“Now this is not the end. It is not even the beginning of the end.
But it is, perhaps, the end of the beginning.”
  —Winston Churchill

Recovery?

Our regular readers know we’ve been skeptical of the of the so-called “recovery” — and we’ve been warning of a “Double-Dip Trip” as far back as a year ago. Recently unfolding economic news hints $trillions of government stimulus (via money created out of thin air) is not doing the trick. We never thought it would. It’s long been our opinion government spending never causes sustainable economic growth — especially if the consumer is not taking part.

Here are excerpts from an interesting August 14th Bloomberg article:

“Prospects for U.S. economic growth took a hit this week after reports showed the trade deficit swelled and consumers reined in spending… A record jump in the trade gap for June capped figures that indicated the world’s biggest economy grew at least a percentage point less than the 2.4 percent pace the government estimated last month. The Standard & Poor’s 500 Index slumped 3.8 percent in the five days ended yesterday, the biggest one-week loss in a month, and a surge in Treasuries pushed the yield on the benchmark 10-year note to the lowest level in 16 months on concern the economy will relapse into a recession.

“Reports this week showing Chinese industrial output cooled and growth in Europe was uneven added to pessimism over the prospects for the global economy, just as the Federal Reserve said the U.S. recovery was weaker than anticipated… Purchases at U.S. retailers in July climbed 0.4 percent… Excluding auto dealers and gasoline stations, sales dropped 0.1 percent, the second decline in three months… Consumer spending, which makes up 70 percent of the economy, is being held back by an unemployment rate close to a 26-year high… more Americans than estimated filed applications for unemployment benefits last week… J.C. Penney Co., the third-biggest U.S. department-store chain, lowered its profit forecast for the year. The guidance reflects “a conservative approach to what continues to be an uncertain consumer climate, particularly for the moderate consumer,” Chief Executive Officer Myron Ullman said yesterday on a conference call…

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said… The U.S. trade deficit widened by $7.9 billion in June, the most since record-keeping began in 1992, to $49.9 billion… Exports posted the biggest decline since April 2009… China’s industrial output rose the least in 11 months and retail sales growth eased, government reports showed, adding to signs the world’s No. 3 economy is cooling…“¹

Not a pretty picture indeed.

Shell Game

What’s next? It’s been our continual belief the Fed would print more money (again, out of thin air) to buy more U.S. Government debt — to fund the overspending of an effectively broke country. And to attempt to stimulate a teetering recovery. Even though the Fed said they wouldn’t continue to do so, we never believed them. That’s because the alternative would be for the Fed to step out-of-the-way and let money, credit, and prices (across the board) contract to (we’re not kidding) possibly early 1980’s levels (not politically popular at all). And a shrinking money supply means a stronger/more valuable Dollar — the same Dollar the U.S. Government would have to pay its $trillions of obligations back with. Remember, debtors don’t like paying their debts back in a more valuable currency. Instead they like to pay them back in one that’s watered down/less valuable.

In what looks like quite a 180 degree policy change by a Fed which recently talked about winding down the massive amounts of stimulus created over the past 2–3 years — the Fed Open Market Committee announced on August 10th it would use principal payments it receives on maturing mortgage bonds it owns to purchase long-term Treasuries.² In other words, instead of using the principal payments it receives to reduce its balance sheet — the Fed will use the money to buy more government debt (keeping its balance sheet the same size). To us, doing that vs. printing money to buy Treasuries is 6 of one — half dozen of the other.

We are not surprised at all. It looks to us like nothing more than a “shell game.” And we think it may very well be just the “end of the beginning.”

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, J.D.
Vice President
Ernharth Group

“Everything popular is wrong.“
—Oscar Wilde

Popular Opinion

Well maybe not “everything” – but we think Wilde makes a very good point. We tend to cast a wary eye at consensus, and like to think for ourselves. To us, following popular opinion involves a lot of “others you don’t even know thinking for you.” And having strangers doing your thinking, is to us, a potentially dangerous thing. Especially when you consider the possibility those strangers may be trying to shape your opinions for reasons which don’t necessarily align with your best interests. Or that they are uninformed. Or just plain wrong!

