Slow down - credit crunch at work?

Eric Fry, in today's Daily Reckoning Australia, shows that substantial tightening in the credit market has already started.

The big picture (as I see it)

Home economics: making a mint

Most of the people now managing our money - the money that we plan to retire on - are too young to remember the financial world of the 1970s. This hampers their judgement, and a debacle like subprime lending shows how they have underestimated both the likelihood and the impact of Black Swan events.

In one of George Goodman's books, the financial journalist author (aka "Adam Smith") is shown round a dealer's office by a friend, and the young people are all chirping away optimistically about how they're going to make fortunes for the company in this or that opportunity. His friend turns to him and smiles ironically. "See what I mean? Kids!" Of course, in a rising market you want optimists: the scarred old bears will tend to hang back and miss out on the bonanza. Which is why Adam Smith's friend was employing kids.

But the tide is turning.

I called it far too early (but how was I to know that governments would lose their sanity and print money as fast as their presses would work?). Here's what I wrote to a client on 21st October 1999:

As you are now around three years off the maturity date of your personal pension with XXX Life, you should be considering the security of your fund.

I went to a very interesting investment seminar yesterday, at which it was said that the American stockmarket could be as much as 50% too high, and a correction is overdue. It has already slid 20% off its highest point, by degrees, but a bigger drop could happen. If and when it does, this would have consequences for other markets around the world, since the US is the biggest stockmarket of all.

As you know, the XXX Fund is designed specifically as a safe haven for your investment in uncertain times, and I enclose a form for you to sign and forward to XXX Life, if you agree with my suggestion.

To those in the know, the crash of 2000 was not a surprise. What was your adviser telling you then? Yet the tone of that seminar was upbeat - the market's overpriced, so what?

If governments had maintained financial integrity, then following the mad tech boom, the Great Correction would have started in 2000 and the cleansing and healing process would be well under way. Instead, our politicians chose inflation.

If you were earning money in the mid-70s, you'll know what runaway inflation is like. To counter it, we had financially-motivated strikes: strikes for more money to restore real incomes, strikes to maintain pay differentials between different categories of worker, and strikes for pay parity by those who were left behind. Then settlement, paid for by inflating the currency further. Then more price inflation, and more strikes.

In the new globalized economy, strikes aren't going to work. Here in the UK (and Alan Greenspan has recently advocated the same), we simply allow the import of lots of poor people to undercut our indigenous skilled and semi-skilled workers. This keeps down wage rates and improves productivity. But it also earns little tax/National Insurance, and builds up massive obligations for Health, Education and Welfare (present, for those undercut; future, for all).

For a former Chancellor of the Exchequer keen on off-book financing, it's not a big issue: let the future take care of itself. For most of us, who have to move into the future without a bomb-proof PM's pension and lifelong special police protection, those debts will come home to roost.

I've often wondered how middle-class Germans coped when their money was wiped out by hyperinflation; and how the Russians on State pensions survived in the hinterlands, after the economy collapsed some years ago. Today I read (UK's "Mail on Sunday", page 31) an account by one of the few remaining whites in Robert Mugabe's Zimbabwe:

"The professional generation before me, the doctors and lawyers and the engineers who built Zimbabwe, are all starving to death on their pensions." (If you want to help them, please contact ZANE - they're on the Web. And there's millions of black Zimbabweans who are even worse off.)

But it's to the Sunday Express I have to turn, to get a serious warning about inflation for ourselves. Geraint Jones (page 10) notes that China is hinting at dumping the dollar wholesale; Saudi Arabia has refused to follow the Federal Reserve's interest rate cut; China and India are emerging as this century's budding supereconomies; oil's going up; food is getting pricier; the subprime disaster hasn't finished; mortgages are costing more.

The Express' Financial section wants to lock the stable door after the horse has bolted - much good a reformed Bank of England will do us now. Back in the main paper, Jimmy Young supports the suggestion that UK savers should be given guarantees for the first £100,000 of their deposits - again, too late: it's inflation guarantees we need - in the Germany of late 1923, 100,000 marks wouldn't get you a postage stamp.

The American Jim Puplava, on his excellent Financial Sense Newshour, thinks the latest desperate reflation will buy us a couple of years.

Use them.

Sovereign wealth funds: debt-for-equity swapping

A $20 American Eagle gold coin from 1914

Bill Bonner, reflecting on news from the International Herald Tribune such as this, notes yesterday that sovereign wealth funds are taking advantage of the falling dollar to buy US assets:

As the dollar goes down, Americans become poorer…and their assets become cheaper...The foreigners have huge piles of dollars which are losing value... Doesn’t it make sense for them to use the dollars to buy American assets?

The Arabs must think so... They [are] making offers on the Nasdaq…the London Stock Exchange…and the Carlyle Group, a US buyout firm.

China , meanwhile, recently took a big stake in Blackstone, another big corporate chop shop. Buying up the buyout firms is a particularly important omen, we think. It allows the foreigners to take up more and more US (and UK) assets without getting their name in the paper. And it allows Anglo-Saxons the soothing flattery of thinking that their assets are becoming more and more sought after…it takes their minds off the sour news, that foreigners are using their mountains of trashy dollars to get control over genuinely valuable assets…and that Americans will increasingly be working for foreigners…

A potentially dangerous form of debt restructuring is in progress. As small businesses yield to huge corporations, increasingly foreign-owned, could Big CEO become the new Big Brother? Will the excesses of consumerism end in our descendants serving in a modern version of bonded labour?

