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.

Slither

Gold $7.04, the British pound bumping up against $2.03. Is the system settling for a controlled skid?

UPDATE

A day later, gold is up another 1%, (or would that be, the dollar is down 1% against it?), the pound is marginally nearer $2.03, and the Dow is rising.

Michael Panzner agrees with Marc Faber

In Blogging Stocks, September 7:

We're in a rare moment in history where cash is king... My prediction is that the Standard & Poor's 500 could fall at least another 10% from here. I think the economy is weakening and the crisis in the credit markets will worsen from here... this is not the time for a buy-and-hold strategy. But if you must stay in stocks, look at more defensive sectors like food, beverage and healthcare... Gold...

Read the whole item - and see the video - here.

Dow 9,000 prediction revisited

September 8: since August 31, the Dow has slipped further to close at 13,113.38 on Friday; gold has risen to $701 (London PM gold fix). Adjusted for the rise in the price of gold, the Dow is now the equivalent of 12,117.25. So in terms of Robert McHugh's prediction, it has lost 10.98% since July 6. Time for another quiet release of gold by central banks?

How much physical gold does the Fed still hold?

A reassuring image from the Federal Reserve

US bond pressure mounts

...and China has been selling off US Treasury bills, according to Gary Dorsch of Global Money Trends, featured in GoldSeek today:

"Beijing sees a “veto proof” protectionist bill sailing thru the US Congress later this year, and has been a net seller of US T-bonds for three straight months by a record amount of $14.7 billion, the longest period of sales by China since November 2000."

UPDATE

More on this from the Daily Telegraph here.

Selling the family gold?

According to The Mogambo Guru on 30 August, "...gold suddenly plummeted on Thursday, making me laugh nervously, as things have now gotten so bad that central banks are apparently actually increasing their selling of sovereign gold to get the money to pay current bills! Hahaha!"
This would be interesting information for gold bugs. Unfortunately, the World Gold Council has not updated its list of gold holdings since June. Any information, anybody?

UPDATE

Physical gold has enjoyed record purchases in some regions, according to The Market Oracle yesterday.

Scare stories - "the S&P to fall to 700"

Dan Denning, in today's Daily Reckoning Australia, considers whether it may be a good time to unload your investments, and refers to reports of large bets made that the S&P 500 may drop to 700 (currently it's around 1,474) - or possibly rise to 1,700! It's got the conspiracy theorists exercised, although experts say it's a technical matter (see The Street); but the sums involved are large. Stormy weather ahead?

The outlook from Financial Sense

Some voices and topics from Financial Sense, 25 August:

inflation, deflation, gold, cash...

Jim Puplava: ...I've had Bob Prechter on this program and Bob is a deflationist and Bob believes that we get deflation first and then hyperinflation where I guess my views are we get hyperinflation and then what follows will be deflation. And that's the way it has unfolded with great debtor nations. And I think history will repeat itself here with the US. There is too much debt here and it has to be inflated away...

...I really believe that the full force of these storms aren't going to hit until somewhere between 2009 and 2010 when this really comes home to roost. And all of these debt problems, the problems that we have with energy today, availability, peak oil, the geopolitical problems in the Middle East – I do not expect the next decade to be a pleasant one, John. I wish I could say otherwise because as a father with three children, one to get married shortly and looking forward to grandchildren, you know, this is something that you don't like to think about...

credit bubble, credit crunch, commodities, East delinking from West...

Doug Noland: ...the economy is much more vulnerable than many believe because of the credit that was going to the upper end; and I think the upper end mortgage area is where we had the greatest excesses.

So I think when all is said and done, subprime losses are going to be small compared to the losses we see in jumbo and Alt-A, and especially, unfortunately out in California...

...there’s desperation out there to find buyers for mortgages... Washington generally doesn’t understand the risk of Fannie and Freddie [US government-sponsored entities - "GSEs" - that offer mortgages], so of course they would think it’s their role to step in and provide the liquidity.

But... their total exposure is over 4 trillion dollars now. And this is a huge problem, and I fully expect down the road these institutions to be nationalized. And I think the US taxpayer is going to pay a huge bill for this... To be honest, I don’t mind the GSEs if they want to play a role in affordable housing; if they wanted to try to rectify some of the problems at the lower end because of the lack of the availability of credit in subprime. But to think that the GSEs should start doing jumbo mortgages, to try to be the buyer of last resort for California mortgages, my God, it’s hard to believe that makes sense to anyone because that’s just a potential disaster. It’s also reminiscent of the S&L – the Savings and Loan problem that, you know, was a several billion dollar problem during the 80s that they allowed to grow to several hundred billion by the early 90s. And definitely, the tab of the GSEs is growing rapidly right now...

...even if the central banks add a trillion dollars of liquidity to help out this deleveraging we still have this issue of how are we going to generate the trillions of additional credit going forward to keep incomes levitated, to keep corporation earnings levitated, to keep asset prices levitated, to keep the global economy chugging along...

...The global economy may be something of a different story because we have credit bubbles all over the world. Like the Chinese bubble right now is pretty much oblivious to what’s going on in the US and in Europe. You can see a scenario where, you know, you have serious credit breakdown but let’s say Chinese demand keeps energy and resource prices higher than one would expect. So I’m going to be watching this very carefully because we’re going to see some very unusual dynamics as far as liquidity and inflation effects between different asset classes and different types of price levels throughout the economy.

Agriculture on the up

An interesting report this week in the International Herald Tribune about the coming boom in agricultural commodities, powered by demand from emerging economies.

Meanwhile, cattle are moving off the Argentine pampas to make way for crops of soybeans and corn. The cattle are being crossbred to cope with the rougher conditions they'll face.

What Bank of England?

Further to yesterday's piece on the licence to the European Central Bank to seize the Bank of England's assets, here are two relevant articles from the Maastricht Treaty. The Campaign for an Independent Britain was stating no more than the truth. (In the extracts, red highlighting is mine.)

