Wealth International, Limited

Finance Digest for Week of April 30, 2007

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


The world has a way of worrying right now. Subprime! Iran! High oil! Ben Bernanke’s inflation babble! Profligate consumers! Soft landing! The yen carry! These are small, petty, garden-variety suicidal excuses to miss the reality that this is a uniquely spectacular time.

This is the very first time in modern history that we have seen a prolonged worldwide interval of equity arbitrage. That is where you borrow money to buy equity, earning more from the equity than you owe in interest on the borrowed money. The arbitrage comes in three forms: corporations buying other corporations for cash, corporations buying some of their own shares for cash, and private equity investors buying corporations using mostly borrowed money. The arbitrage has to do with the fact that the earnings yield on equities (earnings divided by price) is often more than the aftertax cost of money (which is, roughly, two-thirds of whatever your long-term interest rate is).

Equity arbitrage has cropped up before, for fairly long stretches, in single countries. It has occurred globally, for example in 1974 and 1982, but only for a short while. What is unprecedented is the worldwide breadth of the phenomenon and its duration – 55 months and counting. Far from being about to exhaust itself, the leveraged buyout/buyback binge is, I believe, accelerating. Why? Because it takes a while for corporate bosses to catch on. After a few years of seeing LBO-meisters get rich, they realize that they had better do some borrowing and buying of their own, or else someone else will do it to them.

What does this mean to small investors? That you should own equities. The acceleration in buyouts and buybacks will keep creating a booming world stock market by shrinking the supply of equity while boosting earnings per share. This year the global equity supply will shrink by 5%, or $1.75 trillion. That dwarfs the things that people worry about, like the U.S. deficit, the cost of the Iraq war, or the likely losses of principal on subprime mortgages. Buy good stocks and enjoy the ride.

France has lots of cheap stocks right now. If, as I suspect, the 2007 global economy does far better than consensus expectations, Lafarge (LR, 40) should be strong. This is the world’s largest cement company, 2nd-largest concrete firm and 3rd-largest gypsum wallboard maker. Lafarge’s earnings are increasing, and yet the company is cheaper than most building-material peers at 13 times this year’s earnings. Sanofi-Aventis (NYSE: SNY, 44) is the world’s 3rd-largest pharmaceutical firm. Generally, European drug stocks are cheaper than their U.S. peers and should perform better as stocks now. This firm’s cardiovascular and oncology drugs are aimed squarely at the West’s aging demographic. Sanofi is a growth stock priced like a value stock at 13 times this year’s earnings.

Atlanta’s Aaron Rents (NYSE: RNT, 27) is a perfect beneficiary of a stronger than expected economy. It rents and sells residential and office furniture, consumer electronics and home appliances. Small, with a market cap of only $1.4 billion, Aaron has 1,280 stores and lots of room to grow domestically. The stock sells at one times revenue and 14 times my estimate for this year’s earnings.

I always hold a few stocks that should do well if the rest of what I expect backfires. If the economy and market weaken, Australia’s Amcor (NASDAQ: AMCR, 25) should shine. Here is a global leader in a wide array of packaging containers that are economically insensitive. At 70% of annual revenue and 17 times trailing earnings, this high-quality firm is cheap enough to be defensive, particularly with a 4% dividend yield.

Link here.


“Dead man walking” is the phrase shouted by guards when a condemned prisoner is taken down to Death Row. The words have also been used to describe individuals who face an unwelcome but unavoidable fate. In other words, although they might be employed or involved in a particular relationship right now, circumstances will soon change – for the worse.

In many ways, this epithet describes today’s U.S. equity market. That is despite the fact that the majority of investors seem to believe that the increasingly exuberant run-up we have seen since the fall of 2002 can only lead to one thing: more of the same. Yet while optimists might welcome news that the current bull run is 4 1/2 years old, “only three out of the past 15 bull markets have lasted five years or longer, with the average surviving only 3.4 years,” according to Jim Stack, editor of the InvesTech Market Analyst newsletter. What is more, “even that is distorted by the longevity of the 1990s bull. The median length of a bull market ... is only 2.6 years.”

The current bull market has also been unusually correction-free. Despite the swoon that took place two months ago, share prices have yet to experience a typical, but healthy, pullback. According to the International Herald Tribune, again citing the research of Mr. Stack, “the past four years have been the second-longest period during which the S&P 500 has gone without a 10 percent correction (the longest was a six-year stretch in the 1990s).”

Many of those on and off Wall Street have welcomed the sometimes frantic buying we have seen, especially of late, which has helped push the Dow Jones Industrials Average to 13,000. Even so, the record-setting string of 19 higher closes in 21 trading sessions that has occurred over the past three weeks, coming as it has after a multi-year run, is characteristic of the kinds of climactic blow-offs that investors should fear rather than cheer.

As to why this particular bull market has gone past its presumed sell-by date, the explanations seem to fall into two categories, technical and fundamental. With regard to the technical factors, many market-watchers argue that, especially in recent years, the equity boom has been aided in large measure by a rapidly shrinking supply of publicly-traded equity resulting from corporate buybacks and a plethora of large-scale, debt-fueled leveraged buyouts. These two developments have undoubtedly been a major positive for share prices. They have also sown the seeds of their own demise. They set the stage for a coming tsunami of equity supply that will eventually overwhelm the market, most likely sooner rather than later.

As the credit cycle turns, companies that have wracked balance sheets in pursuit of short-term operational leverage will quickly discover that borrowing has become a costly financing alternative. With the debt spigot running dry, many will be forced to try and raise equity capital instead, on increasingly onerous terms. For the swollen ranks of lowly-rated firms that are up to their necks in debt, selling shares – as well as various other assets – will be a matter of survival, often regardless of price. Meanwhile, frenetically one-sided deal-making by private equity firms and Wall Street bankers will undergo a turnaround, as formerly sanguine players turn into nervous, cutthroat operators looking to cash out while they still can. Suddenly, everyone will understand the maxim that today’s LBO is tomorrow’s IPO and they will rush headlong, like a herd of elephants through revolving doors.

In addition, heavily-leveraged operators such as hedge funds will be forced to downsize balance sheets and sell risky holdings – like equities – as the cost and availability of credit moves against them and volatility-based risk management systems leave them with much less room for maneuver. The harsher credit environment will also foster a widespread reassessment of risk. Banks will demand more compensation from borrowers in response to regulatory pressures and the fast-spreading, subprime meltdown-inspired contagion. Fixed-income investors will seek returns that more closely reflect the historic dangers associated with financing risky credits and holding dubious instruments. These adjustments will quickly feed through to other asset classes, especially equities, and will exacerbate a widespread push for sharply higher risk premiums that will already reflect the pressure from rapidly deteriorating economic conditions.

Those who argue that the stock market will continue to rise because of “fundamentals” will no doubt face a rude awakening. For one thing, many of the so-called positives – fat profit margins, low interest rates (relative to the past few decades, at least), and a Goldilocks economy – represent “old news” that is already factored into prices. Even aside from that, the belief that companies’ bottom lines can grow at the same heady pace they have up until recently seems delusional, at best. Corporate profits have risen faster in this business cycle than in any other over the past half century, and at around 12% of U.S. GDP, they are not far off 50-year highs. To assume that this traditionally mean-reverting series, which has not increased, on average, more than 2% above the rate of inflation over the course of time will continue to do otherwise is a bad bet.

Furthermore, profitability has been boosted in recent years by such factors as labor costs that have lagged overall economic growth rates, low levels of business investment, and juicy returns from high-margin financial activities. All three will likely provide much less of a benefit going forward. Earnings growth has already shown signs of deceleration, based on data from Standard & Poor’s.

The prospect that profits will not be as rich as they have been before now also calls into question another big talking point for the bulls: valuation. With the “E” component of the widely used price-earnings ratio at risk of falling short, what might currently be viewed by some as attractive on a P/E basis could become the best reason not to own equities.

Given recent economic news, that moment of truth is probably much closer than what many optimists might believe. The pattern of recent quarters lends weight to the idea that the U.S. economy is headed towards contraction. Many take comfort from the fact that despite the weak GDP report, consumer spending apparently held its own. But this is not a forward-looking perspective. The reality is that most people have nothing in reserve, as evidenced by the fact that the nation’s personal savings rate continues to hover near multi-decade lows. The bursting property bubble means many prospective consumers can no longer tap the equity in their homes. Meanwhile, many Americans are stretched to the breaking point, with household debt service payments and financial obligations as a percentage of disposable personal income hitting a record 14.53% in the fourth quarter, according to the Federal Reserve.

Even though some data give the impression that consumers are still in the game, a slew of anecdotal and industry specific reports, including many that relate to the travel, auto, building materials, furniture, and other sectors, suggest otherwise. Several indicators are signaling that a recession is imminent.

For a long time, any sign of weakness has been seen by the bulls as a plus for stocks, based on the curiously convoluted logic that it would force the Fed to loosen monetary policy, thus kick-starting another liquidity-driven leg up. However, five decades of economic and market history suggest that recessions are, for the most part, bad for share prices, at least during the first six months – regardless of what the Fed does.

Yet even without taking any sort of economic downturn into account, “stocks are extremely expensive right now,” notes Fortune. “The S&P is selling at a price/earnings ratio of about 18, based on the past four quarters’ earnings. But remember, those earnings stand at a record level. ‘That makes stocks look cheaper than they really are,’ says Cliff Asness of AQR Capital Management, a highly successful hedge fund.”

“To gauge how much you’re really paying for a dollar of profits,” the magazine writes, “it is more revealing to compare today’s prices with average earnings over the past ten years. That formula takes out the big swings in earnings that can make stocks look artificially undervalued or overvalued.”

