 | | The Daily Reckoning | Tuesday, July 19, 2011 |
- The value of imagination in the face of imminent financial crisis,
- $1,600 per ounce: Gold’s new record, where to from here...and how?
- Plus, Bill Bonner on geniuses, scam artists and shiftless malingers...
| | Investing Ahead of the Curve | | More Thoughts on the Financial Rewards of a Good Imagination | |  | | Eric Fry |
Reporting from Laguna Beach, California...
A fertile imagination is usually the enemy of successful investing.
Imaginative investors tend to see their stocks as the “next Microsoft” or the “next Berkshire Hathaway,” even when the stocks they own are much closer to being the next Enron or WorldCom. That’s why successful investors are much more likely to possess a skeptical eye than a fertile imagination.
“But on the threshold of a crisis,” as we observed in yesterday’s Daily Reckoning, “a fertile imagination can be an investor’s most valuable asset. [During normal times], investors can focus only on buying quality stocks one-by-one from the bottom up, without also trying to envision what tragedies might befall them from the top down. But in the context of a euro crisis that could become a dollar crisis that could become a global monetary crisis, it may be time to begin imagining the unimaginable.”
It may be time, in other words, to begin considering that the next phase of the global monetary system might not include the US dollar as its reserve currency...or that the next two decades of life in America might not look anything like the last two decades.
Not just any sort of imagination will do. The wrong kind of imagination is already running rampant in the US economy. As Bill Bonner put it recently, “the dollar pretends to be real money. Debt pretends to be capital. And regulators pretend to be smarter than capitalists.”
This game of make-believe is not likely to end well.
Therefore, to prepare effectively for the end game of the world’s make-believe monetary “system” will require the imagination of a Sean Egan, at least, if not the imagination of a Vladimir Lenin.
Over the weekend, Egan-Jones Ratings Co., of which Sean Egan is president, cut its rating on US government debt from AAA to AA+, becoming the first of the four credit-rating agencies to do so. The downgrade will not likely cause any noticeable ripples in the financial markets because the financial establishment considers Egan-Jones to be an also-ran. It is not Moody’s or Standard & Poor’s which, from our perspective, is precisely the reason to pay attention to Egan-Jones’ assessment. This ratings agency has distinguished itself numerous times for being ahead of the curve.
But honestly, it doesn’t take much imagination to envision the United States as a AA+ credit instead of a AAA credit. Investors may need to think even farther outside the box than Egan, perhaps as far outside as Vladimir Lenin.
When most of us think of imaginative individuals, we might think first of J.R.R. Tolkien, and then maybe J.K. Rowling. Lenin would be third, at best. But way back in 1917, as Joel Bowman observed recently, Lenin offered some shockingly prescient predictions for the century ahead:
Germany will militarize herself out of existence,
England will expand herself out of existence,
and America will spend herself out of existence.
“Had he known the inherent shortcomings of his own political ideology,” Joel remarked, “Bolshevism’s bad boy might also have added, ‘And Russia will plan herself out of existence.’
“As for the United States,” Joel continued, “it seems she is not content with simply spending more than she produces, foisting the unfunded obligations onto future generations; instead, she militarizes, expands, spends AND plans toward her own demise...as all once great empires eventually do.”
The process Joel described is the process Bill Bonner dubs, “Imperial Suicide” – the inevitable tendency of empires to implode upon themselves. Some form of this process appears to be underway in the “wealthy nations” of the West, not excluding the United States.
As empires implode, so do their national currencies. As some point, cause and effect become indistinguishable from one another. The economy and the currency of the imploding empire begin circling the drain together.
Imagination is the best protection. A fertile imagination will not prevent a euro crisis or dollar crisis, but it could protect an investor from the consequences of such a crisis.
To illustrate the destructive power of a currency crisis, let’s examine a few pages from recent history...
During the Argentine peso crisis of 2002, the shares of the Argentine oil giant, YPF, climbed more than 50% in five months, even while MERVAL Index of Argentine stocks fell. Unfortunately, YPF’s impressive, market-beating returns occurred in the context of a massive currency crisis, during which the Argentine peso lost about three quarters of its global purchasing power. In US dollar terms, therefore, YPF did not gain 53%, it fell 55%!
An identical story played out in Brazil, as the real unraveled during the second half of 2002. Shares of the Brazilian mining company, “Vale,” climbed 40% between March and October of 2002, while the Bovespa Index of Brazilian stocks fell 40%. In dollar terms, however, Vale’s “strong” 40% gain was actually a 15% loss.
