In This Issue
Stagflation emerging, guest essay by Clyde Harrison with Tedbits notes
The Bomb, er Bond Market
Friday's unemployment report was consistent with an economy that is fairly well underpinned in terms of job growth, outside some "fingers of instability" in the construction and capital goods sectors. Employment is robust at 4.4% (this is the doctored rate it is actually much higher see below) and wages are rising 4% year over year (they are rising much faster). After a brief foreword I will print a speech given by Clyde Harrison 1 year ago, Clyde was a little early then but his words were prescient.
The Bond market is looking toppy, and is set to break down hard, for domestic reasons as well as international. It will fail as we can predict what the authorities will do. Business and the Economy in general is set for broad inflationary attacks from the Mandarins in Washington DC, and Brussels, and the unintended consequences (not unanticipated, these are big, big investment opportunities) of their plans. Let's take a look!
Close inspection of the details of recent economic releases spell a problem we really haven't seen since the 1970's. That problem was one of stagflation. It is really no surprise as many of the policies now being pursued are eerily familiar to those that study the history.
In the 1970s there were several overriding themes, paper was in a relentless bear market and things were in relentless bull markets. Real estate, gold, oil, wages, taxes and regulation were all rising relentlessly. If you were from Wall Street your name was slowly changing to "MUD". Money could not be left in the bank or the stock and bond markets; it would lose its purchasing power relentlessly as people realized if they waited to spend it would always buy a little less than the day before. We are entering that time period now, it will grow like a slow moving freight train gathers speed, as it rolls through the coming years and people slowly but surely change their behavior to coupe with the next 10 years of the unfolding commodity super cycle, combined with the relentlessly expanding monetary and credit base.
We are entering this psychological time period now. As more and more people wake up to the fact that "WORLDWIDE" money and credit is being created in a manner never seen in history (except in places like the Weimar republic, Viet Nam, Argentina, Zimbabwe). These stagflation trends are firmly in place and accelerating in the Developed economies, in the emerging world things will play out differently in that they have something the west doesn't'; Good work habits, savings, consumers and governments who are not drowning in debt. The results are predictable and invest-able themes.
Conversely, during that period paper was trash, Bonds were known as guaranteed certificates of confiscation, and the stock market went through a 10-14 year period that culminated in the massive bearishness that set the bottom in sentiment, and created the Pain necessary to provide the political impetus to change the destructive government economic and tax policies. This set the stage for the bull market in wealth creation and the free markets that commenced in 1982 and has lead to stock markets at nominal new highs at this time (In terms of real money "gold" we are on the lows). It was hell for the lower and middle income classes as they could just not keep up with the rising costs of everything, their wages rose, but not fast enough to cover the loss in purchasing power that their savings and wages underwent. By the time stagflation was attacked and whipped by Paul Volker and Ronald Reagan only 14% of peoples assets were held in liquid investments such as stocks, bonds and currency in the bank. Thank you Clyde for these wonderful thoughts and insights.
Governments and Central Banks are Completely
Incapable of Keeping Tomorrow from Coming
By: Clyde Harrison
God gave me the ability to recognize the obvious, some common sense and a sense of humor to stand the first two. The one trend in place is the overall advance of mankind. It began when we emerged from the cave.
The world is going through a dramatic change. The world has discovered capitalism. China and India are transforming their economies from poor agrarian economies to industrial powers. The effect of these changes will be felt for years.
One of my favorite quotes is, "Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for life." Today in order to teach a man to fish, you need two fishing licenses, a state boat sticker, OSHA approved life jackets, EPA approved weights and hooks, you pay a park fee, obtain a fire permit to cook the fish and an EPA permit to dispose of the waste. Thanks to the government, fish you catch costs 8 times as much as the fish you purchase in the supermarket, caught overseas.
When I started in the investment business 38 years ago, the Golden Rule was "Do unto others as you would have them do unto you." In a few years it was corrupted to, "He who has the gold makes the rules." Today it has been totally corrupted to, "He who makes the rules gets the gold."
Our educational system is failing the students. US high school graduates do not have the knowledge to pay teachers pensions. In 2005 in the US, 70,000 engineers graduated from college, 30% were foreign students. India graduated 200,000, China 500,000. By 2010, 90% of all PHD engineers and scientists will live in Asia. When US students enter school, they test at #1 in the world for over all knowledge. After 12 years with the NEA, they graduate from high school 24th in the world.
