Not to crunch too many metaphors right here at the top, but a consensus seems to be firming up in the animate jello of the Internet that we have entered the Season of the Witch. An odor of ripeness fills the virtual air — something between dead carp and apples baking. Whatever else appears to be going on in the upper stories and verdigris-tinged turrets of capital finance — currency rackets, gold switcheroos, interest rate arbitrage games, concealment of losses under rugs and behind curtains, Chinese fire drills performed by Spanish prisoners, executive three-card-monte set-ups, boardroom work-arounds, accounting quicksteps, Peter-to-Paul-shuffles, check kitings, pigeon drops, Ponzi schemes, hugger-muggers, bezels, shucks, jives, and enough monkeyshines to make Lord Greystroke cry for mercy — apart, in other words, from business-as-usual, such as it is these days, on Wall Street, there is a rising collective sense of anxious expectation that things are about to shake loose in the sad-ass shell of what remains of our economy. And the most perplexing part is that there hardly seems any safe place to preserve one’s savings.

The showmen over at the Financial Sense website, have put on an excellent month-long series of interviews and debate podcasts between leading inflationistas and deflationistas — Daniel Amerman, Peter Schiff, Robert Prechter, Mark Faber, Michael “Mish” Shedlock, Harry Dent — and after weeks of sedulous listening I still remain flummoxed as to where to stash the dwindling cash.

Harry Dent was a curious case in point this week. He has made some howlingly wrong calls before (e.g. in 2006, predicting a Dow 40,000 at the conclusion of the post-2001 bubble). Perhaps he missed the crack-up aspect of the most recent boom. He did not foresee the long gruesome meltdown of late 2007 to March 2009, or rather, his timing was off, since he called for the commencement of a new Great Depression in 2010. (And I hasten to insert here that my own timing of events has not been so great either.) Anyway, Dent sees a “winter” of finance and economy looming from here forward, characterized by extreme deflation, based on his view that the amount of private debt going bad (est. $40 trillion) far outweighs government’s ability to create new “money” (a few measily trillion) and hence that there is no chance in hell we’ll find ourselves in an inflationary situation for some time ahead. The private debt workout has to be completed first.

Most curious, though, was when the interviewer, Jim Puplava, probed Dent about his views on Peak Oil. Dent said he didn’t believe in it; that when he was in college in the 1970s (remember the OPEC oil embargo of ‘73), he learned to disregard any suggestions that we are “running out of oil.” He stated this, by the way, as a simple assertion, without any further explanation, and Puplava didn’t belabor him with arguments. But it was a weird moment. Of course, it hardly need be said that Peak Oil story has never been about “running out of oil” per se, but rather about declining flows, geopolitical management of flows, and the effects of depletion on industrial economies — in particular the effect on regular, expected, cyclical “growth” of the type that financial markets utterly depend on to power the trade in investment paper.

It is exceedingly odd that this does not factor into Dent’s thinking, because what Peak Oil inescapably does is introduce the very sobering idea of discontinuity — that is, that the game has changed radically, especially where all our assumptions about continued “growth” are concerned. In that brief exchange on Peak Oil, Dent seemed to take the position that the “winter” part of any historical financial cycle always produced “new technology” that invariably saves the day, putting this seemingly very smart man in the camp of so many techno-cornucopian triumphalists all wishing for the same outcome: that some mythical “they” will “come up with” a set of rescue remedies to keep all the cars circulating on the freeways, and all the WalMarts groaning with swag.

Like so many major league prognosticators, Dent arrives at his ideas by building models of reality, assembling “data” to create charts of trends in prices, interest rates, and especially demographics – what age group of people are buying a lot of what in which stage of their lives. The whole business seems very rational and reasonable except when you realize that it is just another “narrative” — to borrow one of Nassim Nicholas Taleb’s terms — girded with statistical justification. One can hardly fault it from a strictly procedural point of view — since, in our culture, conclusions ought to proceed from evidence — but one can’t escape the feeling that it amounts to little more than old-fashioned augury… that someone examining the entrails of a dead chicken, spread over the front page of The Wall Street Journal, might arrive at very similar conclusions. All that said, Dent was an appealingly confident personality on-the-air, the kind of authoritative voice you’d like to believe, if only it were possible.

Prechter was much the same a few weeks earlier, and he, too, foresees a darker American future, based on a different set of models called Elliot Wave principles. His forecasts derive from a picture of “social mood” as much as economic data flows. He, too seems to disregard the Peak Oil story and its implications as the master resource driving growth in industrial economies.

Personally, I am not at all sure that the Peak Oil story, or its associated general resource scarcity story, will shed a whole lot of light on the question of inflation-or-deflation. I say this because I think it is a short way down the road of depletion-and-scarcity before the major complex systems we depend on for daily life become so unstable that general socio-economic collapse ensues. After all, capital finance is only one of these many complex systems — some other biggies being food production, trade and manufacture, transportation, electric power distribution, infrastructure maintenance, the military, and governance. Inflation-or-deflation will only be symptomatic of larger failures and instabilities in these systems necessary for modern, civilized life.

All of it begs the question not only whether you or I will have two nickels to rub together, or two gold eagles, or a bundle of six month US Treasury bills, or a zillion shares of Apple, or a gainful vocation, or a roof over our heads, or a hot meal at the end of the day, or a safe place to sleep, or a country we can recognize. I’ve done my share of forecasting, with some episodes of notably bad timing. I don’t do it for grandstanding effect but to provide some basis for knowing what to do in the years directly ahead, so we can hope to construct lives worth living. I’m impatient with models, charts, and statistical analysis. Perhaps this is childish. I’d rather tell a story or paint a picture. So, I’m going to spend the rest of the week finishing the last chapter of World Made By Hand Two: The Witch of Hebron while the US economy wanders where it will.

