Vigilant Investor

Yale Professor Dr. Robert Shiller was one of our key sources several years ago who helped us be well ahead of the curve on the real extent of the housing bubble. Here he is being interviewed about how dysfunctional the housing situation still remains.

Its still the early innings, folks. Think it through!

Are manias the byproduct of irrational exuberance, as Yale prof, Robert Shiller’s same titled book asserts? That’s an idea correctly refuted by one of my favorite economists, Frank Shostak, in a worthy article that discusses the real reasons behind why so many investors and entrepreneurs end up making the massive errors that Shiller wants to foff off on the “old animal” spirits theory. Give the good Doctor a read because he does a good job at pinning the cause of bubbles and their crashes where they firmly belong: on the price fixers for money and credit at the Federal Reserve and other central banks.

Coincidentally, I read a Gary North 50th Anniversary piece on Ayn Rand’s Atlas Shrugged, which dovetails nicely with Dr. Shostak’s observations. North rightfully criticizes Rand’s idealistic view of the capitalist, but not for the tired socialist reasons many of us who generally like Rand’s work usually hear.

Combine both pieces and you get an interesting clarity on the fundamental purpose and priorities of most entrepreneurial types, and how meddling on different fronts perverts the natural goodness preserved by the natural balance of free markets.

In that context, readers stand to learn a bit about why present policies pursued by governments and their central banks are on a collision course with economic gravity 101. Plan accordingly!

Well, we’ve warned about what’s now going down for a long time. The other shoe is dropping right through the floor — and it’s a Clodhopper!

Just this week we’ve learned from the National Association of Realtors that the number of Americans signing up to buy previously owned homes in August dropped 6.5 percent from July. Over the past year, pending home sales are down over 20%. We also learn from Moody’s that the most recently created (2007) sub-prime mortgage backed bonds contain loans growing delinquent at literally a record pace. But wait — the reckless, loose money caused fiasco is hardly contained to the U.S! Moody’s also reports that loan delinquencies in Spain could grow 15 times by the close of 2008!

We’ve said it before, and we’ll say it again. You can’t borrow your way to prosperity. There is a yin to every yang. What goes up must come down. Every action has an equivalent reaction.

As things become critical in an era where the “pundits” seem to make everything so illogically complicated — we encourage you to find consultants who believe they understand the basic laws of financial physics.

Interest rate pro, James Grant, who is among the few who predicted accurately that the credit markets would be in for dire problems well in advance of the current mess, has a WSJ review of Greenspan’s new biography, “The Age of Turbulence“.    We’ve not yet read the book ourselves, so we can’t fully comment other than to say that Grant has been reliable on interest rates and economic observations for many years now, and has shown a good deal of character in remaining steady despite his opinions causing mainstreamers to throw flack his way for being such a wet blanket on the credit bubble party.

We can, however, agree with Grant’s non book-specific implied conclusions about Greenspan and all central bankers:  In the end, they are nothing more than price fixers and central planners, and given the disruptions and massive dislocations invariably caused by fixing the price and supply of credit and money, probably deserve less respect than any other bureaucrat assigned such a role.

Addio, Luciano. Rock on.

Here’s a recent piece from Ron Paul, one of the few in Congress who actually understands what is transpiring in the credit markets and the complicity to it of Congress.  He is the only member of Congress and presidential candidate willing to stick his neck out by discussing the serious implications of the situation.

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August 20, 2007 Credit RiskAs markets went on a rollercoaster ride last week, our economy is coming close to a day of reckoning for loose credit policies being followed by the Federal Reserve Bank. Simply, foreign banks we have been relying on to buy our debt are waking up to the reality of much higher default rates than predicted, and many mortgage backed securities have been reduced to “junk” ratings. Wall Street fears the possibility of tightening credit and the tightening of America’s belts. Why, they say, “if Americans spend only what they can afford, think of the ripple effects throughout the economy!” This is the cry, as the call comes for the fed to cut rates and bail out companies in trouble.

More inflation is, however, never the answer to inflation.

The truth is that business involves risk, and businesses that miscalculate risk should be liquidated, so their assets can be reallocated to businesses that correctly judge risk and make profits. Instead, the Fed has injected $64 billion into the jittery markets, effectively amounting to a bailout that keeps these malinvestments afloat, but eventually they will become the undoing of our economy.

