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U.S. HOUSING CRASH CONTINUES
Who disagrees with the idea that house prices will continue to fall? Real estate related businesses disagree, because they do not make money if buyers do not buy. These businesses have a large financial interest in misleading the public about the foolishness of buying a house now. Buyers’ agents get nothing if there is no sale, so they want their clients to buy no matter how bad the deal is, the exact opposite of the buyer’s best interest. Mortgage brokers take a percentage of the loan, so they want buyers to take out the biggest loan possible. Banks get origination fees but sell most mortgages, so they do not care about the potential bankruptcy of borrowers, and will lend far beyond what buyers can afford. Appraisers are hired by mortgage brokers and banks, so they are going to give the appraisals that brokers and banks want to see, not the truth. Newspapers earn money from advertising placed by Realtors®, so papers are pressured to publish the Realtors’® unrealistic forecasts. Finally, owners themselves do not want to believe they are going to lose huge amounts of money.
What are their arguments?
What should you do? If you own, consider selling so you can actually keep some of that funny money that appeared out of thin air. Otherwise, it will be painful to watch it vaporize back into thin air. If you want to buy, look around and see that house prices are falling. Why hurry to buy into a falling market? Save your cash and buy for much less in the future. Find a nice cheap rental, sit back, and enjoy the show till then.Link here.
THE FEDERAL WAR ON GOLD
Given the rising price of gold and the fact that federal spending is totally out of control, the prospect of gold confiscation and criminalizing the private ownership of gold by federal authorities inevitably rears its ugly head. There are few things that federal big spenders hate more than gold. Why? Because they know that, historically, gold has provided the best means by which people could protect themselves against the ravages of a rapidly depreciating currency.
The mainstream press often uses the term “inflation” to describe rising prices. That is incorrect. Actually, when the general price level is rising, that is a result of inflation, not inflation itself. Inflation is the process by which governments print up the money to pay for ever-increasing expenditures. Why not instead simply increase taxes on people in order to get the money to pay for the soaring expenses? Taxes make people angry at government officials. It is much easier and safer to simply print the money because then most people have absolutely no idea that the government is behind what is happening.
When prices of commodities, goods, and services start rising in response to the depreciating quality of the money, the average person is likely to blame those in the private sector, such as oil companies, speculators, and businessmen, for the woes. Being unaware of economic principles, people will even demand that federal officials impose price controls and excess-profits taxes on the evil offenders, a demand that the authorities are often willing to oblige. Although clearly a fraudulent way to finance government operations, history has proven that the possibility that such fraud will be figured out by an ignorant and trusting citizenry is minute.
Such ignorance and such trust in government did not characterize our American forefathers. Having studied economics and monetary history and having experienced the ravages of inflation firsthand with the Continental currency, they decided to establish a monetary system based on gold and silver coin rather than paper money. They knew that while the government could still debase the currency by “clipping” a bit of each gold coin it received before putting the coins back into circulation – a process of plunder that governments used before the printing press was invented – that was a relatively small danger, especially compared with paper money, which could be expanded at will through the printing press. A close reading of the Constitution leaves little room for doubt about the intentions of the Framers. The Framers rejected paper money in favor of money they could coin, which meant gold and silver coins. And that is what happened. From the very inception of our nation and through most of the 1800s and early 1900s, the American people used gold and silver coin as their money.
While the system was not perfect in that it still left the determination of money under government control rather than the free market, there were nevertheless two remarkable results of this system. One, the gold standard eliminated the power of federal officials to do what governments had historically done to their citizenry – plunder and loot the people through the issuance of depreciating paper money. Two, the gold standard had an enormously positive effect on capital markets, which was one of the major contributing factors for the tremendous economic expansion and prosperity that characterized the U.S. through most of the 19th and early 20th centuries.
So how did things change so dramatically? How did it come to be that the monetary system of the U.S. is now based on irredeemable paper money? Why are gold and silver coins and gold and silver certificates no longer used as our country’s money? There was never a constitutional amendment changing America’s monetary system, so how did things change so radically? The answer lies with two presidents – Abraham Lincoln and Franklin D. Roosevelt. Their respective actions revolutionized our nation’s monetary system. Their actions culminated in a monetary system that has enabled federal authorities, decade after decade, to fraudulently plunder and loot the American people, even to the point of denying them the ideal means – ownership of gold – by which to protect themselves from the federal government’s immoral and insidious monetary behavior.
n 1862, Congress granted Lincoln’s request to issue $150 million in Treasury notes to finance the war effort during the War Between the States. Given that the power to borrow money was among the powers that the Constitution delegated to Congress, there was obviously nothing unconstitutional about what Congress had done ... except for one major factor that ultimately formed the basis for one of the most revolutionary transformations in American life: at the same time it authorized the issuance of the Treasury notes, Congress provided that the notes would constitute “legal tender” – which meant paper money. For the first time since the founding of the nation, Americans would be required to accept the federal government’s paper money as a medium of exchange. Like so many other government officials in history, Lincoln was resorting to the printing press – inflation – to finance his war expenditures.
In 1862, Treasury notes were trading at a deep discount relative to their face value, because of the doubts that people had regarding the federal government’s ability to repay the loans in gold when they ultimately came due. In the absence of the legal-tender law, even though the government could continue borrowing money, people could still protect themselves from the ravages of inflation by stipulating their contracts in gold coin. The effect of the legal-tender law was to remove that protection by requiring creditors to accept depreciated paper money in lieu of gold and silver coin stipulated in the contract. In 1869, five years after the war had ended, the U.S. Supreme Court ruled 4-3 in Hepburn v. Griswold that legal-tender laws violated the U.S. Constitution. One year later, however, the legal situation changed dramatically. President Ulysses S. Grant, who had commanded Union forces during the war, appointed two new justices to the Supreme Court who promptly joined the minority in Griswold. In Knox v. Lee, decided in 1879, the Supreme Court voted to overturn the decision in Griswold and to uphold the constitutionality of Lincoln’s legal-tender law.
In a dissenting opinion, Justice Stephen J. Field pointed out the obvious: “The power ‘to coin money’ is, in my judgment, inconsistent with and repugnant to the existence of a power to make anything but coin a legal tender. To coin money is to mould metallic substances having intrinsic value into certain forms convenient for commerce, and to impress them with the stamp of the government indicating their value. Coins are pieces of metal, of definite weight and value, thus stamped by national authority. Such is the natural import of the terms ‘to coin money’ and ‘coin;’ ... The power to coin money is, therefore, a power to fabricate coins out of metal as money, and thus make them a legal tender for their declared values as indicated by their stamp. If this be the true import and meaning of the language used, it is difficult to see how Congress can make the paper of the government a legal tender.”
Field also pointed out that the Constitution had not delegated to Congress the power to impair private contracts. With Knox v. Lee the seeds were sown for a monetary revolution in American life – a revolution that would bring the inflationary plunder and moral debauchery that have characterized nations throughout history. The revolution began with Lincoln. But it would culminate in one of most massive assaults on private property in U.S. history – President Franklin Roosevelt’s nullification of gold clauses in contracts and his confiscation of gold from the American people. It is impossible to overstate the significance of the Franklin Roosevelt administration’s confiscation of gold and its nullification of gold clauses in contracts. It is one of the most sordid episodes in American history. To get an accurate sense of Roosevelt’s actions, it would not be inappropriate to compare what he did with the domestic economic policies of a later 20th-century ruler, Cuba’s socialist president, Fidel Castro.
On April 5, 1933, newly inaugurated President Roosevelt issued Executive Order 6102, which prohibited the “hoarding” of gold by U.S. citizens. Americans were required to turn their gold holdings over to the federal government at the prevailing price of $20.67 per ounce. Anyone caught violating the law was subject to a federal felony conviction, 10 years’ confinement in a federal penitentiary, and a $10,000 fine. Soon after the confiscation, U.S. officials announced that the government would sell its gold in international markets for $35 an ounce, thereby devaluing the dollar by almost 70% and immediately “earning” a potential profit of almost $15 an ounce on the gold it had confiscated. Two months later, Congress enacted legislation nullifying gold clauses in both government and private contracts, thereby requiring creditors in such contracts to accept devalued paper money in payment of such contractual obligations, even though the contract itself stipulated payment tied to gold.