Regards,
James Howard Kunstler

September 29, 2009

Inflation, Deflation, Peak Oil and Complex Systems was originally featured on Whiskey and Gunpowder

Do try not to choke on your coffee.  All right, crew, which of you have been pigging all the goodies and adjusting your motors so that they smoke, having useless MRIs and cosmetic by-pass surgery, and stomping on puppies?

Fear not, for Brian says that Generations X and Y are going to clean up the messes and that they’ve asked us nicely this time to give up our polluting land yachts and other (unspecified) evil practices, but that they won’t do it again.  I got the feeling he was thinking happily of tumbrels, guillotines, and vacations in Guantanamo, not remaining silent sensibly.

Gracious, no, I don’t need a buggy whip to cope with gratuitous insults, that being what words are for, and I even admired his line that my “railing against plugging in cars is like a caveman railing against the wheel.”  He thinks we should all be riding bicycles to solve the oil crisis and the obesity problem in America.

Hmmm.  It is fifteen miles to our beautiful Kroger store, and by the time I had pedaled that far in 100 degree temperatures and been able to bring back only what would fit in a little basket I would surely either have heat stroke or starve three men and myself to death.  Fortunately I do not know how to ride a bike so I am free to continue “to sadden him by defining myself by the cars I drive!”

Pity he doesn’t know we have a bucket truck, a back hoe, and an eight-ton truck capable of pulling 55,000 pounds.  Danged if I wouldn’t drive the big yellow Blue Bird school bus to the grocery store if it wouldn’t mean registering and insuring it.  Some jokes are too expensive to justify.

Which is where the buggy whip comes in.

Today a totally restored doctor’s buggy, resplendent in glossy black enamel and new upholstery was delivered–complete with a whip in the holder!  She’s a beauty–and a Deere, Emily!  Studebaker was top of the line, so ours is more like a fully loaded big Buick.

You missed a real La Vida Whiskey moment when Freddie got between the shafts and galloped down the hill to a storage barn, the wheels, picked out in silver, glittering in the sun!  I guess we could call it the American version of a rickshaw?

Charles and I are having an unprecedented failure to be of one mind on a subject.  I think his larger male horse should be taught to pull the buggy (clearly a shocking use of a highly-trained cow horse), while he suggests that my dainty, elegant thoroughbred Bonnie Blue should perform labor that is clearly not befitting her exalted breeding and aristocratic mien.  Fear not, one of the great love stories of the ages is not endangered because the solution is obvious:  if both equines decline to become cart horses we will simply buy one trained to pull buggies who doesn’t know this is beneath its dignity.

Or I’ll get Freddie to pull me around in it and learn to use my whip delicately enough to flick a fly off his ear.   “Whoa down, there, Freddie!” and “Haw, big fellow!”  Freddie has a great sense of humor and we just laughed uproariously over the idea.  He wants a silver-mounted bridle.  No bit, of course.  We don’t use bits.  And a reasonable stipulation that he doesn’t have to pull me up hills.  Buck (occasionally known as “Clyde,” for obvious reasons) loves to be ridden so that he lowers his head eagerly for Charles to slip his bridle on, and Charles rides him bareback when not working cattle.  Bonnie gets jealous and goes out and rounds the cattle up all by herself  and moves the Black Dexters up to the house.  She’s not up to Charles’ weight, some two hundred pounds on his six-one frame, but try to explain that to a horse with hurt feelings.

The lighthearted but serious lesson for today is that the most ethnocentric nation on earth really needs to stop sneering at old-fashioned technology.  Mankind got along splendidly for thousands of years with real horsepower, and it is only for the last hundred years that mechanical horses have come into being.  Alexander the Great and Genghis Khan conquered a fair bit of territory on horse back, although the Carthaginians came to grief trying to get 37 elephants over the Alps.  Asia rode Buck today without saddle OR bridle, because Buck both knee- and neck-reins and he likes to be worked.  Try THAT with an automobile.  On the other hand a massive war horse required a bushel and a half of oats a day…

WHY did even two of the world’s prime eccentrics want a buggy?  I really would drive a horse and buggy before I drove a trash can powered by a sewing machine motor, and because it may really be that the time will come when Dobbin and the buggy are the best transportation left if gas supplies are cut and we run out of diesel.  And because it will be fun, of course!  I admit cheerfully that I would have loved to live about 1812.  Assuming I weren’t a scullery maid, of course, but a plutocrat.  I can foresee situations where a pair of horses and their ludicrously expensive tack might be, quite literally, life savers.  If there were still a grocery store open it would take close to two hours in a buggy to get there, and the same to return.  That’s why towns tend to spring up about 25 miles apart, because half that distance makes a day-long trip to get supplies.

The old ways may not be the most convenient, but if we live to see the world of Jim Kunstler it would be mighty nice to have a buckboard to take into town once a month for staples.  Gary walks to the grocery store a few blocks away.  I wonder how frequently he has to go.  Several gallons of milk would be difficult to handle without one of those oriental pole yokes that fits over his shoulders and a growing, neophyte powerlifter can drink a gallon a day.  Imagine a grown man pulling a little red wagon!  If you haven’t priced a Red Flyer recently they’re a couple of hundred dollars.

This article is to balance the really gloomy (but totally justified) fear-mongering I wrote earlier, and I hope you enjoy hearing about our joyous La Vida Whiskey life on the Rafter TS, aka the nearest consulate and Residenze for the Republic of Texas.

