues that must be confronted by our policymakers. … I do agree with the notion that ‘ideas are critical’. Unfortunately, our new Fed chief has some very flawed and dangerous ideas of how to deal with critical events that could very well develop early in his term.”

Pensions are coming under withering attack, and many corporations have not adequately funded them. A formulaic bankruptcy filing under Chapter 11 may enable them to dump their obligations to current and oncoming retirees. Think of the airlines and automobile companies. Ironically, rising health care costs are seriously hurting US corporations. Yet, a communist system that would share equally and lower costs cannot be seriously considered. The Japanese national health plan, includes everyone, and is run at half the cost of our private system. Our system seems to work for drug and health suppliers and providers; yet seems bad for the people and employers. The new bankruptcy laws have been engineered to tighten the noose around all debtors, and is particularly onerous for home owners. Debt will not go away. Will a new category of low wage indentured servant be created, from the former middle-class, who can and is willing to work smart – but is forced to work at Wal-Mart?

While we have not thoroughly digested newly recommended tax laws, we do note that the National Association of Realtors has come out strongly against them because they will hurt the home owner significantly. These proposals may be dead in the water on reaching Capital Hill; but make no mistake about it, the Administration’s intent is to raise more taxes from the middle-class (liquidate the middle class?), while continuing to maintain tax cuts for the wealthy.

In sum: Best not to be a debtor with any type of adjustable rate product, or in need of health care or retirement. While we are not financial advisors, and recommend you get one that understands what is argued above, it might not be a bad idea to liquidate property while the market is sort of holding, and gasp, yes, pay cap gains, invest safely in short-term Treasuries, commodities until the housing market goes through its changes. Come back to real estate when the market has been wrenchingly cleansed. Do not be in it when the wrenching comes, unless, you have a fixed rate mortgage. If so, well, that might be all right for investors because rents may go up, and maybe you can safely ride it out over the long-term. But, residential investors might be much better off to get out, watch and wait, and then: “Buy when blood is running in the streets.” ~ Baron Nathan Mayer Rothschild (1777-1836).

Link here.

More of the same at the Federal Reserve.

Benjamin Bernanke, a former member of the Board of Governors at the Federal Reserve, is all but certain to be confirmed by the Senate as the next Chairman of that institution. He may find that the adulation given to Mr. Greenspan does not carry over into his tenure so easily, especially if he continues to help Congress run up huge deficits. Mr. Bernanke is a consummate Fed insider, widely seen by the financial press as the logical heir to Alan Greenspan. In fact, judging by his public statements he may be more like Greenspan than Greenspan himself.

What I mean is that Mr. Bernanke appears to have embraced the idea that the Federal Reserve can create prosperity more than Mr. Greenspan ever did. Like his predecessor, Mr. Bernanke views our system of fiat currency as a tool for creating wealth out of thin air by producing more dollars, whether paper or electronic. But he seems to take things further than Greenspan by refusing even to consider the destructive consequences of monetary expansion. In fact, he earned dubious notoriety for this quote in a 2002 speech discussing the supposed threat of deflation in the American economy: “The U.S. government has a technology, called a printing press, that allows it to produce as many dollars as it wishes at essentially no cost.”

But there is a cost, and it is a heavy one. It is called monetary inflation, which destroys the value of the dollar and punishes those who save and invest. The money supply, as measured by the Fed’s own M3 figure, has increased about 5 times since 1980. Yet for years officials at the Fed have insisted that inflation is firmly in check. Inflation is not in check, as anyone who examines the cost of housing, energy, medical care, school tuition, and other basics can attest. In one sense the remarkable rise in housing prices over the last decade really just represents a drop in the value of the dollar. The artificial boom in the 1990s equity markets, engineered by Mr. Greenspan’s relentless monetary expansion and interest rate cutting, ended badly for millions of Americans holding overinflated stocks. What will happen when the same thing happens with housing?

The fundamental question is whether a central bank can manage the supply of money and credit better than the free market otherwise would. We should not kid ourselves about the true nature of the Fed, which is inherently incompatible with real free market capitalism. Centralized planning of the money supply is a form of economic control that significantly affects prices, wages, and production levels. Remember how market economists once criticized central planning of prices, wages, and production levels in the former Soviet Union?

Link here.

Fed abandons M3 without honest explanation. Action will obfuscate rapid money growth, providing an ideal environment for an inflationist Fed chairman and conspiracies.

Unilaterally and without reasonable explanation, the Fed has decided to stop reporting money supply M3, the broadest of the monetary aggregates and probably the most important statistic published by the U.S. central bank. The decision comes as a shock to many in the financial community and apparently to other central banks, which reportedly were not consulted. One obvious explanation that makes sense is that the Fed does not want anyone to see what Presumptive Fed Chairman Ben Bernanke is going to do to broad money growth. Suggestions that Mr. Bernanke has the odor of an inflationist about him are not going to help quell the speculation. Something is terribly afoul at the Fed, but the popular financial press offers little but moronic platitudes and attacks on “conspiracy theorists” who dare to question the sanctity of the Federal Reserve Board.

I even saw one related comment yesterday from a well known financial reporter who laughed at the concept of there being a Plunge Protection Team that intervenes in troubled stock markets. She cited such a concept as evidence of the absurdity of some conspiracy theories. I first saw the term “Plunge Protection Team” used in 1997 by The Washington Post, when it published an extensive article detailing the activities of the Working Group on Financial Markets. Anyone interested in this “imaginary” group, which includes the Fed Chairman, might wish to read the article. And for what it is worth, my colleague, Doug Gillespie, published a piece November 14th entitled “Bye-Bye, M3, but Why?” There was an outpouring of reader response to Doug’s article, and to a person, respondents expressed the opinion that the Fed’s action failed – and failed badly – the smell test.

Sorry for the diversion, but there is a point to this. The Federal Reserve, not the Treasury, generally is the ultimate backstop for the financial markets. Sometimes the Fed does intervene on behalf of the Treasury, particularly in the currency markets. Despite Mr. Greenspan’s denials of Federal Reserve Involvement in stock market intervention, I have had a former Fed official confirm to me that interventions, at times, have been coordinated by the New York Fed. Mr. Greenspan often does not make accurate statements, despite his carefully chosen words. He knows very well where the economy and financial markets are headed; he sometimes even talks about it. With the federal deficit out of control and the U.S. dollar vulnerable to a massive sell-off, there is a looming problem in getting someone to buy all the securities that are going to be issued by the U.S. or dumped by existing investors.

The ultimate solution likely will be Fed monetization of debt, which would tend to increase the money supply as reported in M3. In turn, the heavy monetization would evolve into a pattern of accelerating inflation. Oh, how nice it would be for Mr. Bernanke not to have to report those nasty M3 statistics. (As an aside, the price of physical gold is up more than $20 or about 4.5% since the Fed’s M3 announcement; the Philadelphia Gold & Silver Index [XAU] has risen more than 10%. Perhaps this is merely a coincidence … or not.)