In addition to the negative reactions in financial markets, many Americans have taken on too much personal debt owing to exotic mortgage products and artificially low interest rates. Unfortunately, these families are now in the position of losing their homes in unprecedented numbers as the teaser rates expire and the real bills are coming due.

The real answers are, and always have been, found in the principles of the free market. Let the market set the interest rates. If we had been functioning under a true and transparent free market system, we would not be in the mess we are in today. Government, like the American household, needs to live within its means to get back on stable fiscal ground.

We’ve been headed in the wrong direction since 1971. This week marks the 36th anniversary of Nixon’s decision to close the gold window, which convinced me to seek public office to call attention to the runaway money train that would come in the aftermath of that decision. The temptation to print and spend money with impunity, like the temptation to max out lines of credit, is too strong to for government to resist. While Nixon brokered exclusivity deals with OPEC to prop up demand for the tidal wave of green pieces of paper the Fed pumped into the markets, the world is tiring of marching to the beat of our drum in order to secure their energy needs. The house of cards Nixon built is now on the verge of collapsing on our heads, and on our children’s heads.

As the dollar weakens, it becomes ever clearer that we need a return to sound, commodity-based money for a secure future. Money based on real value, not empty promises and secretive backroom machinations, is the way to get out of the current calamity without causing even bigger problems.

Dr. Ron Paul
Project Freedom

It is with sadness that we pass on to our readers news we just learned, that internationally renowned economist Dr. Kurt Richebächer died earlier this week on Monday at the age of 88.

Dr. Richebächer was a great devotee of the Austrian School of economics, and was extremely helpful and accurate in predicting the present breakdown in the world’s credit markets. While lately, those espousing Austrian critiques of the wild credit excesses of recent decades have been dismissed and ignored for being wet blankets at the party, Dr. Richebächer was more of a celebrity some years ago.   Once the head of the Dresdener Bank in Germany, his retirement party in 1982 was attended by luminaries such as Otto Pohl, then head of the Bundesbank, and Paul Volcker of the Fed.  After retiring, Dr. Richebächer continued publishing a newsletter (The Richebächer Letter)  that remained highly relevant up until its final issue in February of this year, when health issues prevented him from continuing.

We have quoted him often at both Vigilant Investor and through proprietary client materials via our wealth management firm, Ernharth Group. For years now I’ve retained a quote of his in my own email signature, as follows:

“Bulls of 1929 - like their 1990s counterparts - had their eyes glued on improving profits and stock valuations. Not a thought was given to the fact that the rising tide of money deluging the stock market came from financial leverage and not from savings.”
- Dr. Kurt Richebacher

What is astounding is that so many were blindsided recently despite his acute and well articulated warnings.  His clarity and insights will be deeply missed. Those seeking a deeper understanding of the current situation would do well to read whatever materials of his they can find, including the timeless wealth of knowledge contained in his past newsletters.

Update: We just found a wonderful tribute piece from Wilfred Hahn, a long time colleague of Dr. Richebächer, which provides substantial detail about his life and legacy.

In one way, I’m sympathetic to the institutional reluctance to face the music. I’d give a lot to mark my weight to ‘model’ rather than to ‘market.’ - Warren Buffett, Fortune, 8/16/07 (On the financial institution practice of valuing subprime assets on the basis of a computer model rather than the free market price.)

History is merely a list of surprises. It can only prepare us to be surprised yet again.

      ~Kurt Vonnegut

While most of the nation was catching up on American Idol or attending a viewing of the summer movie season’s first blockbuster, Spider-Man 3, the investor faithful had their annual pilgrimage to hear the Oracle of Omaha once again. Asked about the sub-prime mortgage meltdown at the Berkshire Hathaway annual meeting this past weekend, Warren Buffett couldn’t have described the housing bubble mentality better: “I think that’s dumb lending and it’s dumb borrowing.” To that, we’d add “enabled by excessively dumb credit / money supply expansion.”

Buffett also struck a chord with us by suggesting that the sub-prime fiasco is a problem for the companies involved. We take that to mean “no bailout for the aforementioned partnership of Dumb & Dumb.”

