Mark Skousen warns of market turmoil

I have just received an email from Investment U, featuring an article by Mark Skousen, who says that he recently attended a pre-book launch talk by Alan Greenspan. The Federal Reserve's ex-Chairman's memoir "The Age of Turbulence: Adventures in a New World" is due out in September.

Reportedly, Greenspan spoke of the scary periods in 1987 and 2001, and his surprise at the resilience of the US economy. Skousen notes two important points from the talk: Greenspan's enthusiasm for the future of the European Union under its more conservative economic leadership, and surprise at the low global interest rates that have helped to drive up the markets. Skousen suggests that interest rates may be on the rise, and the recently increased yield on the 10-year US Treasury bond seems to bear the same interpretation.

For investors, Skousen suggests using stop-loss triggers on share holdings (in a real emergency, will they work as intended?), gold and silver coin to pay your way if the worst comes, and a large amount of cash. Definitely a bear, and with a reputation for prescience: if you look at his website, you'll see that Skousen advised his readers to get out of stocks 6 weeks before the crash of October 1987 - "one of the few advisors to anticipate the crash".

I have to say that I expected it too, but I wasn't an adviser at the time; and I also anticipated the Far East slide of 1997 and the falls post-2000. Not because I'm a genius, nor on account of insider whispers: being naturally wary, I looked and listened for warnings from experts. And so, if I may suggest, should you.

Is modernisation good for India?

I am grateful to a respondent to my earlier post, "Have we overlooked India?" and I think the exchange is relevant to India's future generally. The visitor says:

I am wondering where we are heading in so called modern era. Example in textile machinery, one airjet can replace 100 handlooms, this means 100 peolple are displaced by a single machine. I am from Handloom city of Panipat (India). Earlier a person with 20 handlooms was happy and feeded his family well. Now even 50 looms are not enough because of the increased cost of living in so called modern era and people are getting trapped in vicious cycle of high cost, loans and increasing capacity.

My reply:

Yes, I am sure that this is extremely difficult and in fact English weavers suffered the same way nearly 200 years ago, which is why some of them turned to wrecking the machines that were harming their trade. But it didn't succeed in halting the changes. On the other hand, people in Britain are now materially much better off, so in the long run industrialisation is to everyone's advantage.

I suppose that the best thing that can be done is for government to support people who have been affected by modernisation, and help them to re-train in new areas of work. If you look at the post after the one you commented on, I give a link to Cafe Hayek. That writer points out that if saris can be made more cheaply, then sari-buyers will have more money left over to buy other things, so there will be demand for items that they could not have afforded before.

I think you cannot stop change happening, but governments can help manage the transition and far-sighted individuals can take advantage of new business opportunities.

Michael Panzner on bond yields

Michael Panzner commented in Monday's Seeking Alpha on the increased yield of the US Treasury 10-year bond. He sees it as another straw in the wind - "goodbye to the good old days". Ironically, in the ad box next to his article, a message flashed up, promising to double investors' money in the China boom. Fear meets greed.

Naturally, each day that disaster doesn't strike is taken as further confirmation that Panzner is wrong. I shouldn't count on that: exact timing isn't possible, but I haven't seen a refutation of his threat analysis, or a relatively painless solution.

The banks cause market bubbles, too

I plan to review Richard Duncan's book "The Dollar Crisis" soon - it's not just time constraints that are the problem, but trying to condense his arguments.

Essentially, Duncan sees the unlimited creation of credit as the mischief-maker in economics. Since the dollar is not restricted by valuation against gold, the government can print as much money as it wants.

But even when there was a gold standard, credit could still be multiplied, because banks lend out many times more cash than they've been given to look after. Banks only retain whatever fraction they (and the regulators) feel is essential to deal with likely withdrawals by depositors.

Then when bad times come, they multiply the problems by cutting back on credit - remember the old saying, "Banks lend you an umbrella when the sun shines and want it back when it starts raining"? I recall hearing (in the recession of the early 90s) of a businessman with a big turnover and a £3.25 million overdraft facility, who received a payment from a customer for £3 million. Acting on head office orders, the bank manager promptly reduced the overdraft to £250,000 and hurriedly left for the day, while the now-ruined businessman grabbed a shotgun and went looking for him at his office.

