THE THREE STOOGES

The three stooges: Barney Frank, Nancy Pelosi, and Harry Reid have done it again. Attempting to tax bonuses at 70% to 90%, spending money like it was theirs, slapping on earmarks, and denying any involvement in the chaos of the mortgage debacle. Nancy Pelosi proposed that Credit Card Companies should extend a larger credit line to the card holders in the hope they will spend more money. You can’t make this up. There are other stooges like Chris Dodd, Timothy Geithner, and Rahm Emanuel, to name a few. There all killing us. It never ends. And our current leader said, “When you’re headed for a cliff, you have to change direction”. How about putting on the breaks! The politicians feel like they have to do something, so they do. So they throw money around like it theirs.

Is it just me, or does our leader look like Alfred E. Newman of Mad Magazine (Mad Magazine-www.dccomics.com/mad/). Below, courtesy of Mad Magazine is Alfred E. Obama. Check it out.

The basic Obama solution to our economic crisis using FDR’s and Keynesian policies of the 30’s quite frankly don’t work. They did not work then, and they won’t work now. Attached is a chart of the unemployment rate during the depression. Sadly the War reduced unemployment, not Politicians spending plans. In 1938, unemployment started to rise again. By 1939, the inception of WW II, unemployment rates finally declined.

You don’t have to be an economist to realize that our problem today, is the unemployment level. Large unemployment rates create social and economic problems. You can’t fix the housing problem by screwing around with mortgage rates, principal reductions, and extending the mortgage life, if the mortgagee does not have a job. You can’t fix the problem of toxic assets by changing accounting principles (mark to market). If the assets stink, they stink.

The current unemployment problem is very much like the classic question, “what came first, the chicken or the egg? If you believe in evolutionary theory, the egg came first. What came first, employment or unemployment? If you believe in a free market economics, the employer came first. Give American Business and employees some incentives. Reduce payroll taxes, give tax credits for fixed asset purchases, allow a tax deduction for dividends, and lower income tax rates for the top individual tax brackets. Let’s face reality; for Economic growth, entrepreneurs make much better employers than the US Government.

Our leaders gave money to the Banks, and are now upset because the banks “won’t lend money”. How can they be upset? Banks don’t want to make risky loans and good companies don’t want to borrow. The “Geithner” joint venture between our Government and Hedge Funds will bid on toxic assets (now referred to as “Legacy Assets”) of banks and other financial companies. Obviously, in an un-leveraged world, the bids will be at less than book value. Ah, but our leaders have given the Hedge Funds 6 to 1 leverage. Now they can bid much more since the leverage is non-recourse. Bank of America as of 12/31/08 was leveraged 18.95 to 1 (if you believe their Financial Statements). The Balance Sheet indicates an asset “Investments” totaling $1.375 Trillion, and a Tangible Net Worth of $86.583 Billion. Assuming the investment is worth a generous 75% of carrying value, the loss would be $343.75 Billion or almost 4 times their net worth. I don’t think Bank of America will sell their assets at a deep discount, and I also don’t think the hedge funds would pay a premium for stinky assets. Good luck with your plan Geithner. In my opinion most of the large banks, AIG, Auto Makers, should be placed in receivership, letting the receivers restructure the failed companies.

The war continues between deflation and inflation. Below is a chart of inflation expectations. The chart measures the yield difference of the 10 year T-Bond and

the Treasury 10 year Inflation Indexed Bond (TIP). Currently, Inflation expectations are rising. Investors sense a rising price level in the immediate future. Do you think it’s because of all the money being printed by our beloved leaders in Washington? Below is a graph of the 10 year TIP and Gold. Both prices are rising.

One of the most powerful economic tools the United States has is our Dollars status as the main Reserve World Currency. If the US lost its reserve status, we would not be able to print the money our debt is denominated in. It would also mean that our creditors would no longer hoard dollars as a safe haven or as a store of value. Taking away the reserve status of the US Dollar would be one of the most significant ways to weaken the USA. China recently called for an extension of the use of SDR’s (special drawing rights) created by the International Monetary Fund (IMF), and the eventual replacement of the dollar as the World’s reserve currency. China, Russia and most of Europe bristles at the thought of the US as the perpetual world economic power. The Achilles heel of the USA is the dollar, and the powers that oppose the US know it. On March 27, at the United Nations, the UN Advisory Committee said: “World leaders should give urgent attention to reaching consensus on creating a global reserve system that would replace the US Dollar as the main international currency.


We as a County are in big trouble. If we lose our Reserve status, Richard Russell (http://www.dowtheroyletters.com/) writes, “…if it happens it will happen through the United Nations by “Order” of the World. God help us.

I still think stocks are still overvalued, and recommend staying liquid, with a little Gold as a hedge against inflation and panic. Get out of debt, and prepare for a continuing struggle between deflation (in the short run) and inflation in the long run.

NOTHING IS POSSIBLE

“WHO SAYS NOTHING IS IMPOSSIBLE?
SOME PEOPLE DO IT EVERY DAY!” MAD
MAGAZINE E.C, PUBLICATIONS INC.

The money flowing out of Washington is so large and has happened so fast, that only the tooth fairy understands what just happened. What we do know is that the mammoth infusions of fiat money is hyper-inflationary over the next five years, and probably does very little to “Put America Back on its Growth path”. The Euphoria over the election of the new President is about to come to an end. Our Congress and President have lost it.

