The Daily Reckoning
Where we part company with Warren Buffet…
Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.
Even in the US, where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”
For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of US Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.
High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments — and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.
Under today’s conditions, therefore, I do not like currency-based investments.
Buffet goes on to explain why he doesn’t like gold either. He points out that since 1965 the total return on gold (not adjusted for inflation) was 4,455%. But the total return on stocks was higher, at 6,072%.
The difference between the two is that gold is a ‘sterile’ investment, says Buffet. Stocks are not.
He’s right. Gold is only useful at protecting purchasing power when the monetary system is in danger. At almost all other times, you’re better off with stocks…businesses…farmland or another productive asset.
That’s why Buffet now prefers stocks. And it is why we now prefer gold.
Buffet willingly gives up the protection of gold in order to the get the upside from stocks. We willingly give up the upside from stocks in order to get the protection from gold.
Only time will tell. Our guess is that time will tell us that Buffet is right…in the near term. But we’re still not going to switch to stocks. Because the risk is too high that time will be on our side.
In other words, the most likely outcome…as far as we can tell…is that the financial world will stumble along more or less in the same direction it is going now. Perhaps for many years. Gold, already expensive in terms of purchasing power, may go nowhere…or even down. After all, we’re still in a Great Correction. As long as we follow in Japan’s footsteps there’s no particular reason for gold to rise.
But we do not bet on the most likely outcome. We bet on the outcome that is underpriced. The outcome that is most likely to pay off…or blow us up. In our view, investors do not yet fully appreciate the risks of a financial catastrophe, a war or a revolution.
In yesterday’s news, we learned that 100,000s of Greeks had taken to the streets. “Rioters burn buildings…” reports Bloomberg:
Feb. 12 (Bloomberg) — Rioters set fire to buildings and battled police in downtown Athens as the Greek Parliament prepared to vote on Prime Minister Lucas Papademos’s austerity package to avert the nation’s collapse.
Ten fires were burning in central Athens including buildings housing a Starbucks Corp. cafe, a bank and a movie theater, a fire department spokesman said, speaking on the condition of anonymity in line with official policy. The blazes were near a bank that was set on fire in May 2010, killing three bank employees, during a general strike against Greece’s first bailout package.
“Today at midnight, before markets open, the Greek Parliament must send a message,” Finance Minister Evangelos Venizelos told lawmakers in Athens today as the final debate on the accord to secure a 130 billion-euro ($171 billion) second aid package got under way. “We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst.”
“We are seeing Athens go up in flames again,” Mayor George Kaminis, said in an interview on ANT1 television. “This must stop. What they are trying to do to Athens is what they are trying to do to the entire country.”
Meanwhile, hardly a day passes that we don’t hear of an impending attack on Iran.
The developed economies are borrowing money at 2 to 5 times the rate of GDP growth.
And the world’s major central banks eagerly print money.
Maybe Buffet will be right. Maybe the next 47 years will be like the last. But it seems like a bad bet to us. All the key circumstances are completely different — even opposite.
You remember the years from ’65 to 2012. They weren’t perfect. But they weren’t bad. The US was on top of the world…and headed higher. It was owed more money by more people than any nation ever had been. It was the leading energy exporter. It was the world’s leading capital investor. Its people were earning more and more money — in real terms. Total consumer and government debt, as a percentage of GDP, was barely a fifth of today’s level.
Of course, it wasn’t all good. The US was getting deeper and deeper into a costly and losing war. This would lead to some big bills to pay in the ’70s…and to some tough times. But, overall, America’s best days were still ahead.
Now, the emerging markets are growing much faster…taking more and more market share from the US. America is deep in debt…and adding more debt every day. Major industries have been zombified. More than half the voters depend on money from the government. America’s degenerate capitalism…and its geriatric democracy cannot adapt to the challenges it faces. And the typical working man hasn’t had a real increase in wages since the Johnson administration.
In ’65, the US was heady for glory. In ’12, it may be going to Hell.
But who knows? Maybe Buffet will be right.
Still…we’ll stick to our formula.
Buy gold on dips. Sell stocks on rallies.
“Wanna lose some money?”
Easy. Buy Facebook. It’s said to be going public at 150 times earnings.
In order to justify the price, says our colleague, Chris Mayer, Facebook would have to sign up every human being on the planet…and a few extraterrestrials too.
The whole Internet complex is a “bubble that’s about to pop,” he says.
“It’s rumored that Facebook’s IPO will value the company somewhere between $75 and $100 billion — about 150 times 2011 net income, 212 times free cash flow, and just shy of 27 times last year’s sales. Facebook’s sales have grown 77-fold since 2006, and its valuation based on private secondary markets has soared 92-fold during the same time.”
Wow! How do you beat that?
We tried to use Facebook. It just seemed like too much trouble. And what do you get out of it? Another way to keep up with your friends? That is, another way, in addition to phone, mail, SMS, email…and carrier pigeon. Seems like more than enough ways already.
We also tried LinkedIn. We signed up. But we could never figure out what the point is.
So…we apologize to all the many people who offered to make us a ‘friend’ or a ‘contact.’ I’m afraid we had to ignore them all. Not because we don’t want them as friends and contacts. But simply because we can’t keep up with the volume of contacts we have already.
Our advice to Dear Readers: Sell Facebook and LinkedIn…as soon as you get a chance. Turn off Facebook. Unplug yourself from LinkedIn.
Tune out. Turn off. Buy gold. Be happy.
for The Daily Reckoning
“The savings of the citizens would be at risk. The state would be unable to pay salaries, pensions, and cover basic functions, such as hospitals and schools, and…the country — public and private sector alike — would lose all access to borrowing and liquidity would shrink.
“The living standards of Greeks would collapse. The country would drift into a long spiral of recession, instability, unemployment and prolonged misery. These developments would lead, sooner or later, to exit from the euro.”
Sounds good to us! The Greeks have been living beyond their means. Living standards must fall. Best to get on with it.
But the efforts of a whole class of over-paid meddlers have been directed at trying to avoid this outcome. They’ve hesitated…prevaricated…vacillated…and generally fornicated up the situation.
They’ve swept so much dirt under the rug that there’s now an Everest in the middle of the room… It can no longer be ignored.
