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| The Daily Reckoning | Thursday, March 18, 2010
| Flirting With Disaster
| Why betting against an economic recovery is still a smart play
| |  | | Joel Bowman |
Markets were dallying last we checked, up a bit, but not enough to sway an opinion. The majors in the US are up on average 5% for the past month, aided, as far as we can tell, by slapdash political rhetoric, myopic investor optimism and cherry-picked data analysis. That said, a 5% gain is a good month by just about anybody's measure. So why are we so dour?
The short answer is, "we're not...we're just cautious."
In his terrific book, Fooled By Randomness: The Hidden Role of Chance in Life and in the Markets, Nassim Nicholas Taleb explores, among other things, something he calls the "zoology" of bullish and bearish sentiment. In one particular example, Taleb describes the scene in a New York office when he is asked to give his forecast on the trajectory of the market over the coming week.
Taleb answers that he thinks the market will rise. He gives it a 70% probability of doing so, a seemingly bullish outlook.
"But Nassim," interjected one of his colleagues, "you just boasted being short a very large quantity of S&P 500 futures, making a bet that the market would go down. What made you change your mind?"
"I did not change my mind," replied Taleb. "I have a lot of faith in my bet! As a matter of fact I now feel like selling even more!"
Taleb goes on to explain that, although he suspected that the market would move higher, it was preferable to short it because, "in the event of its going down, it could go down a lot."
In other words, the possible upside of going long - even though that outcome was, by his own analysis, more likely - was marginal compared to the dire consequences of what would happen in the less likely scenario that the market tanked.
"How frequent the profit is irrelevant," writes Taleb. "It is the magnitude of the outcome that counts."
US markets are, on average, up some 50% since their lows just over a year ago. That's an incredible bounce, to be sure, one for the history books. Nevertheless, the steps higher seem less and less resolute, more and more tentative. It's as if a mountain climber, after a momentous ascent, suddenly remembers that he has an acute case of acrophobia. Where to now?
The markets might well rise a little in the coming weeks, in other words, but they might also fall...a lot. We'd rather miss out on a minor advance in stocks than suffer a cataclysmic retreat. There are a slew of worrying macro-catalysts that inspire more than a little trepidation in your editor's heart. Here's one:
China and Japan, the two largest foreign holders of Treasurys, are slowly, steadily, incrementally reducing their exposure to American government debt. Now, if you were sitting on $900 billion or so of US debt - as China happens to be - and you wanted out, you couldn't simply bolt for the door. That kind of movement would spook the market, signaling a run on the dollar and decimating the value of your remaining holdings. Instead, you'd have to creep out very quietly...exactly as China and Japan appear to be doing.
Bloomberg reports: "China has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar's role as a reserve currency and recently sought assurances about the safety of US government debt as the budget deficit widens to a projected record $1.6 trillion this year."
The relationship between America and her foreign creditors is one built primarily on faith. China, Japan, Russia, Taiwan and the rest of world's dollar holders rely on the "full faith and credit" of the United States government to stand behind its currency, the world's reserve. But faith is a fickle thing. It takes a lifetime of monogamy to forge a faithful marriage...but just a single night of reckless abandon to destroy one.
The "recovery" may well deliver a few more sessions of stock market passion, in other words, but those tempted to flirt with it are advised to remember the wrath of a lover scorned
| | The Daily Reckoning Presents | | Is Your Money What You Think It Is?, Part II | |  | | Doug Casey |
Doug: There's a titanic battle right now between the forces of inflation and deflation. When a big corporation like General Motors, or Fannie or Freddie, defaults on its debt, hundreds of billions of dollars disappear. Assets people thought they had and could have been converted into cash disappear. That's deflationary. In a sound banking system, in which money is a commodity like gold, money can't disappear. It can change ownership, but it can't disappear. But in our current system, it can dry up and blow away as easily as it can be created.
One major problem that stems from this is that some people benefit from government money creation and some don't. Who gets to spend it first, when it's most valued, and who gets stuck holding the Old Maid card when it vanishes? It's usually the little guy - the middle-class guy - who gets hurt when this happens. And in the US, the middle class is contracting. The financial gyrations we're going through are destroying the middle class, which naïvely believes that traditional American values still hold sway and that their government is honest. The lower class has long since lost any values, and the upper class is way too cynical and self-interested to really care. Most middle-class people will end up joining one or the other of these two classes, and that'll be a moral disaster for the country.
America used to be a place where class wasn't really important, and you could move between classes easily - not at all like Europe or the Orient. But as the middle class gets squeezed, we're likely to get class warfare between those on top and those on the bottom.
Louis: One way to look at the inflation/deflation debate is that even if we do in fact have financial asset destruction - a kind of deflation - on a scale necessary to outdo the truly phenomenal amounts of money creation the US and other governments are engaged in.