The Stock Market which represents the best and brightest minds in America, and back their opinions with real cash, have voted on all the Politicians bail-out’s, and “Saving America Programs”, and have posted the following results from Election Day to 2/20/09: SP500 lost 26.70%, NASDAQ lost 21.12%, DOW 30 lost 26.76%, DOW Transportation Index lost -41.13% and the Wilshire 5000 lost 25.86%.

How do you like the vote by real people who invest real money? To add insult to injury, the loss in dollars, since election day (measured by the Wilshire Index, above), is $2.303 Trillion.

Since the peaks of the American stock market and housing, $8.05 Trillion has been lost in the stock market and $7.5 Trillion has been lost in housing. Investments in stocks and housing (since the peak in October 2007), have lost $15.5 Trillion. Globally, the estimated losses from the peak in stocks and housing are $30.0 Trillion for stocks and $ 30.0 in housing. A whopping $60.0 Trillion has been lost because of excessive liquidity and the expansion of irresponsible credit. You think that providing bee keepers with insurance will set the US Economy on fire?

We have a big problem. Yes, someday housing and stock prices will advance, but today, World investors are mad, and do not trust housing and stocks as an investment. It is my experience (since 1968) that investors are not quick to return to investment alternatives that buried them. Housing will again be a place to live and the Stock Market will be a trader’s arena, with the general public staying away.

The chart below indicates the ratio of Money to the market value of the Stock Market. The average ratio since December 1991 has been 54.07%. For the seven days ended 2/9/09, the ratio is 107.24%. Note that the Ratio rose over the average from 1/14/02 and peaked on 3/10/03 at 81.14. After the peak, money still exceeded the stock market and occasionally dipped under the market value of stocks but never got a major foothold. As a result the stock market has been rather boring on the upside and only recently got interesting with its crash. The possible good news is that there is a lot of liquidity standing around waiting for an opportunity in investing in something other than boring old cash.


Money in the chart above is MZM which is defined as: Currency in circulation plus demand deposits plus Large Time Deposits plus Term Repurchase Agreements minus small denomination time deposits plus Institutional Money Funds. The stock market value is defined as the Wilshire 5000 index.

Is the Stock Market today really cheap? In my opinion, no, and I’ll tell you why. Over the past 20 Years, the advent of individual retirement plans increased the demand for stocks exponentially. Add to it Hedge Funds, and other investors of OPM’s (other people’s money) and you had the perfect formula for a Bull Market. The supply did not keep up with the demand. New suppliers emerged (Mutual Funds, ETF’s etc) to accommodate the new demand, but the stock supply didn’t match up with the new demand. Since Mutual Funds and 401K Plans were “always” invested in the Stock Market, it was this set of players that created of one of the greatest bull markets in the History of America.

The Bull Market from November 1990 to August 2000 was the longest in history lasting 118 Months. The most current bull market was the third largest on record lasting 56 months from March 2003 to October 2007. The second longest Bull Market lasted 71 months from November 1923 to September 1929 (remember that one?). In the most current bull markets, most decisions were made by men that had never seen a market crash.
Due to the advancing prices, new theories of value emerged. The old school of value that said “buy good stocks that had a 5 to 12 PE multiple and a 4% to 6% dividend.” was dismissed as “out of touch”.

From the period December 1973 to October 1990, the average of the price earnings ratio and dividend yield for the SP 500 was 11.75 and 4.32% respectively. From November 1990 to December 2008 the PE and dividend yield on the SP 500 was 23.71 and 2.04%. The demand and supply increased to the point that everybody was invested one way or another in the stock market forcing up the PE and driving down the yields. Old school investors learned the hard way, that investing in stocks can be very risky. In the good old day’s stocks carried a risk premium.

At this writing the SP 500 closed at 770.05. Per share earnings estimates, for the years 2009 and 2010 are $41.88, and $51.48 and dividends per share estimates are $12.62 and $23.20. This results in a PE ratio for 2009 of 18.39 and 14.96 for 2010. The dividend yield for 2009 and 2010 would be 1.64% and 3.01%. This hardly represents a risk premium. To arrive at a historical “stocks are cheap” basis the S&P 500 would have to be at 617.76 to achieve a 12 times PE (2010 Earnings). On a yield basis, the SP based on 2010 dividend expectations would have to be at 464.00 to yield 5.00%. Using 2009 earnings and dividend estimates would make matters even worse.

I suspect that the earnings and dividend estimates for 2009 and 2010 are overstated, because historically analysis’s are slow to change their estimates (they work for the very people that are trying to have you buy stocks).

As a concept: buy stocks when they are cheap and sell when they are expensive is common sense. In his book “Irrational Exuberance” Robert J. Shiller (Professor of Economics at Yale University) did a study of returns on stock investments and showed that PE ratios and Dividends indicate to a great extent when stocks are cheap and when they are expensive. He says:

“…as a rule and on average, years with low price-earnings ratios have been followed by high returns and years with high price-earnings ratios have been followed by low or negative returns.” (Page 187 2nd Edition). And, “As a matter of historical fact, times when dividends have been low relative to stock prices have not tended to be followed by higher stock price increases in the subsequent five or ten years. Quite the contrary: times of low dividends relative to stock prices in the stock market as a whole tend to be followed by price decreases (or small-than-usual increases) over long horizons, and so returns have tended to take a double hit at such times, from both low dividend yields and price decreases. Thus the simple wisdom—that when one is not getting much in dividends relative to the prices one pays for stocks it is not a good time to buy stocks—turns out to have been right historically.” (Page 188 2nd Edition).


