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The Daily Reckoning | Wednesday, April 27, 2011 We want to know... Is America really ready for Ron Paul? How to avoid ruinous losses by taking the long view, Plus, Bill Bonner on the Fed's zero-calorie daily bread and more... ------------------------------------------------------- External Advertisement The Easiest $10,000 I Will Ever Make I want you to know that I just placed a $10,000 wager on your behalf. There could be a lot of money in it for you as well. Click here for more info... Is America Finally Ready for Ron Paul? Why the Good Doctor’s Financial Medicine is Finally Gaining Traction Addison Wiggin Checking in from Agora Financial's H.Q. in Baltimore, MD... On October 30, 2007, we got in a tussle with a reader. Can you imagine? On that day, it was because we weren't stumping for Ron Paul as conscientiously as Lew Rockwell. This morning, we see we may yet get another chance. Dr. Paul is holding a press conference today in Iowa. We're told he'll launch an "exploratory committee" - that fateful first step toward a run for the presidency. In 2007, we suggested the country - pre-Lehman, pre-stimulus, pre- bailouts - wasn't ready for the medicine Dr. Paul prescribes. Perhaps now that we've seen a few trillion-dollar deficits and a community organizer who's proven equally adept at military adventurism as his "aw, shucks" predecessor...a few more people are willing to go to the pharmacy...or, at the very least wondering now what that mysterious lump is. "This would seem to be an ideal year for Paul," muses the Washington wonk weekly National Journal: "Since the last election, the Republican Party has moved much closer to his view on deficit reduction. All of the party's top-tier presidential hopefuls are focusing on lowering debt, government spending and tax rates, issues Paul has long advocated." "Ron Paul Is Starting to Make Sense," reads the headline the May issue of Esquire. He "is the most important politician in America today," the profile begins, "because he's the rare politician - maybe the only politician - who always says exactly what he really believes. "Unlike Paul Ryan, Haley Barbour, Mitt Romney, Mitch Daniels and Mike Huckabee, who all raised taxes while calling for lower taxes, Ron Paul gives us a chance to examine the ideas currently driving the conservative movement in their pure form." We'll see. One way to examine those ideas is by reading this review penned by our own Gary Gibson. While Dr. Paul is away in Iowa, the nabobs in Washington are twittering over two "competing visions" of the way forward - the 12-year budget plan of the president and the 10-year plan of Rep. Paul Ryan. We can see why. The difference between them is "vast": Hmmn... Shall we raise the national debt by 84% in the next 10 years, or merely 62%? To even suggest the national credit card may be revoked long before then...well, that makes you a "kook" in these parts. Still for a growing number of people in "flyover country," it's starting to make sense...and get real. P.S. We're spreading the word about Ron Paul's "Lost Gold Bible." Have you heard about it yet? We'd like to get a copy into your hands. Simply click here for details on how to claim yours. The book the US Congress never wanted you to see... Ron Paul's "Lost" Gold Bible Buried away in secret since late in the last century, this 200-page guide shows you: Why $15,000 gold is likely inevitable, BUT why that's not a GOOD thing for investors... The only REAL way out of our monetary crisis... And a glimpse into the future...when everything BUT the dollar could be used as money... We're spreading the word... Click here to find out more. The Daily Reckoning Presents Di-Worsification Rob Marstrand Much as it feels good to get rich quick, the reality of successful financial investing is much less dramatic. It's about steady accumulation of profits. And profits on those profits, through the "power of compounding." But to make it all work, you also must avoid "ruinous losses." Imagine you make 10% a year for 10 years after all taxes, dealing costs and other fees. If you reinvested the profits every year, it works out at a total profit of over 159%. $100,000 becomes $259,374, in other words. Now imagine you make 20% every four years out of five. But you lose 30% every fifth year. Over 10 years you have eight years with 20% gains and two years with 30% losses. This time you make a total profit of only 7.5% - or an average of 0.7% a year. Your original $100,000 has become just $107,495. Standard investment dogma says bonds are less risky than stocks. I'll come back to this later. But let's assume for now it's true. So when you talk to your financial advisor for the first time, he'll want to do a "risk assessment" on you to see what suits. Let's call our man "Bob." (No offense to anyone named Bob. Some of my friends call me Bob from time to time. Let's just say "Bob" is short for "Broker or Banker.") In doing his assessment, Bob is basically trying to work out how much money you expect to make and how much you will be able or willing to lose without firing him. This is tough, because every single one of us wants huge profits with zero risk. Bob has to work out where you really stand. Typically, younger investors and "expert" investors are reckoned to be able to take more risk. Older investors near to retirement and/or rookie investors usually get put into a "low risk" strategy. Since bonds are meant to be less risky...and stocks are meant to be more risky...Bob's recommended allocation is where he thinks you fit on the risk spectrum. If