Anti-Leverage: A Theoretical Masterpiece

As the economy is slowing, I am more desperate for cash than usual, and so I am making another pathetic, emergency bid for a Nobel Prize, and that lovely million bucks that comes with it. Not to mention, of course, the income from the CD I’ve been fantasizing about recording, “Nobel Prize Winner Yodels Songs From ZZ Top!” which I consider an annuity, you know, in case I actually do live through this whole thing without my brain exploding.

From a scientific standpoint, I will admit that it is not the most elegant methodological paradigm that I ever heard of, but it works for me. And if you want to send me a few bucks, you know, to sort of tide me over until this whole Nobel Prize thing gets worked out, that would be swell, too.

Anyway, my startling and ground-breaking theoretical insight came to me as I was recently applying large amounts of cash to a mortally wounded asset, the latest example of an asset going to Asset Heaven, in this case the air conditioner. Before that it was the brakes on my wife’s car. And before that it was the lawnmower. And the month before it was the washing machine, and then there was the increase in health insurance premiums, and before that it was something else, yada yada yada. Every freaking month it’s something. And then last night the smoke detector started beeping that it needs a new 9V battery. So like I said, it is always something.

Nobel Prize in Economics: Have Assets, Replace Assets

But as I was trying to control the involuntary shaking of my hand as I reluctantly made out the check, it occurred to me, suddenly, in a revelatory moment that I liken to the apple falling on Newton’s head, that if I didn’t have all these assets, see, I wouldn’t be spending this huge chunk of money on maintaining them or replacing them. But – and this is the crux of the matter – there was no money in the damn accumulated depreciation account, because, like the other spend-o-holic financial managers of the last decade, I did not actually set aside any cash, and now I have to use the woefully short stack of money that is listed on the books as “Petty Cash Account – Sex, Drugs and Rock and Roll” to plug the sudden income-expense gap. Ginger and Barbie, down at Stud-Land, which bills itself as America’s Lap-Dancing and Cheap Porno Emporium, are not going to be happy about THAT.

Then, extrapolating in a simple-minded, linear fashion like I am forced to do because it is a symptom of that undefined something that is tragically wrong with me, I realize that when I have more assets, this increases my total costs when I add in maintenance and depreciation. Bad enough. But if I compound my misery by borrowing money to buy the asset in the first place, then I am exercising – and here is another of my arsenal of potential Nobel Prize gems – “anti- leverage.” The reason I have not submitted this “anti- leverage” theoretical masterpiece, this Mogambo gem of genius, to the Nobel Prize people is that 1) I just now made it up and 2) I have no idea what the hell it means. But it just seems so, I dunno, pregnant with potential somehow. It sounded right as it sprang – pop! – out of my mouth, and if you are like me, then if it sounds right, then by golly it must BE right!

Getting back to the point, expenses are rising but income does not go up as much, and now if I have to borrow the money to buy the new asset, which makes the original problem of “more assets and linearly more maintenance and depreciation expense,” into one of “more assets and compoundingly more maintenance and depreciation expense,” then there is some multiplier effect.


Nobel Prize in Economics: The Mogambo Millstone

An excited twitter goes through the crowd. It’s that compounding of cost thing that is the big theoretical breakthrough. Famous economists, even dead ones who now sit bolt upright in their graves at the revelation, slap themselves on the forehead, and say, “Of course! It is so obvious now! Thank you, Mogambo! Praises to Mogambo!”

I hope to call it the 2M, which stands for the Mogambo Millstone. I chose the word “millstone” because it began with an M, like Mogambo, and it just so happens, what a lucky break for me, that a millstone is a huge rock that is so damn big that it is used to crush cereal grains into powder. But this is the shortened, popular version. The full title, as it will appear in the textbooks, will be “The Mogambo Millstone Around The Neck Of You Debt-Addled Proletariat Jackasses For Whom It Will Feel Like A Freaking Millstone When You Start Swimming In Debt That Has Finally Risen Over Your Head And That Heavy Weight Drags Your Worthless Butt To The Bottom Of The Ocean of Debt And Drowns Your Sorry Ass Because There Is No Freaking Way In Hell That You Can Swim With a Millstone Around Your Scrawny Neck, You Ignorant Bastard You.”