Reflect for a moment on the significance of what Roosevelt did. Gold coins and gold bullion were private property, just like a person’s automobile, clothing, home, and food. On the mere command of the president of the U.S., federal authorities simply confiscated gold holdings that were the private property of the American people and made it a grave federal offense to own such property in the future. The gold seizure was no different in principle from Fidel Castro’s seizure of homes and businesses more than 25 years later in Cuba, an episode that U.S. officials still rail against while praising what Roosevelt did. Sure, Roosevelt paid Americans more money for the gold he seized than Castro paid Cubans and American companies for the property he seized, but the principle was the same: the rulers in both Cuba and the U.S. could appropriate people’s property at their whim.
Roosevelt’s justification for the gold seizure was that it was necessary to battle the Great Depression. The real reason was twofold: First, he seized people’s gold for the same reason that Castro later seized people’s homes and businesses – to enrich the coffers of the federal government. Second, but more important, he did it to prevent the American people from protecting themselves from the onslaught of ever-depreciating paper money that he planned to use to finance his ever-extravagant welfare-state programs.
With his seizure of gold, Franklin Roosevelt revolutionized the monetary system of the U.S. – and without even the semblance of a constitutional amendment. It is instructive to understand how he pulled this off in a legal sense. What the Congress had done is delegate its power to make certain laws to the president, essentially vesting Roosevelt with dictatorial powers. In March 1933, Congress amended the Trading with the Enemy Act to vest the president with the power to declare “national emergencies” and then issue necessary decrees to deal with such emergencies, including even setting criminal punishments. It was a type of executive power – rule by decree – that had characterized dictatorships throughout history. Thus, it should not surprise anyone that one of Roosevelt’s biggest admirers was Adolf Hitler, who was dealing with the Depression in Germany in much the same way that Roosevelt was dealing with it in the U.S.
What was the reaction of the American people to Roosevelt’s gold seizure? By the 1930s, most of the U.S. had been under systems of public (i.e., government) schooling for at least three decades. After years of such indoctrination, even though Americans had not yet become dependent on the federal government’s welfare dole that Roosevelt was initiating, most of them nevertheless now deferred to the wisdom of federal officials to deal with such complicated subjects as economics, depressions, and monetary policy. Thus, when Roosevelt issued his decree, it was not met with massive protests and demonstrations but rather with the same degree of meekness and submission that many (but certainly not all) of the Cuban people would display when their homes and businesses were confiscated by Castro several decades later.
In 1974 Congress made it legal to own gold once again, providing Americans the means to protect their wealth from the inflationary propensities of the federal government. Is there a possibility, however, that federal officials could confiscate gold again and make it illegal to own it? You bet your bottom gold dollar there is. For one thing, the Trading with the Enemy Act is still on the books and is still being used as the basis for presidential decrees. For another, ever since the Roosevelt administration, federal officials, assisted by the Federal Reserve, have never desisted from issuing ever-growing quantities of paper money, an inflationary process that has ravaged people’s savings. Finally, federal officials hate gold because its rising price in the face of inflation provides a public and an easily readable market message to the citizenry that government officials are destroying the currency.
And make no mistake about it. If another U.S. president issues a gold-confiscation decree, it will be enforced violently and brutally by federal officials. In the climate of the perpetual “crisis” known as the “war on terrorism”, combined with an “economic emergency”, it is not difficult to imagine that federal officials would conduct warrantless raids on banks to search bank records and safety deposit boxes and prosecute dangerous “enemy combatants” and “terrorist sympathizers” who show they “hate their country” by violating the law against the ownership of gold.Link here.
GOLDMAN, DEUTSCHE BANK SAY DOUBLE DOWN ON COMMODITIES
Anyone who followed the advice of Goldman Sachs last year and invested in the Goldman Sachs Commodity Index would have lost 15% of their investment. Like so many of Wall Street’s best and brightest, Goldman, the biggest securities firm by market value, says it was not wrong, just early, and to expect an 8.1% return in 2007. “The long-term secular story is very much intact,” Jeff Currie, global head of commodities research at New York-based Goldman, told customers in London earlier this month. That is the same outlook provided 13 months ago by Arun Assumall, the firm’s London-based head of commodities sales.
Like Goldman, Deutsche Bank AG is not discouraging anyone from doubling down in what increasingly looks like a bear market. Germany’s largest bank in September said oil will trade between $60 and $70 a barrel this year, well above the $49.90 fetched last week. Barclays Capital, the securities unit of the U.K.’s #3 bank, said four months ago crude would not drop below $60. As losses mount in copper, oil and sugar, these firms say the 20% plunge in commodities, as measured by the Reuters/Jefferies CRB Index, since May offers a chance to buy before demand from China and India causes a rebound. History shows otherwise. The CRB index dropped at least 20% six times since 1970, and on average, fell a further 7.7% before bottoming.Link here.
DAY TRADING RISES AGAIN
As stocks soared in the 1990s, countless Wall Street wannabes became “day traders” – quitting their jobs and making their living by trading stocks at a furious pace. When the boom ended, so did the day trading craze. But rising stock prices and new highs in major stock indexes have tickled investor interest, and aggressive trading by individuals is on its way back. “There’s no other way to live,” said Robert Earl, a 52-year-old Long Beach, California, man who began trading full time in 2004. “My friends think I gamble, but this is not gambling if you do your homework.”
Although trading activity does not resemble the frenzy of the late-1990s, electronic stock brokers such as Charles Schwab and E-Trade point to a marked uptick in business. Schwab, for example, averaged 242,300 trades a day in the first nine months of 2006. That was up 29% from the same period a year earlier, and a click above its 242,000 peak in 2000.
The trading scene is much different now than in the 1990s. Back then, fewer people had high-speed Internet connections, leading to the establishment of day trading shops stocked with rows of computer stations. Caffeine-fueled traders “scalped” a handful of stocks all day long — jumping in and out repeatedly as stocks bounced like ping-pong balls. The goal was to notch dozens of small gains. Stocks are much less volatile today, forcing traders to hold for days or weeks to net sizable gains. And the wide availability of speedy online hookups has rendered the day-trading centers obsolete. It is easier than ever for investors to trade from home, not just those who hope to make a living at it.
Some investors are holding back because of bad memories from the last bear market and uncertainty about how much longer today’s bull market will run. And many people may have shifted their money into real estate earlier this decade, as stocks tanked and home prices rose. Nevertheless, interest in trading is heating up. In the last year or so, several brokerages and Web sites have popped up catering to online stock traders, including TradeKing, Just2Trade.com and Zecco.com. Don Bright is capitalizing on the trend. His Bright Trading in Las Vegas teaches trading skills, and demand is growing. About 50 people took his course in October, he said, or double the number in 2003. He said 34 people enrolled in a recent three-day, $1,000 course.
Of course, some active traders never went away despite the market’s slump in 2000-02. Ziyue Fu, 32, of Manhattan, got hooked on stocks in 1997 and dropped out of podiatry school to day trade full time. He hung on through the bear market, but altered his trading style in 2003 when “scalping” became less profitable. He still does about 30% of his trades intraday, but is now more of a “swing” trader – holding shares for days or weeks. But he has seen a lot of his friends fail over the years, and predicts that many more will. “I see a lot more newcomers than in 2005,” he said. “Most of them wash out in the first six months. Very few of them stay.”Link here.
MISHKIN ON ASSET BUBBLES AND MONETARY POLICY
Fed Chairman Bernanke testified last week before the Senate Budget Committee. He spoke clearly and forcefully about our nation’s dire fiscal predicament, noting that we are in the “calm before the storm” of a major “fiscal crisis”. Untenable contingent liabilities – most conspicuous today in retiree income and healthcare benefits – require a major system overhaul. But as much as the Fed and Budget Committee members may see eye-to-eye the severity of the problem, the environment is anything but conducive to making tough decisions and taking decisive action.
