Reversion to mean

Echoing recent comments by Vitaliy Katsenelson (also on Barron's), Jeremy Grantham thinks profit margins will decline towards normal and the Standard & Poor's 500 will head from its current c. 1334 to 1100 in the year 2010 - a drop of about 18%.

Grantham is emphatic that borrowed money is not a stimulant to the economy:

I have an exhibit that shows the 30 years prior to 1982 when the debt-to-gross domestic product ratio was completely flat at 1.2 times. Total debt is defined as government debt, personal debt, corporate debt and financial debt. Then in the 25 years after 1982, the flat line goes up at a 45 degrees angle from 1.2 times to 3.1 times GDP. Massive. In the first 30 years, when debt is flat, annual GDP growth is its usual battleship, growing at 3.5% and hardly twitching. After the massive increase in debt, GDP, far from accelerating, grew at 3%. So debt in the aggregate does not drive the economy. The economy is driven by education, man-hours worked, capital investment and technology.

That last sentence is really pregnant. I'm not sure about the man-hours (the closer we approach peasanthood, the harder we'll work), but I think that on both sides of the Atlantic, we've been falling down on the other three.

In Britain, our government has failed to distinguish between investing in education, and managing it - and where it has tried to do the latter, has pursued a Romantic-heritage political agenda. Capital investment? Going abroad. Technology? Ditto - and eagerly taken up (if not positively filched) by our Eastern trading partners.

I live in what used to be Car City; now, the vast Longbridge site is being redeveloped for housing and shops - in other words, open prison for the new ex-industrial underclass.

But Rome, too, kept control of its plebs with bread and circuses for a couple more centuries, before it fell.

Will monetary inflation be absorbed by the bond market?

In the previous post, I looked at the expectation that interest rates will rise. But it seems that freaky things can happen if the government tries to stimulate the economy by progressively cutting interest rates and pumping more money into the system.

Professor Antal E Fekete thinks that in a deflationary environment, governmental attempts to reflate by introducing more money will be thwarted by the ability of the bond market to soak up the excess liquidity. Higher bond yields result in lower bond valuations, so reducing interest rates inflates the price of bonds. Fekete says that halving the rate doubles the bond price, and since mathematically you can halve a number indefinitely, the bond market can absorb all the fiat money you can create. Therefore, you can have hyperinflation and economic depression at the same time.

This trap is possible because the abandonment of the gold-and-silver standard means that the dollar has no limit to its expansion. And bond speculators have their risk covered by the need of the government to return to the market for renewed borrowing. If the Professor is right, it would be a nasty trap indeed.

But maybe our conclusion should be that this explains why interest rates must rise.

A quibble on style: especially in England, money is regarded as dull. So financial commentators try hard to add flavour, and in the Professor's case, too hard - it has been difficult for me to detect the meat of the argument under its many-spiced similes. Byron's Don Juan comes to mind:

And Coleridge, too, has lately taken wing,
But like a hawk encumber'd with his hood,
Explaining Metaphysics to the nation--
I wish he would explain his Explanation.

Warren Buffett's misleading optimism

Jonathan Chevreau reports Warren Buffett's bullishness on the US economy, long-term; but the real gem in this piece is the extensive, but cogent and crunchy comment by Andrew Teasdale of The TAMRIS Consultancy, who analyses Buffett's real approach to equity valuations.

Teasdale points out that although interest rates hit 21% in 1982, there was less debt, higher disposable income and lower valuations: relative to disposable income, debt is a bigger burden today than it was 25 years ago. He summarises his position pithily:

It is also worthwhile remembering that not everyone holds a Buffet portfolio and not everyone has the luxury of a 220 year investment horizon. If I was a long term investor with no financial liabilities arising over the next 15 years equities would be my preferred asset class relative to cash and bonds, but I would be mindful of valuations in determining where I put my money.

Not all the bad debt has yet surfaced, and as Karl Denninger comments, even at this stage Citibank has recently been forced to borrow foreign money at 14%, and other banks at over 7%, in preference to the 3% Federal Funds rate, presumably to keep the scale of their insolvency in the dark.

Inflation is increasing, therefore money-lenders are going to want more income to compensate for risk and the erosion of the real value of their capital. For the yield to rise, the capital value of bonds has to fall.

So I read Teasdale's summary as implying that for now, it's cash rather than either bonds or equities.

The Golden Compass doesn't work

FTSE closed today down at 5,724.10, a point first reached (travelling the other way) in December 1998. The longer-term chart above suggests to me a glass ceiling. Or flogging a dead horse (I can't tell you how some ten-year-olds I know misheard that last saying recently, or how their conversation continued. That generation appears to be developing backwards from middle age.)

Adjusted for inflation, the line would look worse, of course. I think my gut feeling was right ten years ago: essentially, we've been going down since the late nineties.

But what inflation measure to use? Gold seems to go down together with equity sell-offs, rather than seesawing against them. And unlike with the Dow, there doesn't seem to be an easily accessible index of the FTSE priced in gold terms; but GATA last week went very public with their theory that gold is being held down by surreptitious selling - and has been quietly disappearing from central bank vaults. This is something I've touched on a number of times before, and MoneyWeek gives its take on it here. Meanwhile, here's the ad:

The New World Order: a philosophical objection

A deep essay by Christopher Quigley here, but one I intend to re-read. Marxist philosophy always made my eyes water, practically instantly, as I have little tolerance for prolonged abstract multisyllabic holy-rolling, but I'll steel myself because we have to have some understanding of the madness that seems to have seized our modern conspiratorial ruling class. "Affairs are now soul-size".

Gold chart confusion

Here's a chart of gold against inflation as measured by CPI, from Captain Hook, and it suggests that high as it is now, the price of gold is still below its 1973 - 1997 average:

... and here's another reproduced on the Contrarian Investor's Journal (possibly from TedBits, which I'll come to in a moment), which seems to show the opposite:

... and here's another from Ty Andros's TedBits, comparing gold to gobal financial liquidity:

Which line of reasoning would you support at this time?

Why equities should go down

I'm breaking radio silence because of a brilliantly lucid article (from the subscription-only Barron's site) found for us by Michael Panzner.

Vitaliy Katsenelson explains that the current average price-earnings ratio may seem cheap, but that's because recent profit margins have been well above the 8.5% trend. Even allowing for a shift since 1980 away from industry towards the higher-margin service sector, the present 11.9% profit margin should be seen against a longer-term background figure of around 8.9 - 9.2%, which if current p/e ratios continue would imply a downward stock price correction of 22 -25%.

This chimes with Robert McHugh's "Dow 9,000" prediction from last July. And in many fields it's usual for overshoot to occur in the process of regression to a mean, so if it holds true in this case we could see even deeper temporary lows.

Day traders, be warned: this piste is a Black Run.

Au revoir

It looks as though the bear market has begun, though of course, events are liable to make fools of all of us. A recent peak was in October last year and if we take a recession as lasting typically 30 months, we should be grounding by around April 2010.

I've done my best to add my voice to the growing chorus of somethingmustbedonners, and tried to warn investors as I did in the late Nineties - not that I'm wise, but I seek out the wise. This won't put off the day traders, who rush in where angels fear to tread and will try to make fortunes on the rattlesnake-fast turns of bear market rallies; some will get it right, and fair play to you, as they say.

For the rest of us, I don't think I can better the common sense, brevity and clarity of this in the comments section from Jim in San Marcos, answering an investor's query as to what to do:

The basic premise is to pay off your debts and have some spare cash in the bank. There will be layoffs.

Buying a big item right now could tie you to a commitment that could be more than you anticipated. I know of one person already that was surprised by a layoff. They didn't see it coming.

If it gets worse, a lot of people will be selling big ticket items to raise cash. There should be some pretty good deals out there.