We need to watch two statistics that will determine the investment strategy for the next 2 to 5 years. The first relationship that bears watching is the ratio of Gold Prices divided by 10 Year Bond Prices. In determining the war of Inflation/Deflation, Gold and 10 Year Bond Prices should de-couple. Currently, both Gold and 10 Year T-Bonds Prices have been going up together. For Deflation to be the winner, the ratio above should start going down. If Inflation is the winner, the ratio should be going up. Note the chart above indicates, the Ratio is going up, which translates to a brief victory for Inflation.

The 2nd thing that you have to pay attention to is the yield to the Chinese in investing in US Bonds. The above chart reflects what the Chinese yields are in Yuan, in investing in 10 Year US T-Bonds for a holding period of 1 year (including interest).
Note the yield for the year ended 2/20/09 is 7.70%. However, the yield is declining. The significance of this chart is, that if the Chinese start losing money on owning US Treasuries, they will be inclined to sell these Bonds, which would drive T-Bond yields higher, and contribute to an Inflationary expectation.

I continue to advocate buying Gold on dips (10% to 20%), and short term Cash Instruments such as T-Bills, and Federally Insured CD’s. The stabilization of the World Economies will take a long time (2 years or more), and in the interim, stay liquid, out of debt, and own some Gold.

Game Theory 101

Many moon’s ago, the Mathematics Department of various Universities, came up with the notion of “Game Theory”. The theory dealt with games from Business to Monopoly. The results of those studies were profound. The basic principals of the theory centered on the concept of “fair games”. That is, a game is “fair” when the player has a 50% chance of winning, and a 50% chance of losing. Thus, “fair” produces no winners or losers.

In investing, the propositions of Game Theory are:

(1) Never play fair games (other than for amusement). Find games that have a higher probability of success than failure.

(2) Never play games unless you understand the rules. The rules must be articulated in an understandable way. The rules cannot change during the game. Do over’s etc cannot be allowed.

(3) Make sure you know the players in the game, and their skill level. Your skill set should be as good, or better, than the other players in the game.

(4) You must understand the game. Life is short – If you don’t understand the game, find another one. If there are no games you understand, become a spectator.

In the current crisis, most players in the game are under 50 years old, and have never seen a “game” this tough. Folks under 50 did not play the bear markets of 1969-1970, 1973-1974, and 1976-1978. In business school they probably did not even study the Depression of the 30’s. Currently, there is no game you can play (other than Gold), that gives you a fair chance of success. Stocks, Real Estate, Commodities, Foreign Currencies, Bonds – they all suck! Why?

(1) BECAUSE THERE ARE NO RULES, AND THE RULES CHANGE DAILY.

(2) Who are the players? You, me, the Federal, State, and Local Governments, Banks, Other World Sovereignties, Finance Companies, Special Interest Groups, the Unemployed, etc. In short - everyone on this planet.

(3) The Game today is totally incomprehensible. Do-overs are now allowed. Without understanding the game or rules, you must sit on the sidelines and allow the other players to fail.

There is a major war going on between Deflation, and Inflation. We all know that there is a credit collapse. The market value of assets is under siege. Liabilities against those assets in many cases exceed the asset value. The collapse of asset values and credit is clearly deflationary. Wait – here come our favorite rule changers, the US Federal Government. The Fed’s always gets us with taxation and inflation.

Our Governments boondoggle (TARP, Stimulus Plan, etc) is presumably going to “get our Economy back on its feet”. As of this writing I have seen nothing that will materially stimulate the Economy. In fact it appears that most of the money has been thrown at Banks and Auto Companies that are Bankrupt and social programs that provide no stimulus. Our beloved leaders, (President Obama, Nancy Pelosi, Barney Frank and Harry Reed) are running amok. The package totals $819 Billion, and may run up to $900 Billion.

There is: $345 Million for the Agriculture Department computers; $650 Million for TV converter boxes; $15 Billion for college scholarships; $1 Billion to deal with the Census problems; $88 Million to help move the public Health Service into a new building next year; $2.1 Billion to pay off a looming shortfall in public housing accounts; $870 Million to combat the flu; $400 Million to slow the spread of HIV and other sexually transmitted diseases such as chlamydia; $380 Million for a rainy day fund for the Women, Infants and Children (WIC) program that delivers healthful food to the poor (this group got $1 Billion last fall), $87 Billion to bail out the States providing Medicaid, Bee Keepers Insurance, and Medicare funds for Illegal Aliens.

Also everyone that has an Income Tax ID card (which includes those that do not have a Social Security Card) will receive a tax rebate of $500 if single, and $1,000 if married. People that do not pay taxes get the tax credit too. Remember the last Tax Rebate program didn’t work because people saved or paid bills with the windfall.

There is more nonsense in this package, but you get the idea. Upon being questioned on the bill, Rep David Obey, D-Wisconsin, one of the chief authors of the house package and chairman of its appropriations committee said, “If the house is burning, you’re not going to worry about which hose you grab, so long as you get water on the fire.” Is he crazy? The printing presses are going wild. As Richard Russell the guardian of the Dow Theory (www.dowtheoryletters.com) said (tongue firmly in cheek), “buy Paper Stocks.”

The forces of Deflation have been strong. Yet Gold and TIPS (Inflation indexed US Bonds) are rising, suggesting that: (1) There is an Inflation expectation over deflation, or (2) There is a major fear that the Worlds paper currency will become worthless or (3) both of the above. The Worlds currency today is referred to as fiat currency or fiat money. By definition fiat money is currency or money whose usefulness results not from any intrinsic value or guarantee that it can be converted into gold or another currency, but instead from a government’s order (fiat) that it must be accepted as a means of payment. For example the US $100 Bill is only worth $100 because our government says it is. Obviously there is no intrinsic value of the bill except maybe the value of the paper (5 cents?)