However, we won’t hold our breath on that. In the past, any time Wall Street looks to be holding the bag on big losses on risky deals gone sour (usually after already earning really big profits on the same deals precisely because they were risky), usually the cry goes out that the economy will be irreversibly dragged down. In the case of sub-primes, many of the the victimolgists in Congress are already calling for bailouts of the sub-prime borrowers who were given sufficient rope to hang themselves in a noose of debt. Traditionally bailouts come from taxpayers and dollar holders in the form of government contributions to the problem, as well as in the form of a further deflated currency as the banking system simply papers over the problem with freshly minted dollars.

Buffett still thinks the sub-prime mess will remained contained, but we’re not so confident. Housing is still shifting gears downward slowly — as is the nature of any housing downturn. But as Buffett himself once observed, you don’t know who is swimming naked until the tide goes out — and the tide is just started heading outward on housing related effects on the economy. As it recedes, more and more credit bubble induced nakedness (bad business decisions, economic dislocations, inflationary pressures, etc.) is going to be seen if you know their relationships. Those relationships give an advanced look at the dangers and opportunities ahead.

Buffett also criticized hedge fund managers, who he called an “electronic herd” rapidly moving in an out of assets in a “fools game.” Of the current (over)confidence in continued comfortable economic conditions and unprecedented profit growth, Buffett issued a warning. “Corporate America is living in the best of all worlds, and history has shown that those conditions don’t persist indefinitely.”

Such should be expected from the inevitable fiction that is long-term money supply / credit expansion induced economic “growth.”

Vigilant Investor was started over two years ago as a offshoot of the privately distributed Wealth Report produced by my investment management firm. We were repeatedly told by our clients, friends and associates that the material they were reading was good stuff and that it really needed a wider audience. Hence, our journal / blog was started and traffic to the site quickly climbed as we converted a quarterly publication started in 2001 into a daily commentary.

Most of the problems we discussed from the start have been centered around the belief that the world’s central banks, lead largely by the actions of the United States, have been creating a massive global credit bubble. The equity / tech bubble of the late 1990s was fueled by it, as was the massive U.S. housing bubble that is now unwinding as we speak.

Other asset classes are being driven up in price / down in yield, such as U.S. Treasuries, High Yield debt, and emerging market securities — both debt and equities.

Well, when little old Vigilant Investor says its so, many accustomed to feeding from the pop-culture media trough at the WSJ or MSNBC, etc., simply dismissed it as wild talk. (Yet one need only look at our record of calling a housing bubble, higher commodity prices, including oil and gold, higher inflation and a slowing U.S. economy to see we’ve been well ahead of the mainstream…)

Now some big guns are talking. By big guns, we mean the esteemed Jeremy Grantham, who in no uncertain terms called the environment “the first truly global bubble,” in his most recent quarterly letter to clients. Unlike prior bubbles that were localized, such as the U.S. tech bubble and the Japanese bubble of the late 1980s, “this time, everyone, everywhere is reinforcing one another. Wherever you travel you will hear it confirmed that ‘they don’t make any more land,’ and that ‘with these growth rates and low interest rates, equity markets must keep rising,’ and ‘private equity will continue to drive the markets.‘”

Some other gems:

“All three major asset classes — real estate, stocks, and bonds– measure expensive compared with their histories and compared with replacement cost where it can be calculated. The risk premium has reached a historic low…”

Continue Reading »

Here’s a great interview of Congressman Ron Paul being interviewed by Al Korelin a few weeks back. Without question, Paul is head and shoulders above his compatriots in Congress in his understanding of the laws of economic gravity, and the economic history of the U.S. It’s a great interview running just over 20 minutes.

Perhaps the most jaw dropping revelation is that some of his colleagues on the House Banking Committee still believe the dollar is backed by gold!!??!

….uhh…

…eh-hem….

….And there are so many out there who think our federal fiscal problems are not an issue in the long run.

How can the people running Congress’ financial legislation oversight not even understand such a basic fact? If they don’t know that, how can they know even the most elementary nuances of economics?

Did I happen to mention Ron Paul is running for President? We have just crossed The Rubicon. We have a fight on our hands to turn back, but there’s no doubt in this author’s mind that it is our last chance.

What follows is a reminder to all of the historic role gold has played as money, and that the recent assertions otherwise are really an experiment in finance about 35 years old. Note the word “experiment” since we seem to believe that fiat currency backed by nothing, zero, zilch, is the norm, when in reality it defies the “Gods of the Copybook Headings.”