With federal government receipts growing double-digits during 2006, there is today little impetus to deal with uncertain deficits somewhere down the road. This is the case in Washington as well as in Sacramento, Albany and elsewhere. It is worth noting that federal receipts during fiscal 2007’s first quarter were up 8.2% from comparable 2006, with the federal deficit rapidly shrinking a third to $80.4 billion (for the quarter). And to better ascertain the current tide of Washington consensus opinion, tune into Larry Kudlow and hear the clamor of economic miracles, evaporating deficits, and soon to reemerge budget surpluses. Today, bullish euphoria has the incredible U.S. economic engine handily coping with the burden of guns and butter – today, tomorrow and forever. Besides, if at some point the economic expansion were to prove not quite up to the task, the Bernanke Fed would be right there keen to make it right.
My frustration with Mr. Bernanke is simply a continuation of the issues I had with Mr. Greenspan. They talk an especially great game on Capitol Hill. Both are impressively capable of articulating some of the serious issues facing our economy – captivating our legislators and media in the process. Wall Street snickers. It is disingenuous for Bernanke (as it was for Greenspan) to propound the necessity for Congress to deal forcefully with forthcoming problems, while ostentatiously cultivating faith in the capacity of monetary policy and the markets to cure all ailments.
I hope readers will recognize that we today confront one of the corrosive consequences of inflationism: complacency and lack of resolve to deal with critical issues. Confidence in the Fed’s capacity to cut rates, manipulate market behavior, and “reflate”/“reliquefy” has never been as unyielding as it today. If the banking system needs recapitalized, there is no problem. Hedge fund and Y2K scares, the Fed’s on the case. If a collapsing tech bubble is weighing on growth, simply inflate home prices. If the corporate bond market suffers from bursting bubbles, fraud, and problematic risk-aversion, well, just communicate to the marketplace that it is the Fed’s policy to garnish outsized financial profits on the risk-takers and leveraged speculators. When the debt load – for individuals, businesses, governments, speculators – for the entire nation – becomes too onerous, just inflate system credit, liquidity, asset prices, incomes, earnings and tax receipts.
There are apparently few problems that today’s astute monetary policymakers cannot resolve. The days of hard decisions, (personal and national) sacrifice, and saving for a rainy day are, conveniently, a thing of the past. Activist central banking has somehow – over this protracted boom – relegated the structure of the real economy, our nation’s balance sheet, and our financial system to peripheral issues.
One of our new Fed governors gave a speech last week that I will not let go unanswered. Dr. Frederic Mishkin, an academic partisan of Dr. Bernanke’s, presented “The Role of House Prices in Formulating Monetary Policy”. It received little media attention, though it will provide lush fodder for future financial and economic historians. Among his statements are: “A lesson that I draw from Japan’s experience is that the serious mistake for a central bank that is confronting a bubble is not failing to stop it but rather failing to respond fast enough after it has burst.” And: “Another lesson from Japan is that if a burst bubble harms the balance sheets of the financial sector, the government needs to take immediate steps to restore the health of the financial system.”
Not atypically, Dr. Mishkin’s article fails to even use the word “credit”, let alone analyze the prevailing role of the credit system in fostering destabilizing asset Bubbles. Not engendering credibility, the issues of liquidity and speculation go similarly neglected. The crucial error in Dr. Mishkin’s asset bubble analysis is to disregard Financial Sphere dynamics, certainly including the expansive repercussions historic mortgage credit inflation imposed upon U.S. and global economies and global finance, generally. More insightful analysis would consider – should begin with – the prominent role of system credit expansion, liquidity excess and speculative dynamics. Housing inflation was only one of myriad consequence of the mortgage finance bubble. This powerful financial “evolution” unfolded after years of loose financial conditions, only to be inflated to dangerous extremes with the Fed’s post-tech bubble monetary “reflation”. Instead of being chastened from the gross excesses that fostered myriad bubbles and busts (MBS/bonds 1994, Mexico, SE Asia, Russia, LTCM, Argentina, tech and telecom), Fed “activism” nurtured and emboldened an escalation of lending, leveraging, and speculation in housing, mortgage-related securities and instruments.
The Fed’s policy of responding to asset price risk disregards the reality that behind the serial asset market bubbles have operated a credit system and pool of speculative finance that, by its very nature, inflates only larger, more powerful, and increasingly destabilizing with each passing year of accommodation. Over time, as bubble infrastructure and psychology become more entrenched, failure to “prick” the bubble is to further accommodate it. Moreover, incorporating into policy the intention of “appropriately dealing with the consequences” of asset bubbles openly invites the by now dominating leveraged speculating community to aggressively position to profit from prospective rate cuts and “reflations”.
I am personally a little sick and tired of the cop out nonsense that bubbles cannot be identified until after the fact. If the focus were on credit – where it should and must be – the analysis would become much less nebulous and the policy task much less ambiguous. When home mortgage debt growth accelerated from 1998’s 8.0% to 1999’s 9.4%, the Fed should have been on notice. When 2001’s 9.3% growth jumped to 2002’s 10.6%, they should have been on guard. When mortgage Credit then expanded 11.6% in both 2003 and 2004, there was no doubt that a problematic bubble in mortgage credit had emerged, and the Fed should have aggressively tightened policy. Yet the Fed sat idly by and watched mortgage debt expanded a further 20% in two years, with resulting unprecedented current account deficits, leveraged speculation, and global liquidity excess inspiriting speculative bubbles in asset, securities and commodities markets across the globe.
Dr. Mishkin’s focus is misguided. The crucial question is not whether a bursting asset bubble will lead to a severe episode of financial instability. Rather, the key issue is what impact a vulnerable or faltering asset bubble has on the underlying credit and economic systems. The 1929 marketplace featured gross speculative leveraging, acute financial fragility, and a deeply maladjusted credit-driven bubble economy. The ‘29 stock market bubble closely intertwined with the system credit bubble. Japan in the late-‘80s was less extreme. The Fed’s response to the tech bust only energized and emboldened the credit system and leveraged speculator community. The ballooning Financial Sphere has been of late further empowered by the prospect of bursting housing bubbles and the Fed’s foreseeable response. Not unpredictably, unprecedented bubble propagation enveloped the world.
Devastating credit system crashes – fortunately much rarer events than bursting asset bubbles – are the consequence of protracted periods of credit and speculative excess. Regrettably, the Fed’s asymmetric strategy with respect to ignoring asset bubble while they are inflating and then reflating aggressively when they falter is tantamount to flagrant market manipulation. A Hippocratic Oath is in order: First of all, Federal Reserve monetary policy must do no severe harm. To live up to such an oath, monetary policy would strive to avoid fostering credit and speculative excess, while being prepared to take all necessary measures to ensure that protracted credit booms not be tolerated. Monetary policy should not be used to stimulate the economy or asset markets – it must avoid being “activist”. Absolutely never should the Fed use the leveraged speculating community as a reflationary and liquidity-creating policy mechanism. And never should the Fed pre-commit to inflationary policies in the event of bursting speculative bubbles. Drs. Bernanke and Mishkin’s views on asset bubbles and monetary policy are so dangerously ludicrous I find it difficult to believe they do not provoke heated debate, some consternation, and at least a little outrage.Link here (scroll down to last heading in the left/content column).
GOLD, M3, AND WILLINGNESS TO LEND
Let us start with a quick look at the expansion of the monetary base in comparison with the expansion of broad money supply, as measured by M3 – here and here. For this article, pay attention to the green line in the second chart and ignore the others. M3 started exploding in 1971, and it was not happenstance, either. Here is a snip from “The Last Great Bubble – Counterfeiting the Dollar”, an interesting read from 2002 predicting the demise of the dollar, even as it was still rising at the time:
“1971 – Aug. 15 – President Nixon closes the international gold window. U.S. dollars are no longer redeemable in gold for international settlements. This marked the beginning of the current, anchorless floating currency regime, and not, coincidentally, a decade of inflation.”
