Thursday, May 31, 2007
In the long run and given free global trade, surely low-wage economies will take work from the higher-wage ones, until we reach equilibrium. It's the rate of change that makes it messy. For people like the Chinese, they have to work out how to take over our manufacturing capacity without bankrupting their biggest customers; for the West, how to lose all this work and wealth and remain democracies.
Richard Duncan thinks it can't be done without some original form of intervention - he suggests a steadily rising minimum wage, to give the worker in the developing economies enough money to take over the job of buying things, a job that we in the West thought was ours for life.
But the implication for us seems clear - we must become poorer. The winners among us will be those who are able to extract capital out of their possessions and preserve it. Marc Faber says that there are bubbles everywhere - property, shares, commodities - but I guess that in a deflationary world there must be something that will increase in value relative to most other things.
Cash seems obvious - the deflation of the Thirties was such that in the UK we had the Geddes Axe, actually cutting the wages of public servants to maintain a steady relationship between money and things (UPDATE: I got Geddes wrong - see HERE - sorry). So public servants who had accumulated savings would have done well - if they had saved. For many others, it was unemployment and poverty. To get an idea of the process and consequences, read "Twopence to cross the Mersey" by Helen Forrester, a real-life story about the economic descent of her middle-class family, which had (typically) lived on credit before the Crash.
Some fear that our governments will shudder at the thought of repeating that period and will try to buy their way out of the jam by printing money, in which case we could go from deflation to hyperinflation, and this is where the gold-bugs raise their voices.
On this analysis, I should think the strategy is clear. First, get out of/avoid debt. Then, live simply, and if possible convert unnecessary assets to cash - which you may partly invest in whatever you think will hold its value. And look for the steadiest job you can find?
Wednesday, May 30, 2007
Contrary Investor is from a group of institutional investment managers and analysts. Parts of this site are charged.
The Contrarian Investors' Journal appears well-informed and readying us for a crash.
The Daily Reckoning A free, bearish/contrarian newsletter published by Bill Bonner and Addison Wiggin. Hosts columns and comments from many bears. See also sister publication, The Daily Reckoning Australia, and the Daily Reckoning blog.
Richard Daughty aka The Mogambo Guru. Financial adviser and fervent monetarist. Chief Operating Officer (COO) of Smith Consultant Group. A regular contributor to The Daily Reckoning. Style very breezy/gonzo/slapstick, but the substance is serious and he quotes many sources in his tirades.
Marc Faber Swiss-born, Hong Kong-based investment manager. His firm manages $300 million. Parts of his site are charged. Look at his Resources section for guides to further reading.
Financial Sense is a site run by investment adviser Jim Puplava, featuring editorials by many others.
GoldenBar is by Ed Bugos, a stockbroker and investment adviser who retired after 12 years in the industry. His is one of many "gold-bug" sites, and offers comment on the markets and economics.
iTulip is a successful contrarian site with many links and a history of warning investors about market bubbles.
Michael Panzner Author of "Financial Armageddon" - see Book Reviews page. A five-star bear who warns of dangers to the financial system. Very active in promoting his message. Has 25 years' experience in investment, and has worked for a number of major banks.
Safe Haven is a site for the cautious investor. If you click on "about SafeHaven" you will see useful recommendations for further reading.
Puru Saxena Owns Hong Kong-based investment advice firm. 10 years in the industry. Publishes financial newsletter "Money Matters" (annual fee).
Peter Schiff Author of "Crash Proof" with John Downes - see Book Reviews page. President of brokerage firm Euro Pacific Capital.
Mark Skousen - libertarian, economist and (currently) bear.
David Tice David manages a couple of mutual funds and heads a team that publishes Prudent Bear, a respected website. This calls itself "the one-stop shop for the bear case".
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Tuesday, May 29, 2007
This site looks for ideas to protect your wealth. It's not personal financial advice (a highly regulated activity), but I feel it's important to spread the word and discuss the issues. If you agree, please let others know about "Bearwatch".
The Book Reviews page is a good starting point (sidebar). Each title links to a review and summary.
The main page shows recent news and articles. You can also now automatically get updates by email (sidebar). To search for specific words or phrases, you may prefer the "Search this blog" tool - it's more comprehensive than the labels list.