The moral values they are taught are: diversity, tolerance and respect for the environment. Jefferson said "without an educated voter, the republic will not stand."
What's the latest suggestion from the national education association? It is to grade papers with purple pencils instead of red because red hurts the students' feelings and to ban the game of tag at recess, because it is too aggressive.
Governments in most cases and most places make things worse. George Washington said "Government is not eloquence, it is not justice; it is force. Like fire, it is a dangerous servant and a fearsome master."
The definition of politics is the advance auction of goods that have not yet been stolen.
Whenever a government does something for someone, it must do something to someone. If expanding government were the solution, Russia would have been paradise. In the US, we have a two party system and what a party they are giving themselves. Since 1960 government spending has grown 8 times as fast as the GNP.
Republicrats borrow and spend. Democins tax and spend. From 2000 to 2005, federal spending increased 38.2%. Federal debt increased 40.5%.
The government taxes and regulates success and subsidizes failure. The Government's motto, "If it ain't broke, fix it until it is." Whenever you contact the Government, you are met by one of two groups who work for the government. The first group is just out of college hoping to work in government for three years, learn who to talk to in order to get things done, then get a real job and triple their pay. The second group is much older.
They couldn't get a real job after 3 years. Government has either no experience or no talent. If you believe in government, FEMA has 10,000 trailers in Hope, AR they would like you and your friends to move into.
Today lawyers run the government. Seventy-three percent of the cabinet are lawyers. Eighty-five percent of the gang of 535, the Congress are lawyers. Lawyers train on the principle that when there's a solution to a problem, they stop making money. You know the system is corrupt when Congressmen spend 6 million to get a job that pays $162,000 per year.
In 1987 the US signed a treaty allowing Japanese lawyers to practice in the US and US lawyers to practice in Japan. At the signing there were a total of 14,000 lawyers in Japan and 650,000 in the US. Two years later, Japan entered a depression. It is just starting to recover. Just coincidence? Maybe.
Consider the following:
The Lord's Prayer: 66 Words;
The 10 Commandments: 179 Words;
The Declaration of Independence: 1300 Words;
U.S. Government Regulations on the Sale of Cabbage: 26,911 Words; and
U.S. Income Tax Code - simplified: 1,607,000 Words, (Tedbits note; Unsimplified 9,000,000 words, to call the tax code simplified is an oxymoron)
Last year congress failed to change course on the unsustainable path of Social Security and Medicare. The financial cliff is still out there. It would be a great improvement if the government respected individual's rights as much as they respect the rights of the caribous.
If the current congress wrote the bill of rights it would be as follows:
- The right to pay taxes.
- The right to adhere to any and all federal regulations (Tedbits note; new generations of "Bureaurats", er Bureaucrats have forgotten completely the lessons of the 1970s" (runaway inflationary and wealth destructive regulations" and are set to repeat them! In triplicate. and the 1980's "wholesale deregulation, surging wealth generation and work rewarding, and huge tax cuts unleashing the entrepreneurs to create the huge expansion that lasted till 2000 are now being reversed at astonishing speed, short memories I guess)
- The right to be guilty of any and all IRS accusations until you prove yourself innocent. (Tedbits note, government spending is on a runaway path, they will not consider the reduction of government spending only the reduction of the taxpayers wealth, government priorities are always more important than yours)
- The right to turn your property over to the government if they have a better use for it.
The government is already too large and too expensive, Bush Sr. simplified taxes. Now we only tax the living and the dead. Clinton promised to tax only the rich. Once in office, he defined rich as, "Those Americans with Indoor Plumbing." Bush Jr. said he cut taxes but the tremendous increase in spending means W just delayed tax increases.
God, who created everything only wants 10%!
The demands of the majority are always greater than taxation alone can provide and that's where the FED comes in.
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 it's 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.
The 1% Fed funds rate moved the savings rate to between zero and zip, while mortgage debt increased 62%. The last central banker to get it right was Joseph, in the Bible. Seven good years followed by 7 bad years. The Fed is like the Post Office giving out money instead of stamps. Faith in the Fed is based on elaborate mathematical models relying on the breathtakingly faulty assumption that human beings behave rationally.
