Wealth International, Limited

Finance Digest for Week of December 17, 2007

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


It’s capitalism, Jim, but not as we know it.

In the annals of American-style “capitalism”, last Tuesday resembled an episode from The Twilight Zone. For starters, the country’s monetary central planner – the Bernanke Fed – dropped rates 1/4%. Investors were miffed, hoping for even more candy. As the kiddies came down from their 1,000 Dow point sugar high of the last 2 weeks, their mood was agitated and whiny. The Dow dropped 300 in less than 2 hours.

Right after the “disappointing” news was released at 2:15 pm, former reporter turned fund-of-funds manager Ron Insana complained, “This is a decidedly wimpy move by the Fed.” Perhaps Insana is showing strains from running actual money in the real world. We would be surprised if he does not return to the more forgiving world of business journalism, that is, if there is anyone left hiring as this bear market firms its grasp.

Next up: American capitalism’s folk hero, Warren Buffet, raising funds for Hillary Clinton. How ludicrous – the country’s best known and beloved “capitalist” along with prominent venture capitalists were raising funds for a committed welfare statist and socialist. On CNBC, Hillary agreed with Buffett’s position to maintain the estate tax because, in her words, “It is really a tax to prevent us from having inherited wealth generation after generation which would undermine the kind of spirit and meritocracy that the United States stands for.”

This is awfully charitable of Hillary and Warren to provide such a vital service to our “free” society. Never mind that Mr. Buffett sells life insurance to these very people attempting to protect their family businesses and family estates from the ravages of the tax man, just so they can keep them intact for their children. Buffett chooses to hand over the vast majority of his $57 billion fortune to charity, so why should he care? Repeal the exemption on charitable giving and you would see him go apoplectic.

In 1995, Buffett was quoted on the subject: “I personally think that society is responsible for a very significant percentage of what I’ve earned. If you stick me down in the middle of Bangladesh or Peru or someplace, you find out how much this talent is going to produce in the wrong kind of soil... I work in a market system that happens to reward what I do very well – disproportionately well ...”

So on the one hand, Buffett realizes the free market maximizes human potential, and on the other supports Big Government, itself the greatest threat to free markets. Some capitalist. Note to Oracle of Omaha: If you feel the need to give back, why not write a few checks to free market think tanks?

Next in line: Larry Kudlow, so-called supply-side “economist” who talks a good game when it comes to lower taxes and fewer regulations, but supports the very institutions that pump up Big Government most – the military-industrial complex and the Fed. Kudlow is apparently suffering from dementia, extolling heroes such as Joseph Schumpeter and Ludwig von Mises while forgetting they were fierce opponents of central banking. He defended the monetary madness of Greenspan from 2001 to 2004 and now Helicopter Ben and will be the last to admit their interventions caused an epic credit bubble which is coming unglued. Kudlow’s advice to Bubblevision viewers after the close? “I wouldn’t panic. Investors should stay in for the long-term. Goldilocks is alive and well.”

Thanks, Larry.

Next up to the plate: Jim Cramer, host of CNBC’s aptly named Mad Money, former hedge fund manager, and author of several popular books on navigating the financial markets. Cramer was indignant that the Fed failed to cut rates 1/2%: “I am angry because today the Federal Reserve cost this country an enormous sum of money by giving us a dinky 1/4 point rate cut. ... Today we learned that no matter how bad things get, the good folks running the Fed are going to take a calm, measured approach – even if to be calm at this moment is the height of insanity.”

The kiddies love Jim Cramer because he advocates an all-sugar diet, 24/7. In his bizarre world of asymmetric risk, the Fed’s job is to prevent investor losses, no matter the consequences. Quite a free market role model for his adolescent fans.

Earlier in the day, the Maestro himself, Alan Greenspan, wrote an op-ed for the WSJ titled “The Roots of the Mortgage Crisis”. We will give you a hint – the Greenspan Fed failed to make the short list of culprits. Central planners always blame free markets for the messes created by their own intervention. Greenspan sees “the expectation of rising prices” as “the dynamic that fuels most asset-price bubbles.” Driving the fed funds rate down to 1% in 2003 and practically handing money to speculators apparently had nothing to do with turning the traffic lights all green and creating a massive pile-up.

And lastly, on Wednesday morning, the Fed apparently caved to the tantrums of investors by announcing a scheme to add liquidity through “alternative measures”. On cue, the kiddies salivated, taking the Dow up 250 points on the open only to see nearly all of those gains evaporate by the end of the day.

To paraphrase H.L. Mencken, “Fed intervention in the financial markets is the art and science of running the circus from the monkey cage.”

Beam me up, Scotty. There are still no signs of intelligent life.

Link here.


The Bernanke “put” has expired. And now speculative markets may have to take a beating – for appearance’s sake, at least.

The Fed cuts rates by a quarter point, and what happens? Wall Street’s ungrateful wretches knock 294 off the Dow in an hour and half. The home builders index dives 10%. Japanese bonds surge. Euribor spreads rise to an all-time high of 99 basis points.

Have the markets begun to digest the awful possibility that central banks cannot cut rates fast enough to prevent a profits crunch because they are caught between the Scylla of the credit crunch and the Charybdis of inflation, a new deviant form of stagflation? U.S. headline CPI is stuck at around 3.5%to 4%, German CPI is 3% (and wholesale inflation 5.7%), China is 6.9%, and Russia is skidding out of control at 10%.

As for the Fed, it now has to fret about the dollar. A little beggar-thy-neighbour devaluation is welcome in Washington. A disorderly rout is another matter. No Fed chairman can sit idly by if half of Asia and the Mid-East break their dollar pegs, threatening to end a century of U.S. dollar primacy.

Yes, inflation is a snapshot of the past, not the future. It lags the cycle. After the dot-com bust, U.S. prices kept rising for 10 months. Alan Greenspan blithely ignored it as background noise, though regional Fed hawks put up a fight. Ben Bernanke has not yet acquired the Maestro’s licence to dispense with the Fed staff model when it suits him. In any case, his academic doctrines may now be blurring his vision.

So, in case you thought that every little sell-off on Wall Street was a God-given chance to load up further on equities, let me pass on a few words of caution from the High Priests of finance.

A deluge of pre-Christmas predictions have been flooding into my e-mail box. The broad chorus – by now well known – is that the U.S. will hit a brick wall in 2008. Less understood is that Europe, Asia, and emerging markets will also flounder to varying degrees, knocking away yet another prop for U.S. equities – held aloft until now by non-U.S. global earnings.

Morgan Stanley has just added a “mild recession” alert for Japan (Buckle Up) on top of its “manufacturing recession risk” for the eurozone. Its U.S. call (“Recession Coming”) is no longer hedged about with many ifs or buts. Americans face a “perfect storm” and CAPEX is buckling. Demand will shrink by 1% a quarter for nine months.

Merrill Lynch has much the same overall view, as does Goldman Sachs. Now, stocks can do well in a soft-landing (which Goldman Sachs still expects, on balance), since falling interest rates offset lost earnings. But if this does tip over into outright contraction, History is not kind. The average fall in S&P 500 over the last 9 recessions is 13% from peak to trough.

As for the canard that stocks are currently cheap at a projected P/E ratio of 15.3, this is based on an illusion. U.S. profit margins are currently inflated by 250 basis points above their 10-year average. While Goldman Sachs does not use the term, this is obviously a profits bubble. Super-cheap credit in early 2007 – the lowest spreads ever seen – flattered earnings.

I would add too that free global capital flows have allowed corporations to engage in labor arbitrage, playing off cheap Asian wages against the U.S. and European wages. This game is surely played out. Chinese wages are shooting up. Voters in industrial democracies will not allow capitalists to continue take an ever-larger share of the pie. Once you strip out this profits anomaly, Goldman Sachs says the P/E ratio is currently 26. This compares with a post-war average of 18, and a pre-recession average of 17.

“It is clear that if the U.S. enters a recession, there is significant scope for both earnings and stock prices to decline beyond what the market has already priced. The average lag between peak and nadir in stock prices is only 4 months. This implies a swift correction in equity prices.”

The spill-over would be a 20% fall in the DAX (Frankfurt) and the CAC (Paris), 19% fall on London’s FTSE 250, 13% on the IBEX (Madrid), and 10% on the MIB (Milan). This is not a Goldman Sachs prediction. It is merely a warning, should the economy tip over.

Now, whatever happens to U.S., British, French, Spanish, Italian, and Greek house prices, and whatever happens to the Shanghai stock bubble or to Latin American bonds, the Fed and fellow central banks can – and ultimately will – come to the rescue with full-throttle reflation. Merrill says the Fed may cut rates to 2%. (Rates were 1% in 2003 and 2004).

Let me go a step further. It would not surprise me if debt deflation in the Anglo-Saxon countries proves so serious that we reach Japanese extremes – perhaps zero rates, with a dollop of “quantitative easing” for good measure. The Club Med states may need the same, but they will not get it because they no longer control their monetary policy. So Heaven help them and their democracies.

The central banks are not magicians, of course. We forget now that Keynes and his allies in the early 1930s knew that monetary policy could be used to flood the system by buying bonds. They concluded that such a policy might backfire – possibly causing panic – since investors were not ready for revolutionary methods. This at least has changed. The markets expect a bail-out, demand it, and believe religiously in its benign effects.

