Wealth International, Limited (trustprofessionals.com) : Where There's W.I.L., There's A Way

W.I.L. Finance Digest :: March 2009, Part 1

This Week’s Entries :

THIRD AVENUE FUND’S DISTRESSED DEBT PLAY

Marty Whitman had a rough 2008. Now he is looking for deals in distressed debt where, he says, Third Avenue can exercise some control.

Marty Whitman is a highly respected veteran value manager. He too has been having trouble of late, even vs. his peers. His funds’ performances have lagged their benchmarks for the last three years. A pioneer in distressed debt investing, his funds have nevertheless been restricted to investing no more than 10% of assets in that class. Now Whitman wants to limit raised, in order to take advantage of all the bargains he sees around now. What about all the bargains in the stock market? “With stocks you have to worry about the market. With debt I just have to understand the contract,” he says.

Martin J. Whitman wrote the book on distressed debt investing. Literally. His 256-page tome on the subject comes out next month. Meanwhile, the 84-year-old founder and co-chief investment officer of Third Avenue Funds is aiming to write a new chapter in his own storied career by pouring up to 35% of its Value, Small-Cap Value and Real Estate Value funds into distressed debt. Currently the funds are limited to 10%, but Whitman has asked his board to approve a change.

While best known as a value stock picker, Whitman has invested profitably in distressed debt since the 1970s, and these days it is where he is most comfortable.

“With stocks you have to worry about the market,” he says. “With debt I just have to understand the contract. If my analysis is right, I will make money.” By “contract,” he means documents that spell out debt holders’ rights. It also helps to own enough of a sickly company’s debt to have a say in any reorganization.

Certainly the equity markets have given Whitman and Ian Lapey, the senior research analyst at his flagship $4.4 billion Value Fund, plenty to worry about these last couple of years. ... [T]he duo have lagged the fund’s benchmarks over the last three years.

But by shifting more dollars into distressed debt now, Whitman hopes to avoid the fate of Bill Miller and his Legg Mason Value Trust. Miller, another vaunted value manager, bought stock in Citigroup, Bear Stearns and Lehman Brothers on the way down and performed so badly in 2008 that he erased a decade of gains. At least for the decade, Third Avenue Value is beating its indexes with a 3.9% annualized return.

“Bill is a smart guy,” Whitman says of Miller. “But in this environment it is not enough that a stock is cheap. Creditworthiness is more important.”

In an interview in 2006, Whitman, decked out in a sweatshirt from his Syracuse University alma mater, said he planned to manage money as long as he was physically able. But at the time he also noted he had bought an apartment in Paris and named a successor as chief investment officer – Curtis Jensen, a former Yale student of Whitman’s who manages Third Avenue Small-Cap Value.

This time around Whitman again sported a Syracuse sweatshirt (the business school there is named for him, and he lectures there regularly) and still held out Jensen as his successor. But the brutal market seems to have wiped out any thoughts he may have had of scaling back his hours at the office. This octogenarian is doubling down. Over the past year Whitman has sunk an additional $3 million of his own money into Third Avenue Value.

Whitman’s strategy is to buy high-yield debt on the cheap in the hope that it will perform to maturity while he collects double-digit yields but to make sure he is well positioned if it does not. So, for example, he likes to buy enough of an issuer’s debt to have a say in bankruptcy court and controlling equity should a company emerge reorganized.

It is a long view that can pay off. In 1986 Third Avenue invested $17 million in the debt of Mission Insurance, a California insurer that wound up bankrupt with Whitman holding most of its debt. When Mission emerged from bankruptcy, it had no operations, some cash and $1 billion in tax losses that could be used to shelter profits. In 1997 Whitman sold a minority stake to Sam Zell, made Zell chairman and told him to acquire something. The company is now known as Covanta, which recycles garbage into electricity. The Third Avenue stake is worth $155 million.

Much of the responsibility for the successful execution of Whitman’s strategy falls these days to Michael Fineman, head of distressed debt analysis. Whitman hired him from a hedge fund in 2006 to help out after Third Avenue spent $50 million to buy $250 million in debt from Collins & Aikman, an auto supplier that wound up in liquidation. David Barse, chief executive at Third Avenue, calls the investment “one of our mistakes.” Nevertheless, Fineman impressed Whitman and stayed on with Third Avenue.

When scouting for distressed debt, Whitman and Fineman avoid “covenant-lite” debt – a term for deals where a borrower is not considered in default until it misses payments. Such borrower-friendly debt can find its way to market during boom times. It is the corporate world’s version of subprime mortgages. With tougher covenants, creditors can crack down as soon as a company's debt ratio or other financial measure gets out of line.

Here is an example of why they like to keep borrowers on a short leash. Swift Transportation, the largest owner and operator of tractor-trailer rigs in the U.S., was bought out by management in 2007 for $3.3 billion (including debt assumed) and now is worth maybe 1/4 of that (if you value the equity at nothing and the debt at market prices). Third Avenue started buying pieces of Swift’s $1.7 billion first lien loan in October 2008 at 50 cents on the dollar and paid as little as 37 cents for the debt. It now trades at 48 cents.

Third Avenue’s yield to maturity will be 29% if the loans continue to perform. Except that such a result is not what Whitman is counting on. Instead, this is what he calls a “rehab in a hurry” play. Swift, Fineman says, is “close to the line” of breaching a covenant that limits its net leverage ratio to 6.15 times. If Swift breaches, Third Avenue plans to move quickly to shape up the company. Fineman will not say exactly what it will do, but he believes Swift will be an industry survivor and that Third Avenue could eventually double or triple its money on the investment. Swift’s operating income is $409 million.

One advantage Swift has is size. Smaller truck operators have to constantly replace their rigs and trailers and sell the old ones cheap on overseas auction markets. Swift is such an important customer that it has “put back” rights, which allow it to force truckmakers to buy back old rigs at better prices. Also, says Fineman, the recession will probably claim a lot of Swift’s smaller competitors, leaving a reorganized Swift more room to grow.

Whitman and Fineman also look for “large case reorganizations,” such as the recent Nortel bankruptcy, where they can make a buck without being a big player. Third Avenue owns $79 million (face value) of Nortel senior secured debt purchased at 17 cents on the dollar. Whitman expects that a liquidation of Nortel’s assets would turn out well for Third Avenue, because the bonds were purchased so cheaply.

Last year Third Avenue bought, at par, $360 million of new notes issued by insurer MBIA that are due in 2013 and pay a 14% coupon. Whitman has had to mark the investment down to $209 million, but he believes there is still an 85% probability that these notes will pay in full. He is certainly not going to sell now, what with a 29% yield to maturity on the notes.

He figures he has got a bit of extra cushion here courtesy of Uncle Sam. MBIA could get government Troubled Asset Relief Protection funds that would not have to be repaid until after Third Avenue has its money back. (Diplomatically, Whitman disdains the pejorative term “bailout” for the government’s effort. He would rather see it as Uncle Sam pursuing an investment opportunity.)

Whitman still expects most of his investments to perform without government help. Fineman projects that the default rate on corporate junk, 6.7% last year, will climb to 8% in 2009 and 10% in 2010, then peak in the low double digits in 2011 as the covenant-lite loans are worked out. Those default rates are high, but they will give rise to a lot of buying opportunities for vulture investors.

While Whitman focuses on the Value Fund, Third Avenue’s other managers are on the prowl for distressed debt, too. The Real Estate Fund, managed by Michael Winer, who once traded distressed debt for Cantor Fitzgerald, will have an easy time finding distressed targets. The fund already lends to Land Bank, just north of Los Angeles.

Jensen, Whitman’s designated successor, has just invested $13 million of his small-cap fund in first lien debt of building supplier Ply Gem Industries, with a 28-30% yield to maturity in 2013. Third Avenue’s International Value Fund will not chase debt, because foreign laws are not as favorable to debt holders.

It is hard for an individual investor to cherry-pick distressed debt the way Whitman and his crew have. But given his long-term track record, his funds are a reasonable way to play this sector. There is no load, the expenses are comparatively low, and, if Whitman’s strategy succeeds, Third Avenue Value’s built-in capital losses will shield buy-and-hold investors from capital gains taxes for a while.

A WINNING SMALL-CAP TEAM CALLS THIS A GREAT BUYING OPPORTUNITY

You can’t eat relative performance, the old adage goes. Nevertheless, the principals behind the Natixis Vaughan Nelson Small Cap Value Fund deserve a hearing given they rank in the top 1% among their peers for the past one and three years. Moreover, they have broken even over the past five years while the S&P 500 and Russell 2000 have fallen 6% annually.

The fund appears to be in the “growth at a reasonable price” (GARP) as opposed to the deep value camp, if the stocks featured in this piece are a valid indication.

This market presents a great buying opportunity, according to principals of the Natixis Vaughan Nelson Small Cap Value Fund NEFJX. Their views carry some weight, since the fund has beaten 99% of its small-cap blend competitors over the most recent 1- and 3-year periods, and has bested 98% over five years.

It is “our chance to snap up the category-killers of tomorrow, because they are selling for a deep discount to their intrinsic underlying value,” says Scott Weber, 37 years old, who runs the fund with Chris Wallis, 40. The Houston-based twosome, known for their stock-picking prowess, have even stashed their cash position, 7% of assets, in the iShares Russell 2000 Value Index Fund (IWN).

But these days, leaving your rivals in the dust does not necessarily put you ahead. Small-caps have gotten hammered since last October, and the fund, which carries a 5.75% front load and a pretty standard 1.46% expense ratio, has lost 30.5% of its value over the 12 months through Febryary 26, compared with the 44.1% drop in the Standard & Poor’s 500 index in that span. It has fallen 8.77% a year on average for the past three years, compared with a 14.62% annual drop for the S&P. For the 5-year period, it is up 0.30% per annum, compared with the S&P’s 6.19% decline.