The FED's invisible hand of intervention is trying to keep interest rates as low as the world will allow. But the world is becoming a bit nervous. The US has borrowed over $1 trillion from overseas (Tedbits note, I believe it's over 5 trillion Clyde). Some day it will be repatriated. The exchange of paper for wealth will go into reverse. We will get our paper back and have to return real wealth. Recently, the dollar has been rapidly declining against the Euro and gold but at a much slower rate against the Asian Tigers. 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. (Tedbits note, it's started and is accelerating, invest in it)
The dollar bears the legend on it, "In God We Trust." Placing your faith in the Fed could be a dangerous plan. Someday, the dollar could fall to its intrinsic value. Denial is not just a river in Egypt. Currencies do not float, they sink at different rates. Currencies are abstractions not redeemable in any specific amount of anything, they are an "I owe you" nothing certificate. (Tedbits note, "backed by the full faith of the US government in Washington, there is not a promise they won't break through deception and redefinition as in George Orwells 1984)
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. (Tedbits note; Alchemy has been tried many times in history, changing lead into gold, it has never Worked, you can't print wealth you can only create it through hard work, savings, and investment in meeting peoples needs).
Now we have Bernanke as the new head of the FED. Bernanke has studied the depression and deflation at great length. He has stated the FED has many options to avoid deflation including dropping dollars from helicopters if necessary, earning him the nick name "Helicopter Ben."
The FED is attempting a neutral interest rate policy. Neutral for the FED is like pornography to the Supreme Court. They can't define it, but they will know it when they see it. Stagflation is coming. Slow GNP growth, inflation increasing, and net disposable income declining.
Currently the FED is raising the rent on money but you can get all you want. Money is very loose. It just costs more. We all work for something. Our government manufactures with no sweat, no work, no creativity - just turn on a computer and create more dollars.
Unless you have the ability to chain weight, seasonably adjust, and substitute in your check book. Your dollars probably don't go as far as the government would like to have you believe. The Bureau of Labor lies are a bit better than the government's response to Katrina because the footnotes explain why these reports are worthless.
There is a disconnect between the man on the street and how he feels and how the government tells him he should feel. The BLS over time has made tiny incremental changes in the way they manipulate the statistics. In a bipartisan effort, presidents, Congress 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. 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%.
The real degeneration over time is the CPI. In the 90's, Michael Boskin at the council of economic advisors and Greenscam 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.
The Clinton administration and the BLS changed the weightings method of the CPI. Arithmetic was changed to Geometric weightings which as the benefit that if something goes up in price it automatically gets a lower weight. If the price goes down, it gets a higher weight. They also try to adjust for product improvements. If they determined the products price increased but it was improved, the price didn't go up with hedonic adjustments.
Wall Street economists and bank economists don't adjust for these changes because like politicians, they tend to have an upbeat view. If inflation is understated then reported real growth (the GNP) will be overstated (Tedbits note, GDP after real inflation is zero or below, those who point to an inverted yield curve predicting a recession don't understand that the yield curve is correct and has predicted the recession correctly, we are in it now, only we don't know it because the numbers used to see it "GDP and Inflation" are so doctored as to make it unrecognizable, see easy money forever in the Tedbits archives www.TraderView.com).
Bob Reich, in his memoirs wrote that they found in their polling that if you could overstate economic growth, understate inflation, tell people things were are better than they really are. It could help you win a tight election. That was their conclusion, so of course the numbers were adjusted. (Tedbits note, as I said real inflation is 7 to 8 percent and GDP growth percent is below 3 percent, therefore the economy is actually shrinking now, we are in the recession).
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 governments. If your using government statistics for your investment decisions, you'll substitute cat food for hamburger when you retire. (Tedbits note, retirees across the country are doing this now)
Since the Feds creation there has been deflation - deflation of the currency. It shrinks on average 2.5% to 3% per year. In the US, we have voters who are deep in debt. Deflation would crush the voter. Currency deflation will help the debtor. Expect stagflation - the value of the currency goes down while the economy goes no where; an, "L" shaped recession.
Prices will be lower for every thing that can be manufactured in China or serviced in India. Prices will be much higher for what can only be made in the US; medical care, insurance, plumbers, trash collection, raw materials, real estate, and government.
