Billion-Dollar Protectionist Measures

We’re cut off from the financial news…and happy for it. We’re taking a mini-vacation this weekend.

The book by Mr. Coleman, that we quoted yesterday, made us realize how much foreigners hate Americans. Or, at least it made us wonder about it…

Why should they hate us? It’s probably more complex than that…they probably hate us, love us, envy us and despise us all at the same time. America is the cop on the beat…walking all over the globe with a very big stick in his hand. The United States spends almost as much on its military as all other nations combined. And it spends an unknown sum on its secret services…for unknown services. That’s just what an empire does.

Some people are pleased to see the United States policing the world; they wish it would do more. Others don’t appreciate America’s protection services.

It is all very natural and normal. The imperial power has certain prerogatives, responsibilities and pretensions; it’s bound to stir up resentment in certain quarters. It is also bound to do what empires do.

Temptation is irresistible at all levels – to organized nations…as well as to individuals. To the question – “when will a person do something to excess?” – comes the ready answer: As soon as he thinks he can get away with it. When too much credit is offered a man, with no apparent punishment forthcoming, he will avail himself of it. And when a nation finds it can throw its weight around – it will do so. We know of no counter-examples. Egypt, Greece, Rome, Persia, the Mongols, the Chinese, the French, the British, the Germans, the Japanese…and now the Americans. Give a nation big guns and big battalions…and the temptation to use them is irresistible. Naturally, those that are being bossed around don’t like it very much. Eventually, they get even.

(And that, dear reader, is the subject of a new book by your editor, co-authored with colleague, Lila Rajiva. Why do crowds of people go nuts…and do crazy things? No one ever bothered to explain it – until now! Coming soon…to bookstores near you.)

But every episode of imperial history has its nuances. The thought crossed our mind yesterday as we were making our way through Stansted Airport. The lines were shorter, and the capos were politer, but it was almost as bad as going through an American airport. They’d installed a machine we had never seen before – an X-ray machine just for shoes. So, after going through security, our shoes had to go through a security of their own. From the tiniest pair of toddler shoes to the clunkiest “goth” butt-kickers…everyone’s shoes went through the machines.

How many people have actually been harmed by a pair of shoes, we wondered? How many people have actually been killed by airborne terrorists? How many have been killed by terrorists at all? On our flight to Dublin we saw not a single person who looked like he wanted to blow up the plane. Since the most spectacular terrorist incident in history, terrorists have led a fairly quiet life – at least in the West. Britain has seen the most activity; the typical terrorist, we now know, holds a U.K. passport and works as a doctor for the National Health Service! What we also know is that everything we were told about terrorists was a lie.

They are not desperately poor people. They are not uneducated. They are not without opportunities in the secular world. They are not even very religious. According to the report on 9/11, some of the terrorists entertained themselves before the attack by going to a lap-dance bar.

Importantly, they are not very many. And they are not very competent. If they plant a bomb somewhere, odds are fairly good that it won’t go off. If they concoct a shoe-bomb…it won’t even blow off their foot. It is as if they were pretending to be terrorists…playing the part, rather than actually causing much havoc.

Of course, there are a few well-known exceptions. The London subway…the Madrid commuter train…the Twin Towers. But if the worldwide terrorist threat were really what it is made out to be, it is surprising there are so few serious incidents.

Maybe we’re missing something. But it would seem to be such an easy thing to derail a crowded train…to set off a smoke bomb in a crowded subway…to hijack a big bus and drive it into a crowded market? Even to stampede a crowd and kill dozens – it could be done without weapons. Terrorists so far have displayed a remarkable lack of initiative or imagination. They are supposed to be killing people. But, so far, more people are killed by accident than terrorists.

In WWII, before the D-Day landings, a handful of commandos and resistors were able to interrupt almost all German train transport towards Normandy. On the Eastern front, meanwhile, partisans were able to cause so much trouble that whole armies had to be diverted to combat them. A determined foe can always cause a lot of trouble, especially in a civil society.

What’s wrong with these terrorists? We don’t know. As near as we can tell, they’re the most dangerous enemy that doesn’t really threaten us. But billions of dollars and countless hours are spent trying to protect us from them.

Why?