Why has the Fed suddenly abandoned M3 and its non-M2 components of jumbo CDs, repos and Eurodollars? No explanation was given with the announcement, but a pre-packaged, explanatory e-mail, received by inquirers from a Federal Reserve public affairs officer, advised that: “M3 does not appear to convey any additional information about economic activity that is not already embodied in the M2 aggregate. The role of M3 in the policy process has diminished greatly over time. Consequently, the costs of collecting the data and publishing M3 now appear to outweigh the benefits.” The proffered rationale is utter nonsense. In October 2005, seasonally-adjusted M2 was $6.6 trillion, while M3 was $10.1 trillion. It is incredible that the Fed would even suggest that the shifts in and growth of the $3.5 trillion in non-M2 assets had no meaning. The senselessness of the Fed’s statement can be demonstrated by a quick glance at the following two graphs (here and here). The first graph shows year-to-year change in both the M3 and M2 measures, the second graph shows the difference of M3 growth less M2 growth, against annual change in CPI-U inflation.

While the series move together 80% of the time, there have been some interesting divergences, particularly the one at hand. For most of this year, annual M2 growth has held around 4%, but M3 has been accelerating towards 8%. If one thought M3 had any meaning, pending inflation might be a question. That clearly is not the case with M2, however, which fortunately contains all the meaningful information both the Fed and the public will ever need, or so suggests Mr. Greenspan. Since M2 embodies all the information in M3, subtracting M2 growth from M3 growth should be a useless exercise. Yet, the plot of that difference has about a 60% correlation with annual CPI growth. It even might suggest there has been a little bit of monetary-inflation pressure mixing in with oil prices, recently.

Finally, despite the strong M3 growth in nominal terms, net of inflation (calculated on a pre-Clinton Era basis), a reliable recession signal was generated several months back. Of the liquidity measures, inflation-adjusted M3 is the best leading indicator of economic activity. What game the Federal Reserve is playing will become clear soon enough. Chances that M3 was eliminated because it just duplicated M2 are nil. The cost factor also is a canard. The Fed could privatize monetary reporting, if it wanted to, the same way the government put the Index of Leading Economic Indicators out to bid.

Link here.


For readers in the middle of this conversation, we are in a series on the debate held at a London restaurant between Charles and Louis-Vincent Gave (father and son) and Bill Bonner. The Gaves openly declared that “This time it’s different,” much to Bill’s amusement. We all know that it almost never, ever is. They make their argument in a book called Our Brave New World. The next thing that GaveKal argues is that monetary policy no longer works like it used to. “In the wake of the Asian Crisis, lower rates are more stimulative to supply than demand while it used to be that lower rates were more stimulative to demand.”

This is a subtle argument, but part of an overall theme that we are in a deflationary world. Bonner would agree, but where he sees a negative aspect of deflation, they see a deflationary boom. Readers of Gary Shilling would recognize this position. Shilling has maintained for years that we will enter a period of what he calls good deflation. At its roots, a deflationary boom exists when supply is structurally ahead of demand. Prices drop, and in a classic world, when prices drop, demand rises, thus stimulating even more supply. This, they point out, makes it easy for central bankers, if you assume the job of central bankers is to keep inflation under control. When there is always “more stuff” coming into the market, inflation does not result from supply side problems. Which means that central bankers need only worry about the demand side of the equation causing inflation. Thus, raising rates will lower demand, taking away the demand driven inflation. If they need to stimulate demand, as they wanted to in 2001-02, they simply lower rates. But here is the GaveKal twist:

“In terms of managing demand, the Fed may have overdone the demand stimulation in 2001-04, but an important lesson was learned: low rates not only stimulate consumption in the US, but capacity expansion abroad even more. For a while, we get a window where demand surges (i.e., U.S. housing cycle, energy) and people believe we have entered an inflationary boom. For a brief period, it appears that demand has caught up with supply. But, monetary demand stimulation at the core also creates supply stimulation at the periphery. And while this is going on, investment in capacity looks like demand. At some point however, the rise in commodity and house prices we have witnessed in recent years will likely be viewed more as a reflection of capacity growth around the world, not true demand.”

This is the chicken-and-egg analogy, but an important distinction. Yes, the Fed did want to stimulate demand when they lowered rates. But they also made cheap money (with the help of other central banks, and especially Japan) available WORLDWIDE for increasing production. Thus, China has some 1,000 ball bearing companies when it needs, maybe, 10. Each day, the managers of those 1,000 companies wake up trying to figure out how to get to be big enough to be one of the 10 who will survive. And that means growing even more capacity, which is not really needed. They do this by borrowing money, getting foreign investment, offering lever lower prices, etc. And since rates are low and the money is easy to come by, they have every incentive to do so.

It is the same for chips and copper wire and appliances and, well, just about everything. And the developed world responds by letting the developing world (not just China!) do the low profit manufacturing and keeps the profitable design and marketing parts of the business. And this results in a trade deficit. GaveKal asserts that a dollar asset standard is developing, and that it is superior to gold. Quite simply, they argue that since gold cannot grow at a fast enough pace to maintain global growth, it has to be replaced, otherwise we revert to a world where consumers lose and governments dominate by their power of controlling gold flows. Now, let us turn to page 109 in our hymnbook and let them explain how they see their Brave New World developing:

“If we assume that a new part of the world is getting richer (China, India, Russia, Brazil, etc.), then we should probably assume that some entrepreneurs in those countries are making it big. This assumption is not a stretch; there is enough anecdotal evidence to support it … If we further assume that, in the countries getting richer, we will start to witness the emergence of institutional savings (pension funds, mutual funds, family offices, etc.), then we should expect big ‘savings flows’ from the rapidly growing developing world into the Western world. … In simple words, the emerging markets’ newly rich will feel like investing a part of their newly created wealth in regions of the world where property rights are well protected and where there is a rule of law. The excess trade balances earned by the ‘industrial world’ have, in fact, little choice but to be reinvested in the assets of the ‘creative world’. … This implies that the assets in the ‘creative world’, and especially the prestige assets will always border on the overvalued.

“… [W]e can assume that, as a result of the constant capital flows, the countries with a well-developed capital market will have an overvalued currency and a very low level of long rates. Which in turn leads to robust real estate markets (see chapter 8) and higher asset prices. … We call this ‘the dollar asset standard’. Basically, diversified and safe assets in the Western world replace gold as the standard of value in the eyes of new savers in Asia, Latin America or Eastern Europe.

“… [O]nce they make the switch to the ‘platform company’ model, a number of companies will likely realize that they should domicile their research and marketing activities in countries with low marginal tax rates, both for their shareholders and their employees. … Hong Kong Land, a property developer is incorporated in Bermuda. Electronic Arts, one of the world’s biggest video game designers is incorporated in the Caymans. … As an increasing number of companies move to the ‘platform-company’ model, it is likely that the top talent will want to work, or at least be taxed, in low tax environments. This will lead to a collapse in tax receipts in countries that do not adjust to this new model. In the new world towards which we are rapidly moving, income taxes will becoming increasingly voluntary and governments will have to get their pound of flesh through property and consumption taxes instead. This should lead to more efficient (i.e., downsized) governments all over the Western World. The platform companies might end up killing off the Welfare State.”

This sounds like James Dale Davidson and Lord Rees-Mogg in their important book written a few years back called The Sovereign Individual, although GaveKal comes to the same end from a different road. And it is an idea to which I subscribe, though for different reasons. It will not just be the pressure from platform companies wanting to avoid taxes that will precipitate that change. I would make the argument that the current generation (in nearly every country in the developed world) and our forebears have written a check in the names of our children, which they will not be able to pay. By this I mean our social security and pension programs. And if they cannot pay it, they will not. The social contract between generations and governments is going to be re-written in the next 20 years.