Follow the Bears (sidebar) provides links to selected sites so you can track up-to-date comment from these bears.
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Monday, May 28, 2007
As I understand it, America is like a gourmet and the Far East is his favourite cafe. With the party of friends he brings, he is by far its most important customer - but he pays for the meals in IOUs. He's been such good business that the cafe has borrowed from the bank to build an extension and hire extra staff.
But some start to worry that America won't be able to settle the now-enormous bill. What to do? If he pays up, he runs out of money and stops visiting the restaurant. America will go on a diet of bread and water and the cafe will go bust. On the other hand, if the restaurant accepts that his IOUs are worthless, it's bust anyway.
One solution is to look for new customers before the crisis hits, so the cafe can keep going. And another is to outlaw IOUs - if you haven't got the cash, you don't get the meal.
So Mr Duncan proposes:
(a) a global minimum wage, so poorer people around the world can have the money to buy the goods and services the Far East is geared up to provide.
(b) a global bank, to oversee financial balances between countries and prevent these credit problems recurring.
Meanwhile, America must face a much lower standard of living for a long time, until he's out of the hole he dug for himself. And maybe he'll be allowed a discount on his debt (i.e. inflation). The cafe is going to suffer a loss; the question is whether the business can find a way to survive it.
If the yuan is allowed to appreciate against the dollar gradually, Chinese business will start to suffer, but starting now may mean less pain overall. The USA will also undergo painful - and politically unpopular - adjustments. Can the crisis be managed without a crash?
Saturday, May 26, 2007
The proposed Bill seems to draw a line under the past, but is much tougher on future immigration. This raises the issue of fairness: for example, the amnesty would cover some 3 million resident "illegals" from India (see here) but make entry more difficult for "legitimate" Green Card holders' relations.
The Christian Science Monitor gives good coverage to the debate - see their article here and also the linked articles below it.
And if you wish to see the draft text of the Bill itself - all 326 pages of it - click here.
I guess that the difficulties of a bill like this arise from a conflict of objectives. If the US education system provided all the skilled workers America needs, the US could be simpler and firmer on immigration.
Instead, senior figures like Alan Greenspan voice support for easier immigration as a quick economic fix, ignoring the implications for the future. Why, that's almost like printing money now and leaving tomorrow's inflation for others to handle.
Friday, May 25, 2007
President Bush defended the bill as a comprehensive approach that will fix what most Americans believe is a broken immigration system through which millions of illegal immigrants have entered the United States.
"If anybody advocates trying to dig out 12 million people who have been in our society for a while, you know, it's sending a signal to the American people that's just not real," Mr Bush said.
"The immigration bill brought forward and apparently likely to pass demonstrates an unattractive new political trend in the United States: the end of the classless society for which the U.S. has been famous [...] the rich really are getting richer in the US...the poor really are getting poorer [...]
The economic effect of large amounts of unskilled immigrant labour is very clear: it drives wage rates down to rock bottom levels [...] for the lower classes, it is hell...Instead of the well-paid factory jobs their fathers had, making physical products in which they could take pride, they are now reduced to competing with infinite numbers of illegal immigrants for personal service, retail and construction jobs that have not been mechanised or out-sourced.
Theoretically, they could get more education and turn themselves into brain surgeons or computer-aided designers; in practice, these possibilities merely make them mourn that they hadn't paid more attention in math class. Thus the social gulf grows ever wider."
Thursday, May 24, 2007
But America's indebtedness is also a challenge for China and the rest of the world, in a different way. Richard Duncan's book makes it clear that making too much money in international trade is perhaps as big a problem as losing it. More about this soon.
Wednesday, May 23, 2007
Meanwhile, searching for information on him, I stumbled across a different, but similarly-named author, Richard C. Duncan, who propounds what he calls "Olduvai Theory". This is a real spine-tingler. It looks at the history of world energy consumption per capita and concludes that we passed the peak a generation ago. He says industrial society is a unique and unrepeatable period, has a life-span of some 100 years, and will decline fast, starting in 2008. I hope he's wrong, but it gives us a terrific motive to look after the world much more carefully.