Money isn't everything, and there are bigger issues facing us: the growing military as well as economic power of Russia and China; our failure to nurture and educate our young, which points up the selfishness of our adults; the threat to democracy that is big government combined with big business, and the growing divide between an increasingly internationalist managerial class and a resentful, paralysed underclass whose numbers grow while our economies shrink and twist. And perhaps it is not entirely paranoid to suggest that there are many (often well-meaning, by their lights) proto-revolutionaries hacking away at the cultural and social ties that bind us, still dreaming that Bakunin was right when he said that the urge to destroy is also the urge to create.

I now have to take some time out to set my own affairs in order - too many commitments, personal and professional. Good luck to you all, and thanks for reading and commenting.

We have tracked the beast to his lair

Many an honourable man is underrated. Richard Daughty (aka The Mogambo Guru) takes this opportunity to show that the banks created the problems that some of them are now called upon to solve. It's like that film (Blowback) where the arsonist villain turns out to be a firefighter. Doubtless no-one will suffer condign punishment for using inflation to steal from gullible savers.

Meow boing splat

Both Karl Denninger and Michael Panzner interpret yesterday's rise on the Dow as a bear market rally. There are already references to "dead cat bounce", but we haven't anywhere nearly touched the bottom, I think.

People speak of the crash of 1929, but it took much longer for the crisis to work through and there were lots of opportunities for investors to step off with smaller losses. There were also plenty of traps for those who thought it was time to buy back in.

Here's a chart (source) of the process:

As they say, history doesn't repeat itself, but it rhymes. Today's central banks are acutely aware of this past history and do not wish to be remembered for making the same mistake, i.e. worsening the situation by deliberately contracting the money supply.

However, Denninger and others think we can't stop this contraction anyway, once the credit bubble has been pricked, and attempts to reflate will merely devalue the currency while failing to stimulate the real economy.

Dow 9,000 prediction fulfilled

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.

Funny line

Traders described the losses on the FTSE 100 Index as "incredible", with the Footsie at one stage plummeting by as much as 330.7 points.

(Press Association release today.)

Less than 6%. Maybe they should raise the minimum age to be a trader.

Oh, and the PA uses the hack line "More than £x billion was wiped off the value of ... shares". Enough experience for cliche, not enough to remember history.

"See what I mean? Kids!"

It can't happen here

The US bemoans its fate, but we in the UK have also had something of a crash in the last three months, too. FTSE on 12 October: 6,730.70; now: 5,578.20 - 17% down.

It can't happen here
It can't happen here
I'm telling you, my dear
That it can't happen here
Because I been checkin' it out, baby
I checked it out a couple a times, hmmmmmmmm

(The Mothers of Invention)

There was a period of hip journalism in the 60s and 70s that thought it clever to quote pop trash as if it were Holy Writ, and I'm afraid I couldn't resist the cheek. Retro, but maybe appropriate for a rerun of the econogrind of those years.

Trad wins out over Progressive

Jazz is in vogue, and so, it seems, are old-fashioned financial virtues (though not, of course, here in the Western world). Ty Andros points out what I have long suspected: we've been failing for a long time, and only inflation has hidden the truth from the masses. He goes back further than I would, and suggests the real-wealth stagnation in G7 countries began in 1990-1991.

Ben Bernanke half-joked about dropping money from helicopters if necessary; now the first $500 tax rebate parcels are on their way. Andros says we're into a Ludwig von Mises"crack-up boom" which means that nominally, assets won't fall in price, but in reality they will be eaten hollow by inflation:

“Volatility is opportunity” and it is about to SOAR! (As you will see in the next installment of the 2008 Outlook) They will “Print the money” as the unfolding “Crack up Boom” powers generational moves in grains, commodities, currencies, and stocks are on the table.

Danger of systemic breakdown

Doug Noland looks at the world of financial speculation, which has used loads of borrowed money to boost returns, and worries that as liquidity dries up, the market will become inefficient. This is, I think, one of the things about which Richard Bookstaber has warned. Perhaps the gunslinger day traders should assure themselves of the robustness of their counterparties when playing with futures and options.

We've just had a crash

... and Robert McHugh figures that the US stock market (as measured by the Wilshire 5000 Index) has already lost $2.6 trillion in the last three months.

He's begging for inflation now, rather than a useless stimulant later when the mule has died.

The $1 trillion loss figure reappears

Thomas Tan thinks the addition of plausible losses in the credit default swap market to write-offs in other areas of banking, could bring the total hit on the US financial system to the $1 trillion mark.

Economics in the dark

In 1971, the economist Stafford Beer brought the cybernetic revolution to Chile. His key perception was that economic decisions needed not only accurate, but timely information. So he set up a computer network and data analysis systems to empower the government's ministries without overloading them with irrelevant data.

In advanced economies, it's important for companies, banks and individuals to receive such information, too.

But nearly 40 years later, the USA needs to re-learn the lesson. The Federal Reserve ceased reporting M3 money supply data in 2006; accurate assessment of inflation is complicated by "hedonic adjustment" and periodic (and tendentious?) alteration of the types of item included in price surveys; the Bureau of Labor Statistics seasonally adjusts unemployment figures so that an increase can sometimes appear to be a decrease; nobody (not even the lenders) yet knows the full figures on bad loans and "Tier 3 assets"; it is not even clear how we should assess a nation's wealth (GDP per capita seems a misleading measure).

How can you navigate without up-to-date information? Even in the nineteenth century, Mississippi river pilots had to keep track of the river's changes, or risk getting stranded on new sandbars. And as John Mauldin reports, party political manoeuvering is stymying two appointments to the Federal Reserve's Board, at a time when the Fed most needs to concentrate on resolving the unfolding complex financial crisis.

Even given the right data, decision-making has become tougher. Increasing global interconnection and wealth transfer between nations means that normal cycles may be broken by epochal linear developments, so the past is now a very unsafe guide to the future.

We need clarity, direction and vision.

Panzner votes DE (flation)

Michael Panzner is in the DE camp, because the bubble was caused by credit creation: "The way up is the way down" (a maxim of both Taoism and Heraclitus, apparently; but then the Greeks have always been great travellers and interested in ideas).

In his excellent book (reviewed here last May), he suggests that inflation will come afterwards (actually, not just IN- but HYPER-).

A small town in Germany

The TV was on, and I forget what programme we were watching. Sometimes they were Dutch - we were near the border - but more often German. I was eleven, and would watch anything. Even the adverts were fun, linked by shorts featuring little cartoon characters, the Mainzelmännchen. HB cigarettes, Allianz insurance, Bear condensed milk ("Nichts geht über Bärenmarke……Bärenmarke zum Kaffee!")

Then a newsflash cut in: the President of the USA had been shot on a visit to Dallas and had been rushed to hospital. My father went upstairs. The programme resumed.

My father came down. I still remember him buckling his belt over his uniform, as ever uncomfortable and determined to do his best, a stocky man with a straight back, now full of tension. He watched with us as another newsflash came: the President was dead.

I think the camp sent a driver with a Jeep; in any case, Dad was gone. We watched some more TV, interrupted by occasional updates and speculation. Then it was time for bed. Flannel pyjamas, cotton sheets, the heavy blankets that trapped your feet. I went to sleep.

Lights woke me, illuminating the curtains. Heavy engines, headlights passing, heading in the direction of Düsseldorf. One after another after another. Now, I know they were tank transporters, racing to position the heavy armour in readiness for the Red invasion.