We live in interesting times.

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


Joel Greenblatt is not famous … he is merely rich. Last week, I discovered why he is so rich. Joel is a Harvard Business School graduate, but let us not hold that against him. He is also the founder and managing partner of Gotham Capital, a private investment firm established in 1985. He started with $7 million of outside capital – mostly from junk bond king Michael Milken. Over the next decade, he earned 50% a year – compounded. Even after paying back all of the original seed capital and factoring out expenses, Greenblatt grew his $7 million stake to over $350 million. A mere $1,000 investment was worth $57,665 in 1995. A $10,000 investment was worth more than a half a million dollars. So when Greenblatt took the podium at the recent Value Investing Congress in New York City, I listened … intently.

Greenblatt declared that he had a simple two-part investment process that could deliver far greater returns than the rest of the market. He called the process his “magic formula”. I thought to myself, “Wow, that’s pretty corny … but maybe there’s something to it anyway.” As it turns out, there is. Greenblatt’s formula relies on a “value-oriented” process that ranks stocks on the basis of two variables – the earnings yield and the business’s return on capital. The first part of his formula requires that a stock trade for a bargain price relative to earnings power (or yield). E.g., if a company cannot earn more than 5% a year – the return you would receive from 10-year U.S. Treasury note – it is not a business you want to be in. Quite simply, it is not cheap relative to the risk you must take. To calculate a company’s earnings yield, you divide its annual earnings per share by its share price.

Investors must also ask a second question: Is the business a solid one? The last thing you want to do is to buy stock in a company that is cheap for a good reason. Greenblatt determines whether a company is “good” or not by looking at its return on invested capital. Is it investing its capital wisely adding to its earnings power? Or is it wasting its cash on frivolous investments that will create no (or even negative) value for shareholders moving forward? For instance, if a company spends $1 million on a new factory and it is able to crank out an additional $500,000 in profits the next year, the result is a 50% annual return on capital. That is outstanding. It says management knows how to spend YOUR shareholder money to create added value.

So Greenblatt wondered how much money you would make if you invested ONLY in good companies (those with a high return in invested capital) that trade for a bargain price (companies with high earnings yields). To answer that question, he researched the historical returns of the stocks his magic formula would have identified. Specifically, he went back and examined the top 3,500 American stocks (from your large behemoths like Microsoft on down to microcap companies with market caps of $50 million) from 1988-2004, according to his formula’s ranking system. He ranked each stock in terms of earnings yield and return on capital – from 1 to 3,500. The idea was to invest in the companies with the best combined score – those with the highest earnings yield AND the highest return on capital. So if a company ranked 100th in terms of earnings yield and 50th in terms of return on invested capital, it got a score of 150.

After generating a score for each company, Greenblatt created a portfolio of the top 30 companies. Greenblat created a new “Top 30” at the beginning of every year within his test, and then calculated the return an investor would have received by investing in each year’s top-30 stocks. From 1988-2004, if you had bought the top 30 companies generated every year using Greenblatt’s formula, you would have averaged a 30.8% return for 17 years. During that same time frame, the market averaged a 12.3% return. Moreover, there was never a 3-year period between 1988 and 2004 where this portfolio of 30 solid, bargain stocks was not profitable, nor a 3-year period in which it failed to beat the return of the S&P 500. An $11,000 investment in 1988 in Greenblatt’s magic formula stocks would have been worth over $1 million by 2004.

As a small-cap specialist, I was particularly intrigued by the fact that the small-cap value stocks within Greenblatt’s system dramatically boosted the overall results. For example, when Greenblatt excluded the smallest 2,500 stocks from his sample universe of 3,500, he discovered that his magic-formula portfolios produced an annual return of “only” 22.9% – still far better than the S&P 500’s, but the not nearly as good as the 30.8% annual returns that resulted when the mid- and small-cap stocks were included. So I wondered, what small-cap companies in today’s market would meet Greenblatt’s stringent value criteria? I ran some numbers of my own, and came up with 10 companies that had at least a 25% return on capital and an earning yield north of 9%. Check ‘em out … here.

You will notice immediately that most of the stocks in the table above have been performing very poorly all year. That should be no great surprise. You do not find value stock on the “New Highs” list – value always dwells among the stock market’s worst performing stocks. The trick, of course, is to identify the ones that will soon begin to perform well, and that is where Greenblatt’s magic formula comes in handy. Over the coming weeks and months, I will be tracking these 10 companies – and many others like them – to seek out some great value investments in the places where Wall Street’s big boys rarely bother to look. And we will apply Greenblatt’s magic formula to the research processes we already conduct.

Joel Greenblatt is no doubt one of the finest investors of all time. But unless you are a money manager, run a hedge fund or follow the market every day, there is a good chance you have never heard of him before today’s essay. He is not as high profile as Peter Lynch. And he is not quoted like Buffett or Templeton. But he is every bit as successful. And his investment theories are priceless. You would do well to follow them. In fact, if you did, I cannot imagine you would ever lose money.

[Note: Greenblatt has authored a terrific book about his magic formula entitled, The Little Book that Beats the Market. He has also created a Web site dedicated to the process.]

Link here (scroll down to piece by James Boric).


“Every 7 seconds another boomer turns 50,” BullMarket.com reports. “There were approximately 78 million baby boomers born between 1946-1964. The numbers increase 56% every year, and will until 2011. As the largest consumer spending group – $900 billion a year, boomers will control the vast majority of the nation’s wealth within the next 20 years.” One likely beneficiary of all that spending will be Levitt Corporation (NYSE: LEV), a builder of “active-adult” communities. Watching the baby boomers stamp their ever-growing financial footprint on the world has been, and will continue to be, like watching a pig go through a python. Only difference is, with the python, the lump gets smaller. With the boomers, the lump is going to get bigger. Much bigger. And it is going to leave its giant footprint all over the housing market.

Jeff Jenkins, deputy director of the seniors housing council for the National Association of Home Builders, says that since 2001, when the first boomers became age-qualified for 55-plus communities, the impact has been “staggering”. “According to our figures,” says Jenkins, “people age 55 and over accounted for … about one-fifth … of the 1.1 million new-home purchases made in 2003. The active adult market accounted for an estimated $51 billion in new-home sales in 2003.” Levitt, therefore, seems very well positioned to cash in on this trend.

The company does most of its building in Florida right now, but CEO Alan Levan knows that the boomers are not choosing retirement destinations based on weather so much anymore. “People think of Florida as a place for retirement,” Levan explains, “but most people who retire, retire 50 miles from where they live. (So) every market is an opportunity.” Today, 75% of active adult communities are outside the Sunbelt. That is why Levan is transforming Levitt from a Florida-focused homebuilder into a national homebuilder.