Please reach into your memories and come up with old techniques and objects we could stock in case the Greater Depression is really bad.  I’ll start with this:  a fascinating item to add to your emergency stores is calcium carbonate, which, when exposed to water, produces acetylene gas which will provide ample light.  In its dry state it isn’t highly flammable, like white gas, it doesn’t need special storage like propane, and it doesn’t cost seven dollars a gallon like Coleman lantern fuel.  If you have a supply of wicking almost any oil can be used as a lamp, although you might not enjoy having your cave smell like fried chicken.

Piazza time, crew, when we sit on the terrace with alcoholic libations, admire the pasture art (our horses), cows, and the sundown reflecting off the lake, and explain to an adoring young goat that tables are not good to eat.

Wish you were here.

Linda Brady Traynham

June 29, 2009

Dude, Where’s My Buggy Whip? was originally featured on Whiskey and Gunpowder

In the markets, all the really interesting action is happening behind the scenes. On the surface, things appeared to get better on Friday. In the U.S., Ford told investors that it lost $1.4 billion in the first quarter. Apparently this was less than analysts expected. The Dow closed up 1.48% and climbed back over 8,000.

What a battler that Dow is. It’s got nothing on the S&P 500 though. The S&P is up 28% in the last thirty-three trading days. It hasn’t done anything like that since the 1930s. However the index did close down for the week. That broke a six-week run of gains.

One more note about that. Four-week winning streaks of ten percent are more are generally followed by much smaller gains or losses over the next four weeks, according to the analysts at Bespoke Investment Group. Their research shows that in the four weeks following a four-week rally of 10% or more on the S&P, the index followed up with average gains of 1.87%.

How about one more note about that. There were two four-week rallies of more than twenty percent, according to the same research. The S&P 500 surged 54.2% in just four weeks by early August of 1932. Over the next four weeks in went up another 30%. Then, in April of 1933, the index provided an encore to one four-week surge of 33.8% with another surge of 19.2%.

So there you go. What we do we make of all that? Well, it shows you that even in the middle of the Great Depression, the market was capable of staging mammoth rallies that would tempt investors back in. No doubt those were extremely tradable rallies. But they were followed by lower lows once the forces of economic and earnings reality reasserted themselves on the collective mind of the market.

This time will be different because it’s always different. But if you’re wondering if the stock market is flashing a recovery sign for the economy, you might want to take a look at insider selling. The insiders are selling this rally, according to Data by Maryland-based Washington Service. That outfit says the during the S&P’s 28% climb from twelve-year lows on March 9th, CEOs, directors, and senior officers of U.S. corporations sold 8.3 times more stock than they bought.

The insiders are probably not paying attention to the first quarter earnings reports that are responsible for the current rally. They’re looking at the rest of 2009 and probably planning for more layoffs. If they think the rally is over, it probably is. Not that there won’t be others. But behind the scenes, other things are happening which are going to drag on stocks.

One of those things is that many of the world’s sovereign governments are in the process of going broke. Spain, Ireland, Greece, and Portugal have all had their sovereign credit ratings downgraded by the ratings agencies. These countries face different challenges like burst property bubbles, declining government tax revenues, and banking sectors hobbled by massive bad loans. But what they have in common is that their respective governments have responded to the crisis by ramping up borrowing to credit-rating ruinous levels.

The scale of global borrowing plans is pretty breathtaking. And what you begin to wonder is a simple question: where is all the money going to come from? Or, to quote David Gray in Night Blindness, “What we gonna do when the money runs out?”

For example, the UK’s Debt Management office, which issues bonds on behalf of the British government, says that British bond sales between now and 2013 will exceed £696 billion. The Guardian reports that it will be more like £815 billion, according to figures from Deutsche Bank.

Do you think private investors are super excited to loan the British government money when the British economy is expected to contract by 3.5% this year? Under the budget revealed last week by Chancellor of the Exchequer Alistair Darling, the UK will borrow A$356 billion (£175 billion) this year alone, or about 12.5% of British GDP. Over the next five years, public sector debt would rise to 76% of British GDP from its current level of 46%.

Gee. That is a lot of borrowing. Britain is country drowning in debt. Adding more millstones around its neck would not seem to improve its chances of paying that debt down. You could pay it down by, say, generating national income from exports. This is what Australia is hoping to do.

S&P’s ratings agency keeps track of the sovereign debt to income ratio. If a country exports a lot of finished goods or raw materials, the government benefits from tax and royalty revenues. These monies are used to service the sovereign debt.

But if you’re not generating large export revenues, then you find a big gaping hole in your budget where royalty and tax revenue should be. Maybe that’s one-reason Britain’s new budget raises tax rates on high-income earnings from 40-50%. What you gonna do when the money runs out?

If Britain’s government thinks it can make up for disastrous public finances by raising taxes, it’s probably making another in a long-line of stupid mistakes. The high-income earners who would face the big tax increase are exactly the same people getting fired from their jobs in the City. This shows, once again, that building an entire national economy around high finance puts you in all sorts of trouble.

But wait. Maybe the high-saving nations of the world will bridge the gap between British expectations and financial reality. We wouldn’t count on it though. Remember the big hoopla from the G20 meeting in London when it was announced that the International Monetary Fund’s funding would be tripled to $750 billion?

That funding is desperately needed. The IMF itself reckons it will have to dole out some $187 billion in new loans to national governments just to ride the current phase of the global financial crisis. But a key piece of information was left missing in London. How would the IMF be funded?

