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April 25, 2007

Our Community
by Charles Zentay

I recently wrote someone about our community, and what I think it is. Here is what I wrote:

"Currencies do not float, they sink at different rates." - blog comment

"By the end of this bull market in commodities, there will be a bounty on caribou, you will be able to see an oil rig from every beach and they will be digging a copper mine in Barbra Streisand's yard." - speech posted on a blog

"The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise." - Alan Greenspan, 1967

Our community is especially relevant now that the dollar is approaching all time lows. Our community comes about because of the growing trend of blogging and the sharing of information in a decentralized manner. I think the overarching theme is how the Internet can lead to the empowerment of new ideas that challenge traditional power structures, even in the financial markets.

The basic gist is that there is a whole community on the web that has lost faith in the Federal Reserve and has a very alternative and interesting viewpoint on our monetary system and its shortcomings. Collectively, this community has assembled a lot of data on what is wrong with our current monetary system and what can be done about it. While not accepted in the mainstream, the community continues to grow and gain converts. With slow economic growth and rising inflation, more and more investors and readers are turning to this community to seek advice. Personally, I've based a lot of my own investment selections on this community's viewpoints, and I've made 15% a year for 6 years in a row now, without a single down year. Also, some mainstream voices are coming around to the same viewpoint as the community. On March 29th, William Rhodes, senior vice-president of Citigroup, wrote an op-ed in the Financial Times, which sounded just like the warnings from the community members. He wrote that "much of the good news has come as a result of extraordinary levels of liquidity pouring into opportunities around the globe. To a large extent this is due to the Federal Reserve's expansionary monetary policies early in the decade and the US administration's fiscal stimulus...pockets of excess are becoming harder to ignore...liquidity will recede and a number of problems will surface."

The community is made up of a variety of websites and blogs. The websites are made up off articles sent in by independent writers, which are reviewed, edited, and posted. In other words, the websites are kind of a nexus, which then link out into individuals' blogs.

There are many theories in the community, but one main theme is that the Federal Reserve has been injecting too much liquidity into the financial system for several decades now, and the current rise in inflation (with much more to come) is the result of this policy. In the 1990s, as the end of the Cold War created a massive global labor market, the effects of the liquidity increases were masked by the disinflationary effects of cheap labor. However, as China, India, and other emerging markets have become saturated with U.S. dollar reserves, and as their internal consumer markets begin to grow faster than U.S. markets, this disinflationary effect is reversing itself and becoming inflationary.

At the same time, the U.S. financial system has become addicted to liquidity. From consumers to hedge funds to the U.S. government itself, we need the continued supply of cheap money to keep up the momentum of our economy. The result: even as inflationary forces are taking hold in emerging markets, the Fed cannot easily raise interest rates to fight this inflation because of the leveraged nature of the U.S. economy. The problem is not, however, easy to solve, because its origins line many years back, when Greenspan was keeping rates low (despite fast liquidity growth) and encouraging U.S. indebtedness, rather than taking advantage of the disinflationary trends of the 90s to prepare for a more balanced future with higher savings levels for our aging population.

At present, the Fed is in the uncomfortable position of witnessing slowing growth in the U.S. (as higher short-term U.S. interest rates slow down the housing market), higher commodity prices as worldwide growth and demand continue at a fast pace (China's economy grew 11%), and a weaker U.S. dollar (the U.S. dollar index is nearing its all-time low versus a basket of other currencies). If the Fed lowers rates to help the U.S. economy, the dollar will continue its slide and inflation will only become more of a problem. If the Fed raises rates to stop inflation, the U.S. economy is likely to go into a recession. Therefore, the Fed is keeping rates steady, and yet the problem continues; liquidity continues to grow. Here are the latest liquidity growth estimates from one member of the community:

US reconstructed M3: up 11 percent
Euro zone M3: up 10.0 per cent
United Kingdom M4: up 13 per cent
India M3: up 20.3 per cent
China M2: up 17.2 per cent
Australia: up 12.7 per cent
South Korea M3: up 11.3 per cent
New Zealand: up 18 per cent
Australia M3: up 13 per cent
Japan M3: up 6 per cent
Russia M2: up 49 per cent

The more cynical members of the community believe that the Fed and the banks are both to blame. They believe it should be the bankers (not the robbers of the banks) who should be wearing the masks. In other words, the bankers take your money at 5.25%, then overlend at 8.25%, and to keep default rates low, they encourage the Fed to keep liquidity high to avoid systemic risk. The problem is that because the Fed is constantly assuring the banks that they will help avoid systemic risk, the more savy banks, hedge funds, and LBO firms leverage themselves even more, because they know the Fed will come to their rescue with more liquidity to avoid "contagion." The result is a moral hazard, with more and more leverage and more and more debt coming into the system. This increasing liquidity leads to a weak U.S. dollar.

What investor, the cynics ask, should put money into a bank at 5% in a currency that is falling 5% to 10% a year? They continually point to statistics that show the declining purchasing power of the U.S. dollar vs oil, gold, housing, etc. They also show graphs highlighting how the U.S. market indexes are rising in U.S. dollars, but they are actually falling when priced in gold, oil, or foreign currencies. In other words, the only thing that is pushing up the markets is the falling dollar! The money you make on the market actually doesn't help you buy anything more than when you put it in the market (that is, if you're like me and you're buying gasoline, housing, food, education, health care, etc.). These cynics think the hedge fund industry is overrated, with the average hedge fund (after fees, taxes, etc.) earning less than the amount by which the U.S. dollar is declining, so again, you as an investor are actually losing money in adjusted terms, yet the managers of the fund are making millions off 2/20 fee structures to lose you money!

If that's the case, I'd guess you'd have to call me a cynic, too!

Below are links to some of the websites and blogs. Below the links, I've included some of my favorite quotes I've picked up from some of these sites.

www.safehaven.com
www.biiwii.com
www.depression2.com
www.bullnotbull.com
www.financialsense.com
http://www1.investorvillage.com/smbd.asp?mb=4380&clear=1&pt=m
http://globaleconomicanalysis.blogspot.com/

Favorite Quotes:

""I've read hundreds of articles over the last few years and everyone keeps using the US dollar as a unit of measure. The US dollar is an idea, an abstract figment of the imagination. Of course inflation of THE DOLLAR is possible, because it inherently has no value. However, look at the stock market in terms of lumber, nickle, gold, silver, steak sandwiches, palladium, real estate, or ANYTHING and you will see a picture of brutal deflation. It's amazing that so many economists overlook the fact that VALUE and TRADABLE WORTH are deflating rapidly even as assets appear to be rising. Or even simpler, assets and incomes are not rising faster than WORTH and VALUE are diminishing. This is why people are turning to more and more credit. The FED can inflate Federal Reserve Notes but it can't stop value and worth from deflating unless capital goods production in the US increases. So economists need to stop looking at the inflation/deflating debate in terms of dollars. We can all be millionaires, but if a loaf of bread cost $1,600 then we will still be drowning in MASSIVE DEFLATION. DEFLATION of our WORTH and VALUE. It's all relative. Stock charts when compared to ANYTHING but the dollar are all deflating rapidly.....and show a downslope crash into the abyss. Someone has to be pretty naive to think the stock market has been going up for the past few years.....look at the markets in terms of gold and silver if you don't believe me!! Keep up the debate."

"the first thing that troubles me over this question is that the common man's (and i speak as someone who grew up in a time when debt was something to be feared and avoided so i am a man 'out of his time') understanding of the issue is clouded by his real world experience of how he must run his own economic affairs. bankers used to be the policeman on the corner safeguarding the children. now they're more like the drug pushers on a very different street corner, there to tempt the weak and gullible. now there isnt even caution in the breeze. lets hope the wind doesnt pick up."

