A Faux Boom Built on Phony Money

There are good booms…and then there are bad booms.

A good boom is like the one following WWII. Real money was invested. Production increased. Real savings were spent. Wages increased. Profits increased. At the end of the boom, people were wealthier than they were at the beginning of it.

A bad boom is based on bad money. When the Fed (actually the Treasury) prints up an extra dollar bill, the gesture lacks sincerity; like a duelist who first smiles and shakes your hand, then walks back twenty paces and pulls a trigger; you know he didn’t really mean it. Instead of being built on real savings, the faux boom is built on monetary inflation and credit. And when it comes to an end, people are no better off. Their money is worth less than it used to be. And the average fellow has dug himself deeper into debt in order to enjoy the boom years.

“But many people really have gotten much richer during this boom, haven’t they?” you might ask.

Yes, a crack-up boom is fundamentally a financial boom. Money comes into the system – a lot of it. People don’t know it’s phony money; they can’t tell the difference. This money hangs around the financial industry and everyone there has a good time. But society, as a whole, is not any richer because Monet paintings are more expensive…or because stocks are more expensive…or because a hedge fund manager makes a billion dollars. Society is richer when people generally earn higher wages, stash away more savings, and pay down debt. That is not what is happening.

“Well, okay, maybe in the end, a lot of people regret it…in the meantime, why not join the fun?”

Be our guest. Buy a Warhol. Put some money into China. Get a parking space in New York for $225,000.

Better yet, start a hedge fun. That’s the best way…make “2 and 20” on other peoples’ money. Take big risks…the bigger the better. Heck, the bigger the risk, the more you’ll make…right up until the end. Then, of course, the hedge fund will get wiped out. But what do you care? The investors will take the loss.

Which, of course, raises a key question: “When will this boom end?”

Heck…if we knew that…we might even be tempted to charge something for this Daily Reckoning, rather than give it away for free.

But our dear readers, being persistent fellows, have more questions.

“Well, why do you keep your Crash Alert flag flying?” they want to know. “Isn’t it because you expect a crash?”

Actually, we confess we don’t. You can’t predict how these things will go. We wouldn’t be terribly surprised to see U.S. stocks shoot up a lot higher, for example. There could be a kind of hyper blow-off in several financial markets, before the end comes. Or, the Dow could crash tomorrow.

We fly the Crash Alert flag to remind ourselves – and you – that this is a very dangerous market. Since it is a crack-up boom, and not a healthy boom, it is fundamentally unstable. And we do not see any easy investment opportunities in it. Yes, there are plenty of speculative opportunities. There are plenty of things that could go higher. But there are relatively few that are priced so low – stocks that give you so much value for your money – that you don’t care if they go up.

Remember, a good investment is something you want to own – because it is a solid, growing business that pays you a nice dividend. “Tangible assets that sweat”, as our friend Chris Mayer calls them. He looks for companies have assets with real value in the marketplace – hard assets that the company actually owns – cash, land, equipment.

By paying close attention to tangible assets that sweat, you build in a healthy margin of safety to protect your money from any downturn. Find out which companies Chris is looking at right now.

A good investment is not something you buy, hoping it will go up so you can sell it to someone else.

Remember too, that most people earn their money from a business or a job. The stock market is merely a place to put money so it will be available later in life – modestly enhanced by time and compounded earnings. The worst thing that can happen for most people is to place their money in a speculative market and then lose half to two-thirds of their wealth. In other words, the risk of losing money in the stock market trumps the hope of making more.

“So what should we be doing with our money?”

Of course, there are still good investments – even in over-priced, over-hyped, speculative markets. Not many, but there are some. A good stock researcher can always find them.

And there are some stock markets that offer better value than others. Japan, for example, looks like a good bet. While the Dow generally rose, over the last 17 years…the Nikkei Dow generally fell. Now, stocks in Japan seem to be finding their feet. Japan has a huge trade surplus. A deep well of savings. Efficient, productive industries. And it seems especially well positioned to benefit from economic growth in Asia, generally.

Japan offers another advantage – currency diversification. Besides the real danger of a stock market crash, there is also the real danger of a dollar crash. In fact, the whole worldwide super-bubble can be traced to the inflation of the buck. Eventually, we expect the world will get sick of dollars.

It seems like it already has. Just last week, for example, Iran told its Japanese customers that henceforth it wanted to be paid in yen. It is not the first country…and won’t be the last…to want to turn its back on the dollar. Americans might do well, too, to keep a little bit of their wealth out of dollars…just in case.