Ben Bernanke said in his 2002 “helicopter” speech that there was practically no limit to what sorts of assets the Fed could buy in order to inject money. So, in the end, the Fed can always stop a deflationary spiral. As Bernanke said to Milton Freidman on his 90th birthday, the Fed will not repeat the monetary crunch it allowed to happen 1930-32. “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Bernanke is undoubtedly right. The Fed will not do it again. But before the United States can embark on an economic course that radically transforms the nature of capitalism, speculative markets may have to take a beating – for appearance’s sake, at least.

Link here.


Bubble dynamics proliferate even in the face of a Wall Street bust.

U.S. Consumer Prices were up 4.3% y-o-y in November. Our Producer Price index registered a 7.2% y-o-y surge. November Import Prices were up 11.4% from a year earlier. Euro-zone inflation jumped to 3.1% y-o-y, the strongest rate since May 2001. German consumer inflation rose to an 11-year high (3.3%). Chinese inflation was at an 11-year high of 6.9% in November. Score of countries and regions – including Australia, Russia, Eastern Europe, and the Middle East – now confront heightened inflationary pressures, in what has developed into a powerful global phenomenon.

U.S. financial markets traded dazed and confused – understandably. For some time now, Wall Street has operated under a certain premise of how the Fed would respond to financial crisis. Recent expectations had our central bankers poised to lower rates to whatever level necessary to rekindle “animal spirits” and spur the credit system and Wall Street risk intermediation more generally. The overriding presumption has been that inflation was a moot issue – inflationary pressures were well contained and, in any event, would rapidly dissipate in the face of housing, credit and economic woes. Last week the market came face-to-face with the reality that inflation is not only a major issue. Inflation is in the process of significantly limiting the Fed’s flexibility and capacity to orchestrate another Wall Street bailout.

Markets boisterously protested the meagerness of the Fed’s 25 basis point cuts in fed funds and the discount rate. The next morning’s news of concerted global central bank unconventional liquidity injections garnered a curiously lukewarm reception. This was likely due to its limited scope as well as the recognition that such an approach indicated the Fed was exploring policy instruments outside of Greenspan-style zealous rate slashing. Many on Wall Street are calling the Fed’s handling of the situation a “fiasco”, while some are even asking for Dr. Bernanke’s head. I would instead argue that unrealistic Wall Street expectations were once again instrumental in fostering marketplace instability.

There is certainly more than ample pontificating these days on the nuances of central banking. Meantime, there remains scant attention paid to underlying fundamental forces driving both the financial markets and monetary management. Last week’s Z.1 “flow of funds” data go far in illuminating today’s market and Federal Reserve dilemma: The enormous scope of credit expansion necessary to sustain Wall Street’s bloated securities markets – to keep the contemporary credit mechanisms generally liquid and functioning – has become patently inflationary for the system overall.

The third quarter demonstrated how, in spite of double-digit system credit growth, an acutely fragile credit system came to the brink of imploding. In particular, ongoing rampant Financial Sector expansion could not ameliorate revulsion to Wall Street-backed securitizations. Double-digit expansion in “money-like” debt instruments – including Treasuries, agencies debt, GSE MBS, and bank and money fund deposits – had become powerless in providing liquidity support for Wall Street’s asset-backed commercial paper, CDO, ABS, and private-label (non-GSE guaranteed) MBS markets. Rapid expansion of financial market credit (15.6% annualized!) was, at the same time, sufficient to adequately (over)finance the real economy, certainly including corporate cash-flows and household incomes and attendant ongoing massive current account deficits.

Back in 2001/02, some Wall Street analysts were keen to argue that aggressive Fed reflationary policies were required to elevate “THE price level” to ensure that deflation was not allowed to take hold. This was dangerously flawed reasoning. There was not and is not an actual “price level” within the real economy to be manipulated by central banks. Instead, inflationary policies ensured that the interrelated operations of Wall Street’s asset-based lending, securitization, and leveraged securities speculation ballooned in unimaginable excess. Resulting monetary disorder saw wildly destabilizing price inflation and distortion, especially in housing, securities and asset markets generally. U.S. CPI may have remained tame, but massive credit-induced current account deficits and the depreciating dollar set in motion credit and asset bubble dynamics in economies around the globe.

Today, the Fed confronts bursting credit bubbles throughout Wall Street finance, with resulting acute asset market vulnerability. Yet the unusual structures that permeate the U.S. Financial Sector at this time foster continuing rampant inflationary credit creation. First of all, “money-like” financial sector liabilities (i.e., agencies, “repos”, and bank/money fund deposits) are proving thus far sufficient to sustain bubble economy excesses. Second, the global recycling of ongoing massive current account deficits and speculative outflows ensures over-liquefied markets (and artificially low interest rates), including key U.S. debt instruments such as Treasuries, agencies and other perceived low-risk securities. Bubble dynamics proliferate in the face of a Wall Street bust.

The extreme divergence in liquidity conditions between bursting bubbles in Wall Street finance and still rapidly inflating bubbles in “money-like” Financial Sector liabilities poses both a major quandary and policy dilemma. Aggressive rate cuts would definitely further stoke the powerful bubbles inflating in GSE, “repo”, money fund, and bank deposit liabilities. Such ongoing Financial Sector debt expansion would likely sustain destabilizing liquidity outflows to the world, further fueling myriad global bubbles and worsening an already problematic global inflationary backdrop. A rapidly expanding U.S. Financial Sector also significantly increases the risk of an eventual catastrophic breakdown in U.S. and international financial systems. And anyway, it is likely that lower rates would have only minimal effect on the investor and speculator revulsion that has taken hold throughout the Wall Street securitization marketplace.

Those arguing for a Greenspan-style rate collapse fail to appreciate the extraordinary circumstances and risks that have accumulated from years of reckless credit bubble excess. The outcry for an audacious policy response to avert a recession is misguided. Today’s rampant Financial Sector expansion is unsustainable. There are today acute inflationary risks to go with major financial system stability issues. While the dislocation will be substantial, the sooner the bubble in financial credit is reined in the better.

We are today in the midst of dangerous “blow-off” excesses in “money-like” Financial Sector liability issuance. Few seem to appreciate that such a circumstance places the stability of the entire U.S. and global financial system at considerable risk. Wall Street is clamoring for a rate collapse and bold inflation in “money” to bailout its faltering securitization markets. At this point, this would equate to throwing massive (relatively) good “money” after bad – ensuring that a dreadful situation festers into a historic calamity. The least bad course for central bank policymaking would be to hold the line on rates, while injecting liquidity as necessary as part of a program to check credit excess and permit the economy to commence its desperately needed adjustment period.

Link here (scroll down).
Morgan Stanley posts steeper-than-forecast loss, sells stake to China – link.


Last week’s announcement by the Fed that it will create a new mechanism to provide funding for credit challenged banks has been lauded by Wall Street as an innovative approach to solving the credit crisis. In truth, it is really just the same response the Fed has had for all problems great and small: crank up the printing presses, shower money on the problem, and hope that financial pain can be obscured by the balm of inflation. Both the Fed and Washington politicians are completely clueless regarding the ill effects of the plan, and are simply acting in desperation to keep a ticking time bomb from exploding before the next election.

The Fed and other foreign central banks will provide this liquidity by auctioning low interest rate loans to holders of U.S. mortgaged-backed securities. The loans will be made under the same terms currently in use at the Fed’s “discount window”, with the added benefits of even lower interest rates and anonymity (borrowers wish to avoid the public stigma that comes from utilizing the discount window). Since the loans can be collateralized by mortgage-backed securities, the Fed will be on the hook should these loans not be repaid. In other words, the losses will simply be monetized – or more precisely socialized – as they are passed to the public in the form of inflation.

To get a sense of the losses that potentially await the public, in a recent transaction, E-Trade liquidated its entire portfolio of subprime mortgaged-backed securities for a mere 27 cents on the dollar!

The hope that this additional credit will somehow alleviate the problems in the U.S. housing market is extremely naïve. Virtually none of this newly created credit will find its way back into the domestic mortgage market. With our real estate prices still too high, the gathering potential for lenders to be forced to assume liability for “unsophisticated” borrowers, the added uncertainty regarding mortgage terms, and the persistent weakness in the U.S. dollar, such loans will be far too risky for most foreign lenders to consider. Instead, these banks will take this cheap Fed money and invest it in higher yielding assets overseas. Offloading risky U.S. mortgages to the Fed in exchange for cheap loans that can be used to finance better yielding foreign investments could well develop into the next carry-trade of choice.

The real losers will be ordinary Americans, who do not get the benefit of the newly created money, but merely suffer the consequences of rising domestic prices and a falling standard of living. With this new plan, the Fed is laying its cards on the table and its hand is a loser. If mortgage losses are socialized through inflation, this new cure will be even worse for the economy than the “housing bubble disease” the Fed infected us with in the first place.

Now that the Fed has upped the inflation ante it is time to press our bets on gold. About two weeks ago Goldman Sachs predicted that shorting gold will be the best trade of 2008. Call me cynical, but knowing Goldman Sachs, my hunch is this shrewd investment bank, recently criticized for shorting the very subprime loans it was touting to its customers, may be perusing a similar strategy with gold. Perhaps Goldman has a current short position it needs to cover or wants to buy a lot more gold, but needs to convince others to sell it to them.

Maybe Goldman will be right after all. Shorting gold could turn out to be the best trade of 2008, but not for those who short it, but for Goldman Sachs as it takes the other side of the trades. Recent moves by Paulson and Bernanke virtually guarantee that gold will rise. It is good to be the king.

Link here.


Losses on Credit Default Swaps could dwarf those on subprime mortgages.