“By smoothing earnings, Asness gets an adjusted P/E of around 25 for the S&P 500. That’s well above the historical average of 14 or 15. That’s expensive, and buying in at high prices has always been the ticket to low future returns.”

So, even though talking heads, Wall Street Pollyannas, and momentum-infatuated traders argue that now is not the time to be worried about the outlook for share prices, the facts say something else. When you read about “Dow 14,000” – or 15,000, or maybe even 36,000 – on newspaper front pages or on flickering TV screens, it might make sense to remind yourself what you are seeing.

A dead market walking.

Link here.


The leap in the number of billionaires and mere millionaires in recent years has exploded the demand for expensive luxuries: BMWs, exotic private Caribbean resorts, huge second homes, Viking stoves, private jets, expensive art and $500 bottles of wine. But the subprime mortgage contagion is spreading to the rest of housing and will sink consumer spending, the global economy and stocks. Real estate, commodities, private equity and other wealth-creating bubbles will disappear.

With them will go demand for many of these unnecessary and high-priced items. Then, however, small luxuries will flourish. These are goods and services that do not cost much but give status and uplift to those without vast wealth. Years ago, when South Africa was under apartheid rule, most blacks there had little income and could not afford status symbols like cars. But many black men carried slim silk umbrellas as they walked around town, emulating the wealthy London investment bankers. Hallmark greeting cards cater to the same motivations. You can pick a birthday card off the supermarket rack for $2. But you will pay a buck or two more for one with the Hallmark label on the back.

There is a revealing negative correlation between auto purchases and spending on apparel. In the tough economic days of the mid-1970s, early 1980s, early 1990s and early 2000s many people had difficulty buying new cars. As consolation prizes, they treated themselves to new clothes. Now auto sales are weakening again, and apparel outfits may once more enjoy consumer favor.

In this column I will not recommend specific stocks. Nor am I making a bullish call on equities, since I think a big chance exists of a recession this year, following the spreading of the subprime mortgage plague. Nevertheless companies in the small-luxuries category that may do well in sales and earnings include Hartmarx (HMX), Oxford Industries (OXM), Warnaco Group (WRNC), Polo Ralph Lauren (RL), J. Crew Group (JCG) and Phillips-Van Heusen (PVH), as well as housewares vendor Williams-Sonoma (WSM). Tiffany (TIF) will probably lose sales of costly jewelry as investment bankers’ huge bonuses disappear. Regardless, a partial offset will be key chains, cuff links and other relatively inexpensive gifts in those well-known Tiffany blue boxes.

Starbucks (SBUX) is a prime example of selling affordable luxury. Never mind that the upgraded coffee at McDonald’s was better-rated in a Consumer Reports blind taste than the plain coffee at Starbucks. What matters is the experience, and the fancier drinks like espresso and latte served in a relaxed and pleasant setting. In its drive for growth Starbucks is stretching itself thin. It is not uncommon to find two Starbucks within walking distance of each other. The chain is selling, besides $4 beverages, sandwiches, mints, stuffed animals, books and CDs. Starbucks is also moving downscale from its affluent college-graduate customers to poor neighborhoods. The chain is going beyond its trademark coffee-house atmosphere with new drive-through sales windows. And the firm is selling coffee to offices that want to keep employees from running out for a cup of their favorite java. Could expansionism take Starbucks out of the small-luxuries category? Maybe so. This is a serious risk. Chairman Howard Schultz worries, in a recent memo about the “commoditization” of the Starbucks experience, that his company will lose its cachet. But Starbucks may find a way to combine mass and class with a spectrum of stores and menu items.

This is what Tiffany has already succeeded in doing. It can display a $250 silver bracelet not far from a $2,100 diamond- encrusted pendant without tarnishing the latter. Starbucks does face competition that could limit its growth plans. Dunkin’ Donuts, now owned by private equity groups, and McDonald’s are expanding specialty coffee offerings while aiming lower on the price spectrum. Without making a call on whether Starbucks or McDonald’s will win more of the growth in the gourmet coffee market, I will simply include the latter in the small-luxuries category, albeit at the extreme low end of the price range. For someone with a modest income, a meal out is a small luxury. Note that the fast-food chain’s profits have held up well in recessions.

Link here.


An occupational hazard of being a money manager is that someone inevitably corners me at a cocktail party and asks, “So what do you think of the market?” While inwardly groaning I smile and try to answer politely, thinking to myself, “If I knew that I would be on the beach in Tahiti.” A better question is, “Are you finding anything interesting to buy these days?” Currently the answer is definitely, “Yes.” I have two stocks for you to look at, both related to energy.

The price of oil is not going down soon. One way to ride the trend is to buy producers of petroleum. A better way is to buy companies that supply services to the producers of petroleum. Remember, not all of a gain in the price of oil stays in the bank accounts of the oil companies. Since oil is getting ever harder to find and extract, much of the price increase exits as higher outlays for drill pipe, well logging, drill ships and so on.

Trico Marine (TRMA) is a $560 million (market capitalization) company in the oilfield-services industry – a midget among giants. Trico’s 67 ships transport equipment and supplies for the offshore drilling industry in the Gulf of Mexico and throughout the world. The risk in this cyclical sector is that you buy into it just before a downturn in demand. With the worldwide utilization rate for offshore oil rigs now between 82% and 84%, it would seem that rig demand is more likely to go down than up. Demand is already softening in the Gulf of Mexico, where easily drilled fields are being depleted.

But outside the Gulf, including the North Sea and the waters off Africa, demand is as firm as it has ever been. In the past few weeks the cost of renting a deep water semisubmersible offshore rig rose 16% to $500,000 a day, and contracts are being signed for as long as five years. Trico is not in that league, but its supply ships yield an average $11,000 to $20,000 a day in revenue over the course of a year, depending on the type of vessel. At just under 10 times earnings, Trico’s share price has an awful lot of skepticism built into it, with pessimists fearful that oil will slump worldwide, as it has in the past. But, while the oil business is volatile, the long-term bias these days seems to be toward the upward side.

Now here is another angle on energy: farming. I have discussed our government’s misguided but relentless subsidy of ethanol. Sure enough, there is even more corn springing up than we thought. On March 30 the Department of Agriculture released a survey showing that farmers intend to plant 90.5 million acres of corn, up from 78 million last year and the highest since 1944. That requires a lot of seed, a lot of fertilizer and a lot of tractors.

Titan International (NYSE: TWI) is a manufacturer of wheels and tires for makers of farm machinery. John Deere, Case, New Holland and the like are all immediate beneficiaries of this frenzy to plant. Tires wear out faster than tractors do, and Titan cannot sell them fast enough. The company is the world’s largest manufacturer of off-highway wheels and the third-largest maker of off-highway tires, ranging from 6 to 42 inches.

As you might imagine, Titan has a lot of pricing power now. It just announced a 6% price hike, which is likely to stick. This is a bit of good fortune, for not too long ago wobbly food prices hurt earnings. A Q4 2006 loss clouded the entire year. The stock has a $700 million market cap and sells for 21 times 2007’s consensus earnings forecast of $1.22 per share, up from 2006’s 26 cents.

While Titan’s sales should track acres of corn planted, not the price of corn, investors can keep track of ethanol’s fortunes via the crush spread – the gap between the price of a gallon of ethanol and the price of the 0.36 bushels of corn used to make it. It is, so to speak, the gross profit from distilling corn into ethanol. Corn and ethanol futures are quoted on the Chicago Board of Trade’s Web site. At the moment, the corn spread is 85 cents. If it widens over time, Titan’s sales should keep expanding. If it shrinks for a while, then the party is over.

Link here.


It has only been in the past few years that much of the public has started to notice the power of options, even though they have been around since ancient times. In fact, Aristotle demonstrated the power of options in his masterwork, Politics, written sometime around 350 B.C. Of course, they did not have stocks back then, but they did have a thriving commodities trade.

Aristotle tells the story of Thales of Milesian, a mathematician and philosopher who used his knowledge of astronomy to predict a great olive harvest in the spring. He went to the people who owned olive presses – essential for extracting olive oil – and paid to reserve the presses when the harvest came. With no other business coming in, the press owners were more than happy to take Thales’s money.

Spring proved that his prediction was right on. Olive farmers took their bounty to the oil presses – only to discover all the presses were reserved for Thales. However, Thales was more than happy to let the farmers use the oil presses he had rented – for an exorbitant fee. When it was all over, Thales had turned the good olive harvest into a fortune – without growing olives. And without owning olive presses.

Believe it or not, modern stock options work almost the same way. ...

Link here.

Don’t Get Caught Naked

Once people learn about the incredible profit potential of options, they suddenly want to learn as much about them as quickly as possible. Of course, there is nothing wrong with that. I encourage my readers to explore all the possibilities options contracts offer. The trouble comes when budding traders hear about a new strategy and jump in without getting all the details.

Link here.


Richard Suttmeier on Real Money hit the nail on the head when he said that the real estate explosion is about to implode. I too believe that the subprime lending collapse is not just a speed bump in the “New Economy”. Instead, it is a sign of wider problems in mortgage lending that threaten the viability of the New Economy itself. That is because the collapse of the housing bubble means that a major “band-aid” has been ripped off the country’s Achilles heel, the cash-strapped, savings short American consumer, exposing the scab underneath.

Who would have thought it would come to this? For three decades after World War II, the average American worker’s income grew by 2-3% a year after inflation, and stateside consumer spending grew apace. But after the mid-1970s, these income gains slowed to a crawl, while spending growth continued at the same pace. But Baby Boomers felt that the 2%-3% average annual real income growth enjoyed by their parents was their birthright. Lacking that, they settled for 2%-3% average annual spending growth financed by artificial means. The result is that the average American is now spending at a level not sustainable by income, but only by borrowing against increasing asset values – specifically in real estate. When those asset values collapse, and they are doing so as we speak, so will U.S. consumer spending and overall economic growth.