Four years earlier, the Russian ruble suffered an even more spectacular collapse than the Brazilian real. Amidst this harrowing currency crisis, Russian stocks soared nearly 300%... in ruble terms. But they went absolutely nowhere in US dollar terms.
Just a wee bit of imagination enabled some investors to steer clear of these crises. But shockingly, the vast majority of professional investors failed to imagine these crises, even though Argentina, Brazil and Russia all possessed a rich history of monetary incompetence and chicanery.
In 1969, for example, the Argentine government trimmed two zeros off the existing Peso Moneda Nacional to create the new Peso Ley. In 1985, the government slashed four zeros off the Peso Ley to create the Peso. Then in 1992, the government cut three zeros off the Peso to create the Austral, simultaneously linking it to the US dollar, one-for-one. Ten years later, this peg to the dollar ruptured and the Argentine currency swiftly lost 75% of its purchasing power...again.
In other words, investors required almost no imagination to envision the Argentine currency crisis of 2002. Today, however, investors will require an imagination so vivid and wild that it would border on hallucinogenic. They must not merely imagine that an Argentina might have a currency crisis...again...they must try to imagine that the euro might splinter apart...or that the dollar might suffer a disastrous hyperinflation. Today, the looming potential crises are not unfolding in banana republics or in chronic economic basket cases, they are unfolding in the world’s strongest economies.
As your editor pens these words, he is sitting in a beach chair, digging his toes into the warm sand of one of Laguna’s nicest beaches. The sites before his eyes are beautiful, tranquil and comforting. The folks lounging in chairs nearby are playing cards, drinking beer and sharing laughs. A short distance away, others are a playing in the surf.
Life is good, even if the economy isn’t perfect. A true crisis seems unimaginable. After all, even the 2008 crisis wasn’t that bad. And today, the Apple store in the mall is always packed, most of the restaurants in town are full...and the dollar is still strong enough to buy a nice vacation almost anywhere in the world.
A currency crisis that triggers an economic crisis – or vice versa – just feels like a bunch of wacky, doom and gloom stuff. And it may well be. We hope it will be.
But what if it’s not? To prepare effectively for a large-scale currency crisis requires a lot of time and energy, as well as a dose of good luck. So a lack of imagination is no longer a viable luxury.
In the context of America’s legendary resilience and economic might, a catastrophic currency crisis seems almost unimaginable... But the time has arrived to begin imagining it...not because it is certain, but because it has become less unimaginable.
A Brazilian newspaper recently featured the following photo:
It’s just a joke, right?
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| | The Daily Reckoning Presents | | Gold Hits $1,600! | |  | | Chris Mayer |
Stock markets around the world have been looking pretty ugly lately, but gold has climbed for eleven straight days – reaching a new all- time high of $1,605 an ounce! Prediction: More of the same.
The European crisis is deepening. Couple that with the ills in the US and it makes for a grim picture. Concerning the EU crisis, Barron’s ran a fascinating interview over the weekend with Sean Egan, the head of Egan-Jones, an independent credit ratings agency. “Independent” means that Egan-Jones earns money from subscribers seeking insight, not from companies seeking the rosiest assessment possible. Egan-Jones’ revenue model, therefore, is in direct contrast to S&P and Moody’s, who earn money from the companies they rate.
You can bet that incentives are vastly different between the two business models. It’s like the difference between investment banks and my newsletter, Mayer’s Special Situations. The former write “research reports” that recommend the companies they do deals with. I am paid only by my subscribers.
In any event, Egan offered up some very dire predictions about the EU. He summed it up like this:
Look for the Greece situation to be replayed in Ireland, Portugal, Spain, Belgium and Italy... Companies dependent upon bank funding are likely to face extreme pressure over the next couple of years. They are going to [get] squeezed real hard. Investors should look for bank mergers, major asset sales and widespread company restructuring. The sovereign-debt crisis is probably the biggest credit event faced since the decline of the Weimar Republic. Forget about post-World War II. This is bigger. It’s like 2008 all over again, but this time, the epicenter of the credit quake is Europe. And Europe is in far worse shape than the US was in 2008, as Egan points out.
First, it is not a unified country, which leads to a lot of dragging of feet as the different EU bankers dawdle. It means the bailouts that were so forthcoming in the US may not be in offing in the EU. Secondly, EU banks have less capital. Meaning, they have less of a cushion to absorb credit losses. And finally, the EU can’t so easily print money to get out of its troubles. The euro is not the dollar, which, despite all of its flaws, is still the world’s reserve currency.