That outperformance helped Natixis Vaughan earn four stars from Morningstar. What is more, the returns came with only moderate volatility relative to other small-cap-value funds. Assets have more than doubled to $285 million as of February 13, from $117 million on March 1, 2004. The median market cap in the portfolio is $1.4 billion.

While they are fully invested, neither manager expects a quick turnaround for small-caps as long as access to capital is constrained and consumers keep belt-tightening. Uncertainty about what the government will or will not do in its various financial programs has further unsettled the markets. They both would prefer a sharp contraction now to a protracted decline, but admit that is unlikely as consumers pay down debt and start to save.

Smaller companies may face greater challenges from the slowing economy, but the current market affords a golden opportunity to load up on long-term bets. “We do not market-time, but we will capitalize on the inefficiencies of the market,” says Weber, who says the firm uses a 3-year time horizon to measure the success of its investments.

Wallis and Weber spend their time examining balance sheets in search of diamonds in the rough. They look for shares of companies with stable-to-improving returns on invested capital over a complete business cycle that trade at a 50% discount to their underlying asset value, and that either have a catalyst for narrowing that discount, or offer a secure dividend yield of at least 10%. They also want predictable earnings and higher profitability than their benchmark offers: A return on assets of 7%, compared to 2.4% for the Russell 2000 Value index.

Although Wallis and Weber are savvy stockpickers, they have been forced to pay more attention to macroeconomics during the last year-and-a-half.

One concession: As the credit crunch worsened in 2008, they purged the fund of any company that needed to roll over its debt within 12 months. Another: Once it became clear that the credit crisis was spilling beyond U.S. borders, they reduced exposure to global infrastructure and transport names. Finally, they reviewed commodities cycles. Because slower global growth requires less energy, they reduced their energy position to 2% at year-end from 13% in mid-2008. Still, they are not afraid to snap up cheap shares of promising companies in challenged sectors.

In one case, their confidence comes from familiarity. They use the analytic products of FactSet Research Systems (FDS) every day because – after trying Bloomberg and Thomson Reuters – they consider them the best for traditional long-only asset managers. The company aggregates information from various vendors, but makes it easy to merge it all with other portfolio applications, says Weber. He is not concerned that brokers and marginal hedge funds may disappear. They are not FactSet's core customer, Wallis says, pointing out that the main clients are money managers like themselves who can cut costs by consolidating with one provider. The small-cap fund started buying FDS at 37.76; it recently traded at 38.94. Wall Street pegs profit at $2.81 for fiscal 2009 and $3.04 in 2010.

Micros Systems (MCRS) is another longer-term opportunity with end markets – hotels and restaurants – that are under pressure. They bought the stock at 18.90, and it recently traded at 16.10. The Columbia, Maryland-based software maker provides point-of-sale software applications for restaurants and hotels to manage inventory and sales.

Wallis estimates the company has only a 30% penetration rate of its existing clients' outlets and also has an opportunity to move more aggressively into the quick-service restaurants. Hotels may present an even bigger market. By increasing market share, the company could have earnings of $1.33 in fiscal 2010 (June) and $1.51 in 2011.

One company well positioned to take advantage of the coming efficiency drive in health care is LHC Group (LHCG). The Lafayette, Louisiana-based home-health-care provider focuses on rural areas. Wallis says, “Visiting nurses are a cost-effective way to deliver patient care and improve outcomes, because it is cheaper than having a hospital provide the care.” At 20.50, the stock is just below where they started to accumulate it, at 20.65, due to concerns that Medicare reimbursements may not continue rising in light of federal-budget constraints.

But Wallis argues that a large consolidator such as LHC should gain market share if smaller operations go out of business. Earnings are expected to come in at $1.56 for 2008 and $1.99 in 2009.

With a nod to these dark days, they also like First Cash Financial Services (FCFS), a pawnshop chain and payday-lender from Arlington, Texas. They began buying it at 15.96; it was recently trading at 14.12.

Regulators have been cracking down on payday-lending practices, causing investors to pull back. However, Wallis expects that aspect of First Cash’s business to be “almost immaterial.” Instead, First Cash is expanding its Mexican pawnshop business. Earnings are expected to climb to $1.37 in 2009 before hitting $1.54 in 2010.

SIMON PROPERTIES IS A SURVIVOR

David Simon refused to prop his REIT atop a mountain of debt. Now he is ready to feast on fallen rivals.

Major obligations binding the disposition of corporate cash flows are the payment of interest to debt holders and of rents to the real estate owners, i.e., landlords. Equity holders get whatever management feels like paying out of whatever is left. If the company owns the real estate it uses in its operations, the rent payments are to itself. We are not aware of any major bankruptcies caused by a company walking away from a portion of its operating leases. The lease-holders are often willing to renegotiate the terms without involving the courts, and in a truly distressed situation have to get in line behind to debt holders – but they get to repossess their collateral without controversy. Retail leases often include terms that benefit the lessor if the lessee does well, e.g., a percentage of gross sales. Bottom line: Real estate is an asset class which has equity- and debt-like characteristics, with a risk profile between the two when it comes to probability of being paid as contracted.

The real estate bubble ca. mid-1990s to 2006 featured ridiculous prices and overbuilding. Buyers paid high multiples of inflated rents. Now the rents and multiples are going the other direction. The overbuilding aftereffects will be around for a while, how long depending on region and sector (residential, commercial, or industrial). There is no reason the wise buyer of real estate cannot do as well as the canny investor in debt or equities. In principle, real estate offers an inflation hedge similar to stocks backed by real assets. And renters will stiff their stock holders before their landlords.

This article from Forbes is about REIT Simon Property Group. David Simon was disciplined about the multiples he was willing to pay, and the margin of safety he insisted on vis a vis debt coverage. The REIT's stock is down around 2/3 from its peak, but it is not on the verge of bankruptcy as is the case for some less prudent competitors. It is selling around 7 times adjusted funds from operations – the REIT equivalent of earnings, keeping in mind that REITs have to pay most of their AFO as dividends to avoid corporate income taxation. Simon Property’s debt is low enough that their credit lines have not been pulled. Interesting? We think so.

Real estate stinks, and that goes doubly for shopping malls. David Simon's company, Simon Property Group (SPG), owns more malls than anyone else, so you would expect him to be a wreck. It turns out he is sitting rather pretty, at least compared with the competition. He is likely to emerge from this recession with additional assets purchased at bargain prices.

No question, the addition of U.S. consumers to the endangered species list poses problems. The value of Simon’s 386 properties – large shopping malls plus a few dozen outlet centers – has fallen 30% over the past two years to a recent $42 billion. This year Simon Properties’ adjusted funds from operations (net income plus amortization and depreciation in excess of necessary fix-ups) are likely to only inch ahead from 2008’s $5 a share. [“Only”? That sounds pretty good!]

The REIT’s stock, at $36, is scarcely 1/3 of what it was two years ago. The 12% of the namesake firm owned by David Simon, his father and his uncle, the company’s founders, has lost $2.9 billion in value. So what is to brag about?

“Look at the earnings power of this company,” says Simon in his office across from the state capitol in downtown Indianapolis. “We were up 8.8% last year, and that was after we took writedowns for developments we shut down.” He expects earnings per share to reach at least the same level in 2009 as last year.

What makes Simon a standout is not that its day-to-day operations are that much more profitable than those if its rivals. It is that Simon’s debt is manageable. Chicago’s General Growth Properties (GGP) and the Pennsylvania Real Estate Investment Trust (PEI) each are laboring under debts equal to 80% to 90% of the value of their properties. General Growth is desperate to roll over $3 billion in debt but has been able to get banks to extend it credit for only a few weeks at a time. Its stock has tumbled from $65 two years ago to 52 cents recently. Chairman John Bucksbaum is struggling to avert a bankruptcy filing.

Simon, who left a job with New York investment bank Wasserstein Perella [one of the LBO pioneers] in 1990 to go to work for his family’s company, retains a healthy fear of how high leverage ruined commercial property owners during the last bust. “When I came to Indianapolis, the real estate business was a basket case,” he recalls. “Dealing with that environment created a certain level of prudence around here.”

Thus Simon’s $24 billion debt load represents a loan-to-value ratio of just 58%. At that level, bankers and bond investors are still willing to lend Simon money. As General Growth and the other highly leveraged mall owners struggle to survive, Simon may thrive by picking up some of their assets on the cheap.

“This is an unfriendly credit market and what looks like a 100-year [disaster] for consumer spending,” says Green Street Advisors analyst James Sullivan. “Simon appears to be among the best equipped to emerge unscathed.”

Simon, 47, owes his good fortune not only to his conservative midwestern streak but also to skills honed as a relentless opportunist. He outbid a host of other prospective buyers, acquired Corporate Property Investors for $5 billion in 1998 and quickly flipped its most famous landmark, the GM Building on Manhattan’s Fifth Avenue, for $800 million to Donald Trump and insurer Conseco. Having unloaded the glitzy property for far more than his expected price, Simon went on to turn the two dozen shopping malls that came along with it into a highly profitable piece of his retail empire.

By 2004 Simon was growing wary of rising shopping mall prices, and shifted gears. He paid $5 billion for Chelsea Property Group (Other-OTC: CHSPP.PK), an owner and developer of outlet malls, which were out of favor among real estate investors. The knock on outlets at the time was that no sooner would one open on the outskirts of some metropolis than a rival would build a few miles away and cannibalize its business. Simon noted that Chelsea often managed to circumvent the problem by opening outlets in refurbished commercial spaces where nearby land was scarce and zoning restrictions onerous.