But, some might say, the country is much wealthier today than in the 1970s, which would support much higher consumer spending. That much may be true for the country as a whole, but it is not for the whole country by any means. The reason is that while (President) John F. Kennedy’s “rising tide lifted all boats” through the 1960s, most of the gains since then have accrued to the top 20% of the population. For instance, as late as 1980, the average CEO made only about 40 times as much as the average worker, now it is more like 400 times. On the other hand, antipoverty programs and removal of lingering discrimination have greatly reduced the number of the truly poor. So the person in top decile of the economic ladder is decidedly better off than the equivalent 30 years ago, and someone in the bottom decile is somewhat better off. But the average person is the one who has gained very little real income in the past three decades. Nevertheless, it has been in the interest of U.S. economic policy to pacify this person by allowing him/her to maintain spending growth at historical (post World War II) levels, even though income growth had not been keeping up.

The housing bubble was a good a tool as any for this purpose. At first the gap was plugged by reduced savings. But as savings rates plummeted in the 1980s, this fuel could not last for long. So credit card debt took up the slack. But that soon played out, especially when the deduction for credit card interest (but not mortgage interest) was removed in 1986. With interest rates were falling through the 1980s, periodic refinancings meant that homeowners could save money by capturing progressively lower – and still tax deductible – rates on their mortgages, and using the difference for spending.

Falling interest rates with constant mortgages implied progressively lower monthly payments, but they also meant that a homeowner could choose maintain constant payments by taking out a larger mortgages and buying more house. And if a synchronized housing boom was underway, or at least could be orchestrated, many might be persuaded to do so. And so it was done, which is why housing values doubled in real terms between 1996-2006, an unprecedented rise in American history. Now the consumer had a house (or two) that could also double as an ATM. Using this twisted logic, going over one’s head (taking out a mortgage that consumed 50% or more of income) was a smart thing to do because it meant a more valuable asset and more spendable income down the line.

Thus did housing become the nation’s latest Ponzi scheme, which could work only if more and more people were sucked into it. But even if the housing market was on fire, as it was in the past decade, it needed firewood to burn. And if there was a growing shortage of “firewood”, to feed this boom, there was always “kindling” (soft materials such as leaves and hay that burn for only a short period of time), in the form of such monstrosities as interest only and negative amortization loans to subprime borrowers. From a financial point of view, however, such borrowers were placed in the position analogous to “tearing down their (financial) house for firewood”, i.e., being forced create a problem of less house for tomorrow because today’s problem of freezing to death was so severe.

The collapse of the housing bubble is bringing about an end to this game, and will soon face average American consumers with the fact that their consumption standards of the mid-2000s, were way out of whack with income levels that had reached only a mid-1980s trendline. To bring income and consumption back into balance, average Americans will have to fall back two decades in terms of standard of living, which would still put them back at Western European levels of today. But such a pullback would represent “the modern 1930s”.

That is because the original 1930s took American consumption back to 1910s levels, which then represented “prosperity” by prevailing global standards. But that was a big comedown for an American public that had just experienced the 1920s, which gave a glimpse of a prosperity that would be experienced in the 1950s by their children, but not by themselves. Likewise, the Internet Boom of the 1990s gave adult Americans of the time a glimpse of the world that their children will inherit for their middle age – in the 2020s. Like the peers of Moses, who saw the Promised Land but never got to enter it, Americans will wander the desert for two generations until their children are ready to take the big step. The collapse of the U.S. housing bubble will force the hands of central banks globally to take actions that will complete the crisis.

Link here.


But buyers were still shopping for vacation homes.

Sales of homes to investors plunged almost 30% in 2006, according to the study recently released by the National Association of Realtors. Even so, more than 1.6 million U.S. homes were purchased by investors. About 22% of all houses sold last year were acquired by investors, compared with about 28% in 2005, the Realtors’ research found. It was the lowest percentage of investment sales in three years.

“We expected the drop in investment sales because speculators left the market in 2006, which caused investment sales to fall much faster than the primary market,” economist David Lereah said in the report. But buyers of vacation or weekend houses shrugged off worries about a stalling housing market. About 14% of U.S. home sales last year were for vacation or weekend use – a new high. Sales of vacation homes increased almost 5% in 2006. At the same time, sales of primary homes dropped about 4 %.

The Realtors’ survey found that the average vacation homebuyer is 44 years old, has a median household income of $102,200 and buys property within a few hundred miles of their primary residence. The South and West were tops for vacation home demand. On average, investor buyers were younger and had less income than vacation homebuyers, according to the study. And they bought properties a median distance of 22 miles from home.

More than 40% of investment buyers said they were making the purchase to diversify their investments and generate rental income. Investment buyers said they planned to hang onto their property for a median of five years. The median price of vacation homes purchased was down slightly to $200,000. The median priced investment home sold for $150,000 – down more than 18% from 2005.

Link here.

Bond demand put risky subprime borrowers into homes.

Demand for bonds, and investors’ complacency toward risk, can be blamed for the record early delinquencies and defaults on subprime home loans, speakers at an industry conference in Miami said. The poor performance of subprime home loans made last year stems from an average drop of at least 0.50 percentage point in the yield premiums for credit risk on all types of fixed-income assets since 2000, Mortgage Bankers Association Chief Economist Doug Duncan said, citing research by other economists.

“That allowed another cohort of borrowers to get into homes that would not have if credit spreads were wider,” Duncan said, citing cheaper loans and looser underwriting. Investors, seeing “clear signs” that subprime home loans had gotten too risky, did not pull back from the securities because of the “increased global liquidity and increased quest for yield,” according to Stefaan DeDoncker, head of asset- and mortgaged-backed securities in the structured credit group of Fortis Bank SA in Brussels.

“Deals would get oversubscribed from the moment they were announced, even before you could get a look at the collateral characteristics,” said DeDoncker. Fortis’s €35 billion investment portfolio is about 60% in U.S. assets.

The U.S. bond market has been flooded with money first transferred overseas to China, oil-producing countries and other nations through trade deficits, said David Wyss, chief economist at Standard & Poor’s. Their higher savings rates, he said, means the cash returns to the world bond markets. U.S. bonds have been attractive because of higher yields on government debt, and because the nation has the “only large and liquid private bond market,” which offers even greater yields, Wyss said in an interview. Of the $1.1 trillion in foreign investments in the U.S. last year, 89% went into bonds, Wyss said, citing Treasury Department data.

Spreads on typical floating-rate BBB rated bonds backed by subprime mortgages rose to a record 5.5 percentage points over the one-month London interbank offered rate in mid-April in secondary trading, from about 1.5 percentage points in early February, according to RBS Greenwich Capital Markets.

Michael Bykhovsky, CEO of Applied Financial Technology, a company that creates models for bond investors, blamed rising subprime defaults on “... investors that have been screwing up” by relying too much on the credit ratings of firms like S&P and Moody’s. “The whole idea of bond ratings is antiquated,” he said. “It might be applicable to corporate bonds, but it is not applicable to mortgage bonds, where it is so complicated,” because returns can depend on interest rates, appreciation, home sales, economic growth and other factors.

Managers of portfolios with CDO investments backed by subprime bonds now are being asked by superiors, “Why did you buy this?” Katy Huang, head of structured products at Avendis Capital SA, an asset manager in Geneva and London, said. “As you can imagine, the typical CDO buyers are not in the market right now actively buying.”

Link here.
GMAC has $305 million Q1 loss on home loans – link.


Japan and China, the world’s largest holders of foreign exchange reserves with $2 trillion between them are considering investing those reserves in the stock market. Russia has announced it will invest its $108 billion oil stabilization fund in foreign stocks. If you try to remember the last time major government money pools were punted in the stock market (other than for a bailout) you will not be able to. It was in 1720. That episode did not end happily, but it is I suppose encouraging to see that government can avoid such an egregious mistake for as long as 287 years!

Modest propping up of depressed domestic stock markets by government is fairly common. Dubai did it last year, Hong Kong did it notoriously in 1998, Malaysia does it regularly and Japan has done it on numerous occasions in the past. Even the BP rescue of Burmah Oil in 1975 in Britain can be thought of as a similar activity. Here the motivation is clear and the activity generally limited.

Purist economists bleat about this being a grotesque interference in the free market but since the free market is prone to bouts of irrational depression, it may well produce useful liquidity if government props it up at the bottom. It certainly appeared to work in Hong Kong, not a hotbed of government interference. Indeed, there is an argument to be made that if Herbert Hoover had done this in 1931-32, instead of raising taxes and making loans to politically connected companies, he might have caused an economic “bounce” a year earlier than it occurred, filled in the trough of the Great Depression’s darkest period and prevented thousands of bank failures.

Then there are the “heritage funds” invested by governments that are exploiting natural resources and wish to provide some of their benefits to future generations. Alaska has one of these, so does Norway. They appear to fulfill their purpose without excessive market distortions, although both Alaska and Norway are small jurisdictions. The most spectacular example of a heritage fund was Nauru, a Pacific island statelet that nearly mined itself out of existence in phosphates, setting up a trust fund that peaked at $800 million in 1991 and for a time gave the Nauruans the highest living standards in the world. Regrettably, the Nauru Phosphate Royalties Trust was mismanaged and embezzled, the phosphates ran out in 2000 and Nauru now exists on handouts from the Australian government.