Just as the Levittowns of old were built for the returning soldiers, the new Levittowns will be constructed for their retiring offspring. Levitt’s Homebuilding division consists of the two operating subsidiaries, but that is not even half of what the company owns. The other major division is the land division, operated by Levitt’s Core Communities, LLC subsidiary. Core’s two big projects are both on Florida’s Treasure coast, on the Atlantic Ocean in southern central Florida. Even assuming a modest value for all of Levitt’s housing lots, it looks like the land alone is worth more than what the entire company is selling for today. A modest price for these lots would be $50,000 for each lot. I will assume that the Homebuilding Division’s lots are worth half that, since some of them are outside Florida. If you add all that together at $50,000 each for the Land Division lots and $25,000 each for the Homebuilding Division lots, you get a total value of $852,375,000. The entire company is selling for less than $600 million, including all of its outstanding debt.

My land value calculations for Levitt assign ZERO value to the Homebuilding Division’s backlog of 1,899 homes, on the balance sheet at a value of $522,785,000. Valuing the land solely by making a lowball fair market estimate also has the advantage of eliminating the capitalized interest and construction costs on the balance sheet. Levitt also owns 31% of the outstanding shares of another NYSE-traded company, Bluegreen Corporation (NYSE: BXG). Bluegreen develops timeshare resorts, golf communities and residential land. As yesterday’s close, Levitt’s 31% stake in Bluegreen was worth about $147 million. In all, when you buy Levitt shares, youare getting about $830 million of net assets – based on my conservative estimates – for a price less than $600 million, as summarized here.

Link here.


Is the stock market on the level? There are many investors who, comparing their own paltry returns with overall market performance, get a little paranoid about this, and convince themselves that somebody has to be manipulating the thing. However, according to a recent report, they may be onto something, if not quite in the ways that they think. Dishonest brokers, greedy, deceitful CFOs, and their henchmen in crooked accounting agencies have gotten plenty of publicity. But the role that government may play in the stock market is seldom even acknowledged, much less openly discussed. A year ago Sprott Asset Management, a Toronto-based financial services firm, published an exposé of central bank manipulation of gold prices. This August, they followed that up with a paper entitled “Move Over, Adam Smith: The Visible Hand of Uncle Sam” (PDF file). The report, written by the firm’s president, John P. Embry, and his assistant, Andrew Hepburn, concludes that the U.S. government has intervened to support the stock market often enough that “what apparently started as a stopgap measure may have morphed into a serious moral hazard situation, with market manipulation an endemic feature of the U.S. stock market.”

This is distressing news because, while American investors understand that the government is involved in the bond and currency markets, most like to believe that the value of stocks is driven by market forces alone. Using only publicly available sources, the Sprott team makes its case that this is probably not true. It concludes that the government almost certainly intervened in the stock market on four notable occasions – in 1987, 1989, 1992 and 1998 – and may have done so at other times as well. The first was, of course, to stop the bleeding from Black Monday, the following two to prevent a repeat of same, and the last to temper the effects of the LTCM hedge fund crisis. All instances of stabilization probably involved the surreptitious buying of stock index futures, where a little money can go a long way toward reversing price trends in the broader market.

Much of the post-‘87 activity was apparently due to the efforts of the so-called “Plunge Protection Team” – a joint executive branch/private sector working group created in the aftermath of the crash and composed of representatives from government, banking, brokerage houses and the exchanges – whose function is to prevent unacceptably large market declines. This shadowy partnership is not officially admitted to by the government, but its existence has been confirmed by former presidential aide George Stephanopoulos and by a former National Security Council economist quoted in the New York Post.

A 1997 Washington Post story described the team this way: “These quiet meetings of the Working Group are the financial world’s equivalent of the war room.” The Post article, however, stuck to the subject of planning for crises, and avoided the question of whether the team had conducted any real-world interventions. But Stephanopoulos was more direct, saying in a 2001 interview that the team has “kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem.” Chairman Greenspan himself, while denying that the Fed has ever been involved, has addressed the subject on several occasions, using words such as these from late 1996: “We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstances, through direct intervention in market events [italics mine].”

The Sprott report acknowledges that it cannot state its conclusions with absolute certainty, due to the shroud of government secrecy surrounding the subject (indeed, there is evidence that even the Federal Reserve may not entirely know what the Treasury Department is doing). But that very secrecy is a primary target of the authors’ criticisms. Their opinion is that there may in fact be times when government intervention is warranted “in extremely small doses and with the most stringent safeguards and transparency.” However, they point out, if the government has in the past acted decisively to prevent a terrible financial catastrophe, then why not admit it and even promise to do the same again, should circumstances warrant? We would not like for the answer to be this: The secrecy means that the government is actively involved in tweaking the market on a regular basis, to keep it running by someone’s definition of “orderly”. Or, worse, for someone’s profit. “By not informing the public, successive U.S. administrations have employed a dangerous policy response that is subject to the worst possible abuse. In this regard, the line between national necessity and political expediency has no doubt been perilously blurred.”

Link here.


In 2004, the German economy grew 1.7%, which ended a long period of slowdown and surpassed even the average 1.2% growth rate of the “roaring nineties”. That was a remarkable and surprising comeback, especially considering how concerned European economists had been that the strengthening euro would kill German exports and thus the prospects for an economic improvement. Ever since the euro began gaining on the U.S. dollar back in 2001, economists have warned that the trend would not end well for European exporters. A strong currency is never good for exports, they said. It boosts imports by making foreign goods cheaper on the domestic market – and at the same time, it hurts exports because they become more expensive to foreign buyers.

Germany fully switched from the Deutsche mark to the strengthening euro in 2002. And in 2004, the euro hit a record high of $1.36 against the U.S. dollar. Such tremendous currency appreciation should have slowed down Germany’s exports considerably. Instead, to everyone’s surprise, they jumped 8.2% last year, effectively pulling the country out of the recession. Moreover, Germany has now overtaken America to become the world’s biggest single exporter. Strong euro or not, Germany’s trade surplus is now greater than that of China, Japan and India combined. Which brings us to this question: How does the conventional economic theory explain growing German exports amidst the strengthening German currency?

Take a look at the chart below. Could it be that the presumed relationship between “a strong euro” and “weak exports” is just that – a presumed relationship? One would expect to see a clear negative correlation between the top and bottom graphs. But there is none. If anything, in the past few years there has been a positive correlation between Germany’s exports and the strength of its currency. Isn’t it amazing how a simple chart can change your perspective on things?

Link here.


It is not a big deal to spend more than you earn these days. Really. Well, not unless you are attached to the quaint idea of defining “big” in literal dollars. In that case, a literal-minded person might think it is a big deal for U.S. households to spend $531 billion more than they earned after taxes, especially during just one quarter (Q3 of 2005, annualized).

These are just words and numbers, obviously, and even if you are literal-minded, we live in a time of excess: $531 billion is not as impressive as it once was. So allow me to offer some pictures (here and here). These appeared over the weekend (Nov. 27) in the New York Times, and show activity not for one quarter, but trends and trend reversals that unfolded over the past 30 years.

As I said, we live in a time of excess. Something weird happened in the 1990s. It got weirder over the past five years. When it comes to savings, equity, and debt, people behave differently. Changes in behavior produce changes in language too, as in vulgar euphemisms like home equity “cash-outs” – are they not more accurately described as “debt-ups”? OK, perhaps I sound like a scold, even if I did begin by saying that spending more than you earn ain’t a big deal anymore. Maybe our parents and grandparents had it all wrong about personal financial habits. Maybe they tricked us about saving for rainy days, and the very concept of home equity is completely bogus. On the other hand, if you suspect that the financial laws of gravity have not been revoked, then we have got a lot to talk about.