you are a "high risk" investor, you may get a recommendation to put, say, 30% into corporate bonds and 70% into "growth stocks." If you are a "low risk" investor, Bob may advise you to put 70% into government and municipal bonds and 30% into "value stocks." Either way, Bob has put you into a mix of stocks and bonds. Mix together a few mutual funds...some of which might individually contain dozens or even hundreds of stocks...and you end up with a portfolio of hundreds or even thousands of stocks. The same goes for bond funds. Since you own "the market" you are likely to get market-tracking returns. So there you are: You now have a "balanced" portfolio. Part of it tracks stocks in general; the other part tracks bonds in general. Bob has assured you that historical analysis proves that this is the best thing to do. It shows that this "balanced" approach will deliver excellent returns in line with your risk assessment and, of course, with little risk of major loss. Sounds great, but it could be dead wrong. Let's be charitable here. Bob genuinely, honestly and from the bottom of his heart may think that he's giving good advice. He's a family guy. And he's just trying to do his job, so he can put his kids through college. All his 20 years of experience tells him that this kind of balanced portfolio has worked out well in the past. But there's the rub. Even if Bob has been in the investment game for 20 years, he's only seen a snapshot of the bigger picture. Investment returns move in long cycles. Bob has only seen about half of an up cycle. Even if he's been around 30 years, he still hasn't seen a time when bonds and stocks have both gone down at the same time over many years or decades. And the impressive risk model that his rocket scientist colleagues came up with only has good data going back 15 years. Large volumes of price data have only been computerized since the early to mid 1990s. This of course is the same problem that hedge funds and investment banks ran into in 2008. All their risk models were telling them exciting things about uncorrelated asset classes and the low probability of "tail events" ever happening. That's why so many of them thought it was a good idea to leverage themselves up 50 times or more. It's also why so many of them went bust in 2008. A little more time studying history and a little less time with fancy math, and they would have been okay. Luckily, there is information out there that can help guide us. And help us avoid these kinds of costly...even ruinous...mistakes. I recently finished reading the "Credit Suisse Global Investment Returns Yearbook 2011." As Credit Suisse put it, this "provides 111 years of data on financial market returns in 19 countries, from 1900 to date, making it the definitive record on long-run market returns." One of the really useful things in this report is its study of "drawdowns." A drawdown is the difference between the value on a particular date and its high water mark (the highest value in the past). The "recovery period" is how long, adjusted for inflation, it takes to get back to the previous high water mark. Put another way, the folks at Credit Suisse are looking at periods where prices of stocks or bonds fell and how long it took them to get back to even again, after adjusting for inflation. In both cases the report's authors assumed the income received - stock dividends or bond coupons - was reinvested on a tax-free basis. (Taxed returns would be worse.) Let's start with some stock examples - and in particular US stock examples. After the Wall Street crash of September 1929, stocks fell in real (inflation adjusted) terms by 79% until July 1932. They took until February 1945 to recover fully. So the recovery period was 16 years. From January 1973 to October 1974 stocks dropped 56% in real terms. And they were underwater until April 1983. So the recovery period was 10 years, taking account of inflation. Since March 2000, when the tech bubble burst, stocks fell 52% in real terms until October 2002. Eleven years later, and they are still underwater despite ultra-low interest rates. There was also a serious episode either side of 1920, which also lasted about 10 years (with a maximum drawdown of about 50%). So in 111 years there have been four times when stocks have fallen hard and taken over a decade to recover, after inflation and before taxes. What about bonds? Surely these "low risk" investments would have done much better? Wrong. As the Credit Suisse report puts it: The scope for deep and protracted losses from stocks makes fixed-income investing look, to some, like a superior alternative. But how well do bonds protect an investor's wealth? [...] For those who are seeking safety of real returns, [the data] are devastating. Historically, bond market drawdowns have been larger and/or longer than for equities. The report highlights two major periods when US bonds were in bear markets in real terms. The first was between August 1915 and June 1920. Bond values declined 51% and then remained underwater until August 1927. The recovery period from start to finish was 12 years. Or about the same as the recovery periods for stocks. But far worse was the second bear market. Between December 1940 and September 1981 bonds fell 67% in real terms. And they took until September 1991 to get back to even. In other words, the bond market recovery period was over 50 years! Ah, but Bob would point out that his "balanced portfolio" strategy would sort this out. Wrong again. Credit Suisse also worked out the data for a portfolio split evenly between stocks and bonds over that time. On the