The article fails to point out that it was not just the U.S. abandoning all ties to the gold standard, but it was every country in the world. This was the biggest experiment in fiscal madness the world has ever seen. Unleashed from the “burden” of gold redemptions, credit has soared far faster than base money supply. This in turn fueled asset bubble after asset bubble, but most notably in the global equity markets and housing. Do those charts represent inflation? Absolutely. What else can they represent? Inflation is the expansion of money and credit, and both money and credit went on a tear. But although the chart patterns are similar, the scale is enormously different. M3 dwarfs monetary base expansion.
There is without a doubt a bubble in credit. Money is being “swept” out of checking accounts and lent out. Bank reserves are nonexistent. Fannie Mae and Freddie Mac have been creating debt out of thin air. That is what happens when money is no longer backed by anything. But the question is not, “What happened?” The charts clearly show what happened. The pertinent question is, “What happens next?” As long as asset prices keep rising, the bubble can keep expanding. Consumers can then keep borrowing against the rising value of their houses and stocks, which in turn supports current consumption.
Is the ability to expand that credit bubble infinite? I think not. Therein lies the problem. Every bubble sows the seeds of its own demise. Wages are not keeping up with ability to service debt. Global wage arbitrage and outsourcing ensures that trend will continue. Housing is not affordable and has risen several standard deviations beyond wage growth and rental costs. People purchased homes they could not afford just because someone was dumb enough to lend them money. The result is rising bankruptcies and foreclosures at a massive annual rate of growth.
Can the Fed keep expanding the bubble? Once again, the answer is no. Debt bubbles end when the central bank is no longer able or willing to extend credit and/or when consumers and businesses are no longer willing to borrow because further expansion and/or speculation no longer makes any economic sense. Here is an alternative reason: Debt bubbles implode when the ability to service the debt can no longer be maintained. Bankruptcies and foreclosures are two ways to measure inability to service debt. Foreclosures are actually at a fairly low rate currently. It is the rate of change, however, that is alarming.
Right now, there is enormous faith in the ability of the Fed to keep the bubble inflated. Inflationists fail to see that much of that credit borrowed into existence can never be paid back. Yet somehow everyone thinks the Fed will expand money enough to matter if a credit bust happens. It has never worked that way in history. Take a good, hard look at monetary base vs. M3. Interest rate policy at the Fed cannot fuel that expansion forever.
The Treasury Department has massive ability to print money, but it cannot force banks to lend. It is important to understand the difference. Credit lending standards can only go so far before bankruptcies and foreclosures force a change. That change is finally upon us, and a huge secular reversal is now under way. The Fed simply does not have the power to deposit money into consumer accounts so that bills can be paid. It probably would not do so even if it could, because it would be to the detriment of banks and creditors. Will the Fed react to a debt implosion by cutting interest rates? Absolutely. The Fed will likely attempt anything it can to help consumers service debt. History proves it, and history proves gold will benefit, as well. But the Fed cannot create jobs or revive housing, and neither can the Treasury.
Conditions now are radically different than conditions in the ‘70s and ‘80s. A couple decades ago, households went from one wage earner to two wage earners, which increased purchasing power. Wages and benefits were rising, and not just for those at the top end. Mortgage rates were set to decline nine full points. Credit lending standards had plenty of room to drop. Debt levels were low, the savings rate was high, and ability to take on debt was huge. Virtually none of those conditions exists today. Not a single one. Yet many think that because commodity prices are rising, this is some sort of ‘70s and ‘80s replay. It simply cannot be.
The Mortgage Lender Implode-O-Meter is reporting, “Twelve lenders have now gone caput since December 2006.” This number has been increasing at a rate of one-two a week since December. Two of those lenders were among the top 20 subprime lenders. The pool of willing lenders is clearly shrinking. The pool of eligible buyers is now shrinking, as credit standards tighten. The pool of willing buyers is shrinking along with a decrease in the willingness to speculate on housing.
The psychology of both lenders and borrowers has now changed at the margin (subprime lending). This is how cascades start. When defaults continue, it will progress further and further up the chains of credit worthiness. It is a mistake to think this will be confined to housing. It will not. If and when there is another huge hedge fund blowup, and/or there is a huge junk bond default, the leveraged buyout and merger mania markets will be hit hard. This is all poised to feed on itself once the ball gets rolling. A major credit bust is coming, and it is only a matter of time.
There is massive belief in the Fed to be able to do something about that bust when it happens. That faith is totally unwarranted. Note again the huge difference between M3 and base money. Note that even if the Fed could deposit money into consumers’ pockets (the helicopter drop theory), to do so would be at the expense of banks and creditors. That makes the helicopter drop scenario implausible. The Fed will undoubtedly be willing to slash rates. But will banks be able and willing to lend? Will consumers be able and willing to borrow? A history of credit bubble collapses, as well as the data presented above, suggests otherwise.Link here.
LADY BOUNTIFUL’S ILL-GOTTEN GAINS
U.S. Treasury Secretary Hank Paulson’s announcement that he will devote $800 million of his Goldman Sachs fortune to charitable activities, primarily in the area of the environment, brought coos of approval from the business and establishment press. In reality, it raises serious questions about the market’s efficiency. Does a system in which wealth is achieved primarily through rent seeking, and then redistributed through charitable donations, bear any relationship to a free market?
Free market absolutists may assert that Paulson’s wealth was acquired honestly, as were most of the other gigantic fortunes that have appeared in the last decade, and that through charitable donation Paulson is able to mitigate the malign effects of excessive wealth concentration, and return wealth to the community at large. However from a free market perspective there are severe objections to both the last decade’s creation of these huge wealth pools and their dissipation through charitable bequests.
First, the free market paradigm assumes that money is of constant value, and that all prices are set by willing buyers and willing sellers in the market. In the days of the Gold Standard that was more or less true, although variations in the rate of finding gold produced inflationary and deflationary periods. However, with the rapid increase in world population after 1900 a Gold Standard which depended on finding new sources of gold to keep up with world population and wealth increase rapidly became excessively deflationary. Overall price levels were forced to decline by 2% per annum – dangerously close to the level at which the monetary system ceased to work properly because holding cash became too attractive an investment alternative. However since the world went off the Gold Standard we have had fiat money, in which central bankers create money more or less ad hoc, according to whichever monetary theory is currently fashionable. It is possible to run the world’s financial system under fiat money, but to do so and maintain the conditions under which classical economic laws remain valid you have to expand money supply at a modest even rate, announced in advance – as did the Paul Volcker Fed of 1979-87 or the pre-1999 Bundesbank.
Nothing in economic theory suggests that the price mechanism should work properly in allocating resources with a randomly fluctuating money supply. The introduction of a non-market driven money controller into the financial system invalidates the assumptions on which free-market economic theory is based. Since 1995, the Federal Reserve under Alan Greenspan and Ben Bernanke has increased M3 money supply by almost 10% per annum, far more quickly than the growth in nominal GDP (since March 2006, when the Fed stopped reporting M3, we cannot tell what it has been doing, but market conditions suggest that the laxity has continued.) It is only to be expected that this excessive laxity over a period of more than a decade had a major distorting effect on the world economy.
One would normally expect that a period of excessive monetary laxity would produce a burst of inflation, as the quantity and value of money adjusted themselves. It did in the 1970s. However since 1995 the world has enjoyed a supply-side benefit from the Internet and modern telecommunications, which have made it for the first time economically feasible to subcontract the production of a vast proportion of goods and services to the low-wage-cost Third World economies of India and China. This supply side effect has counterbalanced the monetary laxity, preventing the increase in consumer prices that would normally have occurred several years ago. The suppression of price inflation has been assisted by politically-driven revisions in price indices by which inflation reported to the public was kept considerably below its actual rate. In the long run, this deceptive practice will be corrected for by the market. However, combined with the supply side effects, it has allowed the Fed to gun the money supply more than it should – producing low real interest rates but not the burst in reported inflation that would have brought the bubble to an end.
