Gold, Water and MREs

Freddie Kruger, The Grim Reaper, Count Dracula. We all have our fears; Mogambo’s just got back from vacation. So please forgive him if, today, he seems a little edgy…

Doug Noland got back from vacation. For two weeks now, my simple mind has been liberated of those awful nightmares. You see, while Doug was lounging on a white sandy beach somewhere, he was not able to ferret out any more horrendous economic idiocies and point them out to me. Without all these hideous concerns over debt and inflation, my achy-braky heart had a chance to heal itself. The air smelled sweeter! The birdies, perching in the lush, green trees, sang with a new beauty! The sun seemed to shine with a bright glow, and all was a picture of utter tranquility and delight.

But now (insert dark and gloomy soundtrack) he’s back! He’s baaaaaaaaccckkkk! And like a sledgehammer hitting me between the eyes, he starts off his weekly bulletin at the Prudent Bear with – "Total Non-Financial Credit expanded at a seasonally adjusted annual rate of $1.927 trillion during the quarter. Examining seasonally adjusted data, Federal Government debt expanded at an 11.6% rate, State & Local 9.6%, the Household sector 10.9%, and Business 4.1%. One can only be discouraged by the continuing surge in non- productive debt growth."

Did he say "discouraged?" Who is this Noland guy that he can look Death in the face and say he is "discouraged"? I’d give anything to be only discouraged! If I was only discouraged, then maybe I could sleep and not have to be strapped down to the bed every night with these big leather things with buckles on the end. And I wouldn’t have to endure my wife and our angry, sleepless neighbors, cramming rags into my mouth every night at 2 a.m. as they try to muffle my screaming tinged with raw, primordial fear.

Mr. Noland obviously doesn’t care about me, because he goes on to say, "The Household sector increased debt at a record annualized $1.008 trillion. Total Mortgage debt increased by $251.3 billion ($1.01 trillion annualized), or 10.7%, to $9.618 trillion. Total Mortgage debt was up $1.04 trillion over the past year (12.1%), with growth of 24% over two years and 83% over the past 25 quarters (since the beginning of 1998)."

Doug Noland: $7,304.35

I’m flopping on the floor! This is insane! I heroically pull myself up onto one elbow, look deeply into your soul, and say, "Look into my bloodshot eyes so that you can comprehend my cosmic intensity, and attend my words, my little grasshopper! There are only 138 million people in the damn country who have jobs! Look at me when I am talking to you! And sit up straight! I said that there are only 138 million people in the country who have jobs! And about one of out six of them, 17%, works directly for the government! If you were as handy with a calculator as I am, then you, too, could have impressed people by determining that that annualized householder debt increase comes to $7,304.35 for every last worker in the country, including government workers. Notice that I have figured it right down to the cent! To the very penny!

Of course, this is after rounding off the number of employed people to the nearest million or so, which is a cheap statistical trick that the government is also fond of doing. And since it is obviously so popular with everybody, then maybe if I do it too, I will also be popular! And maybe then I will get invited to parties! And maybe I will finally find a friend who won’t turn me in for a reward! And maybe I can finally get a real life of my own that does not revolve around court dates, or mental health professionals talking about how vivisection might reveal some important clues about what the hell is wrong with me.

But I am not here to talk about my problems. The crucial bit of information is that, on average, everybody who has a job will go farther into debt by another $7,304.35, and once again, for all you obsessive-compulsives out there, I included the 31 cents.

"Household Mortgage debt expanded at an 11.4% rate during the first quarter ($819bn annualized), 26% over two years and 85% over 25 quarters. Since the beginning of 1998, Total Mortgage debt has increased from 65% to 85% of GDP."

Doug Noland: Why Would Greenspan Let This Happen?

Suddenly, my eyes would not obey my brain, which was screaming: "Look away! Don’t look at it! Look away!" Like a man in a trance, I remember reading "Foreign sources accumulated U.S. financial assets at a stunning pace during the quarter, expanding at a record $423 billion (not annualized) to $8.43 Trillion (a 21% growth rate)."

Why would "foreign sources" do this to themselves? And why would Alan Greenspan let this happen? One of the big mysteries to me is why Alan Greenspan, a guy who once wrote a defense of gold as money, while writing, at the same time, a classic denunciation of fiat currency, would do what he does. It makes no sense.