But Greece isn’t the only country to live beyond its means. And the Greeks aren’t the only ones to suffer. In Britain, the economy is holding its own…but only by loading the young with debt in order to continue supporting the old in the style to which they’ve become accustomed.
Here, The New York Times reports:
Perhaps the most debilitating consequence of the euro zone’s economic downturn and its debt-driven austerity crusade has been the soaring rate of youth unemployment. Spain’s jobless rate for people ages 16 to 24 is approaching 50 percent. Greece’s is 48 percent, and Portugal’s and Italy’s, 30 percent. Here in Britain, the rate is 22.3 percent, the highest since such data began being collected in 1992. (The comparable rate for Americans is 18 percent.)
Classified by statisticians as NEETs (not in education, employment or training), they number about 1.3 million, or one of every five 16-to-24-year-olds in the country.
Lower incomes…unemployment…fewer benefits… Get used to it.
There have always been booms and busts. There were years of good harvests…and years of bad ones. The prudent farmer saved some grain…just in case.
But in the 20th century real money — gold — was replaced by paper money and ‘just in case’ became ‘just in time.’
Even John Maynard Keynes, the architect of modern government meddling in the economy, suggested that governments should save money so they would have something to spend when the private sector cut back.
But the feds didn’t save. They spent. And when times got tough, they spent even more money. Trouble is, without savings, they had to borrow the money to spend…which means taking it out of the very economy that is short on money already.
The only other option is to print up extra money — in effect, creating it ‘out of thin air.’ But if you could just print ‘money’ and make yourself better off, everyone would do it. People are not made richer just by printing up pieces of paper with green ink on them. They get richer by having real purchasing power…and real resources at their command…and by being able to produce goods and services that people want.
*** Hillary Clinton calls up Egypt, Syria, Libya, and China to “democratize.” But democracy, as practiced by the US and other developed countries, is a fraud. It is just a way for the insiders to scam money and power from the outsiders, by pretending that the voters are in charge.
Just ask how many taxpayers would vote to spend about $10,000 each on the war against Iraq?
How many would vote to spend $1.60 cents for every dollar in tax revenue?
How many would vote for the latest mortgage deal…where homeowners who saved their money and paid their mortgages are forced to make up for those who bought houses recklessly…and then couldn’t make their payments?
How many would vote to bail out Goldman Sachs…Bank of America…or Citigroup?
But voters never get a chance to vote on the issues. They vote for candidates…financed by insiders, with agendas the outsiders cannot even imagine.
The word ‘democracy’ arose in small, Greek city states, where the voters actually voted on the concrete issues, not just the slippery candidates. Citizens voted to go to war…knowing not only that they would have to pay for it…but that they could be killed in the battles themselves. War was a matter of life and death, not just a campaign slogan of a chubby, middle-aged draft-dodger.
The Italian city states practiced real democracy too. In 15th century Florence, for example, citizens voted on whether or not to build a cathedral… Then, they voted on what shape it should take.
A scale model was built. Citizens knew what it would look like. They understood how it was built and how much it would cost them. They cast their ballots and took responsibility for the outcome.
American democracy, circa 2012, has no more in common with real democracy than American capitalism has in common with real capitalism. Both are degenerate…corrupt…and geriatric.
for The Daily Reckoning
The Dow down 97 points yesterday.
And the Greek story nears its conclusion…
The Germans agree to bail out the country…at least for a while…
…and the Greeks agree to act more like Germans…at least while everyone is looking…
But now everybody agrees that the farce has gone on long enough.
The big banks lent the Greeks money. Then, the bankers paid themselves big bonuses, rewards for having booked so much business.
The Greeks spent it like they stole it…which they practically did. With the help of Goldman Sachs, they rigged their accounts so as to appear to be better credit risks than they really were.
Then, of course, the Greeks could not repay. Since they gained independence from the Ottoman Turks in 1828, the Greeks never, ever repaid a loan as promised. Instead, they were in default about half the time.
But rather than let Mr. Market sort it out…as he had every other time, Mr. Government Fixer stepped in. He promised to manage the situation so that the careless lenders wouldn’t have to take the losses they deserved. How? By lending the borrower more money!
So, the Greeks were given more money…and told to straighten up.
And the Greeks made an effort. Rather than spend money as freely as before, they cut back. Thousands of government employees were laid off, budgets trimmed…belts tightened.
This, naturally, led to an economic slump. GDP fell at a 5% rate in the 3rd quarter of last year. In the 4th quarter it was falling even faster, at a 7% annual rate. The New York Times reports:
By many indicators, Greece is devolving into something unprecedented in modern Western experience. A quarter of all Greek companies have gone out of business since 2009, and half of all small businesses in the country say they are unable to meet payroll. The suicide rate increased by 40 percent in the first half of 2011. A barter economy has sprung up, as people try to work around a broken financial system. Nearly half the population under 25 is unemployed. Last September, organizers of a government-sponsored seminar on emigrating to Australia, an event that drew 42 people a year earlier, were overwhelmed when 12,000 people signed up. …
The situation at the macro level is, if anything, even more transformational. The Chinese have largely taken over Piraeus, Greece’s main port, with an eye to make it a conduit for shipping goods into Europe. …
The latest austerity plan meant to satisfy Greece’s creditors and allow for new infusions of financial aid may have averted involuntary default — and a global economic downturn — but will nonetheless make life for ordinary Greeks even more difficult. The plan reduces the minimum wage by more than 20 percent, mandates thousands of layoffs and reduces some pensions, probably ensuring that strikes and demonstrations will continue to be a feature of the Greek landscape.
As in Argentina 10 years ago, the Greek middle class is being hit hard. The upper classes are protected. They own stocks. They have bank accounts in foreign countries. And the lower classes had nothing before the crisis. They haven’t lost a penny.
But the middle classes lose jobs, income…and benefits.
That is what is happening in America too. Middle class wealth, built up between 1980 and 2007, was largely an illusion. It was money borrowed from the future… Now, it must be paid back.
And there’s not much Mr. Government Fixer can do about it. The problem is too much debt. Adding more debt doesn’t help.