Simon's price (including debt assumed) was 12 times Chelsea’s net operating income – essentially, earnings before interest, taxes, depreciation and amortization [EBITDA]. That was just over half the enterprise multiple that big traditional shopping malls were fetching at the time. Weeks later General Growth paid 19 times EBITDA for shopping mall developer Rouse Co. The debt General Growth incurred to swing its deal is partly what threatens to sink it. In contrast, Simon’s Chelsea buy looks like a master stroke. Outlet malls account for more than $600 million of Simon’s EBITDA.

Now that traditional shopping malls are trading for less than half the enterprise multiples that Simon shunned in 2004, General Growth is desperately seeking to sell three of its most valuable properties, which are all in Las Vegas. With sales in excess of $1,000 per square foot, they were once thought to be worth almost $3 billion combined. These days they might go for 2/3 of that.

What says Simon about making a bid? No comment on specific properties, but he emphasizes that he aims to buy “the highest-quality real estate that adds to our franchise value.”

Says Green Street’s Sullivan: “I think you will see him buying assets in the next year or two at prices that we will later look back at and call laughably low.”

BEWARE DEFAULTING MUNIS

Municipal bonds are safe in normal times. These times are abnormal.

Historically high yields vs. Treasuries and the tax breaks have attracted unusual interest to municipal bonds. Smart? We do not know. We defer to those more knowledgeable. For those who choose to wade in those waters here is some good general advice to think about before getting specific.

California Treasurer William Lockyer is outraged. Standard & Poor’s just dropped its rating for municipal bonds issued by his financially maladroit state to single-A, the lowest of any state.

Whatever its rating, this state is not going to stiff you – probably. Munis “almost never default,” says Lockyer. Among general obligation bonds bearing an S&P rating of BBB or higher, “the likelihood of default over a 20-year period is only 0.03%,” the treasurer has been telling California’s creditors.

Creditors are not buying those odds. Credit default swaps on California debt cost three percentage points a year, or 2,000 times as much as they ought to cost with Lockyer's probability formula. What the treasurer is not saying is that during the Great Depression, just before S&P started rating munis, 16% defaulted. In 1873 the default rate was 23%.

Diversify and do not reach for yield.

How bad will it be this time around? Nobody knows. But you can do things to insulate your portfolio so you will not be wiped out in a depression. It boils down to age-old precepts for prudent investing: diversify and do not reach for yield.

As Lockyer rightly points out, defaults among taxpayer-backed bonds have been rare in recent decades. But they account for a small fraction of the $2.7 trillion in munis outstanding. Most are so-called revenue bonds, which range in quality from gilt-edged (like AAA-rated Long Island Power Authority bonds, backed by utility revenues) to the ragged (a highway through California's San Joaquin Hills, backed by tolls and rated BB-).

But municipal governments can go bust. Following the 1994 bankruptcy filing by Orange County, California, voters rejected a tax hike that was proposed so that the county could continue paying its creditors on time. Its bondholders were forced to wait an extra year to get their money back. They got their money, with interest.

In 1975 New York City defaulted on its debt, giving bondholders the choice of sitting still for a moratorium on payments or exchanging their bonds for new pieces of paper that would later turn into cash. Eventually creditors were repaid in full.

Weighed down by pension obligations, Vallejo, California last year filed the biggest municipal bankruptcy in a decade and a half. Its bonds were assumed by banks that had backstopped the debt. Bondholders continued receiving regular payments; it is unclear how much the banks will recoup.

Many cities and states now face a nasty mix of soaring pension and unemployment claims, plunging tax revenues and a plague of other fiscal woes. If state and local finances continue to deteriorate, wide-ranging defaults will quickly lead muni investors into uncharted territory because their legal rights are not entirely clear under current law, according to Todd Zywicki, a bankruptcy expert and law professor at George Mason University. Does the “full faith and credit” of a government mean the government can be compelled by a court to raise taxes in order to pay off a bond? Do not count on it.

Here are some ways to minimize your default risk.

Prefer states. History suggests it is safer to own bonds issued by a state than by an obscure town or sewer authority. At the peak of the Great Depression, 851 cities and towns were in default, but Arkansas was the only state. (Its bonds fell to 10 cents on the dollar, but creditors who hung on were eventually repaid in full.)

There is some logic to the notion that states are just too big to fail. If the federal government could not resist pressure to throw lifelines to Merrill Lynch and AIG, it is hard to imagine it would let California or New Jersey go bust. In fact the Obama Administration and members of Congress have already said they will guarantee at least some munis against default.

Prefer better states. When Alexander Chisholm sued Georgia to make good on Revolutionary War debts, the U.S. Supreme Court ordered the state to pay up. That 1793 ruling led to passage of the Eleventh Amendment barring future federal interference in similar cases. The practical result is that states have been free ever since to set their own rules for how to deal with creditors.

“It is functionally similar to what would happen if Venezuela repudiated its debts,” says George Mason’s Zywicki. (Insolvent municipalities, by contrast, are likely to file for Chapter 9 reorganizations and end up before bankruptcy judges.)

While the U.S. Constitution grants states leeway to stiff bondholders, state constitutions often constrain them. Muni bondholders spooked by California’s $40 billion budget deficit can take solace in the fact that its constitution declares it will honor general obligation bonds before all other obligations, except funding mandates for public education.

In New Hampshire, by contrast, the constitution says nothing about bondholders’ standing relative to other creditors’. (The online version of this story describes the constitutional protections afforded bondholders in a variety of states.) One way to add a measure of safety is to own only muni bonds backstopped by private default insurance. But remember: In a severe financial meltdown the insurer’s claims-paying ability is likely to be stretched, too.

Avoid most revenue bonds. Revenue bonds, which are backed by income from parking garages, sewers and other projects, are a relatively risky class of munis. Their cousins, general obligation bonds, are backed by the full taxing authority of a municipality and thus safer.

Usually, anyway. Owners of Vallejo’s revenue bonds, backed by revenues from the water district and motor vehicle license fees, have continued receiving payments without a hiccup. The city's general obligation bond creditors have no right to the revenue bonds' cash streams.

Find pre-refunded bonds. In some cases tumult spells opportunity. That seems to be the case with pre-refunded muni bonds. These are bonds that issuers plan to call and have fully collateralized with Treasury notes.

Since such munis are as safe as the Treasury notes behind them, they usually carry a tax-free yield of about 85% as much. These days, however, the pre-refunded bonds are yielding more than Treasury notes. The reason is that hedge funds have been raising cash by unloading their holdings, according to James Colby, a bond fund manager at Van Eck Global.

Van Eck has launched a new exchange-traded fund that takes advantage of this unusual situation by owning a basket of pre-refunded bonds. It boasts an average duration of just over three years and pays (net of expenses) a yield of 1.2%, which is equivalent to the pretax yield on 3-year Treasury notes. Expense ratio: 0.24% a year.

Another option is to buy pre-refunded bonds directly and hold on until they are called. In either case, the free lunch of Treasury-like safety and munilike yields is not likely to last. One hopes high stress levels for muni investors will not, either.

AVOIDING THE CAR CRASH

Car dealer AutoNation is so far steering through the miserable auto sector.

Even Toyota is getting battered by the downturn in the U.S. auto market. Toyota and Honda will undoubtedly do well come the recovery, but that may be a while from now. For those looking to speculate on a company situated to do well come turnaround in auto industry fortunes, here is an auto dealership group which appears to be good at keeping their costs in line during bad times and whose management did not lose their heads during good times.

AutoNation’s shares are selling at around $10, about 10 times operating earnings – earnings after a “one time” writedown of some store values. The balance sheet is debt-heavy, which one might expect with a real estate-intensive business. It is reasonable to assume the auto retailing business is not going to disappear, and that the marginal operators are going to get weeded out during this downturn. Small dealers with the big parking lots and skinny margins “will get obliterated,” predicts AutoNation’s CEO. The post-restructuring industry should be profitable for the efficient operators.

The American auto industry is a shambles. Two of Detroit’s three automakers are limping along on taxpayer loans and say they need billions more to stay alive. Even once mighty Toyota Motor (TM) is awash in red ink.

What, then, do Microsoft founder William Gates and hedge fund manager Edward Lampert see in this beleaguered industry? The two wealthy investors have been buying shares in AutoNation (AN), the country’s largest publicly traded dealership group.

Gates’s private investment fund, Cascade Investments, and his charity, the Bill & Melinda Gates Foundation, disclosed their stake in November and increased their holdings in January to a combined 12%, making them AutoNation's 2nd-biggest shareholder. The recent buy was at $10 a share, where it remains today.

Lampert, who controls Sears Holding, has been a longtime investor in AutoNation, serving as a director for five years until 2007. His hedge fund, ESL Investments, raised its stake last year to 45% and is looking to boost it to above 50% in exchange for capping his voting power at that level, according to AutoNation.

Gates and Lampert are not talking, but analysts see their buying as an endorsement of AutoNation Chief Executive Michael Jackson’s cost-cutting management. The Fort Lauderdale, Florida company, which owns 239 dealerships in 15 states, has not been immune to the hurricane buffeting the industry. New-vehicle sales dropped 40% in Q4, compared with 35% for the industry. But the big surprise, Goldman Sachs notes, is how deftly AutoNation has slashed costs – more than $200 million on an annualized basis, with many of the reductions coming in the 4th quarter. They include 3,650 job cuts, or 17% of the total workforce, and a 34% cut in ad spending.

For the year, AutoNation reported a net loss of $1.24 billion, most of that to write down the value of some stores. Without those charges the company netted $181 million, down 35% from 2007. Revenue fell 19% to $14.1 billion.