Link here.


When markets go against a trader, it is so often easy to believe that it is “a conspiracy”: professional traders do better, because they have better information to trade on. Even though Bob Prechter does not believe in this conspiracy theory, he does believe that professionals have an advantage. Here is an excerpt from his question-and-answer book, called Prechter’s Perspective, which describes what it is.

Link here.


Over the past few years, anti-American sentiment around the world has increased almost as rapidly as this country’s huge financial deficits, yet foreign investors cannot get enough of U.S. assets. The latest figures from the U.S. Treasury Dept. showed surprising facts: In September alone, foreigners poured a net $118 billion into U.S. securities, comfortably more than enough to cover the nation’s $70 billion-a-month current account deficit. With investor sentiment so decidedly in favor of U.S. assets, some says it is no wonder that the U.S. dollar is “headed for its first three-month gain against the euro and yen in almost four years” (Bloomberg).

On the other hand, says The Times, this “rosy picture” may disappear in a blink of an eye: “The U.S. fiscal position may deteriorate again; the hurricane-related spending is adding to the fiscal deficit; the apparent collapse in central bank purchases of U.S. assets may be illusory; some of the private capital inflows in September may have been U.S. companies repatriating profits.” And last but not least, the looming interest rate hike by the European Central Bank can shift the balance away from the dollar-denominated assets in favor of the euro-denominated ones.

Talk about a handful of flies in the ointment. Is that why the euro dollar rate has gone nowhere for the past two days, stuck near $1.1780? Even after the U.S. Q3 GDP figure was revised higher, the dollar “failed to respond positively” (AFX Press). But you can bet that this lull will not last for long. A massive triangle can now be seen in the daily EURUSD chart. Triangles indicate a temporary lack of conviction by market players – but when that conviction returns, triangles usually resolve in sharp, violent moves. Question is, which direction will the EURUSD shoot from here?

Link here.


News follows price, not the other way around. This is no groundbreaking observation – we first noted the fact years ago – yet the latest chapter in the gold market saga illustrates the point particularly well. For all the ink spilled along gold’s way to $500 per troy ounce, you would be hard pressed to find a useful news report. There is no shortage of rationalizations for gold’s bull run to the new 18-year high, but a truly rational explanation is much harder to come by. In the absence of mainstream consensus about the yellow metal’s latest step in the 4½ year, 97% rally, a line from the end of a November 30 BusinessWeek article sums up the variety of vague nonsense you will get instead: “While it’s hard to point to a single reason for the rise in gold, ‘everything going on globally points to much higher prices.’”

That is not to say that others do not offer up specifics. As in practically every other case this year, the energy market appears as the most commonly cited suspect for gold’s surge. According to one financial newswire, “Investors are buying gold to guard against accelerating energy prices, which are fueling inflation.” The article kindly points out that “Oil prices have risen 30 percent this year” – yet it neglects to mention that they have fallen 10% since November 4, when gold started its latest 10% climb. In short, the fashionable “correlation” between oil and gold prices holds up about as well as the much older yet equally phony notion that gold prices rise when the dollar weakens. You can still find plenty of fuss about “currency concerns” in the latest gold stories, but the facts are clear: The dollar has been trending up this year – to recent two-year highs against the euro – yet gold’s climb continued nonetheless.

And lest you think we have only scorn for mainstream sources, we applaud the Washington Post for their more frank appraisal of fundamental analysts’ current confusion: “Investors traditionally pile into gold as a safe haven when the dollar drops, inflation rises and economic calamity looms. The trouble is, none of those things appears to be happening.” Yet even this honest effort falls far short. The reason is simple. If you focus on the fundamentals in a financial market like gold, you will always be a step behind. In fact, a single explanation accounts for both the steady decline in gold prices through the 90s and the prolonged rally you are seeing now – investor psychology.

When each buyer and seller agree on a price, they make a trade. That agreement is above all a meeting of the minds. Accordingly, each tick – even each individual trade – immediately reflects the psychology of the market. Over time, the price data for all of those trades reveals patterns in the natural ebb and flow of that psychology. The wave patterns we see now in gold are compelling. As Specialty Services Metals Analyst Mike Drakulich explains, “I am not at all surprised to see a huge battle at $500 gold fully engaged. This type of key long-term action is not seen very often and if you can’t get excited about what is now happening it is time to try something different!”

Link here.


So much for Sarbanes-Oxley and all of the other corporate-governance changes instituted by regulators and the stock exchanges. Nearly half of all organizations worldwide, including U.S. companies, admit they have been the victim of corporate crime in the past two years, according to PricewaterhouseCoopers’s Global Economic Crime Survey 2005. The number of companies reporting fraud increased from 37% to 45% since 2003, a 22% increase, according to the study. The average cost to companies was $1.7 million from what PwC calls “tangible frauds”, those that result in an immediate and direct financial loss. These include asset misappropriation, false pretenses, and counterfeiting.

Perhaps the most disturbing finding from the report is that most cases of crime are detected by accidental means. 34% of these frauds were discovered by accident, making “chance” the most common fraud-detection tool. In other words, companies are learning about the frauds from calls to hotlines or from whistle-blowers, for example. Internal audit detected just over 30% of the reported cases in North America, and 26% of the reported cases globally.

There is more at stake besides financial loss. According to the survey, 40% of companies reported suffering significant so-called collateral damage to their businesses. Of those, 43% suffered damage to their brand, 42% to their relations with other businesses (including suppliers and contractors), and 54% to staff morale. On average, companies recorded suffering eight serious incidents. Since 2003 there has been a 71% increase in the number of companies reporting cases of corruption and bribery, a 133% increase in the number reporting money laundering, and a 140% increase in the number reporting financial misrepresentation. One more note of interest: nearly 80% of the companies did not consider it likely that they would suffer fraud in the next five years.

Link here.


The world’s investment bankers are on a torrid pace of deal making that has already topped a record $2 trillion this year, with five international private equity firms announcing in the latest mega-deal that they would pay $12 billion for Denmar’qs top telecom company. The bull market in M&A activity includes both public corporations and private equity firms that are taking advantage of cash-flush coffers and low interest rates to undertake the largest leveraged buyouts since Kohlberg Kravis Roberts mounted its historic $25 billion deal for RJR Nabisco in 1989. In the Danish deal, a consortium of private equity companies – including KKR, Blackstone Group, Providence Equity Partners, Apax Partners and Permira – have agreed to pay $12 billion in cash and assume $3.6 billion in debt to acquire TDC AS, a Copenhagen-based phone company that has holdings throughout Europe. The TDC buyout is part of a massive wave of restructuring and consolidation in Europe’s telephone and cable market.

It is part of an international wave of acquisitions as globalization and accommodating financial markets contribute to the biggest round of asset reshuffling since the stock market collapse in 2000 and recession of 2001 dried up business. Richard Peterson, a senior researcher with Thomson Financial, said global M&A deals have exceeded $2.2 trillion so far this year, the best showing since 2000 when mergers and acquisitions set a record $3.4 trillion. Of the total, private equity firms have accounted for $233 billion in leveraged buyouts this year, exceeding last year’s record of $165 billion. Mr. Peterson said that while low interest rates have helped spur the global deal making, more important is the cash-flush position of both corporations and the private equity firms.