And now there are no more Communists, or so it seems. We buy fuel from the Russians, hardware and toys from the Chinese. The people my father, a gentle and sensitive man, was prepared to die fighting, are our friends and trading partners. As reported by The Independent, Chinese interests even supported our Conservative leader and former Prime Minister, Edward Heath (Sir Edward protested the following week, saying the claims were "misleading and inaccurate" - but did not go so far as to say that they were untrue). Surely, we're all friends now. After all, Dad had helped the Germans start to rebuild their country; he'd worked with German civilians, learned to speak the language fluently, married a German refugee. Wars happen, and so does peace. The people of the world are vexed by their leaders, yet love for one another endures and triumphs.

But Communism is not a nation, and does not love people. Everything, even its own most ardent supporters, can be burned on the altar of abstract principle. Informed that a general nuclear war would kill a third of humankind, Mao said good, then there would be no more classes.

And dictators, dressed in a little brief authority, ignore warnings. On the eve of World War II, when the conflict could yet be averted, Hitler was with guests in Berchtesgaden when the clouds over the mountains assumed an ominous red and yellow appearance. A woman told him "Das bedeutet blut, und mehr blut" ("This means blood, and more blood"); Hitler trembled, but then said if it must be so, it must be so.

As gypsies and beggars used to sing:

So proud and lofty is some sort of sin
Which many take delight and pleasure in
Whose conversation God doth much dislike
And yet He shakes His sword before He strike

(The Watersons performed it on "Frost and Fire", which our English teacher played to us in the late Sixties. I associate it with cold, freshness, the musty fragrance of the Monmouthshire woods, animism, hope.)

By degrees, this brings me to the current state of affairs. Our leaders wish us to believe that the history of our fathers is at an end, and now only efficient administration remains to be achieved. The revels of democracy are ended; they were fun, but their time is past.

No: as Christopher Fry said, "affairs are soul size", still. Although I do believe that sudden and total conversion is possible, as in James Shirley's now implausible-seeming play "Hyde Park" (who would have believed the Earl of Rochester's conversion? - and there are those who still doubt it, not knowing how the sinner hates sin), I doubt that all who worked with the old Soviet and Chinese Communist regimes have abandoned their principles and plans. Like the remark about the significance of the French Revolution (variously attributed to Chou En-Lai and Mao Tse-Tung), it's "too early to say".

Even if our leaders should be gullible or merely suborned, Jeffrey Nyquist reminds us again that there are still people who think differently from us, and we must be prepared. It is not all right to be weak, whether militarily or in our economies. Good fences (and good borders) make good neighbours.

Punish the perp

Karl Denninger says we should make the people who caused the subprime problems pay for the consequences. Either they should burn up with their own debt (Marc Faber has said some players should be taken out of the game) or pass on the grief to their shareholders, issuing new shares to raise capital and so diluting the existing stockholders' portion.

Unfortunately, we in the UK have chickened out - for party political reasons to do with its power base in the north of England, the Labour government is currently holding the baby in the case of insolvent lender Northern Rock, even though the tax payer is on the hook for nearly $120 billion as a result. (Hey, that's nearly as much as the proposed new tax break to reflate America - and our population is one-fifth the size of yours!)

Hope you have better luck - or better leaders - over there. Buy a Lottery ticket and hope?

Dow 9,000 update

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.

Stocks may follow bond yields down

Bob Bronson gives us a striking graph of the apparent correlation (since 2000) between the stockmarket and the yield on 10-year Treasury bonds. There is now a very wide gap between the two and seemingly the implication is that stocks are overdue for a large correction.

Here we go

Two from Karl Denninger in the last two days:

Monday, he reasserted his belief in DE-flation; but as I've been saying for some time, maybe the real issue is the divide between haves and have-nots, and he deals with that, too. No point being rich if you daren't go out.

Yesterday, he sounded the bells for a possible crash today. Maybe this is when Robert McHugh's prediction is fulfilled.

Time to buy into Northern Rock?

Two hedge funds have punted heavily on the British lender that the government has supported with £55 billion.

The share price has slumped from over £12 last February to 69 pence, assisted by the gleefully gloomy 20/20 hindsight of the news media. We had voxpops today from small "windfall share" demutualisation shareholders ruefully reckoning their notional losses and admitting they can't find the (now-near worthless - ha!) certificates.

One of Sir John Templeton's maxims is "The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell."

Let me offer two of mine: "Never buy what the fund managers try to sell you at financial adviser seminars", and "Remember the journalists who had their pensions in Equitable Life with-profits, because EL didn't (ugh!) pay commissions".

If I had the spare, I might speculate on NR. Hedge funds may be able to afford losing money, but they certainly don't go out of their way to do it. I wonder what will happen?

Oil to crack the dollar?

Nathan Lewis reminds us how, when President Nixon cut the dollar's link to gold in 1971, OPEC protected the real value of its oil with price rises (thus earning a reputation for having caused our inflation).

Now that the gold dinar has been introduced in Malaysia, Lewis wonders whether the dirham should link to gold, too, so oil exporters can avoid being robbed by a falling dollar.

Brownouts and lines at the gas station again, perhaps.

USA / UK Sovereign Wealth Funds?

Shares are supposed to be the best long-term investment, better than bonds or cash. The usual concern is the time horizon of the investor. Who lives longer than a state like America or Britain?

Foreign governments with trade surpluses (based on artificially low currency exchange rates and stupid overspending by the West) are building up trillions in reserves and eyeing our companies and real estate. If our own leaders aren't willing to rebalance the world economy, the least they can do is get a piece of the action.

Why not?

Dow 9,000 update

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.

To Gordon Brown: please remit £4bn ASAP

From Bob Hoye in Safe Haven yesterday:

"U.K. Sold 395 tonnes of gold at an average price of $274.9 per ounce. The first sale at $254 caught (or caused?) the low point in a 20-year slide in the price of gold.

The losers are us, Brown's gold sales raised around $3.49 billion.."

-- Telegraph.co.uk , January 2, 2006

That was written when the price was $627 and at today’s gold price of $895 the position would be worth $11.4 billion. And - remember the reason for selling was to improve central bank returns - what did they buy with the funds?

I make that a loss of $8 billion to date, or £4bn sterling.

We hear a lot about accountability. If only politicians could be made personally financially accountable.

Or if they could be paid to go away. In recent times, it would have saved the country a fortune if each senior politician had been given £10 million to do nothing at all.

Debt and slavery

Doug Noland sees the debt crisis spreading to the corporate sector; David Jensen writes a letter to the Governor of the Bank of Canada, including very telling graphs of mounting debt and the bubble in the financial markets; Michael Panzner discusses a piece from the Financial Times on the threat of a downgrade of America's historic AAA credit rating, and refers to the weakening of the USA's military pre-eminence; Sol Palha worries about the acquisition of Western assets by sovereign wealth funds ("Slowly but surely America and Europe are going to be owned by foreigners. The irony is that Congress is trying to keep immigrants out of this country but right in front of their eyes foreigners are slowly gobbling up huge chunks of this country.").

All this leads me to Jeffrey Nyquist's grim, but compelling latest piece. He despairs of the irrelevance of mainstream political discussion, especially as the polling process rattles on, and paints a far greater picture. I think you should read it all, but here are a few extracts:

What is happening in the news today, what is happening in the markets and in the banking system, has profound strategic implications... There are no invulnerable countries... If a government does not see ahead, make defensive preparations, establish a dialogue with citizens, lead the way to awareness and responsibility, then the nation stumbles into the next world war unarmed and psychologically unprepared.

Even worse, today's politics has become a politics of "divide and conquer" in which one constituency is played off against another: poor against rich, non-white against white, the secular against the religious. Before a positive outcome is possible, we must have unity and we must have reality.

It's more comfortable to ignore the crying of Cassandra, but maybe Nyquist is like Churchill in the pre-WWII political wilderness, trying to prepare us for the next conflict. We in Britain only just made it, and how we have paid for that struggle ever since.