But instead of concentrating on the fear, which is how journalists sell their papers, let's look at the themes this throws up: increasing world population and everyone's aspiration for a higher standard of living. So there are very powerful driving forces pushing up the demand for food, water, land, metals, and energy sources. This is why the Daily Reckoning says commodities are an asset class that will dominate investment for the next 15 years.
On average, 20 percent of all consumer products in the Chinese market are counterfeit. If a product sells, it is likely to be illegally duplicated...
There are several factors that undermine enforcement measures, including China’s reliance on administrative instead of criminal measures to combat IPR infringements...
Patents: China follows a first to file system for patents, which means patents are granted to those that file first even if the filers are not the original inventors...
Trademarks: China has a ‘first-to register’ system that requires no evidence of prior use or ownership, leaving registration of popular foreign marks open to third party...
Copyright: Unlike the patent and trademark protection, copyrighted works do not require registration for protection...
As I said in an earlier post, there may be more to argue about on the first two headings. Yes, there is some system of investigation and redress, but it doesn't necessarily have the rigour and powerful enforcement that Americans would expect in the USA.
Tough, but true, and tough. The press weren't in on the whole two-day session, but this kind of sets the tone, don't you think?
But China is not only acquiring the custom and capital (even the factories) of the West: she is also very keen to catch up on know-how. The arguments at the moment may be about pirated music and videos, but I wonder whether industrial patents and designs may become a bone of contention in the future. I can't think it is safe for the West to watch its physical production processes migrate abroad, consoling itself with the thought of licensing the use of its inventions.
Pakistan's Daily Times gives useful detail on the economic issues: US manufacturers are calling for further appreciation of the Yuan against the dollar, but "an international think tank, Oxford Economics, estimated that even a 25 percent revaluation of the yuan against the US dollar would decrease the total deficit by only 20 billion dollars after two years."
For the American side, it must be like an uncomfortable meeting with your bank manager.
Tuesday, May 22, 2007
Nostalgia apart, let's look at the economic implication. The article notes this development as "yet another sign of the region’s increasingly affluent middle class showing a growing preference for made-in-Asia products". One can only hope that the East creates enough demand, fast enough, to take over when America's wallet finally fails.
"Studies show being in the right asset class accounts for over 90% of your total return in any given investment.
--This happens to be why we are still bullish on Aussie resource stocks despite the China melt-up. Resource stocks are the right asset class to be in right now, and probably for the next 15 years. There will be dips and potholes. But if the asset class is right (and resource stocks made a 200-year low in 2000, so they are still very cheap in historic terms), then the investment maths is really simple."
That's it, unless you're a gunslinger investor and fancy your chances against people who stare at computer screens all day, all week. The world's governments can print all the money they like, but they can't print the resources that turn into things money buys. This is where most bears are bulls.
Again, read more closely - Saville says he expects both currencies to drop against gold, it's just that the Euro has further to fall.
So where does he think your money should be?
"Faber recommended investing in "depressed assets,'' citing the Middle East market and the Detroit property market. He also said farmland in Argentina and Brazil is a good value and property in New Zealand and Australia may be a sound investment because of their proximity to China. [...] he has large positions in real estate and equities in Vietnam."
In this case, it is loans from Japan to invest in US Treasury bonds. The columnist, Professor Antal E. Fekete, says that Japan will keep its interest rate low, because otherwise the yen would rise, hitting Japanese exports. On the other side, the US Treasury will maintain or even increase interest rates on its bonds, to prevent the dollar from collapsing, despite America's economic weakness. China has no wish to destabilise the dollar, and as the Professor points out, some of China's enormous gains from the US come from its holding of Treasury bonds. So there are powerful vested interests sustaining the status quo.
This is a cool-headed contrary view to that of the most pessimistic bears, who feel in almost a moral sense that the present state of affairs ought to end in tears. It is the very awfulness of the potential consequences of a sudden, radical change of balance in the world economy that motivates the main players to keep the polite fiction of normality going.
So the Professor is a "bond bull": yes, the dollar may gradually decline; no, it will not suddenly dive. That's his position.
Bonner has a jaundiced view of the fees and wheeler-dealing of market-makers, and believes that a flood of Chinese investors' money is raising share prices generally.