There is a vast gap of perception between the real economy of production and jobs and the financial economy of loans and investments. The real economy, though weakening, is hardly in a state of collapse. In 2007, it has grown about 2%. Payroll jobs are up by 1.3 million. Even economists who expect a recession generally think it will be mild. Meanwhile, financial markets are described hysterically as being “in turmoil” – there is a “credit crisis”.

This contrast reflects fear of the unknown. Since 1980, America’s financial system has changed dramatically in ways that are now arousing widespread anxieties. Many loans once made directly by banks are “securitized”: packaged into bondlike securities and sold to investors (pension funds, investment houses, hedge funds and banks themselves). There has been an explosion of bewildering financial instruments – currency swaps, interest-rate swaps and other “derivatives” – that are used for hedging and speculative trading.

Until recently, the transformation seemed a splendid success. Credit markets had broadened; risk was being spread to a larger spectrum of investors. So it was said. This was an illusion. The securities containing “subprime” mortgages – loans to weaker borrowers – have experienced unexpected defaults, rating downgrades and losses. The unpleasant surprises have ignited fears among bankers and investment managers over how the new financial system operates. Credit and financial markets subsist on trust and confidence. The subprime crisis has corroded both. Estimated losses range upward from $50 billion.

The subprime debacle also posed a question: What if it is not the only problem? Consider “credit default swaps” (CDS) as a possible sequel. CDS’s are, in effect, insurance contracts on loans or bonds: The seller receives a payment and, in return, agrees to pay the buyer some or all of the amount of a designated loan or bond if the borrowing company (say, GM or IBM) defaults. But note, neither party to the CDS has to be the underlying lender or borrower. They usually are outsiders. They are simply betting on the creditworthiness of different borrowers.

Since 2004, the volume of CDS’s has increased about 7-fold. Possible losses could dwarf those on subprime mortgages, argues Ted Seides of Protégé Partners, an investment fund. In a strong economy, defaults on corporate bonds and business loans have been low. On “high yield” bonds (a.k.a. “junk bonds”), they have been about 1% recently, compared with a historic average of about 5 and 10% in recessions. As the economy weakens, junk-bond defaults will increase, Seides says. This will give rise not only to direct loan losses but to additional losses on CDS’s.

There is a pyramiding effect. The economy has become more vulnerable to credit setbacks. In theory, one investor’s CDS losses should be offset by another’s gains. In practice, Seides expects, some CDS investors themselves will default. The capital and loss reserves of banks and investment houses would suffer, limiting their ability to lend to businesses and consumers.

What ultimately matters is the connection between the financial economy and the real economy. In housing, it is clear. Subprime losses reduced mortgage lending, housing construction, sales and prices. But not all credit cutbacks have such dramatic effects. If too many junk bonds were sold at foolishly low interest rates to finance “private equity” deals – buyouts of companies – the process had to reverse someday through higher rates and fewer bonds being sold. That is not turmoil so much as the distasteful reality of retreating from dubious investments.

Despite all the bluster, evidence of a widespread credit crunch is so far scant. Though credit standards have tightened, bank lending is still increasing. Many U.S. companies have paid down short-term debt, and corporate cash flow is running at a respectable $1.2 trillion annual rate. This insulates many firms from strains in credit markets.

The obvious danger is another wave of large losses that would cripple investors, particularly banks. The Federal Reserve acted last week to forestall that possibility by creating a new lending procedure by which banks can borrow from the Fed. This provides an escape valve if the interbank market remains too unforgiving. The Fed seeks to maintain confidence without bailing out lenders from bad decisions. It is also trying to avoid recession while cutting inflation. The difficulty of reconciling all these goals may well explain the great perception gap.

Link here.


London real estate, long-term U.S. bonds, Chinese stocks top the list.

In the spirit of the endless year-end speculations about developments in 2008, I thought it worth looking at which markets – debt, equity, commodities or real estate – were most overvalued in December 2007 and hence could be expected to provide the best “bear food” for the year ahead. After all, for us bears picking losers is much more enjoyable than picking winners!

Overall, 2008 looks to be a good year for bears. The Fed has been walking a tightrope since August between the precipices of a collapsing financial system and resurgent inflation. With a 3.2% November Producer Price Index rise (7.2% over the previous year) and a 0.8% Consumer Price Index rise (4.3% over the previous year) announced last week, it can now be officially confirmed that the tightrope has vanished into thin air. The United States over the next 12 months will experience both a collapse in its financial sector and a violent resurgence in inflation, and there is nothing whatever the Fed can do about it, no interest rate trajectory that will not worsen one problem more than it alleviates the other.

If the Fed lowers interest rates further to bail out Wall Street, it will worsen inflation. Oil prices moved from $70 to $90 on the 0.75% drop in the Federal Funds rate from 5.25% to 4.50% so will surely soar to around $120 if the Fed is foolish enough to lower it to 3%, as several Wall Street and permabull commentators are calling for. Equally, if the Fed were to raise rates, even gently, in order to contain resurgent inflation, the U.S. stock market will tank and the housing finance market will suffer yet further losses. The right stance would be a significantly higher level of rates, perhaps in the 6.5%-7% range, which would be fairly close to neutral on inflation, but that would devastate stocks and housing – both necessary declines, but the Fed’s #1 objective is not to be blamed for such events. Most likely, the Fed will be frozen into immobility, keeping interest rates at or near their current levels, in which case both inflation and the housing crisis will steadily worsen, while stocks decline.

The U.S. stock market, after more than a decade of excessive and unjustified optimism, seems destined to crash several thousand points onto the rocks below. The only question is the timing. If the Fed continues to lower interest rates, it is possible that the housing decline will slow, fed as it will be by an ocean of liquidity, so that at least in the first half of 2008 optimism will once again reign. However it seems unlikely that any false dawn of this type will last long. The collapse of the securitization mechanism, and the withdrawal of confidence from asset-backed commercial paper vehicles, make it unlikely that the credit bubble can be sustained for much longer. Bank balance sheets are simply not large enough to absorb all the necessary paper.

At this point, the election comes into play. The Democrat candidate will undoubtedly be relatively protectionist, so the Republican will be forced to move towards protectionism in order to deflect Democrat attacks on a highly flawed Bush administration economic record. Consequently whoever wins in November 2008 will have made pledges on trade that he or she will find it difficult to ignore. Without the U.S. somewhere close to acting as free trade cheerleaders, the world seems likely to move into an era of beggar-my-neighbor protectionism similar to the early 1930s, although one hopes less intense than that unhappy period. Globalization will go into reverse. The brunt of the cost will be borne, not by India and China, whose economies will remain highly competitive, but by Western consumers, who will find their jobs disappearing as output declines and their living standards suffering as persistent inflation is no longer alleviated by an endless flow of ever-cheaper manufacturing and services from emerging markets.

Outside the U.S., it seems likely that the commodities boom or bubble will continue, at least for the first few months of the year. The merits of oil, gold and other commodities as inflation hedges will increasingly recommend them to the huge money pools of hedge funds and sovereign wealth funds. Gold in particular is likely to see quite a spurt – maybe heading towards the $1,500 level. Later in the year, the commodity boom will collapse, but over the year as a whole it seems unlikely that commodity prices will greatly decline.

Given the Fed’s dilemma, long term bonds must be about the most dangerous of current investments (low quality bonds being even more dangerous than Treasuries). Rising inflation will weaken their appeal as a safe haven while the tightening liquidity and increasing U.S. budget deficits in a period of U.S. slowdown will tend to drive yields higher. The Fed will be able to do nothing about this.

Housing and other real estate assets may see a modest bounce in value, or at least a slower decline, in the early part of the year as the Fed and other central banks continue trying to stimulate the world economy, producing mostly inflation. The various bailout schemes proposed by politicians will also increase confidence somewhat. Eventually however, as the market comes to realize that the U.S. housing finance market as we have known it for 30 years is dead, the house price decline will continue and indeed intensify.

Outside the U.S., the continental West European economies seem likely to have a quiet, albeit somewhat negative year. They do not have real estate bubbles in the process of bursting. German house prices are actually lower than they were 10 years ago. German mortgage banks would be thus in fine shape – if they had not foolishly speculated in the more “developed” market of U.S. mortgages.

Eastern Europe is a different matter. Too many of these economies have been borrowing internationally to finance their domestic real estate and consumption booms. While the overall trend for these economies to catch up with Western Europe seems likely to continue, balance of payments deficits in the likes of Estonia and Latvia of more than 10% of GDP are likely to prove extremely difficult to finance as international cross-border investment declines into a recession. With liquidity high in the early months of 2008, their recession may be delayed into 2009, but recession there will be.

The one exception to the moderate optimism for Western Europe is Britain, which seems likely to have a very tough year indeed. The financial services business must inevitably suffer a very poor year, and these days that business forms a very high percentage of the London economy, if not of the British economy as a whole. Further, London house prices are overvalued by at least 200% at the high end of the market, and have not yet begun to drop. Unlike in the U.S., where the first half of 2008 may see a temporary let-up in the house price decline, in London house prices will drop increasingly swiftly, with the total top to bottom drop of as much as 40-50% over the next few years.

Since most middle class Britons foolishly have their wealth largely tied up in housing, this will have a very severe negative wealth effect on consumer spending. Add in the fact that the profligate Blair/Brown government has increased public spending by more than 5% of GDP during its decade in office, producing a public sector deficit of more than 3% of GDP at the very top of an unsustainable boom, and you have the recipe for the worst downturn in Britain since 1980-82. This time, however the pain will be concentrated not in the manufacturing North of England but in overpriced service-oriented London, and on the successful over-leveraged yuppies who have rendered that city uninhabitable for those of middle incomes. About the only saving grace for the British economy will be a collapse in the value of the pound against the euro as it resumes its long term purchasing power parity of $1.50 against the dollar.