Have a look at this article by Wladimir Kraus in the archive of the Luwig von Mises Institute, criticising "fractional reserve banking".

Should India move away from hand-made goods?

Speaking of the potential benefits of industrial capital, I note an article today in Cafe Hayek about machine-made saris, balancing the loss to the traditional weaver with the gain to many buyers.

Have we overlooked India?

Indian respondents to Mr Venkatesh's article worry about the movement of the dollar relative to the rupee. But just as America's problem is not the dollar but its national economic fundamentals, so perhaps India should raise her eyes to a more distant prospect. The country has a well-established democracy and an independent judiciary; respect for law, family and property rights; many millions of fluent English speakers (don't worry, the call centres will eventually overcome problems of Western vernacular); and a famously entrepreneurial culture.

India may not be sitting on a vast coalmine, like China, but natural resources aren't everything. It's not natural resources (other than mountain ranges) that preserved Swiss independence, but the history and character of the Swiss. As to commerce, I forget which mega-businessman said he could lose all he had, but so long as he kept his staff he'd get it all back again.

If India avoids over-reliance on its low wage advantage and continues towards more intensively capitalised production, then it too can be a powerhouse in the new world economy. Remember that recently, the British Swan Hunter shipyard has itself been shipped to India.

Planning for the dollar drop

The bear view continues to spread. Greg Peel at Australian financial news site FN Arena today rehashes the article by Mr Venkatesh I covered yesterday.

The IHT article from March 28 last year was significant in that the Asian Development Bank was then urging countries to appreciate their currencies in concert when the dollar falls, so as to minimise the additional disruptive effect of national economic rivalry in the region. I guess that contingency plans are indeed being formulated.

The point of my own coverage is not to add to the gloom-and-doom, but so that readers may make their own plans to survive and thrive in the coming changes. Some will do well. What is your strategy?

To sum up... from India

A chartered accountant from India today summarises the general bear case about USA trade deficits and the future of the dollar. Mr Venkatesh apportions some blame to Asian countries, for choosing to keep their currencies weak in order to sustain their trading advantage.

The article is well worth reading in full, in particular the comments on oil and the threat of trading crude in Euros rather than dollars. It is also worrying that...

On March 28, 2006, the Asian Development Bank is reported to have issued a memo, advising members to be ready for a collapse of the US dollar. [see the International Herald Tribune report here.]

Since end March 2006, the US Federal Reserve has stopped publishing the quantum of broad money [...] This is the worst possible signal that the US Federal Reserve could have sent to the world.

[The rise in commodity prices] has led to inflation across the globe. No wonder countries are forced to increase their interest rates to fight inflation. This has triggered an interest rate hike across continents and the US is finding it extremely difficult to sustain its current borrowing programme: it hardly has any elbow room to manoeuvre.

The author says that the US can neither raise interest rates much further, because of the cost of servicing debt, nor lower them, because that may deny it fresh supplies of credit.

Either we are witnessing a global meltdown of the US dollar, or a controlled US dollar devaluation (read, revaluation of other currencies). If it is a global meltdown the global economy is doomed, if is an orderly devaluation, it is damned.

Dollar's rise only temporary

Chris Gaffney in Friday's Daily Pfennig comments on the recent rise in the dollar and puts it down to a sell-off in emerging market equities and some selling of gold to settle cash calls. He says the money is only "parked" in the dollar and will be off again soon:

The dollar will continue to trend down versus the currencies of economies that are better off.
As investors move away from riskier assets, the countries with strong balance sheets will begin to trade at a premium.

This refocusing on fundamentals suggests a return to sanity is on its way - initially not pleasant.

US Commerce Department figures: the good news is bad news

The US Commerce Department reported on Friday a narrowing of the trade deficit in April.

What is remarkable is the positive spin on the story. When you look at the figures, exports increased by $0.25 billion, but imports fell $3.6 billion. So 94% of the improvement is simply down to reduced demand for imports. This could be interpreted as a sign that Americans are tightening their belts, rather than improving their trade.

