Vigilant Investor

Sober thinking from Jim Rogers. What’s most worrisome is how entrenched mainstream thinking is in the two journalists doing the interviews. While some might suggest that these two are just financial talking heads, their objections are straight from the standard list of most apologists of the fractional reserve financial system and the current spate of bailouts to “save the system from even worse.”

What a racket.

“I think we were really on the verge of a financial collapse of unbelievable proportions that we haven’t seen since the 1930’s.”
– Former U.S. Treasury Secretary Paul O’Neill describing the Bear Stearns bailout in an April 16, 2008 interview on Bloomberg

Read that quote again by Paul O’Neill – because, yep folks, that’s really where things stand. Our financial system effectively patched together by an inflationary, money printing band-aid. And, as the real estate markets in England, along with those in Spain, Ireland, et al. continue to melt down, we maintain our belief that the whole fiasco is far from over. (Our regular readers know we said the same when conventional pundits said the worst was over in 2007).

The interesting thing about economics is that people have been conditioned to believe in the charade that it is a mysterious, complex, science – and to be successful at understanding it, explaining it to the great unwashed, and at running large portfolios – one must be a superior mathematician educated at the most prestigious of universities. As we watch the same geniuses educated at said universities – some of whom had supposedly developed mathematical models which had eradicated risk – continue to drive hedge funds (and at least one major Wall Street brokerage firm) valued in the $ billions straight over the cliff – we say – “oh really?”

We instead choose to take Harry Truman’s quote — “There is nothing new in the world but the history you do not know” – to heart when we look at economics. History is in fact the study of human behavior – of what has worked, and what has failed. To ignore historical facts one must be either arrogant, a fool – or an arrogant fool. So, as Sir Alan Greenspan and his knights at the Fed Round Table repeatedly cut rates earlier this decade – we warned that the unfolding scenario looked a whole lot like Japan in the 1980’s and 90’s! A Stock market bubble, followed by a stock market crash – and subsequent economic pain. Then came massive interest rate cuts to supposedly “stimulate” – which instead caused a real estate bubble – followed by a real estate collapse, and a severe, prolonged recession.

Sound familiar?

What next? We see the bailouts continuing — simply because the alternative is the severe and necessary corrective pain to clean out the mess and get prices of all things back in line. And what politician, Wall Street banker, investor, or voter wants to deal with that reality? And bailouts spell inflation. Not the fudged low-ball inflation that’s used to calculate Social Security payment increases or “official” economic growth. We’re talking about real inflation. The rapidly rising kind you are seeing at the supermarket and the gas pump on a daily basis. As these inflationary bailouts continue – look for prices of all things tangible to increase dramatically.

Commodities bubble? We think not – because bubbles require excessive stockpiles/inventory/supply – and we don’t see that at all – in anything. And we see inflationary (money printing/bailout) policies accelerating.

Oil at $125 in the near future anyone? $5 Dollar gas at the end of the year? Food prices continuing through the roof? It would not surprise us at all.

 Leave it to the British to hit the economy with such a bold declaration.  Granted, in the United States all policy makers are very fond of saying something to the effect that this situation and the subsequent policy reactions  are the most drastic since World War II.  World War II?  We think this is a polite way of saying “since the Great Depression,” while hoping folks won’t go all panicky on the situation as they load their bunkers and prepare for the worst.

 

Granted, contemplating the concept of “bunker” has been more or less what Vigilant Investor has been doing since April 2005 — which by the way, today marks our 3rd anniversary since going full bore on the internet. Prior to that we published to our client base only as the Ernharth Wealth Report discussing the emerging Great Credit Bubble with issues dating back to 2001.

 

But what of this Great Depression talk the British press had jumped on?  Let’s take a look.

 

We knew things were bad on Wall Street, but on Main Street it may be worse. Startling official statistics show that as a new economic recession stalks the United States, a record number of Americans will shortly be depending on food stamps just to feed themselves and their families.