In Asia the principal loser will be China, which is already suffering from tighter credit conditions in the domestic market. Rapid Chinese growth has finally sparked off consumption, while inflation is rising fairly rapidly and real interest rates in the domestic economy remain heavily negative. At some point, Chinese domestic savings in the banking system will prove insufficient to finance both consumption and the continuing needs of loss-making state owned entities. China can solve its domestic banks’ bad debt problems by using its foreign exchange reserves – it is already doing so – but that is bound to lead to further inflation, possibly tending towards hyperinflation. It seems likely that China will in 2008 enter something like the U.S. Great Depression, albeit with high inflation rather than deflation, with an eventual drop in GDP of 20% or so and in the Chinese stock market of 75-90%. That will be extremely painful for Chinese domestic investors, and for those foreign investors who have been sucked into this highly speculative market, but like everything in China it is likely to take place quickly, so that in 5-6 years time China will once again be enjoying its rapid climb up the league tables of relative and absolute economic prosperity.

India is more difficult to read. On the negative side, Indian public spending is increasing far too rapidly, tending to crowd out more productive sectors of the economy, while rising inflation and a bubbly stock market both suggest a downturn is near. Further, the Indian political situation is unstable, with a leftist government led by an aging moderate facing elections in 2009. That seems almost certain to lead to a further bout of wasteful public spending. On the positive side, the Indian economic sectors that have liberated themselves from the dead hand of the “permit Raj” are not going away anytime soon, and seem likely to continue taking market share from their overstuffed Western competitors. On balance therefore, I would see a wobbling beginning to an Indian downturn, with inflation reaching double digits and the government resorting to dubious price control schemes to control its reported level. Further developments will await the election due in spring 2009.

The most positive economic picture will be in those countries of East Asia that have remained rather unfashionable since the Japanese bubble burst in 1990 and the East Asian economies crashed in 1997. Japan itself seems likely to continue its steady if unspectacular growth, with the growth rate accelerating if fiscal policy remains tight for 2008, the current government remains in power and interest rates are increased from their current 0.5% to a more normal level of around 2-2.5% (Japan being such a savings culture, moderately higher interest rates tend to stimulate rather than depress the economy.) Taiwan too should do well – as an economy it is extremely liquid and, unlike in 2000, the tech sector is not the focus of the currently impending downturn. However the most likely stock market winner in 2008 is South Korea, currently selling on a price-earnings ratio of only 12. Presidential elections this week and congressional elections in April will probably remove the fairly anti-business government that has hampered Korean growth since 2003 and replace it with the vibrantly pro-business Grand National Party.

So there you have it. Best bear opportunities: London real estate, long-term US bonds and Chinese stocks. Best bull opportunity (not that we bears care much about that): South Korea. Overall, a satisfactorily bearish year, darkening further in its second half.

Link here.


Wall Street’s 3-year love affair with debt sold by U.S. states and cities is over. Municipal bonds, whose returns trounced Treasuries and corporate debt from 2004 to 2006, are headed for their worst year since 1999, according to Merrill Lynch indexes. They may remain laggards after securities firms reduced their holdings during the third quarter by the largest amount in at least 12 years.

Citigroup, Goldman Sachs and the rest of the securities industry reduced holdings of municipal bonds in their trading accounts by more than 16%, to $45 billion as of September 30 from a record $53.9 billion at the end of June, according to the most recent Fed data. The sales raised yields on municipal debt relative to Treasuries and increased financing costs for state and local governments planning bond sales by as much as $320 million through 2017.

Securities firms are putting less into state and local debt after about $62 billion of writedowns on securities related to subprime mortgages. Barclays Capital estimates losses may increase by $200 billion. Subprime-related losses also hit bond insurance companies that guarantee about half of all U.S. municipal debt, weakening investors’ confidence in the AAA corporate ratings that are applied to the obligations and hurting prices last month.

Munis returned 3.02% this year, compared with 3.85% for corporate securities and 8.42% for government debt, Merrill indexes show. That is the worst performance since 1999, when state and local government debt lost 6.34%.

Municipal yields rose to the highest compared with Treasuries since 2003, data compiled by Bloomberg show. Yields on 10-year municipal bonds averaged about 93% of what the U.S. government pays, compared with 83% on average in the two years before August. Investors typically accept lower rates on state and local debt because interest is exempt from taxes.

Municipal debt has suffered as structured investment programs that sell short-term debt backed by long-term tax- exempt bonds have pulled back, CreditSights Inc. said in a report. “Their structured nature – like anything else structured in recent months – has forced investors to re-examine their true quality,” the report stated. Such “tender-option bond” programs make up almost 8% of the $2.6 trillion municipal market after being “almost non-existent at the beginning of the decade.”

Borrowing costs are also rising in part because the housing market is enduring its deepest slump in 16 years. Falling property values may slash tax revenue for states and cities by more than $6.6 billion in 2008.

“Reduced demand from some traders may keep municipal yields higher than they ought to be for an extended time,” said James Kochan, fixed-income strategist at Wells Fargo’s Funds Management Group, which oversees $3.2 billion of municipal bonds. “Eventually, buyers will emerge and we will see this was a major opportunity.”

That is the opposite of what happened a year ago, when firms such as Citigroup, the biggest U.S. bank, along with hedge funds piled into munis. “The market became more reliant on trading accounts and arbitragers, and now it faces a greater risk of capital being pulled from those kind of buyers,” Kochan said.

Municipal bond hedge funds, which helped fuel the market gains, have also reduced their investments, said Thomas Metzold, manager of the $6 billion Eaton Vance National municipal fund.

Municipal hedge fund losses through early November ranged from 5% to 30%, according to Evan Ratnow, an analyst at Fortigent, a consultant who monitors municipal hedge funds on behalf of investment advisers who control $18 billion of assets. “The funds are seeking new accounts, but their recent performance was a lot worse than some people thought possible,” Ratnow said. “On the positive side, the funds have a history of producing big gains after months with big losses.”

Link here.


“You need to consider contingency plans against the worst outcomes.”

While observing current events through the lens of history over the last few years, there have been times in which the only conclusion I could draw was that we were beginning a bear market that would prove much more severe than the one from 2000 to 2002. As fiat currency and money supplies have exploded the world over, we have seen a proliferation of products, with varying acronyms, as the financial world tries to distance itself from the risky loans it originated. My experiences, as a researcher and investment advisor, suggest that the root of the problem is in investors’ thinking. Between the fall of 2002 and the spring of 2003, multiple markets began bull runs. As 2007 comes to a close, the only lesson most investors learned from the $7 trillion loss of those years is to “hang on” when the market declines.

But while the last five years has produced substantial bull markets in a range of equity classes, it has also produced investors who have failed to read the historic accounts of how rapid credit creation ultimately ends in collapse. The need to slow down and prepare for contracting credit is lost in the fast-paced, unforgiving world of momentum trading. But those who have been reading the headlines since the first of August can plainly see that the world is rapidly shifting from one that embraces risk to one that shuns it. And as historical precedent suggests, since the credit bubble started breaking down just 4 months ago, our government, as well as those of the Europeans and Asians, have sought to intervene.

With several equity markets set to finish 2007 at or near their all time highs, you may be thinking that things are not nearly that gloomy. Two years ago, we released a research paper on short selling, aptly titled Riders on the Storm: Short Selling in Contrary Winds. Some thought it foolish to attempt to thwart the gods of modern capitalism, and I must admit it has been a rough ride. Most who hold to my line of thinking have been unheard by family, friends, and associates.

But, once again I write to encourage some and to implore others to suspend judgment for a few minutes until they have critically appraised the evidence. If you come to the conclusion that I am wrong, what has it cost you but a few minutes of your time? But if I am right, it will not matter who wrote what when, but only that, as crowd behavior shifted from greed to fear, you heard an idea that later proved to be extremely valuable.

Heard it all before?

If we see something one time, and extrapolate that the conclusion will always be the same, we stand a high chance of failure. But, if we watch multiple occurrences of similar patterns unfolding over months, quarters, and years – sometimes fast, sometimes slow – with different degrees of force and destruction, across different nationalities, cultures, and time periods, then those who ignore such data do so at their own peril. So as you read and try to gain your bearings in this unfolding market, let me share with you two hindrances, in the form of words we think or say, that are barriers to accurate assessments.

Statement #1: “Hey, if you’re so smart, how much did you make in the last twelve months?” With the Dow substantially higher than it was when I released our short selling paper, in January of 2006, you know I have heard this statement before. But, this statement reveals a fallacious understanding of how the market, and life itself, works.

First, financial history is littered with the corpses of advisors and investors who thought that things would not or could not change. Taking comfort in yesterday’s successes, we become less and less inclined to ask the question, “But why were the last 12 months good to my investment strategies?” Without asking this question, those being told they are smart and successful have no idea about how to hold on to that success should the reason for their success change course.

This is a fact that I have learned the hard way. In 1999, with no real knowledge of the history of money and credit, and with no real understanding on technical analysis and crowd psychology, I was convinced that my success was because of my two financial planning degrees and all of the reading I had done. Attending financial planning conferences and sharing success stories with other advisors advanced this belief even more. But, when prices declined rapidly in the bear market of 2000 to 2002, I saw how rare experts really are and how quickly praise can turn to criticism.