The game is now very complex. Stocks in my opinion are not cheap but overvalued considering where we are in the economy. A SP 500 Index to be cheap would be 600 or less (currently at 850). US Government Bonds are not cheap (a 10 year yield of 2.842%, is not my idea of a risk justified return). Income producing Real Estate is not cheap, due to vacancy rates rising and a substantial oversupply of rental space. Housing isn’t cheap, since you can’t buy a house today and rent it out at a profit. All other investment alternatives are in a state of uncertainty, because of the absence of rules.

In my opinion to make money over the next three years, the proper investment game to play will be decided on the direction of the price level, and the “real” value of the Dollar and other World paper (fiat money) currencies. If the “people” ever figure out that the current mass flooding of paper money causes inflation, and that our currency is really worthless, we will have the largest Economic and Political crisis ever faced in modern times. Below are some of the charts I use to follow the Deflation/Inflation, worthless US dollar sentiment. Below are three charts that indicate the ratio of Gold Prices divided by: the Ten Year US Treasury Bond Price; the Inflation Indexed US 10 Year T-Bond (TIP); and the US Dollar Index. Also there is one chart indicating the ratio of TIP to the 10 Year T-Bond Price.




Note that the TIP is also rising against the 10 Year T-Bond. Like all market data (that reflects investor sentiment), this could all change tomorrow morning. What’s interesting about the TIP to Bond chart is that it shows the initial Deflationary sentiment (dropping ratio). Currently however the TIP shows strength, and with it confirms the other Inflationary sentiments. My opinion is the stimulus package will stimulate very little except Inflation. It seems likely we will continue our credit and asset collapse followed by high rates of Inflation.







It is prudent to be very risk adverse today. Invest in Federally insured Cash Instruments, and some Gold. If you have a Mortgage that has an interest rate of more than 3.673%, make extra principal payments. Stay liquid, and out of debt. This economy and the Federal Solutions thereon will not have a happy ending.

OH NO, ANOTHER BUBBLE

See the tables below, for the Financial and Economic Results of the bubbles bursting in 2008. 2009’s Bubble will be the collapse in the US Treasury Bond market and Commercial Real Estate. The chart below indicates Commercial Real Estate Expenditures versus The American Institute of Architects Billings for Commercial Real Estate lagged by 10 Months. The AIA Index leads Commercial Real Estate Expenditures by about 10 Months. Note the total crash in 2009 of Commercial Real Estate.



There are several reasons this investment vehicle is the next casualty of the credit crunch.

Many buyers “borrowed money” on commercial real estate based on what “cash flow will be” based on unreasonable inflation and demand assumptions, not on what cash flow actually was. Exceptionally high prices were paid on current small yield assumptions. Liberal financing was provided by “cash rich” banks that bought into these bloated expectations. The result, too many office buildings were built that were overleveraged. As the recession sets in, lost jobs create higher vacancies. In many cases, the current cash flows do not service the Mortgage Debt.

As the bail-out money sloshes into the poor hopeless, hapless US Economy, the potential for the next Grand Bubble becomes probable. In a “free market” economic system those that screw up, are allowed to fail. Most children only learn the lessons of life when they are allowed to fail and pay the consequences. Yet here we are, $8.5 Trillion has been pumped (and printed) into the American Economy (God knows what additional money will be printed) and the borrowing rate for Banks (Fed Funds) is at or near zero. The Federal Reserve is out of bullets. Your and my Government has decided to fight the current mess caused by years of easy money, easy credit, and low interest rates with easy money, easy credit and low interest rates. The Government is now supporting risk taking, with our bailed-out banks having little to lose. The Stag-Deflation is on.

The US Economy is dedicated to consumption. Consumption was 70.52% of GDP, in the 3rd Quarter of 2008. If Consumption falls, GDP falls, and if it falls far enough, we get a recession, or even worse, a depression.



Note the parabolic growth in consumption starting in 1980. The US consumer went on a buying spree due to easy credit, low interest rates and the “Wealth Effect”. The Wealth Effect is that wonderful emotional feeling you get, when assets you own go up in value (like your home and stocks). This increase in paper wealth creates the illusion that you can spend more because your wealth is rising. The US consumer borrowed on his new found wealth, and spent it on consumable goods, not appreciating assets. The average individual does not realize that it’s only wealth creation if you sell it.

Besides blowing money and over levering, the consumer bought a home with no money down, and without anyone checking his credit or his ability to pay. And look what happened. The housing prices declined and the market collapsed. For an encore, he just lost 50% of his retirement plan and/or his personal investment account in the stock market. DO YOU SERIOUSLY BELIEVE THE US CONSUMER IS NOW GOING TO GO OUT AND BUY/LEASE NEW CARS, BIG SCREEN TV’s, AND A NEW HOME? DO YOU REALLY THINK HE’S GOING TO POUR MORE MONEY INTO THE STOCK MARKET? I’LL BET YA THE US CONSIMER IS WORRYING ABOUT HIS JOB. ANY MONEY HE GETS FROM A BAIL OUT WILL BE USED TO PAY DOWN DEBT. IF HE HAS ANYTHING LEFT (WHICH IS DOUBTFUL), HE WILL BUY A PRAYER RUG.