 

Well… Of course this is an issue, but what’s new about food stamps?   So, it would look as if this alarming headline really does not address the issue of Depresssion and Unemployment in a more relevant fashion other than to lament for the poor … so we will address this issue briefly.  Is another Great Depression a reality?   Let’s start from where this article begins: with the unemployed — a figure that hit 25% during the 1930s.

 

America has slowly been subsidizing an underclass for decades.   One wouldn’t know this is happening using the official unemployment figures because,  as we’ve reported over the years, the unemployment stats published by the government have been so politicized that the chronically “not working” are simply removed from the official figures, categorized instead as discouraged workers.  Those folks are  not unemployed, since unemployed, you see, implies someone is actually looking for a job.  So, if you’re not looking for a job, you can’t be unemployed.  So you must be something else.  Discouraged perhaps?  Discouraged it is!

 

The last real figures calculated using older methods like those used during the depression put U.S. unemployment (meaning those capable of working and not) closer to 13% vs. the official number running dramatically lower.  And that does not account for the only employer with long term growth strength in the U.S. — the government, which has also done a slight of hand by hiring otherwise unemployed folks in various welfare to work schemes — reminiscent in its own way to FDR’s give a man any job routine.

 

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Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
– Bloomberg (March 26, 2008)

The reason you want solid collateral to secure a loan is obvious. You want to protect adequately against the borrower’s potential inability to pay you the loan back. How interesting that the Fed is taking 30 $ Billion of illiquid mortgage securities as collateral from otherwise insolvent Bear Stearns to bail the Wall Street firm out. As intriguing (alarming) — is the Treasury’s encouragement of Fannie Mae and Freddie Mac to buy more mortgage-backed bonds.

We ask — who in their right mind would lend out their own money backed by such risky collateral? Who today would buy mortgage backed bonds with their own money?

Ah, there lies the rub! It’s not their money which backs these shenanigans – it yours!

With today’s 75 basis point rate cut – we see continued evidence as to whom the Fed really serves. As we have long said, it’s not you and I – it’s the Big Wall Street Banks. The “Big Rip-Off” of your savings continues. Jon Markman gets right down to it…

Nick Vardy is a well respected guru by most of Wall Street. He’s posted up a mocking critique of those of us contemplating the worst of what’s transpiring in the U.S. economy at the moment. The issue at hand is the consequence of “cry wolf syndrome”, where decades of warnings about horrid Fed policy and decadence in finance were, bluntly, way too early, causing mainstream analysts and bulls to dismiss them entirely as poppycock.

We’ll address Vardy’s comments below, piece by piece:

The Global Financial Crisis Of 2008 by Nicholas Vardy

Here we are yet again in the midst of another “global economic crisis.” From the hilltops of Davos, Switzerland, Morgan Stanley’s permabear Stephen Roach has shouted warnings of potential economic “Armageddon.” Superinvestor George Soros designated the current state of the global economy “the worst market crisis in 60 years.” Bill Clinton labeled it “the biggest financial crisis since the Great Depression” — even as global stocks responded by slumping 7.7% in January — the worst start to an investing year since Morgan Stanley began publishing data in the 1970s.

Uhh, but Stephan Roach has largely been right in his predictions since 2003, and where he erred was in underestimating the credit bubble’s blow-off. Soros has been similarly correct. Clinton? Well, opportunists always know when to hop on a bandwagon!

Bottom line, though, who do you trust? Those who failed to see any of this coming and were conceitedly dismissing warnings as crazy talk? The same ones who then failed to comprehend how severe the implosion would be, and whose advise encouraged investors to overextend and lose $ billions if not $ hundreds of billions?

But before you liquidate your financial assets, buy gold bullion, and move to a cave in Montana, you may wish to consider that current predictions of global economic collapse may be simply hyperbole. It has happened before. Clinton’s quote above actually refers to the collapse of Long Term Capital Management in 1998 — right before NASDAQ clocked an 88% gain in 1999.