Today's Australasian Investment Review, quoted in ACN Newswire, dissents from the bubble view, giving these reasons:
• Firstly, much of the rebound in Chinese shares since 2005 reflects a recovery from a four-year bear market, during which individual Chinese investors lost confidence in shares and allocated most of their assets to bank deposits.
• Secondly, profit growth for listed Chinese companies over the last year has been a very strong 78%.
• Thirdly, while the price earnings ratio for Chinese A shares of around 40 times is high by our standards it is only just above its 10 year average of 36 times and is well below its previous high of 60 times.The PE on Chinese shares is also way below the peak levels reached during previous share market bubbles, eg, the Japanese Nikkei index peaked on a PE of 70 times in 1989 and the tech heavy Nasdaq reached a PE of 160 in 2000.
• Finally, Chinese investors still have a very low proportion of their financial wealth invested in shares, around 25% compared to over 50% in Australia and 40% in the rest of Asia. Bank deposits on 3% or so interest account for 65% of financial wealth.So the long term potential for a higher allocation to shares is high.
The author of this piece admits things need to cool down and the recent raising of interest rates should help. But, he says, China's financial and economic fundamentals are sound.
The arguments are cogent and reassure us about the longer term; but I imagine it's possible that if naive investors in China suffer a setback, they may over-react and become bearish for some time to come. If so, and bearing in mind Chinese light industry's vulnerability to exchange rates, a bold investor might buy medium/large-cap Chinese stocks. Not immediately, perhaps - I seem to recall that historically, a major stock slide takes around 30 months to hit bottom.
Monday, May 21, 2007
Panzner's Financial Armageddon site reviews it (under 18 May) here, quoting and commenting on a previous Wall Street Journal piece. He calls the whole system "Ponzi finance" and Bookstaber himself is calling for a reduction in the complexity of these financial instruments. See also my review of Panzner's Financial Armageddon, which considers these and other risks to America's economy.
For an introduction to his excellent book, "Crash Proof", see this. Click here for audio of Mr Schiff's interview last month on MarketWatch.com, and here for MW's covering note.
There are many implications, some contradictory. Diversification could mean less demand for US Treasury bonds, and if China lends less to America, interest rates could rise in the USA. On the other hand, increasing its holding of other currencies will make it less disruptive for China to let the dollar drop against the yuan.
A stronger yuan will affect some Chinese businesses that trade with America, as previously noted. In a thread discussing America's trade deficit on China Daily, "tradervic" from Chicago says: "Mexico thought it had the cheapest labor market, welcoming all the American companies they could get. Then China showed up with their workforce, and those same American companies left Mexico, leaving the Mexicans running into America looking for jobs. It will be interesting to see what happens when the American companies start pulling out of more factories out China for Vietnam, Bangledesh, and other countries. It is like I told my cousins-in-law in China what happened to my cousins-in-law in Mexico and my immediate family in Detroit: Do not get too used to the jobs - they will not last forever."
I have previously suggested that China may be willing to accept these consequences, to some extent, as part of a strategic economic plan. Just as the Chinese in light industry should not take their jobs for granted, the US cannot rely forever on its bargaining power as one of China's biggest customers.
A Bloomberg article today explains how China is trying to manage the currency appreciation so as to limit the damage in employment terms. It also has a stockmarket bubble on its hands. Did China ever expect that wealth and success could be such a problem?
Now it can also start buying the world's assets. The IHT article quotes Jing Ulrich of J.P. Morgan: "They're not going to be looking for financial assets, but energy assets and natural resources, minerals — things China desperately needs." So bears who look to buy commodities as a hedge against US inflation, may be doubly motivated when they see a big player enter the same market.
Sunday, May 20, 2007
Next in line for this treatment is Korea - but will such terms apply to China? Don't expect too much, Motown: remember Vice Premier Wu Yi's warning two days ago - "Attempts to politicize trade issues should be resisted." Wait till China's car industry really gets going.
Meanwhile, let's see what transpires in next week's resumption of the Strategic Economic Dialogue talks between the US and China, for which Wu Yi's Wall Street Journal essay on May 18 is an advance keynote-setter. Since she'll also be representing the Chinese side there, I don't expect much to be decided in America's favour.