The socialization of America is under way. The Government owns the Auto Industry, the Mortgage conduits (Fannie May, and Freddie Mac), Bear Sterns, and controls numerous big City Banks. The Government is now encouraging us to: spend money by giving us Income Tax Credits; and borrow money because interest rates are at all time lows. ARE THEY NUTS? Isn’t this how we got our self into this mess!

Look at the poor commodity market below. It’s a blood bath. Commodities tell us that Deflation has started.



Now we hear that our Government is very upset with the banks that got the bail out funds. They aren’t lending the money. As of this date we (the people that actually paid for the Bail-Out) don’t know who got the money. The Government is now putting pressure on the Banks to make loans. This means that the poorest credit risks will receive bank funds (taxpayer money), and once again the taxpayer takes a big hit.

The Government also wants to bail-out the poor foreclosed home owner. By lowering his interest rates and adding years to the payout, the homeowner is now supposed to be able to afford the mortgage. Isn’t it highly probable, that the sub-prime borrower is the first to be unemployed? Whatever the Government does to save foreclosed homeowners, only defers the ultimate foreclosure and collapse of credit. Anyone want to own a Mortgage Company?

The other great idea our Government has is to resurrect a plan that did not work in the Great Depression and certainly won’t work this time. Namely, get money out to the “shovel ready” infrastructure projects. This concept will put some folks to work with pay, and may be a benefit to the US Economy in the long run. However, how many “shovel ready” projects do you think exist? Translation: throw the money around as quickly as possible at hastily “dreamed up” projects that have no chance of being efficient. I see projects like building bridges, tea gardens, etc. The Government will of course impose environmental constraints on all of their projects. Just imagine the lobbyists running amuck finding “shovel ready” projects for their Brother, Mother, Uncles and Aunts. The result: another boondoggle, with little improvement in our current situation, and we all go deeper in debt.

President elect Obama has a plan that creates 3.5 Million jobs at a cost of $775 Billion (trust me; Congress will spend a lot more on this monkey business). This translates to an expenditure of $221,400 per new job. What not just give everybody $2,500 Tax Free?

The zero maturity money (money market funds) is now on the rise again growing at more than 10% for the year (See chart below). The world is awash in money and no one is taking any risk. Investors, out of fear, have driven the 90 Day T-Bill to a yield of .11% on 12/31/08. This build up of liquidity coupled with an unbelievable increase in Bank Reserves (printing press money), and low interest rates, sets the stage for the next bubble.

Economists and Financial Analysts base there work normally on past history. The Economic and Financial Models are all very sophisticated and contain elaborate equations that purport to forecast the future. The models are always based on past history and assorted assumptions. From 1965 to 1972 I ran complex models to forecast future Economic and Investment levels. I always achieved the same forecast results: Some I got right, some I got wrong, and mostly I got really wrong. Economists call the difference between what actually occurs and mathematical Forecasts as “white Noise”. What the mathematical models fail to take into account is the “people factor”. Investor and Consumer Psychology play’s a major role in determining outcomes in Finance and the Economy.



The human element needed in all equations, is: what is the investors current experience with investments? What is the consumer’s outlook for the future? In my view the investor is tired of losing money, and the consumer wants to keep his job, get out of debt, and save some money. Soon or later they all change their mind and return to taking risk and spending, but for now I find it highly improbable.

In my view the Recession will last past 2009 and probably end some time in 2010. Falling prices, slow to negative growth, and declining asset prices is our immediate future. Hold on to your cash, get out of debt, and stay close to your family and friends. The only risk you should take is going to and coming home from work.

DEFLATION OR INFLATION OR WHO'S GOING TO FINANCE THIS MESS?

The chart below indicates the relationship between US Public Debt and Gross Developed Product (GDP) of the USA from 1919 until 2008. The ratio peaked in 1946 (World War II), and slowly declined until 1981. It took 35 years to “pay down” the debt created during World War II. Notice that during the great depression the ratio actually fell in 1929 to 16.34% and then rose to the 40% level until the War started. By 1985 the ratio was higher than the pre war level. Our Government (like the American Consumer) love’s borrowing money and blowing it. I estimate that the current US Public Debt of $10 Trillion will rise to $18 Trillion by 2009. I am also assuming GDP drops .79% to 14.4 Trillion in 2009. If the “creation of Government Debt” is greater than a net $8 Trillion and/or the GDP drops more than my estimates, the ratio will be worse. The Ratio by 2009 will be higher that the War high.



The point is not, gosh wowee; look at the spike in the chart; but rather, who’s going to buy all these Bonds? Remember, after the War started, the USA was the odds on favorite to win the War. Of course after the War, the USA controlled the free World, and was the most prosperous power on Earth. The US Dollar was Gold.

We have a much different structure today. We have managed to transfer our “Wealth” to other Nations that have a vested interest in our Economic system (Russia, China, India, Brazil, the Arab Countries, etc). If you ran the Chinese Government’s financial system, would you feel comfortable holding Dollars and Dollar denominated investments? I think not! The World is awash in our dollars and Treasury Obligations.



The Chart above shows what Economists call High Powered Money (HPM) and/or the Monetary Base. HPM is the sum of Currency in Circulation and Bank Reserves.
Increases in HPM allow the Banking System to “print money”. Note that the current HPM total sets a world record high.

What does this mean? The USA is printing money big time. How does this process manufacture money? There are three parts to the printing of money; The Central Bank (Federal Reserve), Commercial Banks, Savings and Loans, Credit Units etc, and us. The Federal Reserve controls the Bank Reserves portion of HPM, and we control Currency in Circulation. Every time you deposit currency in your bank account you increase HPM. Conversely, when you withdraw currency from your bank account you decrease HPM. It was the mammoth withdrawals of currency that accelerated the Great Depression and led to collapse of the Banking System.

