The turning point may be 2016 - 2020

The above chart from here (htp: Global Perspectives) is another of those attempts to perceive underlying order in the apparently random movement of the market and the economy. I've tried the same myself and suggested that the period from 2000 on may be like 1966 - 1982 (the last top and bottom of the market when adjusted for inflation). The interesting thing about the above picture is that the c. 16-year cycle appears to work over a much longer time - starting with the later part of the nineteenth century.

The cycle is not very regular - it varies from about 12 - 20 years - but tend to support my feeling that the real bottom this time may lie in the next 5 - 10 years.

Another quibble is that while some aspects may have a circular form, there are also linear developments that could change everything. One such is China's awakening from its centuries-long economic slumber, with the result that the world's financial centre of gravity is shifting from West to East; another, related to the first, is the unprecedented growth of debt in Western economies. A third is the development of computer technology and lightspeed communications, so that knowledge and expertise that took centuries to acquire can be transferred rapidly to developing economies. What we have lost through folly, we may not be able to regain through hard work.

This is why some commentators have switched their attention to the social, political and military implications of a permanent power shift - from democracies to authoritarian governments of one kind or another. Michael Panzner has tried to follow up the success of his Financial Armageddon with just such a conspectus, but events in the next decades will be determined by even more complex and subtle factors than the ones that led to the crashing end of the twentieth century's money system.

It would be a neat finish to observe that the Titanic had a casino and that the latter didn't have any effect on the iceberg - but (perhaps fortunately for haters of the glib), the ship didn't have a gambling joint. Though there was multimillionaire John Jacob Astor and his cronies, playing high stakes card games in the smoking room.

In short, for those who are focused on the money, I still believe worse is to come than has happened already. Others should remember it's not all about money.

Running out of bigger fools?

What's been powering the market? Max Keiser recently opined that the rich have been moving their wealth out of the USA since 9/11, Jesse has alerted us to insider selling, Mr & Mrs Average have been selling their holding and paying down debt, so...?

According to FT Alphaville (htp: Michael Panzner) it's technical/leveraged buying/betting:

Very likely it is still a combination of program trading, short coverings and portfolio managers desperately trying to make up for last year’s epic losses.

And when it becomes painfully clear that there are no more mugs to buy the rubbish off you?

The Fourth Horseman

Michael Panzner's prescient book "Financial Armageddon" listed four major threats to the economy: debt, retirement and healthcare benefits for the elderly, government bailouts, and financial derivatives. So far, three have exploded into public consciousness; but the fourth is still to come.

Some say that the derivatives market is now worth over $1 quadrillion, as compared with gobal GDP of some $55 trillion. For most people, these numbers mean nothing, so here's a graphic representation:

Supposedly, this shouldn't matter, since every bet involves two parties and so the sum total is zero. This ignores counterparty risk, i.e. the chance that the other person will fail to deliver when the time comes. It's the sort of thing that busted the UK's oldest bank, Barings.

From what little I understand, the derivatives market suffers from much the same complexity and obscurity as the packaged mortgage mess - the dealers are making loads of bets with loads of other people - so the misery could get spread around rather than just take down one or two incautious players.

If just 1% of the derivatives market fails, this equates to some 18% of global GDP. We in the UK are dealing with an economic contraction of less than 6% year-on-year, and that's causing paroxysms.

An argument for holding some emergency cash, away from the banks?

I see a bad moon rising

... sang Creedence Clearwater Revival. And as Panzner points out, inequality and growing poverty are factors that destabilise society.

He reproduces a graph (see below) that shows inequality is now higher than it was just before the Crash of 1929. The line also suggests that the rich do get hurt when the economy goes down - but they still do very well compared to the "ordinaries":

See where the least inequality came? Around 1980 - just when "it was decided" that lending and debt should take off and power a generation-long series of bubbles. Please see below my graph from June, which shows that political conservatives can be far from conservative when it comes to handling the nation's finances:

It's us or Them - and inflation's coming

Paul B. Farrell argues - plausibly - that we're in a life-or-death struggle with the financial elite, and they will "win", until the system can no longer sustain them - or us.

A self-deprecating blogger styled "The Anecdotal Economist" suggests a fight back in the form of switching your savings and borrowings away from these enemies of the people.

htp: Jesse, who has joined the Angry Brigade and whose regularly changed sidebar links for reading ("Matière à Réflexion") are a treasure trove.