ARTICLE 30

Transfer of foreign reserve assets to the ECB

30.1. Without prejudice to Article 28, the ECB shall be provided by the national central banks with foreign reserve assets, other than Member States’ currencies, ECUs, IMF reserve positions and SDRs, up to an amount equivalent to ECU 50,000 million. The Governing Council shall decide upon the proportion to be called up by the ECB
following its establishment and the amounts called up at later dates. The ECB shall have the full right to hold and manage the foreign reserves that are transferred to it and to use them for the purposes set out in this Statute.

30.2. The contributions of each national central bank shall be fixed in proportion to its share in the subscribed capital of the ECB.

30.3. Each national central bank shall be credited by the ECB with a claim equivalent to its contribution. The Governing Council shall determine the denomination and remuneration of such claims.

30.4. Further calls of foreign reserve assets beyond the limit set in Article 30.1 may be effected by the ECB, in accordance with Article 30.2, within the limits and under the conditions set by the Council in accordance with the procedure laid down in Article 42.

30.5. The ECB may hold and manage IMF reserve positions and SDRs and provide for the pooling of such assets.

30.6. The Governing Council shall take all other measures necessary for the application of this Article.


ARTICLE 42

Complementary legislation

In accordance with Article 106(6) of this Treaty, immediately after the decision on the date for the beginning of the third stage, the Council, acting by a qualified majority either on a proposal from the Commission and after consulting the European Parliament and the ECB or on a recommendation from the ECB and after consulting the European Parliament and the Commission, shall adopt the provisions referred to in Articles 4, 5.4, 19.2, 20, 28. 1, 29.2, 30.4 and 34.3 of this Statute.

(Remember that "consulting" may mean no more than finding out how much we hate their plan, before they go ahead and implement it anyway.)

On the nose?

Aubie Baltin in DollarDaze gives it out straight from the shoulder: a 50% drop in US real estate that will take 10 years to turn around; a 30-50% drop on the Dow; we should be positioned 50:50 cash and gold bullion.

This last chimes with others who say there's bubbles everywhere but can't predict whether the Federal Reserve will feel forced to hyperinflate the currency.

The Dow 9,000 prediction

In SafeHaven on 9 July 2007, Robert McHugh predicted the Dow would drop to 9,000 "over the intermediate-term, although if the PPT responds by hyperinflating the money supply, it could be 9,000 in real dollars (gold adjusted), not nominal." This would mean a drop of 33.88% from its 6 July value. Others have also forecast a fall in the Dow and/or the dollar. I plan to test this assertion from time to time.

The situation is complicated by monetary inflation in the USA, and in other countries that are trying to maintain the exchange rate of their currencies against the dollar, in order to protect their trade with America. So we'll take the Dow as it was on 6 July (the chart McHugh was using) and adjust for relative currency movements and the price of gold.

Starting points for 6 July 2007: the Dow was 13,611.69; gold (London AM fix) $647.75/oz.; using the interbank rates as given by O&A, one US dollar bought 122.7160 Japanese yen, 0.49630 British pounds, 0.73450 Euros, 7.60760 Chinese yuan/renminbi.

Situation as at c. 7 a.m. GMT 31 August 2007: Dow 13,238.73; gold $666.30; dollar buys 115.73200 Japanese yen, 0.49660 British pounds, 0.73280 Euros, 7.55580 Chinese yuan/renminbi. Adjusting for movements in currencies and the price of gold, we reinterpret the Dow today as being worth:

12,870.16 against gold
12,485.29 against the Japanese yen
13,246.73 against the British pound
13,208.09 against the Euro
13,148.59 against the Chinese yuan/renminbi

At present and in purchasing terms, the Dow since 6 July 2007 has fallen most (8.275%) against Japan, next against gold (5.45%), then China (3.40%), Europe (2.97%) and the UK (2.68%). I see this last as a measure of Britain's own weakness.

So within two months, and against the yen, the Dow has already fallen by about one-quarter of McHugh's predicted overall drop.

September 8: since August 31, the Dow has slipped further to close at 13,113.38 on Friday; gold has risen to $701 (London PM gold fix). Adjusted for the rise in the price of gold, the Dow is now the equivalent of 12,117.25. So in terms of Robert McHugh's prediction, it has lost 10.98% since July 6. Time for another quiet release of gold by central banks?

September 18: At the time of writing (6 p.m. British Summer Time), 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.

September 21: Dow currently 13,839.54, gold (10.03 a.m. 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?

September 29: July 6 to present: Dow up from 13,611.69 to 13,895.63; gold up from $647.75/oz. to $743.10. So the "gold-priced Dow" is down 11.01% in 84 days.

Annualised equivalent: gold increasing by c. 82% p.a., "gold-priced Dow" falling 40% over a year. Will these trends continue?

October 27: The Dow is currently at 13,806.70, up slightly from its July 6 valuation of 13,611.69. But gold has risen from $647.75 to $783.50 in the same period - up 21% in 113 days, or around 85% annualised. This means the "gold-priced Dow" is worth 11,414.54. At this rate, Robert McHugh's prediction will be fulfilled by March 8 next year.

November 2: Dow at 13,595.10, gold $806 per ounce. Since July 6, Dow has appeared to hold its ground, but the "gold-priced Dow" has dropped to 10,925.83 - a fall of over 49% annualised. And at this rate, gold will have doubled in dollar terms by July 2008.

November 7: Dow at 13,660.94, gold $833.80/oz. "Gold-priced Dow" has therefore gone down since July 6, from 13,611.69 to (effectively) 10,612.71, a drop of 22% (or 52% p.a. annualised).

To put it another way, the Dow has stood still and gold has risen 29% (or 112% p.a. annualised) over the last 123 days.