The G20 finance ministers met in Washington to sort that out. And the early indications are that the IMF will be funded by issuing bonds sold to high-saving nations. If this is true, it’s a victory for the developing world and a defeat for the U.S. and Europe. The U.S. and Europe were both pushing for a direct cash injection funding method. In other words, they wanted China, Russia, Brazil, and India to use their foreign currency reserves to fund the IMF.

But the BRICs batted that proposal away. So now the IMF plans to sell around $500 billion in bonds. They will be denominated in the quasi-currency the fund uses internally (the special drawing rights, or SDRS that both Russia and China have floated as a possible new global reserve currency).

How the bonds actually work still has to be sorted out. But the internal logic of the whole arrangement is now clear: creditors hold the whip hand. Debtors are going to get whipped. The balance of power in the global economy is clearly shifting from the borrowers and spenders towards the savers and producers. Advantage BRICs.

Disadvantage Gordon Brown and Barack Obama and probably Kevin Rudd too. With the existing debt-to-GDP ratios in Britain and the U.K., we reckon it is going to be impossible to fund further expansions of financial bailout programs and welfare state programs without much higher interest rates (borrowing costs).

You can avoid the borrowing problem for a while by soaking the rich with higher taxes. You might also use climate change hysteria to tax carbon (really an indirect tax on consumers). If both happen this year and the result will be even more rapid economic contraction. They will be this Depression’s equivalent of Smoot-Hawley: exactly the wrong thing to do, done at the worst possible time.

Of course the easy out, we feel obliged to point out, is not to borrow the money at all or tax it from your citizens. You could just print it instead. But this tends to unleash hyperinflationary pressures which also tend to destabilize civil society. It’s better to avoid this if you can.

Either way, there is no avoiding the reckoning. Right now, you could make a compelling argument that the value of credit-backed assets is falling so fast that government steps to prop them up simply won’t (or can’t) work. Credit deflation rules the day. The formidable fiscal and monetary stimulus measures are disappearing in the maw of asset deflation while the world goes broke trying to prevent it.

If this is right, and it’s something investors take the time to notice, stocks are going to make lower lows again. A lot lower.

Regards,
Dan Denning
www.dailyreckoning.com.au

April 27, 2009

S&P Ends Its Rally and Government Debt Still a Problem was originally featured on Whiskey and Gunpowder

Now that it’s here, we turn our attention to trying to discern, “How bad can it get?” and “How long can it last?”

While such questions can never be answered with anything approaching absolute certainty, there are methods that can be used to assess what may lurk over the horizon. With that goal in mind, this article focuses on – and then expands upon – the recent work of two economists who painstakingly analyzed a substantial number of previous banking and currency crises in an attempt to derive potentially useful lessons. I have then taken their data and applied them to the current circumstances to see where we are, relative to those other experiences.

The Data

The data are from a study called “The Aftermath of Financial Crises” by Carmen M. Reinhart of University of Maryland and Kenneth S. Rogoff of Harvard University. In their study, the authors summarize the results of a broad sampling of banking crises, with between 13 to 22 crises analyzed for each of the variables.

The Reinhart/Rogoff study is based, in turn, on data extracted from an even more comprehensive study of events in 66 countries, titled “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises,” by the same authors.

I’ve summarized the findings from the latest study in the table below:

The economic measures in the left column show how far the U.S. situation has deteriorated so far. The next columns show the average historical deterioration and the worst case of the crisis analyzed.

I then applied these data to calculate the levels that the U.S. could reach if it followed the path of the historical examples. The projected level is based on the measure analyzed, either from the peak prior to the downturn (e.g., the S&P 500) or from the bottom prior to the downturn (e.g., the lows in unemployment). Thus, as you can see in the table here, the S&P 500 has already dropped from its October 2007 peak of 1565 down to 766. If this crisis were to end up being only “average,” then it would drop to 690.

If, however, the worst case of a 90% drop were to occur, as it did in Iceland last year, then the S&P 500 would trade down to the shocking level of 157. For further reference, if the current crisis were to cause the stock market to fall as sharply as in the Great Depression, the S&P would touch 469.

Duration of Crisis

As you can see in the summary table below, it took 3.4 years, on average, for the stock market to fall from the peak to the bottom. In the worst case, it took five years. With the recent peak in the S&P 500 occurring in October 2007 – just one and a half years ago – the crisis is likely to have some time to go before reaching even an average duration. More specifically, if this crisis turns out to be just “average,” we would not expect to see the low before the first quarter of 2011.

Crisis Horizon: Some Conclusions

The global economic situation continues to deteriorate on all fronts (see charts below).

Housing prices are down 28% from their bubble peak in 2006 but still have a ways down to go to get back to their pre-bubble levels. Even an average downturn will mean that housing remains a problem for several more years. Unless, of course, the government steps in to stave off those resets… a “solution” that carries with it a separate set of problems, making things worse. We continue to expect very serious problems in the commercial real estate sector.

The stock market is approaching a 50% decline, the average of what has been observed in past crises. Further slowing in U.S. corporate activities and profits means additional increases in unemployment, establishing a negative feedback loop that pushes corporate profits – and stock prices – even lower.

The only growth trend at this point is in government bailouts, which are in high gear, indicating we’ll experience the serious growth of outstanding debt seen in other crises. The elevated levels of government borrowing required to fund that spending are absorbing all available credit from foreigners, directly competing with business in need of the new financing that will be required to expand the economy. The combination of declining business activity, coupled with declining levels of household income, will result in declining tax revenues, increasing the budget deficit beyond the size of the new bailout programs. State and municipal governments across the nation are already being confronted with large shortfalls in their budgets, shortfalls that will only widen as the crisis worsens.