The Federal Reserve is allowed to write checks to buy assets, or loan money, without any constraints. Banks, as a generalization, are required to deposit with the Federal Reserve a “reserve” which is defined as a percentage of their Demand Deposits (the money they owe their depositors). The table below illustrates what happens if for example the Federal Reserve Buy’s $100 of US T-Bonds in the open market. The same example could be used if a depositor placed $100 in currency into their bank account.

In the example below the Reserve Requirement is assumed to be 10%. Note that the simple purchase of $100 of Bonds expands the money supple to $1,000 and increases credit (loans receivable) to $900.



Monetary expansion is merely a pyramid game. However, when the bubble bursts, we experience the reverse. All the bad credit blows up. When credit expansion blows up, asset values blow up. The contraction then feeds on itself

In October and November HPM increased $532.637 Billion dollars. The reserve requirement is about 10% so the theoretical expansion of the money supply is 10 times or $5.326 Trillion and the expansion of credit is $4.794 Trillion dollars. To put this into perspective M1 (money supply) in October was $1.46 Trillion. This ladies and gentlemen is a whopper! Our money creation is now on crack!

There are several points to make at this point: (1) the expansion of this process does not happen quickly. Each bank must want to loan money, and it takes time to complete a loan. (2) there is leakage to the expansion of credit.

However, the bail-out is not over. Billions and Billions of dollars are going out the window to banks, credit card companies, auto manufacturers, and anybody else who is “too big to fail”. All under the “headline” of preventing Deflation.

In my opinion, we are in a deflation mode. The unwinding of credit and the collapse of its related assets could take many years. The investment strategy in deflation is to stay liquid and out of debt. For example, by paying more than the minimum payment on your mortgage earns you the interest rate charged. Unless your mortgage rate is less than the 10 Year US T-Bond of 2.657% I suggest you double up.

When all the money creation is through, we will finally be confronted with Inflation. When Inflation takes hold we finally return to the wonderful days of leveraging and spending money like Bozo’s. Hang on, you will survive. Uncle Sam to the rescue!

Bail Everybody Out!

I was recently talking to various office workers, asking them what they thought of the outcome of the recent election. They were excited. I asked them why? They pointed out that the Government bailout of mortgages and the advertised 90 day mortgage moratorium on foreclosures, gives them a unique opportunity to: (1) have their Mortgage Interest Rate reduced; (2) gives them a 90 day grace period for which they don’t have to make mortgage payments; (3) will allow them to get a major discount on their unpaid principal.

They stopped making mortgage payments, and look forward to Foreclosure. MANY PEOPLE CAN MAKE THEIR MORTGAGE PAYMENTS, BUT SEE A FREE LUNCH COMING, THANKS TO OUR WONDERFUL GOVERNMENT BAIL OUT PROGRAM. The Feds will probably allow an upside for the Mortgage holder but who’s going to monitor this? The “defaulters” tell me that their credit rating will be hurt in the short term, but who needs credit? Nine months from now their credit rating will be fine. Obviously the Lunch will be paid for by us – the US Taxpayer. Our Government calls this program “Mortgage Forbearance and Mortgage Modification”. Don’t you love it! Anybody want to become a Mortgage Lender?

On another front many Banks have applied for hand outs from the Feds. They don’t need the Capital, but since it’s there, why not take it. Only in America. I can’t make this stuff up. Meanwhile, the Banks that are really in trouble can’t seem to get help. Finance companies have now become Banks (American Express Goldman Sachs etc)

The stimulus program that was implemented this summer with Tax Rebates to the poor - backfired. The poor saved their money or paid down debt, rather than blowing it on a big screen TV’s. Now comes another boondoggle spending stimulus program. Caroline Baum, an Economist for Bloomberg writes that a Federal Stimulus program is coming, and will pass congress quickly (like in the next 60 days). To get the program started quickly, she writes, “The spending will be focused on infrastructure, things like roads and bridges. Unless this time is different, the money won’t necessarily be allocated efficiently.” In the same article, Jim Glassman, senior US Economist at JP Morgan Chase & Co says: “…there is no plan to assess the cost of sitting in traffic jams, for example. So we get irrational things: The money goes to building bridges.”

The theory that the Stock Market does much better with a Democrat as President is nonsense. Greg Mankiw (Harvard University Economics Professor) says “…the perceived relationship between the president’s party and the stock market is meaningless.” Geoffrey Hirsch, editor in chief of the Stock Trader’s Almanac says that the Stock Market prefers gridlock. That is, no one party controls the ability to control legislation. Hirsch’s data support the idea that gridlock is best for the stock market with a Democratic president and GOP Congress yielding the maximum results: an average gain in the Dow OF 19.50%. No such luck for 2009-2010.

The talking heads tell us that you have to buy stocks for the long term. Ten Years, long enough? Below is the Monthly Compound Yield at Nominal Annual Rates for a ten year holding period from December 1909 to November 30, 2008.



Note that anybody that bought the SP 500 in November 1999 lost money for the ten year period which includes dividends. To go 10 years and lose money on anything is just awful. Also note, that those that bought stocks in 1930 lost money. Although the average yield for the period of 10 years was 9.38% (a Standard Deviation unit of 4.90%), I think the days of holding stocks for ever is not well advised.