And while many continue to look in the rearview mirror as they seek to build their wealth, this practice is foolish and extremely dangerous. While some things are random, certain tendencies prove to be so strong that we call them rules. Though we do not know exactly how something will turn out, or the extremes to which a reaction will reach, we do know that if we mix certain elements together, we will get a specific reaction.

Life does not offer any of us a promise that last year’s journey, however pleasant or painful, will be duplicated in the next. When the yellow dash light is flashing “low fuel”, who expects to stay in their warm car and not stop for gas because the last 100 miles have allowed them this luxury?

Suggestion #1: If your financial strategies have presented you with very positive returns and higher asset values over the last few years, right now, ask yourself, “Why did my numbers go up in the last few years, and what will need to happen in the next few years to keep these numbers rising? If you are unwilling to address these questions initially, you will likely be forced to do so in the future.

Statement #2: “Our capital markets are huge. We have so many government and private sector experts; they will fix any foundational problems that threaten my plans and financial well-being. The next year or two may be a little rough, but the experts will make sure the markets unwind slowly.”

This statement is born out of a lack of understanding of complex societies and their attendant problems. We grow to depend on more and more experts and a bigger and bigger socialistic state to intervene to make certain that our god-given rights, to a college education for the kids and a comfortable retirement, are taken care of.

Any serious student of the Great Depression will see hundreds of parallels with the men and women of today. They watched a new era of credit explode – giving the public the illusion that they were “wealthy”. This massive amount of credit showed up in a new instrument called a car loan, and for the first time ever, an entire generation of American farmers took out farm loans.

Few ever stopped to ask, “How did we come into all of this newfound wealth?” No one was being told that, while our federal debt remained flat from the final days of the Civil War until Woodrow Wilson’s first year in office, between 1913 and 1920, it had exploded from $2.9 billion to $25 billion. Was this “random”? Should we really be surprised at how exploding debt changes a society’s perspectives? The record speaks for itself. People liked the feeling of success that debt and credit produced. Most financial leaders of the 1920s enjoyed this easier lifestyle and watching their balance sheets grow. The government “experts” enjoyed the praise they received. All of this new wealth was “justly due”.

We all know what happened. The fundamental problems went unaddressed. In an effort to keep market prices (the core of the wealth illusion) up in and after 1929, the Federal Reserve tried desperately to flood the money supply, cutting interest rates repeatedly and increasing their holding of government securities from $485 million to $2.432 billion in just 4 years.

Ignoring the fact that it was their policies of the last two decades that had produced our nation’s pain, the government presented numerous “solutions” to declining asset values. The public did not question their newfound wealth on the way up; in the same way, they looked to government and finance leaders’ promises as a means to get their prosperity back.

Ultimately a new monetary scheme, built upon a less stable foundation, was presented to the public as a “rescue”. And, the same basic thing occurred in August of 1971, when, for the first time in history, all the major currencies of the world floated solely on trust, with nothing to slow up credit and debt expansion. Though history had shown time and again the destructiveness of such a course of action, the gold-exchange standard was abandoned and paper money ruled the day.

In examining national and international experts’ speeches over the last several years, we see a recurring theme: As the “almighty” Dollar goes the way of all fiat currencies, how should global capitalism prepare? Since our tendencies are the same today as they were in the 1920s and 1930s, we should expect to endure many failed government attempts at sticking duct tape on the wings of this plane. The government will continue to try to help every one of their “major supporters” through one more day. As they try to rescue us with some new scheme for the world capital markets, we are sure to see government’s role expand. And since the world’s capital markets have made us more dependent on each other than those living in the 1930s, the next market and currency “solution” will be global, rather than national, in scope.

So, does all of this support the hypothesis of prices unwinding slowly? Let me answer with some charts clearly illustrating that standing on the wrong side of a Tsunami is already proving extremely destructive to the plans of millions. First, we see how prices can change in two of the largest holders of mortgage paper in the U.S., Fannie Mae and Freddie Mac. Next we see what can happen to two of our nation’s largest bond insurers, Ambac Financial Group and MBIA.

And in case the last few years have made us forget how fast an entire market indices’ value can change, consider the Tokyo Nikkei Average’s fall from early 2000 into 2001. Twelve months ago, most investors surmised that only a slow unwind – not a sharp plunge – was in the cards. Besides, planning for such extreme conditions was only being espoused by “gloom ‘n doomers”.

All the king’s horses.

Last Tuesday, less than two hours after the famed wizards of modern finance spoke, the Dow shed more than 300 points. The morning after the Federal Reserve cut the Fed Funds Rate for the third time this year, the Dow opened up almost 300 points from the previous day’s close before rolling over to fall more than 300 points during the day. Was there anything that could be learned prior to these swings? Were these purely random events? Or could those who understand the way banking and finance works have factored these swings into their investment strategy and thinking, before the headlines sought to explain what happened?

Exceeding its speed of ascent during the August 16th to October 11th run, the Dow has moved up over 1000 points in less than 11 trading days. Evaluating the Dow’s speed of ascent and descent would have warned investors and advisors that something unhealthy and unsustainable was developing. Those who look at the markets’ reactions through the lens of history know that today’s massive central banking interventions attempting to shore up the system are not natural and sustainable but unnatural and unsustainable.

The real problem lies in our natural tendencies. We do not believe the markets will crash because we do not want to. We enjoy the illusion of wealth that easy credit creates. With easy credit, there is no need to work for years and save, no need for politicians to ever say no, and no need to wait and do without. We do not have to look below the surface and examine the foundation of our markets and economies. If the system is experiencing a problem, liquidity is always the answer. If we encounter a slowdown, just add more liquidity. After all, it has been working for years. And the longer this arrangement persists, the more this belief is reinforced.

Though most financial professionals know very little of Ludwig Von Mises, in his 1952 edition of The Theory of Money and Credit, he says as much. Originally written in German, in 1912, one year prior to the establishment of the Federal Reserve, Von Mises observes, “If one wants to avoid the recurrence of economic crises, one must avoid the expansion of credit that creates the boom and inevitably leads into the slump.”

After the close of World War I, in his 1919 work, The Economic Consequences of Peace, even John Maynard Keynes agrees: “Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless: and the process of wealth-getting degenerates into a gamble and a lottery.”

So if what we are watching is more of a casino, what should we do? Two weeks ago, Clive Brialt, Managing Director of Retail Markets for the Financial Service Authority, the English equivalent of the FDIC or the SEC, stated, “You need to consider contingency plans against the worst outcomes. ... [A]ny such plans need to be considered well before you are engulfed by a crisis since by then it will almost certainly be too late to develop practical responses.”

Link here.


There is sometimes little to distinguish them from pinball wizards.

Scarcely a day goes by without another story of some large hedge fund blowing up due to bad bets. While many of the latest hedge fund casualties are linked to the subprime mortgage crisis, investors should not be lulled into thinking that the problem will be solved once the mortgage mess is mopped up.

Hedge funds are risky for another reason. It is extremely difficult to tell, based on past performance, whether a fund is being run by true financial wizards, by no-talent managers who happen to get lucky, or by outright scam artists.

To illustrate how easy it is to set up a hedge fund scam, consider the following example. An enterprising man named Oz sets up a new fund with the stated aim of earning 10% in excess of some benchmark rate of return, say 4%. The fund will run for five years, and investors can cash out at the end of each year if they wish. The fee is the standard “2 and 20”: 2% annually for funds under management, and a 20% incentive fee for returns that exceed the benchmark./

Although he has no investment track record, Oz has a smooth manner, a doctorate in physics and many rich acquaintances. He raises $100 million and opens shop. He then studies the derivatives market and finds an event on which the market places fairly long odds, say 9:1. In other words, it costs $.10 to buy an option that pays $1 if the event occurs and $0 otherwise. The nature of the event is unimportant. It might be a large fall in the stock market, or Florida getting hit by a Category 5 hurricane.

Next Oz writes some covered options on this event and sells 110 million of them in the derivatives market. This obligates him to pay the option holders $110 million if the event does occur and nothing if it does not. He collects $11 million on the options. To cover his obligations in case the “bad” event occurs, he uses the investors’ money plus the proceeds from the options to buy $110 million in one-year T-bills yielding 4%, which he deposits in escrow. This leaves $1 million in “pocket money”, which he uses to lease some computer terminals and hire a few geeks to sit in front of them, just in case his investors drop by.

The probability is 90% that the bad event does not occur and Oz owes nothing to the option holders. With a gross return (before expenses) of $15,400,000 (option premiums plus interest on T-bills), the investors are thrilled, and so is Oz. He collects $2 million in management fees (of which he has only spent $1 million), plus a performance bonus equal to 20% of the “excess return” (over the 4% return target), namely, 20% of $11,400,000. All in all, Oz nets over $3 million for doing absolutely nothing.

Oz can then repeat the same gambit next year. When the fund terminates after five years, the chances are nearly 60% that the unlucky event will never have occurred. Oz looks like a genius and gets paid like a genius.

While most hedge funds probably do not operate in such a transparently self-serving way, the underlying logic of Oz’s strategy is quite common: Take a position that yields high returns with high probability and extremely poor returns with low probability, and keep your fingers crossed. Credit default swaps are one example, so are bets on interest rate spreads. Such strategies are risky but not fraudulent. The manager can always argue that his opinion about the odds differed from the market odds (he was simply engaging in arbitrage).