But it was a price worth paying. History would have been very different, and very horrible I am sure, if Churchill had listened to some in his Cabinet in 1940 who advised him to make a deal with the Nazis. He said, “If this long island story of ours is to end at last, let it end only when each one of us lies choking in his own blood upon the ground.” It's a line that even now has tears pricking my eyes. The appeasers were silenced by the sound of deeply-moved men banging their fists on the Cabinet table in agreement and applause.

My worry is that I don't see men of that calibre now. As Lord Acton said in a letter to a bishop, "Power corrupts, and absolute power corrupts absolutely". Commenting on the House of Commons after the Great War, Stanley Baldwin remarked on the presence of "A lot of hard-faced men who look as if they had done very well out of the war". Today, the faces are softer, the hair expensively dressed, the manner relaxed and affable, but behind it all one senses cold-hearted, selfish betrayal. To be charitable, it may be that our leaders and ex-leaders don't fully realize the negative consequences of all their deals, compromises and consultancies.

As our reckless debt is progessively converted into ownership, we may find out how much we took our freedom for granted. It's a lot harder to get back.

The Bible has something to say on this, too (and no, I'm not a preacher, this is to show that the issues endure throughout history): Leviticus, Chapter 25 deals with debt, buying and redeeming slaves, and how the chosen people should be treated differently from the heathens - for the latter, enslavement is perpetual.

Gold, the dollar and the Dow

Gold supporters seem to be waiting for a reprise of the heady days of 1980. I think this is another case where you need to decide whether you are a speculator or a long-term investor.


Here's a relatively recent graph of the price of gold, adjusted for inflation (admittedly, inflation can be defined in many ways):

On this chart, it looks as though gold's median price would be around $600/oz, so currently it's above trend and presumably the elevated value factors-in some economic concern.

Now, here's a chart correlating the Dow and gold:It seems harder to spot an average here, since each peak is much higher than the one before. But taking the Dow as it is now (12,606.30) and the current price of gold ($894.90), the present ratio of 14.08 ounces would be in the middle range of the variation since the mid-1920s.

So a purchase of gold now looks like a speculation, rather than a bargain.

Waves and tides

A most apposite article by the Contrarian Investor, in which he considers how all this economic information leaves us confused as to the future direction of the economy. It's like getting millimetre-accurate radar images of all the waves in the harbour, without knowing about the effect of the moon on the tides. Not that the information itself is accurate, anyway.

Stuffed

Michael Panzner hands on a piece from Naked Capitalism: expert, inside opinion is that the banks are so gorged with bad debt that America will mimic the "melancholy, long withdrawing roar" of Japan's ebb tide.

Something's gotta give

Interest on official debt in the USA runs at $430 billion for 2007, and rising steeply, according to the Treasury's own figures (htp Michael Panzner, quoting Mish's Global Economic Trend Analysis); total government debt is now c. $9.2 trillion.

It's more serious than that, of course: James Turk quotes the Comptroller General, David M Walker's estimate that total liabilities, including commitments to future social security benefits, are around $53 trillion. The government's annual revenues are only around 5% of this figure, so the credit card looks like it's pretty much fully-loaded.

However it happens, it seems something must give way under the strain. Frank Barbera reckons the Dow has plenty further to fall (and possible interim correction or not, he thinks gold looks good). Prieur du Plessis concurs, quoting Nouriel Roubini's comment that "... a lousy stock market in 2007 will look good compared to an awful stock market in 2008."

Bob Bronson thinks the downturn will be long as well as hard. He in turn quotes the chairman of the National Bureau of Economic Research: this one “could be deeper and longer than the recessions of the past.”

Boris Sobolev also looks to gold, but prefers the smaller companies because of all the money that's piled into the majors.

In case we in the UK should be tempted by schadenfreude, Ashraf Laidi predicts that sterling will accompany the US dollar's fall against other currencies. From what I read in connection with the USA, a weakening currency may provide a temporary boost to exports, but also inflate the cost of imports; so I don't suppose that our following the dollar will do us much long-term good, either.

Of course, it's possible to dismiss all this as group-think wall-of-worry stuff, but maybe that would be double-bluffing ourselves. Sometimes, things are exactly what they seem. Banks have consistently turned a profit for centuries, on the inexorability of debt.

Oil splat

"Oil crunch" doesn't sound right, although it might be appropriate to shale oil: Jeffrey Brown outlines what looks like a compelling thesis on growing domestic energy consumption by major oil exporters. He thinks that the top five producers will be using all their own supplies by around 2030, and concludes that the USA must rapidly reshape its transportation system:

In simplest terms, we are concerned that the very lifeblood of the world industrial economy—net oil export capacity—is draining away in front of our very eyes, and we believe that it is imperative that major oil importing countries like the United States launch an emergency Electrification of Transportation program--electric light rail and streetcars--combined with a crash wind power program.

That is just the tip of the iceberg, surely: residential and office heating/lighting, mechanised farming, supermarket shopping, centralised medical facilities - so much will have to be reviewed and planned.

Twang money, encore

The Contrarian Investor is also struck by the elasticity of fiat money, and how this vitiates attempts to make fair comparisons and store wealth. Gold for the long term, he thinks.

In the short term, we have this contest between credit contraction and currency expansion. I'm getting the feeling it'll be the first followed by the second, which is what Michael Panzner predicts in "Financial Armageddon".

Grab your pension now, inflation-proof it?

Tony Allison looks at the threats to your prosperity in retirement. A bird in the hand?

Killer greens

Stuart Staniford takes a point I've read recently in Vernon Coleman's "Oil Apocalypse", about biofuels threatening food supplies for the world's poor, and extrapolates frighteningly:

... both oil and cereals are global commodity markets. If it's profitable to make food into fuel in the US, even without a subsidy, then it's profitable elsewhere also - possibly more so given lower labor costs. So the basic growth dynamics are the same. The infection just hasn't got as strong a grip on the whole globe yet, but it's growing at similar rates.

... I expect oil prices to increase in the medium term, though certainly they could go down in the short-term if the credit crunch affects the global economy enough.

... When we have a bidding war between the gas tanks of the roughly one billion middle class people on the planet, and the dinner tables of the poor, where does that reach equilibrium?

... We noted earlier that according to the UN about 800 million people are unable to meet minimal dietary energy requirements. That is 12% of the world population. [...] we can estimate that a doubling in food prices over 2000 levels might bring 30% or so of the global population below the level of minimal dietary energy requirements, and a quadrupling of food prices over 2000 levels might bring 60% or so of the global population into that situation.

Zero sum for the lower echelons

Martin Hutchinson (07 January) makes my case, with particular reference to Tata and Jaguar-cum-Land Rover :

... it seems likely that the most skilled Westerners will continue to give their countries a comparative advantage against emerging markets. However, there is no guarantee that these research-intensive sectors are likely to support the entire Western population, far from it. They are highly cyclical, benefiting hugely from an active stock market and venture capital market. Further there is no evidence that innovation itself, as distinct from the fruits of recent past innovations, is significantly expanding as a percentage of output -- indeed, research expenditure has if anything declined.

... Since the majority of location-dependent jobs in Western countries are low-skill it therefore follows that if governments wish to protect local living standards, they need to discourage low-skill immigration. Except in Japan, they have not been doing so; both in the EU and the United States low-skill immigration, frequently illegal immigration, has got completely out of control and is immiserating the working classes.

... the economic histories of a high proportion of the Western population under 30, except the very highly skilled, will involve repeated bouts of unemployment, with job changes involving not a move to higher living standards but an angry acceptance of lower ones. By 2030, it is possible that the median real income in the United States and Western Europe may be no more than 50-60% of its level today.

This will expose the democratic divide between those who vote and influence the system in their favour, and the rest. The class division could sharpen as "I'm all right Jack" is replaced by "One can't complain, Piers".