In the next 10 years, the government will lie about the deflation of the currency so, (when the baby boomers retire) their social security check will be worth half of what they anticipated in real terms. (Tedbits note, how else will they avoid the coming entitlement train wreck, this plan is in motion, NOW, and it is funded by those same retirees savings accounts and cash holdings when the fed prints the money at night and steals the value of it to pay out the Social security windows,).
When the Fed fine-tunes, the orchestra gets fired. All soft landings by the FED have resulted in thousands of casualties. Ever since the earth was cooling the Fed was headed by a banker. Greenscam was the first economist. Carl Marx was an economist!
If you believe the Fed guides the economy you must also believe the twelve birds sitting atop the rhinoceros guide him through the jungle. Currently the government is trying to boost the economy with one of the largest doses of steroids in history (Tedbits note, Its set to be accelerating Clyde).
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 economies improvement is sluggish considering the massive size of the stimulus because of the size of the debt we're dragging behind us.
The ocean of liquidity has created a lot of jobs. Their just not in this country.
What investments will benefit from this major change? Where should you invest your SEC rebate check, or your own hard earned money?
Long term interest rates are low. The FED is proposing dropping cash from helicopters if necessary. History suggests this might be a good time to be a borrower or at least have a short duration to your interest bearing investments.
The equity market now has 84 million individual investors. Over 50% of these investors liquid assets are in the equities, the historical average is 25%. Using the rules outlined by Graham and Dodd such as dividend yield, PE Ratio, price ratio, price to sales ratio and price to assets, stocks are very expensive. They are over owned and over priced - a dangerous combination. (Tedbits note, The stock markets are probably going higher as people start to move out of their dollars around the world ala Zimbabwe, Wall Street will fight the death of paper tooth and nail with misinformation, and off course back in the 1970's the plunge protection team was unthinkable, now its everyday policy, exasperating the inflation yet to come).
Who's recommending increasing equity exposure? Kudlow and Cramer - CN"BS" - which is a marketing program. It should be listed in the TV guide as paid programming like George Forman's cooker. (Tedbits note, CNBC is bailing the boat as fast they can as analyst after analyst out of Wall Street pooh pooh the commodities bull market and talk up their paper manufacturing processes).
Who's recommending caution and much lower returns from stocks going forward? John Templeton, Carl Icahn, Allen Abelson, Mark Faber, Bill Gross and Warren Buffet to name a few. Buffet currently holds $47 billion in equities and $45 billion in cash. He must be having a tough time finding those bargains from Omaha.
There has never been a ten year period in history when valuations have been as high as they are now and where the broad stock market indexes out performed money market funds - never! I expect a moose market, not a bull or a bear but a moose, rhyming with the period of '66 to '82 where the market went nowhere.
(Authors note; looking for assistance in creating portfolio diversification that can survive and thrive in what I am outlining? If so contact me through www.TraderView.com. Subscriptions to this newsletter are also free at this address; send it to a friend, Thank you)
I believe the paper bull market has ended and the stuff bull market has begun.
Between 1966 and 1982 equities gained nothing while the GNP gained 330%. The DOW went from 1000 to 875. From 1982 to 2000 the GNP gained 170% and the DOW rallied from 875 to 11,700. Currently the DOW is trading over 11,000, about a 25 PE. Between now and 2015 if the GNP gains 100% and earnings gain 100% the DOW could be at 10,000, trading at 10 times earnings. During the past 5 years the S&P is up 5%. And at that rate of compounding, you will have to work till you die.
During the last stuff cycle equity mutual funds were in a dead zone while stuff; raw materials, art and real estate had super returns. (Tedbits note, real estate will be weak in the US as cheap credit has created a glut "finger of instability" which will have to be corrected, housing and retailing space is way overbuilt for a declining consumer. In the 1970's we still had savings, now we DON'T, see fingers of instability in Tedbits archives at www.TraderView.com ).
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 PE 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 dollars worth of earnings (the PE 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. The Dow could be in a trading range of 7,000-11,000 for years.
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. (Tedbits note, If you adjust gold's price to 1980 dollars you get a target of over 3800 dollars a ounce www.traderview.com). 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.
Change is a way of life. You either accept changes or make changes. Capitalism is sweeping the world. Capitalism is easy to understand. It's nature with a balance sheet. If you're wrong, you go broke instead of being eaten.