Some steps toward protecting investors can – and should – be taken. New rules could also require managers to keep investors apprised of the fund’s downside exposure. Alternatively managers could guarantee that losses not exceed a certain level, similar to a car manufacturer offering a warranty. Although individual hedge fund managers may drag their feet, it is actually in the industry’s best interest to encourage greater regulation and transparency. Otherwise, a rising tide of failed funds could cause a collapse in investor confidence, putting both the good and the bad wizards out of business.

Link here.


For the past 2 1/2 millennia, the Lydian king Croesus has been a byword for fabulous wealth, the prime beneficiary of vast riches accumulated partly by the trading skills of his subjects and partly as a result of the copious alluvial deposits of electrum – a naturally-occurring alloy of gold, silver, and copper – which were to be found in the country’s rivers (placed there when the even more legendary Midas washed away the curse of his golden touch, we are told).

It was here in Lydia that the first stamped and standardized coins began to circulate, at the turn of the 6th century B.C. – a development which allowed for a wider monetization of trade and hence unleashed what some historians have called a “commercial revolution” across the Ancient world.

The idea that financial innovation can provide a stimulus to real activity – warranted or otherwise – is one with which we should all be very familiar, but there is a slightly darker parallel at the core of Croesus’s extreme affluence, namely, that the official Lydian coins show a suspiciously low 50-60% gold content, in sharp contrast to the 80% and higher constituency to be found in the unadulterated local alloy.

The strong implication is that, not content with earning a modest degree of seignorage from the royal mint and too impatient to wait for genuine economic growth to add to his storied pile, Croesus greatly enhanced his status as the prototypical uber-high net worth individual by practicing the world’s first recorded instance of surreptitious currency debasement and by profiting all the more from the ensuing inflation.

The analogy goes further, for Croesus, professing himself alarmed at the rise of Persian power on his borders, decided to spend some of his immense hoard in launching a pre-emptive strike on his neighbors’ upwardly-mobile ruler Cyrus (does this all sound horribly familiar?), having been bolstered in his aggression by a quintessentially Delphic prophecy that if he crossed over the border into hostile territory he would bring down a great empire.

Alas! Our Pre-o-Neocon plutocrat forgot to ask the priestess just which empire she meant exactly and nearly paid the ultimate price for “sexing up” the intelligence in this manner when, shortly thereafter, he found himself at Cyrus’s mercy, having been delivered into his conqueror’s hands during the sack of the Lydian capital, Sardis.

Even if we cannot link Croesus’s inflationary policies directly to his subsequent military humiliation, we can share Hemingway’s sour observation that for such “political and economic opportunists” as he, the “first panacea for a mismanaged nation is inflation of the currency; the second is war” and that while “both bring a temporary prosperity,” they also both lead to “permanent ruin.”

The role of gold today.

Morality tales aside, however, does this have any relevance to the role of gold in one’s portfolio today? We think the answer is, yes.

But, before expanding upon this assertion, the first thing we have to make clear is that – however ardently the goldbugs may wish it were – gold is no longer, in any sense, “money”. It does not function as the present good par excellence, the medium of exchange, the one thing universally accepted, on demand and at par, for all the other goods and services one wishes to buy with it.

In short, you cannot easily settle your bar bill with a bar of bullion, nor – under current political circumstances – are you ever likely to be able to, no matter how much better off we all might be were the yellow metal to be reinstated in its rightful place at the heart of economic life. The fact that gold is no longer money means we have to turn its historic function upside down and accept that it is no longer able to provide protection during those rare periods when money itself becomes painfully scarce, i.e., during a deflation (properly defined).

In microcosm, we can see an example of this axiom at work whenever we suffer that lesser species of contraction which is a margin-driven liquidation of market positions – hence gold’s ~7% decline when the credit crunch first began to bite in August of this year.

Conversely, ever since this uniquely liquid, highly fungible, easily storable, durable, scarce, real asset has been denied its monetary birthright by virtue of its intrinsic lack of compatibility with the workings of populist-democracy welfare states, it has had to be thought of as a kind of anti-money: one largely to be held during periods of inflation, when the impaired currency we actually use is in a dangerous overabundance.

Gold’s late run has therefore come about since the Bernanke Fed was first panicked into cutting the discount rate, since the ECB abandoned its stance of “strong vigilance” to send the Eurocopters flying over its shaky banks, and since the Bank of England begrudgingly bailed out Northern Rock (and hence all its counterparts) under explicit government duress.

The arguments may rage about exactly who, or what, was responsible for the recent financial turmoil, or to what extent it will come to affect the wider economy, but one unavoidable conclusion can already be reached: The sustained inflation of money and credit has become such an integral part of our modern way of life that our rulers fervently believe that it must never be allowed to slow (much less reverse) for fear of toppling over the whole, precarious house of cards which we have so painstakingly built about ourselves. During the past few months, the stark truth is that our central bankers have once more revealed that inflation is, and always will be, the preferred policy choice.

The prudent investor cannot afford to ignore the implications of this doctrine. He must realize that the money which he holds in his hands – and in which he routinely calculates both his profit and loss and his overall wealth – is not to be trusted. It is doomed to lose value – now at a slower, now at a faster, rate – but always diminishing in worth.

Not only must he contend with this broad, underlying current of depreciation, but he must also be aware that the quickening and slowing of its stream, as well as the twists and turns which make up its course, give rise to the business cycle itself and so make the longer-term preservation of capital an all the more difficult task to accomplish.

Forget all the fine words about containing “inflation expectations” or “preserving price stability”, from their very first incarnations in 17th century Sweden and England, central banks have been purposeful mechanisms for shoring up profligate governments (whether these are buying guns or butter without properly funding the purchase) while serving as a backstop to the inherently flawed and highly unstable practice of fractional reserve banking.

Thus, at the first sign that a crisis is about to erupt in a financial system which could only have become so perilously over-extended because of a prolonged episode of central bank laxity, the first priority will invariably be to rescue the principal culprits by dousing the wildfires raging about them with exactly the same brand of flammable liquid which was used to fuel them in the first place.

In running true to form at this particular juncture, we can only underline that we feel the price risks being run by the central banks are extraordinary. Not the least of these is the danger that the U.S. will provoke the fourth great reserve currency crisis in a century – the previous three being the abandonment of the gold standard during the Great War, the collapse of the gold exchange standard during the Great Depression, and the break-up of Bretton Woods at the start of the Great Inflation.

Since this is a chronicle of the successive adulteration of money and acceptance of a more bastardized replacement when the burdens of the previous one become too much for political expediency to bear, we can expect profound consequences to follow – social and political, as well as purely financial – if the ailing dollar does, indeed, end up being widely forsaken by its anxious sponsors.

A flight to real values might well be unleashed in such a pass, potentially boosting the price of our anti-money, gold, to unheard of heights along the way. At the same time, the full panoply of protectionism, export bans, income support, wage freezes, and the direct administration of prices – already surfacing in several countries around the world – could devastate entrepreneurial activity and usher in a nasty and protracted recession. In the 1970s, the world painfully relearned the truth that inflation and recession were not mutually exclusive. Perhaps the lesson is about to be repeated for a generation which has again forgotten the rudiments of proper, pre-Keynesian economics.

Solon’s New Deal Athens.

Back in 6th Century B.C. Lydia, Cyrus’s first impulse was to have his captured enemy, Croesus, burnt at the stake. However, soon after the faggots were lit, his royal victim could be heard plaintively uttering the name of Solon. Piqued by this, the Persian ordered the flames to be doused and inquired of his erstwhile foe what he had meant, only to be told that the famous Athenian law-giver had once warned Croesus that fortune was so fickle that it was impossible to say which man was truly fortunate until his life had finally ended and a full account of it rendered.

Recognizing true wisdom when he heard it, Cyrus immediately ordered Croesus to be spared and, indeed, went so far in his reconciliation as to make him a senior member of his council – a far-sighted piece of clemency well beyond the ken of the present era’s serial regime changers.

As for Solon, he too would have been fully at home today. A well-known establishment figure who was appointed to the archonship amid the severe credit crisis which was mowing down broad swathes of woefully over-mortgaged smallholders, Solon first absolved the sad, deluded “condo flippers” of his day of all responsibility for the unpayable debts imposed upon them by oligarchic “predatory lenders”. Next, he attempted to counteract the deflationary affects of this officially sanctioned mass default by means of a 37% devaluation of the drachma – moves which laid him open to charges that he had allowed his certain of his acquaintances (later branded the Repudiators) into the secret ahead of time, so enabling them to profit inordinately from the eventual rescue plan.

Plus ça change, for today we see Treasury Secretary Henry Paulson scrambling to prevent the contemporary mortgage crisis from worsening, while the Fed has cut rates in the face of a dollar declining at an annualized pace not that far removed from Solon’s one-off parity change.

With almost uncanny resonance, Chairman Bernanke has also been reviled for naively sounding out the opinions of the good and great immediately before he started cutting rates, while Paulson, for his part, has been accused of tipping off the members of his notorious Working Group early enough for them to take a lucrative advantage of the imminent policy easing. Neither charge, however unfounded it might be, has done much to restore confidence in either the credit system or the ailing dollar.

So, where for a gold price which has already had a spectacular – if, so far, brief – run to well beyond $800/oz? In the short run, caution must be exercised as the speculative throng on the main COMEX exchange have built up an unprecedented long position of up to 240,000 contracts. To put that into perspective, the size of the bet works out at about 745 tonnes equivalent, roughly equivalent to a four months’ mined supply of metal. With so much hot money having been brought to the party in so short a time, it is little wonder that the recent price action has been so savage.