January 13, 2008: Last year, Robert McHugh predicted that the Dow would drop to 9,000, if not in nominal terms then in relation to gold. The Dow was then 13,238.73 and gold $666.30/oz, which means that it took 19.87 ounces of gold to buy the Dow. McHugh's prediction implies the Dow dropping to 13.51 gold ounces (a fall of 6.36 ounces).

The Dow is now 12,606.30 and gold $894.90, so the Dow is now worth 14.09 gold ounces. It has fallen by 5.78 ounces out of the predicted 6.36, so the prediction is 90.9% fulfilled so far.

McHugh will be fully correct if, for example, the Dow remains unchanged and gold rises to $933/oz; or if gold stalls, the Dow will need to fall to 12,090.

January 18, 2008: Dow 12,082.31, gold $880.50/oz, so the Dow is now worth 13.72 ounces of gold as against Robert McHugh's prediction of 13.51.

Nearly there, and the new announcement of a $145 billion reflation may push gold that extra yard.

January 22, 2008: As at the time of writing, the Dow is 11,820.24 and gold $875.90/oz. The Dow/gold ratio is therefore below 13.51 and has (perhaps fleetingly) fulfilled Robert McHugh's prediction.

Whether the Dow falls below 9,000 nominal in the course of a severe recession is something we shall have to see.

More on the Euro as the dollar's replacement

From the website of the Campaign for an Independent Britain, a point about Britain's gold reserves. This strengthens the speculation that the Euro might become gold-related and take the reserve-currency mantle from the US dollar.

Is it really true that Britain's gold reserves would be transferred to Germany in the event of monetary union?

The arrangements for Economic and Monetary Union are set out in a Protocol annexed to the Maastricht Treaty signed by the British Government in 1992. Article 30 of the Protocol would require Britain, on joining EMU, to transfer around £8,000 million of our gold and dollar reserves irrevocably to the European Central Bank in Frankfurt, Germany.

Article 42 provides that more of our remaining reserves could be transferred to the European Central Bank if a majority of the other EMU countries required it.

Britain would not be able to veto this process.

If so, perhaps holders of these German gold bonds from between the two World Wars might end up with Britain's bullion!

Good luck, Tampa investors.

UPDATE

The suit for German gold was brought by a farmer called Ronnie Fulwood. Here's the (English edition) German Spiegel article from 2004. His attorneys seem to have a history of long-shot claims, as this blog from May 2007 explains.

Money safety update - American banks

"I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I—I withdraw my overdraft." (Punch, June 27, 1917)

I recently looked at the security of deposits in British banks, but what about the USA? As with my earlier post this morning, we find concise information included in a different argument, in this case about the American liquidity crisis.

In the USA, it seems that up to $100,000 in checking and savings accounts (per depositor per "member bank") is covered by the Federal Deposit Insurance Corporation. There were two separate funds - one for banking, the other for savings (following the $150 billion losses in the savings & loan crisis a generation ago) - but they have been merged as from the end of March 2006.

There are three compensation methods used. One is direct payment to the investor, termed a "straight deposit payoff". The other two involve transfer of business to a healthy bank, with some financing from FDIC: these are known as "purchase and assumption" (P&A) and "insured deposit transfer" - full details here and here. (N.B. although FDIC prefers not to make a straight deposit payoff, as it is the most expensive solution for them, it remains an option - Sutton and Hagmahani's brief account skates over this point.)

The $100k upper limit for depositor protection is more generous than in the UK - and it seems to be 100% insured, unlike for the poor British saver. But, the authors warn, FDIC "only works when bank failures are isolated events, and will not work in a systemic crisis...or for that matter one really big bank failure."

Taking a more general view, the article explains that the subprime mess has reduced liquidity in the system, causing it to work inefficiently, which is why the Federal Reserve has pumped in more cash - accepting "toxic waste" collateral in return, and offering a discount on its loan rate to banks.

The authors have two objections to this assistance:

• it rewards bad behaviour and encourages a repetition ("moral hazard")
• accepting unrealizable obligations as collateral is inflationary, since it turns nothingness into money

Their prediction: a fall in the value of the dollar, and if the banks disguise their problems and fail to clean house, at worst a collapse of the financial system. The Fed has bought some time, but that time has to be used for urgent reform.

Doug Casey: business cycles and subprime loans

"The Man In The Moone" by Francis Godwin, Bishop of Hereford (1620)

I noticed years ago that you get the crispest explanations from someone who's busy trying to get to their main point - Isaac Asimov's "Extraterrestrial Civilizations" (1979) is an excellent example. Even if you disagree with the conclusion, you have learned so much on the journey, and so quickly.

Doug Casey in DollarDaze yesterday summarises the theorised relationship between the money supply and the business cycle, plus subprime mortgages and hedge fund gearing, as part of the argument for gold mining stocks. Again, you may not agree with him that gold "is going to the moon", but in the meantime he has given us a clear and concise exposition of two important economic topics.

2012: Olduvai Theory, sunspots and energy planning

Wm. Robert Johnston's reconstruction of the last Ice Age (at 16,000 BC)

A fascinating article by Brian Bloom in The Market Oracle on 6 August. He ties together a number of threads:

• Regular periodic stockmarket cycles
• Richard Duncan's Olduvai Theory (we've passed the peak of the per capita energy use that built our civilisation)
• The possible role of sunspots in cycles of climate change (allegedly we're heading for a deep global freeze in 50 years' time)
• The sun's movement in relation to the Milky Way, tentatively linked to a 100,000-year glaciation cycle

... and relates them to economic and political issues to suggest that we need to take urgent action to reduce debt and become more energy-efficient.