Meanwhile, John Williams of Shadowstats says:

We will see inflation levels not seen in our lifetime by as early as the end of this year. Eventually we will see liabilities of $65 trillion – more than four times U.S. GDP, more than global GDP. There will be a hyper inflation where the dollar becomes worthless, where the paper is worth more as wall paper than as currency.

htp: Michael Panzner, who also is a great pre-reader for us. Michael says he's switched swides to the inflation believers, but he's too modest - he himself predicted deflation followed by inflation in "Financial Armageddon".

The "correction" will come soon

Michael Panzner reminds us that he predicted hyperinflation to follow after deflation, and quoting Edward Chancellor's recent article, thinks the phase change may be on its way. Chancellor answers the argument about global oversupply by reference to run-down inventories, widespread bankruptcies etc - there is now less productive capacity than there was, and what's left is not running smoothly.

A sleep-deprived Jim Kunstler experiences some of this disruption in a Colorado over-dependent on the vagaries of aviation, and rehearses his central theme that US living standards must (in his view) drop 20 to 50 per cent, whether through deflationary depression or savings-destroying inflation. He thinks the page will turn soon, too - maybe in June.

I said to my brother this weekend, that I think America can cope with being poorer, though the adjustment will be nasty; I didn't think it could survive being so rich. Look at what all that easy, phoney, fraudulent wealth did: that gallery of fat rogues in Wall Street and elsewhere, while the poor were exploited with credit cards and doomed home loans.

Kunstler's healing vision is bucolic, like Alexander Pope's:

Another age shall see the golden ear

Imbrown the slope, and nod on the parterre,

Deep harvests bury all his pride has planned,

And laughing Ceres reassume the land.

Quietly edging towards the exits, before the general panic

Htp: Michael Panzer, for this:

They are taking cash out of the bank in preparation for a long-haul bad time. A friend in Florida told me the local bank was out of hundred-dollar bills on Wednesday because a man had come in the day before and withdrawn $90,000. Five weeks ago, when I asked a Wall Street titan what one should do to be safe in the future, he took me aback with the concreteness of his advice, and its bottom-line nature. Everyone should try to own a house, he said, no matter how big or small, but it has to have some land, on which you should learn how to grow things. He also recommended gold coins, such as American Eagles. I went to the U.S. Mint Web site the next day, but there was a six-week wait due to high demand. (I just went on the Web site again: Production of gold Eagle coins "has been temporarily suspended because of unprecedented demand" for bullion.)

Like I said over a month ago: "this is a time for individuals to make their own quiet plans and preparations."

Michael Panzner interview

Some salient points in Michael's answers:

• The crisis could continue for another decade;
• investors will have to tread carefully and consider the risk of dealing with others;
• dividend yields could increase 2 - 4 times (suggesting that current stock prices could halve or quarter);
• after some more deleveraging during this year, it may be useful to accumulate precious metals

Read it all here; htp: Abnormal Returns

Also linked on AN is a story about Warren Buffett's firm insuring third parties against a long-term market drop. Berkshire Hathaway has taken $4 billion in bets; are they right? Or are they right only in the sense that nominal prices will hold, while inflation will mask the real reduction in value?

Money and life

The previous post is a summary of Brad Setser's views on China and the dollar. What with the oil price coming down and the trade deficit reducing because of declining demand, it seems reassuring for Americans. But Michael Panzner also returns to one of his themes, the inflationary phase that he (and many others) fear may succeed the recession-depression.

Marc Faber has observed that this is the first time in history that economies around the world are affected simultaneously, since we are now much more inter-connected. So if inflation should take hold, perhaps it will not be fully reflected in the exchange rates - it might be that the dollar remains relatively buoyant against the pound, Euro, renminbi etc.

So maybe the real victims of global inflation, or hyperinflation, will not be this nation or that, but cash savers as a class. They have set aside some of the rewards of work, instead of spending it, and will come back to the cupboard to find it turned half-rotten, as happened in the 70s (if they'd put it in the stockmarket instead, it would only have been a bit mouldy).