If it's about keeping down wage costs, remember that low-paid workers also claim on a range of social benefits, and the people they are undercutting even more so. The last thing a country needs is a hereditary class of long-term unemployed.
If it's about skill shortages, highly-skilled foreign workers are getting harder to find: as emerging economies develop, they want the same people. My brother in America notes that over the years, his university has attracted fewer foreign mathematicians for this reason.
The quick-fix approach is not a lasting solution. Like the UK, America needs to improve education and vocational training. If times get tough and foreign workers go home, the USA's dependence on them could result in economic "cold turkey".
"The second fastest economic growth in the world resides in India. Interest rates are at good levels, and their relative attractiveness as a country is high, and therefore investors are willing to invest in India."
A rise of 10 percent in the yuan could lead to the loss of 5.5 million jobs in China, according to a report by the Chinese central bank. It said companies hardest hit would be those that make textiles, furniture, shoes and toys for export.
"If the yuan rises by another 5 percent, our profits will be totally wiped out," said Li Shaoxiong, deputy general manager of the Fujian Ala Shoe Co., which sold half its 2006 output of 6 million pairs of athletic shoes to American retailers.
Beijing is counting on such labor-intensive light manufacturers to create millions of new jobs. Even though its bustling economy is expected to grow by more than 10 percent this year, a big share of that is in heavier manufacturing and other industries that create fewer jobs.
Perhaps China will take the view that it can tolerate a rise in foreign-trade-related unemployment while it continues to amass capital; as the East gets richer, it will eventually generate its own demand for the products of light industry.
"...the U.S. is the largest debtor nation the world has ever seen, its debt to GDP ratio is over 400%, it has a negative personal savings rate, its currency is overvalued and its society is heavily dependent on consuming cheap, imported goods."
If you, personally, owed 4 times your annual income and were now supplementing your income by further borrowing ("negative savings rate"), you'd look for debt counselling.
Add this to Jim Willie's comments about the export of jobs, and you can see why The Mogambo Guru is raving in his latest letter.
"LABOR ABSOLUTE DISADVANTAGE
"Much hubbub has been made of "comparative advantage" and how the United States benefits from round after round of creative destruction. The hollow message has that in free trade, both sides win, and where a job is lost, new jobs are created. Few if any advantages can be identified in the present framework, whereby lost jobs seem to be replaced mainly by debts inside the USA. Economists badly misinterpret the labor market here in the USA. They incorrectly label the delay in domestic job creation as "short-run friction," when the entire business cycle clearly has been altered, perhaps permanently broken. David Ricardo's doctrines, outlined in 1817, are misunderstood. The US has an absolute disadvantage on labor costs, across the board, which affects manufacturing, service, and more. His principles are discussed in today's light in the May issue, and shown why wealth is lost in the USA and gained abroad.
"As the work of John Maynard Keynes has been misapplied on federal stimulus, so now the work of David Ricardo is being misinterpreted on exported labor. Expect the entire topic of job export and its misconstrued benefits to become a raging explosive issue."
British readers might ask, how is it different in the UK? And where is the sleuth of British bears, growling their warnings?
Saturday, May 19, 2007
Bigness is no guarantee of security, rather the reverse - think of hedge fund Long Term Capital Management, or indeed the Titanic; on borrowing, the bears have warned until they are hoarse; and complacency has been fostered by increases in the money supply.
Perhaps the complacency is the most dangerous part. People like Michael Panzner and Peter Schiff are like the architect in the 1974 movie "Towering Inferno", worried about a potential disaster because of bad wiring; but the warnings are ignored because there's extra profit in trimming security.
It's noteworthy that the Fed Reserve President, Timothy Geithner, was addressing his remarks to a conference on derivatives, which according to Mr Panzner are another source of instability in the world economy. Derivatives use highly complex mathematical tools, but as far as I can make out their purpose is simple: to see how near to disaster you can go without crossing the line. In other words, trimming security.
The other move looks like part of a longer-term strategy: the band within which the yuan moves against the dollar is to widen from 0.3% to 0.5% (maximum per day - over time, unlimited), presumably partly to accommodate appreciation of the Chinese currency in response to the interest rate. This may please America, as a lower dollar will reduce the price advantage of Chinese good.