And then – and this is the part that I think will swing it for me with the Nobel Prize people – I make the leap to the concept of government as an asset, and one whose maintenance costs make it also so, so, so, it is hard to think with your enthusiastic applause still ringing in my ear, subject to an exponentially approaching natural limit.

As a corollary, this wonderful new theory of economics also concerns us because the acquisition of a permanent asset, or more particularly the maintenance and inevitable depreciation of the asset, namely government, itself directs and controls FUTURE spending. Namely, and please ignore how I give my explanation though gritted teeth and a kind of seething hostility, the installation of an air conditioner ten years ago has led directly to me here, ten years later, to deposit a big freaking chunk of my money into the accounts of guys who sell air conditioners today.

This is how the mere owning of an asset directs future income streams to itself, especially as concerns government.

Because, believe me, if I did not have to, I would not be writing those guys a check. I would instead, in the little dream-world I call Richard Land, be taking that large sum of money out of an over-worked ATM in some loud, smoky, alcohol-besotted, sleazy and deliciously decadent strip joint, with which to bestow on bevies of scantily clad beauties, even though I am not sure how many is actually IN a “bevy,” but it has to be more than one, meaning two or more, and then you could always weave in a little of that girl-girl action that seems to sell tickets. As an aside, I don’t know why I call it Richard Land, anyway, because in that fabulous place everybody knows me as “Hunka Hunka Burning Love,” especially Wanda-Sue, the transvestite hooker with the golden heart, who steals the show.

Nobel Prize in Economics: A Natural Limit to Assets

“Therefore, ipso facto,” I say, and grabbing a piece of chalk, I suddenly wheel around and scribble furiously on the blackboard as I emphatically expound, “So there is a natural limit, L, to how many assets, A, you can manage on a given income, Y, and there is a corresponding lesser limit, L-max, when you borrow the money, M, for the asset, which, as we have previously seen, was A, and is still A. And if the asset, A, is financed at rate I, for time T, then the total cost, TC, goes non-linear, there is a shift at the intersection with the applied exponential multiplier, and with a few arrows, thus, a few dashed lines, thus, and a few regular lines all gloriously curving and criss-crossing multivariate graphs in the defined n- space, I am finished! Behold!” I imperiously throw down the chalk. I step back. I turn. I await your roar of approval. Applause applause applause! I close my notes, I bow slightly at the waist, and bask in your boisterous acclamation. As Mr. Nobel himself presents me with the bouquet of roses and the diamond tiara, whose twinkling diadems are shamed by the iridescent twinkling of my blue eyes, I say, with tears of joy cascading down my cheeks, “Thank you! Thank you! Thank you all so very much! When do I get the money?”

Later, at the press conference, I notice that the beautiful reporter in the mini-skirt, the bright red lipstick and ankle-strap high-heels has a question. “The answer to the question that our readers want to know,” she asks in that charming and slow-as-molasses Southern-drawl that invokes sultry images of Lauren Bacall at her sultriest best, “how can we make a bunch of lovely,” and here she pauses to slowly, agonizingly slowly, lick her lips provocatively, “lovely money on this? Because we are hot, so insatiably hot, sweating and moaning in our unquenchable lust and lascivious cravings, for making sweet, luscious money.”

Naturally, I am enthralled and delighted to see that at least one stinking newspaper in this whole stinking town will sink far enough into the proverbial gutter to pander to my petty, adolescent weaknesses in such a blatant way. Glancing around the room to see if my wife is in attendance, or anybody that may know my wife, and not finding either, I smile broadly and say, “If you are wondering how to make a profit on the inevitable, my dear,” and here is where I pause to lick my own lips provocatively, but am secretly displeased with the gagging response invoked in the rest of the crowd, I continue, “then you ought to turn your money over to someone to manage for you, and I would be happy to talk to you about it. Later. In my room.”

I thought to myself, “If this beautiful piece of fluff is so stupid that she cannot figure out how to make a profit on the inevitable, then this could be a lot of fun!” But apparently she was not as stupid as she sounded, since not only did she never show up, but now I have yet other restraining orders lodged against me, not only by her, but by all the rest of the people who were in the room, who were so disgusted by my behavior that they are all demanding that I never be allowed to lick my lips like that again, at any time, anywhere within fifty miles of them or their families, and everybody is now laughing at me behind my back, and I think that my wife is on the phone with that damned temptress reporter right now, who is ratting me out with her lies. Damn.