In case you are tempted to dismiss frontier thinking of this kind, it's worth remembering that many highly successful investors are intrigued by long-wave patterns. For example, Marc Faber is interested in the Kondratieff cycle, among others:

...business cycles do exist. Some economists claim that they occur, according to Juglar, every eight to twelve years. But according to Kondratieff and Schumpeter, you have these long waves that occur. You have a rising wave of about 15 to 25 years, then there is a plateau and downward again for 15 to 25 years. And then you have a drop and the entire cycle starts again. You have all kinds of cycle theory. I am not so sure you can measure the timing of the peak and the bottom, but definitely cycles do exist.

(Interview with Jim Puplava on Financial Sense, February 22, 2003)

More on Marc Faber and agricultural land

Zee News reports Dr Faber's continuing support for the agricultural sector, in which he himself has invested:

Faber... owns agricultural land and plantation stocks in Indonesia, Thailand and Malaysia.

Gold and farmland: further points

The Daily Reckoning Australia has very stimulating thoughts today.

(1) Dan Denning quotes a friend (David Evans) on the divergence between physical gold and shares in gold mining companies:

If the price of gold rises a lot, gold shares have greater leverage and will tend to go up more than gold bars (the cost of mining the gold stays constant, but the price of the mined gold goes up). When the general public gets involved and everyone just wants gold, gold bars tend to appreciate faster... The obvious strategy is to own gold shares now, and when every man and his dog is clamouring for gold, sell your gold shares and buy gold bars to enjoy the last part of the ride.

So when I looked at gold dropping with the Dow, maybe I should have also taken a peek at what gold shares were doing at the same time. For example, Newmont Mining opened yesterday at $40.30 and closed up at $41.07, whereas gold for delivery in December fell by $2.70.

(2) Chris Mayer looks at agricultural land in Brazil and Argentina, in the light of a hungry and resource-limited China:

In Brazil and Argentina, you have one of the few places left in the world where you can acquire large tracts of land in temperate climates with plenty of rainfall to support large-scale agriculture. Already, the two countries produce about one-third of the world’s agricultural commodities. As China is the world’s workshop and India its back office, so has South America become its breadbasket.

Maybe this is why Hugh Hendry and his colleagues have just launched the Eclectica Agriculture Fund.

Gold: speculative investment vs store of value

White Star Line's "Olympic", launched 20th October 1910 (big picture)

Yet again, the Dow drops (about 2%), and gold limps after the pack (down about 0.3%). Until there's a major financial disaster, or it is returned to currency status, gold will not be able to make up its mind whether it's a quality investment or an emergency provision - a liner or a lifeboat.

Money supply, shares and property

Here's a 22 May article by Cliff d'Arcy in The Motley Fool, comparing house prices and the FTSE 100. From mid-1984 to December last year, the FTSE has outperformed by 7.4% compound per year versus 7.2% for houses. But as he points out, houses are "geared" by mortgages, whereas most of us don't borrow to buy shares.

From September 1984 to the end of 2006, the money supply as measured by M4 showed an annualised average increase of 11.64%. Looking at the growth of M4 as against that of two classes of asset, I wonder where the difference went? Do interest charges roughly account for this?

The money supply, the stockmarket, gold and land

Here's part of an interesting interview with a hedge fund manager in 2003, reproduced in October 2005:

An old interview with Hugh Hendry (2003)

Hendry: What's happening today happened 300 years ago in the French economy when John Law, another Scotsman, was allowed to launch the first government-sanctioned bank, which replaced coins with paper money. Commerce boomed. Politicians recognized this correlation between issuing more money and people liking you. They issued more and more money, but it was a false promise. Nothing intrinsically was being added to the economy except promises, which could never be redeemed. Selling by speculators caused the stock market to correct. The correction encouraged the authorities to print more funny money. Ultimately, the continued pumping of liquidity destroyed the economy, the stock market and France's currency.


More recently, the U.S. came off the gold standard in 1971 and the Dow Jones Industrial Average bottomed in 1974. Over the next 25 years, the Dow goes up 20-fold because every period of economic anxiety brought forward an orthodoxy of generous liquidity. Money has to go somewhere. It seeks to perpetuate itself by going into a rising asset class. This time, it is financial assets. Just like the Mississippi stock scheme in 1720 and the South Sea Bubble in London at the same time.

Hugh Hendry set up Eclectica Asset Management in 2005 and like others I've mentioned before, seems to have discovered an enthusiasm for agriculture; Eclectica's new Agriculture Fund is detailed here.

Elections, inflation and the stockmarket

Here's an interesting 2005 piece from British home lender / banker HBOS/Halifax, correlating periods of government with inflation and share prices. The conclusion:

Martin Ellis, chief economist at Halifax, said:

"Although wider economic conditions clearly play a part in the rise and fall of the stock market, election campaigns do appear to have a marked impact on share prices. The three month period preceding any general election traditionally sees large fluctuations in share prices as the market tries to understand the likely outcome of the election."

I haven't yet tried to relate increases in the money supply to General Elections, but it might be an interesting avenue to explore.

Buy or sell?

FT Alphaville (20 August) summarises an interim (between scheduled GBD newsletters) report by Marc Faber. The gist is that we should be looking for the right moments to sell, not to buy.

Peter Schiff: recession "necessary and inevitable"

Writing in The Market Oracle on Friday, Peter Schiff thinks it's time we took our medicine.

Economic warfare?

Gerard Jackson, in The Market Oracle today, rehearses the economic explanation for what's going on between America and China. He lays the blame on the expansion of credit in the US monetary system, rather than sinister Chinese intentions.

That's not to say that some in China don't see the weakening of America - and the West generally - as a bonus. National pride can be underestimated.

But the real question is whether our democracies can take really tough decisions now, in order to prevent a much greater disaster later.

Enduring Power of Attorney: "October the first is too late"

...to quote the title of a Fred Hoyle novel.

There are big difficulties in handling the affairs of someone who has become mentally incapacited. Even a spouse is not automatically assumed to have the right to sell or otherwise manage property belonging to the affected person - or jointly owned with him/her.