12 years is a period of monetary ease and low real interest rates entirely without precedent. For more than a decade price signals have been distorted and resources have flowed in artificial directions. On the asset side, this has been reflected first in an enormous boom in speculative tech stocks, then in a house price run-up which is only beginning to reverse (and has not yet done so in Britain), more recently in a tsunami of low quality “junk” corporate and emerging market debt, and now in an explosion of private equity funds and hedge funds far beyond the level imaginable a decade ago.
Globalization and outsourcing have kept wages down at the bottom of the scale in the U.S. and Europe. However at the top of the scale those able to benefit from IPOs, those with excessively large homes, the managers of hedge funds and private equity funds, and above all the gatekeepers such as Goldman Sachs, who control access to the overwhelming flood of liquidity, have all benefited far more than they should have in a well functioning economic system. It is in this sense that they have received “rents”. The U.S. and world economic system has been distorted in these people’s favor for more than a decade, to the excessive benefit of their net worth. They have come to expect such benefits. The Goldman Sachs participation in the IPO for the Industrial and Commercial Bank of China, in which the firm and its partners, mostly the latter individually, made a $6 billion profit due entirely to its insider position in the world financial markets, might have landed them in jail for insider trading in a more stringent environment. In this market it only further fattened their bonus pool.
If the diversion of wealth to the very rich was artificial, how about their charitable donations? It is amply clear that these do not restore the status quo. Paulson’s $800 million could buy approximately 80 million pizzas for the working stiffs of America who have lost out in the last decade. If Paulson simply bought everybody pizza, that would restore wealth to its proper free-market destination. However, he has not done this. Indeed I know of no case in which a billionaire bought philanthropic pizzas with his wealth. The billionaire ego gets in the way.
In Paulson’s case, he has donated $900 million to the Bobolink Foundation, an environmental charity he founded, and has stated that he intends to devote himself to charitable work when he leaves the Treasury. If he intends to give away the assets of the Bobolink Foundation during his lifetime, this will at least avoid the problem of many past foundations, which after the founder died became vehicles for left wing activism of a kind their founder would have abhorred. One thinks of the Ford, Rockefeller, and Foundations. The Bill and Melinda Gates Foundation will also suffer from this problem when its founders die, if only because of its size, particularly now that Warren Buffett’s billions have been added to it. However in this case both Gates and Buffett are center-left, so the ideological shift will be less extreme.
Another problem with large charitable donations, if they are made out of money that should in a free market have gone elsewhere, is that they impose the donor’s political and social views on those resources. Objectively, it may be economically and morally optimal for Bill and Melinda Gates’s money to be used to provide old age pensions to Africa, in order that the incentives for reproduction on that continent can be reduced and its catastrophic population growth rate stemmed. However, Gates Foundation money will not be used in an economically optimal manner, it will instead be used to subsidize whichever fashionable aid or environmental nostrums capture the Gates imagination.
To the extent that Gates or Paulson made their money in a free non-rigged market, this is appropriate. The resources devoted to their fads would have been collected through a free market process. However, when they became rich partly or wholly through the rent-granting effect of lax monetary policy and a series of asset bubbles, the ideological and social priorities of fashionable Georgetown and the Upper East Side are being given yet more weight in the economy than they already have ... weight which they in no way deserve. Paulson can avoid this problem by cancelling his donation to the Bobolink Foundation and buying everybody pizza (without imposing the organic vegetarian variety on us.) Hey Hank, mine is a pepperoni with extra anchovy!Link here.
The hard rain that’s falling on capitalism.
A few evenings ago, my wife and I were standing in the kitchen of our home in Rancho Mirage, California, when a song came on the radio. It goes, “If only you believe in miracles, baby, so would I ...” Suddenly a flood of thoughts came into my head: My whole life is a miracle so far. I live in glorious houses – tar-paper shacks by hedge fund standards, but plenty for me. I have a great American-made car. Above all, I have the most wonderful wife and the handsomest son on the planet. My parents had a great, super life. They went from obscurity and lower-middle-class status in the Great Depression to fame and fortune in the postwar period. Their good fate was attributable mostly to their genius and hard work, but also to two culprits usually criticized in the media: President Richard M. Nixon, who made my father famous and powerful, and variable annuities, which made him and my mom well-to-do.
All of the miracles of our lives are because of America and our ancestors’ lucky, brilliant decision to move here from the desperation of Eastern Europe. All of it is thanks to the brave men and women who fought and died and bled on World War II battlefields like Anzio and Tarawa to keep us free, and to the framers of the Constitution. But it is also thanks to capitalism. Under capitalism, my grandparents, my parents and I could be paid the value of what we produced. Their (our) income and position in life were (are) a function of what value we could add, not of the status of poor stateless Jews that we would have been in Europe.
Capitalism values people as individuals according to contract, not according to the status of our birth. This in itself is a miracle. The system of capitalism is wide open. If you have an idea, you can turn it into capital. But, I also had a chilling thought: in capitalism, the most fundamental building block is trust. When yeoman farmers sent their savings to banks in London and Glasgow and Paris, they had to be able to count on it not being stolen. That was what allowed capital to be accumulated and deployed, and for the entire world economy to take off.
When I see what the top dogs at all too many corporations are now doing to that trust, I feel queasy. Outrageous – yes, obscene – pay. Greedy backdating of stock options, which in my opinion is straight-up theft. Managers buying assets from their trustors, the stockholders, at pennies on the dollar, then forestalling competing bids with lockups and insane breakup fees. How long democratic capitalism can survive these blows before it gives in and gives birth to revolution or to an out-and-out aristocracy, I am not sure.
Empires come and go. Economic systems come and go. There is no heavenly guarantee that capitalism will last forever as we know it. It is built on man’s notion that he can trust his neighbor with his money, and that if the neighbor misbehaves, the law will chase him and catch him, and that the ladder of law has no top and no bottom, that even the nobles get properly handled once they have been caught. If that trust disappears – if the system is no longer a system for the ordinary citizen but only for the tough guys – how much longer can the miracle last?
Each day’s newspaper, it seems, brings more tidings of unrestrained selfishness and self-dealing and rafts of powerful people saying it is good for us to be robbed if only we truly understood the system. The problem is, we are getting to understand it all too well.Link here.
LUCK VS. SKILL IN THE CURRENCY MARKETS
I once doubled the size of my investment account in a single day with a well timed trade on the Japanese yen. Most people would chalk it up to luck, and I would not necessarily disagree, but in retrospect I realize that I was in the right place at the right time. This is what trading is all about. You must be willing to take a well-calculated risk. Seldom if ever will you find yourself with all the information necessary to make a well-informed investment decision. If the game where that easy, we would all make oodles of money all the time.
In trading currencies, as in life, you must be willing to take a leap-of-faith. You will never have all the pieces of the puzzle laid out for you in jig-saw fashion. Instead, you piece them together one at a time based on your experience, and on the quality of your own homework – good old fashioned research and analysis. But still in the end it comes down to making decisions based on imperfect information and conjecture.
So why not just head out to Vegas for the weekend and take your chances there. It is certainly more entertaining than getting up at four in the morning to watch the currency markets! But the real key to the puzzle – besides your value-added analysis and experience – is you discipline at risk-management. At the time I made my killing in the Yen, I did not realize how much risk I was taking. Today I understand this factor only too well ... and apply it to every trade I make. Of course the rest of the story is that I gave back to Mr. Market every cent and more that I made in the Yen that glorious day. At that time, I was still paying the tuition for my own education, but it does not have to be that way for you when it comes to currency trading.