“But Bill, aren’t you being a little simplistic,” asks a Dear Reader. “The idea is not to add debt for its own sake. The idea is just to try to mediate the social consequences of private sector de-leveraging while giving the economy time to get back on its feet. Why won’t that work?”
Why won’t it work? We repeat the question to give us time to think…
…oh yes…it won’t work because it ignores the reason the economy was knocked on its derriere in the first place. If the cause of the setback had been interest rates that were too high…or a natural disaster…the strategy might work. Just as an ancient Pharaoh made Bible fame by saving grain in the fat years and then releasing it when the harvests failed, so might a sage government today draw on its own surpluses to help soften the blow of a bad winter or an earthquake.
But the government has no surpluses. Only deficits. And you can’t mitigate the damage of an earthquake by setting off a nuclear explosion. Neither can you solve the problem of too much debt by adding to it.
When an economy has too much debt, there’s only one solution. Debt delenda est. Debt must be eliminated. It can be done in the old fashioned way — by Mr. Market. Or it can be done by Mr. Government Fixer.
Mr. Market will do it quickly…efficiently…and brutally.
Mr. Government Fixer will hesitate…equivocate…vacillate…prevaricate…and generally fornicate everything up. He will protect the guilty insiders…at the expense of the innocent taxpayers and general public. And in the end, he will let the debtor default, too, for he will have no other choice.
for The Daily Reckoning
Tired of running out of time and money? Scrimping and saving just to make ends meet?
Here’s Real Time Economics with a report:
Obama has spoken about having the rich pay their fair share, and $250,000 is a lot of money. But to characterize those households that earn that sum as “rich” depends very much on where they live. Thanks to regional differences on costs, $250,000 does not go so far in places like New York City and Honolulu, compared with cities in Texas or Tennessee.
The Council for Community and Economic Research calculates cost of living indexes for US cities based on goods and services bought by households in the top-income quintile, which nationally covers incomes of about $100,000 and above according to US Census data.
What the data show is that the cost of living in Manhattan is 118% higher than the national average. On the other hand, a household in towns like Harlingen, Texas, or Memphis, Tenn., has a cost of living 15% less than the US average.
What the differences do mean is a New York household earning $250,000 is not nearly as “rich” or has nearly the buying power as a Memphis household bringing home, say, $150,000 a year.
You can live more cheaply in a place like Harlingen. You’re almost guaranteed to lower your spending, because there’s not much there to spend money on.
We’ve never been to Harlingen, so maybe we’re wrong, but we imagine it is a pretty slow place. Few fancy restaurants. Few theatres. Few luxury shops. Which makes it hard to part with money.
Of course this improves your cash-flow. But it also allows you the glorious privilege of doing nothing.
As our friend in Florida reminded us, most people can’t stop. Money in; money out. They have to work to pay the bills. No question of taking time off. No time to think. No time to sit still…and wait for the storm to pass.
Back in the time of the Great Depression, millions of Americans were still not completely caught up in the money economy. Many still lived on the land. They kept pigs and chickens. They tended their own gardens and “put up” their own canned goods. They cut their own wood to heat their houses. They pumped water from their own wells. Many still made their own clothes.
When the Depression came, they could hunker down and wait it out.
But today, the developed world is in a Great Correction. And it shows no sign of coming to an end. Japan is already in a slump that has lasted — off and on — longer than most marriages. Europe is headed into a slump — with half of all young people jobless in many countries. And in the US, at this stage in a typical recession/recovery cycle, the economy should be growing at an 8% rate. Instead, growth is below 2%.
Why? This is no typical recession/recovery cycle. Instead, the private sector is cutting back on debt. At the present, household debt is going down (mostly via mortgage foreclosures) at about 5% of GDP per year.
At this rate, it could take 10 years or more to get household debt down to more comfortable levels, say, around 70% of disposable income.
But the average household can’t wait 10 years for de-leveraging to do its work. Heck, it can’t even wait 2 months. Both parents work. They’ve got two cars. And two mortgages. Money in; money out. 24/7…
No garden. No firewood. No chickens. No time to wait. No time to sit still. Just bills…bills…bills…
They’ve got to work…they’ve got to earn money…they’ve got to spend…
They can’t do nothing.
They should move to Harlingen.
Not much action on Wall Street. The Dow barely moved yesterday. Oil is right at $100 a barrel. The 10-year T-note yield is still below 2%.
The Greeks are “toast,” says our colleague Chris Hunter. The Germans are fed up with them. It looks like they are going to push the Greeks into default…and out of the euro.
But the threat of a Greek default casts a shadow over all of Europe. The New York Times is on the story:
BRUSSELS — Moody’s Investors Service cut the debt ratings on Monday of six European countries, including Italy, Spain and Portugal, and became the first big ratings agency to switch Britain’s outlook to negative.
In a statement, Moody’s said the main reasons underpinning its decision were “the uncertainty over the euro area’s prospects for institutional reform of its fiscal and economic framework and the resources that will be made available to deal with the crisis.” It also cited Europe’s increasingly weak macroeconomic prospects, which it said threaten the adoption of austerity programs and the structural reforms needed to promote competitiveness.
Empires come and go. And in coming and going, they seem to be symmetrical. The way up takes about as long as the way down. The Roman Empire took hundreds of years to reach its peak and hundreds of years to go away. The Third Reich was supposed to last for 1,000 years, too. Instead, it lasted 12, with about 8 years of expansion and 4 years of contraction.
The British Empire got underway with the conquest of Scotland and Ireland. One hundred years after the Battle of Culloden, which crushed the clans and sealed Scotland’s fate, the Brits ruled half the world. But 100 years later, their empire was mostly gone…with the US having taken away the imperial crown.
America’s empire could be said to have begun with the defeat of the South in the War Between the States. Or, perhaps with the invasion of the Philippines in 1899. It peaked in the early ’70s…when US wages reached a top. Or, maybe in the ’80s, when China began to compete with it and the US shifted from a creditor nation to a debtor. Now it is on the downward slope. In a few years, China will have the world’s biggest economy. A few years later, it will probably have the world’s dominant military force.
Will the decline be graceful and dignified? Or marked by bankruptcy, hyperinflation, war and shame?
