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Tuesday, July 7, 2007 Robert S. McNamara, RIP... Why is it Washington will bailout Wall Street, but not California? Are today's rising powers 'trapped'? Patrick Cox on this crisis' unique opportunities...and more! --------------------- Special Offer --------------------------- The "Forever Oil Crash" Has Already Begun The era of "cheap oil" is long gone...but there are two investments that could give you a powerful shield against the fallout ahead - and have the potential to soar, despite the current market turmoil. Keep reading... --------------------------------------------------------------- A Period of Creative Destruction by Bill Bonner London, England And it's one, two, three, What are we fighting for? Don't ask me, I don't give a damn, Next stop is Vietnam; And it's five, six, seven, Open up the pearly gates, Well there ain't no time to wonder why, Whoopee! We're all gonna die. - Country Joe & the Fish, "I Feel Like I'm Fixin' To Die Rag" Robert McNamara must have been in a hurry too. He never had time to wonder why he was sending 500,000 American boys to fight a war when Lyndon Johnson was "publicly promising in campaign speeches not to 'go North,' not to send American boys to fight wars Asian boys ought to fight for themselves," as an editorial appearing in the June 17, 1971 issue of The Washington Post put it. Both the International Herald Tribune and the Financial Times describe the former Secretary of Defense as the "architect" of the Vietnam War. This is news to us and libelous to real architects; as near as we could tell, the war went on without plans or blueprints, clapped together by jackleg meddlers. Then, the whole thing fell down in a heap. But we do not disrespect the dead here at The Daily Reckoning. Instead, we cut them open in order to figure out what was wrong with them. Look for the autopsy report later in the week...until then, Robert S. McNamara, RIP. For today, let us return to the markets. Yesterday, the Dow rose 43 points. Oil sank to $64. Gold traded at $924. The dollar remained about where it was, at $1.39 per euro. And the 10-year note yielded almost exactly 3.5%. Economists are guessing about how high unemployment will go in the United States. One estimate in RealEconomics has it peaking out at 14%. Another, from PIMCO, worries that it might just climb over 10% and stay there for a long time. Naturally, the calls for more stimulus spending are becoming louder. People are wondering how come Washington bails out Wall Street but not California. Wouldn't that stimulate the economy? The Golden State is issuing IOUs to paper over the holes in its budget. Wall Street has announced that it has found a way to make a buck on California's troubles; it will trade the IOUs just like bonds. But major creditors - fearing the paper could decline in value - may not take it...forcing California into a more immediate crisis. This will make people wonder something else: how come creditors take US IOUs, but not California's? The feds' deficit is 70 times greater than California's. Yet, lend money to the federal government for 10 years and you get just 3.5%. Meanwhile, in the business sector, Bloomberg continues its reports on the progress of the depression: "Earnings Drop Worldwide," says the headline. In the United States, dividends are going down faster than at any time in the last 50 years. Businesses are earning less and paying less in dividends because shoppers have stopped buying. Maybe it's just mid-summer. But despite the darkening clouds, there's an air of eternity...like the stillness before a thunder storm...as if time were stuck in a drop of amber...and lightning would never strike. "The worst is behind us," says a report from the British Chamber of Commerce. Of course, those words could have come from any one of dozens of sources. Economists believe it. Businessmen. Investors. The recovery may be "long" and "fragile." Maybe "L" shaped...rather than the V we were hoping for. However, Capital & Crisis' Chris Mayer tells us, the crisis is far from over. "We talk incessantly about bailing out the banks, bailing out Wall Street, when the real question is: who is going to bail out the taxpayers?" Well, it won't be Washington...so most likely, you'll have to fend for yourself. Now, should come the part where the rebuilding begins...and yet, there is no rebuilding. Instead, the economic model that has existed more or less intact since the end of WWII is being dismantled. Yes, dear reader, we have entered a period of creative destruction. Between the Napoleonic Wars and WWI was a period of growth and stability. There were disruptions - even grave disruptions, such as the War Between the States in the United States and the Franco-Prussian War in Europe. There were various uprisings, communes and Risorgimientos. But the 'powers that be' were solid. So was their money. The pound, the dollar, and the franc were all backed by gold. European powers ruled the earth. Britain ruled the waves. And gold ruled commerce and banking. It all came to a disastrous end in 1914. Soon, almost every government in Europe was bankrupt. The royal families of Europe - the Hohenzollerns, the Hapsburgs, the Ottomans, and the Romanovs - all were swept away by war and revolution. And then came the Genoa agreement of 1922 that allowed central bankers to hold pounds or dollars, instead of gold, as reserves. It was a small step for man...but a big step on the road to ruin. Thereafter came a number of other steps leading up to Richard Nixon's giant step in August 1971, removing the last trace of gold from the world's official financial system. The Archduke Ferdinand was shot in Sarajevo in June 1914. The summer that followed was uneasy but, for a while, calm. No one was quite sure what would happen next. As the