Doug: I think that's fair to say. Either way, it's going to be really serious. When you have runaway inflation in a place like Zimbabwe, where most people are living on a subsistence level, people with gardens and chickens will get hurt, but they'll still get by. It's not the same when the world's wealthiest and most advanced economies are falling apart. Americans are going to see a serious drop in their standard of living, which they are completely unprepared for, and it's going to be a disaster. They don't have gardens and chickens to tide them over. There's no way around it.
Louis: Which brings us back to why. I mean, I'm sure many people can see the picture you've painted, but why is it inevitable?
Doug: Because the US government and others like it are between a rock and a hard place. It is simply not a politically acceptable option to step back and let the market correct the gross misallocations and distortions the government has imposed on the economy. They must "do something" - even if they know full well it's the wrong thing. And "doing something" means spending without raising taxes too much, because they know too much of that will slam the coffin on the economy they are trying to resuscitate. Spending on "stimuli" to "fix" the economy - direct spending on bribes to voters, like extending unemployment "benefits" to years and offering them "free" health care, etc... the way things are structured, the government must spend. Not spending is unthinkable.
There are only two ways to pay for that. They can borrow, which they can only do if they raise interest rates enough to make their bonds attractive, and that, too, would pull the plug on what you so colorfully called the "iron lung economy." And they can print money, which they can do with some impunity, hoping the bill won't come due until some other poor fool is in office - but that destroys the dollar sooner or later.
Everything we've seen shows that they are doing what is predictable for politicians, since they can appear to be "doing something" with the consequences left to the future: they are destroying the dollar.
The US government is going to be running trillion-dollar deficits as far as the eye can see. Again, they can't borrow it while keeping interest rates low, so they are going to sell their bonds to themselves, which is to say the Federal Reserve, and inflation is going to explode. There simply is no painless choice, and it's very close to being totally out of control.
Louis: And this financial apocalypse now, as we termed it last week, is the natural endgame of using fiat currencies instead of real money - this is why you can't use debt as money.
Doug: That's why you don't use debt - IOUs - for money. And those people who are complacent about this, those who read these words and know we're right but take no action because they can't believe things will get that bad in America, are going to be very unhappy in the near future.
Readers should do something now, while we're still in the eye of the storm, while there's a small cyclical improvement happening, and when most of boobus americanus thinks happy days are here again.
Not only do we have to go through the other side of this storm, but then there's an even bigger hurricane after that. This is just the beginning of the troubles ahead. Take action now.
Louis: Financial self-defense 101. But let's walk through some of the generalities here. Reasonable actions to take would include: buying gold, diversifying assets offshore, and... would you still recommend going to cash with inflation on the way?
Doug: Here's an easy way to remember it: I would liquidate, consolidate, speculate, and create.
Liquidate: Get rid of any assets you have that might have been favored by the old economy but are likely to be blown away by the new one. That would include speculative real estate holdings in formerly hot markets. Maybe even sell your house, if you can, and rent instead. Or, for sure if you keep your house, get a big mortgage at a fixed low rate that will probably be inflated out of existence. And get rid of your houseful of stuff - the junk filling your basement, your attic, that storage unit you're renting - anything you don't really need. Turn it into cash.
Consolidate: Cut your expenses to the bone and consolidate your assets. The best way to do that is to buy gold and silver in cash form (coins) and put them away as savings. The other critical element is getting a major portion of your assets offshore.
Speculate: With the government creating bubbles through its mammoth spending programs, and other bubbles popping, like the collapse of more major corporations, take chances on winning big on bets placed on these trends.
Create: In the coming years, the world is likely to change as radically as it did entering the industrial revolution. This is going to be a really major change, economically, politically, technologically, demographically, socially, militarily - the whole ball of wax. This is a good time to look around and ask yourself, not, "Who will give me a job?" but, "What goods and services can I provide that people will need in the future and pay me for?" What worked during the late Long Boom won't work - in order to create, you're going to have to think creatively.
Louis: I guess I won't be working on a business plan to become a personal trainer.
Doug: [Laughs] Nor is becoming a barista a good plan for personal survival at this point.
Doug Casey and Louis James
for The Daily Reckoning
Joel's Note: You can check out the fine work Louis does withInternational Speculator right here. International Speculatorcovers the kind of small, precious metals stocks likely to explode during any wide scale sovereign debt crisis. If events unfold as we suspect they will, Louis' research will be a priceless arrow to have in your investment quiver. | | Bill Bonner
| Default, Deflation and Other Financial Curse Words
| |  | | Bill Bonner |
In the US, producer prices fell in February, more than expected. Core inflation was barely positive. That is not just a US trend. In Europe, price increases have fallen to the lowest level in 11 years. Japan is experiencing the biggest price drops in many years.
This sounds like a D-word to us...disinflation, almost deflation.
One report tells us that greater than 5% of Fannie Mae mortgages are 90 days in arrears - or more. Another report says it's 10%.
This too sounds like a D-word. Default.