John Kagan, writing in The Wall Street Journal, doesn’t think he will like it.
If and when American power declines, the institutions and norms that American power has supported will decline, too. Or more likely, if history is a guide, they may collapse altogether as we make a transition to another kind of world order, or to disorder. We may discover then that the US was essential to keeping the present world order together and that the alternative to American power was not peace and harmony but chaos and catastrophe — which is what the world looked like right before the American order came into being.
We don’t know what will happen. But we doubt we will like it either.
Still, we’re not silly enough to think that the path to imperial decay can be blocked by our own willpower. Here’s Kagan again, delusional:
…international order is not an evolution; it is an imposition. It is the domination of one vision over others — in America’s case, the domination of free-market and democratic principles, together with an international system that supports them. The present order will last only as long as those who favor it and benefit from it retain the will and capacity to defend it.
He seems to think that if an imperial power spends more money on its military industry it will somehow resist the tides and the winds. All of imperial history argues that he’s wrong.
When an empire’s time is up…it’s up.
for The Daily Reckoning
We can learn a lot from the Argentines. When it comes to messing up an economy, they’re Numero Uno. They’re Olympians of financial legerdemain and masters of the old false shuffle.
In 2001, the country was deeply in debt. The government was out of money. And the currency was losing value fast. What did the Argentines do?
First, they broke their promise to investors and savers, cutting the peso loose from the dollar. Then, they seized control of banks and bank accounts. People had been saving money in US dollar accounts in order to avoid problems with the peso. But the Argentine feds forcibly converted their accounts to pesos, just as the peso was losing 2/3rds of its value.
The next thing was to take the reserves in the central bank and use them to pay current expenses — which caused the head of the bank to resign in protest.
And finally, a few years later, they took over private pension funds — to protect them for the pensioners, of course. What are they used for? To fund the country’s deficits!
But the Argentine feds are not just scalawags, they’re the pacesetters for the rest of the developed world.
Here’s The Financial Times with a warning:
Watch out as sovereigns eye company cash piles
By David Bowers
Much has been written about how the developed world must tackle its structural budget deficits. But the link that remains to be properly recognised is that the counterparts to those ‘unsustainable’ public-sector budget deficits are equally ‘unsustainable’ corporate-sector surpluses.
The conventional wisdom believes that the current sovereign debt crisis is the result of governments having been too profligate. But it is not that governments have been spending ‘too much’ that is the problem; it is that corporates have been spending ‘too little’. Moreover, because this corporate saving is the main counterpart to the government’s borrowing, until companies start to spend again, the burden of fiscal adjustment will have to fall on cutbacks in public services and higher personal taxation. It is time to shift the debate away from talking about the fiscal position, and focus instead on whether it is a shift in corporate behaviour that is responsible for the fiscal mess in the developed world.
It is very unusual for the corporate sectors to run sustained financial surpluses. Look back at the UK and the US for more than half a century and the corporate sector has tended to be a net borrower, not a net saver.
What has prompted the recent move into financial surplus has been the decision by companies to step away from investment. Investment-to-gross domestic product ratios in the developed world are now close to the lowest levels seen in 60 years. Corporates appear to have decided to run themselves for cash, and not for growth. It is this profound shift in corporate behaviour that policymakers and politicians have been slow to spot. Until this behaviour changes — or is changed — it will be very hard to improve the fiscal arithmetic.
In the Reagan-Thatcher era, politicians cut taxes so that companies would come to their country, invest, create jobs…so that those politicians could, in turn, be re-elected. It does not work like that anymore; globalisation has seen to that. The reality is that public services used by the ‘99 per cent’ are taking the strain, while attractive corporate tax regimes are protected. Just as the trade-union barons of the ’70s failed to see the writing on the wall, so the global captains of industry may suffer a similar fate unless they put their cash to work in the countries in which they are domiciled.
The Argentines are the pacesetters for all modern governments. And The Financial Times is their newspaper of reference. It’s what the policy makers read. And the bankers.
Here, The Financial Times makes it clear what the policy makers should think: that corporations are to blame for current financial problems. They haven’t invested their money the way they should. If they’d invested more, instead of paying dividends and bonuses to rich people, we’d have more jobs…more spending and more growth.
Surely the feds can help them find ways to “invest” their money…
“I love the US…but it does seem to be going in a bad direction,” said a friend in Miami.
“You look around here and everything looks good. The grass and trees are all manicured. People are prosperous. But you go inland and it’s a different story. A lot of people in Florida don’t have two dimes. That’s why you see so many old people working. They’re taking tickets at the amusement parks. They’re working the cruise ships. They’re parking cars. They don’t have any money. They have to work to make ends meet.
“And the real estate market here is a disaster. People tell you it’s bottoming out. I don’t see it. What I see are few transactions…the market is very soft. People keep thinking they’re going to buy at the bottom. They buy…and then the bottom sinks some more.
“This is a consumer society down here. People live in suburbs…almost the whole state is suburb. They go to work. They come home. They go out to eat. They go out to shop.
“At any hour of the day, you’ll see work vans in about half the driveways. Someone’s cutting a lawn or fixing a cable TV. Nobody does these things for himself. That’s the way people live down here. They call someone. It’s money in and money out…all the time. Nobody’s got any savings…or any time. It’s go…go…go…You go to work. Then you go shopping.
“And it can’t stop. If it just slows down a little, the state goes into a slump. Everybody is checking his cellphone or iPhone or email all the time. He can’t stop either. It’s go, go, go….
“Nobody can take the time to think or even to wonder. That’s why a real depression now would be much worse than the Great Depression of the ’30s. Nobody can sit still. They can’t wait for it to pass. They can’t stop to breathe…or think…or wait for all the problems to clear up. They can’t relax and wait for an uneconomic upturn. They have to work.
“They’ve got to have money coming in…and money going out.
“You know, I’ve been reading your Daily Reckoning for years. And the one lesson I take from it is that you have to have some savings…so you’re not forced to run on the treadmill all the time. You need some money and some time. Otherwise, you’re never going to figure out what is going on. And you’re not going to have a clue of how to make any money. You just go from day to day…from job to job…from one shop to the next mall…from bill to bill…
“Scientists have done some studies on how the brain works. They found that most of what we do is reactive… Like someone throws a ball at you…you reach out and catch it. Quick response.
