Fun with extrapolation

Since the 1990s, the stockmarket has been showing such freakish returns that many thought we were in a "new paradigm", whatever that means.

So I've looked at the Dow adjusted for CPI since late 1928, and calculated max/min lines on the basis of the highs in 1929 and 1966, and the lows in 1932 and 1982, to see just how unrepresentative the last decade has been. If we saw a return to these imaginary trends, the next Dow low could be less than half the present value. If, if, if...

Coincidentally, Jim Kunstler is predicting much the same:

By May of 2009, the stock markets will resume crashing with the ultimate destination of a Dow 4000 before the end of the year.

But I think it may take longer than that. The Elliott-wavers are looking for a final upwave first. Having said that, the last 10 years have been out of all comparison with the 70 years before.

Debt forgiveness, inflation and welching

Thus Jesse, discussing Michael Hodges' visionary "Grandfather Economic Report" and US indebtedness:

In a simple handwave estimate, one might say that the debt will have to be discounted by at least half. That includes inflation and selective defaults...

... something has got to give. The givers will most likely be all holders of US financial assets, responsible middle class savers, and a disproportionate share of foreign holders of US debt.

While the debtors hold the means of payment in dollars and the power to decide who gets paid, where do you think the most likely impact will be felt?

I give below the US Treasury's data on foreign holdings of their government securities as at October 2008, but I also reinterpret it in the light of each country's GDP, to show relative potential impact (please click on image to enlarge).

Mind you, even a complete repudiation would only take care of $3 trillion. Funny how not so long ago, $1 trillion seemed a high-end estimate of the damage, and now it's something like seven times that. And that still leaves a long haul to get to Hodges' $53 tn - equivalent to, what, one year's global GDP?

Ed Rates of the Caribbean

Vorsprung durch Technik

Is gold a hedge against inflation?

There are problems with using gold as an insurance against inflation.

1. Governments interfere with it - from making it the legal base of their currency, as in the US Constitution, to making it illegal to have any, as in the US in 1933; from guaranteeing the exchange rate of gold against the dollar (post WWII) to the Nixon Shock of 1971, when the gold window was closed.

2. Central banks claim to hold it, then (it is widely suspected) lend or sell it surreptitiously.

3. There is so little of it, that speculators can have a significant effect on the price, especially if (as appears to have happened in recent years), the speculation has been powered by vast amounts of borrowed money.

Below, I give three graphs, all comparing the price of gold per ounce in US dollars with inflation as measured by the Consumer Price Index (and that's another can of worms). It's clear that gold has a very volatile relationship with inflation and can spend a very long time above or below trend.

In the fourth graph I divide the Dow by the price of gold. It seems obvious that gold is a contrarian position for equity investors, rather than a simple hedge against inflation.

Currently, the Dow has come back to something like a normal ratio to gold, but past history suggests there will be an overshoot. And gold itself seems above trend over all three periods chosen; which suggests that both still have a way to fall in nominal terms, but the Dow more so.

(N.B. gold prices to the end of 1967 are annual averages, then monthly averages to the end of 1974, then the price is as on the first trading day of the month; all gold price figures from Kitco).

Nominal and real

Marc Faber's latest interviews on Bloomberg and CNBC show him estimating the recession to last "2, 5, 10 years". He also says that Asia is better placed to recover, because after the panic of 1998 they deleveraged, i.e. reduced borrowings.

So it's time for me to review my guesses about when the recovery will come for us. A key consideration is inflation, which Faber says is being stoked up for the long term by all the "stimulus" currently put in by panicky Western governments.

I've suggested that we might compare the present, not to the 1929-32 collapse, but the period 1966-1982, when inflation sometimes growled and sometimes roared. The result was that the nominal and inflation-adjusted low points are very far apart: the start-of-month level for the Dow hit bottom in September 1974, but adjusted for CPI, the real bottom was in July 1982.

So when the upturn comes, depends on your definition. I am still guessing that there will be a nominal recovery in 2010, but inflation will erode gains over time and the real turning point may not come until, say, 2016.

"Efficiency" vs. survival

"...we have to build back into the system Resiliency. This means that each region has to work to become largely energy, food and financially self sustaining and that each region needs to network into the others. In effect we shift from an efficient machine to a resilient network."

Robert Paterson, as quoted by London Banker.

Like I keep saying, it's about diversity, dispersion and disconnection - please click on the label below for my posts on this subject.