Instead, we prefer to seek objective feedback from those we know and trust. We think the best formed opinions eliminate emotion. And it’s also our belief hope is certainly not a strategy. Actually we’re of the opinion it’s often the last resort of those whose game-plan is
unraveling – or flimsy at best. We never want to be cheerleaders. We simply want to determine the facts as clearly as possible, and do our best to get our clients on the right side of the trade.

Facts vs. Emotions

As John Adams said, “Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.” Yep. And while most would reflexively concur with Adams, it’s interesting to watch the reactions of certain people when those stubborn facts challenge, or run contrary to their “wishes, inclinations” and “passions.” To us, that’s when we can really tell what a individual’s opinions and views are based on.

To us, it’s not “doom and gloom” to acknowledge facts (which are what reality is supposed to be based on). And we tend to notice the phrase “doom and gloom” seems to be used primarily by those resistant to change, and who’s strategies (business, investment, etc.) are not in alignment with the information being presented to them. You can lead a horse to water, but…! We simply believe the acknowledgement of facts is the lynchpin of seizing opportunity. Without accepting facts – it’s our opinion one’s strategies simply become more closely related to rolling dice. And that’s a dangerous game we’re unwilling to play.

Based on facts we continually gather, we form opinions – and then decide whether we’re bullish or bearish on things. When we’re very bullish on something, we align with it because we believe opportunity exists. When we’re very bearish on something, we don’t run away from it, instead we align against it for the same reason – our belief that opportunity exists. We know what you’re thinking – this doesn’t sound like rocket science! And you’re right – it’s not! At least intellectually. But just open the door to emotions – along with John Adam’s “wishes, inclinations” and “passions” – and it’s amazing how things can change in the minds of human beings.

For a generation indoctrinated with “stocks for the long haul” suggesting positions contra to broad-based equities can seem downright audacious – even though the S&P 500 has returned around minus 30% over the past decade.¹ Suggesting the Dollar as we know it is near the end of its road (and that paper money is being debased globally) is tough for some people to swallow. In certain quarters it may even be considered unpatriotic. To us – it’s unpatriotic for a government and its central bank to debase the currency its citizens use to store their hard-earned savings. As we illustrated in “Kicking the Can” the Dollar has lost over 95% of its purchasing power since the creation of the Federal Reserve Bank in 1913, and the National Debt enters hyper-drive. To us, that’s not doom and gloom. In our opinion it’s just another opportunity based on facts.

Public opinion has been quite wrong recently. Stocks for the long haul? 10 years seems like a long time to us for –30% return. Real estate always appreciates? It certainly does not. The Dollar as the reserve currency of the world? In our opinion – not forever, and perhaps not much longer.

To us – there are always opportunities. We believe several fantastic ones are staring us straight in the face right now. You just have to seek the facts and accept them – as “unpopular” as they may be.

After all, as the saying goes, “Denial’s not a river.”

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, J.D.
Vice President
Ernharth Group

“Who goeth a borrowing
Goeth a sorrowing.“
—Thomas Tusser

What’s Really Moving the Stock Market?

The answer isn’t obvious at first glance. Some say the economy is recovering, and businesses are doing better. But we also notice weak jobs data, growing federal and state deficits and declining tax revenue – along with a real estate market facing more serious challenges ahead. The real question may be – why after $trillions of government stimulus, does the stock market seem to be indecisive at best – and perhaps teetering?

A Revealing Chart

It’s long been our opinion the sharp increase in assets prices – from stocks in the 80’s and 90’s, real estate during the past decade, followed by stocks again in 2009–2010 – have been fueled largely by an ever-expanding money and credit supply.

The chart below may show the recent stock market gain may not be an indicator of economic recovery, but instead – something else.

One can clearly see the correlation between the upswing of the S&P 500 Index and the Federal Reserve Bank’s purchases of US Government Debt – i.e. “quantitative easing” (also known as “money printing”).¹ Through quantitative easing (QE), the Fed creates money out of thin air – buys government debt – watering down the Dollar your savings are denominated in in the process.²

Looking at the chart it is clear the S&P 500 began its “recovery” in early 2009 when the Federal Reserve began Quantitative Easing (QE).³ The chart also shows the S&P dropping in early 2010 when the Fed stated it would end QE.⁴ We didn’t believe the Fed could end QE for long (because in our opinion the likelihood of a deflationary downtrend would increase) – and others may have agreed since the S&P rallied again.⁵ But the Fed did in fact take its foot off the money printing pedal (at least for now) – and the corresponding recent drop in the S&P 500 is evident in the chart.⁶

What’s Next?