“Corporate profits are very strong – we’ve had something in the order of 11 consecutive quarters of double-digit earnings growth here in the U.S., and companies are sitting on bountiful levels of cash,” Mr. Peterson said. “They have been doing stock buybacks [and] some dividend increases. And merger activity is part of the trilogy that companies have been engaged in of late. Prospects are that it’s likely going to continue into 2006.” The largest M&A deals this year were announced last winter and have already been consummated, including Procter & Gamble paying $57 billion for Gillette, and the $30.1 billion acquisition by UFJ Holdings, Japan’s fourth-largest bank, of its rival, Mitsubishi Tokyo Financial Group. While enormous, those deals are dwarfed by some of the mega-mergers that occurred in the late 1990s and early 2000 when corporations were using hugely inflated share prices as currency. In January 2000 Time Warner announced a merger with America Online in a $181-billion deal that later was greatly criticized.

Experts there see no end on the horizon to the boom. Low interest rates, the availability of cheap debt and private equity funds with billions to spend will maintain the volume of big-ticket European deals, said Kurt Bjorklund, a principal with Permira, one of the buyout firms behind the TDC acquisition. “As long as the debt market liquidity is what it is, I think we will continue seeing deals of this size going forward,” Mr. Bjorklund. Mr. Peterson noted that private equity funds have been playing an increasingly large role in the global M&A business, although they are still relatively minor players. Eight of the 10 largest leveraged buyouts ever took place during 2005, including the $15 billion deal announced in September by three buyout firms to acquire Hertz Corp. from Ford Motor. The largest equity firms, including Blackstone, continue to raise money from private investors and institutions.

Link here.


In early November, President Bush failed to win agreement from leaders of five South American countries on his pitch for a hemisphere-wide misnomered “free trade” accord. The idea of people trading things they do not want for things they do want was apparently so unpopular that demonstrators “had a cow”, smashing windows, torching a U.S. flag and stoning cops in Argentina, where the trade summit took place. Since trade is an excruciatingly complicated topic for most people, this tract, which can be folded into a pamphlet and handed out at Libertarian Party outreach booths, will attempt to clarify the concept. Five areas will be briefly discussed.

The first recorded instance of a “trade” in the newly formed country called These United States occurred three seconds after final ratification of the nation’s Constitution. Twelve-year-old Jonathan Hancock III of Beacon Hill, Boston, Mass, suckered his cousin, Benjamin Lake Champlain, by swapping three Delaware Blue Hen Regimental Regulars, a Roger’s Rangers French and Indian War veteran, and a Connecticut Provincial second-string Militiaman for Marquis de Lafayette’s rookie card. Since this trade was consensual, voluntary, and completely unsupervised, it is an excellent textbook example of a “trade”. A free trade is really the same as a trade, except that the adjective “free” is required in today’s These United States to distinguish it from other, politicized forms of trade. A free trade occurs when, for example, a farmer decides to “have a cow” and gives two sheep in exchange for one. This type of trade, as we shall see, is no longer legal anywhere in the so-called free world.

Fair trade is a difficult concept because it involves something called “Social Justice”. Since “social”, which refers to “society”, and “justice”, which refers to “fairness”, are both ideologically subjective and amorphous concepts, “Social Justice” is a concept of a concept. “Fair Trade” is better understood as “Politically Correct Trade”. E.g., a cup of coffee is a “fair trade” commodity only if the coffee beans are shade-grown, organically fertilized, and handpicked by cheerful unionized peasants chanting “Workers of the world unite” while guilt-addled American Peace Corps rich kids lecture them about sustainable development, social responsibility, and the proper way to use a condom.

Cows produce milk. Sheep produce wool. These creature-goods may become ingredients used in products that might conceivably be shipped across state lines, meaning that they are subject to the regulations of the Constitution’s Commerce Clause. Do not bother to read it. What counts is today’s warped, politically self-serving interpretation of the Commerce Clause. Additionally, all livestock must be branded and ear-clipped and RFID-embedded and AKC-style registered so they can be tracked for mad cow or mad pig or mad sheep or bonkers goat diseases, and tested for chicken flu and duck flu and goose flu and cuckoo flew and chimney flue. Trade under contemporary Interstate Commerce Clause laws is designed to keep lawyers’ cowhide billfolds from running empty.

International trade is an oxymoron – nations don’t trade … people trade. But do not tell politicians that. All trade in today’s world must be managed trade to guarantee that the managers (thousands of international politicians, bureaucrats, agencycrats, regulators, civil servants, get their cut of the skimmed cream from trade activities. Otherwise they might be forced to get productive jobs, which would not be a “fair trade” for the protection racket that currently supports them and their families.

Now that you have learned about the basics of trade in the modern world, you might wish to investigate something called “the illegal black market”, which libertarians refer to as “the free market”. For reference, see “trade” above.

Link here.


Predicting the end of oil era has been a venerable (albeit fruitless) pseudo-intellectual pursuit for most of the 20th century. This Nostradamian pastime regained new vigor during the late 1990s when (mostly retired geologists) Colin Campbell, Jean Laherrère, L.F. Ivanhoe, Richard Duncan and Kenneth Deffeyes–-- and their groupies gathered under the WWW umbrellas of peakoil.net, peakoil.com, peakoil.org and hubbertpeak.com – flooded the media with catastrophist tales of imminent peak of the global oil production to be followed by a precipitous decline of oil availability resulting in the demise of modern civilization. As self-appointed prophets are want to do, these wholesalers of fear have not been cautious when outlining the consequences. In Ivanhoe’s rendering “the inevitable doomsday” will be followed by “economic implosion” that will make “many of the world’s developed societies look more like today’s Russia than the U.S.” In Duncan’s telling there is massive unemployment, breadlines, widespread homelessness and a catastrophic end of industrial civilization.

Kenneth Deffeyes, an experienced petroleum geologist and a former professor at Princeton University, has been the most puzzling member of the peak oil cult. As a scientist he must know that the real world is permeated by uncertainties, that complex realities should not be reduced to simplistic slogans aimed to gain media attention, and that (as even a brief retrospective will demonstrate) making precise point predictions is a futile endeavor. Yet he set all of this aside and proceeded to write about the peak of global oil production in a way that leaves no room for any doubt (“no initiative put in place starting today can have a substantial effect on the peak production year”), that portrays the world’s energy use merely as a matter of supply (utterly ignoring demand) and, most incredibly, he went farther than any of his confrères by predicting not just the year but the very day when the world’s oil output was to peak!

Amidst the ocean of uncertainties concerning the future of global oil production there are two great known unknowns: we do not know with any satisfactory confidence the ultimate amount of oil that we will be able to extract from the Earth’s crust; and we do not know the eventual extent of market reaction to substantial price shifts (a plain way of saying that the elasticity of crude oil’s consumption is an elusive variable). And because we do not know either the eventual maximum of potential (resource-limited) extraction or the actual level of (market-driven) production we cannot know with any readily quantifiable certainty the year (forget the day) when the global oil output will peak. Undoubtedly, there is a finite amount of oil in the Earth’s crust, but even if we were to know it to the last drop we could not predict how much of it we will eventually extract (much of it will be simply too expensive to get out, or too unappealing compared to other choices). Inevitably, sometime in the future global extraction of liquid oil will start declining but we will not be able to pinpoint that event and it may not be of much interest anyway.