No easy bounce back this time, says Marc Faber

Marc Faber, quoted in The Daily Reckoning Australia on Thursday but writing in late August, anticipated the Fed's strategy of interest rate cutting, and thinks it won't work.

Unlike all the Wall Street strategists who compare the current credit crisis to the credit crisis of 1998 (Long Term Capital Management), I believe that the ongoing credit problems will be far worse and of a longer-term nature. This will make it difficult for the market to reach new highs in the near future. Moreover, even if the 1998 comparison were to hold, we would still be looking at a much deeper stock market correction than the 22% sell-off we saw in 1998....

...even if the Fed were to cut rates massively now, it is unlikely that it would stimulate credit growth, which, as I have explained repeatedly in the past, must continuously expand at an accelerating rate in a credit- and asset-driven economy in order to keep the economic plane from losing altitude. Accelerating credit growth is most unlikely now, because I cannot see how financial intermediaries will ease lending standards any time soon after the losses they have recently endured and following their dismal stock performance...

The crises that build up in international financial structures always ricochet from country to country….

...For the last several years, investors have enjoyed a massive global boom. But they should not rule out a massive global panic.

A layman's guide to economics

Outburst

From the Royal Palace of Westminster

This isn't quite on theme, but I turned on the radio for the four o'clock news in time to hear our new Prime Minister's latest proposal: a motto for the country, to show our "values". He is pretending that it has escaped his notice that we have one: Dieu Et Mon Droit. All part of airbrushing out the Monarchy, I assume. What is his suggestion - "In Gord we trust"?

Here's my suggestion: stop indulging your Ruritanian fantasies and do something to restore the economic stability of this once-great country. You've had ten years as the de facto general manager of Great Britain plc, with what results? A social security system that we can't afford and the claimants can't understand; an industrial base that is shrivelling like shrink-wrap on a bonfire; and a demolition derby of a democracy, in a country that mothered many other democracies and paid heavily in blood and gold to save Europe from fascism - twice.

All aboard

Dow 9,000 update

Dow currently 13,839.54, gold (10.03 am NY time) $736.30. Adjusted for the change in the gold price, the Dow would be worth 12,175.15, or down 10.55% since July 6.

Putting it another way, gold has risen 13.67% against the dollar in 77 days; that's getting on for 90% annualised. Is this lift-off for Doug Casey's trip to the moon?

And so say all of us...

Investment experts Jim Rogers and Marc Faber agree with Jim Puplava that (a) the US will try to reflate out of its troubles, and (b) cutting interest rates to achieve this, will lead to worse trouble.

According to Bloomberg today, "Rogers said he is buying agricultural commodities and recommended investors purchase Asian currencies including the Chinese renminbi and the Japanese yen.

Faber, publisher of the Gloom, Boom & Doom Report, said he is buying gold."

DOW 9,000 update

At the time of writing, the Dow stands at 13,493 and gold at $713.70/oz. Adjusted for the change in the price of gold, the Dow has fallen by just over 10% since July 6.

Puplava: this isn't the big one

I'm a bit behind on my listening to Financial Sense Newshour, but as ever, the issues we're talking about aren't momentary. Jim Puplava's view (8 September) is that this crisis isn't the big one: the US will reflate its way out. It can't do that on its own without sacrificing the dollar, so (as has been happening for a long time) there will be cooperation with other nations' central banks. In effect, we are in an international currency inflation cartel, since no trading nation wants a hard currency that leaves its industries high and dry.

But, says Jim, the next recovery will be shorter, and the next fall back much worse. He sees this as happening around 2009/2010, which coincides with the time of Peak Oil, in which he is a big believer. That's when he feels the energy and credit crunches may come together. He sees gold and silver soaring to levels that currently seem fantastic.

For us ordinary people, that may be less interesting than the effects of energy shortage on our daily transportation and domestic heating.

Clausewitz reversed

The Prussian military theorist Von Clausewitz said that war was the continuation of politics by other means; some have since substituted the word "economics" for "politics".

But such is the complexity of modern industrial society, and the horrific potential of modern military technology, that we may invert the relationship: economic ownership and infrastructure may be the new weapons with which to wage war.

It is not hard to see the power potential in China's increasing stake in the US economy - not only US government bonds, but increasingly, other assets such as equities. Already, the bond market feels the jerk of the chain, and within the last couple of years Britain has stepped in to provide some much-needed slack to America. But the growth of "sovereign wealth funds" could see future governments using their investments to interfere in the equity markets, too. What price free trade then?

And there are other gaps in the armour. For example, America's recent allegations against China of cyber-warfare have highlighted our daily dependence on electronic technology.

Two Chinese colonels, Qiao Liang and Wang Xiangsui, have produced a book examining such possibilities: "Unrestricted Warfare" (1999). Some translated extracts are available here, and the Wikipedia article is here.

This is not to say that China is actually hostile; only that, like the rest of us, she has her own agenda, and her own contingency plans. Much of warfare is not outright battle, but the use of threats and potential threats to gain strategic advantage. Pushing your opponent into desperation can backfire disastrously. As Sun Tzu said, "To a surrounded enemy, you must leave a way of escape."

But we must recover our economic balance, or risk having the imbalance used against us.