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“The French President was in Washington this week, speaking to Congress en Français and telling the United States to stop dumping dollars and risking a global financial crisis.

“Ooh la la! Sounds just like old times…

“‘The dollar cannot remain solely the problem of others,’ said Nicholas Sarkozy before a joint session of Congress on Wednesday, riffing on the (infamous) joke made by John Connally, Treasury Secretary to Richard Nixon in the early ’70s.

“Connally said the dollar was America’s currency ‘but your problem.’ Au contraire, replied Monsieur le President this week.”

by Adrian Ash
November 13, 2007

Now for some more views from Short Fuse back in Baltimore…


Views from the Fuse:

“Guess what?” said Robert Shiller in an exclusive Reuters interview. “For those of you who thought house prices would find their bottom in 2008 – think again.”

According to the Yale economist and co-developer of the S&P/Case-Shiller Home Price Indices, “The bottom is hard to predict. I do not see it imminent and it could be five or 10 years too.”

“The housing situation that we got in is unique in history because there was an investor psychology that developed that was stronger than we have ever seen before,” Shiller said. “We have seen housing bubbles many times in history, but they have been much more local than this one.”

Sometime a mass delusion will plague an entire nation…in this case, Americans looked at their homes as an investment – not a residence. They believed that the value of their home would always go up, forgetting a very basic theory: what goes up…must come down. There is always a correction…not unlike the one that we are seeing in the gold market right now.

“America’s financial turmoil is far from over,” says The Telegraph, “if, as Bill Bonner and Addison Wiggin assert in Empire of Debt ‘the force of the correction is equal and opposite to the deception that preceded it.'”

The markets are a bundle of emotions – just take a look at Jim Cramer’s now infamous meltdown. Or, just check out today’s Financial Times: “‘Hysterical’ US bond investors threaten commercial property”.

While that headline conjures up images of bond investors decked out in Brooks Brothers wielding spray paint cans and shaking their fists at buildings, if you read on, you’ll see that “market turbulence is also raising the cost of commercial mortgage borrowing.”

“The difference in rates on AAA-rated CMBS and the so-called risk-free rate has more than doubled since June, reaching its highest level since October 1998,” continues the FT.

“Investors have fled the CMBS market, in part because of worries that riskier lending practices in commercial real estate would lead to higher defaults, industry executives say.”

In markets where emotions are running high, obviously the risk to your investments will be greater. But portfolio disasters happen – in fact, they are an unavoidable fact of life in the investment world. Even the investment greats, like Warren Buffett and Peter Lynch have run into their investment speed bumps, points out Chris Mayer.

“However, there are ways to guard against these disasters,” Chris tells us.

“1. Buy only companies with extremely strong financial conditions. I’m proud of the fact that I’ve not compromised on this point in Capital & Crisis. I believe all of our companies enjoy strong finances. Of course, you can still get snookered and bad things can happen. But going in, we’ve always had super-strong companies.

“2. Buy companies that seem well managed from a shareholder point of view. The easiest way to do that is to buy companies run by owners. A management team that owns a big chunk of stock is a lot less likely to screw you over.

“3. Buy only companies you can understand. That means that the disclosures should be good. That means understanding how cash flows through a business. It also means that certain sectors will be harder to invest in than others, depending on your expertise.

Biotech, for example, is pretty much off-limits for me.

“4. Buy only at a discount. The standard here is what deal makers (i.e., private buyers and control investors) would pay for the business. Buying cheap covers a lot of sins. You can be wrong and still get your money back. That’s why it’s so important.

“Beyond these four points, I have a preference for tangible assets. I like to buy things at a discount to some tangible net asset value.”

Find out for yourself how owning these solid companies – at a price far less than they’re really worth – is like “catching up” on creating a sound foundation of long-lasting financial security.

“It’s like a rabbit crossing the road.”

Elizabeth came to London this past weekend. We were sitting in a little café, drinking $5 coffee…noticing older men, nicely dressed in blue blazers, many of them adorned with so many military medals they stooped forward from the weight of them…some of them wearing red berets.

“A rabbit’s instinct is to dodge,” we had explained. “It sees a wolf coming…it darts one way, then it turns suddenly and goes the other way. The charging wolf is heavier. His momentum keeps him going in the same direction, so he’s likely to miss the rabbit. It’s a survival instinct…rabbits dodge because the rabbits that couldn’t dodge were eaten by wolves before they had a chance to reproduce…

“But come the year 2007, a rabbit sees a car coming down the road. Instead of quickly getting out of the way, he takes the car for a wolf and dodges. Result: dead rabbit. The instinct that was a useful adaptation in an earlier environment is now fatal…”

“Hmmm…” said Elizabeth, “I wonder what instincts we have that were once useful and are now dangerous?”

“You’re looking at one of them right now – the way people go to war…they fight as though the survival of their race depended on it. And how about the way they eat? They eat as if they were on the brink of starvation; because for most of man’s evolutionary period, he was on the edge of starvation. And oh yes…the way they invest.”

We leave our café conversation for later in today’s reckoning. For now, we take up the financial markets.

Yesterday, the Dow took another little hit – down just 55 points, but now below 13,000.

And barely had we warned dear readers that gold was ready to correct when the correction began. Gold lost $27 yesterday…bringing it down to $807.

The dollar fell. But even the dollar needs to correct sometime. The dollar index has lost 37% – just since 2001. It has fallen sharply as of late…which makes us wonder when it will correct – before falling more.