The combined business slowing and jobs contraction assure that the GDP will decline. Components of GDP having to do with necessities like food and shelter will continue to bump along regardless of the economic conditions, but the lack of growth in GDP could extend for years as it did in Japan and as it did after the 1929 stock crash.

Inflation/Deflation

Given that we are currently in a deflationary phase, it is easy to dismiss the case for inflation – and many do. We think that is a mistake. Even a summary tabulation of the unprecedented increases in government debt at this relatively early stage in the crisis make a compelling case for higher inflation, if for no other reason than that it shows clear intent on the part of the government to spend “whatever it takes” to offset the deflationary forces now stalking the land.

The research paints a dismal story of years of economic stagnation. In our view, the trend is now firmly established for dollar debasement, a debasement that will eventually overwhelm the deflationary pressures from collapsing asset values. Therefore, don’t listen to the happy faces on CNBC spouting off, for the umpteenth time since this crisis began, that now is the time to jump back in and buy stocks. It isn’t.

Be extremely skeptical when you hear some pundit pronouncing that this piece of short-term good news or another is an “all clear” signal. Until we start seeing a systematic improvement in the economic fundamentals – for example, an upward movement in consumer confidence – the only signal the economy will be hearing is that of a runaway train coming straight at it.

Regards,
Bud Conrad

April 23, 2009

Assessing How Serious the Financial Crisis Can Get was originally featured on Whiskey and Gunpowder

Some of his early stories written in the 1930s reflect on the mood of the era. And even if you don’t care for reading about the 1930s, you’ve got to love Runyon’s way of capturing the voices of the times. For instance, “I put the old convincer on him by letting him peek down the snozzle of my John Roscoe.” That’s a pretty colorful way of saying you stuck a gun in somebody’s face.

In these stories, there is also that undercurrent of bad times. You never forget it. People view anybody who looks well with suspicion. Prosperity of any kind is seen as unreal in some way. As Runyon writes:

“You cannot tell by the way a party looks or how he lives in this town if he has any scratch, because many a party who is around in automobiles, and wearing good clothes, and chucking quite a swell is nothing but the phonus bolonus and does not have any real scratch whatever.”

There is also a macabre sense of humor. In one story, Runyon writes of being at a track in Miami. He’s having a run of bad luck. It goes on awhile and gets worse. “I wonder if I will not be better off if I buy myself a rope and end it all on a palm tree in the park on Biscayne Boulevard,” he writes. “But the only trouble with the idea is I do not have the price of a rope, and anyway I hear most of the palm trees in the park are already spoken for by guys who have the same notion.”

It was an era with an undercurrent of playful meanness, too. For example, look at the nicknames of some of the baseball players in the 1930s. Author Bill James wrote about this years ago. “In the ’30s, nicknames turned nasty,” he wrote. If you had a big nose, you were “Schnozz” — a nickname earned by Hall of Fame catcher Ernie Lombardi. If you were overweight, your nickname was “Blimp,” as in Frankie “Blimp” Hayes. Or just “Fats,” the nickname pinned on poor Bob Fothergill.

Some other nicknames used by journalists and forever affixed to players’ names in the registers: “Stinky” “Boob” “Boom Boom” (for a pitcher with a 38-69 career record) and “Suitcase” for anybody who had trouble sticking with a team. Joe Medwick walked with his toes pointed out and got stuck with “Ducky.” An outfield named Cuyler stuttered and they called him “Kiki” Cuyler. It was a brutal era.

I guess with bread lines, shantytowns and so many people out of work, no one cared about playing nice. In 1930s, you had to have thick skin.

Floyd Odlum: Making the Best of Bad Times

And more than just reading about the 1930s out of my own personal fascination with the period, there are also some practical benefits. There were people who made a lot of money in the Great Depression doing legal things. There is Floyd Odlum, for instance. He is sometimes described as the only guy to make a fortune in the Great Depression. (He wasn’t.)

I’ve written to you about him before. The reason to revisit him briefly is that James Grant also wrote a little about him in a recent Grant’s Interest Rate Observer. Grant calls him a “salvage artist par excellence.” “None of us can know the future,” Grant writes. “But like Odlum, we can make the best of a sometimes unappetizing present.”

Grant also managed to scrounge up a pretty good anecdote on Odlum. In the summer of 1933, when all the world seemed to be in pieces, Odlum strolled into his office, looked at his glum partners and said: “I believe there’s a better chance to make money now than ever before.”

Odlum liked poking around in the smoking wreckage of the 1930s. Bad times create wonderful pricing. I suspect if Odlum were still alive, he’d find himself very busy. There is a lot to look at now.

Scared? Read This

A friend of mine recently wrote to me about how he was looking at Potash (POT: NYSE) with “fear and lust.” It was a Hunter Thompson moment, and I knew exactly what he meant. Everything feels a little scary right now. At the same time, your rational brain gets excited about the great prices you see dancing on your screen.

“Fear and lust” sums up what it feels like investing in stocks these days…

Every investor will have to overcome fear to buy anything today. I hate to try to call a bottom. But remember that even in bad times, the stock market can put up stunning rallies. Jeremy Grantham at GMO makes the point about sitting on cash too long:

“In June 1933, long before all the banks had failed or unemployment had peaked, the S&P rallied 105% in six months. Similarly, in 1974, it rallied 148% in five months in the U.K.! How would you have felt then with your large and beloved cash reserves? Finally, be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before.”