A crack-up boom is an inflationary boom. Inflation of the currency typically leads to inflation of asset prices followed by inflation of consumer prices. While the rich enjoy it when their assets go up in price, the poor and middle classes get cheesed off when prices of milk and bread rise. They stop spending as much. And sooner or later, investors begin to worry whether the boom is all it is cracked up to be. That is when they begin buying gold, first to protect themselves…and later to make speculative profits.

Paul Kasriel of Northern Trust suggests that the second quarter slow down in consumer spending this year will cut into growth later in the year. As a result, he predicts, real GDP growth (which rebounded slightly in the second-quarter), is going to fall back in the second half to about 1.7% annualized rather than the consensus forecast of 2.7%. But, although Kasriel suggests that the slow down in spending will hold some consumer prices down, he still thinks food and energy prices will go up. Even if the boom starts staggering, your gas and your groceries are going to cost you a lot more.

Yet, on paper…officially…there is very little consumer price inflation now…and very little gold buying.

Not even any speculative frenzy in the U.S. stock market. And, of course, we’ve yet to see a crash. We’re thankful. That means there’s so much more to look forward to!

Bill Bonner
The Daily Reckoning
London, England
Monday, July 16, 2007

More news:


Addison Wiggin, reporting from Baltimore…

“On Friday, the Iranians insisted that Japan pay for all its oil with yen, not dollars. Earlier in the year, Iran’s central bank announced it would be cutting their dollar reserves to less than 20%. Since Japan is on track to spend at least $10 billion on Iranian oil this year alone – it’s a likely place to start.

“Iran is technically a foe of the United States, so their move away from dollar reserves doesn’t wrankle too many feathers in DC… yet. If other countries were to follow suit, like Kuwait did earlier this year, well, then the currency markets would really begin to get interesting.”

For the rest of this story, and for more market insights, see today’s issue of The 5 Min. Forecast


And more thoughts…

*** “Agriculture has gone crazy,” said a farmer we spoke to over the weekend. “We’re getting prices that are twice what they were four years ago. Everyone is planting as much as possible. Of course, in our industry, you can’t know what will happen. You get a bad harvest in Australia or America and prices can go up – even though a record amount was planted.

“But what is really creating havoc is the switch to biofuels. It’s amazing how everyone seems to have grabbed onto that idea as the solution to global warming. But it takes huge amounts of grain to produce significant outputs of fuels. And then, the grain takes huge amounts of inputs – land, water, fertilizer, fuel. I’m not sure that it benefits the earth at all…in terms of the hydrocarbons that it produces, but there is no question that it benefits the farmers. All grain prices are up. If we get a good harvest this year, it will be a very good year for farmers in Europe. We had a lot of water…and now we need some hot, dry days…”

One unintended consequence of all the loose money has been tight farm supplies. Inventories of grains are said to be at their lowest level in 30 years. And an international study said food prices rose 23% in the last 18 months.

This rise in food prices isn’t good if you are trying to buy groceries for the week…but if you are positioned properly in the commodities market, you could stand to turn a nice profit. In fact, Kevin Kerr’s Resource Trader Alert subscribers have made 304% in 2 weeks on soybean call options, 125% in 3 weeks on coffee call options, 155% in 3 weeks on live cattle call options – and that doesn’t even scratch the surface.

See his entire track record – and find out how to make some of that grocery money back.

More dollars in circulation puts more cars on the roads…and more air-conditioners in windows…and more electrons flowing through wires all over the planet. Encouraged to come up with a solution to the energy/global warming crisis, farmers discovered a whole new market for their production – making fuel. They are taking food for humans and turning it into food for machines – just at a time when more and more humans want more and more food themselves. As people get richer, they typically move up the food chain – preferring to get more of their calories from meat, which requires more grains to rise. But now, humans compete with machines for farm output…and farm prices are rising.

“Groceries gobble up budgets,” says a headline in the Sun-Sentinel, from sunny South Florida.

And an item in the weekend news tells us that the U.N. says it can no longer afford its World Food Program, which benefited 90 million of the world’s poorest people.

Ben Bernanke is expected to worry about rising food prices when he talks to Congress this week. But the poor Fed chief is in a tight spot. He needs to raise interest rates to head off consumer price inflation. What will that do the housing situation, he must wonder…

The Daily Reckoning PRESENTS: This week, the Mogambo grabs a calculator instead of an Uzi, and calculates a terrible truth about the mortgage market – all the while sadly pushing one economist to the brink of madness. Read on…


“$5 Trillion in Housing Wealth gone: The Impact of the Housing Bubble Bursting” by a guy named Dr. Housing Bubble, which is such a weird name that one can only shake one’s head in wonder at what in the hell his parents were thinking when they named him!