Jackson has been smart about where to place his bets. When he joined the company from Mercedes-Benz USA in 1999, 70% of AutoNation’s 281 dealerships sold General Motors, Ford Motor or Chrysler brands. “That scared me, because their break-even point was so high,” Jackson said. Today’s mix of franchises is 31% domestic, 16% luxury and 53% Asian import.

He has also, to a degree, protected himself from a collapse in sales. He resisted building Taj Mahal dealerships. He eschewed specialty brands like Hummer, thinking they would languish in tough times. Boy, was he right. As part of its restructuring to qualify for up to $30 billion in taxpayer loans, GM says it will dump three of its marginal brands – Hummer, Saab and Saturn – and reduce Pontiac to a few specialty cars. That will leave Chevy, Buick, Cadillac and GMC, which is good news for AutoNation. Jackson says 86% of its GM business is with Chevy.

Other public dealer groups, including Sonic Automotive (SAH), Lithia Motors (LAD) and Group 1 Automotive (GPI), are now racing to adjust (see table). They recently suspended their dividends, and Sonic said it had hired advisers to help it keep cash in the till.

Jackson expects those publicly held chains to survive but says many individually owned dealerships will not. The National Auto Dealers Association predicts 1,100 dealerships will close in 2009, bringing the total to a still unwieldy 19,110. Small dealers with the big parking lots and the skinny margins? “That business model will get obliterated,” predicts Jackson.

DELL IS DOWN, BUT HARDLY OUT

The once-mighty computer maker is getting ready for its second act.

When you are a commodity producer there is no substitute for having lower costs than your competitors. Just look at Wal-Mart. And note that while many companies claim “low-cost-producer” status or goals, there can only be one in a given industry.

Dell Computer took a dominant share of the PC market with its low-cost direct sales and cheap Far East manufacturing business model – simple to implement in principle but requiring relentless execution. Just when it seemed that Dell was ready to rule the world, in the turmoil of the Hewlett-Packard/Compaq merger, decline set in. The most important element of the decline was that Dell lost its cost advantage when a revived HP opened new plants in China.

What is the situation today? A stock selling below $9 with $5/share in cash and one of the better brand names in the tech industry, whose traditional market has matured to the point where it has decidedly cyclical characteristics. Cheap enough to raise eyebrows.

Some of Dell’s cash is earmarked to make manufacturing more efficient. The rest could probably be well used on a complementary product line acquisition, which ideally would dovetail with their distribution network and core commercial customer list. The basic bet is that Dell, led once more by founder Michael Dell, will not do anything value-substracting with the cash. It is the best time to be looking for such acquisitions since the early-1990s tech bust, we would wager.

Is Dell dead? Read technology blogs and Wall Street research about the personal-computer seller, and it is clear many commentators are thinking along such downbeat lines. After all, Dell’s business – and its shares – both resemble shrunken versions of their once-glorious selves. The company reported last week that its fiscal Q4 net income plummeted nearly 50% amid a steep downturn in sales, while its stock now trades for $8.53, far below the $58 a share it fetched in March 2000. [At the peak of the dot-com mania.]

It is far too soon, however, to hang a “Do Not Resuscitate” sign on Dell’s door. For one thing, the Round Rock, Texas, company (DELL) is sitting on $9.5 billion of cash, equal to $5 a share. Back that out of the stock price, and you are paying just $3.61 a share for a computer-wholesaling business that just netted $2.5 billion, or $1.39 a share in the fiscal year ended January 30, and could earn $1.11 in fiscal 2010. Average these estimates, and the business sports a price/earnings multiple of just under three.

You will not find Dell’s other key asset on the balance sheet, but in the executive suite. Founder, Chairman and Chief Executive Michael Dell returned to lead the company about 25 months ago, and is busily crafting a turnaround strategy to see it through some of the darkest days the U.S. has endured in decades. If Dell, the CEO, can implement his plans, which include a combination of cost cuts and new products and services – and arguably ought to include a potentially transformative acquisition – shares of Dell, the company, could get a new lease on life. And a bid, down the road, of as much as 20. Dell executives declined to comment.

For now, pessimism rules. Amid the global economic rout, PC sales have plunged, and IDC, a market-intelligence firm that tracks demand, sees a continuing erosion. Both consumers and corporations have delayed purchases. The latter is particularly painful for Dell, as corporate buyers still account for almost 2/3 of its sales, which topped $13.4 billion in its latest fiscal year.

Dell is more exposed to the PC slump than either Hewlett-Packard (HPQ) or Apple (AAPL), both of which also recently reported disappointing earnings. The toll was apparent in Dell’s Q4 results: Revenue fell 16%, to $13.4 billion, and earnings from operations slumped 30%, to 29 cents a share, two pennies more than the market’s subdued expectations. Nor did management say anything to dispel the gloom.

In a conference call with analysts, Dell executives focused on the company’s cost-cutting initiatives, particularly a plan to eliminate $4 billion in costs in the four years ending 2011. That is commendable, and overdue. In the past three years, Dell has lost the competitive edge it enjoyed for so long from its low-cost assembly lines, mainly because rivals like HP have been opening even lower-cost plants in China. Now it is Dell’s turn to play cost catch-up.

The company’s other turnaround efforts have borne little fruit so far. Plans to boost higher-margin server and services sales have stalled, while a deliberate move away from direct consumer sales via the Internet has flopped. Although Dell PCs can now be purchased in 24,000 retail outlets, including Wal-Mart and Best Buy stores, Dell gets only 2% more revenue from the consumer than it did a year ago.

Nothing came, either, of last year’s carefully leaked rumors that Dell would try to leverage its brand name with a planned MP3 music player and smart cellphone. But that is probably a good thing. It is difficult to see what Dell could bring to a party that includes Apple’s iPod and iPhone, and Research In Motion’s (RIMM) BlackBerry.

“A revitalized Dell must first accept that the Dell of 1999 is gone forever, and that the company must go down a new and different road to prosper,” says Richard Kugele, an analyst at Needham.

First, says Kugele, the company should accept that expansion into consumer products like smart phones would be stupid, as would any grand plan to try to grow consumer PC sales. It would be best, he argues, for Dell to expand in its core commercial market via the sale of higher-value software and services. But the only way for Dell to “really make itself over” would be through an acquisition, he says, noting that NetApp (NTAP), a leading provider of storage and data-management solutions, and Accenture (ACN) might make logical targets.

For that matter, Dell itself could become a takeover target, given its sterling brand, entrenched manufacturing network and not least, that stash of cash. That the patient is under the weather is all too clear. But nearing death’s door? Not a chance.

NO SHORT AND SHALLOW FOR ASIAN SLIDE

The case for global equities seems strong, in part because terrorism is peaking.

Emerging stock markets have been hammered mightily in the worldwide stock market rout of the last year. Was there actually something to the bullish fundamental stories which inevitably came out of the woodwork to justify the previously strong stock market performances?

Looking beyond the valley the case is made here that the rest of the world will benefit not just from the re-emergence of emerging markets overall but – most intriguingly – demographic trends which will see young (age 15-29), terrorism-prone, men decline in population relative to their more level-headed elders. Relative peace will break out, leading to declining risk premiums and higher higher earnings multiples for emerging markets stocks. It is a nice thought.

Much of Asia has reported big drops in 4th-quarter GDP due to falling exports. That is likely to continue, since falling exports have secondary effects on fixed investment and export-industry wages.

“Far from representing a one-off drop in activity that will be reversed in Q1, the synchronous Q4 Asian GDP decline should be prolonged,” suggesting that Asian markets will lag the Standard & Poor’s 500 for sometime, writes Lombard Street Research.

“It is ... still hard to make a case for buying [non-Japan Asia] risk assets, including currencies, corporate bonds or equities,” echoes Sanjay Mathur of Royal Bank of Scotland.

The Nikkei is down 14.6% this year, the Hang Seng 11%, Korea 5.5%, India 7.8% and Australia 10.2%.

The Shanghai Composite, on the other hand, is up 14.4% over the last two months – rebounding after a hard knock amid speculation that new bank loans were being spent on stocks, says Jing Ulrich of JPMorgan Chase. Meanwhile, multiples are expanding in China, despite earnings downgrades, which will probably “intensify as China’s FY 2008 earnings season kicks in,” writes Michael Kurtz of Macquarie Securities. Analysts on average think earnings for MSCI China fell 3.5% in 2008, and will rebound 2.8% this year. Kurtz, on the other hand, thinks they will fall 6% this year.

Morgan Stanley has revised its earnings estimates for all emerging markets to a 25% drop, versus 20% previously. Yet it sees the earnings recession ending in December – 17 months after it started – and earnings to jump 20% next year. We will see. On that basis, Morgan Stanley says, the emerging markets index is valued at 9.9 times earnings and 1.4 times book for 2009, 8.2 and 1.2 for 2010.

Looking out even longer, the case for global equities seems strong, in part because terrorism is peaking, avows Ajay Kapur, the global strategist at Mirae Asset Global Research, the Seoul-based fund manager. Kapur, formerly a Citigroup strategist, does not credit any policies to combat terrorism, just demographics.

Says Kapur, “My thesis is real simple. Axiom One: Young men generate almost all violence/conflict. Assumption One: The relative supply of young men is about to decline in most problem areas. Ergo: The supply of global violence/conflict has peaked out, with some exceptions, despite current anchored thinking.”

Kapur sees a sharp drop in what he calls “projected youth-bulge ratios” – the universe of young men aged 15 to 29 divided by men aged 30 to 50 – for some of “the most conflict-prone countries in the world.” In 2000, 96 countries had a youth bulge exceeding 100%. He sees that falling to 84 countries in 2010, 75 in 2015, and to 65 in 2020. Most of what remains will be in Sub-Saharan Africa, where mortality rates have been distorted by the AIDS crisis. Kapur draws heavily from the work of Henrik Urdal of the International Peace Research Institute, published by the World Bank in 2004.