Backlash From the CVR Energy Sell

I’ll end this week’s note with a quick word on CVR Energy, which we parted with after a little more than a year with a terrible loss. I always get lots of e-mail after every sell, no matter whether it was up or down.
I’ll reprint one of those e-mails… from my father:

“Your great analysis costs us $7,200 if we sell now. What happened to all that good stuff you wrote about it as far as the fertilizer plant and using its coke to run it? I thought (you thought) it was going to save it money, etc., on running the plant and make money on the fertilizer.

“Love, Dad”

Guess that will come out of my inheritance, assuming there is any. Well, a lot changed. Fertilizer prices tanked. Natural gas prices tanked, thereby making the company’s use of pet coke less appealing with all this cheap gas around. And gasoline demand fell, as did prices, thereby hurting the refinery. On top of that, there is the seeming inability of the company to get it together and deliver a clean set of results.

I suppose CVR Energy will bounce back from these lows at some point. If you want to hold out for a better price, that seems reasonable. But I’d rather own other things in this environment. Sorry, Pop. We’ll hit the next one!

Regards,
Chris Mayer

March 16, 2009

Fear, Lust and That 1930s Feeling was originally featured on Whiskey and Gunpowder

“Is that rain?” asked a co-worker the other day.

“No. It’s the sound of leaves blowing down the street,” we speculated.

And it was.

Huge drifts of leaves have accumulated on the footpaths in the past week, swirled around by the wind and piling up in banks along the street. All the leaves on the plane trees that line Melbourne’s streets seem to have died at once during last week’s heat wave. Normally, in the autumn, the leaves fall at a statelier pace. The days get cooler and the seasons change at a more natural rhythm.

But not this year. They fell all at once. The whole natural cycle was condensed into just a few days, thanks to the heat wave that scorched the trees last week. And alongside huge piles of dead leaves burnt brown you’ll find the occasional dead brown possum.

We stumbled on three the other day, walking up St. Kilda Road. It’s a veritable banquet of organic matter for the flies. The poor little possums lay on the ground, their prehensile tales curled up in a tidy little spiral. By the looks of things, dead possums do not bounce.

The plane trees are not native to Australia (they were imported from Britain to Victorianise the place). The possums ARE native. But neither one is suited to the kind of extraordinary heat that set upon the city last week.

Sure, there are hotter places in the world. But if something is designed to live in one environment and finds itself in another, it probably won’t last long if it’s not adaptable. Tomorrow is expected to be another 43-degree day in Melbourne. Which brings us to the economy.

Recessions are perfectly natural in the business cycle. Human beings take risks with borrowed money during a growth phase. Some risks pay off. Some don’t. A recession is a reckoning up of the risks. The bad investments are liquidated, asset values readjust, and the next cycle begins.

You can only get a depression when the government and the monetary authorities take unusual steps-driven by political motives-to prevent the natural process of recession. This is why today’s policy moves are setting us up for a Depression. And it’s not the first time.

It’s widely believed that the Great Depression had its origins in the slow response of the Fed to the banking collapse that followed the stock market crash. That failure, so the theory goes, was followed by too little fiscal innovation and government spending by then U.S. President Herbert Hoover.

But all of that claptrap is exactly wrong, we humbly suggest. The Depression was a foregone conclusion the minute the business cycle was hijacked by manipulation of the credit cycle. A recession is natural. A Depression is always man-made.

That’s right; the origin of the Depression is in the credit boom that preceded it. The credit boom of the 1920s made it inevitable that the natural rhythm of the business cycle would be amplified and made more severe. The boom was boomier. The bust was…worse than it had to be.

It was made worse by government policies that put America into debt, allocated capital in the most inefficient hands possible while crowding out business investment, and locked in wages and prices higher than they ought to have been, further delaying the vigorous rebound in employment and wages you usually get in a recovery.

To repeat, recessions are a natural and unavoidable part of the business cycle. Depressions are the bill you pay for trying to avoid recessions with even looser monetary policy and more government spending to stimulate consumption. What you need is a cleansing break. What you get is a money-induced fever of pointless economic activity, full of noisy cash registers, signifying nothing.

So here we are on a Friday, waiting for the Depression. How seen we get one depends, in some small part, on what Timothy Geithner comes up with next week and world stock markets receive it. Geithner unveils his plan to rescue America’s banks and get the credit crisis behind us on Monday. It had better be a good plan.

What can you expect? Well, for one, we’d be really surprised if there wasn’t a suspension-at least for a period-of mark-to-market accounting. This would prevent the banks from having to realise losses on securities they don’t intend to sell, but are currently held on the books at values well below market value.

Another element will be buying “toxic” assets from the bank. At what price? You’ll find out soon enough. It probably won’t be fair value. But it won’t be so far below fair value that it forces the banks to realise huge losses and require even larger infusions of taxpayer capital.

Not to be a stick in the mud, but do you get the feeling that the Feds are already one or two steps behind in the game of “prop up the falling asset values”? Bloomberg reports that, “Moody’s Investors Service is reviewing the ratings of $302.6 billion in commercial mortgage-backed securities as real-estate values drop and property owners fall behind on payments.”

Yes. It all feels a bit like the chart below. It’s the dreaded “Black Swan Formation.” We have asked Swarm Trader Gabriel to take a look at it and will let you know next week what he has to say.

Finally, we have been dodging the question of how you deal the infinite growth in a system with finite resources. We’ve been dodging it mostly because it’s such an abstract and theoretical subject that we fear we will bore you to death, and it is not good to kill your present or future customers. But since we are fundamentally optimistic about the answer, let’s push on!