But I think it's also signalling the stage at which one partner tapes their favourite music, before they pack their bags and leave home for good. Having more flexibility in the dollar-yuan exchange may suit China's bigger plan, to move away from dependence on the US market.
Goodbye dollar, hello Euro?
And what is Mr Greenspan now doing? One of his new roles is as an adviser to investment managers PIMCO - see here for their latest US report. The style of the report is an uncomfortable combination of stuffy and jazzy, but the substance is interesting. Here's a few extracted phrases:
Currently there's a "virtuous circle favoring capital at the expense of labor", which only "a global financial bubble popping of sorts, an accelerated decline of U.S. housing in the short run, or a U.S.-led trade policy reversal that could precipitate counter-attacks from Asian exporters" could stop;
there are "inflationary pressures" in the US and an "asset bubble";
if a housing slump hits the American consumer economy, "anti-trade [i.e. protectionist] legislation may or may not become a reality";
"The emphasis on emerging market currencies rather obviously suggests relative weakness of the U.S. dollar. We continue to believe that U.S. growth will descend towards the lower quartile of countries within a broad global composite. Such U.S. growth, despite relatively favorable demographic labor force trends spiked by immigration, will suffer due to reduced U.S. consumption and the need for higher savings. Even in the face of resistance by Chinese authorities vis-à-vis the Yuan and the Japanese via artificially low interest rates, this lower growth speaks to a weaker dollar and lower relative asset price appreciation in comparison to the rest of the world. PIMCO portfolios will therefore likely feature increasing international diversification in foreign currency terms.";
PIMCO thinks that "sustainable global growth with perhaps an early cyclical slowdown appears to be the likeliest outcome. Those who “own” this growth as opposed to those who lend to it will benefit."
Not hard to boil this down. But potentially rewarding for an alert and adventurous investor. And Mr Greenspan the poacher will act as your gamekeeper, if you go with PIMCO.
Listen with your inner ear to the statement "Attempts to politicize trade issues should be resisted," bearing in mind who is making it. I sense some kind of turning point. If you play the oriental game Go, the term is "sente", meaning that the initiative has passed to the other player.
Friday, May 18, 2007
Thursday, May 17, 2007
Wednesday, May 16, 2007
Could there be really long cycles? Nicolai Kondratieff (or Kondratiev) (see Wikipedia article) thought so. His wave takes around 50 years and predicts decades of booms and depressions. His theory still excites professional investors today - see this article about Marc Faber, and Shane Oliver at AMP.
Of course, the question is how exactly to fit the pattern to our present situation. There is a nice graphic presentation here, showing past data and extrapolating to 2010. But look at other sites, too, like this one from 1998 - here the analysis suggests we have already hit the bottom.
Maybe the answer is that such patterns do exist, but the turning points are impossible to predict, so chartists stretch the waves. For example, you'll see in the second chart above (about technology, related to Kondratieff), that the first 3 cycles are set at 50 years, and the fourth at 40.
But you can prepare. The two books recently reviewed on this blog explain why we should worry about the state of the US economy (and the UK has similar problems, maybe on a different scale). You don't need to know when the fire will start, as long as you've planned how to leave the building in an emergency.
Tuesday, May 15, 2007
"The Swiss currency is still being undermined by global stock market optimism and this trend could continue in the very short term, but there is an increasing threat of market instability which would tend to strengthen the franc sharply."
But he lost nearly a billion betting against the dollar two years ago. Foreign exchange speculation is a casino game and Buffett is famous for caution.
What if his currency purchase is linked to his search for a large company to buy? In other words, Buffett could be looking to protect the purchase price from inflating because of a fall in the dollar. In that case, discovering the currency he's chosen might also hint at the company he's stalking; and vice versa.
Monday, May 14, 2007
Okay, so the goose gets stuffed more slowly; but it'll still be cooked. Meanwhile, what does this imply for investment in port facilities?
That currency hedge wouldn't happen to be Swiss francs, would it?
The exchange rate could alter far more before China lost its pricing edge - just Google up the phrase "China price". Besides, Western industry is getting to the point where it couldn't take up the slack. We have a shortage of skilled labour, and even our factories are being shipped abroad.