This is where an Enduring Power of Attorney comes in. It gives advance permission for someone to look after your investments and other possessions, if you can't. (This permission can be altered or withdrawn before that event.)

Why not simply use an ordinary power of attorney? Because this power is given on the legal understanding that you can step in and reassume control whenever you wish. Obviously, if you're in a coma, you can't, so normal power of attorney ceases to have effect in such circumstances.

Does it matter? Yes: as well as physical, there can be financial abuse of the mentally disabled and other legal minors, which is why these matters come under the Court of Protection (within the Chancery division - remember Dickens' "Bleak House", which exposed legal abuses of protected persons' estates?)

Is this a rare eventuality that you can afford to ignore? No. Here's some statistics:

Although there are no precise statistics about the number of people who may lack capacity in the country, the Mental Capacity Act Implementation Programme has estimated a range of 1 – 2 million, including some of the following:

• Over 700,000 people with dementia (rising to 840,000 by 2010)
• 145,000 people with severe learning disability and 1.2 million with mild to moderate learning disability
• 1% of the population with schizophrenia, 1% with bipolar disorder and 5% with serious or clinical depression at some stage in their lives
• 120,000 people living with the long-term effects of a severe head injury

Source: MHCA Briefing Paper, 2005

At the moment, it's a short and fairly simple form, that only needs the names of your potential attorney/s and a couple of signatures. So it's easy -often part of a legal services package offered by professional will writers - and therefore cheap. 22,508 EPAs were registered with the Public Guardianship Office last year (source: PGO Annual Report 2006-2007). Should the need arise, the named responsible person/s take the form and have it registered with the PGO (see Alzheimer's Society information on EPAs and their successors).

But from October 1st, it will be replaced by "Lasting Power of Attorney". This will be over 20 pages long and much more expensive to arrange - one legal firm estimates up to £600 instead of their current fee of £75 (see Daily Mail article, 22 August).

So it looks like a good idea to do it now.

By the way...

There will be two types of Lasting Power of Attorney. The first is the new and more expensive version of an Enduring Power of Attorney; the second is a form of what is known as an Advance Directive, or "Living Will".

An Advance Directive gives permission to others to make decisions about your healthcare if you're disabled - the life-support machine question, for example. There are serious ethical and religious issues about this, and I'm a bit suspicious of these two quite different legal documents being given the same name from October - it's as though the government is keen to get you to sign away your right to life (e.g. perhaps for budgetary reasons).

And isn't is a little revealing that a Court (of Protection) has been replaced by an Office (of the Public Guardian)? Perhaps part of the airbrushing of the Monarchy out of our Constitution - more revolution by stealth.

Wells Fargo in deep water

Wells Fargo Stage Coach by Sven Ohrvel Carlson

It seems that, encouraged by new US accounting rules, some companies are resorting to optimistic subjective estimates of their own value, in order to reassure their investors. Jonathan Weil reported on this in Bloomberg yesterday.

Let's hope the wheels don't come off! And thanks to Michael Panzner for spotting the article.

Is your money safe in the bank?

Mike Shedlock, in The Daily Reckoning Australia today, raises a point we should all consider - how far your cash deposits are protected by law. This is NOT an academic question - a hard-working and thrifty truck driver has recently lost over $300,000 of his life savings in the Metropolitan Savings Bank in Lawrenceville.

For British savers, here is the current position:

"Financial Services Compensation Scheme

The Financial Services Compensation Scheme (FSCS) was created and put into operation in December 2001. It was brought in to replace the Building Societies Investor Protection Scheme, Deposit Protection Scheme and several other schemes previously in place. The FSCS was introduced to protect customers of firms that go into liquidation or out of business.

The scheme is activated when an authorised firm goes out of business or the Financial Services Authority (FSA) considers that an authorised firm is unable or unlikely to be able to repay their customers.

Most customers are partially protected under this scheme and are entitled to the following amount of compensation:

100% of the first £2,000
90% of the next £33,000

The maximum amount of compensation each individual can receive is £31,700.

The compensation limit applies to individuals and covers the total amount of all their deposits held with that firm. Each individual in a joint account is eligible to receive compensation up to the maximum limit in respect of his or her share of the deposit. The FSCS assumes the account is equal and splits it 50:50 unless evidence shows otherwise.”

Source: http://www.moneysupermarket.com/savings/GuideToSavings.asp (accessed 17 Aug 07)

From this you can see that for your savings lodged with any one deposit taker, any excess over £35,000 for a single account holder, or £70,000 for joint (50:50) holders, is not protected.

Some may say, "It can't happen here", but it did in the Isle of Man in 1982, where the Savings & Investment Bank collapsed, losing £42 million of depositors' money. International bank BCCI collapsed in 1991 with debts of £10 billion, hitting 6,500 British depositors - and the legal case against the bank ultimately collapsed as well.

Savings schemes are not safe, either. About £41 million was lost in the Farepak Christmas hamper collapse last year.

The strategy is to know your rights, and to diversify. As Antonio says in The Merchant of Venice:

My ventures are not in one bottom [i.e. ship's keel] trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.

Invisible earnings may disappear

The UK's trading balance has been substantially assisted by the money flowing through the City of London's financial community. Martin Hutchinson's 20 August essay in PrudentBear explores the possibility that the City will eventually lose its eminence, and the loss of revenue will have to be replaced by higher domestic taxation.

Twang money revisited

John Rubino's 19 August article in GoldSeek supports my contention that since credit works like money, a credit contraction destroys money, and this undermines our ability to make sound financial assessments:

"Prudent Bear’s Doug Noland has for years been pointing out that one of the drivers of the credit bubble has been the ever-broadening definition of money. As the global economy expanded without a hic-up, more and more instruments came to be used as a store of value or medium of exchange or even a standard against which to value other things—in other words, as money."