Our regular readers know we’ve long been of the belief the US (and world) economies have, to a great extent, been driven by expanding money and credit for decades. It’s our belief that if the Fed steps out of the way, no longer funding stimulus and bailouts with newly created money – a great regression to the mean likely awaits. In other words, deflation. The contraction of money and credit. Falling prices and increasing purchasing power for the Dollar. We believe such a drop in asset values would be quite steep because they’ve been driven up for such a long time by money printing.

Do we think Fed Chairman Bernanke will stand idly by and allow such a deflationary collapse? Our answer is “no.” We believe he and his predecessor Alan Greenspan have already shown their true colors. It’s our opinion the Fed will print like mad – and politicians (who want to get re-elected) will let it happen. The last thing an increasingly indebted government wants to do is pay $trillions back in stronger dollars.

So we believe more (and more) stimulus lies ahead – paid for by ever-increasing amounts of money created out of thin air.

And we continue to prepare for the opportunities we believe lie ahead.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group

“But the collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt.”
   — George Soros (June 10, 2010)

“Turn your face to the sun and the shadows fall behind you.”
   — Māori Proverb

“Trouble is only opportunity in work clothes.”
   — Henry Kissinger

“The Chinese use two brush strokes to write the word ‘crisis.’ One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger – but recognize the opportunity.”
   — John F. Kennedy

On Opportunity

We are optimists. We’d like to once again emphasize to our readers our firm belief that any situation, no matter how seemingly dire – presents opportunities. It’s our opinion plenty of them exist right now. And the key to taking advantage of opportunity – is to seek and accept the facts, no matter how unpleasant they initially seem.

To Agree or Not to Agree?

George Soros does have an impressive reputation. That said, when anyone of influence makes a pronouncement – we always ask “why.” Based on our own observations, it’s our opinion Soros’s basic assessment of the situation is quite accurate.

Here is an excerpt from his June 10 speech before the Institute of International Finance in Vienna:

“In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 – global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counter-parties.

As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short-term the exact opposite of what was needed in the long-term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.

This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.

The first phase of the maneuver has been successfully accomplished – a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.

Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip…“¹

Our Thoughts

To us, there is no doubt the credit-driven global financial system is on very shaky ground. It’s our opinion Greece will struggle to avoid defaulting on its debts. Spain, Portugal, and Italy are on the ropes. We believe the Euro is headed lower and its only hope will be if weaker nations leave the currency. German citizens have had enough of bailing out their fiscally irresponsible neighbors (and European banks who made risky loans to them for higher interest rates).

We’re not Keynesians – and we don’t agree with budget deficits, government intervention in the financial markets, or a currency not backed by gold. We do think however that Soros makes very good points regarding the seriousness of the situation and the potential for a double dip. And we believe he’s correct when he states the attempted cure (excess credit and leverage) for the crisis beginning in 2008 is more of what caused the problem in the first place – and must ultimately be withdrawn. And we’re of the opinion he’s right on the money when he states the current sovereign debt crisis has come at a bad time – in that it’s creating more instability which may prevent the removal of the initial excess credit/leverage cure.

We believe the sovereign debt crisis will require even more of the same money-printing “hair of the dog.” After all no politician wants to preside over a deflationary collapse. So we believe world governments will attempt to print like mad.

Swift Currency Revaluation & the Repudiation of Government Debt

We’ve often mentioned history teaches us governments often repudiate their debt via the inflation/money-printing mechanism. We believe the world has far too much debt – and we’d not be surprised to see a swift, surprising currency revaluation over a very short period of time. In such a scenario, the currency would be quickly valued downward by central banks via intense inflation/money-printing. This would severely erode the value of the currency (and make the national debt far cheaper to pay back by the government). In such a scenario, those who trusted the government the most (bond and CD holders) would have their purchasing-power confiscated most severely.