In Pakistan, he says, the youth bulge will remain high into 2015, “then drop sharply into 2020. The Indian youth bulge is highish now, but drops sharply into 2020. Afghanistan will remain problematic all they way into 2020 and actually deteriorates! I foresee Afghanistan and Pakistan to remain the epicenter of violence for some time to come.” He sees “sharply reduced” youth bulges in the Middle East, including Israel.

“The relative abundance of angry young men in faraway, potentially dangerous lands is about to fade away,” Kapur writes. “Their numbers will shrink relative to phlegmatic middle-aged and older men, this outcome predetermined by reproductive decisions already made years ago ... the potential enemy combatants will simply fall victim to middle age over the next decade ... There will still be random acts of terrorism, but the frequency should decline.”

Is it actionable as an investment thesis, as Kapur believes? There are doubters, of course. But Kiril Sokoloff, president of 13D Research, which studies global markets, calls the thesis “brilliant.”

Kapur says “good things” lie ahead for global equities in the next five to 10 years, as risk [premiums] fall in response to greater peace. The greatest beneficiary will not be Asia – in India, the decline in the youth bulge will be “good but not great” – but in the Middle East and North Africa, where the changes are most dramatic. He likes Powershares MENA Frontier Countries exchange-traded fund (PMNA). He also claims that more competitive military spending by emerging countries makes the iShares Dow Jones U.S. Aerospace & Defense ETF appealing (ITA). Under such circumstances, emerging-markets investment banks, fund managers and brokers, tourism and leisure stocks also look attractive. In more ways than one, that is quite a reversal.

GOLD HAS BEEN BOLTING HIGHER, BUT MINERS HAVE DONE EVEN BETTER

Last year while gold was just about the only asset besides cash which avoided the financial markets debacle, the Philadelphia Gold Silver Index lost about 30% – better than the stock market as a whole, but far from the safe haven the metal itself was.

Doug Casey has argued that mining shares are very undervalued vs. the metals themselves, and indeed the ratio of the Philly index to the price of spot gold fell to roughly 10% last year, its lowest level in 25 years. It is still not far above that. Casey and others such as Rick Rule also warn that precious metals mining is a crappy business, like the airline industry. These suckers and not buy-and-forget-them investments.

Mining stocks have been better than gold over the past several months – a trend that some fund managers specializing in the sector expect to persist. The Philadelphia Gold Silver Index (XAU) closed at 119.24 Friday (2-27) – up 87% from its October intraday low. In comparison, most-active April gold on the Comex division of the New York Mercantile Exchange closed at $942.50, up 37% from its October bottom.

"We look for that trend to continue in 2009," says Mark Johnson, portfolio manager with the USAA Precious Metals and Minerals Fund (USAGX). It is happening because, "with the recession, the input costs of mining gold have dropped considerably across the board." The decline in oil from $147 a barrel in July, to lows below $40 in each of the past three months is significant for mining operations. Johnson points out that diesel fuel for trucks can amount to 20% of the cost at a typical mine. Other expenses are also lower, such as the large, heavy-duty tires used in open-pit operations, and the steel used for supports in underground mines and balls used to grind the ore, Johnson adds.

"So you are getting a big margin expansion," Johnson says. "That is why the stocks have been outperforming lately relative to the commodity."

Furthermore, the recent rally in gold – underpinned by safe-haven demand due to financial-sector uncertainties – means that producers of the metal are getting more revenue for their product, says John Hathaway, portfolio manager of the Tocqueville Gold Fund (TGLDX).

In fact, the combination of a recession that means low costs for industrial commodities and the "monetary havoc" boosting gold prices is "the best of all possible worlds for gold shares," Hathaway adds. The metal was down 6% on the week as it corrected from a 7-month high, while the XAU lost 10% last week.

The current situation is a reversal of what happened in 2008 – when gold held up as investors sought safety amid the financial crisis but mining shares suffered. For the year, the XAU lost 29% while Comex April gold was nearly flat, up 1%. Stocks of gold companies fell last year in sympathy with the overall equity market, says Rachel Benepe, co-portfolio manager with First Eagle Gold Fund (SGGDX). Also, credit markets dried up, denying funding for capital-intensive mining operations. And with stocks tanking, companies did not undertake share offerings to raise capital. "People began to worry about what projects were going to get funded," Benepe says. "So they were kind of in a holding pattern."

Now, she says, "the mining industry should be poised to have a good year. They should see costs come down. As long as the price holds up, they should be in a period where their margins should expand."

The ratio of the XAU mining index to the price of spot gold fell to roughly 10% last year, its lowest level in 25 years, Hathaway says. Normal is around 20% to 30%.

"In recent months, we are seeing a catch-up and restoration of normality, although we still have a good ways to go for that old relationship to be back in its historical range," Hathaway says.

ECONOMIC RECOVERY REQUIRES CAPITAL ACCUMULATION, NOT GOVERNMENT “STIMULUS PACKAGES”

Ludwig von Mises and Henry Hazlitt will have the last work yet.

Professor George Reisman was a student of Ludwig von Mises and is a translator of Mises's work. Reisman's magnum opus is Capitalism: "A complete and integrated understanding of the nature and value of human economic life." Short of reading one of Reisman's extended treatises, this article from Reisman will help one understand why overall economic well-being is aided by government "stimulous packages" about as much as sick people were helped by bleeding them in the 18th century.

Here is the bottom line: As long as the government pursues policies which destroy capital the market is acting rationally in marking down the value of the capital stock.

Capital, Saving, and Our Economic Crisis

Imagine an individual who is lethargic and lacks the energy to function at his normal level because of too little sleep. There are drugs that can make him feel fully refreshed, even after a night without any sleep whatever, and apparently capable of functioning the next day with full efficiency.

Nevertheless taking such drugs is definitely not a good idea. This is because the individual's underlying problem of insufficient sleep is not only not addressed by his being stimulated but is actually worsened. For the stimulus further depletes his body's already diminished energy reserves and takes him down the path of utter exhaustion.

This description applies to the current slowdown in our economic system and to the efforts to overcome it through the use of "fiscal policy" and its "stimulus packages." The meaning of these terms is more government spending and lower taxes specifically designed to promote consumption. This includes giving income-tax refunds to people who paid no income tax and who, because of their low incomes, can presumably be most counted on to rush out and consume more as soon as additional funds are put in their hands.

The main difference between such economic "stimulants" and pharmaceutical stimulants is that the economic stimulants will not succeed even in temporarily restoring the economic system to anything approaching its normal level of activity.

An economic system entering into a major recession or depression is in a situation very similar to that of our imaginary, sleep-deprived individual. All that one need do is substitute for the loss of the sleep required for the body's proper functioning the loss of something required for the proper functioning of the economic system.

Capital

In the case of the economic system, that something is capital. The economic system is not functioning properly because it has lost capital. Capital is the accumulated wealth that is owned by business enterprises or individuals and that is used for the purpose of earning profit or interest.

Capital embraces all of the farms, factories, mines, machinery and all other equipment, means of transportation and communication, warehouses, shops, office buildings, rental housing, and inventories of materials, components, supplies, semi-manufactures, and finished goods that are owned by business firms.

Capital also embraces the money that is owned by business firms, though money is in a special category. In addition, it embraces funds that have been lent to consumers at interest, for the purpose of buying consumers' goods such as houses, automobiles, appliances, and anything else that is too expensive to be paid for out of the income earned in one pay period and for which the purchaser himself does not have sufficient savings.

The amount of capital in an economic system determines its ability to produce goods and services and to employ labor, and also to purchase consumers' goods on credit. The greater the capital, the greater the ability to do all of these things; the less the capital, the less the ability to do any of these things.

Saving

Capital is accumulated on a foundation of saving. Saving is the act of abstaining from consuming funds that have been earned in the sale of goods or services.

Saving does not mean not spending. It does not mean hoarding. It means not spending for purposes of consumption. Abstaining from spending for consumption makes possible equivalent spending for production. Whoever saves is in a position to that extent to buy capital goods and pay wages to workers, to lend funds for the purchase of expensive consumers' goods, or to lend funds to others who will use them for any of these purposes.

It is necessary to stress these facts because of the prevailing state of utter ignorance on the subject. Such ignorance is typified by a casual statement made in a recent New York Times news article. The statement was offered in the conviction that its truth was so well established as to be non-controversial. It claimed that "A dollar saved does not circulate through the economy and higher savings rates translate into fewer sales and lower revenue for struggling businesses." (Jack Healy, "Consumers Are Saving More and Spending Less," February 3, 2009, p. B3.)

The writer of the article apparently believes that houses and other expensive consumers' goods are purchased out of the earnings of a single week or month, which is the normal range of time between paychecks. If that were the case, no savings would be necessary in order to purchase them. In fact, of course, the purchase of a house typically requires a sum equal to the purchaser's entire income of three years or more; that of an automobile, the income of several months; and that of countless other goods, too large a fraction of the income of just one pay period to be affordable out of such limited funds.

In all such cases, a process of saving is essential for the purchase of consumers' goods. The savings accumulated may be those of the purchaser himself, or they may be borrowed, or be partly the purchaser's own and partly borrowed. But, in every case, savings are essential for the purchase of expensive consumers' goods.

The Times reporter, and all of his colleagues, and the professors who supposedly educated him and his colleagues, all of whom spout such nonsense about saving, also do not know other, even more important facts about saving. They do not know that saving is the precondition of retailers being able to buy goods from wholesalers, of wholesalers being able to buy goods from manufacturers, of manufacturers, and all other producers, being able to buy goods from their suppliers, and so on and on. It is also the precondition of sellers at any and all stages being able to pay wages.