Given Russian standards of governance, one would expect the Russian oil stabilization fund to follow approximately the unhappy Nauru trajectory. However, Russia is hugely bigger than Nauru (even a Russian government cannot physically wipe the place off the map, as nearly happened to Nauru) and its $108 billion, plus its foreign exchange reserves of $356 billion make it nearly comparable in size to the Chinese foreign exchange reserves piggybank of $1.2 trillion, though not to the combined Japanese piggybanks of the reserves ($909 billion), the Postal Savings Bank ($1.6 trillion) and the Government Pension Investment Fund ($1.3 trillion).

Even if you ignore smaller copycats like South Korea, with $240 billion of reserves, that is $5.4 trillion, more than any GDP other then the U.S., that over time is likely to be moved into the world’s stock markets (assuming the governments do not operate with Nauruan levels of self-preservation and give it all to hedge funds to manage.) That is a lot of dosh. What effect do we think it will have on world stock markets? It will make them go through the roof! Doh!

For some idea of what this may do to the world economy we need to travel back past the Derivatives Era, past the Industrial Revolution, past Adam Smith, past the Enlightenment, to Paris and London in 1718-1720, when the world was young and stock markets had just been invented. Once stock markets had got going, the well-connected and unscrupulous realized that they could be used to make a great deal of money, provided money from an outside source was poured into an actively traded stock – the obvious such source being the government. To be fair to those involved, it was not initially clear that such a practice would inevitably end in financial disaster. The only real prior example was 80 years earlier in Dutch tulips, which they probably did not know about. To them, it was possible that stock prices would continue trending steadily upwards, avoiding disaster and making everybody rich. Promoters of later bubbles (admittedly not themselves fueled by government money) in 1825, 1929 and 1999 did not have the same excuse that it had never happened before!

Two schemes were devised within 18 months of each other, in Paris and London, although British chauvinists can be proud of the fact that the promoter of the Paris scheme, John Law was a Scotsman. Both relied on typical tech-stock stories involving unimaginable wealth, the French Mississippi Company through exploiting Louisiana and the British South Sea Company through exploiting the trade in slaves and gold with Spanish America. In both cases, the source of liquidity that drove the stocks higher was the government, through schemes to swap the shares in the companies concerned for government debt, and assorted manipulations in the government debt market and through an in-house bank to support the shares.

In the French case, the scheme succeeded in its objective. The entire French government debt was exchanged for Mississippi stock. In the British case, the South Sea stock price cracked before the contemplated exchanges could be completed. In both cases, speculators made out like bandits and the stocks concerned rose more than 10-fold, giving market capitalizations for a single stock well in excess of the country’s GDP, before the crash came.

In neither case was the outcome a happy one, even for the promoters, who were mostly jailed on trumped-up charges (the activities concerned were not yet illegal). For the markets, the outcome was even less happy. In Britain, the Bubble Act of 1720 prohibited the establishment of companies without a Royal charter, obtainable only through Parliament. The results were quiescence in the financial markets until 1825 but also, as some commentators have argued, delayed by 50 years or more in the arrival of the Industrial Revolution. In France, the outcome was even more disastrous. French state finances never really recovered, leading to the loss of the country’s North American colonies 40 years later and the Revolution 30 years later still. In addition, France acquired a deep suspicion of commercial and financial activities that it has retained to this day.

Today, the numbers are bigger and the available instruments more complex, but the principle is the same and the outcome will be the same. It makes no sense to accumulate large pools of public money and drop them into the stock market. By doing so, policymakers cause a temporary upsurge in the stock market, but reduce the long term return on investments and depress the national savings rate. As we have seen in the U.S. since 1995, investors will react to higher stock prices by spending their new found wealth, possibly incurring new debt in order to do so. Devoting government-controlled capital to other people’s stock markets is even more perverse, because it produces cheaper capital for foreign companies while raising interest rates on domestic government bonds.

However the principal reason why government should not devote pools of money to stock market investment is its potential destabilizing effect on the market itself. At the bottom of a market trough, the government can provide liquidity and prop up confidence, thus providing a market benefit – it does not hurt that the government buying in a trough is acquiring stocks at an exceptionally good price. At the top of a bull market when liquidity has been excessive for several years, as at present, the government is simply supplying further air to the bubble.

Since, contrary to John Law’s optimistic expectations in 1720, the bubble cannot go on inflating forever, the government is pouring its foreign exchange reserves, pension money, oil trust fund money or postal savings into investments that are almost certain to drop sharply in price in the fairly near future. By doing so, the government enriches speculators in the short term and impoverishes its people in the longer term.

The bottom year of the Great Depression imposed huge costs on the American people, by making the trough deeper than it need have been, as well as weakening the public’s faith in the free market system. In the same way, a bubble that is blown bigger than it would be in the free market destroys more value than it needs to in the collapse, causes more wasted investment in assets that turn out to have no value, enriches more unworthy shysters and impoverishes more innocent unwary folk who are foolish enough to buy at the top. Governments that choose this point in the market cycle to devote their national resources to the stock market are failing their people and doing immense long term damage to the world economy. It is as simple as that.

Of course, I doubt if Vladimir Putin cares. But Shinzo Abe presumably does, and his is the largest pool of money. Putin, when it comes down to it, is relatively a small-time operator.

Link here.


Kevin Landry was searching for someone with a particular background to speak at the annual meeting of sophisticated investors in the private equity funds managed by TA Associates. He wanted someone who made a living in the world’s debt markets. “They can’t understand our business unless they understand what is going on there,” says Landry, chief executive of the Boston private equity firm.

Private equity firms are raising gigantic new funds, which in turn are buying companies on an unprecedented scale. The targets are bigger than ever, and the deals are gushing at fire-hose volume. But that is not just a function of all the billions raised from limited partner investors. Borrowed money is the real fuel driving an overheated market. “I think of this as a debt bubble, not a private equity bubble,” Landry says. “That is the horse, and we are the cart.”

Debt markets that finance private equity transactions have changed in three important ways. (1) They are charging lower interest rates, reducing the premium normally charged for greater risk. (2) They are lending more money for the purchase of an operating company, exceeding normal caps based on the cash generated by the acquired business. (3) Debt markets are reducing or virtually eliminating covenants and other rules that now make it almost impossible for private equity investors to default on loans used to buy companies.

Got that? Low rates, more leverage, practically no conditions. How do you think that story is going to end? “The reality is the markets are willing to provide extraordinary amounts of debt, almost indiscriminately,” says Scott Sperling , copresident of Thomas H. Lee Partners, the big Boston private equity firm. “It is hard to put these companies into default. I can’t think of the last time we had a real covenant in one of our deals.” A relatively new phrase, “covenant lite”, describes the lending terms in big private equity transactions.

Private equity executives take as much as they can get from debt markets, but still raise the issue of lending excess in public because it will be bad for business eventually. The cycle of cheap and easy credit drives up the prices of companies they buy and may hurt future investment returns. Investors stretching for yield are making all kinds of markets do strange things. Look at the subprime mortgage market to see how that practice can end badly. Private equity’s debt bubble could become another story with an very ugly ending.

Link here.


You would expect someone whom the famously dour Dick Cheney entrusts with millions of his dollars might have a gloomy view of the world. Jeremy Grantham does indeed. “From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure and the junkiest bonds to mundane blue chips – it’s bubble time,” he writes inhis latest quarterly letter titled “The First Truly Global Bubble”.

Grantham, 68, is chairman of the Boston-based company that, according to financial disclosure reports, in 2005 managed as much as $6.1 million for U.S. Vice President Cheney. And if his own recent actions are any guide, he is quite the multitasker. The money manager is a critic of the U.S. energy policies for which Cheney bears considerable responsibility. In February, Grantham donated $23.6 million to Imperial College London to establish an institute on climate change. Perhaps these multitasking skills helped Grantham make one of the gutsiest market calls in recent memory: That pretty much every asset class, everywhere, is in the midst of a bubble.

It would be comforting if we could dismiss such negativity. After all, is the DJIA not climbing to all time highs at a time when Japan and Europe are growing, China, India and much of the rest of Asia boom and all is well in the global financial system? Sure, and that is just what worries Grantham. He points to the U.S. in the late 1990s and Japan in the late 1980s – periods when investors thought asset rallies would continue indefinitely. “Most bubbles, like Internet stocks and Japanese land, go through an exponential phase before breaking, usually short in time, but dramatic in extent,” Grantham argues, and he has a point.

Bubbles generally require two dynamics: the perception of near-perfect economic conditions and an abundance of cheap credit. The Bank of Japan left its overnight lending rate at 0.50% last week, giving traders a green light to put on more “yen-carry trades”. Borrowing cheaply in yen and moving those funds into higher-returning assets overseas has been a one-way bet and markets have little reason to think that will change. China’s unprecedented buildup of currency reserves – $1 trillion and counting – also may constitute a bubble of sorts.

The amount of liquidity zooming around the globe has Grantham wondering if risk is really as negligible as many investors seem to think. “Sustained strong fundamentals and sustained easy credit go one better: they allow for continued reinforcement,” Grantham argues. “The more leverage you take, the better you do. The better you do, the more leverage you take.”

Looked at from that perspective, perhaps China’s wacky stock rally is not so disconnected from the world after all. Modern history offers few better examples of a Ponzi scheme than Chinese shares. The CSI 300 Index, which tracks yuan-denominated A shares listed on the Shanghai and Shenzhen stock exchanges, gained 75% already this year and has tripled in the past 12 months. In that time, China’s fundamentals changed little. All that has changed is the amount of attention paid to Chinese stocks, creating a gold rush. It is akin to the media attention lavished on dot-com day traders in the late 1990s. Newcomers armed with get-rich-quick dreams, not economic realities, are propelling shares higher.