Sackerson awards a Prose Prize for Hutchinson's use of the term "immiserating".

P.S.

... and presumably this will have an obvious effect on residential property prices. Who's for selling up and buying a caravan?

Gold boom, gold bust

Brady Willett offers his predictions for 2008, including (at some stage) a major correction in the gold price, and Chinese equities.

I've reported expert comment before, about the vulnerability of gold to market manipulation and speculation. I think I'll keep on sitting out this dance.

Inflation or deflation: an expert writes

So it's not just me, even chart analysts like Captain Hook can't decide about IN vs. DE.

Also heartening to see my suggestion re insider jiggery-pokery echoed here:

As an aside, I still don't know what to make of the triangle / diamond in Goldman's chart (see Figure 4) other than they plan to squeeze stocks higher under the cover of low volumes over Christmas holidays in justifying their bonuses.

A winning combination

The Daily Mail alleges a new craze called "celebrity maths", where you combine two famous faces to make a third. Who might be the third here?

And what other political combinations would you like to see?

Gold and liberty

Fear, and the resentment of the oppressed, are more dangerous than bullish aggression.

I watched a programme last night about how we very nearly had the Third World War in 1983. This was a time when Russia was especially paranoid about the West's military intentions - spies were even ordered to report how many lights were on in late evening at the Ministry of Defence in London, apparently not knowing that the offices were lit so the cleaners could do their work.

Then in September, a Soviet spy satellite, fooled by sunlight reflecting off high-level cloud, reported not one, but five missile launches from America. The Russian monitor on duty ignored the klaxon and flashing screen, backed his judgment and told his superiors it was a false alarm, for which he was ultimately discharged from the Army. Wikipedia says his name is Stanislav Petrov. He's certainly worth more than the $1,000 the Association of World Citizens could afford to award him. We may owe him our lives.

Looking for updates on the gold dinar, I came across this blog by a Pakistani, in which he looks to the Islamic dinar as a way of breaking the enslavement of the world by a fiat-currency banking cartel. Irrespective of whether he's justified in his analysis of the situation, or reasonable in his hopes for such a currency, we should note the victim-perception. I seem to recall a maxim (from Sun Tzu?) that you should fear a weak enemy.

Which brings us back to the economic vulnerability of the UK and USA. Weakness can invite aggression, but also makes the weak fear an attack even when it isn't coming. Worryingly for a potential aggressor, weakness may be feigned:

22. If your opponent is of choleric temper, seek to irritate him. Pretend to be weak, that he may grow arrogant. ("Laying Plans")

I don't think you can truly be free until you are strong and independent. We need to get our houses in order, so we can deal with others from a secure base - which is safer for all involved.

Iraq may have the last laugh

A company called Sebastian River Holdings is substantially increasing its investment in Iraq:

... prior to the war with Iraq the Dinar was $3.00+ per US Dollar.

...Today the country is almost debt free; Iraq is one of the leaders in oil, natural gas and holds a huge amount of gold in its country.

... The Company believes in the near future there will be a revalue of the Iraq Currency, it is the Company's opinion after doing its due diligence and public statements from Iraq's government officials, that the revalue could come in at between .82 and 1.00 per US Dollar.

Twang

Jim in San Marcos borrows and discusses a chart showing homeowners' equity. As residential property prices drop, more borrowers move into negative equity. He says bank-owned properties (REOs) are already pricing-in a fall of 30%+.

"Examine the disappearing equity. It came from no where and is going back to no where."

That's what happens when credit becomes a form of currency, as the bullion moralists keep reminding us.

Why are banks allowed to create so much "fiduciary money"? Who does own the Fed?

Bitter medicine

The Levy Economics Institute runs a range of figures through its economic model and decides that it is pessimistic for the short-to-medium term, but guardedly hopeful for the state of the US economy afterwards:

... the present crisis is already more serious than any that has occurred before in modern times.

... Our projections, taken literally, imply three successive quarters of negative real GDP growth in 2008. Spending in excess of income returns to negative territory, reaching -1.6 percent of GDP in the last quarter of 2012—a value that is very close to its “prebubble” historical average.

... while the rate of growth in GDP may recover to something like its long-term average, all our simulations show that the level of GDP in the next two years or more remains well below that of
productive capacity.

... We conclude that at some stage there will have to be a relaxation of fiscal policy large enough to add perhaps 2 percent of GDP to the budget deficit.Moreover, should the slowdown in the economy over the next two to three years come to seem intolerable, we would support a relaxation having the same scale, and perhaps duration, as that which occurred around 2001.

Our projections suggest the exciting, if still rather remote, possibility that, once the forthcoming financial turmoil has been worked through, the United States could be set on a path of balanced growth combined with full employment.

Raving sane?

"Deepcaster" (Financial Sense, January 4) looks again at the mysterious ownership (and creation) of the US dollar by a private bank, the Federal Reserve. The more one reads about it, the weirder it gets - it's like finding out that ET really does exist!

The conspiracy theory here is that the Fed and other central banks are a cartel that not only inflates the money supply, but has created trillions in derivatives, partly to manipulate the investment markets. "Deepcaster" accuses this cartel of engineering drops in the gold price, just when you'd think gold should be emerging as a natural currency.

He brings in the Amero theory, too - ultimate replacement of the destroyed dollar by a new North American currency, presumably so the crooked poker game can continue with fresh cards.

Can anyone please shed light on all this? For example, who EXACTLY are the owners of the Fed?

If nobody knows or is willing to tell, perhaps one of us should claim ownership - "finders, keepers".

Unemployment B-L-S---

Market Ticker: The Recession of 2008

Karl Denninger reports that the US unemployment rate has hit 5%. He thinks - and it's certainly plausible - that we're already in a recession. Especially if Rob Kirby is right, and the Bureau of Labor Statistics (BLS) is lying about the scale of job losses in the financial industry.

Marquess of Queensberry rules?

One envies the cheerful liberal economists such as those at Cafe Hayek, but will their principles work in a world where other, much darker forces are working? As I suggested in September, there may be those who will use the tools of international trade and investment as part of a vengeful and destructive plan.

Now, Jeffrey Nyquist treats us to another Sino-Soviet frightener, and Nadeem Walayat sees even more potential enemies, who may not refrain from below-the-belt blows. The enemies of the Open Society abide. Are our Western politicians prepared? Will they defend us?

Gold and the Dow

Prudent Bear's excellent presentation "The case for a secular bear market" includes a graph of the Dow divided by the price of gold, from 1920 to 2005.

Taking the present values - Dow 13,056.72, gold $864.80 - the formula works out at 15.098, which suggests that the Dow is still well above trend.

Some would see this as indicating a coming gold spike; but another way to rebalance is for the Dow to fall. As credit deflation takes hold, I suggest that in 2008, both gold and the Dow will drop below their current levels, but the Dow more than gold.

UPDATE

Gary Dorsch is looking at the same ratio ("By the end of 2008, the DJI to Gold ratio might tumble towards 10 oz’s of gold"), but thinks the rebalance could happen the other way, through destructive inflation.

If so (and he doubts that it's possible), Karl Denninger thinks you'd still be better off betting on the Dow, using call options:

So tell me again - if you believe in "hyperinflation" - why do you want to buy the clear LOSER of an asset that metals represent, when you can buy index CALLs and, if your thesis is correct, you will make an absolute stinking FORTUNE!

(Of course if you're wrong and the DOW is under 16,000 by the end of the year, that $20,000 is totally flushed. That's the price of poker - but again - just how sure are you that "The Fed" is going to "hyperinflate"? And by the way, no, I don't think they are - in fact, I don't think they CAN.)

SECOND UPDATE

Gary Tanashian sets a target of $920 for gold, but anticipates a drop-back anytime; but longer term, Julian Phillips can't imagine governments NOT hyperinflating, to avoid the horrors of deflation.