I am not the only one to have pondered this enigma. Many theories have been propounded, including one vicious rumor that I tried to start, in which I postulate that Alan is some kind of robot who married another cyborg robot, named, I think, Andrea Mitchell, and who is, in real life, a shrill Leftist harpy from waayyyyy back, and who regularly hangs out with other robot Leftists who are trying to turn our government, Frankenstein-like, into a brain-dead communist cannibal that eats the guts out of an economy. Okay, I admit that was veering off onto a slight tangent.

But remember that the history of space, from one end of the cosmos to the other, is full of examples of some poor, pathetic planet that was destroyed by idiotic central bank monetary policy after the Starship Enterprise and that horrid Captain Kirk had visited them. And that is why they are, in turn, using central bankers to destroy the Earth, instead of using laser ray guns, which only end up burning things and making a big mess. And laser ray guns aren’t cheap either.

To get back to the point, you don’t have to be the Mogambo to realize that the record of the Federal Reserve is one of abject failure. I suggest you load up with about 700 MRE’s (Meals Ready to Eat, the kind that the Army uses) per person per year, all safely tucked away somewhere, and a nice, deep well to get water. Oh, and a nice bag of gold might also come in handy.

In the meantime, let’s start an uprising.


The Mogambo Guru
for The Daily Reckoning
June 21, 2004

—Mogambo Sez: It just keeps getting weirder and weirder, and I just keep getting weirder and weirder, too.

Nothing much happened last week. Fine with us.

Nothing much is likely to happen this week either. But – and here we are beginning to sound as tedious as a health warning on a pack of cigarettes – there will come a week when something does happen. On that week, and those weeks that follow, you will wish you had done something to protect yourself.

What we are doing is simple. We are out of stocks…except for a few old stray dogs and cats we can’t turn out. We see no reason to be in stocks; they are near the upper end of their price range. Inflation will take them down. Deflation will take them down. An oil shock, higher interest rates, a war…anything could take them down. The only thing that will not knock them down is nothing. And the trouble with nothing is that you can’t count on it. Something always happens.

Happily, nothing is what people expect. So, they under- price the odds of something. Serious inflation, for example. Protection is cheap. Gold is still below $400. And TIPS, the government’s inflation-indexed bonds, were selling for only about 2% above regular 10-year notes – the last time we looked.

And look at bond spreads. You pay almost as much for a risky ‘junk’ bond as you do for a Treasury. Relatively, the Treasury is a bargain. Again relatively, the junk bond is a hidden land mine. Step on the thing at the wrong time and it will blow you up.

House prices rose nearly 40% in San Diego County last year. Rentals, by comparison, are cheap.

The Greenspan Fed continues to encourage the fantasy that high consumer debt levels don’t matter; houses are going up in price, they say, so the debt declines as a percentage of assets. But just imagine what would happen if all houses suddenly rose over $1 million, more than 4 times today’s average price. Householders could double – or even triple – their debt and still be okay, right?

Just one problem. How would they pay it? An average man with a house could only realize his ‘wealth’ by selling his house. But then…where would he live? And whom would he sell to? At 6%, the interest alone on a $1 million house would be greater than the entire man’s salary.

Already, houses are becoming a burden. The median house in California has risen to $453,000. You need a minimum income over $100,000 to afford it. But only 20% of Californians have household incomes greater than $100,000. The safest bet is probably to sell the $453,000 house…and rent one just like it for $2,500 per month, or less.

The problem, generally, is that capital assets – including stocks and houses – are expensive. The risk of owning them outweighs the potential upside reward. Something will happen and they will fall in value. And because so few people expect something to happen, the cost of insuring against something is low. Stocks went nowhere last week. They went nowhere this year. They’ve gone nowhere in the last 6 years. You give up no capital gains by not owning them. Nor do you forgo much in the way of dividends. At less than 2% – let someone else take the risk.

Houses, on the other hand, are going up. But unlike stocks, they can’t go up much more – people of limited means have to be able to afford them. And, like stocks, either inflation or deflation, will knock them down. Inflation leads to higher interest rates, which brings housing to its knees immediately. Deflation puts people out of work – so they can no longer afford to buy houses.

As in Japan, houses have risen for 4 years following the break in stock prices. As in Japan, it is now time for houses to give way too. Why take the chance? Rent; let someone else take the capital risk.

And here’s Eric with the latest news from Manhattan:


– Sometimes we wonder why the New York Stock Exchange even bothers to open its doors. What has it accomplished this year? The Dow is ahead .6%, while the Nasdaq is down .6%…why bother? Last week, the market’s rudderless trend persisted, as the Dow rose 6 points to 10,416 and the Nasdaq lost 13 points to hit 1986.