But wait...
"Fed signals optimism over US economy," is the lead headline in today's Financial Times.
The markets responded, pushing the Dow up 47 points to a new high for this bounce...though still midway between its all-time high and its low of March 2009.
Oil rose a dollar too. So did gold. The euro edged up too...
Reading more closely, we don't see much reason for the Fed's optimism. And apparently, neither does the Fed. It is leaving its monetary stimulus program in place for an "extended period." It says inflation is likely to remain subdued "for some time."
The Great Correction (our term) destroyed nearly 8.4 million jobs (the FT's count) and wiped out $14 trillion in household wealth. And now Americans are struggling to find firm footing in an economy with fewer job openings, less credit available, and an uncertain growth outlook.
What's going on? There's a word for it. Another D-word...several of them. There's Depression. Deflation. And De-leveraging, for example.
Our old friend Porter Stansberry writes to tell us that we're wrong about household de-leveraging. The drop in credit we reported yesterday was caused by defaults...not by voluntary reductions in debt, he says.
He's right. Most of the decline in household credit, so far, comes from defaults. And maybe it is just wishful thinking on our part... hoping that Americans would willingly and eagerly improve their balance sheets. The savings rate is up...but it's not yet clear whether this marks the beginning of a major trend or not.
But whatever the cause - be it voluntary de-leveraging or involuntary de-leveraging - we think there's more of it ahead.
Here's a statistic: 21% of Iraq and Afghanistan veterans are jobless. They're mostly men. And mostly unprepared for the modern job market. After all, who wants to hire someone who knows how to drive a tank or patrol a gas station?
Ultimately, an economy gets rich by making and acquiring things people want.
Ah...we look back nostalgically at the Bubble Epoch. It was so easy to make fun of people back then. They thought they could get rich by buying things they couldn't afford with money they didn't have. Now, we're in a new era... of sorts. Now, it's the public sector that has lost its head. The feds think they can make the economy work better by buying things nobody really wants with money nobody really has.
Who really wants to guard a gas station in Baghdad? Nobody we know. Who's got the money to fund the fed's $1.8 trillion deficit? Nobody.
And think of the poor fellow who draws that sorry duty in Iraq. When he comes back to the US, what does he have on his résumé? He's good at guarding a gas station against terrorists? Not many job offers for that skill set.
So, one in five of these fellows is unemployed. And the feds try to do something about it by spending more money they don't have on more things nobody really wants.
Meanwhile...money may be getting harder to come by.... See below...
And more thoughts...
This, from Bloomberg:
China, Japan Reduced Holdings of US Treasury Debt in January
March 16 (Bloomberg) - China and Japan, the two biggest foreign holders of Treasuries, reduced their positions of US government debt in January as a measure of demand for American financial assets fell to a six- month low.
China remained the biggest owner abroad of Treasuries, even as its holdings dropped by a net $5.8 billion to $889 billion, according to Treasury Department data released yesterday in Washington. Japan cut its holdings in January by $300 million to $765.4 billion, the report showed.
China has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar's role as a reserve currency and recently sought assurances about the safety of US government debt as the budget deficit widens to a projected record $1.6 trillion this year.
"Foreign central banks stopped buying Treasuries in January," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. "If this were to continue, if China were to stop recycling its dollars into US Treasuries, it could have dire implications for Main Street America in that mortgage rates could move higher."
"More Jains taking up santhara," reports the TIMES of India.
Santhara (also called sallekhana) is the Jain practice of voluntary and systematic fasting to death. Jain texts say it is the ultimate route to attaining Moksha and breaking free from the whirlpool of life and death...
Nearly 500 people took the road to Moksha in 2008, the paper reports. The article goes on to tell us that more women than men starve themselves to death, because they are "more strong-willed" than men.
In the past, when people took the holy vow of santhara they used to advertise it in the local papers. This would allow friends and relatives time to come over and say goodbye. Now, the government is said to be cracking down on the practice; apparently, you are no longer permitted to advertise. Now you have to die alone.
"Eunuchs want rape laws to be gender-neutral," is another headline from the Indian press. We couldn't make out the cause of the eunuchs' complaint. Rape laws are already being rewritten in a more politically correct way; the word 'rape' is to be replaced with 'sexual assault.' But the eunuchs feel they are still not getting the attention they crave. They are often "the targets of some of the worst sex crimes in India," said a spokesperson.
"Economy expected to grow four-fold by 2020." Think the headline refers to the US? Britain? France? Think again. It's the subcontinent the article talks about.
Edelweiss Capital predicts a nominal growth rate of 13% per year for India...leading to a GDP over $4 trillion in 10 years. Per capital income is expected to rise too - from $1,017 per year now to $3,213.
Imagine what these mean to business and investors. Even if you have a mediocre business you can expect your sales to triple...or quadruple...over the next 10 years.
Regards,
Bill Bonner,
for The Daily Reckoning
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