“But there are some things where the brain needs time. Some kinds of deep thought require, well, reflection. And nobody has time for reflection when they are on the computer or the iPhone…or rushing to get something done…
“And nobody can stop to think when they are having trouble paying their bills. That’s why you need savings. That’s why you need to have a garden, too. Nobody’s got a garden down here in South Florida. We have to go to the supermarket to buy our food.
“Of course, that’s part of the problem. If you have to work to prepare your food, you get better food…and you don’t get fat. But now you have to work to not get fat. Otherwise, food is just another distraction…like the iPhone or the Internet. You eat because it’s easier than thinking. It saves you from having to figure things out.
“You work. You drive. You shop. You check email. You call people. You eat. Money in. Money out. There’s no stopping it. No hesitating. No time to think. No time just to let things be.”
for The Daily Reckoning
We used to like traveling. Now, it’s a drag.
“No, we don’t want to go through your new x-ray machine,” we told the TSA guard.
“Whassa matter? It’s safe…” she replied.
“How do you know that?”
“The government said it was safe.”
“Do you believe everything the government tells you?”
“Heh…heh… Okay…” then, turning to no one in particular… “REFUSAL on 11. Male.”
We were out quickly…but the poor old woman behind us had to get up out of her wheelchair…hobble through the x-ray machine…and then they still wanted to feel her up on the other side.
You can’t be too safe, right?
This has been going on for 10 years. But it is still shocking. No one seriously believes that 85-year-old crippled Lutherans are going to cause mayhem on commercial airliners. But no one seems willing to say so.
You can’t even ask the question. Because it leads to other questions. Who, actually, is a threat? Probably no one. So, why are we herded…inspected…and pawed…as if the survival of the nation depended on it?
For the money and aggravation, all this security has probably done little to make air-travel any safer. But it’s done wonders at turning the American population into whipped dogs. They bark on command. When they begin the round-ups, interrogations and deportations…Americans will be ready to get in line…
You’ll see part of the reason why, below…
Recent news brought reports of more new jobs. We suspect that most of the good news was merely misinterpretation of the data. Many people have been looking for work for so long, the feds have stopped counting them. Besides, they routinely adjust jobs upward in winter, to make up for bad weather. So when there isn’t any bad weather in January, the job numbers go up automatically.
But there’s another problem.
“Most of the new jobs being created,” complains Robert Reich, “are in the lower-wage sectors of the economy — hospital orderlies and nursing aides, secretaries and temporary workers, retail and restaurant. Meanwhile, millions of Americans remain working only because they’ve agreed to cuts in wages and benefits. Others are settling for jobs that pay less than the jobs they’ve lost. Entry-level manufacturing jobs are paying half what entry-level manufacturing jobs paid six years ago.”
He continues, in the Christian Science Monitor:
Other people are falling out of the middle class because they’ve lost their jobs, and many have also lost their homes. Almost one in three families with a mortgage is now underwater, holding their breath against imminent foreclosure.
The percent of Americans in poverty is its highest in two decades, and more of us are impoverished than at any time in the last fifty years. A recent analysis of federal data by the New York Times showed the number of children receiving subsidized lunches rose to 21 million in the last school year, up from 18 million in 2006-2007. Nearly a dozen states experienced increases of 25 percent or more. Under federal rules, children from families with incomes up to 130 percent of the poverty line, $29,055 for a family of four, are eligible.
Too bad; Reich misunderstands everything. He thinks Republicans are to blame for wanting to reduce government handouts. Reich believes he can replace real middle-class earnings with a cushier safety net…as if there was no difference between a person who earns a living…and one who begs one….
…and as if the middle class wouldn’t have to pay for it.
On the subject of handouts, the Republicans are on slightly more solid ground than Reich and the democrats. They say they will cut them back. At least, those that don’t go to the voters.
For example, Mitt Romney says he doesn’t care about the poor; he cares about the middle class. Why? The middle class votes; the poor don’t.
Trouble is, there are more and more people who are slipping from the middle class…to the poor side of town.
Investment Business Daily is on the story:
The American public’s dependence on the federal government shot up 23% in just two years under President Obama, with 67 million now relying on some federal program, according to a newly released study by the Heritage Foundation.
The conservative think tank’s annual Index of Dependence on Government tracks money spent on housing, health, welfare, education subsidies and other federal programs that were “traditionally provided to needy people by local organizations and families.”
The two-year increase under Obama is the biggest two-year jump since Jimmy Carter was president, the data show.
The rise was driven mainly by increases in housing subsidies, an expansion in Medicaid and changes to the welfare system, along with a sharp rise in food stamps, the study found.
“You can’t get around the fact that policy decisions made over the past two years, on top of those made over the past several decades, are having a large effect on the pace of growth of the index,” said William Beach, who authored the Heritage study.
Government dependence has climbed steadily since 1962, when the index stood at 19. By 1980, the index had risen to 100. It stood at 294 in 2010, the last year for which the data are available. D.C.-based Heritage has produced the index for nine years.
The report also found that spending on “dependence programs” accounts for more than 70% of the federal budget. That, too, is up dramatically. In 1990, for example, the figure stood at 48.5%, and in 1962 just over a quarter of federal spending went to dependence programs.
At the same time, fewer Americans pay income taxes, the report notes. Almost half (49.5%) didn’t pay income taxes in 2009, the latest year for which the researchers have data. Back in the late 1960s, only 12% of Americans escaped the income tax burden.
The number of people dependent on the federal government shot up 7.5% in the past two years.
In 2010, for the first time ever, average spending on dependence programs per recipient exceeded the country’s per-capita disposable income.
Our quick-witted Dear Readers are probably already gasping for air. The zombies now are getting more money than wage earners. And millions of those wage earners are zombies themselves, on the government payroll…or the payroll of some industry — health, education, military — that depends on federal spending.
That leaves honest working people in a minority. And everybody gets a vote.
How do you think the zombies will vote? To cut back on spending on education? On healthcare? On foreign wars or new weapons? On welfare? On food stamps? On unemployment comp?