– These days, the market seems resilient and vulnerable – resilient to the frosty winds of rising interest rates, surging oil prices and endless terror attacks in the Middle East, but vulnerable to the very same trends it has withstood thus far.

– Whatever it’s resilience or vulnerability, the market has been as directionless as a stop sign, for months, tormenting most professional investors. All of the hedge fund managers with whom your New York editor regularly communicates are whining about how tough it is to make a buck in this market, and about how easy it is to lose one…"A half-year in a noncommittal market has given everyone enough time to develop self-doubt," says Barron’s.

– While stock investors struggle, kvetch and curse their luck, bond investors have no luck left to curse. Bond prices have been falling steadily for months.

– "Cycles in the bond market are monumental, literally epochal," writes James Grant in the latest edition of Grant’s Interest Rate Observer. "In the United States, yields fell in the last 40 years of the 19th century. They rose in the first 20 years of the 20th. They fell between 1920 and 1946, and rose between 1946 and 1981. They fell between 1981 and 2003. Now, we believe, they are going back up again. If past is prologue, they might go up for a very long time…[A new] generational bond bear market, which, if our cyclical clock is keeping the correct time, began on June 13, 2003, as the 10-year Treasury touched 3.11%"

– If Grant is correct, the new "epochal" bear market in bonds just celebrated its first birthday, and turning back the clock will be a near-impossibility. During the last 12 months, the 10-year Treasury bond yield has jumped 160 basis points, from 3.11% to 4.71%. "To push the 10-year back to 3.11%," says Grant, "the Fed will need an even more persuasive stable of speechwriters or an actual deflationary crisis."

– Despite the sharp rise in rates, however, buying real estate with barrels full of borrowed money, especially money that’s borrowed at "low-cost" adjustable-rate mortgages (ARMs), remains a winning strategy. But we suspect that the armies of ARM-toting consumers are marching toward their Waterloo. Rising rates will break their ranks like the Charge of the Scots Greys. In a desperate attempt to buy homes they can ill afford or to maintain spending habits their incomes alone cannot sustain, millions of Americans have assumed the risk of floating-rate loans, also known as adjustable-rate mortgages (ARMs). As long as these loans adjust lower, all will be well. But if they begin to adjust higher, trouble will ensue.

– Consider young Robert Cromer, a "Tycoon in the Making," according to CNN/Money. The prospective land baron intends to amass his fortune by borrowing at low short-term rates and investing in long-term assets, specifically, houses. Many have attempted this daring financial feat, but few have succeeded.

– Cromer’s family, which earns about $175,000 in a good year, has deftly accumulated $3.2 million worth of housing assets over the last six years by also accumulating $2 million worth of mortgage debt. What’s the man’s secret, you ask? Simple daring-do, or what we here in New York call chutzpah. To buy their various properties the Cromer’s have accumulated mortgage debt totaling $2 million, "predominantly in the form of 5-year interest-only adjustable-rate mortgages," explains Martin Hutchinson in a column carried by UPI.

– "The rents receivable after expenses on the family’s properties are $3,100 per month less than the interest payments," Hutchinson continues, "and their payment outflows will increase by $20,000 per annum for each percentage point rise in interest rates.

– "The Cromers have alleviated their cash flow problems so far by going into the residential real estate sales business, thus increasing their earnings to $175,000 per annum in this buoyant market. Of course, that doesn’t actually reduce their exposure to a real estate downturn!"

– What becomes of our tycoon-in-the-making if interest rates should fail to cooperate with his plans by going up, for example, instead of down? Or what becomes of his dreams if property values should fall instead of rise? Or, to imagine the unimaginable, what happens to the Cromer Party if interest rates rise while property values fall? The buoy to which Mr. Cromer has moored his family’s financial future might then metamorphose into an anchor.


Bill Bonner, back in Paris…

*** Our friend John Mauldin has written an excellent book called "Bull’s Eye Investing." The tome is so thick and thorough, we get tired just looking at it. But serious investors ought to pick it up and read it, because it shows why what most people believe about investing is wrong. To our argument above, that this is a good time to not be in stocks, for example, people will say that "while you can’t know when stock prices will rise, they always rise over the long run…so you have to stay fully invested, or you might miss the big move."