Such expenditures must generally be made and paid for prior to the purchaser's receipt of money from the sale of his own goods that will ultimately result. For example, automobile and steel companies cannot pay their workers and suppliers out of the receipts from the sale of the automobiles that will eventually come in as the result of using the labor and capital goods purchased. And even in the cases in which the payments to suppliers are made out of receipts from the sale of the resulting goods, the seller must abstain from consuming those funds, i.e., he must save them and use them to pay for the capital goods and labor he previously purchased.

In contrast, the Keynesian reporters and professors believe that sellers do nothing but consume or hoard cash. They are too dull to realize that if that were really the case, there would be no demand for anything but consumers' goods. This becomes clear simply by following the pattern of the Keynesian textbooks in allegedly describing the process of spending.

Thus a consumer buys, say, $100 dollars worth of shirts in a department store. The owner of the department store, following his Keynesian "marginal propensity to consume" of 0.75, then buys $75 worth of food in a restaurant, and allegedly hoards the other $25 of his income. The owner of the restaurant then buys $56.25 (0.75 x $75) worth of books, while allegedly hoarding the remaining $18.75 of his income ... and so on and on. Now, unknown to the Keynesians, if such a sequence of spending actually took place, all that would exist is a sum of consumption expenditures and nothing else.

The fact is that most spending in the economic system rests on a foundation of saving. The seller of the shirts will likely save and productively expend $95 or more in buying replacement shirts and in paying his employees and making other purchases necessary for the conduct of his business, and perhaps only $5 on consumption. And so it will be for those who sell to him, or to the suppliers of his suppliers, or to the suppliers of those suppliers, and so on.

Any business income statement can provide a simple confirmation of such facts. The ratio of costs to sales revenues that can be derived from it, is an indicator of the ratio of the use of savings to make expenditures for labor and capital goods relative to sales revenues. For the costs it shows are a reflection of expenditures for labor and capital goods made in the past. The saving and productive expenditure out of current sales revenues will show up as costs in the future. The higher is the ratio of costs to sales, the higher is the degree of saving and productive expenditure relative to sales revenues. A firm with costs of $95 and sales revenues of $100 is a firm that can be understood as saving and productively expending $95 out of its $100 of sales revenues. This relationship applies throughout the economic system.

Hoarding Versus Saving

To the extent that "hoarding" or, more accurately, an increase in the demand for money for cash holding takes place, it is not because people have decided to save. What is actually going on is that business firms and investors have decided that they need to change the composition of their already accumulated savings in favor of holding more cash and less of other assets.

For example, an individual may decide that instead of being 90% invested in stocks and other securities and having only 10% of his savings in cash in his checking account, he needs to increase his cash holding to 20 or 25% of his savings.

Similarly, a corporation may decide that it needs to increase its cash holding relative to its other assets in order to be better able to meet its bills coming due. Indeed, this is happening right now as more and more firms find that they can no longer count on being able to borrow money for such purposes.

Furthermore, the increases in cash holdings that take place in such circumstances are not only not an addition to savings but occur in the midst of a sharp decline in the overall amount of accumulated savings. For example, the increases in cash holdings that are taking place today are in response to a major plunge in the real estate and stock markets, of numerous and sizable corporate bankruptcies, and of huge losses on the part of banks and other financial institutions.

All of this represents a reduction in asset values, i.e., in the value of accumulated savings. People are turning to cash in order to avoid further such losses of their accumulated savings. Of course, widespread attempts to convert assets other than cash into cash, entail further declines in the value of accumulated savings, since the unloading of those assets reduces their value.

Accumulated savings in the economic system have fallen by several trillion dollars, and nothing could be more incredible than that, in the midst of this, many people, including the great majority of professional economists, fear saving and think that it is necessary to stimulate consumption at the expense of saving. Such is the complete and utter lack of economic understanding that prevails.

One might expect that a group of people such as most of today's economists, who pride themselves on their empiricism, would once and a while look at the actual facts of the world in which they live, and, in the midst of the loss of trillions of dollars of accumulated savings, begin to suspect that there might actually be a need to replace savings that have been lost rather than do everything possible to prevent their replacement.

Depressions and Credit Expansion

The loss of accumulated savings is at the core of the problem of economic depressions. Recessions and depressions and the losses that accompany them are the result of the attempt to create capital on a foundation of credit expansion rather than saving. Credit expansion is the lending out of new and additional money that is created out of thin air by the banking system, which acts with the encouragement and support of the government. The money so created and lent has the appearance of being new and additional capital, but it is not.

The fact of its appearing to be new and additional capital creates an exaggerated, false understanding of the amount of capital that is available to support economic activity. Like an individual who believes he has grown rich in the course of a financial bubble, and who is led to adopt a level of living that is beyond his actual means, business firms are led to undertake ventures that are beyond their actual means.

For an individual consumer, the purchase of an expensive home or automobile in the delusion that he is rich later on turns out to be a major loss in the light of the fact that he cannot actually afford these things and would have been better off had he not bought them. In the same way, business construction projects, stepped up store openings, acquisitions of other firms, and the like, carried out in the delusion of a sudden abundance of available capital, turn out to be sources of major losses when the delusion of additional capital evaporates.

Credit expansion also fosters an artificial reduction in the demand for money for cash holding, which sets the stage for a later rise in the demand for money for cash holding, such as was described a few paragraphs ago. The reduction in the demand for money for cash holding occurs because so long as credit expansion continues, it is possible for business firms to borrow easily and profitably and thus to come to believe that they can substitute their ability to borrow for the holding of actual cash. The rising sales revenues created by the expenditure of the new and additional money that is lent out also encourages the holding of additional inventories as a substitute for the holding of cash, in the conviction that the inventories can be liquidated easily and profitably.

Recessions and depressions are the result of the loss of capital in the malinvestments and overconsumption that credit expansion causes. The losses are then compounded by the rise in the demand for money for cash holding that subsequently follows. They can be further compounded by reductions in the quantity of money as well, such as would occur if the losses suffered by banks resulted in losses to the banks' checking depositors. (Checking deposits are part of the money supply, indeed, the far greater part. In such cases, they would lose the status of money and assume that of a security in default, which would render them useless for making purchases or paying bills.)

The Housing Bubble

Our housing bubble is an excellent illustration of the malinvestment and overconsumption caused by credit expansion. Perhaps as much as $2 trillion or more of capital has been lost in the construction and financing of houses for people who, it turned out, could not afford to pay for them. The housing bubble was financed by the creation of $1.5 trillion of new and additional money in the form of checking deposits created for the benefit of home buyers.

The creation of these deposits rested on the readiness of the Federal Reserve System to create whatever new and additional supporting funds were required in the form of bank reserves. In the three years 20012004, the Federal Reserve created enough such funds to drive the interest rate paid on them, i.e., the Federal Funds Rate, below 2%. And from July of 2003 to June of 2004, it created enough such funds to hold this rate down to just 1%. The end result was a substantial reduction in mortgage interest rates and thus in monthly mortgage payments, which served greatly to increase the demand for houses.

Government also greatly contributed specifically to loans being made to homebuyers who were not creditworthy. It did this through its various loan-guarantee programs, carried out by Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development; and by means even of outright extortion, though the Community Reinvestment Act, which required banks to make sufficient such loans as would satisfy local "community groups."

In physical terms, the result of credit expansion was the passage of literally millions of houses that represented capital to the firms that built them, and to the banks and others that financed them, into the hands of consumers who not only had not contributed anything remotely comparable to the wealth and capital of the economic system but also had no realistic prospect of ever being able to do so. The further result has been that many of the builders of these houses are now ruined as are many of the banks and other investors that financed the construction and sale of those houses. And because so many lenders have lost so much, the business firms that depend on them for loans can no longer obtain those loans, and so they must close their doors and fire their workers.

The growing problem of unemployment that we are experiencing and the accompanying reduction in consumer spending on the part both of the unemployed and of those who fear becoming unemployed is the result of this loss of capital, not of any sudden, capricious refusal of consumers to spend or of banks to lend. Indeed, the kind of consumer spending that so many people want to revive and encourage, by means of "stimulus packages," played a major role in the loss of capital that has taken place and now results in unemployment and impoverishment.

During the housing boom, millions of owners of existing houses thought that they were growing rich as the result of the rise in the prices of their homes and that they could actually live to a substantial degree off the accompanying increase in the equity in their homes. They borrowed against the increased equity and spent the proceeds. This consumption was at the expense of capital investment in the economic system, which was rendered correspondingly poorer by it. And when housing prices collapsed, and fell below the enlarged mortgage debts that had been taken on, the effect was to add to the losses suffered by lenders. This was the case to the extent such equity-consuming homeowners then walked away from their homes, leaving their creditors to lose by the decline in the price of their homes.

Keynesian Ignorance and Blindness

The immense majority of people, including, of course, most professional economists, are ignorant of the actual nature and cause of our financial crisis. This is because they are ignorant of the role of capital in the economic system. They are all Keynesians. (Even Milton Friedman, the alleged arch-defender of capitalism is reported to have said, "We are all Keynesians now.")

But as von Mises so aptly put it, "The essence of Keynesianism is its complete failure to conceive the role that saving and capital accumulation play in the improvement of economic conditions." (Planning for Freedom, 4th ed., p. 207. Italics in original.) In the eyes of Keynes and his countless followers, economic activity begins and ends with consumption.

So deeply do people hold the view that consumption is everything, that it blinds them to obvious facts. Thus, the present crisis has been well underway at least since the late spring of 2007, when the sudden collapse of two large Bear Stearns hedge funds occurred. This was followed by a continuing string of bankruptcies between June of 2007 and August of 2008 of significant-sized and fairly well-known firms, such as Aloha Airlines, Levitz Furniture, Wickes Furniture, Mervyns Department Stores, Linens N' Things, IndyMac Bank, and Bear Stearns itself. The list includes an actual run on a major bank – Northern Rock in Great Britain – in September of 2007, probably the first such run since the 1930s.