The astrologers continue to mutter and gesture over their charts.

Dead Cat Splat

Some expect the market to drop, but bounce quickly as in 2000. Vince Foster says not, since this boomlet has been credit-fuelled.

His view: housing is woeful, emerging markets look as though they may be topping-out, the Ted Spread is signalling insolvency fears, the 10-year bond rate augurs slowing growth; so cash is king.

Little boxes, revisited

I've previously suggested that you don't need to be too technical, as long as you focus on the reward systems (the cui bono?). Here, Michael Panzner quotes and discusses an article by Nat Worden on the failure of ratings agencies in the subprime debacle.

I think it's in "Jane Eyre": a teacher who wishes to instil piety into a little boy, asks him whether he'd rather have a biscuit or a blessing. When he answers, a blessing, he gets two biscuits.

When recession empties the the biscuit barrel, maybe we'll get authentic leadership.

UPDATE

My beloved recalled it better, and so I've found the quote on the Net:

...I have a little boy, younger than you, who knows six Psalms by heart; and when you ask him which he would rather have, a ginger-bread nut to eat, or a verse of a Psalm to learn, he says: "Oh, the verse of a Psalm! Angels sing Psalms," says he. "I wish to be an angel here below." He then gets two nuts in recompense for his infant piety.’

We need recession, to avert total disaster

In a sock-to-the-jaw article that I think everyone should read, Nadeem Walayat shows the political-economic forces tides beating against our cliffs and undermining our liberty and prosperity. Like me, he sees sovereign wealth funds as part of this process.

It seems that we must wish our own countries a spell of hard times, in order to stimulate the changes that will defend us from permanent ruin.

Ta-ta industrial wages, hello Mcjobs

India's leading car-maker Tata seems likeliest to take over Jaguar and Land Rover. The fiddle plays, Rome burns.

Mirror, mirror

A few days ago, I said, "This is where I thought we were in 1999. Thanks to criminally reckless credit expansion in the interim, we're still there, only the results may be worse than I feared then." Now, Tom Madell draws comparisons between 2000 and 2007.

Few are brave enough to come out and declare the start of a bear market; but the watchword is "proceed with caution".

Consequences

Michael Panzner turns his attention to the human implications of recession, as I have been doing for some time, most recently here, here and here. At least America is a democracy and so politicians must have some incentive to clean the Augean stables; I don't know about the UK.

Bad news: we depend on the banks

The long-experienced team at Contrary Investor thinks the credit market needs watching, not the equity market. Outlook: oh, dear.

When things turn vengeful, let's take a careful look at the banks, and those who give them their orders. Not for the first time, they've lifted us up, and are making ready to drop us from a great height.

As the song from Mary Poppins has it:

If you invest your tuppence
Wisely in the bank
Safe and sound
Soon that tuppence,
Safely invested in the bank,
Will compound

And you'll achieve that sense of conquest
As your affluence expands
In the hands of the directors
Who invest as propriety demands

[...]

You can purchase first and second trust deeds
Think of the foreclosures!Bonds! Chattels! Dividends! Shares!
Bankruptcies! Debtor sales!

... for the whole lyric see here.

The scene ends, happily enough, with a run on the bank as young Michael loudly demands the return of his twopence.

Small is beautiful

J R Nyquist argues that internationalism is used as a cover for expansion by aggressive states, and the nation-state is our stoutest defence.

I think this links in with our domestic EU in-or-out debate, on which the allegedly Conservative British MP David Cameron has recently been making flirty noises. I say "flirty" because although the headline talks boldly of tearing up the un-referendum-ed Constitution, the leader of the Opposition says "We think the treaty is wrong because it passes too much power from Westminster to Brussels." How much is enough?

Perhaps some will say mine is a typical reaction from a little Englander, but originally that term meant an opponent of imperialism. Well, I'm used to ignorant brickbats. It was Philip Toynbee who - his son told me - called me a Colonel Blimp while I was still at school, I think because I had dared to ask him about the significance of colour in Lorca's poetry. What I gathered from this experience was: never ask a posh leftie for an explanation, he'll only look down his egalitarian nose at you. (I haven't met his daughter Polly, though.) Intriguingly, though the term "little Englander" is said to date from the 1899-1901 Second Boer War, there is an 1833 German dictionary-cum-phrasebook (published in Grunsberg) called "Der kleine Englander ober Sammlung". I do hope the title wasn't intended to have a pejorative tinge, but you can never be sure with the Germans - they do have a wry sense of humour.

The relevance of all this, aside from the asides? I think the themes of diversity, dispersion and disconnection will grow in importance over the coming years, in politics and economics. As with some mutually dependent Amazonian flowers and insects, efficiency and specialisation will have to be balanced against flexibility and long-term survival.

Recession QED

In an educational (and mercifully profanity-free) essay, Karl Denninger builds up his case from first principles, explaining the processes of creating and destroying money. He expects house prices to fall back by 30 - 50% and notes that in a recession, equities typically lose 30%.

He says the media is not reporting the truth. I tend to agree: I now throw away the Sunday football and financial supplements at the same time. If you want to know what's really happening, he says, watch what is going on at the banks, the Federal Reserve and Goldman Sachs, all of whom are battening the hatches, while CNBS (also castigated by Jim Willie) plays a cheerful tune to the proles.

I've written before how in 1999, as a financial adviser, I sat through a presentation from a leading UK investment house about tech stocks, which were supposedly about to start a second and bigger boom. I suspected then, and even more so now, that they were looking for the fabled "bigger fool" to offload their more favoured clients' holdings. Denninger intimates the same:

Are these shows, newspapers, and others reporters on the financial markets, entertainers, or worse, puppets of those who know and who need someone – anyone – to unload their shares to before the markets take a huge plunge, lest they get stuck with them?

Then he gives his predictions - which are grim, but not apocalyptic. It's the fools who will get roasted, not everybody. (By the way, Denninger is another Kondratieff cycle follower.)

What to hold, in his opinion? Cash, definitely; anything else, check the soundness of the deposit-taker. If you want to gamble on hyperinflation, he thinks call options on the stockmarket index are likely to yield more than gains on gold, even if the gold bugs are right.

This is where I thought we were in 1999. Thanks to criminally reckless credit expansion in the interim, we're still there, only the results may be worse than I feared then.

Oh, and he thinks the dollar will recover to some extent, because the rest of the world is going to get it just as bad, and probably worse. (Interesting that the pound is now back under $2.)

The answer to Olduvai?

I am most grateful for a comment by "APL" on the heroic "Burning Our Money" blog, which directs us to an article on the potential of radiation-free fusion energy.

There is an international project (ITER) in the south of France to develop this, and if it works...

UPDATE

Thanks to GMG for a link to this discussion of fusion power, which tends to the conclusion that a successful and economically viable fusion system is a very long way off, if feasible at all, and we'd do better to concentrate on fission, i.e. the present type of nuclear power station.

Spot the trends

The CIA World Factbook gives global GDP per capita as $10,200 (in purchasing power parity terms). This puts the average standard of living somewhere between Kazakhstan and Mexico. On the same basis, per capita income is $43,800 in the USA and $31,800 in the UK .

Generally, the poorer the country, the higher the income inequality as measured by the Gini Index (except for Azerbaijan, according to this from the ESRC).

The Factbook estimates 30% combined unemployment and underemployment in many non-industrialized countries; developed countries typically 4%-12% unemployment.

There are enormous fortunes to be made (by some) arbitraging the economic differences between countries.

In the USA and the UK, we are relentlessly spending more than we are earning.

What are our governments' plans for us to remain rich? And given the correlation between income and equality, do our business, media and political elites have much incentive to make and seek support for such plans?