Looking beyond this, however, consider that, over the past two years alone, broad money in the U.S., the UK, the Eurozone, and the BRIC quartet (of Brazil, Russia, India, and China) has risen a combined $11.5 trillion – equivalent to around $70,000 for every ounce of newly mined gold in that same period. Bear in mind also that the outstanding notional stock of derivatives has soared to more than $500 trillion over this horizon, representing an extra $1.7 million haystack in which to search for the poisoned needle of mathematically-abstruse, systemic risk for each and every, readily-valued, new ounce of metal brought laboriously into the broad light of day.

Such are the risks and so great is the disproportion entailed in this orgy of overtrading and speculation that a clamor has arisen on both sides of the Atlantic for the central banks to undertake yet more inflation in order to stave off a potentially damaging aftermath.

You see, no matter how big the inflationary bubble, an offsetting deflation is merely a policy choice to be avoided in its wake. No cold turkey will be endured here. No vomitive will be taken to purge the poison. Only a stiff hair of the dog administered to spare the drunk the worst of his pain.

In light of this – and with gold still some 60-65% off its CPI-adjusted peaks in dollars, deutschemarks, and in terms of U.S. average wages – we can confidently argue that while the metal may have undergone an impressive degree of reassessment already in this young century, it has hardly exhausted all its strength in this latest round of its multi-millennium struggle against the endemic evil of inflation – an inference that is likely to hold even if a misguided American electorate fails to give Ron Paul the chance to restore both the long-lost Jeffersonian Republic and the sound money, based on a true gold standard, so essential to its future maintenance.

Link here.

2008 fundamental and technical review for gold and gold stocks.

The fundamentals for gold relates to the confidence level in paper currencies. When demand outstrips supply of dollars, the value of dollars goes up. The supply of dollars has been rising steadily at an average of 10% annually from less than $1 trillion in 1980 to over $12 trillion today. The fundamentals for gold thus have much to do with the lessening demand for dollars.

When dollar denominated assets lose value, people ditch dollars. As we have meticulously documented since August, the subprime mess has been the dollar’s worst disaster in the last three decades. The subprime meltdown is now causing supposedly high-quality government sponsored debts to be selling at 70 cents on the dollar. With the subprime mess as an extensively featured headline, and global central banks coming together to combat mortgage liquidity crises by printing their own currencies to support U.S. mortgage debts prices (interestingly lead by the ECB, not the Fed!), the dollar crisis relative to other fiat currencies may have reached a climax. This means the fall of U.S. dollar index may be suspended, at least temporarily.

Last month, the Canadian dollar at one point traded at a 10% premium to the dollar, highlighting that other fiat currencies have been the main beneficiary from the current flight from the dollar. However we would like to point out the ECB-led charge in printing Euros, the slowing Canadian economy, the housing/mortgage problem in the UK, and a widening trade deficit in Australia as cases where the outlook for other countries’ respective currencies are mixed at best.

With gold already more than having tripled from its low of $250 in dollar terms, the fundamental driver for gold in 2008 will likely come from the flight from other fiat currencies besides the dollar. This means that gold and the U.S. dollar index may very well rise in tandem. Technically, the dollar index is rebounding and gold is on the verge of breaking out from the Euro, Canadian, and Australian dollars.

Gold has lagged behind oil and base metals such as copper since the commodities bull started in 2001. Theories for gold’s underperformance are many, ranging from gold’s archaic status to the famous manipulation theory. That gold’s role is archaic is rubbish. And while we believe manipulation exists, as with just about every market, its impact is very limited and dramatically hyped up. Reasons we can see for gold’s trailing performance vs. other commodities are vanishing. Technically, we can see gold is rebounding against oil and particularly copper.

While the XAU gold stock index has raced from 50 to 160 since 2001, it has failed to live up to the expectation to most investors, many of whom are looking for ‘70s style 10-baggers. The XAU is now only trading slightly higher than it was in April of 2006 when Gold was $700. Considering gold was $850 while oil was $40 in 1980, it is understandable that gold miners disappoint today since gold has yet to outperform oil and other commodities. The fundamentals for gold stocks thus look grim factoring into today’s gold price, high energy, and labor costs. Indeed many gold explorers with defined resources declined so much in price that they are selling as if gold is back to $300.

As the CEO of GoldCorp Ian Telfer puts it, gold miners are a special investment class as people buy them as a call option on gold, not necessarily for near-term earnings. Valuing gold companies based on today’s gold and oil prices is akin to driving using only the rear view mirror. Besides, many project valuations are based on a gold price substantially lower than today’s gold price. Those bearish sentiments are not typical of a top in gold and gold stocks. When projects and companies are being valued at a premium gold price to spot, then a peak is being set up. There is a simple metric in measuring such premium: the XAU over Gold ratio. Currently the ratio sits very close to a bottom.


Gold’s fundamentals have never been more bullish. The second bull phase will start as gold breaks out against all other non-dollar fiat currencies. Comparatively, gold has lagged other commodities this decade so far, but we believe that the factors driving such underperformance are reversing in gold’s favor. Gold stocks have slumped as energy and labor costs outpaced gold’s rise. We expect the pessimism about gold stocks today to turn around to eventual euphoria in due time. Fundamentally and technically gold stocks are firmly in a long term uptrend, staying put in a bull market, while some impatient gold bugs ditch their positions may just be the best prescription for the temporary winter blues. For those of you who received cash Christmas presents, you can visit our home page for our report on five all-star cash-rich resource junior companies that we like and own ourselves.

Link here.


Despite years of reform, the latest numbers show that Wall Street prognosticators are every bit as deluded and inaccurate as they ever were.

Maybe Wall Street analysts are more honest and less compromised than they were pre-SarbOx, but recent events show that they are still awful at their most important job, predicting bad news. They have not lost their habit of falling in love with the companies they cover and refusing to face unpleasant realities until everyone else has already done so. Now, eight years after they were inflating the bubble, we again have to question whether analysts do retail investors any good.

The latest evidence? Analysts have only just discovered that corporate profits in the 4th quarter are not going to be nearly as strong as they had supposed a month or two ago. The consensus view going into the quarter was that S&P 500 profits would go up 12% to 15%, a large jump coming on top of the 20% rise in last year’s 4th quarter. In light of the credit crunch, the housing collapse, and the towering price of oil, that forecast seemed highly – one might say insanely – optimistic. This it proved to be, but only after the quarter began did the consensus view finally lurch into the real world. Their growth forecast is now about 1.5% and still falling.

It has been obvious for many months that profit growth would have to slow way down simply because it could not continue at recent rates. Profits have been rising sharply the past few years, which makes sense after the hole they fell into in 2001 and 2002. But by early this year they had grown to 12% of GDP, way above their historical average of 9%. Analysts knew all this, and in case they did not, various commentators (including Fortune’s Shawn Tully) were insistently pointing it out. But the analysts, ever hopeful, chose to believe that U.S. companies would perform magic.

They still believe it. Merrill Lynch’s chief North American economist, David Rosenberg, regularly and realistically forecasts S&P 500 profit growth. He cut his 2008 forecast sharply – to zero growth – in June, even before the credit crunch. He has since cut it twice more, and it is now -3%.

But Merrill’s analysts hold a far different view. Add up their 2008 profit growth forecasts for individual S&P companies, and you get 14%. In analyst-land, 2008 is going to be another knockout year, with profits yet again growing several times faster than the economy. What is more, Merrill’s analysts have actually been increasing their 2008 growth forecasts in recent months.

How these nonsensical situations arise is no mystery. Each analyst can accept that the future may be tough overall while still believing that the companies he or she covers are special and will beat the trend. The analysts individually think they are being reasonable, but in the aggregate, they are crazy.

It is similar to what happened in subprime mortgages in recent years or stocks in the late 1990s. Many players realized the situation was not sustainable but figured they were especially perceptive and would get out ahead of the pack.

In the days of the market bubble, when many analysts failed to cut their earnings estimates until the collapse was underway, we blamed their motivation. They were afraid their firm’s investment-banking arm would lose business. That problem has at least been reduced by SarbOx and by fear of public scrutiny. But if analysts are still predicting fantasy earnings, who cares why? Individual investors are no better off than they were.

Not every analyst gets it wrong. It is always possible in retrospect to find some who hit bull’s-eyes. The trouble is, you never know who they will be. Of course, you may be tempted to believe that while analysts in general are poor, the ones you are relying on are special and will ... No, wait. We know how that turns out.

Link here.


Barclays has come out with a new ETF, the iShares S&P Global Infrastructure Index Fund (IGF), that is definitely worth considering. Infrastructure is an asset class that has interested me for some time. I believe it is crucial that a diversified portfolio have some exposure to toll roads and airports around the world because they are likely to hold up well in a U.S. slowdown.

I have written about U.S.-listed Macquarie Infrastructure Trust (MIC) several times in the last couple of years, touting it as my favorite product in the space, but IGF also seems compelling. It is probably a better way to invest in the sector than another ETF that debuted recently, the SPDR FTSE/Macquarie Global Infrastructure 100 ETF (GII).

I tend to think that infrastructure consists of two big sub groups. First, builders such as Foster Wheeler (FWLT) offer a lot of growth potential, have a high correlation to the stock market and experience a lot of volatility. Second, “maintainers” (as in maintaining a way of life) such as Auckland Airport (AIA.NZ) are steadier in price, have a low correlation to the stock market and usually offer some yield.