Now take a gander at the chart below that provides the same information but is adjusted for inflation. Now the game changes, as the average yield is 6.89% with a Standard Deviation Unit of 5.36%. Not a lot of room for error. If you further adjust this for Federal and State Income Taxes (the tax rate on dividends, and capital gains) the yields have to be even worse.

When I was a senior in College (1958), the text books on investments said the value of any asset today is equal to the present value of the Cash Flow (income) plus the present value of the Residual (principal) using an appropriate interest rate. The Dividends were relatively easy to project over a given time span, but the Residual was always tough.



In theory it’s a great idea. However, in implementing the math to figure out the correct value of a stock is mind boggling. To compute the current value of a stock based on a 5 year projection you need to estimate: Earnings Growth, the Estimated PE multiple in 5 years, and what your required investment yield is over the next 5 years. There are 5,000 financial wizards willing to give you their research identifying all the variables outlined above. However the reality is an earnings estimate is at best close to the truth and at worst totally bogus. Look at the Banks Earnings. If you believe any their Earnings Reports, you must also believe in the Tooth Fairy. Who in the world can forecast correctly the Growth rate of earnings, over the next 5 years? How about forecasting correctly the PE multiple in 5 years? Do you know your required yield to justify buying a given stock? How do you know when stocks are cheap? Are they cheap relative to the past?

In the good old days (prior to the creation of retirement plans), Most stocks paid dividends of about 6.00% and had modest PE multiples (6 to 12 Times). The common investor had a shot at making some money. With the advent of 401K’s and other “tax free” retirement plans, Wall Street responded. Mutual Funds grew at an alarming rate offering the poor working man a potpourri of choices that included: Growth-Big Cap, Growth-Small Cap, Blended Growth, No Growth-Big Cap etc. Then Wall Street gave us ETF’s (Exchange Traded Funds) that allows an investor to get into any single purpose investment medium you can think of. You name it, they got it. FAN is a ETF that owns Wind Mill generating Companies, TAN is an ETF that owns Solar Energy Companies. You can buy shares in ETF’s that represent every Country on this planet: India, Russia, Hong Kong, Brazil, Mexico, and Bulgaria. They even have an ETF (symbol VICEX) that invests in Tobacco, Liquor and Firearms stocks. All these choices, for which the pour individual investor has no idea what he just bought, and worse yet, has no idea how the Economy Works.

The bubble in my opinion is not only in Real Estate, but just about every investment alternative on this planet. There are too many Common Stocks, too many Mutual Funds, too many ETF’s, too many Bonds, and too much money chasing too many securities. God help us!

Below is a chart of the ratio between the S&P 500 Stock Index and the price of Gold per Ounce. In December, 1947, .3123 ounces of Gold bought 1 share of the S&P 500



By December 1968, 2.5262 ounces of Gold bought 1 share of the S&P 500. The low of the graph was in January, 1980 when .1573 ounces of Gold bought 1 share of the S&P, and the high was booked August, 2000 when 5.4135 ounces of Gold bought 1 share of the S&P 500. Note the decline in the S&P relative to Gold since 2000.

As Richard Russell said recently in his daily newsletter “Dow Theory Letters” (http://ww1.dowtheoryletters.com/dtlol.nsf), (I Paraphrase) - Buy lumber and paper stocks, the Federal Reserve will be printing money at an exponential rate.
He said this with tongue firmly in cheek, but the part about printing money is for sure. You can count on it.

Congress, the new President, and the Federal Reserve will not allow our Economy to go into deflation. Our Government Deflation therapy suggests bail everybody out. If you are not a Bank, Investment Company, Insurance Company, a Business with no profitable business plan but lots of employees, or totally stupid in understanding what you agree to, you are on your own!

The Auto Companies will surely be bailed out. Why? Because - they are too big to fail. They probable would have said the same thing about the Buggy Whip business it its time. Look at General Motors Financial Statistics since 1992. Average profit margin on sales = .43%. Average growth in earnings = negative 10.71%. Net Earnings for the year 2005 = Loss $10.567 Billion, 2006 = Loss $1.978 Billion, 2007 = Loss $38.732 Billion, Quarters ending 3/31/08 = Loss $3.251 Billion, Quarter ending 6/30/08 = Loss $15.471 Billion. Net tangible Net Worth 6/30/08 = Negative $58.04 Billion. They are technically bankrupt. And we are going to save them!

Boys and Girls and members of the Jury, you’re on your own. This is the new era in which the stupid get bailed out, and we get the bill.

Hold on to your Capital. Keep it save. Get out of Debt. Love your Family, and hang on! This will be a long Recession, manifested by the Bozo’s that now run our lives - Washington.

I Just Love "Bail Outs"!

“THE NATIONAL BUDGET MUST BE BALANCED. THE PUBLIC DEBT MUST BE REDUCED; THE ARROGANCE OF THE AUTHORITIES MUST BE MODERATED AND CONTROLLED…IF THE NATION DOESN’T WANT TO GO BANKRUPT, THE PEOPLE MUST AGAIN LEARN TO WORK, INSTEAD OF LIVING ON PUBLIC ASSISTANCE”
CICERO (106BC - 43 BC), 55BC

The “bubbles” have burst. The “bubbles” I am referring to (not necessarily in any meaningful order) are: Residential Housing, the Stock Market, Commodity Prices, Bank Credit, All Bonds collateralized by other assets such as Mortgages, Credit Cards, Rents etc, Derivatives of any kind, the US and Foreign Economies, and anything else you can think of that uses leverage. When interest rates are held artificially low, personal and Government spending run amuck, and credit is given to one and all without regard to repayment, you get bubbles.