plus side, losses in the US portfolio never exceeded 50% at any point in time. But in the 1920s you still lost about 45% at one point; about 20% on three occasions during the 1930s and 1940s; 30% in the early 1950s; and about 35% in 1970s and 1980s. The point here is simple: A traditional stock and bond portfolio may have worked quite well in the past 20 or 30 years. But there are frequent and long periods of time where it hasn't. Losses can still be large. And recovery periods can still be long. And the reality for most investors is worse. Remember I said that the Credit Suisse analysis was all done assuming zero taxation? In reality, investors would have to pay income tax on stock dividends and bond coupons, making the recovery times much longer. What to do? Tread lightly in stocks and very lightly in bonds. At the same time, maintain a healthy allocation to gold and other hard assets. The stocks that you do hold for the long run should consist mostly of value investments in fast-growing economies, as well as commodity and energy stocks that should benefit during inflationary periods. And keep a high allocation to cash, in the short run at least. Cash equals "bullets" that you can use to pick up risk assets when prices are more attractive. You just need to be patient. As for bonds, forget it. Consider the current situation... Interest rates are ultra low. An activist Fed is creating unprecedented volumes of new money. Inflation is ticking up in most parts of the world. Government spending in most of the developed economies is still out of control. Developed country governments and banks need to borrow vast amounts in coming years. Both to refinance maturing loans and to increase their already high debt levels. Who will buy all these bonds? I'd bet that we've either started or are near to starting a long bear market in bonds - of all stripes. After 30 years of bull market, it certainly seems likely we're nearer the end than the beginning. This isn't the "balanced portfolio" Bob would recommend to his clients. You absolutely need to stay diversified, now more than ever. But you need to get your diversification in a different way. Regards, Rob Marstrand, for The Daily Reckoning Joel's Note: As you might well imagine, "What is Bill doing with his own money?" is one of the more frequently asked questions we field here at The Daily Reckoning. Bill knows, of course. And so does Rob. To find out exactly how they are using a different diversification strategy to avoid those ruinous losses, please see their latest Bonner & Partners Family Officereport, here. EXPOSED: The Biggest Scam In American History! Mad men drunk on power and driven by greed are robbing YOUR retirement! Most sickening of all, Washington fully endorses this bold-faced assault on your wealth. But Chris Mayer is exposing this scam in his brand new video presentation. PLUS, he'll show you how you could protect and even grow your wealth in spite of this scam, virtually spitting in the face of these elitist thieves. Don't be a helpless victim... Click here to act right now. Bill Bonner Dependent on Fed Spending and the New Money System Bill Bonner Reckoning from Baltimore, Maryland... Another milestone on the road to Hell! Here's the report from The Fiscal Times: For the first time since the Great Depression, households are receiving more income from the government than they are paying the government in taxes. The combination of more cash from various programs, called transfer payments, and lower taxes has been a double-barreled boost to consumers' buying power, while also blowing a hole in the deficit. The 1930s offer a cautionary tale: The only other time government income support exceeded taxes paid was from 1931 to 1936. That trend reversed in 1936, after a recovery was underway, and the economy fell back into a second leg of recession during 1937 and 1938. Yes, dear reader...now we will give you a quote: "Those who count on the feds for their daily bread will soon go hungry." Who said that? We did! Yesterday, we saw that the feds' QE2 program was a failure. Just like QE1. And TALF. And TARP. Worldwide, the authorities committed about $20 trillion to fight the correction. And what has it bought? It bailed out Wall Street. It made more millionaires. It drove up stock prices - to a new post-crisis record yesterday. But it didn't really lead to a genuine recovery or a real increase the nation's wealth. And we've got news for the "post crisis" folks. This crisis is still going on. Now, we discover that not only is there no real recovery...the phony recovery is so distorting the political/economic picture that no real recovery is even possible. Seventy-nine percent of household income growth since 2007 has come from government transfer payments. People earn less real money. They have less real money to spend. Their major assets - their houses - are going down in value. And now they depend on the feds for more than half their income growth. Who's going to vote for less government spending now? In all of history, there are very few examples where centralized economic planning has produced even plausibly positive results. They can mess up an economy; there's plenty of evidence of that. All their meddling, controlling, twisting - from Diocletian to Robespierre to Lenin to Nixon - every market regulation is a curse...every financial lifeline has a hangman's noose on the end of it. The only counter examples we can think of are those on the Pharaonic model...where wise Pharaoh stored up grain during the fat years and released it to the people when times got tough. How often did