A similar dynamic may be playing out across the global economy. Everyone, as Nouriel Roubini, chairman of Roubini Global Economics in New York, has been warning, is reading about how great things are and throwing caution to the wind. It is more titillating to read about hedge fund managers making over $1 billion a year than about global imbalances.

What makes today’s global financial boom different is that it really is, well, different. Past bubbles came amid lofty claims of new eras. In the 1980s, the new era featured a Japanese business model many said could not go wrong. In the 1990s, the U.S. was awash with similar hubris. “This time, everyone, everywhere is reinforcing one another,” Grantham argues. “Wherever you travel, you hear it confirmed that ‘they do not make any more land,’ and that `with these growth rates and low interest rates, equity markets can keep rising,’ and ‘private equity will continue to drive the markets.’ To say the least, there has never been anything like the uniformity of this reinforcement.”

Markets’ success in withstanding September’s $6.6 billion implosion of Amaranth Advisors LLC and more recent turmoil among subprime mortgage lenders prompted talk of another new era. This latest one seems centered on China producing infinite amounts of cheap labor, U.S. deficits being sustainable, major economies growing in sync and deep, diversified markets being able to multitask whatever comes their way. The trouble, Grantham says, is that the bursting of this bubble “will be across all countries and all assets, with the probable exception of high-grade bonds. Risk premiums in particular will widen. Since no similar global event has occurred before, the stresses to the system are likely to be unexpected.”

Good luck multitasking that.

Link here.


“Current macroeconomic conditions in the big industrial economies are gradually helping to reduce global imbalances, the Bank of England states in its latest Financial Stability Report. ‘Macroeconomic conditions in advanced economies have been moving gradually to reduce global imbalances’, the bank says. The BOE says increased domestic demand and investment in the euro zone and in Japan are serving to unwind the imbalances. In addition, ‘Global adjustment may also be facilitated by the depreciation of the US dollar against the euro over the period since the July 2006 Report.’”

With the global economy robust and securities markets remaining exceptionally strong, apparently even the Bank of England has let its guard down. Clearly, over-liquefied global markets have become increasingly accepting of the view that U.S. and global imbalances can actually be rectified predominantly by strengthening non-American demand. I am just a little astounded that a respected central bank would examine the current backdrop and succumb to such wishful thinking.

When it comes to global imbalances, perceptions today differ greatly from reality. The optimists look to booming exports and relatively stable U.S. trade deficits as encouraging signs. But the massive U.S. current account deficit will again this year spurn meaningful improvement. Years of dollar weakness may have finally, if only at the margin, helped to stabilize our trade position. They have also given rise to heightened speculative flows seeking profits from the allure of stronger foreign currencies and inflating global securities markets. The bottom line is that total U.S. “bubble dollar” flows to the world – the most destabilizing global imbalance – will further worsen this year. Attempts to rectify U.S. credit bubble excesses through a global inflation will fail miserably.

Those discerning hopeful signs from moderating U.S. growth are being beguiled. It would be a positive development if only slower growth was a consequence of more restrained financial system excess. Instead, we are well on our way to another record year of total system (non-financial and financial) credit creation. Unfortunately, any moderation in mortgage credit is being more than offset by corporate, M&A-related, and securities-based credit excess. Of course, inflating markets will fashion participants with rose colored glasses, but a less distorted perspective would ponder the reality (and future ramifications) that enormous ongoing financial excesses these days engender such unimpressive U.S. economic results.

It is worth noting that preliminary first quarter nominal GDP growth was reported this morning at an annualized 5.3% (real at 1.3%). The GDP price index surged to a 4.0% rate during the quarter (strongest quarterly gain in 16 years). This report was notable for quashing the view of sub-3% nominal GDP and bolstering the case for the dreaded combo of weakening output and rising price pressures. But I would expect Q2 (and perhaps Q1 revisions) to show somewhat stronger real growth.

Mortage debt growth plugs along, despite subprime implosion.

Despite the dramatic tightening in subprime, it appears mortgage debt growth is plugging along at a decent clip. Clearly, credit remains readily available at inexpensive terms for the vast number of qualified borrowers – despite what should have been at least somewhat of a blow to the entire mortgage industry.

I have not addressed Fannie Mae and Freddie Mac for awhile. After expanding their retained (held on balance sheets) portfolios $243 billion in 2003 (19%), growth slowed abruptly to $17 billion (1%) after problems began surfacing in 2004. And on the back of Fannie’s $177 billion (20%) contraction, combined Fannie and Freddie retained portfolios actually shrank $161 billion (10%) to end 2005 at $1.438 trillion. One would have normally expected such a contraction to have at least some impact on market liquidity. But with real interest rates atypically low and a massive unfolding credit expansion throughout “Wall Street” finance, marketplace liquidity was not impacted at all.

It certainly did not hurt that Fannie and Freddie’s mortgage backed securities (MBS) guarantee business kept right on expanding (“insurance” that provides “money”-like MBS top ratings and market liquidity). Despite contracting retained portfolios, their combined “books of business” (BofB, retained mortgages/MBS and outstanding MBS guarantees) expanded $227 billion (6.3%) during 2004 to $4.00 trillion. Growth slowed further in 2005 to $166 billion (4.3%), a market non-event due to the marketplace’s newfound insatiable demand for (higher-yielding) non-agency securitizations. Last year, however, robust growth returned, with combined BofB growth of $352 billion to $4.78 trillion. Fannie’s BofB last year grew $202 billion, or 8.7%, and Freddie’s $143 billion, or 8.5%. When Wall Street investment bankers watched the subprime implosion, they at least had confidence that the dauntless GSEs were ready for (big) business.

Well, looking at March data, Fannie and Freddie’s combined BofB jumped 15%, annualized. This was the strongest monthly increase since October 2003. This places y-t-d BofB growth at 11.3% annualized. In nominal dollars, Fannie and Freddie are, after three months, on pace to increase their BofB about $500 billion (a majority of household mortgage debt growth). And, at this pace, BofB will approach $5.0 trillion about this time next year.

Going back to at least 1994, the GSEs have on occasion played the crucial role of “buyers of first and last resort” in the MBS market, in the process operating as central bank-like liquidity creators during periods of financial turbulence and speculator deleveraging. Today, it appears that significantly tightened regulatory oversight (including Fed scrutiny) has restricted the ability to aggressively expand their balance sheets – thus limiting their capacity to directly create market liquidity. I have always assumed that the Fed and others’ belated recognition that the GSEs were creating credit and liquidity was an important facet of efforts to restrain their balance sheet growth. If the concern was really potential taxpayer liability, there would have been some protest directed at the past two years’ $650 billion BofB increase. It is clearly not an opportune time to aggressively expand mortgage exposure, although the market would be in quick trouble if they did not.

Regarding the recent subprime implosion, it developed into an isolated liquidity event. Market yields quickly pushed lower, supporting MBS prices generally (certainly helping to offset some mortgage spread widening). The key development was an abrupt shift in market preference away from riskier mortgage paper to agency guaranteed MBS. Capital constraints and credit cycle risks notwithstanding – the GSEs, at least in March, were willing to step up, write tens of billions of guarantees, and buttress the U.S. mortgage market.

This week, House Financial Services Chairman Barney Frank stated that the “FHA (Federal Housing Administration) in particular, if done right ... could be one of the best answers going forward for subprime.” Between Fannie, Freddie, Ginnie Mae, the FHLB system, and the FHA, it appears the government will over the coming years take on an only greater role in our already largely nationalized system of mortgage finance. I can certainly understand why 10-year Treasury yields have reversed their inversion and now trade at a small premium to 2-year notes. It is certainly possible that we will see trillion dollar annual deficits within the next decade.

Déjà vu all over again as Laffer and Kudlow resurface.

Yet it is like déjà vu all over again. The duo of Art Laffer and Larry Kudlow were trumpeting tax cuts as the reason behind record stock prices, booming corporate profits, and surging federal government receipts. Mr. Laffer tells us the deficit is now essentially balanced and things will only get better from here. Did these two sleep through the technology bust and the abrupt reversal of “surpluses as far as the eye can see” to huge record deficits? For a time, I thought we had learnt a lesson regarding the seductive danger of boom-time receipt bulges. But there is nothing like a major inflation to ensure that lessons are unlearnt.

And the Wall Street Journal’s Paul Gigot interviewed Mr. Laffer extensively on Fox’s “The Journal Editorial Report”, while the Financial Times went with Jeremy Siegel’s op-ed “Presenting the Bullish Case for Equity Valuations”. We have clearly entered one of these perilous euphoric periods where common sense and reasonable analysis/judgment are lost in the fog of easy “money”.

Today’s financial euphoria is unique.

It involves asset price bullishness generally and globally. It is an especially emboldened euphoria, nurtured from repeatedly overcoming various types of market and economic adversity. It is a euphoria built upon the resounding confidence in the power of new technologies and the resiliency of contemporary economies. It is a euphoria underpinned by extreme confidence in the competence and capabilities of the Federal Reserve and global central bankers. It is a euphoria bolstered by the faith in contemporary finance and the capacity to effectively recognize, quantify and manage risk.

Today’s financial mania is also unique. You do not see individual Americans flocking to speculate in the stock market. There is no discernable manic crowd behavior akin to what we have read in financial history books. The stock market rises, yet there is nothing too crazy (Internet-like) with respect to the nature of trading or outward excesses. And stock market gains are not all too outrageous, while increasingly outrageous home price inflation has largely settled down.