If such an inflationary scenario would unfold, a significant portion of the debt value (including government bonds) along with a significant portion of credit value (that includes your bonds bondholders) would be cancelled out in a very short time frame – potentially catching investors by surprise before they could act to protect themselves.

To those who think this can’t possibly happen – just check out the Argentine Crisis from 1999–2002. Bank accounts were frozen to prevent Argentines from sending their money out of the country to protect it from government printing/devaluation.² The resulting
inflation/currency devaluation was about 80% – and it took place in a matter of months.³ To add insult to injury – salaries stayed at pre-crisis levels.⁴

Gloomy sounding? Nah! On behalf of our clients – we just like to think of all the possibilities which may lie ahead. And to plan for the potential opportunities.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group

“Be wary of a woman who only shows up when you are winning.”
— The Most Interesting Man in the World

But Who’s Winning?

We get a real kick out of The Most Interesting Man in the World. His style is classic – and his advice is perfectly delivered with a knowing dryness – making the Dos Equis TV commercials truly funny, and enjoyable. And he’s usually right on the money.

And it’s not just a man who should be wary of a woman who only shows up when he’s winning. Governments who benefit from the purchases of their debt simply because their currency is the best of the worst should be careful also. While U.S. Government bonds have benefited from the potential demise of the Euro – we believe reality may assert itself before long. The fiscal situation of the United States is arguably not much better than that of Greece and certain other European cohorts. Except for one thing – the U.S. has a printing press. The Federal Reserve can print money at will. And it has massively done so already during the current financial crisis in an attempt to keep the credit-fueled party going. Based on the history of the Fed since its inception, we see no reason why it would stop its printing. When Fed Chairman Bernanke and other politicians speak of defending the Dollar – we simply don’t believe them. Instead, we judge them by their actions and those of their predecessors.

Pictures Do Paint a Thousand Words

Thus as we look at the chart below¹ – we see from 1800 to 1913 the pre-Federal Reserve Bank United States had significant negative inflation. That’s right – negative inflation where the purchasing power of the Dollar relative to itself nearly doubled! However, from 1913 (the year the Fed was created) until 2009 – the Dollar has lost over 95% of its purchasing power.

The next chart² shows what’s happened from an inflationary standpoint since the U.S. closed its gold window in 1971 – no longer permitting foreign governments to exchange their Dollars for U.S. gold. (Thereby removing a significant limitation from Fed money-printing).

And what’s more, “official” inflation data is potentially being manipulated lower. The chart below³ from John Williams’ Shadow Government Statistics shows that inflation calculated using pre-Clinton era methodology may be significantly higher than what’s being “reported.” (After all lower inflation numbers make net GDP look better. And lower inflation figures – mean smaller social security benefit increases).

It’s our belief politicians in the Unites States (and all over the world) will continue trying to kick the fiscal can down the road. After all who could get re-elected presiding over a deflationary collapse. As we’ve often told our regular readers – history shows us governments repudiate their debt by inflating/printing it away. By doing so the government waters down the value of the dollars it must repay its debt in.

And it’s also watering down the purchasing power of the dollars your savings are denominated in.

We believe it’s imperative to plan accordingly.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group

“Money, when considered as the fruit of many years’ industry, as the reward of labor, sweat and toil, as the widow’s dowry and children’s portion, and as the means of procuring the necessaries and alleviating the afflictions of life, and making old age a scene of rest, has something in it sacred that is not to be sported with, or trusted to the airy bubble of paper currency.”
—Thomas Paine

Our Mission

Like Thomas Paine and other founding fathers – we’ve long been concerned about governments’ uncanny ability to debase their non-gold backed currencies throughout history. Thus, we view it as our mission to help protect our clients’ hard-earned savings from being diluted by the government money printing-press.

The Best Looking Horse in the Glue Factory

In a recent May 5 interview on CNBC’s Squawk Box Jim Rickards and George Doud made some interesting points regarding the Greek crisis – and the impending future of money as we know it. Some excerpts:

“… Jim Rickards: Yes I actually don’t think of this as a just a Greek crisis specifically or even a Euro crisis – this is a more of a global crisis of trust. What is a bond? It’s just a promise to pay you back. It’s all based on trust at the end of the day. So Greece is kind of ground zero today. It’s too bad to see this violence – although not you know totally surprising. They’ve had violent riots in the past unrelated to this austerity. Just imagine what would happen in the United States if China said hey you’ve got to get …your deficit to GDP ratio down to 3% in three years. That would maybe not cause violence but that would be a shock to the US. It’s certainly a shock to the Greeks.