"Human beings adapt best to downward changes in living standards when they come gradually."

"Michael Phoenix at livecharts.so.uk writes: A few years ago I started to do some digging around the Fed as my distrust in the fight against inflation had become too strong to ignore. I found the very words I needed in the transcripts of a FOMC meeting. It's on page 82. You will note the remark is followed by laughter, I kid you not. So I went and looked at page 82 of the transcript of the meeting of the Federal Open Market Committee, dated August 22, 2000, which was almost seven years ago, and realize that Mr. Phoenix is right, and this is a very revealing look at how the Federal Reserve operates. In attendance was a 'Mr. Jordan.' The transcript takes us to, 'Regarding the language on the balance of risks, part of me would like to say that the statement should always be that an unavoidable, permanent feature of a fiat money system is a balance of risks toward higher inflation. [Laughter].' So Mr. Phoenix was right! They know this stuff, and yet they laugh at revealing the truth!"

"The following will not be in Allen Greenspan's book: Between 1800 and 1913, the value of the dollar was more or less constant. Since the Feds creation in 1914, the value of the dollar has depreciated 97%. Since the maestro, Allen Greenspan took over, the dollar has lost 37% of its value. Consumers have gone deeper and deeper into debt in order to spend freely out of artificial purchasing power extracted from over valued homes. All that paints a compelling picture of an excess demand driven US economy...Our biggest export under Greenspan's term was paper - the US Dollar. Japan and China have purchased massive amounts of US treasuries to stem their decline. They loan us money to buy their products because they need the US as a customer. When will this end? It will end when the Asian Tigers develop a consumer credit system and their three billion plus citizens become the customer. At that point we will no longer be able to live beyond our means - the dollar decline will accelerate and interest rates will rise dramatically...Foreigners currently own 45% of US treasuries. The FED can create $30 billion of paper in a week. They can raise rates, but it won't create one drop of oil, one pound of copper or one bushel of rice... The BLS [Bureau of Labor Statistics] over time has made tiny incremental changes in the way they manipulate the statistics. In a bipartisan effort, presidents and the FED chairman have tried to make the news just a little better. Over time, these tiny changes have begun to add up. If we just go back 20 years and remove these changes, then unemployment today would be about 8%, the CPI would be about 7% and the GNP growth would be 0. On the unemployment front, if you were a discouraged worker, you were counted until the Clinton administration. During Clinton's reign, workers who were discouraged for over a year were taken out of the number. That knocked 5 million off the broader unemployment report. U-3 is now the reported number of 4.7 but if you look in the footnotes, U-6, the old number is over 8% unemployment. The real degeneration over time is the CPI. In the 90's, Michael Boskin at the council of economic advisors and Greenscam [sic.] at the FED wanted to fix the CPI simply stating that it was overstating inflation. They created substitution--assuming that if the price of steak went up, the public would substitute hamburger. The CPI was originally designed to measure a fixed basket of goods for a constant standard of living. Today it has changed to a basket of survival...Last year if you didn't eat, didn't drive to work, didn't heat your home, didn't visit a doctor, didn't buy a house, didn't buy insurance of any kind, didn't have a child in college and didn't pay state or property taxes, your cost of living agrees with the government's...Today we have over $1 trillion in fiscal stimulus from the budget and trade deficits and the monetary stimulus of tremendous liquidity and some of the lowest interest rates in over 40 years. The pedal is definitely to the metal. The economy's improvement is sluggish considering the massive size of the stimulus because of the size of the debt we're dragging behind us...In 1966 oil was $2.90/barrel and rallied to $28/barrel. Gold was at $35/oz and rallied to $850/oz. The average price of a home increased 180%. In 1982 the stuff cycle ended and the great paper cycle began. In 1982, the public had 14% of their liquid assets in equities. The Business Week Magazine cover reported "The Death of Equities". The P/E ratio was 7. Stocks were dirt-cheap and stuff was very expensive. Brokerage firms were selling real estate and oil and gas partnerships. 