Thanks to Bob Landis for allowing these comments of his to be reupublished here. We encourage you to visit his own website, The Golden Sextant. There are more rich nuggets there to dig into!

Gold Is Money - Deal with It! [Remarks by Robert K. Landis to the Association of Mining Analysts, London, England, October 2, 2003] IntroductionGold bugs don’t get out much. And it’s very rare that we get an opportunity to address mainstream opinion makers. So it’s a great honor indeed to speak to an organization that counts among its members some of the world’s most influential mining analysts. I’m grateful to the Association, and to Chairman Michael Coulson, for inviting me here to talk today.As the title of my remarks suggests, I’m not here to discuss the dissident theory of undisclosed official intervention in the gold market. Or to introduce or expand upon some new piece of evidence in support of that theory. Rather, I’d like to focus on the mainstream view of gold itself. I have two reasons for doing so. First, because I think as long as you hold that view, there’s no way you can even hear the dissident message.Second, and more important, I think it’s time for influential people to begin thinking about what comes next. The dissident message, after all, is just one facet of a much bigger issue: the current monetary system is rotten to the core. So the question arises, where do we turn when the dikes break? The gold bugs’ answer is simple: we’ll have no choice; it’ll be back to gold. But as long as the mainstream view is in place, it will continue to mask the true nature of the problem and prevent us from thinking constructively about a solution. Continue Reading »

Dr. Marc Faber was again a guest on BloombergTV. You can hit it via this link.

Faber was warning of an overdue correction last month, and now says this is probably not enough, noting a 10-15% drop is possibly in the cards.

The following piece is from Congressman Ron Paul.

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January 29, 2007

The Pentagon recently reported that it now spends roughly $8.4 billion per month waging the war in Iraq, while the additional cost of our engagement in Afghanistan brings the monthly total to a staggering $10 billion. Since 2001, Congress has spent more than $500 billion on specific appropriations for Iraq. This sum is not reflected in official budget and deficit figures. Congress has funded the war by passing a series of so-called “supplemental” spending bills, which are passed outside of the normal appropriations process and thus deemed off-budget.

This is fundamentally dishonest: if we’re going to have a war, let’s face the costs– both human and economic– squarely. Congress has no business hiding the costs of war through accounting tricks.

As the war in Iraq surges forward, and the administration ponders military action against Iran, it’s important to ask ourselves an overlooked question: Can we really afford it? If every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I’m quite certain it would end very quickly. The problem is that government finances war by borrowing and printing money, rather than presenting a bill directly in the form of higher taxes. When the costs are obscured, the question of whether any war is worth it becomes distorted.

Congress and the Federal Reserve Bank have a cozy, unspoken arrangement that makes war easier to finance. Congress has an insatiable appetite for new spending, but raising taxes is politically unpopular. The Federal Reserve, however, is happy to accommodate deficit spending by creating new money through the Treasury Department. In exchange, Congress leaves the Fed alone to operate free of pesky oversight and free of political scrutiny. Monetary policy is utterly ignored in Washington, even though the Federal Reserve system is a creation of Congress.

The result of this arrangement is inflation. And inflation finances war.

Economist Lawrence Parks has explained how the creation of the Federal Reserve Bank in 1913 made possible our involvement in World War I. Without the ability to create new money, the federal government never could have afforded the enormous mobilization of men and material. Prior to that, American wars were financed through taxes and borrowing, both of which have limits. But government printing presses, at least in theory, have no limits. That’s why the money supply has nearly tripled just since 1990.

For perspective, consider our ongoing military commitment in Korea. In Korea alone, U.S. taxpayers have spent $1 trillion in today’s dollars over 55 years. What do we have to show for it? North Korea is a belligerent adversary armed with nuclear weapons, while South Korea is at best ambivalent about our role as their protector. The stalemate stretches on with no end in sight, as the grandchildren and great-grandchildren of the men who fought in Korea give little thought to what was gained or lost. The Korean conflict should serve as a cautionary tale against the open-ended military occupation of any region.

The $500 billion we’ve officially spent in Iraq is an enormous sum, but the real total is much higher, hidden within the Defense Department and foreign aid budgets. As we build permanent military bases and a $1 billion embassy in Iraq, we need to keep asking whether it’s really worth it. Congress should at least fund the war in an honest way so the American people can judge for themselves.

Congressman Dr. Ron Paul