Interviewer: You’re not suggesting that the United States is in the same situation as Greece?

Jim Rickards: I’m having trouble finding a Greek metric where the US isn’t you know as bad or worse or will be shortly. You look at where our deficit to GDP ratio is. Where our debt to GDP ratio is going – money creation and other things. We look a lot like Greece. Now one big difference of course we can print our own money. But where does that get you? That’s really the problem worldwide. In every asset class investors no longer think about the fundamentals. They think about government policy. China – the question is can the government prop up the housing market? In Europe can the government prop up Greece? In the United States can the government prop up the banks? We don’t think about fundamentals or balance sheets any more.

Interviewer: Yeah but in terms of what you’re talking about… In terms of trust – every time there’s a flight to quality you see people rushing back to the Dollar and rushing back to US Treasuries.

Jim Rickards: Well it’s the only place to go – but there are limits to that. And then ultimately it’s going to go to one of two places. There’s a meeting in Zürich on May 11th – I call it the new Bretton Woods. Basically the IMF is convening a meeting. They’re going to look at the issuance of SDR’s – and the alternative is Gold. So the G-20 and the leaders want to go to SDR’s to take the Dollar off the hook. The market may go to gold on their own. So there’s sort of a race between SDR’s and gold. The Dollar is you know pretty much at the end of the line.

Interviewer: George do you agree with that same sort of view about the US vs. everybody else?

George Doud: I couldn’t have said it better myself sadly. I pretty much agree with all of those statements. You’ve seen the Dollar rally – but it’s almost because it’s the best looking horse in the glue factory and there’s nowhere else to go…“¹

[** Bonds are subject to market, interest rate, and credit risk.]

A “To the Point” Summation

And then there is the ever insightful Bill Bonner who writes:

“…At a cost of 110 billion euros, Europe will pretend to protect Greece from its creditors and the Hellenes will pretend to put their financial affairs in order. Instead, the Greek affair will slide into a larger crisis. As we explained last week, all of modern macro-finance can be understood as an attempt to push problems into the future and onto people who were not to blame for causing them. Now we see the formula at work in Europe.

Greeks borrowed money they couldn’t reasonably expect to pay back. Foreign bankers — largely French and German — hoped to earn outsized yields by taking a risk on Greek debt. A just ruler would let them all collapse, and give them the boot on the way down. Instead, the knaves enjoyed their loot. And, under the terms of the bailout, the fools are supposed to get their money after all; it will be squeezed out of taxpayers all over Europe.

The plans of the ruling classes are not merely unjust. They are unworkable. Over the next three years, Greece will add $50 billion in deficits, stabilizing the debt at 150% of GDP. It will also need to come up with $70 billion to pay off debt that matures over the next two years. That is more than the amount offered in the bailout. Which means, Greece will have to borrow more money as early as next year, probably triggering another crisis. Plus, there are the other weak sisters and spendthrift brothers in the European family. Bailing them all out could cost as much as 1 trillion euros.

But the real problem is much deeper. It is philosophical as well as mathematical. Too much debt, like too much dying, is not a transitional state. It’s a final state. And once the soul has left the body, there is no point in trying to keep the husk alive. Similarly, when a debt cannot be repaid, there’s no use pretending. When you cannot keep up with the interest on a debt, it is added to the principle. The debt grows, becoming evermore unmanageable. It’s better to admit the error as soon as possible and start organizing the details of your financial funeral…“²

We’ve seen very little “error admitting” in Europe or the US. Instead we’ve seen accelerating large-scale government bailouts and money printing.

And we prepare accordingly.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group

“An investment in knowledge pays the best interest.”
—Benjamin Franklin

Before We Get Started…

Investors often believe when markets go up they’re getting richer – but they may not be. The value of their portfolio or home may be higher, but the value of the dollars they own may have been diluted/devalued/printed away by the government. And this is often brought to light by the price of gold vs. dollars or things denominated in dollars – like stocks. We believe the relationship between the number of ounces of gold it takes (in dollars) to buy one unit of the Dow (in points) is an important one.