The story of the modern world is, most fundamentally, one of continuous energy transitions as the leading fuel changed from wood to coal and then from coal to oil. But oil never dominated as much as coal did because of the concurrent diversification into natural gas and into hydro and nuclear electricity. These, and other sources, await further exploitation: there is no reason to believe that we cannot eventually move past the oil era. Difficulties of this transition should not be discounted but they will be the best stimulants of our inventiveness and of our ability to cope with new challenges.

Link here.

Energy: The Bottomless Well

Governments exist on a foundation of fear. The more fear they can generate, the bigger they can grow. Fears of terrorists, of WMDS, of bird flu, of Global Warming (or Global Cooling), of nuclear power, etc. etc. Any fear is a good fear for government. Popular support for wars is based on fear. The Iraq war was originally supported on a basis of fear of nonexistent WMDs. As that fear has receded, new fears are used as supplements. One of the most popular is the fear of “Peak Oil”. The idea is that America must fight over the little pool of oil in the Middle East, because that is all the energy in the universe and we have to have it to drive to the mall. One is supposed to picture your great great grandchildren in 2100 driving to malls in Chevrolet Suburbans, fueled by the last dregs of Iraqi oil. They will, of course, but only in historical reenactments (and the Suburbans will probably be powered by “Mr. Fusion” He-3 units).

The truth is that our current energy use is minuscule. The entire world burns about 345 Quads of fossil fuel every year. Known coal reserves contain 200,000 Quads, oil shales 10 million Quads, the deuterium in the ocean 10 trillion Quads. (Of course we are no longer allowed to think about using the huge thorium reserves… if you are younger than 30, you probably do not even know what thorium is). To believe that energy shortages are our biggest problem requires very special blinders.

People have been panicking about “energy crises” since Og the cave man noticed that the supply of fallen branches near the cave was dwindling. There was a panic about “running out of wood”; Watt developed an efficient steam engine and England switched to coal. There was a whale oil shortage in the 1800s; Drake developed oil drilling. There were multiple panics in the 20th Century about running out of oil; we developed nuclear fission, offshore natural gas, efficient solar cells, fuel cells, hybrids, better wind turbines … and then continued to find oil anyway, but when we do need to switch there are multiple technologies available and more on the way.

Talk of “conserving energy instead of producing” is self-contradictory. Any successful “energy-conserving” technology in fact leads to the consumption of more energy. The authors point out that more energy now goes into lighting after the invention of energy-conserving bulbs; people make more use of the superior technology and outpace the savings of each individual bulb. The same is true in computers; the energy per logic gate keeps falling, but the overall energy use for computers and Internet keeps rising as the superior technology is more useful and runs more of the time. In fact, the Internet and supporting infrastructure may consume over 10% of our power already. As computers get more useful, more of them will be demanded. Any good economist could have predicted that.

The public’s confusion over energy, entropy, and economics has led to a lot of counterproductive, even outright destructive effects. Huber summarizes the effect of the anti-nuclear movement thusly: “400 million more tons of coal have been burned.” (Coal produces over 100 times more radiation per kilowatt-hour than nuclear plants!) Was this what those who funded the “environmental” organizations wanted? I doubt it was the objective of most environmentalists. The moral is that putting your efforts into depriving other people of the freedom to innovate probably is not going to achieve your goal, no matter what your goal is.

There is no reason to fear “Peak Oil”, “Peak Coal”, “Peak Uranium”, “Peak Deuterium”, “Peak Antimatter”, etc. Free human beings will not run out of energy for billions of years, even if we never learn any more physics in all that time. Our only shortage is of freedom itself. And that is something to fear.

Link here.


My personal theory is this: The higher up the political and bureaucratic food chain in Washington you look, the more certain you are to see that it as as hard for high officials to do real good as it is easy for them to do real harm. Now, please do not chew on that one too long because my real purpose is to talk about the exceptions to my “theory” – namely the academic economists who go to work for the Federal Government. They do not do anything real, good or bad. So I was mildly perplexed at first by the recent New York Times piece (Nov. 27) under the headline, “Help Wanted: Academic Economists, Pro-Bush”. Its premise is that there is a shortage of economists who fit that description, and that “much of Washington’s expert economic team has disappeared.” The perplexing part is why this qualifies as “news”, given the (very) relative importance of what economists in Washington do.

The article also listed the Director of the Congressional Budget Office among the jobs that have gone begging, when that is not even an appointment the president makes. As for the unsubtle suggestion that academic economists generally oppose President Bush’s politics, gimme a break. The economics faculty at most universities is a hotbed not of politics, but of esoteric prose and torturous math formulas. All that said, is there a story worth telling about a shortage of academic economists in Washington? Yes, once you discount the political leanings of the Times and consider the larger context. Economists do not want to leave cushy teaching jobs and go to work for a president who just registered his lowest-yet job approval rating.

And what of the explicitly non-political positions at the CBO and the Federal Reserve? Well, the truth is that job approval ratings are tanking not just for George Bush, but for every elected official in Washington. The headlines played up Bush’s low 36% approval rating recently, yet, at about the same time, a Wall Street Journal/NBC poll showed Congress’s job approval at an even lower 28%, with just 37% of respondents saying that their representative deserves reelection in 2006. Add it up and it is easy to understand: Washington is not popular, and there is not much appeal in going to work in an unpopular place. Of course, this begs the question: WHY is there so much discontent? Why indeed, when we keep hearing about how well the economy is doing, and how attractive the stock market looks?

These questions are too rarely asked, never mind answered. We do not hesitate on either count: Social mood defines the trend in society and the financial markets. Understand this, and you will see dangers and opportunities that others only read about or suffer through after the fact.

Link here.


No individual likes to believe that he or she is prone to “herding behavior”, because, well, we would rather believe that we act as individuals. The very word “herding” conjures an image of many people all doing the same thing together, often something no person would do alone. It suggests rationality gone missing with emotion filling the void.

Yet herding can also be a choice. Let us say you are a guy who graduated high school in the 1970s. Get out the yearbook and look at the photos of yourself and the guys you remember. Why were the hair and sideburns so much longer then versus today (if you still have enough on top to matter)? And speaking of today, why do you and/or so many people you know drive an SUV? Of course, herding behavior is stronger in some environments than in others. In the financial markets, it is strong indeed – this is why sentiment can be such a vital tool for investors. And with sentiment in mind, one should expect stronger emotions from some investor groups than from others.

Take overseas investors with a stake in U.S. equity markets, for example. It is easy to imagine that their collective moves in and out happen with even greater speed than do domestic investors. Yet there is no need to merely imagine, because the facts and data are readily available – and it shows that this is exactly what overseas investors have done for the past 10 years: moved in and out with great speed, consistently piling in at the tops and piling out at the lows. What is more, these investors have been “piling” to an extraordinary degree in recent weeks, to an extreme we have seen only one other time in the past 15 years. All this is laid out plainly in the just-published December issue of The Elliott Wave Financial Forecast – our commentary erases any doubt about what it means.