It is true, John explains, that stocks do make big moves up in short periods of time. It is also true that you are likely to miss them if you’re not invested all the time. But it is not true that you’re best off being invested all the time for fear of missing the growth spurts. Markets run in cycles, from bull to bear, bust to boom, peak to trough. The average length of a full cycle over the past 200 years is 28 years, peak to peak. But "your actual returns for any one 10-year period would be totally dependent on when you made your initial investment," John writes. Being in the market all the time doesn’t help, in other words. Your investment merely goes up and down with everyone else’s. Sometimes you’re up. Sometimes you’re down. About the same amount of time for each. Your total capital gains, in real terms, during the entire 200-year period, were only 2.2% per year. Buy and hold for the long term? Forget it. The only way to make money is to buy low and sell high. Imagine that.

*** "Aren’t you embarrassed? You told people to buy gold at $400. Since then it fell below $375."

We have not actually gotten that question from a Daily Reckoning reader. Not that we didn’t deserve it. But readers were too polite to ask.

We answer anyway.

Over the weekend came news that the U.S. current account deficit widened to $144.9 billion – a new record – in the first quarter. That is nearly $600 billion per year…and nearly 6% of GDP. Banana republic countries sometimes run such extreme deficits. But for the world’s largest economy…the experience is unprecedented in history.

What it portends we don’t know. But the traditional way such imbalances are corrected is by a steep drop in the value of the currency. Were the dollar to go down, it has to go down compared to something. And since so many things are calibrated in dollars, the most likely event will be for it to go down relative to a lot of things – yen, euro, oil, etc. We might simply guess that the dollar will go down and everything else will go up. But it is not as simple as that. For on the other side of the equation, much of the rest of the world economy depends on Americans squandering their wealth. Were they to cut back, demand for both finished goods and primary commodities would go down. Prices, even in dollar terms, could fall.

What’s more, the U.S. economy is saturated with debt…which is to say, with obligations, promises and wishful expectations that are not likely to be kept. The debts are also measured in dollars. Dollars will be in demand. The financing gap of the U.S. government alone is estimated at $52 trillion. It is simply not possible that that gap will be closed with additional revenue. Instead, it – like so many promises in the private sector – will be closed by defaults, bankruptcies, workouts and abnegations. But people will scramble for every dollar they can get their hands on.

We cannot know which way it will go…or when. Will dollars be suddenly scarce – and more valuable? Or, will people rush to get rid of them. First one…then the other, most likely. But if anyone knows for sure they do not work here at the Daily Reckoning. We buy gold because we can’t predict what will happen. It is merely insurance, and it is still cheap.

Is gold a good investment? Not really. It is just protection against a lot of bad investments.

Gold jumped on Friday, closing at $395.

*** We love Paris in the spring. Summer. Fall. And winter too. Friday, walking back from lunch, all of a sudden horns began blaring. An entourage of French WWII heroes was being escorted across town by a group of police on their blue BMW motorcycles. In the lead car sat an aging general, in full dress uniform…with so many medals on his chest it looked like he could barely breathe.

After the official group had passed, we noticed two policemen grappling with a man on the edge of the Pont Neuf. The man had hopped over the stone railing and seemed to want to jump into the Seine. The police – a man and a woman – were struggling to hold onto to him. Passers-by stopped. A few came to the aid of the police. But then, after an exchange of words with the man, the police let go and stepped back.

"Oh let him jump if he wants…the son of a bitch," said one.

They walked away. The man stood there, on the edge of the bridge. People went about their business, walked on… no one, not even the police, bothered to turn around to see if he jumped.

No sirens wailed. No squad cars stopped traffic. No psychiatrists were brought in to talk to the man. What a civilized place.

*** And this just in from our Pittsburgh correspondent: Byron King…

"But it seems to me that the war has already commenced, with the other side taking the initiative while we were otherwise occupied. The fall of the Shah (thanks to Jimmy Carter) gave radical Islam a state sponsor, and a set of secure internal lines of communication for intellectualizing and planning a war against the West."

"Afghanistan gave radical Islam its boot camp and advanced infantry training, in learning how to fight a militarily sophisticated foe.

"The Internet has given radical Islam its day-to-day communications and connections to the world at large. And Western complacency ("What, me, worry?") has given radical Islam its fifth-column in every target set. (For example, the 9/11 hijackers were hiding in plain sight, taking flight lessons, marrying German girls and collecting welfare in Hamburg…)

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