Contradicting the contrarians

Cash is king for now, but later next year it'll be equities up, dollar up, bonds down, according to the round table on Safe Haven.

UPDATE

But Tim Wood expects the market to hit a low - "The straw that finally breaks the camel’s back may be closer than you think."

Desperate hope

"Desperate hope" is an oxymoron, which sounds like a dumb bull: mine is that we will have a tough landing rather than a complete crash. Goading the dumb bulls is The Mogambo Guru (Richard Daughty), who delivers another comical end-of-the-world sermon on inflation. He thinks dropping interest rates will encourage borrowers to take on still more debt.

However, many have already pointed out that (a) lending criteria are tightening and (b) not all of the interest rate cut is being passed on to the borrower. So lenders are trying to reduce their exposure and are also being paid more for the risk they have already assumed. And we see from this Christmas shopping season that (c) the consumer is becoming more reluctant to spend.

That's not to say that we won't get inflation (in some sectors, not housing), since falling interest rates tend to depreciate the currencies of debtor countries relative to their cash-rich trading partners. On the other hand, the latter will continue trying to hold down their currencies, in an attempt to keep the show on the road - the show being the osmosis of wealth from the lazy, spendthrift West to the hard-working, hard-saving developing world.

We're going to be buying less, but I don't know how fast the Eastern co-prosperity sphere will take up the slack. In his book "The Dollar Crisis", Richard Duncan argues for a worldwide minimum wage to stimulate demand; but maybe events have overtaken him. Certainly, China aims to expand its middle class, rapidly.

But there's another way for China to stave off depression while waiting for the sun to rise in the East. According to James Kynge, manufacturing and transportation costs account for only about 15% of the end-price of Chinese exports to the US. Some of the expanding Chinese middle class will surely go into advertising, marketing, sales, distribution and finance. As China develops its own version of Wal-Mart, Omnicom and banking, credit card and financing operations, it'll own more of the total profit in the supply chain - some of which it can sacrifice to retain market share. And they're motivated to do so by the fact that domestic consumption yields very little profit for their companies: the money's in exports. The longer this game goes on, the more the decline of capital and skilled labour at our end.

So let's worry about the effects at home first. Yes, for investors inflation may be a worry, but perhaps they should extend their concern to include the stability of the society in which they live, as unemployment and insolvency stalk through the West. The issues are no longer financial, but political and social.

And we'd better hope that we don't go for the wrong solutions. Daughty quotes Ambrose Evans-Pritchard's 12 December article in The Daily Telegraph, which concludes (amazingly), "... it may now take a strong draught of socialism to save the Western democracies." I do not think Mr Evans-Pritchard is very old. Or maybe he's just saying that to bug the squares, an expression I'll wager he's too young to remember.

Anatomy of a CDO

The Wall Street Journal provides a grisly visual dissection of a subprime mortgage package - thanks to The Contrarian Investor for the lead.

If I follow correctly, the trickery seems to come in step 4, where a CDO largely composed of middling-rated mortgage risk sells bits of itself with unreasonably optimistic ratings attached. "Skimmed milk masquerades as cream".

Some interesting correlations

Greg Silberman reveals the results of some interesting research:

1. Since 2003, if the dollar falls, all other asset classes rise; and conversely, if the dollar rises, the rest drops.

2. The "real" (adjusted for the price of gold) interest rate on 3-month Treasury bills predicts movements in the exchange rate of the dollar a year later.

Since the "real" interest rate has fallen sharply, he therefore expects a strengthening in other assets next year.

Modestly, Silberman adds, "Correlations are never perfect and tend to fail just when you need them most."

I think he's right there. To me, there seems to be a lot of jiggery-pokery in the gold market (speculators vs. central banks), and the predominance of "fiduciary money" (credit) in the economy means that we're measuring sizes with elastic bands.

In times of stress, the normal predictors don't hold, so currently I view all investments as speculative. My first priority is to reduce my vulnerability with respect to creditors, and my second is building cash to take advantage of emerging opportunities.

Defensive investing

Michael Panzner's latest is lucidly entitled "Today's Lesson: Bad Economy = Bad Stock Market". At last, financial analysis I can understand.

I've never understood why the stockmarket seems serenely unrelated to the dire state of the economy. Supposedly the market "looks ahead" around a year, but it can't be seeing what I'm looking at.

Anyhow, Panzner reproduces Dan Dorfman's article in the New York Sun, which reviews what's happened to the market in past recessions and gives tips on strong defensive areas - booze, cigs and "household products". I can understand that, too - or the first two, at least.

Jim Willie goes bowling

Bowling is fun - some would say, too much fun. Apparently, Connecticut passed a law in 1841 banning "ninepin lanes" and so fostered the invention of tenpin. In the old game, still played in England, you set them up manually - it gives you something to do while downing your beer and waiting your turn. The uneven boards of the alley add a pleasantly unpredictable element, too.

Jim Willie stands up nine reassuring statements about the US economy and smashes the lot down. He goes to the back of his mule for material to throw at Greenspan, Wall Street, CNBC etc and concludes that nothing is going to stop the financial melt. So he recommends gold.

He may be right, since on both sides of the Atlantic the authorities have decided to bail out lenders, instead of following Marc Faber's advice to let some of the players be taken out of the game.

However, as Faber has also pointed out recently, gold is an item everyone thinks everyone else supports, without committing themselves (elections have been lost that way). Is it not possible that we could see a continuing uptrend in the (relatively small) gold market, simply because of increased demand from existing fans? In which case, don't come late to the party - you'll have brought fresh beer but missed the fun.

Uncertainty

A trio of articles from Safe Haven: Paul Tustain thinks that inflation, and even hyperinflation are indeed possible, because of support operations for the banking system; Michael Swanson reads the charts and thinks the stockmarket could be teetering on the edge; Adam Oliensis of The Agile Trader is man enough to admit he's baffled:

A couple of things seem pretty clear to me: first, that I haven't lived long enough to have enough experience to know whether the bulls or bears are right about just how far the ripples will spread from the credit market problem; second, that there's never been an economic cycle just like this one, so even the people who have lived long enough to know who's right are speculating at best. (highlight mine.)

So it's not just me that's confused. And we're in distinguished company: Marc Faber also says we are in a new situation, with the possibility of a first-time-ever worldwide bust.

If we're into guesswork, then mine is that for a while, the monetary inflation will offset the credit (or "fiduciary money", as I'm learning to call it) deflation.

And then? Here's what worries me, in my amateurish, hunchy fashion: balance can be achieved in different ways (an empty seesaw is not the same as one with an elephant at each end). There's been a massive buildup of energy within the system, and the question is, can the Xbox take it?

Can democracy resist the hyperinflation route?

The Contrarian Investor thinks that rather than face economic depression, voters will force the US government to destroy wealth by hyperinflation. The arguments are therefore not economic but political.

I'm not so pessimistic; and if I were, investing in gold would be of less concern than physical survival.

Marc Faber: profile and views

Here's a profile of Marc Faber from 18 months ago, describing him as an ace, though I'd say he's a wild card: a hedonist whose philosophy is non-attachment, a lover of life who festoons his website with images of mortality. It's a cavalier, death-spiced duality that women tend to find very seductive.