Financial failures reached a crisis point in September of 2008, with the collapse of such major firms as American International Group (AIG), Lehman Brothers, and the Halifax Bank of Scotland. These were followed by the bankruptcy of Fannie Mae and Freddie Mac, the two giant government-sponsored mortgage lenders that had led the way in guaranteeing sub-prime mortgages to borrowers who could not repay them.

Yet as late as September of 2008, the unemployment rate in the United States was no more than 6.2% and at mid-month the Dow Jones Industrial Average was still well above 11,000.

All this confirms that the crisis did not originate in any sudden refusal of consumers to consume or in any surge in unemployment. To the extent that unemployment is growing and consumption is declining, they are both the consequence of the economy's loss of capital. The loss of capital is what precipitated a reduction in the availability of credit and a widening wave of bankruptcies, which in turn has resulted in growing unemployment and a decline in the ability and willingness of people to consume. The collapse in home prices and the more recent collapse in the stock market have also contributed to the decline in consumption, and probably to an even greater extent, at least up to now. Both of these events are also an aspect of the loss of capital and accumulated savings.

What Economic Recovery Requires

What all of the preceding discussion implies is that economic recovery requires that the economic system rebuild its stock of capital and that to be able to do so, it needs to engage in greater saving relative to consumption. This is what will help to restore the supply of credit and thus help put an end to financial failures based on a lack of credit.

Recovery also requires the freedom of wage rates and prices to fall, so that the presently reduced supply of capital and credit becomes capable of supporting a larger volume of employment and production, as I explained in "Falling Prices Are Not Deflation but the Antidote to Deflation," which was my first article in this series. Recovery will be achieved by the combination of more saving, capital, and credit along with lower wage rates, costs, and prices.

In addition, recovery requires the rapid liquidation of unsound investments. If borrowers are unable to meet their contractual obligation to pay principal and interest, the assets involved need to be sold off and the proceeds turned over to the lenders as quickly as possible, in order to put an end to further losses and thus salvage as much capital from the debacle as possible.

In the present situation of widespread financial paralysis, firms and individuals can be driven into bankruptcy because they are unable to collect the sums due them from their debtors. Thus, for example, the failure of mortgage lenders would be alleviated, if not perhaps altogether avoided in some cases, if the mortgage borrowers who were in default on their properties lost their houses quickly, with the proceeds quickly being turned over to the lenders.

In that way, the lenders would at least have those funds available to meet their obligations and thus might avoid their own default. In either event, their creditors would be better off. In helping to restore the capital of lenders, or what will become the capital of the creditors of the lenders, quick foreclosures would serve to restore the ability to originate new loans.

Recovery requires the end of financial pretense. There are banks that do not want to see the liquidation of various types of assets that they own, notably, "collateralized debt obligations" (CDOs). These are securities issued against collections of other securities, which in turn were issued against collections of mortgages, an undetermined number of which are in default or likely to go into default. The presumably low prices that such securities would bring in the market would likely serve to reveal the presence of so little capital on the part of many banks that they would be plunged into immediate bankruptcy. To avoid that, the banks want to prevent the discovery of the actual value of those securities. At the same time, they want creditors to trust them. Yet before trust can be established, the actual, market value of the banks' assets must be established, even if it serves to bankrupt many of them. The safety of their deposits can be secured without the banks' present owners continuing in that role.

When these various requirements have been met and the process of financial contraction comes to an end, the profitability of business investment will be restored and recovery will be at hand.

The Nature of Stimulus Packages

As was shown earlier in this article, economic recovery requires greater saving and the accumulation of fresh capital, to make up for the losses caused by credit expansion and the malinvestment and overconsumption that follow from it. Yet the imposition of "stimulus packages" results in the further loss of capital. The Keynesians not only do not know this, but would not care even if they did know it.

Because of their ignorance of the role of capital in the economic system and resulting inability to see even the clearest evidence that suggests it, the Keynesians can conceive of no cause of a recession or depression but an insufficiency of consumption and no remedy but an increase in consumption. This is the basis of their calls for "stimulus packages" of one kind or another.

They assume that the economic system always has enough capital, indeed, that it is in danger of having too much capital, and that the problem is simply to get it to use the capital that it has. The way that this is done, they believe, is to get people to consume. Additional consumption will be the "stimulus" to new and additional production. When people consume, the products of past production are taken off the shelves and disappear from the stores. These products, the Keynesians believe, now require replacement. Hence, the shops will order replacement supplies and the manufacturers will turn to producing them, and thus the economic system will be operating again and recovery will be achieved, provided the "stimulus" is large enough.

The essential meaning of a "stimulus package" is the government's financing of consumption, indeed, practically any consumption, by anyone, for almost any purpose, in the conviction that this will cause an increase in employment and production as the means of replacing what is consumed. Despite talk of avoiding wasteful spending and being "careful with the taxpayers' money," the truth is that from the point of view of the advocates of economic stimulus, the bigger and more wasteful the project, the better.

This was made brilliantly clear many years ago by Henry Hazlitt, who chose the example of government spending for a bridge. It is one thing, Hazlitt showed, if the government builds a bridge because its construction is necessary to facilitate the flow of traffic. It is a very different matter, he pointed out, if the government builds the bridge for the purpose of promoting employment. In the first case, the government wants the best bridge for the lowest possible cost, which implies the employment of as few workers as possible, both in the construction of the bridge and in the production of any of the materials that go into it.

In the second case, that of stimulating employment, the government wants a bridge that requires as many workers as possible, for their employment is its actual purpose. The greater the number of workers employed, of course, the greater must be the cost of the bridge.

Indeed, no one could be more clear or explicit concerning the nature of government "fiscal policy" and its "stimuli" than Keynes himself, who declared (on p. 129 of his General Theory) that "Pyramid building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better."

Acts of sheer destruction, such as wars and natural disasters, appear as beneficial to Keynes and his followers for the same reason that the "stimulus" of government-financed consumption appears beneficial. This is because they too create a need for replacement and thus allegedly result in an increase in employment and production. So widespread is this view that one can very often hear people openly express favorable opinions about the alleged economic benefits of such things as earthquakes, hurricanes, and even wars.

Stimulus Packages Mean More Loss of Capital

Despite the fact that what the economic system needs for recovery is saving and the accumulation of new capital, to replace as far as possible the capital that has been lost, the effect of stimulus packages is further to reduce the supply of capital, and thus to worsen the recession or depression.

The reason that stimulus packages cause a further loss of capital is that their starting point is the consumption of previously produced wealth. That wealth is part of the capital of the business firms that own it. The stimulus programs offer money in exchange for this wealth and capital. But the money they offer does not come from the production of any comparable wealth by the government or those to whom it gives money – wealth which has had to be produced and sold and thus put into the economic system prior to the withdrawal that now takes place. The starting point for the government and its dependents is an act of consumption, which means a using up, a loss of previously existing wealth in the form of capital.

The supporters of stimulus packages look to the fresh production that is required to replace the wealth that has been consumed. It will require the performance of additional labor. They are delighted to the extent that this fresh production and additional employment materialize. They believe that at that point their mission has been accomplished. They have succeeded in generating new and additional economic activity, new and additional employment. The only shortcoming of such a policy, they believe, is that it may not be applied on a sufficiently large scale.

Unfortunately, there is something they have overlooked. And that is the fact that any fresh production and employment that results is incapable by itself of replacing the capital that was consumed in starting the process. The reason for this is that all production, including any new and additional production called into being by stimulus packages, itself entails consumption. And this consumption tends at the very least to approximate the fresh production and, indeed, is capable of equaling or even exceeding it.

Thus, for example, we start with the purchase and consumption of a new television set by someone who has not previously produced and sold anything of equivalent monetary value that provided the funds for his now buying the television set. He has simply received the money from the government. In this case, what we have is one television set withdrawn from the capital of the economic system and placed in the hands of a non-producing consumer.

We can assume, for the sake of argument, that the retailer of the television set will order a replacement set from the wholesaler, and that the wholesaler in turn will order a replacement set from the manufacturer. We can assume further that the manufacturer will now produce a new television set to replace the one that he sells to the wholesaler from his inventory.

The production of the replacement television set entails a using up of materials and components and part of the useful life of the plant and equipment required. Aspects of such using up of capital goods also take place on the part of the retailer and wholesaler and in the transportation of the television set.

Very importantly, any new and additional workers who may be employed – precisely the goal of the whole operation – in producing a new television set or in moving a television set through the channels of distribution must be paid wages, which they in turn will consume. The goods these workers receive when they spend their wages represents a further depletion of inventories, on the part of all the retailers with whom they deal. In addition, the various business firms involved have additional profits, or at least diminished losses, as the result of the various additional purchases. This enables their owners to consume more and probably results in the payment of additional taxes, which the government consumes.

Even whatever depreciation allowances are earned along the way in the various stages of replacing the television set are likely to be consumed. This is because in the context of a recession or depression investors are afraid of losses if they invest in private businesses and thus prefer to invest in short-term treasury securities, such as treasury bills, which they consider to be far safer. But when depreciation allowances are used to purchase treasury securities, they end up financing consumption rather than capital replacement. This is because the Treasury uses the proceeds from the sale of its securities to finance nothing but consumption, either that of the government itself or that of the private individuals to whom the government gives money.

The point here is that any replacement of a good consumed by a non-producer itself entails very substantial additional consumption of inventories and the useful life of plant and equipment of business firms. The same is obviously true of the replacement of goods that have simply been destroyed, whether by war or by an act of nature.