Anyway, how to make money on the inevitable? Jeez! I get so tired of this question that I am currently soliciting bids on some tattoo work, so I can have, permanently written on my forehead, the words “Buy gold, you freaking moron!” and then I would not have to say anything at all, which would be a big productivity-booster. I could write this Mogambo drivel with one hand, and with the other hand, at the same time, point to my own forehead in answer to that perennial question, “So tell me, you egghead doofus; how can I make some money by investing?” And since productivity-boosting is so dear to the heart of Alan Greenspan, and if you know him, then I would appreciate it if you would tell him I’d be happy to enlighten him to this ground-breaking productivity-through-tattoo thing, and while I have him on the phone I can tell him how every thing that he is doing is wrong, because I am sure he really, really wants to know what I think, even though he never calls me and he won’t answer my calls when I call him anymore, and he has that same snotty receptionist tell me that he is not at home, and I say that I KNOW he is not at home, and that is why I am calling him at work at his freaking office at the freaking Federal Reserve, where YOU are working, you irritating worthless skank, so let me talk to Alan pronto, or I’ll come down there and strangle the whole lot of you, and then she says “No” and hangs up on me. Man, I hate dealing with the government. They are so rude!

But, on the bright side, I have told you why we are doomed, I likened the economy of the USA to air conditioners, and I have told you how to make some money on the inevitable. Now, all I have to do is get that tattoo on my forehead and wait for Alan Greenspan to call. Or the Nobel Prize people to call. Whichever one comes first.

My hand is on the phone, and I am waiting for it to ring.


The Mogambo Guru
for The Daily Reckoning
June 23, 2003

P.S. I am still predicting, in the next few weeks, the huge downdraft in the stock market as predicted by the Fabulous Mogambo Indicator, a mutant forecasting device that I stumbled upon when trying to cross the DNA of financial apples with that of economic oranges in the light of a full moon, during an electrical storm. This little Frankenstein of an indicator seemed to be prescient both times it ever appeared before, especially if you hold the graph at a little angle like this.

And yes, I still think that gold is going to shine, no pun intended, but I thought of it being a pun before I actually wrote it, but wrote it anyway, so maybe the pun IS intended.

Mogambo Sez: As an economist, it is the most amazing time to be alive.


The Fed is a “serial bubble blower,” says Stephen Roach. First, it blows up a bubble in stocks…then in housing…and then in bonds…and then back to stocks. Each time, when the bubble began to leak air, the Fed puckers up, and a new bubble bulges out.

And each time, the Fed seems to guarantee that investors will not lose money – no matter how extreme prices become. In the stock market, the ‘Greenspan Put’ was supposed to make sure stock prices didn’t fall significantly; if prices began to fall, or so the Moms and Pops believed, Greenspan would simply lower rates and drive them back up again. When that failed, along came the ‘Bernanke Put.’ The economy depends on housing, went the logic, and housing depends on low mortgage rates. No way will Bernanke let rates rise; instead, he’ll cut them further in order to keep ‘the recovery’ on track.

The weekend brought news that the Fed is considering another bubble-blowing rate cut. Tech stocks are already puffed up to grotesque size. But the obscenity seems to attract the simple-minded investor, not repel him. Like tourists at a Paris show bar, they wait to have their drinks watered and their pockets picked.

“All of us thought it would take years of healing time [before the lumpeninvestoriat returned to the stock market],” said the president of E-Trade to the New York Times.

“Instead,” continues the Times article, “investors appear to be returning to equities with their wounds barely healed. Three years of stock market torment seem not to have shaken the long-held view that stocks are best for the long haul.”

Stocks are best for the long haul, of course, when they are exceedingly cheap…such as they were in 1980, when you could get the average S&P stock for 6.8 times earnings. Then, you could sit back for the next 20 years and enjoy exceptional returns. But now the average S&P stock sells for more than 32 times earnings, and the haul back down is likely to be long and painful.