The answer is in the architecture of the system you’re talking about and the energy inputs it requires. We have a global economy that’s developed a great deal of complexity thanks, in part, to an abundance of credit. It’s a system of systems built on two key inputs: credit and energy.

The more important input to the current world order is cheap energy. It began when Colonel Edwin Drake drilled his first oil well at Titusville, Pennsylvania in the spring of 1858. The world has never been the same.

With the huge amounts of energy available from petroleum came the Industrial Revolution, the acceleration of the division of labour with mechanisation, dramatic increases in agricultural yields (allowing for a major structural shift in employment as fewer people were engaged in growing food and more in making things), the growth of large urban population centers (and later the exodus to the suburbs and the housing boom as the cities went bad), and all the many capital investments and institutions that are somehow related to the fact that energy has been cheep and abundant for the last one hundred fifty years.

So is all that really collapsing now because of the fundamental physical limits on the amount of energy we can get from oil? Can an economy that’s evolved around oil as the chief energy input survive when its rate of growth has been so artificially accelerated by easy credit and fractional reserve banking? See. We told you. It’s a pretty ambitious question.

John Robb posts an answer over at his Global Guerillas blog. Robb quotes from Joseph Tainter’s book, The Collapse of Complex Societies. “The method of collapse favored by Tainter as a tipping point is defined by a fundamental change (assumption level) in the underlying costs of running the society. He maintains that every great society is driven to the heights of its organizational potential by leveraging a ‘free’ (for all intents and purposes) energy input.

“Unlimited access to this energy resource allows them essentially ‘free’ problem solving and rapid recovery from mistakes. However, once that ‘free’ energy becomes erratically available or expensive, the cost/benefit equations of many (if not most) of that social system’s evolved solutions turn decidedly negative. Collapse, at that point, is inevitable. In our case, this ‘free’ energy input would be fossil fuels (the negligible cost of which underwrites all social solutions).”

In a closed system, the amount of energy available to you is finite. In an open system, it is not. The Earth is an open system. Energy rains down on the planet everyday in the form of solar radiation. We do not, however, have a global economy that’s scaled to live and produce off this kind of energy.

Your editor’s guess is that we are headed to a fundamental reorganisation of the world’s economy that will be driven by how we get and use energy. The current system of production is based on cheap energy for the production of goods which are consumed with the help of cheap credit.

A graph of the growth of Wal-Mart stores across the U.S. from 1965 to today (where Wal-Mart became the largest private employer in America) reminds us of that scene in War Games with Matthew Broderick.

Only in the Wal-Mart example you have little nuclear explosions of consumerism. They should probably be red though, instead of green, those “store strikes”. America bombing itself to debt by cheap Chinese goods imported on container ships (efficient transportation) and distributed via Wal-Mart’s warehouse network (cheap energy and good logistics).

Add to this whole system the historically cheap cost of labour inputs (mostly in the Far East), and you have a global system buckling under its own excess and complexity after an enormous but abnormal rate of growth and innovation. As Bill points out below, creative destruction is a normal part of the business cycle. It’s essential, in fact.

And while the Austrian theory of the credit cycle is becoming vogue now for its successful prediction that a boom in credit leads to a later bust, a lot of Austrian theory is also focused on entrepreneurship and human action and wealth creation. If you spend some time in that part of the Austrian textbook, you might actually be encouraged about the future. Why?

Entrepreneurs love recessions. Not only is it a chance for investors to buy assets at a discounted price, it’s a time of reorganisation of economic life. People still have everyday wants and needs. And in a recession, there is much less competition. Most people are inclined to be conservative and take fewer risks with their capital.

This is why the entrepreneur is the hero of Joseph Schumpeter’s capitalism. The capitalist provides surplus capital. But real business innovation and risk-taking comes from the entrepreneur. During a recession, he can form a long-lasting relationship with his customers. But what does that have to do with the current situation?

For the better part of one hundred years global trade has expanded, bringing more and more people into the world trade system. We suspect now that it must contract and eventually reorganise itself into smaller, more scalable systems. These smaller systems will produce and use energy more efficiently because they have to.

Of course no one is sure what it will look like yet. But it’s likely to be a lot different than what we’re used to. It will have to be, if we’re going to successfully adapt. We have an idea of what the characteristics of these smaller systems will be and will tell you about them next week.

But from an investment perspective, your Permanent Portfolio ought to maintain some small allocation of capital for aggressive growth stocks, especially in the energy space. They will be key to the success of any system which evolves out of the disintegration of the present one.

So yes. In a closed system without new energy inputs, there are inescapable limits on growth. We reckon the rate of growth is about to slow down dramatically (contract) as the complex systems and institutions supported by cheap credit and cheap energy collapse. But this does not mean we plan on finding a cave to hide in so we can curl up and die.

Far from it. There is only one way through a time like this. You have to have a plan. You have to use your own brain. And you have to have some idea of what’s coming so you can put yourself in a position to avoid the calamity and profit from the opportunity.

All easier said than done. But what else are you going to do? Wait for your government check? More on “The Plan” next week. And in the meantime, keep an eye on the efforts of the people who have the most at stake in the current system-the banksters and the Feds-to keep it alive. We reckon there is only one logical way for them to go, and we’ll tell you about it next week too.