And how do we factor the dollar's exchange rate into these import and export figures? How do the numbers actually translate into quantities of physical goods?

Also, it's still a deficit, and at $58.5 billion in one month, divided by the USA's estimated (CIA, July 2007) population of 301 million, that's $194 bucks worse off per head. Or, given the average US household size (2.59), it's $6,037 per household per year. AAA statistics show you could run a small sedan on what you're losing to overseas trade.

Is the bear view becoming more generally accepted?

Friday's CNBC echoes familiar themes: Leburn of Weiss Capital Management tips high-dividend stocks in financially strong companies (as per Peter Schiff's book); David Tice favours cash (see Marc Faber recently), maybe with precious metals to protect against the dollar's decline; the stockmarket looks volatile (maybe kept up for a time by inflation).

US dollar needs to fall; intellectual property needs protection

An interesting report from China Daily yesterday. The American Chamber of Commerce there is asking for less pressure to revalue the renminbi and more for structural reforms in China.

The value of the renminbi is not the answer to everything. If the Chinese yuan rises against the dollar, then Chinese imports will cost more, and America might well cut back; but US industrial exports could be slow to grow because of eroded manufacturing capacity. And a weaker dollar would mean foreigners could bid more for US products (including foodstuffs), so creating price inflation in the US while production lags behind demand.

And there is also the question of just how much the dollar would have to drop to make US products globally competitive anyway. What you could see is Chinese light industrial manufacturers suffer a contraction, losing business to countries that have even lower wage costs, such as Vietnam. When the dust has settled, America's balance of trade crisis could simply have widened from US-China to US-Far East.

So it's not so much the renminbi that has to rise, but the dollar to fall.

Also interesting to see intellectual property rights come to the fore. As America sees her economic strength sapped, she must worry about the scruples of her competitors. If "might makes right", patents and copyright may not be the pension she was hoping for. I did discuss this a while ago (May 23), and think it's an issue to follow.

When gold may not be safe

Marc Faber has commented recently that there are bubbles everywhere, including commodities. Although gold has intrinsic worth, its price is still going to be affected by the laws of supply and demand. It has risen very quickly over the past couple of years, but if you believe those experts who tell us that our inflation has been fuelled by credit, then if and when a "credit crunch" comes, the scramble to disinvest in order to pay creditors and get ready cash may well mean a temporary drop in the gold price, too.

I think gold bugs are looking to the longer future, when governments desperate to get out of a slump may choose to print currency and so devalue it against precious metals, which they can't multiply at will. Meanwhile, if you follow Dr Faber, you may consider waiting with your cash at the station instead of boarding any of the asset trains, as he puts it.

Michael Panzner: government guarantees increase risky behaviour

Michael Panzner returns to one of the four central risks of which he warns, here in Seeking Alpha: the government mortgages the future with potential claims on the taxpayer's money.

Peter Schiff: China will dump the dollar

Peter Schiff predicts China must de-link from the dollar in today's Market Oracle. Because their economy is robust (based on actually making things), they will cope with the disruption and thrive; the USA will face the reckoning for its folly.

No easy way out for the US economy

Martin Hutchinson at Prudent Bear gave his view on Monday - the way out of the crisis will either be long and difficult, or short and painful:

...the choice is between a short sharp depression, albeit presumably less severe than 1929-33 (unless the forces of protectionism take a hand as well) or a lengthy period of stagflation like the 1970s, probably with a deeper dip than 1973-75. The third possible pattern, a prolonged period of stagflation like Japan in the 1990s, now seems rather unlikely.

Marc Faber: cash may be king

Please read this thoughtful essay by the modest Marc Faber yesterday. He looks at the zooming valuations of the Zimbabwe stockmarket and explains that it's because local investors' money has nowhere else to go if it doesn't want to lose value. He says the rest of us have a similar problem.

Currently, Faber is cautiously bearish about most types of asset:

...it will become increasingly important for investors not only to decide which asset-class train they want to board, but also, and even more importantly, whether they want to board ANY of the asset trains.