I have talked with a lot of people over the years that are really excited about the potential for pulling down big profits trading currencies. They are enticed by the advertisements showing a guy on the beach in some tropical paradise, with laptop in one hand and piña colada in the other, leisurely racking up profits in forex trading. The presumption of course is that “you too” can make so much money in the forex markets that you can quit your day job. There is a kernel of truth to that, and best of all, we make forex as easy as possible for you to profit from. Many people unnecessarily fail to get the benefit of guidance from someone who has actually been there and done that. Currencies are a great market to trade – highly efficient, open for trading 24-hours a day, and you can do well with the right guidance and investment discipline. But you need to learn the ropes first.
A novice can make big bucks initially in forex, but keeping it and staying in the game long-term requires risk-control. This most important factors in spot forex is not an easy one to master. Essentially it comes down to occasionally admitting you were wrong, and quickly cutting loses. In my view, currency options are the best single way for most people to speculate in the currency market-big profit potential, limited risk, and straightforward, disciplined trading instructions that anyone can follow. Big profit potential because currency options give you the advantage of trading with huge amounts of leverage, yet your maximum risk (if you stick to buying options) is limited to the cost of your option plus brokerage commission.Link here.
The Perfect Storm dramatized the events surrounding a powerful nor’easter that raged over the Atlantic Ocean in 1991. The storm was the product of some fluky weather patterns, all of which converged to create a monster of a storm. The movie focused on the ill-fated travails of a small fishing boat, the Andrea Gail of Gloucester, Massachusetts, which was lost at sea. It was a good movie, I thought. You could almost smell the fish and salty sea air, even while tossing back kernels of popcorn. The film’s success helped to introduce a new phrase into the English lexicon: A “perfect storm” describes any combination of events which, taken individually, would have produced far less powerful effect.
The idea of a “perfect storm” comes to mind when I think about the world’s need for new electrical power grids. Major blackouts already occur about once every four months on average in the U.S. And that includes only those blackouts that affect at least half a million homes. Of course, power shortages and blackouts occur in locales all over the world. If only North America were experiencing frequent blackouts, electric infrastructure would not seem like such a powerful investment theme. But it is the nascent boom in power infrastructure construction and renovation is a global phenomenon. Not surprisingly, China is an important part of the picture.
I recently read a fascinating book entitled, From Wall Street to the Great Wall, which further brings home this point. In China, the authors note “electrical power shortages are chronic ... Blackouts are not uncommon, and manufacturing is affected directly.” Later, the authors quote a story from The Guardian: “China is on the biggest power plant building spree the world has ever seen.” Hydroelectric dams, coal-fired generators and nuclear facilities sprout like weeds throughout China. “The equivalent of Britain’s entire electrical output is being added to the capacity of the country’s national grid every two years.”
Really, the power story is only one part of a major investment opportunity. The world’s infrastructure needs span the gambit from power generation to electricity transmission to telecom to water. What we are talking about is a major long-term boom in all facets of infrastructure construction and renovation. India, often paired up with China in these kinds of stories, has its own infrastructure problems. “The nation’s capital is bedeviled by the same sort of cramped airports, rough roads and frequent power outages that recall the darker days (often literally) of China’s own economic opening,” the Wall Street Journal notes.
The infrastructure build-out in China and India may be grabbing the headlines, but similar trends are unfolding throughout the smaller emerging markets as well. Consider Africa. War, poor management and under-investment have crippled infrastructure in many parts off the continent. And while the infrastructure of Africa crumbles, the population has tripled since the 1960s. Investment dollars, though, are trickling back to Africa. There is the promise, for example, of the great Congo River. Given a decent power station and linked to a modern power grid, the Congo River could satisfy much of Africa’s power needs for a long time. The nation of Congo is typical of much of Africa. At Inga, Congo, there are two hydropower stations. The more modern one has eight hydroelectric turbines. However, years of neglect have left only three working.
But the lights in Africa are starting to come back on, thanks, in part, to an unlikely investor: China. Because of China’s growing hunger for natural resources, it has taken a big interest in the African continent. The Chinese have already committed $10 billion to finance various infrastructure projects. They have already built roads, railways, ports and more in Africa. China’s approach to Africa is a pragmatic one. African investment dollars also come from within. For example, in South Africa, the government plans to spend $49 billion on roads, ports and power plants over the next three years.
This is a very brief look at Africa. I could relate similar stories about the Middle East. Or about Southeast Asia (in particular, Vietnam and the Philippines). All of them plan to raise, or have raised, billions and billions of dollars for building the basics – things like power grids. It is all part of the perfect storm I see shaping up in the world’s infrastructure boom – especially in power generation and transmission. And now comes the universal and coldly pragmatic question, “So what?”
In response to that question, I offer you ABB Ltd. (NYSE: ABB), a stock I recommended about two months ago to my subscribers. The stock has advanced about $1 since then, but I still like it at current levels as a practical way to take advantage of the global infrastructure boom. The company operates on a global scale and routinely adds contracts from locations all over the world. In fact, ABB recently won a $130 million contract in Poland. Keep an eye on ABB, and buy on any market weakness. In the meantime, I will keep digging for other possible ways to take advantage of this “perfect storm”.Link here (scroll down to piece by Chris Mayer).
China’s unquenchable thirst.
In the Spring of 2004 there was a spate of thefts of manhole covers in Gloucester and Aberdeen, the craze spread to East London, Montreal, Chicago and Kuala Lumpur. As darkness fell, they would be levered up, sold to local merchants who cut them up and loaded them onto containers. The motives for the thefts were financial. China’s runaway economic growth had forced up the price of steel, and scrap metal prices followed suit. The 130 manhole covers stolen in Aberdeen were worth £13,000 and the metal would be shipped to China and used to make washing machines and the like. At the time this incident brought home to me the growing influence of China on our way of life.
Then this autumn I read a news item about an outbreak of rioting in the Zambian capital Lusaka in which supporters of the defeated opposition alleged vote rigging. Nothing new here, you might say. But what really caught my eye was that the opposition’s anger had been targeted at Zambia’s rapidly growing Chinese community. Beijing had been investing heavily in the country and Chinese firms, some of which came under attack, have been accused of driving Zambians out of business. Just as the manhole cover thefts were a symptom of China’s voracious appetite for raw materials, was this evidence of 21st colonialism another manifestation of the same thing?
The Chinese have had a stab at securing influence in Africa in the past. In the 1950s Zhou Enlai backed left wing governments, giving aid and funding lavish infrastructure projects. But the strategy was not very successful. Maoist China was not wealthy enough to establish China as a leading force, while the export of revolutionary ideas did not go down well with African leaders. Now, rather than using ideology, China is using trade. While African trade with the EU and the U.S. has been declining, its trade with China has been booming, because unlike the west, China imposes no duties on commodity imports. Europe’s share of total trade with sub-Saharan Africa has fallen from 44% to 32% over the past 10 years, meanwhile China's has increased from around 2% to 10%. China is now Africa’s third most important trading partner after the U.S. and France.
China’s push for breakneck economic growth has resulted in an unquenchable thirst for raw materials, including copper, cotton, platinum, lumber, iron ore and most important of all, oil. This year Angola overtook Saudi Arabia as China’s largest supplier of crude oil. In January this year the China National Offshore Oil Company paid $2.27 billion for a 45% stake in a Nigerian oilfield, trumping a $2 billion bid from an Indian rival. China has shown a similar interest in other oil producers like Sudan, Equatorial Guinea, Gabon and Congo-Brazzaville, which already sells a third of its output to Chinese refiners. Besides a buyer for its raw materials, Africa has found a new source of aid and investment.
China is now Africa’s biggest source of aid. This investment is often an entry ticket. African nations have found that dealing with China offers fewer complications than with the IMF, where loans are sometimes conditional on good governance and human rights records. There are an estimated 44,000 Chinese workers in Namibia. The Chinese are building a railway line in Angola from the capital Luanda to the eastern province of Malange. There are also numerous Chinese traders that sell cheap electronics, plastic goods and textiles manufactured in China, undercutting local traders and manufacturers.