Regards,
Dan Denning
Daily Reckoning Australia

February 6, 2009

The Real Causes of Depression was originally featured on Whiskey and Gunpowder

My dad always liked silver coins. I recall the late 1950s and early 1960s, when my dad kept a can of silver coins hidden I his bedroom closet. (Well, he couldn’t hide the can from me and my sisters.) My sisters and I used to crawl into Dad’s closet and play with the coins. We stacked them up and then knocked them over to hear that unique silver jingle. Back then, the U.S. had real money.

But by the early 1960s, the “real” silver money was competing with the nation’s paper currency. And as Gresham’s Law states, “Bad money drives out the good.”

Bad things were happening to the value of the U.S. dollar, although I was too young to appreciate the problem in the making. So in 1965, the U.S. stopped minting coins with silver. What a shame. I could tell that something was wrong. I remember my dad and other family members and friends just shaking their heads back and forth at the news. “Bad money is the sign of bad government,” said my grandmother, an Ohio schoolteacher.

It was sad when those silver coins went out of circulation. The country really lost something when in gave up silver money. And today we can appreciate the loss only in hindsight. Where would we all be now if the U.S. had kept both its industry and money strong?

Nowadays, you almost never encounter silver coins. They don’t normally circulate. But silver coins still hold exceptional value. The old dime contains over $1.40 worth of silver at today’s silver price. The old quarter is worth nearly $3.60. A 50-cent piece contained about $8 of silver. And a good old silver dollar is now worth more than 16 times its face value. And these are just the silver values of the coins. The coins themselves might be worth far more, depending on condition and rarity.

My dad always carried two old silver dollars in his pocket. Those silver dollars went everywhere with him. My dad said that the coins were the first silver dollars he ever earned, back during the depths of the Great Depression. So the silver dollars meant a lot to him. He never spent them. In fact, my dad flew with the coins in his pockets during World War II. He drove P-47 Thunderbolts on the European front. And those coins must have had some serious magic in them. My dad escorted bombers across Germany, dodging flak and Messerschmitt fighters. He flew over Normandy on D-Day, and later supported the U.S. armies that liberated France. Unlike a lot of his friends, my dad always brought the airplane home. It must have been those silver dollars.

After the war, those two silver coins stayed with my dad. There was no way he would part with them. They were his “lucky” coins. My dad even carried his silver dollars when he played golf. And my dad was a heck of a golfer. One time, he went head-to-head with Arnold Palmer in a Pro-Am event, and I won’t embarrass Arnie by saying who won.

By the time my dad died, in 2000, his silver dollars were pretty badly worn from all the jingling in his pocket over the years. They looked almost blank. But on close inspection, you could tell that they were U.S. currency from the 1920s. Those coins had been with my dad during his lifetime. So before we closed the casket, I put the coins into his hand, just in case my dad needed some silver to pay Charon for the last voyage across the River Styx. Really, you never know what is on the other side.

And this illustrates a point. In both life and death, it’s good to have some silver.

Until we meet again…
Byron W. King
May 16, 2008

Silver Currency was originally featured on Whiskey and Gunpowder

When, inevitably, the errors start to be corrected, the result is an economic downturn. It will be called a “recession” if the government succeeds in preventing widespread bankruptcies and unemployment through one more dose of inflation.

Or it will be called a “depression” if today’s economic tempest slips out of the government’s control. From a financial point of view, a depression is a period when the distortions of an inflationary boom are liquidated — a mass die-off of the economically misbegotten. From an economic point of view, it’s a period when the general standard of living decreases significantly.

The point is that the more highly taxed, regulated, and inflated an economy is, the more likely that it’s eventually going to experience a real depression.

Perversely, the more control a government has, the longer it can put off the day of reckoning. But the longer the artificial structure is propped up, the bigger the mess will be when it eventually collapses. From my point of view, what will happen next is almost written in stone. The only real question is: When?

In 1980-82 things almost did go over the edge. But the recession was serious enough, and some subsequent extraneous positive events (the collapse of the USSR, the coming of age of China and now India) were significant enough to pull things out.

But now, more than a generation after the last serious crisis — and four full generations after the Great Depression — I think there are lots of reasons to be afraid. Very afraid.

Am I predicting the Greater Depression may be upon us? Let me preface my response with a disclaimer. I’m not a fortuneteller. But my gut feel is: Yes. I’m not going to mount all manner of statistics to buttress the assertion. My point here is to draw your attention to the fact that there’s a lot that’s likely to go wrong besides the central problem of the business cycle, a problem that is now evidenced in the collapsing housing sector and all the pain associated with that collapse.

The “other” problems now include the Forever War against Islam, Peak Oil, increasing political control over virtually all aspects of life, the potential for social unrest (within the U.S. Mexican community, for instance), the historically high level of foreign holdings of U.S. dollars, a rise in nationalism and protectionism, etc. While not always obvious, all of these things are related, so it’s likely that when one of them starts running out of control, so will the others.

What will, in fact, happen? Nobody knows, including me. But I’m quite afraid we’re in for truly stormy weather in the next few years. Most people aren’t adequately, or even at all, aware of this prospect.

I suggest you stay with the approach we advise that has a foundation in gold and carefully selected gold stocks.

As I am in for the long haul at this point, selling only reluctantly and when absolutely necessary to keep Caesar mollified or for portfolio rebalancing, I still view any weakness positively.

Making mid-stream adjustments to your portfolio based on these buying opportunities is important. Being bold when others are timid can make a big difference.

In my opinion, gold isn’t just going through the roof in the next few years. It’s going to the moon. And gold stocks are a leveraged way to capitalize on it.

Regards,
Doug Casey
Chairman, Casey Research, LLC
February 4, 2008

From Recession to Depression was originally featured on Whiskey and Gunpowder