warm days went by, it began to look as though nothing would happen at all. People had lived through a century of relative peace and prosperity. Smart people believed that something fundamental had changed. It was a new era, they thought. Globalization was making them all rich. And new technological innovations - the internal combustion engine, automobiles, airplanes, electrical appliances - promised a better, easier life for everyone. This better life was based on capital...savings put to work in factories, buildings, machines and transportation systems. Wars no longer made sense, since they destroyed this vital capital. Everyone clearly benefited from the new system of globalized trade; no one stood to gain anything worthwhile from war. One popular book of the time argued that war had become obsolete...unthinkable in this new modern world. Alas...here we are. Now, for the news from The 5 Min. Forecast: "We've found a raging bull market despite the current recession: Congressional travel expenses," writes Ian Mathias in today's issue of The 5. "Lawmaker spending on overseas vaca...sorry, diplomatic excursions has nearly tripled since 2001. See for yourself: "According to a study from The Wall Street Journal, hundreds of lawmakers traveled overseas last year at a record taxpayer cost of $13 million. And that doesn't include off-budget costs like spending in war zones or borrowing government planes to jet set abroad. "Some of last year's most diplomatically vital trips include: Five representatives checked out the Galapagos Islands to 'learn about global warming.' Six senators attended the Paris Air Show. Eight lawmakers enjoyed a delightful eight-day Italian excursion. And perhaps taking the cake, the House Homeland Security Committee's jaunt to Brazil, Argentina, Peru and Panama... pertaining to the defense of US borders, we must assume. "While the official numbers aren't out yet, the WSJ claims expenses this year appear just as outrageous. There are over 20 government employees whose sole job function is to plan congressional outings." Wanna make sure you get The 5 - in its entirety - sent to your inbox, every Monday through Friday? You can...by becoming a subscriber to one of Agora Financial's paid publications, such as Outstanding Investments. In the latest report, you'll learn about one investment that our intrepid correspondent, Byron King, says is actually better than gold. And given gold's performance so far this year, that's saying something. Get the full report here. And back to Bill, with more thoughts: Despite the comforting arguments in July 1914, the guns opened up in August and didn't stop until four years later. Even then, the destruction was not over. The next three decades were spent settling scores and sorting out the debris; the Bolshevik coup in Russia...Mao's victory in China...taking the Germans and Japanese down a notch...hyperinflation in Germany...depression in America - taken together, these developments created a new world order. The United States of America emerged triumphant. The US has dominated the planet's military affairs ever since; the dollar has dominated its financial affairs. But now this giant seems vulnerable. It still has the world's strongest military, but depends on it rivals for financing. Britain depended on financing from America in WWII. But America's elite were anglophiles...gladly sharing power with the British Empire in the interwar period, and then stepping into its boots after WWII. The handover of imperial power was smooth. Diplomats still speak of the 'special relationship' between the United States and Britain. Today's rivals are different. They speak different languages. They have different political systems...and different cultures. They are not European powers. Led by China, they are responsible for a larger and larger share of the world's output. And they already are responsible for a large share of the world's savings - with the biggest piles of cash in the world. Until now, they have recycled those savings back into the United States. It was as if you bought a new automobile and then the manufacturer gave you back your money so you could buy another one. This arrangement seemed to serve everyone fairly well for a long, long time. Americans got to enjoy a standard of living that not even they could afford. Emerging markets got to emerge much faster than they would have otherwise. Factories went up in Asia; debts went up in America. But that economic model is finished. Broken. It's over. Kaput. American consumers are not going to go further into debt so that Chinese factory workers can add to their savings. Instead, savings rates are soaring in the United States. And the Chinese are facing riots (described as "ethic riots" in the paper...they have left 156 dead in a remote Chinese province...How much effect did the financial downturn have on this civil insurrection? We don't know...) Like the great powers in the summer of '14, no one has an interest in upsetting the economic model of the last 50 years or disturbing the political stability of post-Cold War period. Besides, the rising powers - again, led by China - are "trapped," say analysts. They are thought to have "no choice" but to back the United States and its dollar. "China - with 80 different car makers to bail out... tens of thousands of huge socialist-era factories... and 100s of millions of workers to support - has a big problem," The Richebacher Letter's Rob Parenteau tells us. "Much bigger than they're letting on." "But when you are trapped, you spend all your time trying to figure out how to get free," said an analyst we met with yesterday. "Sooner or later, they'll find a way. Then, watch out." Until tomorrow, Bill Bonner The Daily Reckoning P.S. While Shanghai stocks haven't yet collapsed anything close to what we're seeing on this