The table below is telling. You already know these countries are in trouble, but these numbers boil it down to some essentials. Look at those interest cost figures compared to tax revenues. Greece is already paying out more in interest payments on its debt – 50 billion euros – than it is receiving in tax revenue: 46 billion euros. The picture is almost as grim in Portugal and Ireland.
If interest rates rise, those interest costs will go higher. Plus, these economies stink right now. So tax revenues could easily fall. Deficits could widen, causing debt levels to go even higher.
The term that comes to mind is “death spiral.”
No surprise, then, that the gold stocks I’ve recommended to my subscribers are on the move. If you assume $1,600 an ounce sticks – which I think is a good bet – then the profitability of the gold stocks I have recommended will be extremely high, which means these stocks are still cheap.
On July 5, I wrote about the five gold stocks I have recommended and the reasons why I thought they were finally due to make a move. All five stocks are up since then, for an average gain of 12%. I think all five have a lot of room to go, especially if a $1,600 gold price is a new reality.
[Existing Mayer’s Special Situations members can access those specific stocks, if they have not already done so, by logging in to our “member’s only” page, here. Fellow Reckoners who wish to view my latest research presentation can access it here.]
Hang onto your gold stocks!
Beyond that, I think you should hold a healthy amount of cash and precious metals. And no matter how you invest, be sure you can stomach the volatility that is bound to come down the pike. I have a feeling it will test the linings of your stomach.
Regards,
Chris Mayer,
for The Daily Reckoning
Joel’s Note: Chris will be joining an all-star line up of world class investors, contrarians and “imaginative thinkers” at this year’s Agora Financial Investment Symposium in Vancouver, scheduled to kick off next week. If you haven’t already reserved your advanced audio set – whereby you’ll be able to listen to all the presentations and information-packed breakout sessions on CD and/or MP3 – simply drop your email address in here and we’ll add you to the list. The pre-conference discount expires the minute the event kicks off, so you’ll want to be nimble. Again, here’s the link.
| | | | Mayer’s Special Situations Presents... |
Captain Cook’s Monster $21 Billion Alaskan “Oil Jackpot” Surfaces 233 Years Later...
And soon, a handful of serious investors will reap the rewards from British Explorer James Cook’s massive Alaskan “oil jackpot” discovery...
It’s a huge $21 billion “oil bounty” on American soil... that’s poised to make a select few very rich. Might as well be you!
Click here for all the details...
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| | | | Bill Bonner | | A Positive Approach to a US Government Default | |  | | Bill Bonner |
Reckoning from Paris, France...
Who can honestly say that he is not enjoying the show?
Clowns to the left of us, jokers to the right...it’s fun, isn’t it?
Yesterday, the Dow fell and gold rose above $1,600 to a new record high. The euro fell, but against the dollar it is still more than 50% higher than it was when it was introduced 10 years ago.
In Europe, the world’s leading bankers and financial policymakers try to figure out how to avoid doing what comes naturally – going broke.
And in America, politicians scramble to raise the debt ceiling level before it is too late.
The big question is: who will default first? The Europeans? Or the Americans?
Larry Summers, former US Treasury Secretary, warned on TV that failing to raise the debt limit would be worse than after the Lehman bankruptcy in 2008. Ben Bernanke told Congress the same thing.
In Europe, the IMF and the rest of the financial elite have the same message. Don’t let Greece default, or there is a serious risk of “contagion,” and financial catastrophe. Larry Summers even crossed the ocean to give bad advice to the Europeans:
“No big financial institution in any country [should] be allowed to fail.”
On both sides of the Atlantic, the situation is about the same. The geniuses and scam-artists who run the big banks want to keep the honey pots open as long as possible. But there are pressures – mostly from the middle classes, who feel they have been ripped off – to put on the lid.
In Europe, the Germans resist giving more money to the spendthrift Greeks and Portuguese. In America, Tea Party activists want to bring an end to Big Government by cutting off its source of funds. They want to hold the line on the debt limit. Many would be happy to see the nation default.
And here at The Daily Reckoning, we stand with the Tea Party and the Germans. We’d like to see the US government default. Why?
- Because the feds have already done enough damage with their borrowing; it’s time they lived within their means...
- Because we already have enough zombies, supported by borrowed funds...
- Because it will be less painful to stop the debt build up now than later...