No, dear reader, there are some ailments that can’t be cured…and some problems democracy cannot solve.
for The Daily Reckoning
Get out your chopsticks! Brush up on your sushi! Learn to read backwards and upside down!
Yes…we’re going to Japan!
The gist of the Japanese situation is this:
The bubble burst in 1990. But rather than let their big businesses go belly up, the Japanese used every trick in the book. Counter-cyclical deficits up the Shinanho. ZIRP (zero interest rate policy). And QE too.
The economy didn’t grow. It didn’t collapse. It just got stuck…like a moth in amber. No new jobs. No new output. And get this, Japan is expected to lose 40% of its working age population by 2050.
Growth is expected to be negligible over the next 40 years in Japan. But it will be almost nothing in many other countries too, according to an HSBC report. It estimates that the US will grow at around 1.5% annually. France 1.1%. Denmark, Norway, Sweden — barely anything at all.
What does this sound like to you, dear reader? It sounds like the whole developed world going Japan’s way — with low growth and high debts from here to eternity.
Growth is stalled…debts are mounting up. Hello Tokyo!
But wait…here’s the Congressional Budget Office telling us that Congress will have those deficits under control in no time.
“Deficits to fall sharply, US forecast says,” reports the International Herald Tribune.
What a relief that is! The CBO has crunched the numbers. It has beaten up the 2s. It has punched out the 5s. It has pounded the 6s. And now, finally, like prisoners at Guantanamo, the numbers tell us what we want to hear.
US debt is going down!
Wait a minute…are these the same number crunchers who, at the beginning of the 21st century, forecast federal surpluses as far as the eye could see?
Yes, it is!
But, okay, that didn’t work out exactly as planned. They crunched the numbers but then the numbers got un-crunched on their own. Damned numbers! You just can’t trust them.
So, how can we trust these numbers?
That’s just it, dear reader, we can’t. In order to work out as planned, they require:
1. Congress has to let the Bush tax cuts expire on schedule. Hmmm… Will that happen? Beats us. It probably depends on who wins the elections in November…which probably depends on what the economy does between now and then…which probably depends on more things than we can begin to estimate and compute.
But the central idea of it — that Congress will act responsibly — seems like something you can’t say with a straight face. Will pandas stop eating bamboo? Will teenagers stop slouching? Will liquor stores make free home deliveries? Nope. Everything has a nature of its own. And the nature of Congress is to spend money it doesn’t have on things it doesn’t need. And then to push the bill onto the next Congress…the next administration and the next generation.
2. Not only do taxes have to go up, so does economic growth. There’s a problem right there. According to prevailing theories, if you increase taxes during a de-leveraging spell, you don’t get faster rates of GDP growth. You get slower growth.
The CBO acknowledges this problem, to a degree. It allows as how unemployment may go up, thanks to the tax increases. In fact, they say it will go to 9% in 2013.
How will the President, Congress and the Fed react to rising unemployment? Mightn’t it tempt them to engage in a little more counter-cyclical stimulus…at the expense of the tax cuts?
And what happens to growth rates? The CBO figures that growth can outstrip deficits. Maybe. Maybe not. Now, it’s not even close. There’s a $1.1 trillion deficit this year. Growth? Maybe a fifth of that. In other words, debt is growing 5 times faster than the economy.
During Mr. Obama’s first (and maybe last) term, US debt will grow by more than $5 trillion. Another term like that and we’ll be over $20 trillion.
And already the weight of debt is pressing down growth rates…and it’s getting worse.
And if HSBC is right, US growth will be very slow. Will deficits also be very low? Below 1.5% of GDP? Down from over $1 for the last 4 years to under $225 billion for the next 40?
Heck, we’re as soft-headed as anyone. We’d like to see the whole problem go away too. And maybe it will…
But we wouldn’t bet on it…
for The Daily Reckoning
Several of the ‘Capitalism in Crisis’ thinkers — even those who should have known better — thought the government needed to invest more money in education.
Kenneth Rogoff, for example, concludes that “improved education alone will not resolve the flaws inherent in today’s capitalism, but it [is an] essential first step down any path to a solution.”
Oh? We never quite figured out the connection. The problem in a nutshell is that developed countries have too much debt and not enough growth. And their debt is growing faster than their output. How then does spending more on non-productive behavior increase GDP output or decrease debt?
Contemporary education is a dead end. The industry has been taken over by zombies. Huge amounts of money — public, private, charitable, debt, savings, earnings — are invested. The output is small, dubious and perhaps even negative.
We know that in some fields, such as economics, the more instruction a person has, the less he knows. Economics — as taught in many universities — is a value-subtracting discipline. As to other fields — politics, sociology, literature, gender studies — we are suspicious.
We have also noted that despite huge increases in per capita, inflation adjusted spending over the last 40 years, test scores have not increased. This suggests that the money was wasted.
But our suspicions run deeper. We suspect that — outside science and engineering — most education, from the first grade to a PhD, is at best a costly luxury…at worst, a big waste of time and money.
Here is evidence, a letter from a former slave to his former master, written only a few years after the War Between the States came to an end. We don’t know, but it is unlikely the former slave had any formal education. But you will notice that today’s typical university graduate could not match his clear thinking or his polite, funny, sarcastic style:
August 7, 1865
To My Old Master, Colonel P.H. Anderson, Big Spring, Tennessee
Sir: I got your letter, and was glad to find that you had not forgotten Jourdon, and that you wanted me to come back and live with you again, promising to do better for me than anybody else can. I have often felt uneasy about you. I thought the Yankees would have hung you long before this, for harboring Rebs they found at your house. I suppose they never heard about your going to Colonel Martin’s to kill the Union soldier that was left by his company in their stable. Although you shot at me twice before I left you, I did not want to hear of your being hurt, and am glad you are still living. It would do me good to go back to the dear old home again, and see Miss Mary and Miss Martha and Allen, Esther, Green, and Lee. Give my love to them all, and tell them I hope we will meet in the better world, if not in this. I would have gone back to see you all when I was working in the Nashville Hospital, but one of the neighbors told me that Henry intended to shoot me if he ever got a chance.