Link here.


What must bother the dead more than being ignored is the ingratitude of the living. The hard lessons were passed along as an heirloom, but instead of displaying them on the mantle, along with photos of the departed ancestors, they were shoved into a forgotten drawer. They were not even admired, let alone honored. What get put on display are the family silver, the wealth, and the patrimony that one generation leaves to another. You would think the living would at least be grateful for that. But no, they hardly notice.

They take 6,000 years of accumulated progress and wealth for granted, as if they had figured it all out for themselves. Granted, the present generation invented the Internet, but only because generations in front of them had figured out how to generate electricity, rig up phone lines, work copper and plastics – and a million other things. As Sir Isaac Newton put it, he was able to see things that others had not, because, “he stood on the shoulders of giants,” who came before him. And yet, the living act as though they had not only created the whole thing from scratch, but invented sex, too! But we write today neither to blame the quick, nor to thank the dead. Instead, we write on behalf of a group that is neither quick nor dead: the group that has not yet been born yet. Today’s leading generation not only ignores the stiffs that came before it; it stiffs the larval generations to follow.

In a letter to James Madison, Thomas Jefferson asked how, “one generation of men has a right to bind another.” He concluded by saying, “No generation can contract debts greater than may be paid during the course of its own existence.” But contracting debts greater than may be paid during the course of its own existence is precisely what Americans are doing. In fact, they are contracting debts that increase over the course of their own lifetimes. George W. Bush will go down in history not as a great war president, we recall predicting earlier this week, but as the greatest debt-beat president the country has ever had. In his few years in office, the feds have borrowed more than $1.05 trillion from foreign governments and banks. This is more than all the rest of the nation’s administrations put together, from 1776 to 2000.

Last month, the U.S. national debt passed the $8 trillion mark. This year’s budget deficit alone added $319 billion to the country’s obligations. According to the feds themselves, deficits will rise to $873 billion per year within 10 years. Two years more and they will be at $1 trillion per year, with a national debt edging up to $20 trillion. By 2017, annual deficits are supposed to reach $2 trillion per year. These figures are not just guesses. They are projections based on boondoggle laws already on the books. According to the Bush-friendly Heritage Foundation, federal deficits are expected to rise to $1 trillion per year, by the year 2017, with a $16 trillion national debt, twice today’s level. After that, deficits should grow to $2 trillion per year.

Public debt is a remarkable thing. Through generation after generation, over thousands of years, each one usually left the world a little bit better off than it found it. More land was placed under cultivation; more animals were tamed and corralled; more houses were built; more factories were put up. Occasionally empire builders, adventurers, or natural calamities set things into reverse. After the collapse of the Third Reich, for example, Germans found themselves with a pile of rubble and armed occupying troops on every street corner. Still, the little German born in Dusseldorf in 1945 entered the world almost completely free of debt! He could rebuild, and enjoy the fruits of his own industry.

Today, the child born in America practically has an electronic ankle tag put on him immediately. He has got his share of about $50 trillion in obligations to pay; they need to make sure he does not get away. As far as we can tell, no other generation in history has ever been burdened to such an extent with the expenses of its parents. Even in the private sector the “get it while you can” attitude crushes the next generation. In the third quarter of 2005 alone, Paul Kasriel of Northern Trust reports, U.S. households spent $531 billion more than their after-tax earnings. About half of that money came from “equity extraction”. In other words, the present generation is selling off its houses one room at a time. By the time the tadpoles come of age, there will be nothing left.

Consumer spending has risen to 76% of the economy; before 2000, it was only two-thirds. The savings rate has fallen to less than 2%. Student loans outstanding have risen more than 800% since Ronald Reagan took office. Mortgages are up nearly 900%. Credit card debt is up more than 500%. Finding no better source on the subject, we quote ourselves: “America’s debt will not be paid by those currently working, nor even by those currently breathing. It will be pushed on to the next generation … and the next. One generation consumes, the other pays. What the first enjoys as a blessing comes to the next as a curse.” It doesn’t seem fair.

Link here.


In a recent trip to visit relatives in Pennsylvania, the following conversation was overheard as family and friends were catching up on how their children were faring in life. “Our oldest son was in an accident a while back – he’s recovering, but slowly,” she said. Then she paused, rolled her eyes, and continued, “And our youngest quit his job and gambles full-time now – on his computer. He says he’s able to support his wife and their newborn, but it’s only been a couple months.”

Talking about their offspring is something that aging parents are wont to do – sometimes not so much to share or inform, but just to have something to discuss. There is much to be learned by paying close attention to conversations like this – sometimes the body language speaks louder than the words. It seems that the older generation has much to say about what the younger generation is doing these days, but often times they are not heard.

Things have not always been the way they are today. One thing that has been pretty much the same over the years is the purchase of Christmas gifts around this time of year. What is popular this year? By the looks of what is for sale in local stores and at Costco Online, poker sets seem to be a hot item. It is a pretty safe bet that very few retired adults are buying items on this list for the parents of their newborn grandchildren. These items do, however, seem to find their way into the living rooms and basements of baby boomers – in many cases baby boomers with teenagers. Gambling has sky-rocketed in recent years among the nation’s youth – many parents apparently feel it is better to have their children gambling at home than roaming the streets. Gambling just seems to be part of the culture now - European teenagers drink wine at the family’s dinner table, American teenagers gamble at the family’s poker table.

Then there is real estate – everyone needs a place to set up that new poker table. The real estate gamble has paid off handsomely for many Americans in recent years, though many of its participants do not see it as a gamble at all. The risk-free interpretation of real estate investing often includes the logic, “Real estate is only going to go up. People are always going to need a place to live.” Thanks to easy home equity extraction, many millions of people now have easy access to many millions of dollars that can be wagered on investment property and second homes. As David Lereah, chief economist of the National Associate of Realtors once said, “If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years. It’s as if you had 500,000 dollar bills stuffed in your mattress.” He called it “very unsophisticated”. Paying off your mortgage is apparently for old people – unsophisticated old people. At a seminar some time ago, the Citibank home loan specialist commented that this sort of “mattress money” was in fact “dead money” – just sitting there, doing nothing. He argued that it should be put to work – investment real estate was his recommendation.

Many years ago, the only reason people needed credit was to start a business or if they were in trouble. Borrowing against the family home was done only to help pay for medical expenses due to some tragic accident or illness, or as a last ditch attempt to save the family business. Today, credit is too easy. Too routine. From credit cards funding Party Poker accounts and Las Vegas cash advances, to all-too-easy home loans – the amount of credit available and the ease with which debt is acquired surely must surprise the older crowd. “I don’t know how they do it,” they say, “Where do they get the money?”

To really appreciate how much the world has changed in the last 20 years, you must go to Las Vegas – to see the new casinos and the new condominiums. The scale of things is breathtaking. The amount of money people have to spend is daunting. While the younger generation crowds around the craps table, the older folks contently sit in front of the quarter slot machines, avoiding the condo sales offices completely. Casinos and condos and generational changes in attitudes toward credit, debt, and risk. What will Las Vegas look like in another 20 years? Who knows? Today it is just another part of our gambler nation.

Link here.
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