And here's an interview he gave to Resource Investor 5 days ago. Some snippets:

it’s clear that in the U.S. we are already at some kind of a stage of stagflation where say retail sales are strong because grocery prices are rising very strongly. So that boosts essentially grocery sales whereas sales of discretionary items are sluggish...

the whole credit bubble that we’ve built over the last 25 years, I have to point it out, has now basically come to an end. We will have lower credit growth... that leads to poor economic conditions... the Fed will eventually win because they can print an unlimited amount of money, and they can essentially expand their balance sheet by not only acquiring treasury securities, but also lower quality paper... at that point I suppose that inflation will become a problem. And so in real terms you will have no economic growth, and you have a real kind of stagflationary environment...

whenever ... you have relative tightening of international liquidity ... you have a period of dollar strength... I think that we may have for the next three months at least a rebound in the U.S. dollar... I think long-term the dollar is a doomed currency because you have a money printer at the Fed and you have basically Hank Paulson at the Treasury who comes straight out of Wall Street and who has more interest in stabilizing the price of Goldman-Sachs stock than of having a strong dollar...

the global economy will slow down very considerably over the next six to 12 months...

I’m not very bullish about commodities right now. I think the price of gold will also come under some pressure... But long-term I think that having Mr. Bernanke at the Fed, you have essentially a friend of gold at the Federal Reserve because he will print money...

I would like to add to your comments that so many people are bullish about gold... people have actually very little gold in their portfolio... the gold bugs are bullish about gold, but the other 95% of the world, they have no gold exposure at all.

If he's right, my guesses (23 December) aren't too far off the mark.

Liberty Dollar Update

A news item here about a bill introduced by Ron Paul, to stop the government misusing its power to kill-off rival currencies.

Visions of 2008

Following Dearieme's comment on the previous post*, I'm going to try to visualise a chain of events over the next year - guesswork, of course, with plenty of obvious ones:

USA

a marked deflation in property prices
a reduced demand for luxury goods and services
reduced imports of the above
consequent recession abroad
further interest rate cuts
higher unemployment
higher taxes
higher State and Federal budget deficits
a sell-off in equities
increased demand for bonds
a weakening currency
higher prices for food, fuel and clothing

increase in the price of good-quality agricultural land
consumer price inflation indices will not be able to continue to mask the real increases in costs of living, and this will have further consequences for public finances
public enquiries, leading eventually to a thorough reform of the financial system

UK

much the same as above, except I don't think our house prices will fall so far - the US subprime mess will hit investments, but we will drop our interest rates to devalue the pound to maintain stability against the dollar

Gold

will continue to fluctuate interestingly, but although some smart money is after it, there will be less spare money around generally, and other commodities will offer interesting opportunities for inflation-beaters. It's already above its inflation-adjusted long-term trend, and lenders will make sure that the real value of their loans is not destroyed by hyperinflation

... in short, slumpflation.

UPDATE

*and, by way of comparison, here is Karl Denninger's outlook in his Dec 24 post.
... plus a more sanguine assessment by Nadeem Walayat.

A Merry Christmas to all, and thanks for your visits and comments.

IN, not DE

Peter Schiff argues the opposite way to Karl Denninger, pointing to the large amounts of US currency held abroad. In paper-money terms, he foresees continuing consumer price inflation, faster than for the assets you hold, so you're going to get poorer. If assets also inflate, we're into hyperinflation. Reasoning this way, he is, of course, a gold supporter.

Righteous wrath

Karl Denninger comments angrily on the failure of authorities to grasp the nettle - issuing warnings instead of downgrading credit ratings, holding back from forcing off-book liabilities back onto the balance sheet.

I've been looking for one of those famous photographs from China's "Great Leap Forward", showing children standing on a field of wheat, such is the success of the Party's new agricultural techniques. Can anyone help me find it on the Net?

For it's certainly a bit like the official-fudged miracle economy we've got now. Except even the peasants have stopped believing in it, to judge by what's happening in the retail outlets.

Green screens

The traders seem to be filling their boots with annual bonuses, as I guessed on 20 November (Red Screens) - or is it just the cyclical winter upswing in the market, as Joseph Dancy shows?

Hark what discord follows

David Galland rehearses the argument for gold. He points out that, relative to stocks, the gold market is so small that a small shift into it from stocks would massively inflate demand. Against that is the fact that it hasn't happened yet, and that a small market can also be manipulated downwards by suppliers, particularly the central banks. Besides, in a real panic, Joe Average isn't looking to make a killing in commodities, he's trying to pay bills in cash and buy food and fuel ditto. Nice area for speculators with quick reflexes, though.

What is inflation, anyway? Ronald Cooke looks at the damned lies and self-serving statistics that underpin the official Consumer Price Index.

Jim Patterson reads the stockmarket runes and concludes:

Sub-Prime issues have been discounted. With overall market returns compressed the downside is limited. We expect a better market in the weeks and months ahead.

In his slightly starchy prose, The Contrarian Investor agrees with Patterson, up to a point, but also gives a serious warning:

1. In today’s market, the probability of the market going up is higher than the probability of it coming down. Hence, it is rightly called a bull market.

2. But should it come down (which is unlikely), it can collapse at extremely great speed and magnitude.

Hence, the stronger and longer this uptrend continues, the greater in magnitude and speed (as in volatility, not timing) the Great Crash III will be. Hence, the coming Great Crash III is a Black Swan event—an improbable but colossal impact event.

The importance of a particular event is the likelihood of it multiplied by its consequences. Black Swan events are events that are (1) highly unlikely and (2) colossal impact/consequences. One common mistake investors (and many professionals) make is to look at the former and forget about the latter i.e. ignore highly unlikely but impactful events.

Therefore, when contrarians are preparing for a crash, it does not necessary mean that they are predicting doom and gloom. Rather, they see the vulnerability of Black Swans and prepare for them.

Credit default swaps - a line of dominoes, one falls

Karl Denninger reports on the savage downgrading of a credit default insurer from "A" to "CCC" (junk) in one move - essentially a collapse in creditworthiness - and explains the implications for credit and investment markets. His conclusion is crystal clear:

If you're long stocks, bail now.

Stockmarket crash on the way?

Clearly, The Contrarian Investor (2 Dec) thinks it's a possibility. So does Frank Barbera, who looks at the jaded market response to interest rate cuts and says:

All investors take heed, you are staring at a market that is NOT responding well to “Good News.” Markets that cannot rally on Good News tend to accelerate downward on any type of bad news, and that is the kind of market which appears to be taking shape.

Here we go

California's 2004-enacted Proposition 58 requires the State to balance its budget. Revolutionary - how about something like this for the US Federal Government, the UK and its regions?

Now Governor Schwarzenegger is looking for a 10% cut in expenditures across the board, as the San Diego Union-Tribune reports.

What goes around, comes around

Rob Kirby quotes the Privateer newsletter's report that the European Central Bank is furious with Britain, for borrowing vast sums of Euros and forcing the stock of Euros to inflate.

Interestingly for me, he relates this action in part to the UK's having taken on so much of US Treasury debt, a matter on which I commented repeatedly some time ago.

Snippets, straws in the wind

Randy's Credit Crunch Update pictures a cycle of emotions in relation to the markets, and forecasts first deflation, then inflation;

Nadeem Walayat predicts another brightening of the FTSE's candle flame, before it flutters again;

Jas Jain says "total household debt growth below $300B annual rate will lead to outright deflation within months" and this is why the Fed has to keep trying to stimulate lending, with ever-diminishing responses;

Ghassan Abdallah counsels against trying to short the market, what with many forces attempting to support it - best to sit out the dance;

AFP interprets the slide in world stocks as a disappointed response to the Fed's limited interest rate cut, and a sign of fear of inflation - something Alex Wallenwein predicted recently;

Finally, Captain Hook plays with ideas that have occupied me for some time (rubric mine):

... If what we are witnessing is at a minimum a Grand Super-Cycle Degree event, then a total collapse of stock, bond, and currency markets world-wide could be in store as the globe reverts back to more regionalized economies, and localized currencies...

... the swings in the markets are enough to curl one's spine these days, so speculator exhaustion could play a role in curbing interest in speculation. This is a natural considering the aging western populations at this point and will play a big role in curbing the demand for financial assets moving forward as retirees attempt to spend their savings.