Bear Market in Stocks?

Yes, a bear market in stocks. Despite rallying substantially since its 2008 lows, today the Dow stands at 11,205.¹ At the beginning of 2000 the index was 11,501 points.² In other words, since the start of 2000 the index has lost –2.6%. One could call it a lost decade for many stock investors.

Or worse. The more substantial ongoing bear market is the one in the Dow vs. gold (which has been considered real money for thousands of years). The index has been getting walloped vs. the precious metal for more than a decade. Let’s look at the chart below – which tracks the Dow/gold ratio (i.e. how many ounces of gold it takes in dollars to buy one unit of the Dow in points) back to 1901. We see in 2000, it took around 40 ounces of gold (in dollars) to buy one unit of the Dow (in points). In other words:

Today 9.7 ounces of gold (at $1,153⁵ an ounce) buys one unit of the Dow (at 11,205⁶ points). To sum it up – in a little over 10 years the Dow has lost 75% of its value vs. gold.

After a 75% drop – it would be tempting to say the bear market in stocks vs. gold has nearly run its course. However, it may be nowhere near over.

Source: ShareLynx.com

By further examining the chart all the way back to 1901 – it gets more interesting. Let’s remember the Federal Reserve Bank – which can create money out of thin air – came into existence in 1913.⁷ We can see the swings in the Dow/gold ratio were relatively mild between 1901 and the early 1920’s. Beginning with the monetary expansion of the 1920’s⁸ the swings in the ratio have grown wider. The chart shows the Dow peaking vs. gold at ever-increasing ratios of 18, 27, and 43 ounces of gold (in dollars) to buy one unit of the Dow (in points). The chart also illustrates the Dow bottoming vs. gold at decreasing ratios of 2 and 1 ounces of gold (in dollars) to buy one unit of the Dow (in points).

With the Dow currently at 9.7 ounces of gold – history indicates the ratio may have to drop much further for the Dow to bottom vs. the precious metal. If that bottom were in fact at 1–2 ounces of gold – what would that mean? With gold currently trading at $1,153 an ounce – would the Dow have to drop to 1,153–2,306 points (1–2 times the price of gold)? Or at today’s Dow at 11,205 – would gold have to go to $5,602-$11,205 an ounce? Or with continued government money printing (inflation) in an attempt to stimulate the economy and pay the massive national debt – would this mean higher Dow and even correspondingly higher gold?

We’ve long believed in the inflationary scenario. Actually our main concern is hyper-inflation (high levels of money printing) as the government continues to increase spending and the debt at unsustainable levels. Others seem to agree with us. We notice central bankers who not long ago sold gold en masse in the $300 range – today buying gold en masse at over $1,100 an ounce.⁹ What does this say about current inflation expectations among central bankers?

And those who’ve put their trust in the government – the most conservative investors – may be most at risk in a hyper-inflationary scenario.

As always, we believe multiple opportunities exist. In this instance, it’s our opinion they include owning the right well-run companies.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group

“Man can believe the impossible, but man can never believe the improbable.”
 —Oscar Wilde

We’ll Take the Austrians

We’ve long been proponents of the Austrian School of economics because, unlike the Keynesian School, it trusts the judgment of consumers and business owners over that of government central planners.

Ludwig von Mises (1881–1973) is still regarded as one of the Austrian School’s foremost leaders. The Austrian tradition dates back to the 15th century where, at the University of Salamanca, Spain, followers of St. Thomas Aquinas…

“…observed the existence of economic law, inexorable forces of cause and effect that operate very much as other natural laws…discovered and explained the laws of supply and demand, the cause of inflation, the operation of foreign exchange rates, and the subjective nature of economic value…were advocates of property rights and the freedom to contract and trade…celebrated the contribution of business to society, while doggedly opposing taxes, price controls, and regulations that inhibited enterprise… And they lived up to Ludwig von Mises’s rule: the first job of an economist is to tell governments what they cannot do.“¹

We think this sounds like a pretty good philosophy. It’s interesting however, that we were never exposed to it in all our years of high school, college, or law school.