Clinton’s a politician and a particularly adept one at saying whatever he needed to placate his power alliance. He’s a lousy example. However, what’s the point of bringing up the NASDAQ’s huge gains in 1999? Most who participated in that run-up gave that gain and a whole lot more back the following three years. Indeed, this was a bubble of insane proportions and who on earth can credibly use that as part of their defense for the health of today’s credit bubble economy?

Nor does this global crisis stand up to the scrutiny of historic comparison. Remember the S&L crisis in the early ’80s? It cost the U.S. economy about 3.5% of GDP — about 5x the size of subprime write-offs so far. Or how about the dark days of 1981, when the Federal Reserve drove its key interest rate to 19% in an effort to whip inflation? Bill Clinton’s “Great Depression of 1998″ doesn’t even merit mention.

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NEW YORK — Wall Street was expected to plunge at the opening of trading Tuesday, extending its huge losses from last week and taking more cues from heavy selling that has spread throughout the world. Indicators showed the Dow Jones industrial average was set to fall by more than 500 points when trading begins.Fears of a recession in the United States that could pull down the global economy as well have infected markets around the world, and those declines further unnerved U.S. investors who were unable to trade Monday, when Wall Street was closed for Martin Luther King Jr. Day. Meanwhile, U.S. bond prices soared as investors fled the stock market, and the price of oil skidded as investors dumped futures in the belief that a recession would slash demand for energy.

It looks like the markets are finally taking the credit crisis and recessionary risks seriously. It was as if a switch was flicked at the turn of the year, from “will there be a recession?”, to “Yikes! A recession! How long and how deep?”

Our answer? Deep. Long. And very liquid.
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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!

UPDATE: Oops! We crossed our labels in our DJIA and S&P500 vs. Oil Charts. Those are now corrected. If those barrels per unit seemed off before, they’re now corrected! 10-14-2007

In America its very common to think of the dollar in a vacuum. You actually hear pundits dismiss the dollar drop, saying “Who cares! In America we spend dollars.”

Well, while we believe the dollar dropping vs. other currencies has some serious implications for the debt addicted U.S. economy, the dollar has been dropping not just against other currencies. Here are a few sobering charts worth considering when change our measure away from dollar terms.

Grocery prices in the 12 months ending 6-30-2007

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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.

If you don’t take my word, take that of David Walker, U.S. Controller General, whose been on tour telling the truth about the real Federal deficit vs. the headline number. The numbers used by politicians: $315 and $265 billion in 2005 and 2006. The real numbers: $3.5 and $ 4.6 trillion, when the slight of hand that returns to the balance sheet the many social obligations that were removed thanks to the creativity of L.B.J and Congress back in the 1960s.

Cut programs? Raise taxes? Show me a politician who’d dare run on that — a scarcity confirmed in this video.

To us, this smells like more money printing in the future. Add that to the current credit market fiasco, and suddenly there’s a real issue regarding the slumping dollar!

We’re live 3:30 NYT to discuss the recent weeks events with the giant credit bubble unwind. Has the Fed been nearly as liquid as many suspect, or have they been stingy? The market seems to think all is ok, but should it be so quick to jump back on the carry trade and drive equities yet higher?

Join our live worldwide streamed talkcast today. Call in. Chat. Just listen or download for later!

Nothing like a little throwback media, but don’t let the format distract you from the crucial subject matter. Circulate this sucker — for your kids and less-informed friends and family.

The story of Tulipmania is not only about tulips and their price movements, and certainly studying the “fundamentals of the tulip market” does not explain the occurrence of this speculative bubble. The price of tulips only served as a manifestation of the end result of a government policy that expanded the quantity of money and thus fostered an environment for speculation and malinvestment. This scenario has been played out over and over throughout history.

It’s been said that history is the only laboratory we have in which to test the consequences of thought. With today’s massive global expansion of credit driving asset prices, perhaps the past can offer a look into the future, and so we present a link to George French’s research (quoted above) about another inflation related bubble, in his The Truth About Tulipmania.

Perhaps for our readers we can help overcome George Bernard Shaw’s unfortunately valid criticism, that the only thing we learn from history is that we learn nothing from history.