I want to know particularly what the good chance is you propose to give me. I am doing tolerably well here. I get twenty-five dollars a month, with victuals and clothing; have a comfortable home for Mandy — the folks call her Mrs. Anderson — and the children — Milly, Jane, and Grundy — go to school and are learning well. The teacher says Grundy has a head for a preacher. They go to Sunday school, and Mandy and me attend church regularly. We are kindly treated. Sometimes we overhear others saying, “Them colored people were slaves” down in Tennessee. The children feel hurt when they hear such remarks; but I tell them it was no disgrace in Tennessee to belong to Colonel Anderson. Many darkeys would have been proud, as I used to be, to call you master. Now if you will write and say what wages you will give me, I will be better able to decide whether it would be to my advantage to move back again.
As to my freedom, which you say I can have, there is nothing to be gained on that score, as I got my free papers in 1864 from the Provost-Marshal-General of the Department of Nashville. Mandy says she would be afraid to go back without some proof that you were disposed to treat us justly and kindly; and we have concluded to test your sincerity by asking you to send us our wages for the time we served you. This will make us forget and forgive old scores, and rely on your justice and friendship in the future. I served you faithfully for thirty-two years, and Mandy twenty years. At twenty-five dollars a month for me, and two dollars a week for Mandy, our earnings would amount to eleven thousand six hundred and eighty dollars. Add to this the interest for the time our wages have been kept back, and deduct what you paid for our clothing, and three doctor’s visits to me, and pulling a tooth for Mandy, and the balance will show what we are in justice entitled to. Please send the money by Adams’s Express, in care of V. Winters, Esq., Dayton, Ohio. If you fail to pay us for faithful labors in the past, we can have little faith in your promises in the future. We trust the good Maker has opened your eyes to the wrongs which you and your fathers have done to me and my fathers, in making us toil for you for generations without recompense. Here I draw my wages every Saturday night; but in Tennessee there was never any pay-day for the negroes any more than for the horses and cows. Surely there will be a day of reckoning for those who defraud the laborer of his hire.
In answering this letter, please state if there would be any safety for my Milly and Jane, who are now grown up, and both good-looking girls. You know how it was with poor Matilda and Catherine. I would rather stay here and starve — and die, if it come to that — than have my girls brought to shame by the violence and wickedness of their young masters. You will also please state if there has been any schools opened for the colored children in your neighborhood. The great desire of my life now is to give my children an education, and have them form virtuous habits.
Say howdy to George Carter, and thank him for taking the pistol from you when you were shooting at me.
From your old servant,
for The Daily Reckoning
Baltimore…best bet for investors?
We drove back into town on Sunday night. People moped around in front of bars. Groups walked uptown from the stadium, their shoulders down, the chins dragging. The city was dark…and unhappy.
There was no joy in Baltimore on Sunday night. Baltimore is a sports town. The Ravens — the only team we know named after a poem — had lost. They would not be going to the Super Bowl.
Baltimore is a funny place. We were happy to leave it for 15 years when we lived in Europe. And we are happy to be back. Living in Europe was hard. Here it is easy. Living in Europe was chic and fashionable. Here, moving to a trailer park would be moving up in the world. Living in Europe was expensive. Baltimore, meanwhile, is one of the cheapest cities in the world.
But we’ll come back to Baltimore in a minute…
What’s in the news today? The Dow rose 83 points yesterday. The 30-year, ‘long’ bond yield dropped below 3%. The price of gold rose to $1,749.
Bond yields signal a recession. Stocks hint at a recovery… Gold? The correction in the gold market didn’t go nearly as far as we expected. And now it’s over. What to make of it? Do people expect inflation? Why are they buying gold?
We know why the Syrians are buying gold. There’s a war on. Gold has always been the thing to own in a war zone. But here, people think the economy is recovering.
The public and the investoriat seem to think all is well. We’ve just had one of our best months in stock market history. Many investors are convinced that it is the beginning of something big.
Our old friend Mark Hulbert, for example, tells us that some of the oldest and wisest of the newsletter gurus are now bullish on stocks.
We don’t have any opinion about stocks. We just don’t like them. And we figure that if they were as valuable as people think, the owners wouldn’t be in such a hurry to unload them. At least, not to us. Instead, they’d hold on.
But some people are always selling. Others always seem to be buying. Prices go up…and down…the world goes ’round and ’round…
…and who are we to argue with it?
The trouble is, the economy is not nearly as strong as most people think. There is no growth to speak of. And without growth, it doesn’t make sense to pay so much for stocks. Forbes:
The Q4 2011 GDP reading of +2.8% produced what may appear to be a respectable headline number, a full percentage point above Q3 GDP growth of 1.8%. On the surface, the Q4 report also compared favorably to an increase in real GDP of 1.7% for all of 2011. But 2.8%, even at first look, is still softer than the 3.0% gain in real GDP logged for 2010, repeating a pattern that we’ve seen over the past few years: GDP rises, only to drop off again.
Although it may be tempting to look at the economy as a glass that’s half full, I’m afraid it’s far emptier than it looks. Diving into the Q4 GDP report, we see that two-thirds of the amount of growth reported (1.9%) was due to private inventory build-up. (According to standard accounting practice, growth in inventory increases GDP, while sales of inventory reduces it.) Drilling further, the stat that is most meaningful is the real final sales of domestic product — GDP minus the change in private inventories. This data point eked out only a 0.8% increase in Q4 2011, compared with an increase of 3.2% in Q3 2011. That is very telling.
Another weakness in consumer spending was reported by the Commerce Department: Personal income grew by 0.5% in December, up from a 0.1% rise in November. Spending was flat, however. The personal saving rate, meanwhile, was 4.0% in December, compared to 3.5% in November. Saving instead of spending may be good for consumers’ personal balances sheets, but it doesn’t do much good for an economy that needs to gain traction. Additionally, sales increases still appear to be driven by increases in debt which is not sustainable.
Without growth, the average stock will go nowhere. How could it? There’s nowhere to go. No growth means that the economy is no larger at the end of the year than it was at the beginning. So, for any company to grow, it would have to take sales and profits from some other company. For one to grow another must shrink. Overall, there would be no growth, and no capital gains for investors.