We don’t know…but it is sometimes amusing to go through airport checkpoints and see someone who hasn’t been watching the news. Occasionally, someone makes it to the airport directly from the backwoods. He is so naïve that he thinks it is still a free country. He is flabbergasted when the petty tyrants start barking orders at him – “get in line…take off your belt…have your ID’s ready.” He is silly enough to think he should treated like a customer rather than a criminal. He’s amazed that he has to take off his clothes off. “Remove your jacket, belt and shoes…do you have a laptop?” He is outraged when they take away his toothpaste…and beside himself when the guard gives him the once-over with his rubber-gloved hands. The poor hick! But he’ll get used to taking orders. Give him time.

Bill Bonner
The Daily Reckoning
London, England
Friday, July 13, 2007

More news:

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Addison Wiggin, reporting from Baltimore…

“On this Friday the 13th, We could have, just as easily, been writing about the U.S. markets falling 1%, citing this news: Fitch and S&P simultaneously downgraded 531 classes of subprime mortgage backed securities wiping out over $8 billion in bond ‘value’…. or lower than expected earnings from Home Depot, Sears, JC Penny, and Kohl’s pushed jittery investors over the edge. Or, the fact that, Alcoa took their bid for Alcan off the table, means the buyout binge is losing steam.

“But, the markets went up, not down, so let’s party on… ‘The market can remain irrational,’ JM Keynes said once famously, ‘longer than you can remain solvent.'”

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

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And more thoughts…

*** Every day, as we walk back to our apartment along the South bank of the Thames we are amazed that there seem to be almost no Englishmen in London. We pass people speaking Russian, Persian, Italian, French, Chinese – any one of dozens of different languages. When we hear people speaking English – it is as likely to be American or South African English as the British variety.

It seems as if a new life form is taking hold in this city. One in three people in London were born overseas, according to the paper. Here in the center of town, it could be more like one in one. These people are usually single, youngish, wealthy (relatively), and remarkably mobile. Talk to them and you find that they have lived in other major metropolises. They are in London because their jobs are there or because they like it. They are looking for opportunities; they’re open to new ideas. But they’re not English and never will be. They may hold a British passport and may spend most of their lives in England. They will contribute the culture and wealth of this great metropolis…but they will never share the values, attitudes, and prejudices of the native British peoples.

A lot of real Englishmen do not particularly like this situation. They remember when immigrants came to England and wanted to become as English as the people who welcomed them. Not these new Londoners. They are a new breed with no particular cultural attachment to Britain; it’s just a nice place to live and do business.

These new cosmopolitans living where the living is good – not where they were born. They speak several languages. They earn high salaries and often own significant assets. They are likely to spend a few years in New York…then a while in Tokyo…then move to Vancouver.

They are transforming the world’s major metropolises too. Cities that attract these people are rich and expanding. Those that don’t are getting left behind.

But what does it mean when a substantial part of a capital city’s population is not connected to the culture or politics of the nation itself? And how does a government control and direct these new smart, well-educated, moneyed and footloose masses, these large groups of people with no real loyalty to the host country, who speak different languages and worship different gods?

We don’t know, but in London, as in America, two things seem to unite these worldly tribes – greed for making money…and the fear of terrorism.

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The Daily Reckoning PRESENTS: With the advent of telecommunications and the Internet, it seems like the world has no shortage of self-proposed geniuses. But if this is in fact the case, why are so many people falling into such obvious financial pitfalls. Bill Bonner explains…

WHEN GENIUS FAILS…AND FAILS…AND FAILS…

The principle difference from one age to the next is the line of flimflam each falls for.

Remember that gobbledygook by George Gilder in Wired Magazine, during the last big delirium? Towards the end of the ’90s, it felt as if the moment of Rapture had arrived. Who could doubt that electronic communications, fed through the Internet like a belt of ammunition through a machine gun, were annihilating space, time and ignorance?

At last, everyone with a Yahoo account had infinite access to information. Even the lowliest assembly line worker in Guangzhou could read Shakespeare…even the humblest bellhop at the Ritz could solve Poincare’s last theorem…and even the dustiest goat-herd in the Hindu Kush could learn to make a car bomb. We were all supposed to become geniuses.