Now that lenders are pulling in their horns, central banks are creating more cash to replace the "loss", and the result must be a dilution of value in the currency.

UK debts mounting

And Rob Mackrill in today's email edition of The Daily Reckoning reveals that Britain has problems that, relative to the size of our economy, stand comparison with America's:

UK consumer debt now weighs in at £1,345bn - a sum that exceeds our entire output of goods and services, according to accountants Grant Thornton in a note this morning.

Official receivers and trustees in bankruptcy generally seem to do rather well out of this kind of mess - perhaps rather too well.

I had some clients who wound up their firm but pulled out all the stops to collect all debts and pay creditors as much as possible themselves; both clients and creditors benefited far, far more than if they had yielded to the usual arrangements - which I saw in other cases. Ordinary people are shaved going into debt and skinned coming out.

Safety first

Dan Denning comments on the recent rush for cash and safe bonds in The Daily Reckoning Australia today. He also repeats Marc Faber's point about an "earnings bubble" that skews p/e ratios:

Be careful about using low P/E ratios as a buying indicator. We read in this morning's paper that the average P/E on the ASX 200 is the lowest its been in 12 months. That doesn't automatically mean stocks are "good value." In fact, in the past, low P/E ratios have been a sign of the market top. Why?

At the height of an economic cycle, corporate earnings are high. When earnings rise faster than share prices, the P/E ratio will look low, flashing a "buy" signal. But this may be just the time that earnings themselves have peaked. That's definitely not the time to buy a stock.

And even commodity shares have to be chosen with care, when you factor-in rising costs.

Twang money

Richard Daughty (aka The Mogambo Guru) writes in The Daily Reckoning (21 August):

The big, big problem with the whole subprime/CDO/Armageddon market thing is that while the values on these assets can go down, the debts incurred to buy the assets don't.

Quite so. And since much of our money has been created ex nihilo by banks, then presumably it can also be reduced quickly by a credit crunch, so we have potential volatility in the money supply as in other things. Assessing things in money terms now seems to be like going to a tailor who makes all his measurements with an elastic band.

David Tice bearish on commodities

Prudent Bear's boss is cautious about natural resources - though still in the market for energy and precious metals (see page 2) - Institutional Investor article dated 14 August.

Marc Faber profile

Marc Faber at home in Chiangmai, Thailand (from Asia Inc profile - see below)

Marc Faber is a very highly respected financial analyst and commentator. Listed below are some items by him, or about him, that may help you to get a sense of his character, outlook and opinions. I shall update this page from time to time.

SELECTED ARTICLES & INTERVIEWS

Article by Marc Faber in Whiskey & Gunpowder 21 December 2006: "Will the US become a banana republic?"

Round-table discussion on Jim Puplava's Financial Sense Newshour 9 February 2003

BIOGRAPHIES AND PROFILES

Profile of Marc Faber by Graham Lees in Asia Inc Sept/Oct 2006

Profile of Marc Faber by Jean Louis Richard in Le Temps (Switzerland) 20 May 2006

Interview and profile in BusinessWorld (India) 13 October 2003

Biographical entry from Marc Faber's GloomBoomDoom website

Wikipedia biographical entry

REFERENCE SECTION

Home

CARRY TRADE, THE

May 22, 2007: Professor Antal E. Fekete (exchange of letters in The Market Oracle)

CHARITIES

September 30, 2007: World Children's Fund - questions about value for money

CHINA

Sept 25, 2007: China's growing class of advertising and media professionals
Sept 23, 2007: China may use its trade surplus for political/military advantage
Aug 09, 2007: Growing inequality of income in China
Aug 06, 2007: China's near-$1 trillion ownership of US assets
July 18, 2007: James Kynge (my review of his book, "China Shakes The World")
June 19, 2007: James Kynge (article in The Alchemist, November 2004)
May 23, 2007: Intellectual property rights in China
May 21, 2007: China's sovereign wealth fund

CURRENCIES / MONETARY INFLATION

Aug 31, 2007: Maastricht provisions for the European Central Bank, post-EMU
Aug 16, 2007: The weakness of the British pound, in gold terms
Aug 15, 2007: The German DM stronger than the dollar, in gold terms
Aug 14, 2007: The weakness of the dollar compared to gold
Aug 03, 2007: The Euro as a possible international reserve currency
July 31, 2007: Mike Hewitt (article on global money supply in The Market Oracle)
May 28, 2007: Richard Duncan (interview on BusinessInAsia.com)
May 11, 2007: Peter Schiff (my review of his book, "Crash Proof")
May 10, 2007: Michael Panzner (my review of his book, "Financial Armageddon")

DEPOSITOR PROTECTION

Aug 30, 2007: Federal Deposit Insurance Corporation (USA)
Aug 23, 2007: Financial Services Compensation Scheme (UK)

DERIVATIVES

July 31, 2007: Richard Bookstaber (interview on Financial Sense, July 21 2007)

ECONOMIC CYCLES & PATTERNS

Sept 16, 2007: Jim Puplava sees crisis in 2009: Peak Oil and other factors
July 27, 2007: Kress cycles
June 28, 2007: Hindenburg omens
May 23, 2007: Olduvai theory
May 16, 2007: the Kondratieff cycle

GLOBALISATION / NEW GROWTH THEORY

Sept 23, 2007: My view that Western economies are facing inflation and recession
Aug 09, 2007: Globalisation and competition from the Far East
July 28, 2007: Thomas Friedman (interview on Yale Global Online, 18 April 2005)
July 28, 2007: Paul Romer (interview on Reason Online, 2001)
July 27, 2007: Wikipedia / Gladys We on New Growth Theory, aka Endogenous Growth Theory July 07, 2007: Thomas Friedman (Edward Leamer's critique)
May 20, 2007: Jim Willie on unemployment caused by globalisation