How is it that China can award death sentences to those who adulterate milk with melamine, but adulterating the currency - the accumulation of millions of years of human labour - is not even punishable by loss of office? In the year George Washington took Presidential Office, "coining" in England was treason, and perpetrators were accordingly hanged, drawn and quartered (or, in the case of women, burned).

Money is stored life, and devaluing money is stealing life. Next month will be the 20th anniversary of my becoming a financial adviser, and the people I have advised would mostly not bother with investments if only their cash savings could hold their real value. What a scam this all is.

History rhymes

The stock market is experiencing a snap-back rally, similar to what we saw in 1930, after the Crash of 1929.

You don't look that old.

Hickey: I wasn't around. They had a name for it, the "little bull market." It came about after the Federal Reserve slashed interest rates to 3.5% from 6%, and later to 1.5%...

More here.

The next wave of bailouts

It's not just the banks that are short of money. Many US States and local authorities are also suffering financial problems, and this is affecting the trade in their bonds, i.e. their borrowings on the money market. ("What are bonds, exactly?" - see here.)

Michael Panzner reports that municipal bonds ("munis") offer a better yield than US Treasury bonds, but the difference is still not enough to pay for the extra risk. Professional investors are short-selling "munis". i.e. betting that they will fall in price. A steep fall may indicate imminent bankruptcy, and some say this is on the way for many authorities, as Mish reported at the end of December.

So, what will happen when the US Government is seen to be buying everybody's bad debts?

People (even here in the UK, where we tend to wait patiently for our wise rulers to solve all) are beginning to worry about inflation, and are thinking about investing again. An article in Elliott Wave International warns us not to be panicked into parting with our cash, and reminds us:

... there are periods when inflation does erode the value of cash. I mean, look at the seven years leading up to the October 2007 peak in U.S. stocks: big gains in the stock indexes, while inflation was eroding cash. No way did cash do as well as stocks during that time.

Right?

Wrong. Cash outperformed stocks in the seven years leading up to the 2007 stock market high. That outperformance has only increased in the time since.

Since this is the view I took and communicated to clients in the 1990s, you will understand that I didn't make much money as a financial adviser. But it was certainly good advice, even if it was based on strongly-felt intuition rather than macroeconomic analysis.

Not that analysis guarantees results, in a world where the money game's rules are changed at will by politicians with a host of agendas that they don't share with us ordinary types. But my current guess is that the stockmarket will halve again in the next few years, when compared with the cost of living.

Stock market could halve again

As you know, I've been doing my own extrapolations recently, based on the Dow since 1928, and the implication is that the low point could be as deep as c. 4,000 points, i.e. another 50% off where it stands today.

Now, "Mish" looks at revised earnings estimates for companies and relates them to stock prices, applying various price-earnings ratios. His conclusion is broadly the same.

As Michael Panzer predicted* (reviewed here in May 2007) there's been a flight to cash, and now (as he also predicted) it looks as though inflation is set to roar. This will disguise what's happening to stocks, but underneath it I see that decline. As in the '60s-'80s. it may take some years after the apparent turnaround before real values increase again.

Provided you trust the government to pay up when due, and to calculate inflation fairly, National Savings Index-Linked Savings Certificates (or US TIPS) may be a valuable weapon in your anti-inflation armoury.

*"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."

The seventh seal

Denninger's question:

With the $7 trillion dollars we have committed we could have literally given every homeowner with a mortgage a fifty percent reduction in the principal outstanding.

This would have instantaneously stopped all of the foreclosures by putting all (essentially) homes into positive equity - overnight!

So why wasn't this done?

His answer: the government is trying to cover the staggering bets of the derivatives market. With borrowed money. The Treasury has swallowed the grenade and put its fingers in its ears.

This is the fourth horseman of the financial apocalypse that Michael Panzner predicted, as summarized here on Bearwatch on May 10, 2007.

UPDATE: Jesse comments on another fresh sum - tens of billions - needed to cover AIG's losses. As he says, there is an air of expectancy; but also of unreality, like the announcement of a major war.

The answer is blowing in the wind

I said on Friday, "I think 2008 will be seen in retrospect as the year that the global balance of power underwent a sudden tectonic shift, from West to East." I forgot to add, "...and from North to South, too"; but Michael Panzner is not alone in seeing America's exclusion from the Brazilian summit as a straw in the wind.