However, given China’s unsatisfactory human rights record it is not surprising that it backs the vilest regimes in Africa. When Western nations imposed sanctions on Robert Mugabe’s Zimbabwe, China stepped in with aid, arms and electronic communications technology for the corrupt tyrant. China’s record in Sudan is just as bad. But China’s aid and support for African nations comes with the quid pro quo of the ditching of their recognition of Taiwan. To date 48 African countries paid due obeisance to Beijing, which brings us back to the Zambian presidential elections. Given the suggestion that Michael Sata, the main opposition candidate, would have recognized Taiwan, the Chinese ambassador said he would consider cutting diplomatic relations if he won. This is tantamount to a public intervention by China into the internal affairs of a sovereign African country.
There will be plenty of hand wringing in the West about its impotence in these issues, but the actions of its leaders are partly to blame. The war in Iraq has preoccupied the West. Whether the mission was to secure oil supplies for the West, give ordinary Iraqis security or spread freedom and democracy in the region, it has failed dismally on all counts. And there is a wider diplomatic and strategic cost to the West. While Bush and Blair got the West bogged down in Iraq, China has stolen a march on the Western interests in Africa. With the result that China has an increasingly tight grip on oil supplies and political influence in the region. The West will be regretting playing its first “regime change” card so ineptly.Link here (scroll down to piece by Brian Durrant).
THE STUFF OF THE MADDING CROWD
“Social and cognitive psychologists have identified a number of predictable errors (psychologists call them biases) in the ways that humans judge situations and evaluate risks. Biases have been documented both in the laboratory and in the real world ...” ~~ Nobel laureate Daniel Kahneman
Let us reflect on the psychological underpinnings of the madding crowd. An impossible creature who never existed, “rational economic man”, is an egghead yeti of sorts – an abominable snowman of lost legend, roaming the stuffy halls of academia. Like his furry Himalayan counterpart, rational economic man has been thoroughly exposed as a hoax. The great debunking was due, in large part, to the work of noted psychologists Daniel Kahneman and Amos Tversky. In the late 1970s, Kahneman and Tversky developed something they called “prospect theory” – which, confusingly, had little to do with prospecting and everything to do with human behavior.
Prospect theory was, at long last, a real-world answer to the hopelessly sterile “utility maximizing theory” of neoclassical economics. Based on observed human behavior, rather than abstract blackboard calculations, prospect theory laid the groundwork for the discipline of behavioral economics – and was thus a big nail in the coffin for Homo economicus rationalis. In recognition of his groundbreaking work, Kahneman won the Nobel Memorial Prize in Economics in 2002. (Tversky, sadly, had passed on by that time, and prizes are never awarded posthumously.) In the past few years, behavioral economics has developed a bit of pop culture cachet, catching nods in hastily written articles and books.
As a result of this, cognitive biases are practically old hat as a topic of discussion in some circles – you can, in fact, find a very nice list of them on Wikipedia. Yet though cognitive biases have duly made the rounds as cocktail party chatter, few have really pondered their influence on the crowd ... and, by way of extension, the crowd’s inevitable influence on how markets work.
To better grasp the nature of the multiheaded beast called “the crowd”, let us begin with the first-person biases inherent in you and me. After all, we have all given way to the crowd from time to time. As Pogo once said, “We have met the enemy and he is us.” John Maynard Keynes had an early bead on this topic, stating that “Practical men ... are usually the slaves of some defunct economist.” But the situation is far more deep-rooted than that. The average man, practical or not, is actually a slave to his genetic wiring.
We were born, you see, with all kinds of biases hard-wired into our hearts and minds. These biases are not so much “errors” as quirks in the program. Like a durable but slightly outdated piece of software, the programming in place today is still optimized to hunter-gatherer parameters. Thanks to strong cultural overlays and the inherent plasticity of the brain, the old operating system has been significantly modified – but the ancient kernel still remains. It is very hard, if not impossible, to pinpoint where genetics ends and culture begins. In many ways, they are two sides of the same coin. Do societal rules shape natural behavior or do the exigencies of natural behavior shape society itself? It is really a chicken-and-egg question. Even the lesser animals routinely engage in bluff, bluster, and deceit when self-interest demands it.
Most fascinating of all, in your editor’s humble opinion, is the evidence that hard-wired genetic behavior can lead to distinct situation-specific responses. As mentioned in E.O. Wilson’s Consilience, when common long-tailed arboreal monkeys of Africa encounter certain kinds of snakes, they emit a unique chattering call. The apparently inborn response is limited to the poisonous cobras, mambas, and puff adders. Others of the monkey group come to the side of the caller, and they all watch the intruder until it leaves the neighborhood. Harmless snakes are ignored. They also possess inborn eagle and leopard calls, which trigger rushs to safer areas of the canopy. In turn, man has his own set of factory-installed predilections and reactions – some of them helpful in this day and age, some decidedly not.
In addition to genetic wiring, humans are deeply influenced by their elders and peers through the influence of external culture. From an early age, we are all shaped by the cultural and moral reinforcements that shore up functional society. Human children are born with a natural disposition to believe their parents and take in vast amounts of information on faith. In his excellent book Influence: The Psychology of Persuasion, Robert Cialdini demonstrates how our genetic and cultural hard-wiring can be used against us. In a nutshell, unscrupulous practitioners can take advantage of our programming by exploiting the soft underbelly of general-purpose patterns we all rely on.
Because life is so complicated, humans tend to navigate by rules of thumb – or heuristics – without realizing it. We constantly rely on shortcuts and approximations to manage the endless flows of information and choice we are battered with each day. As a result, certain rules of thumb can be so deep-seated we completely forget they are there. Under cover of subliminal darkness, the determined influencer can deliberately manipulate our autopilot rules in powerful ways. Cialdini sums up this state of affairs in noting that “Although ... there are many situations in which human behavior does not work in a mechanical, tape-activated way, what is astonishing is how often it does.” The rub is that Cialdini’s six “weapons of influence” – reciprocation, commitment and consistency, social proof, liking, authority, and scarcity – can be used for good or for ill with equal flair. The difference is often a matter of subjective opinion. Wall Street and Madison Avenue are certainly not shy in employing these weapons of influence. Neither are the various evangelists of the world’s popular movements and religions. Where you stand on such matters depends on where you sit.
Reflecting on all this, you hopefully now have an idea of what a poor state John Q. Public is in. He is a slave to his genetic wiring without even realizing it. His perception of the world is distorted six ways to Sunday by cognitive biases he does not even know exists. If he does know they exist, he probably assumes himself “above average” and thus immune to them – a cognitive bias in itself. And last, but not least, he is constantly being pushed and pulled by benevolent and not-so-benevolent interests, all of them intent on using the “weapons of influence” to make him go a certain way. Add the strong emotional tang of fear and greed to this mix and here you have the basic building block of crowd behavior. Get a few thousand or a few million John and Jane Q’s together, stir them up with the right cocktail of influences, and there is practically no limit as to what you can get them to think, say, or do.
More to come on this ...Link here.
MAKE WAR YOUR FRIEND
With the advent of yet another year, we take a close look at the most powerful and least welcome driver of geo-politics – war. As in the misnamed yet overarching War on Terror and in the more specific War in Iraq and, maybe, coming to a theater near you, the expanding New Crusade for the Middle East. The topic of war is, of course, emotionally and politically charged. Some believe to the depths of their soul that we need to “stay the course” in Iraq and Afghanistan, “fighting them over there, so we don’t have to fight them over here.” Others judge, correctly in our view, that any military effort in the Middle East is akin to entering a knife fight without a knife. You might survive, but not without losing a lot of blood. Individuals in the latter camp are accused of wanting to “cut and run”, as the talk show morons like to say. But few seem to remember the origins of that phrase. When weather demands it, sailors would cut the anchor line and run before the wind to avoid an approaching catastrophe. It was a sign of intelligence in the face of danger.
Missing from the debate is a candid discussion of the true implications of our current war, not just for the U.S. soldiers killed or wounded, and not just for the local citizens wounded or killed by soldiers sent to deliver “democracy” to people who do not know what the word means. To an Iraqi caught in the crossfire between an occupying army and its tormentors, the word “democracy” now translates as “duck!”