Three basic things make up an economy; labor, natural resources, and capital (Tedbits note, the US lacks all three at this point). There is a surplus of well educated labor. (Tedbits note, so the cost of brains in the US is set to decline).
30 years of restrained and neglected natural resource supply is being overwhelmed by demand. (Tedbits note, fail to plan, plan to fail, resource development stopped over 20 years ago in the United States when the Sierra club and the big unions got a hold of the democratic majority and began the evisceration of manufacturing and resource development, it is ending now around the rest of the world as governments around the world seize the commodity producers in a cash grab and put nothing into future exploration, development, and maintenance of the resources). 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 (Tedbits note, its billions not millions of new consumers, but the US will not participate in these growth opportunities are will be locked out because of the trade wars just now beginning in Washington DC, why should they let us sell into their markets when we increasingly don't allow them to sell into ours?). 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 tones today to 57 million tones in 2020. ( Tedbits note, right into the teeth of bio fuels, food costs are set to skyrocket in the coming years, this doesn't even really illustrate the coming price rises from corn based ethanol, so the shortages are front loaded).
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.
Lead times to create raw materials are measured in years. In Canada $80 billion in infrastructure has been committed to production of the tar sands. The goal is to produce 3 million barrels a day by 2015. At $60, oil is a bargain liquid. It costs 10% less than bottled water, it's one third the cost of milk, one fifth the cost of beer and only 2% of the cost of Jack Daniels. Phelps Dodge is planning to open a new copper mine in 2007. It took 12 years of paper work to receive federal approval. Currently oil companies who search for oil at great risk earn 9 cents per gallon. Government, at no risk makes 51 cents per gallon.
In the US, half of our energy problem is government regulations. The only place oil companies are allowed to drill for oil is next to a dry hole. The only place you can build a refinery is no where. (Tedbits note, and clean environmentally friendly nuclear is out of the question as NIMBY and environmentalists will tie it up in the courts for years until it is too late to avoid unbelievable price disruptions to Americans lives, and of course corn based ethanol is a emerging nightmare courtesy of Uncle Sam see Tedbits archives at www.Traderview.com).
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, there will be a bounty on caribou, you will be able to see an oilrig from every beach and they will be digging a copper mine in Barbra Streisand's yard. As you climb the ladder of financial success, check to make sure it's leaning on the right wall. I believe raw materials will be one of the best investments for the next 10 to 15 years.
Long-term- the future is very bright because man has been succeeding in bringing about change for the better since he or she first emerged from the cave. Big problems usually disguise big opportunities.
Governments and central banks are completely incapable of keeping tomorrow from coming. In the next 12 months, let the winds of change fill your sails. Thank you.
TedBits note, Thank you Clyde, a thought provoking essay, which lays out of roadmap to the next 10 to 15 years. Some of it will play out with new twists over what happened in the US in the 1966-82 time periods. The US no longer has the manufacturing base it once had, we now have no savings as a nation or a people. The United States at that time was the greatest creditors to the world, now we are the greatest debtors. Entitlements were a small fraction of what they are today, and liabilities were growing at a far slower rate, as the baby boomers were in their prime, creating wealth at an enormous rate.
Now they are set to retire on the money they accumulated, wealth creation is slowing and under attack. That money is set to lose its value, the money printing in front of us is exponentially higher, then what was done in the 1970's. The government is set to confiscate the baby boomers hard work, accumulated wealth and savings through their vote buying and money printing schemes. The US economy is much sicker at this point then it was then. As these things spiral out of political control look for the politicians to try to control the problems with more regulations and laws that are contrary to history and the laws of nature. Remember wage and price controls? If you don't you probably will get a history lesson very soon. Inflation causing Regulations exploded in the 1970's as politicians tried to control everything!!! The federal registry of regulations in Washington are now exploding, up over 60% in the last six years, Brussels is not to be outdone and is working hard to compete with the US leviathan. Taxes exploded higher as they are winding up to do so as we speak. New taxes on everything from Global warming to all types of Income. Lots of money to be made if you are positioned correctly and because of Clyde's insights we can see....
The Bomb, er Bond Market
Just like the previous cycle we illustrated above which was 1966 to 1982 bull market in things, swinging to a 1982 to 2000-2007 market in paper. Now we are moving into the initial phases of the 1966-1982 cycle. Where paper turns to trash. US Bonds and Treasuries actually topped in June 2003, and have formed a broad top on all fixed income indexes since that time. Secular trend lines initially established in 1984 have been broken and after a brief rally to test the break down point the declines are set to begin again.