side of the ocean... it won't be long before they catch up. Before that happens, be sure and check out Rob's latest report that details a hedge against the entire Asian downturn and gives you a key "super shield" against a new collapse in Asian currencies. Get the full report here. --------------------- Special Offer --------------------------- Options Made Simple Let's face it - playing options can be tricky. But they can also be incredibly lucrative. Well, in this report, we lay it all out for you. It's quite plainly, the easiest way to play options...ever. And the gains are just as big. Keep reading here. --------------------------------------------------------------- The Daily Reckoning PRESENTS: To offer you extra diversity of thought today we have a perspective that's a little different from usual. Breakthrough Technology Alert's Patrick Cox is optimistic about the economy in the long run. He believes we will not only see recovery, but also new growth that will continue exponentially when it emerges. Though we face serious challenges in the short to medium run, Patrick says this is a unique time historically, with unprecedented opportunities for patient farsighted investors. Read on... Don't Let a Good Crisis Go To Waste by Patrick Cox Marco Island, Florida You probably know the old Chinese curse, "May you live in interesting times." I heard it first 30 years ago from an economics professor - my mentor, in fact. He was lecturing about the problems Austrian economic models predict when banking is controlled by government. There are, I know, politicians and pundits who blame the financial crisis on a "lack of regulation." Frankly, anybody who says that has failed the IQ test, or perhaps the ethics test. For all practical purposes, the American banking system is a branch of the federal government. It has been for decades. Without government guarantees, backed by taxpayers, Fannie Mae and Freddie Mac could not have attracted the level of investor trust they did. The subprime mortgage and housing bubble wouldn't have been funded. Nor would politicians have had the leverage to pressure banks into offering bad loans. Perhaps most importantly, financial institutions would have had no reason to lavish huge campaign contributions and cushy make-work jobs on the political classes. The banking crisis, however, is not my primary concern right now. It's happened, despite numerous warnings for years from rational economists and commentators. And it will pass. It is a structural problem, and restructuring is happening even now. The so-called bailout will delay the emergence of new institutions, but it won't stop it. Alternative institutions are rising that will avoid many of the past mistakes. Some are likely to be offshore. Even Vladimir Putin is talking about metal-backed currencies. It is ironic evidence that others are learning the lessons our political class has forgotten. My concern at the moment is the federal budget and ongoing deficits. This new expansion of government spending and debt is not some one-time event that markets can repair. According to the Congressional Budget Office, current annual deficits have quadrupled. Independent CBO economists forecast that they will level out in a decade to about triple pre-stimulus levels. Frankly, I failed to predict the magnitude of these budget increases coming. I expected increases and never believed candidate Obama when he promised to cut net spending. Neither, however, did I imagine he would increase it as much as he has. It is inevitable, however, that this level of spending will be reduced. It will happen for a variety of reasons. For one, such levels will slow the economic growth Americans are used to. It will stifle productivity and reduce income tax revenues. As it always has before, this will send the political pendulum swinging away from big government. Incidentally, claims that the spending increases are either a "bailout" or a "stimulus" are bilge. No one has ever seriously tried to explain how spending that does not take place currently can appreciably stimulate the economy in the short run. Still, less than 24% of the stimulus will occur this year. That other 76% stimulates nothing but advocates of government spending. "Economics is called the ‘dismal science’ for a reason. And it often falls to rational economists to play the role of parent, explaining that we just can't afford all those cool toys people want right now." So today, I want to take the time to deal in some depth with the effects all this will have on breakthrough technologies. I realize, incidentally, that some of my comments may be interpreted as partisan. They shouldn't be. I was a critic of President Bush's spending record as well, though it pales compared with current levels. And for the record, I don't think I've ever registered with either major party, even when I was working with a candidate in the last presidential campaign. He was a Republican, but he understands Federalist principles that would have limited the power of the GOP. I would gladly vote for the sort of tax-cutting Democrat my father was. Ours was a loyalist Democratic household and my parents revered John F. Kennedy - one of America's great tax cutters. His across-the-board tax cuts were greater proportionately than those passed during the Bush administration. They were enormously successful in promoting spending and economic growth. Give me a Kennedy over a Nixon any day. Nevertheless, I am prepared for e-mail from those who mistake my criticism of destructively high taxes for partisanship. It's not. Honestly. Economics is called the "dismal science" for a reason. And it often falls to rational economists to play the role of parent, explaining that we just can't afford all those cool toys people want right now. The term "dismal science," by the way, was