GOLD

Sept 27, 2007: Marc Faber sees bubbles everywhere, but recommends gold
Sept 25, 2007: More from Frank Veneroso on gold reserves and speculation
Sept 24, 2007: Frank Veneroso thinks speculation has created a bubble in gold
Aug 16, 2007: Mike Hewitt's essay on the global money supply, and gold
Aug 15, 2007: The surreptitious depletion of central bank gold reserves
Aug 07, 2007: The case for owning gold
Aug 02, 2007: The postwar rise and fall of central bank reserves of gold

LEGAL

Aug 24, 2007: Enduring Power of Attorney / Lasting Power of Attorney

MORTGAGES

September 29, 2007: Mortgage lending a key factor in high property costs

PERSONALITY PROFILES

Faber, Marc (Dr)

RISK ASSESSMENT & REDUCTION

Aug 09, 2007: Tips from the Daily Reckoning on defensive investment
June 21, 2007: Nassim Taleb's "Black Swans"
June 15, 2007: Harold Markowitz (inventor of Modern Portfolio Theory)
June 06, 2007: Asset classes
May 11, 2007: Peter Schiff (my review of his book, "Crash Proof")
May 10, 2007: Michael Panzner (my review of his book, "Financial Armageddon")

SOVEREIGN WEALTH FUNDS

Sept 26, 2007: Sovereign wealth funds expected to boost markets - but a threat to Western economies
Sept 22, 2007: Creditor economies switching from bonds to equities
May 21, 2007: China's sovereign wealth fund

STOCKMARKET VOLATILITY

Aug 31, 2007: Robert McHugh's "Dow 9,000" prediction - with updates
Aug 09, 2007: Is the Dow more overvalued than the FTSE?
June 20, 2007: Dow and FTSE past falls


Home

The chef eats his own cooking

News: Indochina Capital Vietnam Holdings Limited is the largest (and LSE quoted) managed fund of Indochina Capital, whose non-executive chairman is Dr Marc Faber. It has just announced that it bought 60,000 of its own shares on Friday. That looks like putting your money where your mouth is.

More on Faber and Vietnam

Marc Faber is, it seems, chairman of a company called Indochina Capital and this report of a meeting in Ho Chi Minh City in April quotes him as saying, "Among emerging economies, Vietnam has the most potential for development."

In an edition of his GloomBoomDoom report dated May 2003 he remarked, "Vietnam... is developing rapidly and will, in my opinion, with its 80 million very hard-working and thrifty people, overtake Thailand economically within the next ten years or so." For those who may be considering subscribing to his newletters, it's interesting to see an example of his reporting style.

Marc Faber comments on Fed rate cut

Bloomberg today reports on Friday's 0.5% cut in the discount rate, and quotes Marc Faber saying "...it's an intervention... that is not justified [and will] create an additional set of problems at a later date.''

I'm mildly curious to see he was in Danang, Vietnam. And for Faber-watchers, there's news of a new channel featuring his interviews and predictions, on http://www.barreloworld.com/.

UPDATE:

See here for Marc Faber's interview on MoneyControl.com. He, too, recommends selling-out on the ups and staying in cash.

Another bearish opinion

"The Contrarian Investor" (on Saturday - see sidebar) says sell, too:

"Anyway, we believe that Friday’s stock market rally (in the US) is a good opportunity to liquidate any existing holdings of stocks."

Doug Casey goes to Argentina

This is getting very 1920s/1930s - Argentina as the home for the jet set. Here's Doug Casey:

...we're at the end of a 25-year boom. It's gone on more than a full generation now. And I'll tell you how it's going to end: It's going to end with a depression, and not just a depression; not just another Great Depression; it's going to be the Greater Depression...

I think what you ought to have is your citizenship in one country, your bank account in another country, your investments in a third, and live in a fourth. You've got to internationalize yourself...

What am I doing about this? I've been all over the world. I guess I've lived in 12 countries now. And out of 175, I've been to most of them, numerous times actually. What am I doing, where do I want to go, where am I living? Well, in New Zealand.... But... the currency has doubled and the real estate within that currency has doubled at least. So I'm getting out of New Zealand. Where am I going now? I'm going to Argentina...

I wouldn't touch Europe with a ten-foot pole...

...everything in Argentina costs between 10% to 30% of what it costs in North America. That's correct. It's that cheap... So you're getting a massive immigration from rich Europeans that can see the handwriting on the wall and like it down there. And I really like it down there. It's just a great society, great society, great place to hang out, prices are right. I mean this can solve most of your investment problems right there, just by transplanting yourself, if you've got some capital.

This may sound like it's only for the really rich, but I have had perfectly ordinary clients sell up their over-priced ordinary British homes and move permanently to the Far East. For personal reasons, I can't be a globe-trotter, but international relocation is happening on a much bigger scale than London to Provence. For a while, I subscribed to one magazine, "International Living", that looks for bargain locations to spend the rest of your life - Panama appears to be a good one, if you dress conservatively and mind your own business.

So although Mr Casey talks dramatically in a non-Brit sort of way, he is backing his judgement with his considerable money; and ordinary types like ourselves currently have options that we could scarcely have dreamed of before WWII. Whether we will always have such options, is another question.

More on Marc Faber and the bear market

From Friday's Daily Reckoning:

"Excerpts from CNBC-TV18's exclusive interview with Marc Faber:

Q: How do you read the events as they have unfolded in the past fortnight? How do you think this might shape up?

A: Basically as you know, the US market went up until July 16. The Dow peaked out on July 17 above 14,000 and then it started to slide, mainly driven by financial stocks and by what people call a crisis in the subprime lending sector and the CDO and the BS markets. The question obviously is where do we go from here? Is it like 1998, where we dropped first and then recovered strongly towards the end of the year or is it something more serious? I think it's something more serious.