Now, a decade later, what happened to all those geniuses? One humbug gives way to another. The flimflam of this New Bubble is that only some people are super-smart…and everyone else is a moron. These new Werner von Brauns work for hedge funds, investment banks, and private equity firms. Like old Werner, their funds aim for the stars…and are likely to blow up in London.

So smart is this new brood of geniuses that they are able to spot overlooked values – right in plain view of the rest of us in the public markets. Somehow, we missed them! Private equity mavens can even pay a premium for these stocks, and still add so much value that everyone comes out ahead. At least, that is the theory. And just to show how smart they are, they’re able to do what million-dollar managers can’t – buffing up their acquisitions to such a shine that… Lo! The whole world looks upon their beauty like Anthony on Cleopatra. And with similar consequences.

In America, no further proof of genius is needed than the evidence that comes with dollar signs in front of it. While the average person earns no more per hour than he did in the Carter Administration, the two Blackstone founders, Stephen Schwarzman and Pete Peterson, took home more than half of the $4.8 billion from their recent IPO – the biggest payday in history. Overall, no group is better paid that hedge fund managers and private equity entrepreneurs…no art auction is complete without their professional buyers…and no luxury private aircraft manufacturer could stay in business without at least a few of them.

Alas, now theory is giving way to fact, and the pretensions of the Smart Set are getting marked down faster than subprime-backed CDOs.

If you went back and looked at all the leveraged buyouts over between 1981 and 2003, according to researchers from Harvard and Stanford, you’d find that the buying firms were almost always harmed by the transaction. Last year, KKR raised $5.1 billion from the public for a company that invests (funds) KKR deals. Despite the biggest bubble in private equity ever, the shares now sell for about 10% less than the IPO price. And over the long sweep, KKR’s track record is no better than an index-following mutual fund; it is just more highly leveraged.

A conceit of the private equity industry is that taking companies out of the public markets allows managers to focus on longer-term strategies. But on Tuesday, a Moody’s report contradicted that claim too. Private equity “does not really invest over a longer term horizon than public companies…” said the report. “They’re taking capital out over a short period of time, providing themselves with a dividend in the first three years…”

Meanwhile, according to figures from Credit Suisse Tremont, the data provider, the average hedge fund across all strategies has returned 7.86% over the year to date – almost exactly the same as the performance of the S&P 500 index.

And a recent S&P study of Absolute Return Funds – funds designed to outperform the benchmarks – showed that none of them hit their targets, after fees. The worst in the group, Baring’s Directional Global Bond fund, hoped to produce 4% over the London Inter-Bank Lending Rate, net of charges, thanks to elaborate use of derivatives. Heisenberg himself probably would have been proud to call the funds’ formulae his own, so complex were they. But despite the highest rates in the business, what the fund delivered over the last 12 months was a net loss of almost 6%. Of the 21 funds tracked by S&P, only four beat the rate of return an investor could have gotten from cash – without paying any fees at all.

Both in theory and in practice, an investor would have to be a moron to want to pay a hedge fund “2 and 20” for the privilege of getting ordinary returns (actually, many funds charge an additional 1% management fee…plus an additional 10% of performance as a commission…bringing the total to ‘3 and 30’). But a man who was looking for idiots in the investment markets of 2007 is spoiled for choice. He might as well be trying to identify the dumbest member of the British parliament or the fattest American tourist.

But the financial world, circa 2007, is full of wonders. Who could have imagined that professional investors would buy leveraged packages of mortgages made to people who lied about their incomes and were unlikely to be able to pay the money back? Or that shareholders would allow their companies to be loaded up with debt, stripped of assets, and used to pay huge “dividends” to the private equity marauders?

And now, who would have imagined that those same public shareholders would buy shares from Henry Kravis, Stephen Schwarzman, and other private equity hustlers? What do they think, that they are going to put one over on the very geniuses who made such suckers of them?

Bill Bonner
The Daily Reckoning
July 13, 2007

Editor’s Note: Don’t forget – you can hear Bill (along with all of your favorite DR editors) speak at this year’s Agora Financial Investment Symposium in Vancouver, British Columbia. This year’s theme is “Rim of Fire: Crisis & Opportunity in the New Asian Era” – and it’s your first look at investment opportunities, global market concerns, and the best investment bets across the globe.

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

Empire of Debt