Into this morass, we push forward Doug Casey, Chairman of Casey Research and the editor of the International Speculator. Never one for moral equivocation or political correctness, Doug, who wrote the best-selling Crisis Investing (1980), is an avid student of crisis in its many varieties. He foresaw the coming of what many are now calling a world war in his July 2001, International Speculator article, “Waiting for World War III”. And in August of 2002, he (correctly, it turns out) extrapolated where the attack on Iraq would lead, even before the bombs started to fall. And here we are, four years later-with Doug’s dire predictions borne out. Where does Doug see things going over the next four years, and what are the Forever War’s more immediate implications for the global economy? We caught up with him in Buenos Aires, Argentina.Part 1, Part 2.
Oil services giant Schlumberger (NYSE: SLB) recently reported earnings that blew away analyst estimates. Q4 operating income grew 13% sequentially and 77% year over year. By leveraging its dominant presence in oil and gas exploration and development projects around the world, management anticipates extending the company’s recent streak of strong sales growth several more years into the future, albeit at a decelerating pace. The company will earn impressive margins on these sales, representing the gradual payback of years worth of heavy investment in cutting-edge oil field technologies, highlighted by WesternGeco, its 3-D seismic division.
But considering that SLB trades at roughly 16 times 2007 estimates – or the “market” multiple – investors remain skeptical about the volume and pricing of Schlumberger’s future business, anticipating a steady erosion of investment in worldwide oil field projects. Over time, I expect the consensus opinion to recognize the positive leverage inherent in this business and mark up the stock’s valuation accordingly. Schlumberger’s board authorized a 40% increase in its quarterly dividend. Increasing a quarterly dividend is one of the strongest messages a company can send about the long-term outlook for its business prospects, especially when a company is in the midst of a strong growth spurt.
So why do I not currently recommend SLB as an investment idea? Because the stock does not trade at a large enough discount to my estimate of intrinsic value. A long-term investor’s return usually hinges far more on the price he or she pays for a stock than the accuracy of his or her outlook. Nevertheless, it is important for energy investors to pay attention to this company. Every quarter, Schlumberger management provides insight into the health of the oil field service industry, and this outlook is critical to the three oil field services companies that I have recommended.
Probably the greatest knock against Schlumberger is its exposure to North American natural gas drilling. Any stock even remotely connected to this sector has been pummeled in recent weeks. More specifically, there is fear of further deterioration in Canadian natural gas drilling activity. But I do not expect fears over North American natural gas drilling to worsen. In fact, I expect slower drilling activity to cut directly into future supplies and cause another spike in natural gas prices, thereby setting a floor under future drilling activity.
In a conference call, Schlumberger’s management communicated a few key points about the next few years of growth in world oil supply. They expect that production from the deepwater Gulf of Mexico will not even enter its development phase until 2015. They also stated that simply maintaining current global hydrocarbon production levels in the face of accelerating decline rates will require enormous, persistent investment by all major producers. The world is realizing that the era of cheap oil has ended, and Schlumberger is preparing for a long boom. Schlumberger customers include the Saudis and the Russians. Last week, Saudi Oil Minister Ali al-Naimi reiterated his view that the kingdom can expand oil production capacity nearly 40% by 2009. Whether or not we think this is possible, it will require tens of billions of investment along the entire chain of oil field production.
Already, the number of rigs in operation throughout Saudi Arabia and across the Middle East is soaring. Meanwhile, back here at home, the number of land rigs in operation continues to climb, even at the prices of oil and gas slump lower. It looks like the drilling boom has many good years ahead of it.Link here.
SUMMERS, TRICHET WARN DAVOS PARTY-GOERS THEY UNDERESTIMATE RISK
Lawrence Summers has a message for investors heading to the Swiss mountain resort of Davos this week to toast a year of booming returns and record bonuses. “It’s worth remembering that markets were very upbeat in the early summer of 1914,” the former U.S. Treasury secretary observes. While Summers is not predicting the onset of another world war, he and European Central Bank President Jean-Claude Trichet are among those who are warning the more than 2,200 movers and shakers at the 37th annual meeting of the World Economic Forum that they have become too complacent about risks ranging from trade imbalances to terrorism.
A glut of cheap money and the strongest global economic growth in three decades have encouraged banks, private-equity firms and hedge funds to bet that the good times will keep rolling. “It’s too good to be true,” says Vittorio Corbo, head of Chile’s central bank, who was scheduled to speak at Davos about the dangers of derivatives. “Tomorrow the mood could change. We have to be prepared.”
Davos attendees have heard the warnings about complacency before. In fact, they heard them last year at Davos, when Summers, the former president of Harvard University, billionaire George Soros and Bundesbank President Axel Weber cited the potential consequences of trade imbalances, budget deficits and the then-surging price of oil. Since then, the rewards have just gotten better for investors. Prices of London’s most expensive homes surged 29% last year, bonuses at the five largest U.S. investment firms rose 30% to $36 billion and the Dow Jones Industrial Average climbed to a record. Profits are soaring, the value of takeovers last year rose to a record $3.6 trillion and the Morgan Stanley Capital International World Index of global stocks climbed to a record on January 3. Goldman Sachs Chief Executive Lloyd Blankfein, another Davos attendee, last year earned a bonus of $53.4 million.
With banks tapping what Trichet calls an “ample” pool of liquidity, investor appetite for risk has never been greater. Several measures show perception of risk is near historic lows. The gap between the yield demanded by investors to hold emerging-market and U.S. government bonds narrowed to a record on January 17, according to JPMorgan Chase, while the amount of debt used to finance European buyouts rose to 8.7 times earnings in the third quarter, the most ever. Hedge funds in the U.S. are the most leveraged since 1998, the year that Long-Term Capital Management collapsed. Regulators from the U.S. S.E.C., the Federal Reserve Bank of New York and the U.K.’s Financial Services Authority, concerned that credit standards for hedge funds are too lax, are jointly probing whether lenders set strict enough limits on loans. One gauge of stock-market volatility – the Chicago Board Options Exchange’s VIX index – shows that concern about a slump in equity prices is at a 13-year low.
Trichet, People’s Bank of China Deputy Governor Wu Xiaoling, and Harvard economist Kenneth Rogoff, said at a January 11 news conference that “we continue to see, overall, a low level of risk appreciation, and a disorderly unwinding of this situation would be a risk that we have to be fully conscious of.” Willem Buiter, professor of European political economy at the London School of Economics, is considerably more blunt. “Current risks are ludicrously underpriced,” says Buiter. “At some point, someone is going to get an extremely nasty surprise.”
Among things that might go wrong: a renewed surge in oil prices. Higher interest rates might also topple exuberant markets. The Bank of England surprised investors this month with a quarter point increase in its benchmark rate. Trichet’s ECB is raising borrowing costs to try to rein in soaring asset prices and credit growth. Some investors have already been stung. Venezuela’s Caracas Stock Exchange Index has lost more than a quarter of its value in the past three weeks after President Hugo Chavez pledged to nationalize industries. The prices of copper and other commodities have plunged partly on concern a slowing U.S. economy will cool demand.
Summers, in an e-mail drawing his World War I parallel and expanding on a column he wrote in the Financial Times, says that “financial history demonstrates that the biggest liquidity problems always follow the moments of greatest confidence.” The six months after the Sarajevo assassination of Archduke Franz Ferdinand, heir to the Austro-Hungarian throne, saw the DJIA lose a third of its value – an object lesson in the perils of failing to adequately price risk. “Complacency can be a self-denying prophecy,” Summers says.Link here.
DELIVERANCE FROM DRAINING LIQUIDITY
What will happen to pull the plug on this huge bath of liquidity? We can think of several things:
What can you do to protect yourself, dear reader? A single, simple thought: Over the last 12 years, the supply of dollars has increased at roughly 10% per year. The world’s economy has grown at roughly 3% per year. And the world’s supply of gold has increased at only 2% per year. We buy gold, and wait to see what happens.Link here.
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