Instead, like most Americans – we were taught Keynesian economics. John Maynard Keynes advocated that economic fluctuations were caused by over-saving and under-investment due to uncertainty in the private sector.² And he believed…

“…The solution to this conundrum was seemingly simple: replace the missing private investment with public investment, financed by deliberate deficits. The government would borrow money to spend on such things as public works; and that deficit spending, in turn, would create jobs and increase purchasing power. Striving to balance the government’s budget during a slump would make things worse, not better… Keynesians deemed “government knowledge” to be superior to that of the marketplace.“³

Negative Bang for the Buck Borrowed

While Keynesians may be surprised by the chart below – we’re not. Austrians have been warning about this for a long time.

In the mid-1960s every dollar of new debt generated nearly a dollar of U.S. Gross Domestic Product (GDP).⁴ While the chart indicates the trend has been steadily downward – recently something quite sobering has occurred as GDP added per dollars borrowed seems to have fallen off a cliff.⁵ By the third quarter of 2009 every new dollar of debt created minus 15 cents of GDP.⁶ By the end of 2009, each newly borrowed dollar generated negative 45 cents of GDP.⁷

Think of it in terms of a business which has borrowed so much money the debt service has caused negative income – to the tune of minus 45 cents per new dollar borrowed. We’d call that the terminal phase. Who in their right mind would lend such a business any more money?

Who would lend to such a country? (This is a primary reason we believe the government money-printing press will heat up even more).

Von Mises’s Words Echo From the Past

Perhaps that venerable Austrian scholar Ludwig von Mises had it right when he said:

“The unprecedented success of Keynesianism is due to the fact that it provides an apparent justification for the “deficit spending” policies of contemporary governments. It is the pseudo-philosophy of those who can think of nothing else than to dissipate the capital accumulated by previous generations.

Yet no effusions of authors however brilliant and sophisticated can alter the perennial economic laws. They are and work and take care of themselves. Notwithstanding all the passionate fulminations of the spokesmen of governments, the inevitable consequences of inflationism and expansionism as depicted by the “orthodox” economists are coming to pass. And then, very late indeed, even simple people will discover that Keynes did not teach us how to perform the “miracle … of turning a stone into bread,” but the not at all miraculous procedure of eating the seed corn.“⁸

Do we believe this provides opportunities? Yes.

And we plan accordingly…

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group

“Put your hand on a hot stove for a minute, and it seems like an hour. Sit with a pretty girl for an hour, and it seems like a minute. That’s relativity.”
—Albert Einstein

It’s All Relative

Is there a better definition of relativity than Einstein’s?

And today we’re hearing of problems in Euro-land due to the fiscal woes of the “PIGS” countries (Portugal, Italy, Greece, and Spain). As the Europeans debate whether they should be bailed out (and the relatively fiscally sound Germans voice their displeasure at such a thought) – the Dollar has strengthened relative to the Euro.

The problem (in our eyes) lies in the fact that all world currencies (none of which is backed by gold) are losing purchasing power relative to themselves. In “Race to the Bottom” we discussed competitive global currency devaluation. As certain countries (including the U.S. and U.K) overspend, and print money to pay for what they can’t afford (watering down the value of their currencies in the process) – other nations purposefully debase the value of their money to keep their exports affordable in the global market. While the Euro and Dollar jockey against each other – it’s important to note that neither buys what it did several years ago. It’s our opinion the trend will continue.

Why do we feel this way? When Congressman Ron Paul introduced the “The Federal Reserve Transparency Act of 2009″ (a bill to audit the Federal Reserve Bank which the Fed is actively fighting) he said, “…Throughout its nearly 100-year history, the Federal Reserve has presided over the near-complete destruction of the United States dollar. Since 1913 the dollar has lost over 95% of its purchasing power, aided and abetted by the Federal Reserve’s loose monetary policy. How long will we as a Congress stand idly by while hard-working Americans see their savings eaten away by inflation? Only big-spending politicians and politically favored bankers benefit from inflation.“¹

We highlighted the last two sentences of Congressman Paul’s quote because we feel he answered his own question. Congress, in our opinion, will continue to preside over the confiscation of American’s hard-earned savings via the inflation (government money printing) mechanism precisely because they and “politically favored bankers“² (who are a powerful lobby) “benefit“³ from it. With a printing press, the U.S. Government/Congress (and the Fed) can continue to spend and also bail out Wall Street banks – with money it does not have, by creating it out of thin air.