...a peculiar feature of the bull market in asset prices since 2002 has been that all asset prices around the world have appreciated in concert, as a result of highly expansionary monetary policies, which has led to excessive credit growth and a credit bubble of historic proportions. Therefore, if my theory of slower credit growth in the future holds, it is conceivable that, for a while at least, all asset markets (with the exception of bonds and cash) could come under pressure, albeit with different intensities.

In fact, asset markets would come under pressure, even if credit growth continued at the present rate and didn't accelerate. In this instance, investors would be better off not boarding any investment train at all and, instead, staying at the station loaded up with cash. (However, they would still have to decide what kind of cash to hold.) U.S. dollars might not be the very best choice.

The Ditching of the Dollar begins...

See David Galland's article in the Daily Reckoning Australia here.

Boom or bust? Cash, shares, property, government promises, or commodities?

The latest posting from The Daily Reckoning Australia includes this exchange:

We got this note the other day, "You say in part, "In markets today, to get along, you have to go long. And if you don't, well you're out of luck." Are you no longer worried about a melt down in the short term? How long is long? One year or two? Your past words of imminent doom had me very worried with its effect on my investment actions, (or inaction ) are you now changing your timeline? I am a daily reader of your investment letter and look forward to your response."

We answer that a melt-down must be preceded by a melt-up. Or in economic terms, a deflationary bust characterised by over production and capacity surpluses must be preceded by an inflationary boom.

We are in the boom phase. And like it or not, related to real value or not, prices are going to rise as global money and credit creation booms. If you're in the markets, you've got to make a choice with your money. So we'll be choosing assets with tangible value that are in economic demand as well.

This is the quandary for a cautious investor. During the inflationary period, cash is not a store of value. In a fair world, if the money supply expands by 13%, then the interest rate on deposits should increase to, say, 16% (allowing for tax) - anything less, and your wealth is being sucked out by an irresponsible government. Which it is. Paradoxically, to be cautious about your wealth, you have to get away from exclusive reliance on cash.

This is because inflation is not transmitted evenly throughout the economy. For example, I estimate that in the last 6 or 7 years, the money supply as measured by M4 (bank private lending) has expanded by around 80% in the UK. Deposits have certainly not returned 80%, but house prices have doubled.

However, borrowing must be repaid sometime - with interest. If a crunch comes and everyone has to pay up, then there will be a desperate shortage of ready money. Even houses can fall in value - whatever you treat like an investment will behave like one. So in the long term, it looks as though the saver has had the last laugh. Cash will be king again.

But the paupers have votes. So democratically-elected governments have a very powerful incentive to print money to put into the voters' hands - even if this means stealing the value of other people's accumulated savings.

No-one knows the timetable for all this, except that it's human nature to delay facing unpleasant situations, so we expect more fudging for a while yet.

Speaking of fudging, how does the government calculate inflation? Do its own "inflation-linked" products really store your wealth safely? Should you buy Treasury Inflation-Protected Securities (TIPS) in the US, or National Savings And Investments Index-Linked Savings Certificates in the UK? If the government gets your taxes and your savings and your investments, it's pretty much got you altogether. Do you trust it that completely?

How about equities? What shares would you buy? If you went into business yourself, how would you try to run it in this very unpredictable situation? Would you borrow cash to expand, risking suddenly having to repay it just as your customers disappeared because of their own money problems? Other than making profits by exporting jobs to low-wage countries (and slowly impoverishing the West), what good business opportunities exist in our wildly gyrating economies?

The Australian bear quoted above is indicating commodities, since the demand for natural resources isn't going to disappear entirely. Intrinsic value is an important consideration for him. If inflation continues, then presumably the price of commodities inflates; if deflation strikes, there will still be some money paid for commodities. Car companies can go bust, but iron and steel will only vary in price.

In a nutshell, it looks as though there's no one type of asset to hold in all conditions. The question instead is, what mix should you have?

The monstrous scale of the US and UK trade deficits

Have a look at the table in this article from Market Oracle. The figures speak for themselves!

British readers, please consider the fact that we are only two above the US, although our GDP is far smaller.