Thinking of ourselves, of course…we’d like to see a correction in gold and the dollar. It is just getting too expensive for us to live. Last night, we went again to see Maria’s play – You Can’t Take it With You. It’s gotten better in the few weeks before our first visit and our last. The cast is more relaxed…more comfortable with their roles. Last night, the audience whooped and cheered…the cast came out for three curtain calls.

After the theatre, we took a 10-minute cab ride – $21. Then, we went to dinner at a cheap Chinese restaurant. By then, we had gathered a party of eight people…the bill came to $425.

Meanwhile, every day, we lose more than we earn. Our salary has not changed since 2001. But, living in Europe, it has been cut in half. And every day the dollar goes down, we lose a little more purchasing power.

Living in the United States, Americans are less alert to the dollar. Still, they see prices rising too…and eventually, they will realize how much they have lost.

In the meantime, we are hoping for corrections. Partly because we’d like to see our living costs go down…and partly because we’d like to use the opportunity to get out of the dollar even more.

Since the turn of the century, our approach has been very simple: buy the dips in gold…sell the rallies in stocks (and dollar-based assets, generally). That still looks like a winning formula.

“I put the U.S. economy up against any in the world in terms of competitiveness,” says Henry Paulson. But this is the same man who said the United States was “strongly committed to a strong dollar.” If the U.S. is strongly committed to a strong dollar, there is no evidence of it that we can see. A strong dollar would require a strong man at the Fed to raise rates. We don’t think there is anyone that strong ready to take the job. Instead, U.S. financial policy has been in weak hands for many, many years. Deficits have been tolerated…excused…and then accepted. Now, “deficits don’t matter,” says Dick Cheney. The dollar has been allowed to float…free from any connection to the real world of real things. The world has been saturated in them…drenched in them…up to its neck in them. That is why the value of the dollar goes down; we see no one strong enough to reverse the policy.

Instead, government spending is out of control. The dollar is out of control. Debt is out of control. The trade balance is out of control. The Government Accounting Office says the IRS is out of control, too.

And get this…college presidents are now earning more than $1 million a year. There was a time when running a college was seen as an honor. People enjoyed the prestige of it. They relished the ivy-covered campus…the great thinkers…the books…the coeds. They didn’t expect money.

But now…it’s money, money, money…everywhere you look – and the value of money itself is disappearing.

The hypothesis put forward in our new book (Mobs, Messiahs and Markets, written with Lila Rajiva) is that people were shaped by thousands of years of evolution to work together. Their survival depended not on individual action, but on group solidarity. They ‘learned’ to conform, to think the same things, to act in concert so that, while individual members of a tribe might perish, the group survived. And the group carried its genes forward to become what we are today.

What we are, in other words, are groupthink animals…a clan species…whose members tend to believe the same things at the same time. That is one reason that markets tend to go up and down. As a purely logical matter, there is no reason why people should think a dollar’s worth of earnings is more valuable one day than the next. Yet, they do. When people buy stocks, sometimes they will pay as little as about $6 for every dollar of earnings. Other times, they will pay as much as $40 or more. And here, we’re referring to the averages. There are many reasons why investors might want to give a particular stock a higher P/E than other stocks. But there is no logical reason, ceteris paribus, why they should judge all stocks more valuable – in terms of the earnings they produce – at one time than the next.

Mass sentiments take hold of investors like a rabbit’s dodging reflex. It is instinct at work. When an investor sees his fellow investors take flight, he straps on his wings too. When he sees them calmly buying more stock at 20 times earnings, he buys too. This herd instinct is fatal to investors. While the rabbit dodges…and dies, the investor forgets to dodge…and gets killed.

There are times when the great masses of people are bullish. And there are times when they grow gloomy. These changes in sentiment tend to correspond to changes in the credit cycle. And what we are seeing is a major shift in both the credit cycle (it’s getting harder to borrow money)…and in mass sentiment (people are not so sure that prices will rise forever).

“There’s a reason,” said Henry Paulson, “why the dollar was the world’s reserve currency.”

Yes, there was a reason. But that reason too, is disappearing.

If we’re right, mass sentiment is changing in a fundamental way…and thrift may even become popular again.

Here’s a herald of things to come: from the Atlanta Constitution Journal:

“Radio host Dave Ramsey’s advice to people climbing out of debt is slap-your-forehead simple. It’s as blunt as a health guru telling fat people, ‘Just shut your pie hole.’

“So why did 5,000 people this week pay their way into the Gwinnett Arena – some shelling out $169 – to hear the ever-more-popular Ramsey tell them the obvious?

“‘It’s not the information, it’s the inspiration,’ Ramsey said before the event. ‘This information is not rocket science.’

“It’s not. But it has made the once-bankrupt real estate investor a multi-millionaire. His syndicated show, based near Nashville, Tenn., is heard on 325-plus radio stations. He is among the nation’s top eight radio hosts with a weekly audience of 4 million, according to Talker Magazine. He implores listeners to cut up credit cards, pay off debt and live within their means, even if it means eating beans and rice or rice and beans.

“Ramsey, wearing a workman’s shirt and jeans, marched out and immediately connected to the middle- and working-class crowd.

“‘How many of you grew up like I did: not rich?’

“Five-thousand hands shot up.

“Like any good country singer might, Ramsey told the crowd his own tale of woe and redemption, of striking it rich in real estate by age 26 and losing it all when the bank called in his notes.

“Ramsey then went on a ‘quest to see how money really works. I found this disturbing concept called common sense.'”

Until tomorrow,

Bill Bonner
The Daily Reckoning