“It’s hard to find any real news to justify the market’s leap,” writes Paul Krugman, also in the Times. “Payrolls are still contracting…desperate state and local government are continuing to slash services…and raise taxes…”

The U.S. trade deficit just hit a new record, MSNBC tell us. So did the current account deficit. So did the U.S. budget deficit. And so did the number of people whose houses are being taken away in foreclosure.

“Oh, and the banana-republic policies now being followed in Washington,” Krugman concludes, “won’t just drive up interest rates; they’ll probably generate a full-blown fiscal crisis one of these years. That can’t be good for equity prices. In short, the current surge in stocks looks like another bubble, one that will eventually burst.”

Over to Eric Fry, with more of the latest news from the Big Apple:


Eric Fry in New York…

– The stock market continued dancing higher last week, although the dance seemed to lack its usual élan…Are the dancers tiring? The Dow sashayed 83 points higher to 9,200, while the Nasdaq waltzed to a 1.1% gain, to 1644… Meanwhile, the music stopped altogether in the bond market. As Treasury prices tumbled, the yield on the benchmark 10- year note moved sharply higher to 3.38%, up from 3.11% the prior week. The 30-year Treasury bond yield also surged, to 4.45% from 4.17%.

– “We think bonds have peaked,” says Donald Straszheim of Straszhein Global Advisors. “Investors would be wise to not get too greedy at these levels – the lowest yields in 40-50 years. Are we a little early in making this call? Maybe…[But] the bond market during 2002-03 has begun to look like Nasdaq, June 1999 to March 2000 – a blow-off. Too far, too fast. Too good to last.

– “When memories and their lessons fade,” Straszheim continues, “investors pay the price. The last double in the Nasdaq took just nine months (2524 on June 18, 1999, to the peak of 5,048 on March 10, 2000). The bond market move has been equally outsized…The 5-year Treasury yield is not 2.21%. From 6.35% in June 2000 and 4.34% in June 2002. What a move!…Looks like a top [in price] in bonds to us.”

– The stock market is also looking a little toppy and – maybe, just maybe – nearing the point of exhaustion…Last week’s trading action resembled the final hour of a 1950s dance marathon. The once-peppy Nasdaq and Dow are still standing, but they aren’t kicking up much dust…Let’s give the spunky couple a prize for endurance, but don’t expect them to continue dancing for much longer…These kids are tired! One tell-tale sign of fatigue: the blue-chip stocks are lagging far behind the market’s most speculative issues – biotech and high tech. In other words, the worst stocks are going up the most.

– Alan Newman of CrossCurrents points out that biotech stocks have rocketed nearly 50% since early March. He also took a look at the companies that comprise the Merrill Lynch Biotech Holders Trust (BBH) and determined that only half had any earnings, and these sported an average P/E of 58. One final tidbit about the companies making up the biotech trust: five insiders bought, 94 insiders sold; the ratio of shares sold to shares purchased was 67 to 1.

– “The same exercise performed on the (IGW) [semiconductor stocks],” Barron’s reports, “shows that nine of the top 10 issues in the fund have an average P/E of 77.3 (the tenth is in the red). Insider sellers among the companies making up the fund outnumbered buyers by 81 to 2 and the ratio of shares sold to shares bought was a staggering 1,665 to 1.” Plain and simple, since mid-March ugly stocks have led the way. Another telltale sign of exhaustion is that fact that the stock market’s popularity is soaring.

– “A rising market begets bulls and the crowd en masse has been hustling over to the sunny side of the Street,” says Barron’s Alan Abelson. “According to a Merrill Lynch survey of fund managers, those worthies are the most fully invested they’ve been in two years and cash is down to a minuscule 4% of assets. Obviously, they’re no longer haunted by the fear of redemptions…Very much participating in this growing but still rather mannerly orgy of optimism are the investment advisors. According to the latest soundings by Investors Intelligence, a full 60.2% of the seers are bullish, a mere 16.2% bearish.