What makes this period unique and especially dangerous is that the current mania is in sophisticated private credit instruments, most having little or no transparency and issued outside the traditional purview of central bankers and financial regulators. Unprecedented gains in financial wealth come not predominantly from stock or asset prices shooting openly to the moon. Instead, the mania involves the enormous (and highly concentrated) accumulation of “small” spread profits on tens of trillions of “dollars” of highly leveraged “structured” credit instruments. Pricing is not a critical issue and they do not even need to trade, as gains are accumulated with the receipt of “payment in kind” spread profits through the issuance of only more debt instruments.

The heart and soul of this credit mania is uniquely electronic and largely “over-the-counter”. It is operated chiefly by the powerful international “banks”/securities firms, largely to the betterment of themselves and a relatively select group of clients. It remains invisible to most. I am suggesting one think in terms of a unique mania that has evolved over years and under extraordinary circumstances to the point of becoming deeply entrenched. Today, it is incredibly powerful but at the same time supported by increasingly fragile underpinnings. For one thing, the associated financial flows are becoming increasingly unwieldy and its “reserve” currency an accident in the making. We should expect its eventual unraveling to be similarly exceptional. In the meantime, this mania is an imbalance exacerbating and “currency”-debasing behemoth.

Link here (scroll down).


If any longish marriage is an exercise in irritation management, so is listening to the hype by media commentators about the soundness and superiority of the U.S. economy and about how well U.S. stocks are performing. I suppose that if Larry Kudlow were living in Zimbabwe, where the economy has been contracting for eight straight years and has shrunk by 50% since 1999, and where hunger is spreading and life expectancy is down to 35 years, he would also be enthusiastic about the prospects of Zimbabwe’s stock market, which is currently soaring as inflation is likely to reach 5,000% this year.

As in the case of the U.S., but in a more extreme way, while stocks are soaring in Zimbabwe, the currency is collapsing. (In fact, it is an exact replica of what happened during the Weimar hyperinflation of 1919-1923, in local currency terms, the stock market index soared into the trillions but collapsed in gold terms.) It forces one to ask how much of the growth in Western stock markets over the preceding 25 years has been created by a vastly increasing money supply, and how much is due to actual wealth creation.

Now, I do not anticipate that a Zimbabwe-like scenario will unfold in the U.S. soon, but the phenomenon of investors realizing that cash deposits do not give them adequate protection from the loss of their paper money’s purchasing power and therefore rushing into any kind of asset is the same everywhere in the world. Also similar is the increase in asset prices in local currency in Zimbabwe and the U.S., and the collapse of the Zimbabwe dollar and, to a far lesser extent, the decline in value of the U.S. dollar.

Still, for now, there is some hope for the U.S. dollar. It is not the Fed that has tightened monetary conditions, but the marketplace through the collapse of the subprime lending industry. Since the housing market is more likely to deteriorate further than to recover, credit problems could get much worse. In any event, Robert Toll, CEO of Toll Brothers, just sold another $8.3 million worth of shares. Since his company’s shares are down from almost $60 in 2005 to $27, his selling would indicate that he does not see any immediate turnaround in the housing industry.

Moreover, there are several reasons why the Fed is unlikely to cut interest rates in the near future. Food and energy prices as well as import prices are rising, which could further increase inflationary pressures. The dollar is also in a very precarious position, and bond yields have so far failed to decline despite evidence of an economic slowdown.

Finally, I suppose Mr. Bernanke understands very well the difficult position he finds himself in as the chairman of the Fed. Should inflation under his chairmanship at the Fed become a problem, he knows that he will be blamed for it. Conversely, he is also well aware that if some sort of recession occurred due to a currently somewhat more hawkish monetary stance, financial observers will be quick to blame Mr. Greenspan for it, since the former Fed chairman addressed any financial crisis or any potential problem (Y2K, for example) by printing money and can thus be considered directly responsible for the housing bubble. So, from a career and reputation risk point of view, Mr. Bernanke will likely move very slowly in cutting rates and rather take the risk of some mild form of recession occurring. He could then blame a recession, which would have come from the housing sector, on Mr. Greenspan.

Ben Bernanke recently gave a speech at Stanford in which he said that “increased trade with China has reduced U.S. inflation, now running at about 2%, by only about 0.1 percentage point.” He also noted that while emerging economies have added to the global supply of manufactured goods, they are also adding to the demand for oil and other commodities. And according to Mr. Bernanke, “There seems to be little basis for concluding that globalization overall has significantly reduced inflation in the U.S. in recent years; indeed, the opposite may be true.”

And this is where I think the Goldilocks prophets with tunnel vision, who argue for continuous economic growth amid low inflation, will be as wrong as they have been for the past few years. The super-bulls on the U.S. have simply overlooked the fact that if economic growth in China, India, Vietnam, and other emerging regions of the world remains strong and the U.S. economy continues to expand, this synchronized global boom will be supportive of commodity prices whose price gains have significantly outstripped the performance of U.S. financial asset prices since 2001. So, in the event, as the entire Goldilocks sect argues, that the global economy remains strong, inflationary pressures should increase. Commodity prices, especially for agricultural products, are in real terms still extremely depressed and, contrary to expectations, could rise far more than many would think possible.

However, illiquidity among the U.S. household sector, along with the reluctance of the Fed to cut rates right away, combined with the requirements for enormous capital investments for infrastructure in emerging and developed economies, could lead to some tightening of liquidity around the world. Therefore, I expect a more meaningful setback in asset prices and would certainly defer the purchase of financial assets. In particular, I am concerned by the inability of financial stocks to rally convincingly from their March 2007 lows, since financials are usually leading the market up and down.

In my opinion, there is an ongoing deterioration in the U.S. stock market. In the summer of 2005, the homebuilders peaked out. Last year, it was the turn of the subprime lenders to top out. And early this year, financial shares, including brokers, made their highs. The economy is likely to follow this slow stock market erosion and gradually deteriorate, with disappointing corporate profits to follow.

Investors who must own U.S. shares may find some relative outperformance among pharmaceutical companies, and oil and coal stocks. For the reasons outlined above (a relative tightening of liquidity in the world), I do not expect the U.S. dollar to collapse immediately. However, it should be clear that in the long run the purchasing power of the U.S. dollar will continue to decline against sound currencies such as precious metals. Therefore, I continue recommending the accumulation of gold and silver.

But it is increasingly likely that something will give soon. Either asset prices will decline in a tighter liquidity environment, or the U.S. dollar will fall sharply if the Fed continues to pursue expansionary monetary policies. For the U.S. financial market, this means either weak equities and a strong dollar or strong equities and a weak dollar. Not a particularly appealing scenario!

Link here (scroll down to piece by Dr. Marc Faber).


I have been pondering the word “stagflation”. Nearly everyone but me seems to think we are in it or headed for it. What exactly does stagflation mean anyway? Let us take a look at two definitions and a comment:

  1. “Sluggish economic growth coupled with a high rate of inflation and unemployment” (American Heritage Dictionary)
  2. “A condition of slow economic growth and relatively high unemployment – a time of stagnation – accompanied by a rise in prices, or inflation” (Investopedia.com)
  3. Investopedia commentary: “Stagflation occurs when the economy is not growing, but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries ... For these countries, stagnation increased the inflationary effects.”

From above context, stagflation seems to be based on rising prices (instead of an expansion of credit), and furthermore, the term seems to imply that rising prices are bad only in context of the “stag”.

An Austrian View of “Flation”

  1. Inflation – Expansion of money and credit
  2. Deflation – Contraction of money and credit
  3. Disinflation – Expansion of money and credit, but at a declining pace
  4. Hyperinflation – Rapid rise in inflation accompanied by a complete loss of confidence in currency

The term stagflation makes no real sense from an Austrian point of view. Yet it is only from the Austrian point of view that I wish to debate anyone on inflation. One of the problems I face is that people want to be a part of the debate, even though they refuse to accept the terms of the debate. Austrians in general would accept the “Flation” list above (or something reasonably close). Others do not. Unless one can agree on definitions, however, there can be no meaningful debate. People keep telling me I am wrong when they do not agree to the terms of the debate. Following are three people whom I believe do agree with those “Flation” terms as defined above:

  1. Marc Faber
  2. Steve Saville
  3. Robert Blume

Note that I said they agree with those definitions. All of them disagree with my position. Taking the other side of a debate with Faber is dangerous, but we agree on far more things than we disagree on. Faber also admits deflation is possible (even if unlikely). Most inflationists will not even grant that.

Link here.


Hedge fund returns have become much more correlated of late, meaning managers are generating similar gains and losses in similar market conditions, according to a study by Tobias Adrian, an economist at the bank. That also happened before LTCM collapsed in late 1998, he said.

However, Adrian also noted a big difference between then and now. Today, the increased correlation of hedge fund returns has been driven by an overall decline in the volatility of returns in financial markets, the economist added. In 1998, the increase occurred independently of broader market behavior. And as LTCM collapsed, hedge fund return correlations declined sharply as some managers profited from the crisis and others did not, Adrian concluded.

LTCM collapsed in late 1998, prompting the Federal Reserve to arrange a bank-funded bailout to avert a possible financial crisis. Since then, assets in the hedge fund industry have ballooned to almost $1.6 trillion. That has led some regulators to worry about another blow-up. IMF Managing Director Rodrigo Rato said he is concerned about the growing amount of capital that hedge funds are raising from pension funds. About 30% of hedge funds’ assets now come from pension funds, Rato noted.

“It may be that pension funds are using hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching,” Rato added. Hedge funds contribute more than half of average trading volume in equity and corporate bond markets.

Links here, here, and here.


Were it not for its “reserve currency” status, slowly turning into a post-World War II relic, the U.S. dollar would have already collapsed by now. A string of $4.4 trillion of U.S. trade deficits since 1996, and a heavy reliance on foreign money to fund its external imbalance, has severely weakened America’s global economic leadership over the past five years. The U.S. dollar survives, due to America’s political stability, its military might in the Persian Gulf, its large $12.5 trillion economy (28% of global GDP), and deep and liquid financial markets for bonds and stocks.