Q: If you had to predict - since your view is bearish, what percentage fall would you expect in emerging market equities over the next foreseeable period?

A: The S&P has a very good chance to decline by 20-30% and the emerging economy stock markets could drop by 40%. That may not mean that the bull market in emerging markets is over for good, because in 1987 we had drops in Taiwan of 50% and then the market went up another four times, so you can have a big correction and still be in the bull market.

But if someone came to me and said what is the upside on the S&P? We had 1,452 where the high was 1,555. I would say the upside and the big resistance in the market is between 1,520 and 1,530 so the upside is limited. But what about the risk?

What I noticed is investors are far more concerned about missing the next leg in the bull market on the upside, than about the risk of losing a lot of money. And I think, gradually this will change and that would mean lower equity prices and also prices of other assets such as commodities can go down substantially and obviously home prices around the world.

Dear Daily Reckoning readers should be aware...this is a downturn that COULD be extremely long and severe."

Marc Faber: India rather than the USA

Here is a quote from Marc Faber and a bit of bio info, extracted from INR News:

"If a gun were put to my head and I was asked to choose between two options - putting all my assets into the US or into India - I would choose Indian equities, Indian real estate, and Indian art. The reason behind this choice is partly my strong conviction that US assets will continue to decline relative to assets overseas, and partly because I can see that India may be at the beginning of a lasting economic take-off phase" ...

...From 1978 to February 1990, Marc Faber was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, MARC FABER LIMITED which acts as an investment advisor and fund manager.(Marc Faber - A Simpleton's Guide to Economics and Investment Markets, part II )

By INRnews Correspondent

Dr Faber's comments on Indian urbanisation, the need for new infrastructure, and comparison with China, are also very interesting.

Weathering the storm

The bankers have shown their hand - they fear deflation more than inflation. Pumping-in cash and cutting rates will keep us going through the economic squalls that they created by the same lax monetary policy. If you believe the monetarists, there will be a price to pay, but as long as this crisis management succeeds, the damage will be insidious rather than cataclysmic: money will slowly rot.

Now that we know the opposition's strategy, what do we do? My guess is, hold cash, wait for further crises of confidence, and buy tangible assets, or assets backed by tangibles, at bargain prices.

That's why I think Buffett and Soros have been so clever in acquiring more rail stock in recent months. Railways are a natural Benjamin Graham choice: mature, income-producing investments. There are big barriers to entry - think of nineteenth-century land speculation and skulduggery, and add-in eco protests, modern politics and the unavailability of coolie labour. Rail has advantages over road, especially as so much freight now is containerised and port-to-city; but from an investor's perspective it is also solidly thing-based.

Other experts are into tangibles also. For example, Marc Faber likes real estate in emerging economies - and possibly in depressed areas of developed countries, and Bill Bonner has farmland in Argentina (the Chinese love beef). And then there's various types of commodity.

I think we'll be back to putting money into things we can understand.

Following the markets today

As I hoped and more than half expected, the major Western markets are recovering from some of their fright. The FTSE has passed 6,000 again and at the time of writing, the Dow is back above 13,000. Those chest pains will eventually be laughed off as a bout of indigestion, and it'll be back to the fags and booze after a while.

The subprime mess was well-telegraphed, if ignored by many, and although we still don't know the full cost, it seems that yet again, the central banks are willing to pump money into the system, rather than reform it. Marc Faber's view that the crisis should be allowed to burn through and eliminate some of the players, is too gritty for the banking establishment.

My take on this is that it's an opportunity for those still in the market to quietly come out without panicking everybody else. The rise of the dollar and the temporary sharp falls in precious metals, are reminders that in a crisis, cash is king; though given Ben Bernanke's statement about dropping dollars from helicopters, maybe king for a day.

Risk avoidance leads to stronger dollar

That's the analysis of Kathy Lien at DailyFX.com yesterday:

These days, cash is a valuable commodity since a liquidity crisis means a lack of cash. The sharpness of recent moves and the lack of liquidity have probably pushed more traders to liquidate positions than to add funds. Flight to safety continues to send the dollar higher against every major currency with the exception of the Japanese Yen as more victims of the subprime and liquidity crisis surface.

There's a possibility of an interest rate reduction:

...the biggest question on everyone’s mind is when the Federal Reserve will cut interest rates. The market is current pricing 75bp of easing by the end of the year. There has also been speculation of an intermeeting rate cut.

But:

Like many central banks around the world, the Fed has been reluctant to lower rates because they feel that the markets need to be punished for their excessive risk appetite. Furthermore, they have said that they need to see market volatility have a “real impact” on the economy.

This, she thinks, is becoming apparent:

With major losses and bankruptcies reported throughout the financial sector, we expect companies to layoff staff left and right. [...] For the people in the “real economy,” their 401ks have taken a harsh beating while their mortgage interest payments are on the rise. It is only a matter of time when we see economics reflect that. The bad news is already pouring in with housing starts hitting a 10 year low and manufacturing activity in the Philadelphia region stagnating. Since the beginning of the year, the weak dollar has provided a big boom to the manufacturing sector. Now that the dollar has strengthened significantly, activity in the manufacturing sector should also begin to slow.

US economy over-dependent on housing sector

The Daily Reckoning Australia summarises Dr Kurt Richebacher's analysis: the US economy depends on the housing sector to a dangerous degree, so even a stall in housing will have a big effect.

"...property bubbles have historically been the regular main causes of major financial crises. During its bubble years in the late 1980s, Japan had rampant bubbles in both stocks and property. While the focus is always on the more spectacular equity bubble, hindsight leaves no doubt that the following economic disaster was mainly rooted in the property bubble. Both bubbles burst in the end, but the property deflation has continued for 13 years now, with calamitous effects on the banking system."

I suspect we have a similar problem here in the UK.