These long-term breakdowns have already broken down in European Bonds, led by the German Bund, which is a 10-year note, the correlation between the US and German bund is over 90%. Yield curves are steepening and are set to do so more in the future as the Federal Reserve lowers short term interest rates to SAVE the financial system from "ARM" ageddon (see previous Tedbits archives at www.TraderView.com), exasperating the inflationary implications. And the long end tumbles as the foreign bidders are set to be attacked by the protectionists in Washington, and the Federal Reserve as it tries to cushion the American economy from the unfolding weakness by accelerating money and credit creation.
Inflation adjusted Tips bonds while a good idea in a deflationary world of the 80's and 90's will kill the governments balance sheet in the near future, runaway interest expenses will force the Fed to print the money, as fewer and fewer buyers step to the plate as the era of guaranteed confiscation dawns anew. Bonds are entering a phase of "Capital destruction" and the buyers will come from the Central bank printing presses to defend the asset based financial systems operating in all the major capitals of the world.
Nothing has astounded me more than the sheer volume of issuance the fixed income markets in the developed world has embraced over the last five years. There are lots of bubbles out there, but they are dwarfed by the credit and bond bubble. It doesn't matter what is sold, junk, whatever, investors have had an insatiable appetite for these perceived as risk free assets. There is no fear of the risks (of defaults), and these assets are severely mispriced to reflect the real risk inherent in them. Junk bonds used to pay 5 to 9 % over the risk free treasury rate, this is a exercise in math as the compounded returns on a successful purchase quickly takes the risk out, for example using the rule of 72 a bond yielding 12-14 % repays the principle in 5 ¼ to 6 years. Now they are priced 2 to 4 % above the risk free rate and the time frame to more safety is postponed to a much later date. Negating the ability to quickly recover principle as was previously the case. Credit ratings of most of the borrowers has steadily declined during this period. The risks are severely mispriced. Take a look at this chart credit spreads between junk bonds, corporates and government treasuries in the last several years;
This is an illustration of the investment assumptions of safety that has increased during the time of the 'Greenspan era" of Central banking creating the moral hazard of the assumed rescue provided by the "Greenspan put". It is a story of MASSIVE miscalculation. Miscalculations of the reliability of the central banks and finance officials in creating "prudent", "fuduciarily sound" money and credit growth. There are many things you can call the recent World wide acceleration of the supply of money and credit, but "prudent", and "fuduciarily sound" are not any of them. Institutions, pension funds, hedgefunds, central banks and individual investors have flocked to these investment vehicles based on this assumption of "BAILOUT" by the central banks. So the biggest money in the world is in at the top and will be need of imminent rescue. The main stream bond purchasers are set to be cracked as the assumption of bonds as conservative investment vehicles is turned on its head by the recent money and credit creation that has turned the idea of prudent central banking on its head.
Looking at the weekly technical charts of the bomb er Bond market, it is an epidemic of head and shoulders tops, fast approaching triangle breakdowns, trendline failure on the trendlines since 1984, etc.
If you look at the daily, monthly and Quarterly charts they too are all top patterns with head and shoulders all over the place, low volatility is a sign to look for patterns, and the patterns are all there for the astute chartists among us.
Like the proverbial flock of Sheep, fixed income Investors are about to be "FLEECED" as the value of their holdings undergo steep capital losses through the market or from the central banks and government treasuries printing presses as they print the money to buy them to prevent the collapse of the fixed income and credit based economies they underpin. To take down this supply from all the sellers, the fiat-based currencies will be printed far in excess of the insanity that is currently practiced to keep economic expansion rolling. Releasing kazillions of dollars into the economy of the world.
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Just as mom and pop were killed by Greenspan's lowering of interest rates on savings to 1 percent, they are now set for round two as the longer term and more risky instruments they then embraced to get to any return at all are now set to decline dramatically. A one two punch so to speak. Improverishing the investors who hold them and the "REAL" value of their income return. These Investors will sit at home or in their offices with the belief their money is safe in their government bonds, while at night the value of the currency they are denominated in undergoes "cloning" on an unprecedented scale. They will realize what is transpiring eventually, but by then it will be too late.