Last week, the U.S. dollar fell to an all-time low against the Euro, a new milestone in a steep decline that began more than six years ago. The Euro hit a record high of $1.3682 on April 27th, up from $1.20 a year ago and as little as 83 cents in October 2000, when the rally against the dollar began. The British pound is hovering near $2 area, and the Australian dollar fetches 82.50 US-cents, both at 15-year highs.

Since the beginning of the year, 50 of the world’s currencies have risen against the dollar while only eight have declined. Behind the falling U.S. dollar is a changing global economy. China and the U.S. are the locomotives in the global economy, accounting for 60% of all the global growth in the last five years. But now, the $12.5 trillion U.S. economy is sputtering, due to a slumping housing sector, while the $2.5 trillion Chinese economy is overheating, expanding at a blistering 11.1% pace in Q1. India, China, and other dynamic economies, such as Russia and South Korea are expected to contribute more than 50% to world economic growth in 2007, with China’s contribution alone being 30% and India’s 10%. In comparison, the U.S. contribution to world growth is expected to fall to 12%, after its economic output halved to 1.3% in Q1, the smallest gain in four years.

Every time U.S. year-on-year GDP growth has dipped below 2% since 1960, a full-blown recession unfolded. In contrast, the Euro zone economy is expanding at a 2.6% clip, its best performance in six years, and the European Central Bank is aiming to lift its interest rate in June, thus making the U.S. dollar less attractive next to the Euro. As such, many foreign central banks have been reducing their exposure from the U.S. dollar to the Euro and British pound over the past year.

Since the bursting of the dot-com investment boom on Wall Street in 2001, the U.S. Dollar Index has been sliding on a slippery slope, weakened by rising U.S. trade and budget deficits, and an increasingly unpopular war in Iraq, which is costing the U.S. Treasury about $2 billion per week. The U.S. Dollar Index has a weighting of 57.6% in Euros, 13.6% in Japanese yen, 12% in British pounds, 9% in Canadian dollars, 4.2% in Swedish kronas, and 3.6% in Swiss francs.

Japanese financial warlords buck the trend.

The giant U.S. trade deficit of $763 billion in 2006 produced a huge outflow of dollars to other countries. The People’s Bank of China, the Bank of Japan, and Arab Oil kingdoms have been the key linchpins in limiting the dollar’s losses by buying U.S. Treasury debt. Although the dollar is sliding to multi-year lows against most major currencies, the greenback is up 5% against the Japanese yen from a year ago. The Bank of Japan is the largest holder of U.S. Treasuries, and pursues a radical monetary policy, pegging its overnight loan rate at only 0.5%, or 475 basis points below the U.S. fed funds rate, in order to prop-up the U.S. dollar.

The Bank of Japan is the world’s largest “yen carry” trader. Last fiscal year, Tokyo paid ¥7.6 billion in interest expense, while earning ¥3 trillion in interest rate income on U.S. Treasuries. The U.S. Treasury is thrilled with Japan’s “cheap yen” policy, which encourages the flow of capital from Tokyo to U.S. financial markets. Tokyo also reaps big rewards, as yen has fallen 14% in the past year against the Euro, 5% against the dollar and 9% against China’s yuan. That has boosted Japan’s trade surplus by 74% to a record ¥1.63 trillion ($14 billion) in March from a year earlier. China overtook the U.S. as Japan’s largest trade partner in the year ended March 31st.

Arab oil kingdoms recycle petrodollars into US$.

Washington’s allies in the Arab world, particularly in the Persian Gulf, are now worried about the influence of Shi’ite Iran in Iraq and elsewhere in the predominantly Sunni Muslim region. The U.S. accuses Tehran of seeking to set up a covert nuclear weapons program, a fear shared by Saudi Arabia. Riyadh fears that U.S. troops will leave Iraq prematurely, and enable Iran to consolidate its influence and leaving Sunni Arabs at the mercy of Shi’ite militias.

The Arab Oil kingdoms are supporting the U.S. war effort in Iraq by recycling much of their petrodollar surpluses into Treasuries. But nearly four years into the Iraq war, America’s patience with the war is growing thin.

The Arab Oil kingdoms are willing to recycle petrodollars into Treasuries, but also want to be compensated for a weaker dollar with higher oil prices. The OPEC-10 cartel has lowered its daily oil output by 1.8 million barrels since November 2005. With the depletion of 500,000 bpd from Mexico’s giant Cantarell oil field last year, OPEC is back in the driver’s seat. OPEC has guided the benchmark North Sea Brent price upward to $68/barrel, from as low as $51/barrel in January.

China grows weary of weaker dollar, U.S. protectionist threats.

But while Tokyo's financial warlords and Arab Oil Kingdoms are firmly committed to the defense of the US dollar, how Beijing decides to use its $1.2 trillion of wealth would have much bigger ramifications for financial and commodities markets worldwide. China suffers losses on its massive $700 billion U.S. bond portfolio whenever it allows the dollar to move lower against the yuan. The dollar has fallen only 1.3% against the yuan so far this year, and dealers expect a devaluation of only 4% for 2007.

The slow pace of yuan appreciation could invite “veto-proof” U.S. Congressional protectionist legislation against Chinese exports in the second half of this year. Until now, Congressional efforts to get China to move toward a more flexible exchange rate with threats of tariffs have been frustrated by the leverage exerted by the Chinese through their huge ownership of U.S. Treasury debt. But if Congress slaps tariffs on Chinese imports this year, it might cause Beijing to switch its allegiance to the “Axis of Oil”, a loosely aligned alliance of top oil producers, who are slowly chipping away at the U.S. dollar’s allure, and aim to thwart American economic and foreign policy at every turn.

“Axis of Oil” chipping away at U.S. dollar’s base of support.

The “Axis of Oil” led by Russia, Iran, and Venezuela, is slowly chipping away at the U.S. dollar’s status as the world’s “reserve currency”. Russia, the world’s #2 oil exporter demands rubles in exchange for its crude oil, and Iran, the world’s #4 exporter is earning most of its revenues in the Euro. Venezuela’s central bank began shifting its FX reserves to Euros in 2005.

The “Axis of Oil” seeks to draw China into its sphere, exploiting China’s huge thirst for oil. China’s state-run Zhuhai Zhenrong, the biggest buyer of Iranian crude worldwide, began paying for its oil in Euros late last year. Japanese refiners who buy 20% of Iran’s oil continue to pay in dollars but are willing to shift to yen if asked. A major share of global trade in commodities belongs to crude oil, which is widely transacted in U.S. dollars. That forces oil importers and central banks to buy dollars, regardless of the direction of U.S. interest rates. Last month, world-wide oil consumption rose to 85.5 million bpd. By 2030, crude oil demand is expected to reach 118 million bpd, so the dollar-crude oil link is vital to maintain the dollar’s “reserve currency” status, and allowing America to live beyond its means.

Right now, the only serious threat to the dollar’s international dominance is the Euro. The GDP of the Euro zone is roughly the same as that of the U.S., and its population is 60% bigger. Europe is the Middle East’s biggest trading partner, is a major oil importer, has a comparable share of global trade as the U.S., but its external accounts are much better balanced. The Euro zone ran a current account deficit of only 3.2 billion euros ($4.2 billion) over the past 12-months.

But the “Axis of Oil” could topple the U.S. dollar, if it demands payment for oil sales in Euros. In November 2000, Saddam Hussein insisted that Iraq’s oil be paid for in Euros. When the value of the Euro rose, Iraq’s oil revenues increased accordingly. The economic threat this represented to the U.S. dollar might have been one of the reasons why the Bush administration was so anxious to topple Saddam.

Maintaining the dollar monopoly on the sale of oil is critical to the Fed’s ability to print money, without sending the greenback into a tailspin. However, if the “Axis of Oil” and/or the Chinese dragon decide to shift more of their trade surpluses towards the Euro or gold, it could seriously undermine the dollar, increasing the cost of U.S. imports, and corral the U.S. economy into the “Stagflation” trap.

Such a scenario is more likely in the event of a U.S. military strike on Iran. But the G-7 central banks have worked together for a long time, dealing with many market crises, usually by coordinated inflation of their money supplies, to keep currencies in stable target zones. Still, a shift by the “Axis of Oil” and especially China, away from the dollar could override the G-7’s manipulative antics.

On May 1st, Fed chief Ben Bernanke warned Congress against imposing tariffs on Chinese imports into the U.S., which could spark Beijing’s flight from the dollar. “If trade both destroys and creates jobs, what is its overall effect on employment? The answer is, essentially, none,” Bernanke said. The Fed’s ability to print unlimited amounts of dollars and inflate assets, might hang in the balance.

Link here.


“From Hawaii to New York, Alaska to North Carolina and everywhere in between, an epidemic of breaking pipes is causing unprecedented havoc,” declared one of the presenters at last month’s Gabelli Water Infrastructure Conference in New York. Replacing and repairing all these breaking pipes, therefore, could produce unprecedented profits for the certain water pipe manufacturers.

Last year was the worst year for sinkholes and sewage spills in U.S. history. “This year is shaping up to be even worse,” says Thomas Rooney, president of Insituform Technologies. “Most water and sewer pipes in the United States were built 60 years ago – but were meant to last 50 years. Do the math.” Of all the presenters at the Gabelli Conference, Rooney offered the most eye-opening story. He told attendees about the looming crisis arising from our decaying water and wastewater infrastructure - namely, leaking and breaking pipes. But more importantly, he gave us some tangible evidence that shows just how bad things are getting. The most important statistic was the record number of sinkholes and sewage spills in the U.S. last year. Leaking or breaking pipes are the biggest causes of these things in our cities.