– Unfortunately, the stock market is not a democracy; it does not care what the majority believes or what it hopes. The stock market is autocratic, and it delights in frustrating the majority. It gets its jollies by doing whatever is least expected…

– The stock market may not sell off immediately…but it should. Even after a wicked three-year bear market, this thing is pricey. “In 1982, stocks sold at 7.9 times earnings, yielded 6.3%, were priced at less than one times book value and one-third of sales,” says Barron’s. “Currently, by contrast, stocks sell at 28 times earnings, yield 2%, are priced at 2.75 times book and 1.3 times sales. In other words, this market is anything but cheap by any standard of valuation. As a matter of fact, as we’ve noted before, those incredibly rich multiples smack more of bull-market tops than of bear-market bottoms.”

– Get ready for the last dance.


Bill Bonner, back in Paris…

*** “The yuan is the most undervalued currency in the world,” the Economist reported, back on April 24th, 2003. Using its ‘Big Mac’ indicator, the magazine showed that in China a Big Mac costs $1.20, on average. In the United States, the typical price is $2.40. In order for China’s yuan to reach parity with the U.S. dollar, the yuan would have to appreciate 56% against the dollar.

“Said another way,” writes the always controversial, always entertaining Porter Stansberry, “because the yuan is kept artificially low against the dollar, Chinese goods cost half of what they should in America. China has been taking U.S. jobs and collecting billions in U.S. hard currency because it cheats. This can’t go on forever. So it won’t.”

China, believes Marshall Auerback, has the power to shut down the U.S. economy…the way the IMF pulled the plug on Argentina. We reported Auerback’s thoughts last week. Porter expects the float of the yuan could set up as big a default crisis as the Russian default of 1998, or the Mexican default of 1994…or an even bigger ‘windfall’ than the British EMU debacle, when George Soros made a billion dollars in one day.

When will the Chinese renimbi, er, yuan float? That is anyone’s guess. In fact – will it float? – is perhaps the better question. We suspect it will, some time before the Chinese WTO-membership probation ends in 2008. That is, if China feels the need to keep its membership.

Reading the tealeaves in the media, Porter suspects the yuan float may come sooner, and suggests a few ways to take advantage of it without becoming one of China’s growing legion of foreign direct investors:

*** Could a floating yuan be “the deathblow for the dollar”? We are not readily given to accepting hyperbole… yet it is reasonable to think – as a report we produced last January in conjunction with the Everbank World Markets research squad purports – that the U.S. dollar is in the beginning stages of a multi-year slump.

Accordingly, we’ve updated the report. As you’ll see, many of the initial forecasts of the report have been accurate. The Everbank report explains why, regardless of your opinions on the Chinese yuan, diversifying out of the dollar is a prudent and remarkably easy thing to do. Addison will fill you in on the details…Addison?

*** The moment we dreaded came on Saturday. A posse from West Virginia caught up with us. A colleague and her family came to visit us at Ouzilly. They aren’t actually from West Virginia, but from nearby Cumberland, Maryland. Still, that was close enough. The Appalachians were in their hearts; revenge was on their minds, and a rope in their hands, or so we feared.

Long-term sufferers of the Daily Reckoning may recall our comments. To say that we were unimpressed by the great state of West Virginia would be a lie; we will never forget the appalling architecture…and the junk. The indigenes toss out refrigerators and leave old cars lying around, as if they hoped they would take root and grow new ones.

We say these things not to be negative or unkind. We love West Virginia. But when we see such ugly blemishes on such graceful hills…it is as if someone had broken your girlfriend’s nose.

“Oh, your garden is so lovely,” said one of the Cumberland contingent, after shots had been fired and we were all pleasantly out of ammunition.

“But that’s what I mean,” came the reply…”I don’t see why the West Virginians don’t get off their duffs and do what I have done – hire a gardener to put in a proper garden.”

*** Speaking of dancing, we went to see an exhibition of Tango last night at the Palais de Chaillot. What impressed us most was that while the women performers were attractive and nubile, most of their dancing partners were gray-haired fellows in their 60s. The old guys were graceful and dignified, but not the least bit athletic. They merely kept the pace, while their women made such extraordinary exertions it looked as though they might become completely unhinged.

We have been thinking of taking up Tango the way some men take up golf – as a middle-aged distraction. Like golf, a man can do it without looking like a fool, until late in life. But it has an added advantage; he can do it in the company of attractive young women, rather than his paunchy golf buddies.

*** Mogambo on Monday!…below…(he’s remarkably lucid today)…

The Daily Reckoning