But unusual moniker aside, he figures that the Fed and the banks providing unlimited amounts of money to create the real estate bubble (which I sarcastically note was created by the Fed and Congress to bail out the busted stock market bubble in 2000, which the Fed also provided the financing for) has created $5 trillion in “bubble wealth.”

The significance of this is that “$5 trillion in bubble wealth has created an extra $250 billion in consumption that would not be present if it were not for the housing bubble. This works out to be 2 percent of our GDP; in other words, without that wealth we would already be in a recession.”

And now it’s gone. You do the math.

And speaking of houses, in Barron’s this week we learn that Macro Mavens estimates that “based on the share of ARMs in some state of negative equity at the end of last year and the decline in home prices so far in 2007, a stunning $693 billion in mortgage loans are already in the red.” Wow!

And even worse, “Assuming lenders are able to recover 70% of those assets – which seems optimistic given the massive amount of housing inventory yet to be unwound – that means mortgage lenders are already grappling with $210 billion in outright losses.”

And worse – much, much worse – is that based on the insanely risky degree of leverage that is so pandemic these days, “the total financial exposure to these claims is many multiples of that.”

Mike Larson at Money and Markets hears me absently babbling incoherently at this shocking revelation, and adds to my misery by saying, “The Mortgage Bankers Association says 0.58% of ALL mortgages entered foreclosure in the first three months of this year. That’s the highest level in U.S. history!”

Grabbing a calculator instead of an Uzi (as is my usual response to stark terror), I find that this means that about 1-in-200 homes in America are in foreclosure! Yikes!

But Mr. Larson is not impressed with my impressive math skills, and ignoring me completely goes on to say, “A whopping 14.51% of a specific group of subprime mortgages made in the second half of 2006 are already either being paid late, in foreclosure, or in a position where the underlying property has been seized. That’s simply amazing considering these loans are less than a year old!”

And it gets worse when he reports that loans made in the first half of 2006 are performing even worse, and “Almost 18% of them are failing.”

I was going to ask, “What about the ones made in 2005?”, but I sensed that I would discover that I would rather not know, so I kept my mouth shut for once in my life.

And the news that “foreclosed properties are popping up all over the place” is made worse because, “They typically aren’t as well-maintained as inhabited homes or even ‘regular’ homes for sale. Some have even been stripped of all their fixtures, wiring, and piping.”

So how does a gutted, derelict eyesore affect surrounding property prices? Ask my neighbors and find out! They never seem to tire of telling me how my ratty little house has ruined the values of the whole neighborhood and how gun barrels sticking out of the windows aren’t helping, either, and all this aside from the fact that I am hateful and dangerous and blah blah blah.

So, attempting to be a good neighbor, I helpfully and politely try to convince them to just pack their crap, move out and go someplace else, which I do by thoughtfully throwing my garbage on their lawns all the time. But then – get this! – they get all bent out of shape about that, too! I mean, I’m damned if I do, and damned if I don’t! You can’t please those jerks!

But this is not about how my neighbors are all a bunch of whiners who can’t mind their own business, but about money and mortgages, and if people don’t have the money to pay their mortgages, then that may explain why consumer credit rose at an annual rate of 6.4% in May.

The stunning statistic was that the majority of the additional borrowing was by people using their credit cards, and their “total debt and death by plastic” increased at an annual rate of 9.8%! Yikes!

And what were they buying? Well, I hear that an estimated 700,000 of Apple’s new iPhones were sold on the first day they were put on sale. And most iPhone buyers opted for the more expensive eight-gigabyte model, too, which retailed for $599!

Until next week,

The Mogambo Guru
for The Daily Reckoning
July 16, 2007

Mogambo sez: As the currency falls, gold, silver and oil rise. They always have when the economic situation got this bad, and they are now, too. “How much will they rise?”, you ask. I dunno.

But maybe Rob McEwen of Sprott Asset Management knows, as he said, “by the end of 2010 I believe it will be between $2,000 and $5,000 U.S. an ounce.”

A 750% return in three years? Wow! Sounds good to me! And I’ll bet it sounds good to you, too!

Editor’s Note: This year, the Mighty Mogambo is actually going to bravely exit his Big Mogambo Bunker (BMB) in order to speak at the Agora Financial Investment Symposium in Vancouver, British Columbia. Don’t miss this opportunity to hear his rants live, on why “We are all Freaking Doomed!”

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.