Rooney used the analogy of the aging power grid before the big blackout in 2003. Before that, no one cared about the aging power grid. Afterward, all kinds of wheels were set in motion to correct the problem. Things could get even worse, Rooney warns, hard as it is to believe. “A little-known secret,” he says, is the fact that the large-diameter pipes – those 40-50 inches in diameter, often made of concrete – are starting to leak in Los Angeles, New York and other major cities. When these pipes go, it will be front-page news, disrupting the water supply and affecting the health of millions.

How did things get this bad? The issue is political will. The social pain involved in digging up a whole street makes it hard to tackle. When you have a harried mayor trying to deal with a budget, guess what gets cut out?

Investors are starting to take notice of the opportunities in water. It is endlessly fascinating to me how investment fashions and moods shift over time. One year ago, at Gabelli’s first conference, there was a relatively small audience – maybe a couple of dozen money managers and analysts. This time, the room was full. There must have been over a hundred people at different times. Water is now heating up as a global investment topic. The February edition of CEO magazine featured a front-page story that proclaimed, “Water is now a hot commodity”. I agree. But the bull market in water-related stocks is not even close to reaching the boiling point.

Link here.


The world is not running out of oil just yet, but it is beginning to run out of oil. The downward slope from “more than-enough” to “barely enough” could produce wrenching macro-economic adjustments for many nations of the world, including the U.S. But this downward slope will also produce innumerable opportunities for oil-focused investors, especially those investors who focus on the oil services sector.

Dr. Ali Samsam Bakhtiari of Iran is one of the many leading energy analysts who believe that world oil production “peaked” in 2006. He believes that the world’s daily oil output will fall from its present level of about 85 million barrels of oil per day to about 55 million barrels of oil per day by 2020. That is, there will be a 35% decline in available conventional oil within a mere 13 years from now. If he is right, the world will change profoundly.

But declining oil production does not mean “we are running out of oil.” Rather, going forward, oil will become increasingly difficult to locate and extract. And it will become increasingly valuable. But 55 million barrels per day is still one heck of a lot of oil, and life on Earth will go on in some form or another, if the nations of the world do not kill each other while fighting over access to petroleum supplies. The point to keep in mind is that from now until long into the future, there will still be oil wells pumping oil from oil fields.

And when it comes to developing that oil deposit, you need oil service companies. Oil service companies provide what the name appears to describe – drilling services, down-hole logging, well completion services and production monitoring. Oil service companies make their money providing the services and technical support to the producing entity. Oil service companies, therefore, carry almost no geological or political risk.

If you own a company that explores for oil, you run the risk of exploration failure. But the oil service company gets paid for performing the services whether the well is a dry hole or not. If you own an oil exploration company, you also run the risk that some hostile or capricious foreign regime will simply steal all or part of your reserves. But if the political climate becomes too burdensome, the oil service company can just pull up stakes, exit the unfriendly locale and watch from the sidelines while the bureaucrats mess things up for a few years.

There are many such oil service companies out there, and it almost seems unfair to single out just a few of them, because there are so many good ones. For those of you who want to own an index fund of oil service companies, there are two that I like quite a bit: Oil Services HOLDRs (OIH: AMEX) and the iShares Dow Jones U.S. Oil Equipment Index (IEZ: NYSE). There is a lot of overlap in ownership between these two index funds. But if you want to own one or more of the three biggest and best individual companies in the oil service sector, you have to look long and hard at the larger names that provide oil field services to the industry on a global level. The companies to which I refer are Schlumberger (SLB: NYSE), Baker Hughes (BHI: NYSE), and Halliburton (HAL: NYSE). These three companies are considered by many to be the gold standard of the oil service industry.

The oil service sector funds, as well as the specific stocks that I discussed above, have all had significant run-ups in the past two months, as the price of oil recovered from its January lows. Are these stocks “too high to buy” right now? In all candor, this is a close call for me. Since I believe that the world crossed the “peak” of conventional oil production in the summer of 2006, I also believe that the long-term price trend for oil is up, up and up. Thus, from a long-term view, all of these oil service stocks are still cheap. But over the short-term, anything goes.

So here is my advice:.Start nibbling on these stocks now. But be prepared to pounce and buy aggressively on any general market retreat or pullback. As the rush to find and develop the earth’s scarce oil reserves intensifies, the oil services companies are the ones whose numbers will be on the “speed dial” of every major oil exploration company in the world.

Link here (scroll down to piece by Byron King).


“The horror! The horror!” ~~ Heart of Darkness, Joseph Conrad

The trouble with vacations is that they are much too serious. Instead of war, depression, bankruptcy, and hyperinflation, we are dealing with things where the stakes are really high. Instead of reflecting on trade deficits and subprime credit markets, we have to think about things we actually know something about, and issues over which we might actually have some influence.

One daughter has a boyfriend covered with an exterior of colorful tattoos, and an interior as dull as airplane cutlery. Another daughter has a boyfriend who seems gentlemanly and ambitious. The latter is almost too good to be true, while the former is almost too bad to be false. One son wobbles between medical school in the U.S., and business school in France. The other is wondering whether to pursue a career as a bank manager ... or a bank robber. The point is, every decision is important. Every bit of parental advice has to be carefully considered. And judiciously administered. Even good advice is likely to be taken badly. Like a zoologist giving antibiotics to a sick polar bear, he is lucky to avoid having his limbs torn off.

So for us, it is a great joy to be back from our vacation, back in work-a-day world, where we can get some rest, and have a good laugh or two. We noticed that the outrageous trends that were going on when we left, have become even more outrageous. Seeing a disaster coming, investors are rushing to get in on it before it is too late.

China is clearly in a bubble. Shanghai stocks are up 250% since 2005 – and 35% this year alone. Still, investors are so eager to get in at these prices – while they can still get hurt – that they take up Chinese bank IPOs at twice the PE ratios of banks in developed countries. And what do they actually get when they buy a share? What exactly is a bank chartered and regulated by communists? They have no clue.

But so much foreign money is elbowing its way into China that, in 2007, the central bankers are getting bruised just trying to keep up with it. China is expected to accumulate more than half a trillion dollars in foreign exchange reserves. How does it get that money? It prints up currency of its own to buy the foreign currency from businessmen and investors, who are selling Chinese made goods (including stock certificates) to foreigners at a breakneck pace.

Everywhere, extravagant amounts of cash are flooding into overpriced investments in absurd places. Local central banks are printing money at a furious pace (lifting the great global tide of liquidity) to keep from increasing the value of their own currencies. This freshly minted cash comes into the world like a newborn baby – ready to claim its fair share of resources all its life while being a burden in the long run, but at the crib it is a joy to everyone.

And now we enter the dark heart of this whole cockamamie tale. China is not the only place investors can get themselves into trouble. More than a third of the money that trades hands on the Brazilian stock exchange comes from overseas investors. Brazil has always been the “country of the future,” but six years ago, Brazil’s future was so dismal it looked like it would default on foreign loans. Now, foreigners give it so much money it does not know what to do with it all.

Meanwhile, who would have thought that investors would scramble to buy Hugo Chavez’s paper? But, then again, if they will buy banking stocks in a country organized on Marxist-Leninist principles, why not the slippery bonds of a Latin American strong man who professes to be a follower of Trotsky? Investors not only take up the Venezuelan bonds happily, they do so at less than 7% yield ... barely 200 basis points more than the sovereign debt of the USA. Officially, the Venezuelan Bolivar is quoted at 2,150 to the dollar. On the black market it trades for 3,750 to one. And it is sinking fast – down 15% so far this year. No wonder. The money supply is increasing at 65% per year while the inflation rate is, officially, 20%. And Chavez is still increasing government spending by 50% a year.

But Venezuela has oil. It is to the black goo, not to Hugo Chavez, that investors look for security. But just as investors often search for ways to turn a silk purse into a sow’s ear, so do governments more than occasionally strive to turn their good fortune into national catastrophe. Caracas seems to be doing so in classic manner, spending more than even his country’s oil revenues will permit. What will happen when the Venezuelan treasury runs out of cash and credit? Will Hugo Chavez cinch up the nation’s belt in order to honor his commitments to the foreign capitalists he despises? Two months ago, Ecuador threatened to default on its bonds. Chavez cheered it on.

Even long-dated dollar-denominated bonds issued by Iraq trade at yields less than 10%. In that heart of darkness, too, investors are counting on oil to make sure they get their money. The trouble is, whether in the jungles of South America or in the deserts of the Middle East, the politicians above the ground can destroy a nation’s credit faster than the oil below ground can salve it.

Back in the U.S.A., one of the good things investors are intent upon getting too much of, is in Las Vegas. “Excess” is an old word, but it seems to have been invented in anticipation of modern Las Vegas. Nothing about the city is modest or restrained. Over on The Strip, Goldman Sachs is buying Carl Icahn’s four casinos ... for $1.3 billion. The city had a total of 35,000 hotel rooms in the 1970s, which seemed like more than enough to us. Now it has 151,000. But “too much” has dropped from the English vocabulary in Nevada, and perhaps in the rest of the world too. The Venetian alone is adding 3,200 new rooms. And the owners of the old Stardust Casino judged it too small, so they blew the place up last month to build a new development, Echelon Place, with more than 5,000 rooms. Meanwhile, MGM’s new City Center development is supposed to cost $7 billion, making it the most expensive development in Las Vegas history.

Everywhere you look, it is the same. Intrepid investors push deeper and deeper into the jungle ... exploring ... searching ... reaching ... for some way to ruin themselves in style.

Link here.
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