I have attached some charts that tell the sad story of the consequences of too much credit. The chart below shows the poor consumer’s ratio of installment debt to personal income (in %). It’s no coincidence that the ratio is at all time historical highs. Just imagine what happens when you assemble a pool of this kind of debt (Credit Cards) and issue Bonds secured by the cash flow of debt payments. When credit card debt is not paid, the bonds can’t pay their principal and interest, and the holders of this toxic asset are out of luck.



What’s next for credit card debt and bonds issued against them? More credit contraction and/or Bail Outs. So the Consumer is up to his norkis in debt and now unemployment is on the rise. The chart below shows the unemployment rate (inverted scale). Below +1 is abnormal and recessionary. It probably will go to +2 or more over the next twelve months. This event has happened only 3 times since December 1968. The consumer is in trouble.

Next we have a friendly chart of what Economists call the Monetary Base. The in crowd calls it High Powered Money. The Monetary Base consists of Currency in circulation (which the Federal Reserve does not control, and Bank Reserves (which the Federal Reserve does control). This “money” determines how much Money Supply can be created (“Printed”). In the Depression, currency in circulation increased dramatically due to bank failures, (the folks decided to take their money out of the banks and put it in their mattress). This in turn decreased the amount of money the banking system had to lend (Money Supply), which added fuel to the fire in aiding and abetting the depression. Normally when this indicator rises you can expect the Inflation Rate to rise within 6 to 18 months. The Federal Reserve increased the Monetary Base materially the past two months. Note the current spike reflecting their pumping reserves into the banking system. The reserves were increased to save our wonderful Financial System. Expect bigger spikes over the next 12 months.





Below is the S&P 500 Stock Index Annual compound yield including Dividends, from December 1901 to October 2008. Note the negative yield in October 2008, is the lowest since the Great Depression and World War 2. Also shown is the Annual Compound % Change in the S&P 500 earnings per share. The earnings from the fourth Quarter 2008 through 2009 are estimates made by our trusted stock brokerage financial analysts. It is highly probable that their estimates are too high.

The stock market Gurus have decided the market has hit bottom, and we should all be buying. Note in the Depression, the largest decline occurred well after the initial collapse in October, 1929.





The pundits talked about a de-coupling of our Economy from the rest of the World. They were obviously wrong. What happens in the US affects the Economies and Markets of the World. The US and World economies are and have been in a recession. In my opinion this will be a long and drawn out decline. Rising Unemployment and the decline of Business and Consumer spending will continue to drive down the Economy. The Federal Reserve and your and my Congress have created an expansion of the Credit, Bank Reserves, and Money Supply that is unparalleled in our wonderful but short history. Although these actions are inflationary in the long run, they will tend to stabilize credit over the next 12 months. Below is a chart of my leading indicators through September 2008.



The indicator is below -1 and heading towards -2. Below or equal to -1 is a recession. I think the above chart will approach or decline more than the 1974 recession. Note, I have estimated the recession lasting through 2009.

So what does this all mean? We have a major adjustment in our Economy regarding spending and credit habits, a credit contraction, a major asset contraction (housing, commodities and the stock market) and increasing US debt and Money Supply. This translates to Deflation and Inflation. Debt contractions are Deflationary and Increasing Money Supply is Inflationary. It is the War of the Gilas Monsters.

In the great depression, 90 day T-Bill rates were negative, and 30 year Treasury Bonds yielded less than 3.00%. As of November 3, 2008 the 90 day T-Bill Yielded .49% and the 30 Year Treasury bond Yield was 4.321% and appears to be rising. The Bond market is of no current help, other than reflecting the tug and pull of the contrasting economic conditions. The short rates reflect fear, and the long rates reflect inflation expectations, yet the spread on 10 year T-Bills and the 10 Year US Inflation index Bond implies low inflation expectations. The War is on. The winner will be determined within 12 months.

The stock market has been seriously injured, and should take a long time to recover. The average investor has lost 50% of his capital and is not real happy. Retirement plans have been destroyed. The mob psychology of a Bear Market is ugly. Many of the participants do not return to the market for long periods of time. In the 1974 fall, many individual investors “swore off” the stock market and never returned. The only thing that brought the market back was time and Retirement Plans.

The Chart below indicates the Annual yield that occurred if you bought the S&P 500 Index and held it for 10 years, and collected all the dividends. For the 10 years ended October 31, 2008 the Annual Yield (with monthly compounding) for 10 years was .22%. That means for a $1 invested in October 1999, you would have got back $1.022 for a profit of 2 Cents. Not real shiny. However, don’t give up on the market since the average annual yield for a 10 Year holding period from December 1909 to the present was 9.3861%. That means you would make $2.5471 times your investment in 10 years for a profit of $1.5471.

So the question is - if you are a long term investor, do you invest now?



Those that invested in October 1919 and sold in October 1929 received a 10 Year yield of 12.92% (not bad). If you had invested in October 1929 and sold in October 1939 you would have a yield of minus 1.20% (not so good). If you invested in October 1929 and sold 1 year later in October 1930, you would have a minus 32.61% yield. However, if you had the good fortune to invest at the all time market low of 4.77 in June 1932, and sold one year later in June 1933, your yield would have been 126.01%.

My answer is simple. Due to the damage done to the market by the recent collapse, I think new lows are ahead. I would rather preserve capital and watch from the sidelines as events unfold. Market bottoms are impossible to time, but easily recognized after they occur. To miss a bottom is not a sin: to buy into a false bottom is. In the interim, I choose to preserve Capital.