China's US trade surplus was slightly over $16 bn in April - oddly enough, just about the same as the increase in Federal Reserve credit.
Maybe that's the key, though. The Institute's April 2007 Strategic Analysis observes that a drop in the dollar leads to a nearly-equal increase in exports:
"Since the price elasticity of demand for U.S. exports is, by our reckoning, around 0.9, we expect quite a large positive response of export volumes to dollar depreciation."
However, the Congressional Budget Office's assumptions also imply a continuing increase in private borrowing, whereas the Institute expects the American consumer to cut back spending instead. If US household debt stabilises, the Institute's model deduces lower US economic output and a long period of higher unemployment, thus shrinking tax revenues. In that case, instead of being cancelled by 2012, the budget deficit increases.
A possible alternative government policy is depreciation of the dollar. Here is what the Institute says about that:
"... it would be quite unsafe to rely on this as an adjustment mechanism. First, we would have to be looking at a depreciation in the region of perhaps 30 percent, compared with the dollar’s most recent peak in 2002, and it might become impossible to ignore the inflationary consequences of such a great fall in value.
"Second, all of the econometrics indicate that there are long lags between changes in the exchange rate and consequential changes in real exports and imports, which will make it difficult to synchronize the rise in net export demand with the fall in domestic demand.
"Third, currency depreciation can no longer be regarded as a straightforward policy instrument, particularly if major surplus countries like China and Japan remain determined not to let their currencies appreciate."
Unlike the Institute, Warren Buffett, David Tice and Peter Schiff all seem to expect a major dollar drop. With inflationary consequences and, as in the second paragraph quoted above, economic dislocation.
But the third paragraph gives us more to think about. Is the Far East more concerned to maintain its trading advantage with the USA, or to preserve its capital while it builds up demand closer to home? There is already speculation about alternatives to the dollar as the world's reserve currency; I understand that foreign governments are building up their gold hoards; and I wonder whether the Federal Reserve is making contingency plans to issue loads more dollars to buy Treasury bonds if they are dumped by international holders?
Sunday, May 13, 2007
Saturday, May 12, 2007
In an interview here, David says he'd thought the bear market started in 2001 or 2002. Once again, the analysis is that it's a bear market masked by inflation.
Friday, May 11, 2007
"Crash Proof" is something of a job application, since if you accept Mr Schiff's recommendations you will be looking for the kind of services he advertises. In my opinion, he does well at the interview: the book is good enough to re-read. It is clear, concise and authoritative.
In the last three chapters, he explains how to protect your wealth - but you don't have to be very wealthy to use his ideas. I'll give the main tips at the end of this article.
He starts with where we are now, and how we got here. The US has a huge capital account surplus, which sounds good until you know that it's another way of saying Americans owe a fortune to foreigners. The government has encouraged money and credit in the economy to increase, so we think we're well-off; but the country has shifted from producing goods and services to consuming them, and paying for it all by borrowing. One day, it's got to be paid back - with interest.
There's no panic right now, because the government, Wall Street and the news media are failing us. They downplay the trade and budget deficits; fudge figures on inflation, productivity and GDP; and quote the consumer's confidence back at him, instead of telling him the truth: you can't spend your way out of debt.
Mr Schiff is a monetarist. For him, an increase in cash and credit is inflation; price rises are merely the effects. These price changes give misleading signals to producers, so they make too much of the wrong stuff and go broke. So inflation causes cycles of boom-and-bust. The US dollar was once backed by gold, but now there is no such restraint on the Federal Reserve, which Schiff terms "an engine of perpetual inflation". Money is simply created at will - the dollar is a "fiat currency".
The greenback hasn't yet had its bluff called; one reason is that it is still used as the world's international trading currency. But it could be replaced, for example by the Euro. In that event, trillions of dollars would come home and the real extent of inflation would be revealed. Import prices would rise, and although the weaker dollar would make exports more competitive, US industry has shrunk and couldn't take full advantage of increased foreign demand, so domestic costs would rise as well. Belts would tighten and non-essential services would be hit. You could get hyperinflation and an economic slump at the same time.