An additional reason they must hold bond yields low is the unfolding credit crunch in the subprime, and the "ARM"ageddon unfolding as outlined in a missive by Bill Gross at PIMCO. Using charts outlining credit standards rising and and another outlining Case-shiller home values he postulates that interest rates MUST decline by at least 60 basis points to prevent a additional loss of 20% in home values, and that the federal reserve will do whatever is necessary to head off the additional loss of value, as they don't want to pay the bill for this type of debacle. The systemic problems would be much bigger than the inflationary consequences. It's fed to the rescue, the Bernanke "put" is born. It was actually born last May/July. It is a compelling essay, check out PIMCOS website. Breakdowns in the bond market here are untenable.
Governments can read charts, just as we do, so I can tell you someone at the US federal reserves open market operations in New York are all over this potential Bomb, er bond scare. It will be front and center in this weekends meeting of the G8 central bank and finance ministers. I promise. Watch open market operations for big unidentified buyers which will be your governments at work as you work and sleep. You can see them now, just ask the Mogambo Guru or Greg Weldon.
Look for commercial buyers to get aggressively long in the commitment of traders reports. Primary treasury dealers, big "Money center" banks and wire houses will be big buyers with quiet government guarantees in hand before they begin their buying sprees. For the fed it's just a computerized journal entry to move money right onto their balance sheets. Every G8 Central bank in the world will join these plunge protection team efforts, as the dollar is their reserve currency as well and it sits on their books as US treasury securities for the most part. Just think of the moral breakdowns these central bank and finance officials have undergone over the last 20 years, when they have evolved from semi responsible bankers and stewards of the monetary systems to reckless money and credit creators, would be market manipulators, with total disregard of the people who place their wealth and savings in the currencies they are fuducuiariliy responsible for. A total surrender to political goals rather than long-term economic and monetary responsiblities.
"The inflation solution" is far far superior to government officials than financial system and economic difficulties, as these bankers and ministers look out below into the maws of a credit crisis that will dwarf their "subprime considerations", which in comparison will be a walk in the park. They can't let this trendline back to the early 80's fail very much as the systematic sellers will emerge in force as their computers put on the trades without the benefit of consulting the groups that wrote them (or the central banks and treasury operations around the world). The dollar is breaking down versus the Euro as we go to press, gold is breaking out against every asset class I can identify. The little guy holder of these Bond instruments will be damaged even more as the real inflation rate spirals higher and higher and his yields stay in the 4 to 5 % range, Inflation running at 8% on a bond that yields 5 or 6 is a loss of 2 to 3% a year, compounded annually for the duration of the note!! What a loss, and it is occurring as we speak.
It will be sell, sell, sell as billions of dollars of steepening trades are instituted, outright sales and hedging operations for hundreds of billions of bond holdings will provide further momentum to the emerging moves lower from this massive top. This top is the inevitable result of the Bretton Woods agreements in the early 1970s when we all were taken off the gold and sounder money policies which were practiced previously to that era. The helicopters are firing up as we write this. Talk about a "Finger of Instability" this is it in spades ("fingers of Instability" in the Tedbits archives www.TraderView.com). They have enough money to put this breakdown off into the future (they just have to print it), look for them to do so, the alternative is "UNTHINKABLE", so look for inflationary money printing and central bank and finance officials to prop up your bonds through market operations during the day and steal the money for it at night right out of your bank as their printing presses and computers hum away!!! The Greenspan "PUT" is alive and well... Kicking the can down the road, creating new and bigger moral hazards for our children, future investors, politicians and central bankers to deal with...
In conclusion, Investing is now all a big game, understand the rules and roadmaps and make a fortune, if you don't you will have a tough time of it. Learn the techniques required to thrive, or be the victims of who do. Wall Street has powerful allies on "Capital" Hill (misspelling intended, LOL). Hank Paulson is Wall Streets "Man on the scene", in DC. They will keep the game of abundant liquidity going till the systems finally break, but I believe this is many years away barring a big political miscalculation out of Washington DC, and Brussels and that is quite possible. When politicians are pandering to the voters figuring out how to buy the most of them. If you are looking to diversify your portfolio with top quality alternative investment managers please give me a call or visit the website and request a consultation.
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