Economics doesn't describe the real world

Michael Panzner has unearthed a couple of good items explaining how the assumptions of classical economics are plain wrong - we are not rational - and so the results are also wrong.

And there I was, planning to use some of my Christmas holiday reading an economics primer.

America to default on its debts?

Michael Panzner introduces the topic with an entry from the Economist blog - and look at the comments.

The importance of correctly predicting liquidity movements

A hedge fund manager (Andrew Lahde) says farewell to the industry (extracts):

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? ... Throw the Blackberry away and enjoy life.

...I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle. I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life – where I had to compete for spaces in universities and graduate schools, jobs and assets under management – with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.

On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunctinstitutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government. Capitalism worked for two hundred years, but times change, and systems become corrupt. George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher. My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles. This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft’s near monopoly. I believe there is an answer, but for now the system is clearly broken...

(htp: Michael Panzner)

Rally? The smart money's been moving out for a long time

Read Michael Panzner here. Reminds me of when Jimmy Goldsmith sold all his holdings on the Paris Bourse in the Summer of 1987, and recently how Warren Buffett was reported to be holding massive amounts of cash.

Now Buffett has bought $5 billion of Goldman - but as preferred stock with a 10% dividend (and with warrants representing an instant capital gain from day one); and Philip Green is buying £2 billion of Baugur's debt. Note that these wise men are NOT buying stock market ordinary shares: they are betting on a sure thing, pretty much.

I think bear market rallies are when the pros sell to the amateurs. When the amateurs realise the pros have gone, and there are no more bigger fools, the panic proper starts. And then the pros are there, waiting for the bottom prices. I think this is what is behind legs 4 and 5 of the Elliott Wave.

Cassandra couldn't run Troy

Thanks to Michael Panzner at Financial Armageddon, we can read for free an interview with 70-year-old money manager Jeremy Grantham. Grantham points out that business is run by managers, not by Old Testament prophets, and so he philosophises that crises will recur.

He also believes that this one isn't over yet:

The terrible thing -- after all this pain -- is that the U.S. equity market is not even cheap... it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.

My 26 June guess at the trend for the Dow was c. 7,000 - 10,000:

If that means a midpoint of 8,500 and the overcorrection is 20%, then the momentary low point could be around 6,800, which at least suggests that the gap between my two red lines is approximately correct.

Friday's lowest point during the day was 7,773.71, still 10% away from the theorised minimum; and the Dow closed at 8,451.19. Yesterday it remained above the latter figure throughout, and rose to 9,387.61.

In short, Grantham must be reading this as a bear market rally, and it's not very silly to think that the Dow could come back to 7,000 at some point.

Good luck to the day traders, I haven't the nerve and speed to try to make a fortune on the bucking-bronco stage of the market.

Refuge, flight, battle rejoined, victory, retribution

Brad Setser looks at a flood of demand for US Treasuries and suspects that it's central banks shifting into the securest dollar asset they can find; and away from other dollar-denominated assets.

The first comment on the same post says that the next stage is a run on the dollar.

Continuing the Tolkien fantasy theme, one recalls the flight to Helm's Deep, and the eventual breach. Ultimately, though at a cost, the good side wins, of course (Denninger explains today how we can face the mess and clean it up).

Time to revisit Michael Panzner's "Financial Armageddon" - reviewed here in May of last year.

If he's right - and he's been right so far - it's first cash, then out of cash. But there's not enough gold to act as the world's currency (unless a horrific amount of wealth is permanently destroyed), and if we start up a new fiat currency, the moral criminals of the banking class will play the game all over again.

I note that Max Hastings in the Daily Mail calls for bankers to be "named and shamed"; this is milksop stuff. Yet they're still going to get billions in bonuses this year! Why does the Proceeds of Crime Bill not apply? Heavy, heavy fines, so that generations of bankers and traders will remember and hesitate. How about the last 5 years' bonuses, as a benchmark? Punitur quia peccatum est ("punishment is to be inflicted, because a crime has been committed").

But even that's not enough. What about the political class that opened the financial sluices to alleviate the discomfort of 2002-2003? And did it several times before, too? (See Jesse today on Greenspan's bubbles.) How do we mete out condign punishment to those greedy for power, as well as those for money?

I repeat, this is a crisis of democracy.