Utilities are often maintainers. GII is heavy weighted toward utilities, at 87%. By comparison, IGF takes a much more balanced approach, allocating 40% to utilities, 22% to highways and rails, 20% to energy storage and transportation (think pipelines), 10% to airports (a lot of airports around the world are listed on public markets) and 8.3% to public ports.

Infrastructure products offer security. The demand-driven buildup and modernization of water systems, highways, electric grids and public transportation will continue regardless of stock-market and economic cycles. This does not mean infrastructure stocks will be immune to a bear market. But if the demand driving these businesses holds steady, these stocks will hold up better in a bear market. A slowdown in the U.S. will not make the air or water in China any cleaner.

The IGF fund will have a 0.48% expense ratio. iShares does not yet know what the ETF’s initial yield will be. The country breakdown favors the U.S. at 23%, Australia at 9%, a lot of countries in Western Europe for a total of around 8%, Hong Kong and Canada at 7% each and several others with enough weight to influence the fund. One little quirk: IGF has exposure to 10 countries that each have less than a 1% weighting. I do not think any of these countries can move the needle in terms of performance, but they likely do make the fund more expensive than it might otherwise be.

Link here.
First Trust ETF joins the hunt for foreign dividends – link.


Mobs, Messiahs, and Markets explores what really keeps investors from building wealth – the space between their ears.

While those who watch and follow the advice of CNBC’s Jim Cramer or the conventional Wall Street wisdom are being treated to agonizing stock market volatility, constant readers of Bill Bonner are sleeping soundly while the price of gold hovers near new highs.

In 2003, Bonner and Addison Wiggin penned Financial Reckoning Day: Surviving the Soft Depression of the 21st Century, warning that the United States will have a “slow motion slump” or a soft depression. Near the end of Financial Reckoning Day, he provided the trade of the decade, which was to buy gold and sell the Dow, a trade that is looking good so far. “Should he stay with the trade?” Bonner asked. “We cannot say, but it’s best not to look until 2010.” Speaking in 2004, Bonner said gold is a good thing to hold “when the Vigoro hits the Mixmaster.”

Bonner and Wiggin next examined the American empire built, not on stolen riches, but debt, in their book Empire of Debt: The Rise of an Epic Financial Crisis. Their investment advice was to invest like an insider on private information and personal experience and be patient and faithful. Essential rules must be followed, such as “the traditions, the lessons of history, the distilled wisdom of generations of dead people.” And finally: “Be prepared. Say something nice to your mother. Offer a bum a drink. And buy gold.”

Political journalist Lila Rajiva has now teamed with Bonner to author another investment classic, Mobs, Messiahs, and Markets: Surviving the Public Spectacle in Finance and Politics. Bonner and Rajiva’s message is that when people stop thinking for themselves and become part of the crowd they fall prey to Do-Gooders Gone Bad (title of Chapter 1), assorted witch hunts, politicians of various stripes, romantic radicals, globalization gurus (like Thomas Friedman) and, of course, bubble-making central bankers.

This is not the book for readers looking for discussions of P/E ratios and stock price momentum. Mobs explores the thing that really keeps investors from building wealth – the space between their ears.

On Election Day 2004, voters waited in line up to five hours to cast their ballots. Dubya won because Americans feared the terrorists. But as Bonner and Rajiva point out, you are more likely to drown in your bathtub than be killed by terrorists. In fact, as many people have died of allergic reactions to peanut butter than have died at the hands of terrorists, according to government statistics. But billions of dollars are spent looking for Osama bin Laden and stringing up Saddam Hussein, while jars of peanut butter are much bigger threats to the peanut allergic.

So why is it that humans make such boneheaded moves? Rajiva and Bonner enlist the services of British anthropologist Robin Dunbar, whose work convinces him that the maximum number of people and things the human brain can cope with is around 150. Any groupings beyond that require complex rules and regulations to get the same level of cohesion that you get naturally if one sticks to nature’s limits. When humans do not have firsthand knowledge of something, “their reasoning power tends to lead them astray.”

When it comes to specific investment advice, the authors advise us to “do nothing.” Stocks and real estate are too expensive. “Gold is as close to ‘nothing’ as you can ever get,” the authors advise. But their more important point is that people do not believe they must save to get rich ... that the only way to get rich is to get lucky. And so people buy what is trendy – stocks or houses – so that no one can criticize them. People invest to satisfy “other goals, like status, respectability, and security.”

So, while the romantic young celebrate the fraud that was Che Guevara and baby boomers fall for Thomas Friedman’s nonsense, rich guys are spending millions to convince us that Islamic terrorists are at our doorstep.

The world may be getting crazier, but Bill Bonner never disappoints.

Link here.


Ever since I had my epiphany and realized that Peter Schiff had been right about the imminent collapse of the U.S. dollar, I have been meaning to write a review of his book. When the stock market became increasingly volatile, I thought, “I had really better write that review soon!” But the final straw came today, when I read that wholesale prices in November rose at the fastest rate in 34 years. Readers need to learn how to protect their wealth, while they still have some left.

Schiff is president of Euro Pacific Capital, a broker-dealer specializing in foreign markets. He is very well read in Austrian economics, and his pessimistic analyses on CNBC and other outlets have earned him the nickname “Dr. Doom”.

Just as with Ron Paul, Schiff is a staunch proponent of honest commodity money. He believes that the U.S. dollar is poised for a significant fall versus other currencies but in particular against real goods and services. Since closing the gold window in 1971, the Fed’s inflation of the money supply has been tempered somewhat by the unique position of the U.S. Foreigners, especially other governments, were willing to accumulate large reserves of dollar-denominated assets. But once the illusion is broken, the game will be over. The only thing that buoys a fiat currency’s market value is the widespread belief in its future market value. Once that belief is questioned, the green pieces of paper can become worthless. As Schiff puts it in one of his clever analogies:

Remember when Iron Mike Tyson wore the heavyweight crown, was knocking out everybody in sight, and was so fearsome it seemed inconceivable he could lose? Well, as always happens eventually, he finally met his match. Buster Douglas beat him, and after that he just kept getting beaten. It was the same Mike Tyson, but Buster had broken a psychological barrier.

Any reality check that pierces the myth that the American economy is too big to fail could begin the process of unraveling. (pp. 5-6)

Schiff then goes on to give his own knockout prediction:

Our days as the dominant economic power are numbered. The dollar is going to collapse, and Americans are going to experience stagflation on an unprecedented scale in the form of recession and hyperinflation. Those of you who act smartly and quickly by taking measures I outline later in this book not only will avoid loss of wealth but also will have positioned yourselves to prosper while your neighbors suffer a painful period of reconstruction and reform. (p. 6, italics original)

Although Schiff is remarkably well-versed in Austrian theory for someone who is not a professional economist, I do have a few quibbles with his presentation on the trade deficit. That is not a huge objection, because his ultimate purpose is to guide investors through the storm. This is really where Schiff shines. Of course he recommends getting out of dollar-denominated assets. But Schiff goes much further. He takes the reader step-by-step through the process of selecting foreign assets, and also gives pointers on buying gold.

I will not reveal all of the secrets, but let me give a great example that illustrates the sophistication of his analysis. It is really a lot more than simply, “The U.S. is going to hell in a handbasket!” In a section entitled “SHORT THE MARKET?” Schiff writes:

It’s not everybody’s cup of tea, but an investor of above-average sophistication might reasonably ask, "If the U.S. stock market is a train wreck waiting to happen, why not just sell it short?" ...

Here’s why I would recommend against doing this.

Retail brokers normally require investors to hold any short-sale proceeds in U.S. dollars usually earning no interest. The dollar, seen through my famously jaundiced eye, could lose more purchasing power than the security you sold short lost value ...

I’ve got a much better idea, which is to borrow dollars and spend them to acquire foreign income-producing assets, using the income to pay the interest. Short selling accomplishes the opposite, as you end up borrowing assets, which will probably have some intrinsic value, and acquiring dollars, which may have none. (pp. 112-113)

Beyond his diagnosis of the American economy, and the nuts and bolts of how to ride out the storm, Crash Proof is filled with all sorts of interesting tidbits. For example, he says that China’s advantage is that it is not a democracy, and this is precisely why it will be so successful in the coming decades (p. 177). On the matter of supposedly communist China, Schiff asks if the reader remembers seeing “Made in the USSR” on all sorts of products during the Cold War? Of course not. Schiff’s conclusion is that “in ‘communist China’ entrepreneurs have more freedom than they do in America. It is far easier to go into business there than here.” (p. 176)

Another interesting part of the book is Schiff’s graph of the Dow Jones Industrial Average divided by the gold price. After peaking in both 1929 and 1966, this ratio returned both times to about 1 to 1. If that were to happen today, it would mean a tremendous fall in the stock market and a huge rise in gold. Even if the ratio returned only to 2 to 1 or even 3 to 1, it would still spell a large fall for stocks and a large upswing in gold. (pp. 220-222)

Finally, to give a taste of the passion in the book, I will close with Schiff’s chilling warning of the looming choice that Americans will face:

For years the United States has been traveling a course the Nobel Prize-winning Austrian economist Friedrich von Hayek set forth in a book self-descriptively titled The Road to Serfdom. The coming economic collapse may finally bring Americans to that grim destination. But it is also possible that the same dire economic conditions will inspire a return to the country’s constitutional traditions of sound money and limited government, the foundation upon which a viable economy can be rebuilt. There is a fork in the road to serfdom. One choice leads back to freedom, and it is my fervent hope that Americans will take it. (p. 259)
Link here.
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