- And because we just want to see what happens when the zombies run out of fresh meat.
Finally, at least some people in Congress are getting serious about cutting spending.
WASHINGTON (AP) – One of the Senate’s staunchest budget-cutters unveiled Monday a massive plan to cut the nation’s deficit by $9 trillion over the coming decade, including $1 trillion in tax increases opposed by most of his fellow Republicans.
The plan by Sen. Tom Coburn, R-Okla., is laced with politically perilous proposals like raising to 70 the age at which people can claim their full Social Security benefits. It would cut farm subsidies, Medicare, student aid, housing subsidies for the poor, and funding for community development grants. Coburn even takes on the powerful veterans’ lobby by proposing that some veterans pay more for medical care and prescription drugs.
Coburn would also eliminate $1 trillion in tax breaks over the coming decade, earning him an immediate rebuke from Americans for Tax Reform, an anti-tax organization with which Coburn has had a running feud. He would block taxpayers from claiming the mortgage interest deduction on second homes and limit it to homes worth $500,000. He would also ease taxpayers into higher tax brackets more quickly by using a smaller measure of inflation to adjust the brackets.
Coburn would cut $1 trillion from the Pentagon budget over a decade. He would block military retirees from the Tricare Prime health care plan, the option with the lowest out-of-pocket cost, saving $115 billion, and he would raise the prescription drug co-payment under the program, as well as require higher out-of-pocket fees. He also would reduce the fleet of aircraft carriers from 11 to 10 and Navy air wings from 10 to nine.
“I have no doubt that both parties will criticize portions of this plan, and I welcome that debate,” Coburn told reporters. “But it’s not a legitimate criticism until you have a plan of your own.” This fellow, Coburn, has the right idea. Throw away the scalpel. Get a chain saw. He’d raise the Medicare eligibility age to 69...and cut $1 trillion out of the Pentagon budget. He needs a much bigger chainsaw...but at least he’s on the job.
And more thoughts...
Germans must have a race memory that makes them fear debt and inflation. They’ve suffered from both – especially during the war period, from 1914 until 1946. Even then, their problems were far from over. A third of the country was occupied by the Soviets and then run by communists for another 40 years. They don’t want anything to do with the kind of policies that led to that debacle.
War reparations, imposed on them by the French, British and Americans after WWI, bankrupted the nation and turned the population into bitter enemies of their Western neighbors. Then, the reparations were the proximate cause of hyperinflation of the early ’20s, which destroyed the middle class. Destitute and sour, the riff raff of Germany was easily drawn to extremists. The Nazis promised that their central planning would make Germany healthy and proud. The Bolsheviks promised their central planning would make Germany as successful as Soviet Russia. Scarcely 2 decades after the Armistice, German troops were on the move again, leading to another 5 years of war.
Today, sovereign debt takes the place of war reparations. A generation of taxpayers in Greece, Ireland and America is supposed to bear the debts of their spendthrift elders.
And once again, clouds gather and the sky darkens. Consumers close their wallets, just as they did in the ’30s. Auto sales are running 28% below their level of 10 years ago. Home appliances are selling as this 20 years ago.
Housing is down a third...and keeps dropping.
Unemployment, properly measured, is at Depression levels too.
And this just in: a drought in the South threatens to turn the region into a giant Dust Bowl – just as in the ’30s.
*** “France’s system of social support is too generous,” said a guest last night. “It attracts the wrong kind of immigrants. They don’t want to work. They just want to take advantage of our welfare system.”
Today’s debt problems in Europe can be traced to a cultural misunderstanding. Germany’s low interest rates work for Germans, more or less. They save. They work hard. They have a cultural bias against waste and idleness.
But offer the same interest rates to Irish property developers...or to the government of Greece...and pretty soon you have problems. The cultures are different. Germans may be reticent about borrowing...but not, apparently, the Greeks!
Different groups respond to incentives differently. By trial and error, they develop systems of government and banking that work for them. Some groups value leisure and larceny far more than others. Some place less importance on wealth. Many people disapprove of working too hard...some regard it as a sign of failure and incompetence.
It is all very well to give the Westphalian landser a comfortable safety net, in other words. His pride, his status, and sense of right and wrong will not permit him to use it – unless he really needs to. But give the same safety net to other peoples, and soon they are lolling about in it...happy with the leisure and the standard of living it affords them.
And then, naturally, the net gives way under the weight of so many shiftless malingers.
Regards,
Bill Bonner,
for The Daily Reckoning
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