that happen? The only example we have is from the Old Testament. Is it fact? Or fiction? A wise government today could imitate Pharaoh. But none has. Instead of storing up grain for the lean years, governments run budget deficits year in and year out...through good times and bad times. Then, when the pickins are slim, they run even bigger deficits to "stimulate" a recovery. This pattern has been in place...almost universally and with few exceptions...since the new money system was put in place in 1971. You remember that fateful day? When Richard Nixon interrupted Bonanza to tell the world he was doing two impossibly stupid things at once - imposing wage/price controls...and taking gold out of the international monetary system. We are still suffering the consequences...still lumbering, stumbling, clumsily padding our way to the final act. And now look at Pharaoh. The masses depend on him. And he's handing out bread. But wait...it's phony, ersatz grain. No kidding. Yes, the feds print up money...as if it were real. They give it to the banking system, claiming that it "stimulates" the economy. Then, the banks give it back to the feds...so they can distribute it to the masses. Of course, anyone could see right through it. Everyone knows it is fraudulent. And so, the price of gold goes up... And more thoughts... The insider hustlers game the system. Did you read that account of the Wall Street wives who started a company just to borrow money from the feds? Everyone in the press is bad-mouthing poor Christie and Susan. The two wives put up $15 million. They borrowed $220 million from the government giveaway program, TALF. They used the money to gamble on debt...just like the government wanted. And what if their speculations went bad? No problem, the feds took all the risk! Well, more power to Christie and Susan. The feds wanted people to spend...to speculate...to invest. Well, Christie and Susan rose to the challenge. Besides, they're pretty. Honestly, if Ben Bernanke looked like Julia Roberts, maybe we would have no problem with US central bank policy. We'd go happily to Hell...along with everyone else. That's how shallow we are! But he doesn't look like Julia Roberts. Not even close.. So, we harp, carp, and kvetch.... And what we're complaining about today is the way the middle classes have been bamboozled by the feds, suborned by phony money...and ruined by a rigged economy. Haven't they benefited from all those government payments? Yes, like a man benefits from a hanging! Keep reading... *** Double Whammy from Flimmy Flammy The combination of high food prices...and a high cost of gasoline...is hitting the middle classes hard. Whence cometh these high prices? Why, from the feds of course. Why would the feds want to hurt the middle classes? Don't ask silly questions, dear reader. Here's the APreport: With gas prices now standing at about $3.90 a gallon, energy costs have now passed 6 percent of spending - a level that ...is a "tipping point" for consumers. Of the six US recessions since 1970, all but the "9-11 year 2001 recession" have been linked to - [if] not triggered by - energy prices that crossed the 6 percent of personal consumption expenditures, he said. (During the shallow 2001 recession, energy prices had risen to about 5 percent of spending, which is higher than the long-term 4 percent share.) What may make matters worse this time around, is there has been a steep increase in food prices that occurred as well. In other recent recessions food costs were benign, at between 7.5 percent and 7.8 percent of spending. This year food prices have climbed 6.5 percent since the beginning of early January, according to Consumer Growth Partners. *** Meanwhile, the poor middles classes watch as their most important asset gets marked down. Bloomberg is on the case: April 26 (Bloomberg) - Residential real-estate prices dropped in the 12 months to February by the most in more than a year, putting the market on the verge of eclipsing the nadir reached during the US recession. The S&P/Case-Shiller index of property values in 20 cities fell 3.3 percent from February 2010, the biggest year-over-year decline since November 2009, the group said today in New York. At 139.27, the gauge was just shy of the six-year low of 139.26 in April 2009, two months before the economic slump ended. Values will probably keep falling as foreclosures swell the supply of unsold homes... *** Oh you poor Daily Reckoning sufferer...relief is at hand! Yes, practical, sensible advice! We've been right about almost everything. We predicted the financial crisis in '07-'09... ..and the Great Correction... And then we told you what to expect from the feds... And how even their trillions in "stimulus" would NOT bring genuine recovery... "You can't make something out of nothing," we said. But many Dear Readers have wondered: what good is all this theory and abstract thinking? They wanted to know what to do with their money, now. Well, here comes an old friend to the rescue. Mark Ford is a master at turning abstract thinking into practical, simple, actionable advice. He's been doing it for dozens of businesses for the last 35 years. Now, he's doing it for investors too. In the April issue of his new Palm Beach Letter, for example, he manages to distill about a million pages of Daily Reckoning canoodling, historical philosophizing, and macro-economic theorizing a into a single simple recommendation: "Buy the Saint Gaudens $20 gold Double Eagle coins." Good advice. And there's a lot more where that came from: The Palm Beach Letter Regards, Bill Bonner for The Daily Reckoning