"In the perspective of previous bear markets, notably those of the 1930s and the 1970s, the prospects look even worse. Economic conditions now are as bad as or worse than what existed then." (p. 114)
The implication for US investors? Schiff estimates (p. 95) the Dow ought to drop 30% from its end-2006 valuation (David Tice at Prudent Bear recently predicted a 50% fall - see next posting above), and a weaker dollar will magnify the loss.
Where does he suggest we invest? Here's some pointers:
1. Avoid debt, unless you plan to use the money to make a profit in some way.
2. Get out of the dollar, and out of US stocks.
3. Be wary of Treasury Inflation Protected Securities (TIPS) - the government defines inflation, but it's also the borrower. Schiff says it's like "trusting the fox to guard the henhouse".
4. Think twice about investing in bonds: "[it is] my belief that all governments that issue fiat currency will inflate".
5. Avoid mutual funds, because they add a layer of costs.
10 - 30% of portfolio: gold, and maybe also silver.
Of this, maybe 20 - 50% should be in bullion, some in your direct possession, some held elsewhere. E.g. Krugerrands and pre-1968 US silver coin; Perth Mint Certificates; GoldMoney.com (banking in gold).
Other investments in gold could include gold Exchange Traded Funds (potential risk: false auditing); gold futures (risk: the firm may buy on margin; also, counterparty risk); gold mining stocks (risk: potential future speculative bubble).
Rest of portfolio: non-US stocks - purchased through a broker (e.g. Mr Schiff!)
This is where the broker would make specific recommendations to the client. In general terms, the author recommends a portfolio of non-US shares, maybe 10 -20 in all, in an assortment of companies, sectors, markets and currencies. He likes conservative, high-dividend stocks (a key principle of the Dogs of the Dow - see John Downes) in developed markets - e.g. Canada, Australia, New Zealand. In the shorter term, he thinks the UK and Europe should do better than the US; in the long run, Asia.
As to favoured sectors: power, commercial real estate, commodities and natural resources (much of this seems to chime with what we have learned about Marc Faber - see second posting above).
This book is not only an investor's survival guide, but a layman's economic primer. It is well worth reading.
Crash Proof, by Peter D. Schiff with John Downes; pub. John Wiley & Sons, Inc; Hoboken, New Jersey, USA 2007
If you wish to purchase this book, the author gives this link.
The modern financial bear, a grizzly on economic fundamentals, is also a bull on industrial metals - see yesterday's excellent Daily Reckoning article by Puru Saxena (pictured) here.
Thursday, May 10, 2007
1. Ballooning public and private debt.
2. A retirement system (pensions and healthcare) that is financially unsustainable.
3. Government guarantees to banking and financial institutions, which have allowed them to take even bigger risks.
4. Derivatives, a vast system of mutual bets, deals and guarantees that interlink so that failure in one part could spread rapidly and disastrously to all parts.
Although focused on the US, this work has relevance for the rest of the world. According to Panzner, something's got to happen soon, and when it does, it'll be vast and horrible.
He predicts first a credit squeeze, which makes cash king and ruins our credit-dependent lives and businesses wholesale; then hyperinflation, as the government prints money to keep the system from complete collapse.
In this scenario, at first, stocks, corporate bonds, property, commodities (including gold), even government bonds and savings certificates, all decline in value against hard cash as everybody scrambles to settle their own debt, collect what's owed to them and continue to pay the bills. Then the hyperinflation hits and everybody tries to offload their currency.
We could end up with a system of barter and a dangerous social environment. Mr Panzner recommends using the Web to get forewarnings of imminent change, and gives the reader many web and blog addresses.
Is this impossible? Of course not. It may not pan out quite the way he sees it - a perfect financial storm - but mayhem does not have to be perfect.
Naturally, politicians won't want such a disaster on their hands. They can reduce the State's obligations, e.g. by deferring the retirement age; they can limit free medical care for retirees to core essentials, or maybe apply means-testing so that only the poorest get it free. As in the UK, public employees may be made to retire later, and to make higher pension contributions.
But coupled with huge personal and commercial debt, and a trade deficit that looks set to increase indefinitely, such remedies may not be enough.
Michael J Panzner: "Financial Armageddon" (Kaplan Publishing, New York 2007)