coined by a Victorian historian describing the work of Thomas Malthus. Malthus set the standard for doom and gloomers. An Anglican minister and a terrible economist, he predicted the imminent destruction of civilization, if not humanity itself, in the late 1700s. Despite our survival and amazing progress since then, others make similar predictions to this day. I am, in fact, optimistic about the long run. The economy will not only recover. It will continue to grow exponentially when it does. That doesn't, however, mean that we don't face serious challenges in the short to medium run. This, however, is a unique time historically, with unprecedented opportunities for patient farsighted investors. Rahm Emanuel and Hillary Clinton have both said that you should never let a good crisis be wasted. Though my means of exploiting the crisis are quite different than theirs, I agree with the general sentiment. There will, however, be delays in technology development. Because so many of the emerging breakthrough technologies today are related to health and longevity, I take those delays personally. While the economy will recover, there are people who will miss out on lifesaving therapies because new technologies are not being funded. This irritates me. Nevertheless, we need to look at the situation clear-eyed and figure out how to profit from it. And in the process, we may help move some of these revolutionary new technologies forward. There is another Chinese proverb about crises creating opportunity, and this is no exception. Now, to business. The most onerous impact of excessive federal spending is the absorption of capital. When finite capital is appropriated through taxation and federal debt creation, this necessarily reduces the level of funding available for research and development. This simple math is ignored by those who believe it's a good thing to tax the rich, the people who direct most investment capital into emerging technologies. Historically, overall economic well-being is best accomplished through the promotion of new technologies and businesses. Kennedy made that point with his famous statement that "rising tides lift all boats." Right now, the deficit is lowering the tide. Until this sapping of our R&D lifeblood is rectified, transformational technologies will face challenges. Typically, we know, investors abandon unproven sectors for traditional stability when things get scary. This includes even venture capitalists. New data from PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters verify that this is the case. In the first quarter this year, US venture capital investments fell 61%. In the same quarter a year ago, venture investments were $7.74 billion. This year, the total was barely $3 billion. This is the lowest level in 12 years. Acquisitions of venture-backed companies fell by nearly half from last year. There were no venture-backed IPOs. None. The one notable bright spot in this picture is health care services. Venture capital investment there is actually up somewhat. As I wrote on several occasions while we were waiting for the train wreck, health care is countercyclical. When times gets tough, the last thing consumers cut back on is medical services. This is one reason that my Breakthrough Technology Alert portfolio is so heavily weighted with medical biotech today. It's not the only reason, however. It is simply true that a huge percentage of the biggest and most profitable technologies on the near horizon are medical. Significantly longer healthy life, i.e. "time," is the product they will deliver. Economists talk about the "backward-bending demand curve." It refers to the fact that we max out on stuff. Eventually, if we get enough of something, we value additional units less. Demand for life, however, is unlike any other good or service. It is, in effect, infinite. Regards, Patrick Cox for The Daily Reckoning P.S. Nevertheless, the slightly increased level of VC money in health care startups is far below the level it would be without the current problems. For this reason, we are focusing this month on transformational companies that have been around for a while. There remain huge opportunities in transformational technologies - greater, in fact, than any other sector. Learn all about these opportunities in my latest report, found here. Editor's Note: Patrick Cox has lived deep inside the world of transformative technologies for over 25 years. In the 1980s, he worked in computer software development and manufacturing. By the mid-1990s, he worked as a consultant for Netscape - the company that handled 90% of all Internet browsing traffic at the time. InfoWorld and USA Today have featured Patrick's research many times. He's also appeared on Crossfire and Nightline. This expertise bought him to Agora Financial, where he now heads Breakthrough Technology Alert, the only place you'll find the truly transformational technologies that offer exponential gains. You can catch Patrick (along with the rest of Agora Financial's best and brightest) at this year's Agora Financial Investment Symposium in Vancouver, B.C. The symposium promises to be the event of the year - so don't miss out! Secure your ticket now - before the event sells out! See here: Agora Financial Investment Symposium, July 21-24 --------------------- Special Offer --------------------------- You could have turned $5000 into $1 million in just over five years... Each week, readers to make just one investment buy. And since November 2006, not one pick has lost value! It's no wonder readers of this newsletter could have turned $5,000 into $1 million in just over five years! Now, they're quickly closing in on $2 million! Join them...   The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future Introducing the Single Best Way to Make Sure You'll Never Run Out of Money...