No wonder the Fed doesn’t want to be audited.

Going Greek?

In his Telegraph.co.uk article titled “Moody’s Fears Social Unrest as AAA States Implement Austerity Plans”, Ambrose Evans-Pritchard writes:

“The US rating agency said the US, the UK, Germany, France, and Spain are walking a tightrope as they try to bring public finances under control without nipping recovery in the bud. It warned of “substantial execution risk” in withdrawal of stimulus. “Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion,” said Pierre Cailleteau, the chief author. “We are not talking about revolution, but the severity of the crisis will force governments to make painful choices that expose weaknesses in society,” he said.“⁴

Riots and protests have taken place in Greece as the Greek government proposes austerity measures in an attempt to get its fiscal act together.⁵

The U.K. may be next with its AAA rating potentially hanging in the balance.⁶ Kornelius Purps, fixed income director of Unicredit recently stated, “Britain’s AAA-rating is highly at risk. The budget deficit is huge at 13% of GDP …There will have to be absolute cuts in public salaries or pay, but nobody is talking about that.“⁷

In February the U.S. government incurred its biggest ever monthly deficit – $221 billion – increasing the 2010 year-to-date deficit 10.5% from fiscal year 2009.⁸

On March 5th, the United States Congressional Budget Office (CBO), provided a preliminary analysis of the President’s budget submission for fiscal year 2011.⁹ The CBO determined the federal government would experience a deficit of $1.5 trillion in 2010 – amounting to 10.3% of gross domestic product (GDP).¹⁰

The UK’s budget deficit stands at 13% of GDP.[11] Greece’s at 12.7%.¹¹ The budget deficit of the United States is forecast at 10.3% of GDP.¹² To us, the primary difference isn’t a few percentage points. Instead – it’s America’s massive money-printing press. And it’s our concern fiscally irresponsible governments (the U.S. included) will monetize (print away) their debt.

As always – we believe preparedness often creates opportunity.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group

“To contract new debts is not the way to pay old ones.”
  —George Washington

Ballooning Government Debt

The chart below boggles the mind as it shows the rapid acceleration of the United States national debt. In 2000 the national debt was less than half of what it is today. And stunningly, the U.S. has accumulated more debt over the past ten years than it had over the prior century.¹

On December 24, 2009 the debt ceiling was raised to $12.394 trillion via H.R. 4314.² An additional increase in the U.S. debt limit to $14.3 trillion was signed into law by President Barack Obama on February 12, 2010.³ One thing we’ve noticed, is that Congress seems to have never met a debt ceiling it did not like to max out. And we’d not be surprised to see the new $14.3 trillion limit hit relatively soon as the pace of the debt increase seems to be reaching “warp drive.”

As an aside, we think it’s important to also point out that via the Housing and Economic Recovery Act of 2008 and the 2008 Federal Housing Finance Agency Conservatorship – the U.S. Government has more explicitly backed Fannie Mae and Freddie Mac. The combined obligations of these two independent GSEs is over $5 trillion.⁴ The Congressional Budget Office has recommended adding the assets and liabilities of Fannie and Freddie to the federal budget because of the amount of government control and involvement with them.⁵ Ignoring this recommendation, the government still accounts for these corporations as if they are unconnected to its balance sheet – even though the taxpayers are once again on the hook.

The Real Question Is…

Our clients know it’s long been our view this cannot continue forever. We’re seriously concerned the debt of the U.S. and other developed nations will grow so big they’ll have no alternative but to print money in attempt to keep the party going. In our opinion, talk of raising interest rates to defend the currency is just that – talk. We believe higher interest rates would tank an already cheap-credit addicted economy. And we’ve noticed throughout history – governments (when their currencies are not backed by gold – and today, none in the world are) – tend to repudiate their debt by inflating/printing it away.

To us, the real question is – as the government continues watering down the value of the Dollar it must pay its ballooning debts back with – what are you doing to help make sure the purchasing power of your hard-earned Dollars is not eroded away in the process?

While there is a lot of tough reality going on out there — we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD, AIFA
Vice President
Ernharth Group