Trouble is the dividend yield of the stock market is only around 2%. That’s not enough. Take inflation and taxes into account, says our Family Office strategist, Rob Marstrand, and you need more than an 8% return just to break even.
So, if you’re buying stocks in a no-growth market…with a 2% dividend yield…you’re losing 6% on your money.
Heck, you’re much better off buying gold…or property in Baltimore.
Gold has been up every year for the last 11. Even last year, when it supposedly suffered a big correction, it still ended the year up about $300 — which is what you would have paid for a whole ounce of gold in 1999.
As for Baltimore real estate…
We’ve been looking at apartment buildings in B’more. This city is unusual, so you probably shouldn’t generalize. But we’re seeing buildings with “cap rates” of 10% and more…and return on cash as high as 20%. Interest rates are so low you can finance much of the purchase price at low cost…and leverage your investment to get a higher return.
How does that work? Well, the building we just looked at had 5 units. The sales agent explained it to us.
“You get gross rents of about $100,000 and you can buy the building for $800,000. You put down $100,000 and borrow the other $700,000. Then, you pay off your mortgage, pay the upkeep, property taxes, utilities and so forth… You also have to pay management…leave an allowance for vacancies and major repairs…and you end up with about $20,000.
“That’s your return on cash. Not bad, huh?”
Well, it’s about 10 times what you can expect from the stock market.
Trouble is…trouble. Being a landlord in an inner city is trouble. You get trouble from the tenants. Trouble from the city. Trouble from the pipes, the roof, the wires…lead…asbestos — everything. Buy city apartment buildings and you are asking for trouble.
But if you can handle the trouble, hey…see you in Charm City.
for The Daily Reckoning
Dow down slightly yesterday. Oil falling further below $100. And gold still going up.
What is most interesting is the movement in the price of gold. It seems to be heading up again — almost no matter what else is happening.
So, let’s look at what might be going on…
If investors sensed a recovery…they would expect banks to lend more freely…people to shop more freely…and prices to rise.
This would raise consumer prices; the price of gold should go up.
But if the market sees growth and inflation ahead, why is oil slipping? And why is the Baltic Dry Index — which measures shipping prices — at a 25-year low? And how come last month’s employment figures were disappointing? And why aren’t stock market prices going up?
Most important, if the economy is really recovering, why is the 10-year note yielding only 1.82%? And what about the long bond? Shouldn’t it be trading at a yield higher than 3%?
And how come house prices fell over the last year…and the last month?
And how come incomes are falling?
Or, to look at it from the opposite point of view, how is it possible for a real recovery to take root in the hard, barren soil of falling house prices and slipping consumer earnings?
But if the economy is not improving…then there should be no increase in inflation…and no pressure on the price of gold, right?
Maybe investors don’t anticipate a recovery at all. Maybe they’re buying gold because they see the economy getting worse, not better. We associate a rise in the price of gold with inflation. But gold is much more versatile than we think. It protects your wealth when paper money loses its value. It also protects your wealth when paper money gains in value. It protects you when you are right…and when you are wrong.
During the Great Depression, for example, the price of gold rose…against dollars…even though the prices of food, clothing and other consumer items…as well as the prices of investment assets…were falling in dollar terms. Why? Because money gains value — relative to things — in a depression. Gold is money. It is the best money. It is the only money that has stood the test of time.
Besides, there is more going on. In a financial crisis…or a depression…investors begin to doubt that their counterparties will make good. Banks fail. Investors go broke. You own a mortgage, and then you discover that the homeowner has left town…and the house has lost half its value. You own a note, and then you discover than the payer is bankrupt; your note is worthless. You own shares in a company; and then the company goes out of business.
When you are in a de-leveraging phase, you discover that many of the assets of the previous credit bubble are not assets at all. And while you’re waiting to find out, the best thing to have in your safe is gold.
As uncertainty rises; so does the price of gold.
The price of gold also rises when the return on other assets declines. At 1.82%, the real return on a 10-year T-note is negative. Consumer prices are rising faster. So, the reward for lending to the government is less than zero.
Normally, holding gold costs you money. You give up the return you could get from ‘risk free’ investments (Treasury debt). Now, you give up the risk from reward-free investments.
Gold goes nowhere. It produces no yield. It pays no dividends. It makes no profits. You can’t live in it. You can’t drive it. You can’t hang it on your wall and admire it.
But when the return on Treasury debt is negative, what do you give up by owning gold? You give up a loss!
You also give up the risk of a much bigger loss. The Fed is bound and determined to bring up the inflation rate. Ben Bernanke has suggested that he might set the inflation target higher than 2%. He has announced that he will keep the Fed’s key lending rate near zero for the next 3 years. He has hinted that he is ready to print more money — QEIII — if conditions warrant.
Holding gold protects you from Bernanke’s success. For if he succeeds in raising the rate of inflation, gold will surely soar. And there is substantial risk — bordering on certainty — that he will be no better at creating moderately more inflation than he has been at creating moderately more GDP growth.
It is quite possible that he will overshoot.
Normally, inflation is a feature of the banking system. The system takes the Fed’s monetary grubstake and parleys it into the nation’s money supply. Banks magnify the money supply by lending…and thereby create more demand, which raises prices. They do this by making loans…to people who then spend the money.
This sort of inflation is controllable, by raising interest rates and tightening banking credit rules. But there’s another form of inflation. The kind that starts with an “h.”
Hyperinflation happens when the banking system breaks down. People lose faith in the money itself…and the people who control it. Foreign dollar holders may worry that the Fed is printing too much money. It may even be good economic news that causes them distress; they may anticipate higher inflation rates, and a sell-off of the dollar, which would lower the value of their dollar reserves. They may figure that they are better off diversifying into yuan…or gold.
Then, when other investors and householders see the dollar falling…they get panicky too. Pretty soon, people are digging around in drawers, bank accounts and mattresses…looking for dollars — just so they can get rid of them.
That is when dollars hit the hyperinflationary fan. Our old friend Michael Checkan tells what it was like in Argentina in the late ’80s:
“Imagine a $2.00 gallon of milk spiking to $775.40 within a year — like in Argentina, 1988.”
for The Daily Reckoning