1982 was the beginning of a great bull market in paper. By 2000, the DOW was up over 10 fold. The cost of one dollar's worth of earnings (the P/E ratio) has risen from 7 to 44, and the public had 57% of their liquid assets in equities. The Time Magazine cover featured "The Committee To Save The World: Greenscam, Summers and Ruben". Brokerage firms were selling tech and dot coms with no earnings. The paper bull market was ending. Paper was very overpriced and over owned...Stuff, from 1982 to 2000, was in the dead zone. Oil went from $28/barrel to $26/barrel. Gold went from $850/oz to $280/oz. The average price of a house had increased 1.2% per year by '2000. Stuff was a bargain. In the next 10 years paper could be a trading market while stuff is in a bull or buy and hold market...There is a surplus of well educated labor. 30 years of restrained and neglected natural resource supply is being overwhelmed by demand. The longer things remain stable, the more likely they become unstable. Peace put 2 ½ billion people in the world labor market. India and China alone contain over 2 billion consumers. Suppose each of the 2 billion people consumes a mere quart of gasoline per week as their economy booms; that's an additional 1.7 million barrels a day, new demand that is sure to increase price. Today, China is booming. They have declared the national bird to be the construction crane. Last year China's factory floor produced 50% of the world's cameras, 35% of the TV's and 30% of the refrigerators sold worldwide. In the last five years china went from exporting oil to the second largest importer in the world. The Chinese will go from walking, to bikes, to motorcycles, and to autos. They will need oil and gas, chemicals, forest products and metals. At 80 cents per hour they are deflating manufacturing costs, but as they become more successful, they will throw away their bicycles and buy motorcycles and eat better, increasing the demand for raw materials. China and India are transforming their economies from poor agrarian nations to the newest industrial powers, replete with heavy industries, mass transportation and higher education. Rising from these giant new economies will come millions of new consumers, the very people who are already straining the natural resources of the earth. In 1900, the US started to industrialize. We were using one barrel of oil per person per year. By 1970, we were using 27 barrels per person. In 1950, Japan started to industrialize, they were using 1 barrel per person. By 1970, they were using 17. In 1965, South Korea started to industrialize. They were using one barrel per person per year. By 2000 they were using 17. Today, China uses 1.3 barrel per person per year and India uses .7. In 1950, Japan per capita income was 18% of the US, today it's 96%. In 1965, South Korea's per capita income was 16% of the US, today it's 56%. India and China have 2.5 billion consumers, 9 times the US. The US uses 25% of the world's energy, China and India use 2%. India and China have 280 people per car. The US has 2 people per car. Real incomes are just beginning to rise to levels that create large demands for consumer goods. Between 1950 and 1970, Japan's urban population increased 70%. Personal consumption increased 600%. China currently is 40% urban, 60% rural. The US is 97% urban and 3% rural. China has 20% of the world's population and 7% of the world's land. China's grain imports will grow from 14 million tons today to 57 million tons in 2020. Today, 1 billion people consume two thirds of the world's raw materials. 5.6 billion people consume the other third and they are becoming more successful. There is no need to connect the dots, they over lap...Demand for raw materials has increased. In many cases, the capacity to produce raw materials has declined dramatically in the last 20 years. Tops and bottoms are creatures of extreme. Markets rise above all expectation and then go higher and then fall further than common sense suggests. The most desirable investments for the future might not be in cyber space but back to the basics. By the end of this bull market in commodities, there will be a bounty on caribou, you will be able to see an oil rig from every beach and they will be digging a copper mine in Barbra Streisand's yard."

Charles Zentay
thinkinvest.blogspot.com

Charles Zentay is an independent business person who monitors the financial markets very closely.  Visit his blog at thinkinvest.blogspot.com.

Copyright © 2007 Charles Zentay

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