No matter how long the process of spending and respending of the funds introduced into the economic system by a stimulus package might continue – no matter how many instances of replacement production there might be following the purchase and consumption of our hypothetical television set or of any other such good – the initial loss of capital need never be made up.

This is because each act of replacement production is accompanied by corresponding additional consumption. Thus the initial act of consumption – or destruction – of wealth and capital may be followed by 10 or 100 acts of subsequent production, each carried on in order to replace the goods used up before it. But if each of these subsequent acts of production is accompanied by fresh consumption that is equivalent to it, the net effect is still one act of consumption. As a result, the supply of capital is reduced. For what is always present is X instances of production respectively following X+1 instances of consumption.

What enabled Germany and Japan in the decades following World War II to recover was not further acts of consumption, not “stimulus packages” of any kind, but increases in production in excess of increases in consumption.

Now countries have suffered enormous losses of capital and yet still managed to recover and go on to new heights of wealth and prosperity. Germany and Japan in the decades following World War II are perhaps the most outstanding examples of this.

What enabled them to recover was not further acts of consumption, not "stimulus packages" of any kind, but increases in production in excess – substantially in excess – of increases in consumption. That is to say, it was a process of saving and capital accumulation that made their recovery possible. On average, people in those countries, in those years, saved and reinvested a major portion of their income, often in excess of 25%.

It is possible, but highly unlikely, that the replacement production induced by an initial consumption/destruction of wealth might itself entail some such new saving. If round after round of replacement production were in fact accompanied by some such saving, then, eventually, the original loss of capital would be made good. But that would be the case only if such saving was not offset by fresh acts of "stimulus" or other policies that waste or destroy capital.

However, as I say, such an outcome is highly unlikely. If for no other reason, this is because, as I have already pointed out, the stimulus packages take place in an environment in which investors fear to invest in private firms. As a result, they use not only whatever new and additional savings they might make, for the purpose of buying "safe" treasury securities but also even funds they earn that are required for the replacement of capital goods. In this way, savings are diverted into consumption rather than capital accumulation.

(It is ironic that while, if it did manage to occur and was not diverted into consumption, such saving might mitigate the effects of a stimulus package, it is attacked as undermining the process of recovery. Thus, for example, Paul Krugman, the 2008 Nobel Prize winner in economics, writes: "Meanwhile, it's clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts ... because a large fraction of any tax cut will simply be saved." New York Times, January 26, 2009, p. A23.)

In addition to the diversion into consumption of such new savings as might occur subsequent to a "stimulus," there is the fact that the source of any such saving, namely, the net product produced, is likely to be greatly diminished. The net product is the excess of the product produced over the capital goods used up in order to produce it. It is what is available for consumption or saving out of current wage, profit, and interest income.

The net product is diminished to the extent that production is made to take place in accordance with methods requiring the employment of unnecessary capital goods per unit of output. Environmental and consumer product safety legislation provide numerous instances of this kind.

For example, requiring gas stations, dry-cleaning establishments, and many other types of businesses to substantially increase their capital investments merely in order to placate the largely groundless fears of the environmental movement. Similarly, requiring safety features in automobiles, dishwashers, display cases, ice machines, stepladders, and countless other goods – features that the market does not judge to be worth their cost – adds to the cost of the materials and components that enter into the production of products without increasing the perceived value of the products. In both instances, the result is a larger consumption of capital goods but no increase in production, and thus a reduction in the size of the net product produced and thus in the ability to engage in saving out of current income.

As indicated earlier in this article, the effect of capital decumulation, whether caused by stimulus packages or anything else, is a reduction in the ability of the economic system to produce, to employ labor, and to provide credit, for each of these things depends on capital. The reduced ability to produce and employ labor may not be apparent in the midst of mass unemployment. But it will become apparent if and when economic recovery begins. At that point, the economic system will be less capable than it otherwise would have been, because of the reduction in its supply of capital. Real wages and the general standard of living will be lower than they otherwise would have been. And all along, the ability to grant credit will be less than it otherwise would have been.

Stimulus Packages Are a Drain on the Rest of the Economic System

Even though stimulus packages may be able to generate additional economic activity, they cannot achieve any kind of meaningful economic recovery. Their actual effect is the creation of a system of public welfare in the guise of work. That is in the nature of employing people not for the sake of the products they produce but having them produce products for the sake of being able to employ them.

But stimulus packages are much more costly than simple welfare. On top of the welfare dole that allows unemployed workers to live, stimulus packages add the cost of the materials and equipment that the workers use in producing their pretended products.

The work created by stimulus packages is a make-believe work that is carried on at the expense of the rest of the economic system. It draws products and services produced in the rest of the economic system and returns to the rest of the economic system little or nothing in the way of goods or services that would constitute value for value or payment of any kind. In other words, stimulus packages and the needless work they create cause the great majority of other people to be poorer. I have already shown how they cause them to have less capital. Shortly, I will show how they also cause them to consume less. (For elaboration on this point, please see the forthcoming republication of my article "Who Pays for ‘Full Employment‘r?")

Rising Prices in the Midst of Mass Unemployment

If economic recovery is to be achieved, the first thing that must be done is to stop "stimulus packages" and undo as far as possible any that are already in progress. This is because their effect is to worsen the problem of loss of capital that is the underlying cause of the economic crisis in the first place.

Unfortunately, they are not likely to be stopped. If they are implemented, especially on the scale already approved by Congress, the effect will be a decumulation of capital up to the point where scarcities of capital goods, including inventories of consumers' goods in the possession of business firms, start to drive up prices.

Higher prices of consumers' goods will result not only from scarcities of consumers' goods (which, of course, are capital goods so long as they are in the hands of business firms), but also from scarcities of capital goods further back in the process of production. Thus a scarcity of steel sheet will not only raise the price of steel sheet, but will carry forward to the price of automobiles via the higher cost of producing automobiles that results from a rise in the price of steel sheet. Likewise, a scarcity of iron ore will carry forward to the price of steel sheet, which, again, will carry forward to the price of automobiles. And, of course, the pattern will be the same throughout the economic system, in such further cases as oil and oil products, cotton and cotton products, wheat and wheat products, and so on.

A rise in the prices of consumers' goods is capable of stopping further capital decumulation stemming from the stimulus packages. When the point is reached that additional funds spent on consumers' goods serve merely to raise their prices, then no additional quantities of them are sold. The same quantities are sold at higher prices. This ends the decumulation of inventories. From this point on, the buyers who obtain their funds from the government consume at the expense of people who have earned their incomes but now get less for them.

Once inventories become scarce in relation to the spending for goods, all of the funds that the government has been pouring into the economic system become capable of launching a major increase in prices. This rise in prices can take place even in the midst of mass unemployment. This is because the abundance of unemployed workers does nothing to mitigate the scarcity of capital goods that has occurred as the result of the attempts to stimulate employment.

Even though rising prices can deprive stimulus packages of the ability to cause further capital decumulation, the inflation of the money supply by the government results in continuing capital decumulation. In large part, this occurs as the result of the fact that the additional spending resulting from a larger money supply raises business sales revenues immediately while it raises business costs only with a time lag. So long as this goes on, profits are artificially increased.

Despite the fact that most or all of the additional profits may be required simply in order to replace assets at higher prices, the additional profits are taxed as though they were genuine gains. This impairs the ability of firms to replace their assets. The destructive consequences of this phenomenon can be seen in the transformation of what was once America's industrial heartland into the "rustbelt."

Generations of government budget deficits have sucked up trillions of dollars of what would have been capital funds and have gone a long way toward turning America into an industrial wasteland.

At the same time, throughout the economic system, starting long before today's stimulus packages and continuing on alongside them, regular, almost year-in, year-out government budget deficits do their work of destruction. They cause a continuing diversion into consumption not only of a considerable part of whatever savings might be made out of income but also of the replacement allowances for the using up of plant and equipment and all other fixed assets. Generations of government budget deficits have sucked up trillions of dollars of what would have been capital funds and have gone a long way toward turning America into an industrial wasteland.

The accelerating destruction of our economic system that we are now experiencing is the product of a prior destruction of economic thought.

The blind rush into massive "stimulus packages" is the culmination of generations of economic ignorance transmitted from professor to student in the guise of advanced, revolutionary thinking – the "Keynesian revolution." The accelerating destruction of our economic system that we are now experiencing is the product of a prior destruction of economic thought. Our entire intellectual establishment has been the victim – the willing victim – of a massive intellectual con job that goes under the name "Keynesianism." And we are now paying the price.

I say, willing victims of an intellectual con job. What other description can there be of those who were ready to hail as a genius the man who wrote, "Pyramid building, earthquakes, even wars may serve to increase wealth ..."

Only a brave few – most notably Ludwig von Mises and Henry Hazlitt – stood apart from this madness, and for doing so, they were made intellectual pariahs. But the time is coming when it will be clear to all who think that it is they who have had the last word.

SHORT TAKES

End the Reign of Error

The most recent Forbes had several articles on whether the headline financial company bonuses were deserved or not, e.g. this one. Carl Icahn argues the real issue is how hard it is to unseat entrenched company managements no matter how poorly they perform.

The debate over executive compensation misses the point. We need laws changed so that shareholders can better exercise their ownership rights and elect new board members who will compensate executives fairly, according to the specific challenges a company faces.

These days when shareholders are unhappy with a company's performance, they simply sell their shares rather than complain or take action. This allows bad management to perpetuate its reign of error and is ultimately detrimental to the economy on which we all depend.

No one has a stronger interest in promoting the health of a company than its shareholders. So shareholder input into company decisions ought to be encouraged through better board representation, not discouraged by bad laws.