Not So Benign Conspiracies

The Daily Reckoning PRESENTS: In the U.S. economy, “cash” is being turned into “trash” at a steady pace. The smart money is buying with abandon because it knows the paper bits floating around today will be worth less than the paper bits floating around tomorrow. Justice Litle wonders: how long can this go on?


“You could almost call it a benign conspiracy.”

— Chet Currier, Bloomberg columnist

Hard to believe it’s already December. What a year it has been… and 2007 will have even more in store.

The broad market appears to be firing on all cylinders. About the only thing getting sent to the wood shed is the U.S. dollar.

The action in the greenback looks exceptionally ugly. Yet if you step back and look at a monthly chart of the U.S. dollar index, we haven’t even broken the December 2004 lows.

There is more to come… much more to come. As Jesse Livermore, the greatest speculator of all time, once said: “The speculator’s greatest and truest ally is underlying conditions.” That about sums it up when it comes to the dollar — and gold.

We’ve laid out the macro case from multiple angles over the past year or two, most recently in our summation of the debt liquidation trade. Our own Addison Wiggin, has also gotten a few words in on the subject. His book, The Demise of the Dollar, is seeing a surge of renewed interest along with the greenback’s free fall.

Bloomberg columnist Chet Currier thinks equities are getting a boost from the lack of appealing alternatives – a tongue-in-cheek “benign conspiracy” of sorts. In his piece, entitled “Costly Bonds, Real Estate Make Stocks Look Good,” Currier observes:

“Yields on government bonds are just plain miserly. Ditto for corporate bonds all up and down the quality scale… Yields offered by money market mutual funds and similar short-term vehicles have flattened since the Federal Reserve stopped increasing its target rate… the housing market is undergoing a much-discussed shakeout in many parts of the country.”

Currier goes on to note the “sloshing sea of cash” that is desperate to earn a return, forcing investors to bid up everything in sight.

Meanwhile, private equity players are busy privatizing everything in sight. Raymond James strategist Jeff Saut reports, “Almost 2% of the NYSE’s entire market capitalization has been taken private… since the beginning of this year.”

Meanwhile Ben Bernanke, the warm and fuzzy Fed chair, continues to blame the “global savings glut” for this foamy tide that has lifted all boats.

One of Gentle Ben’s key directives, I suspect, is looking out for his friends. I may have shared the following excerpt with you before; even if so, it is worth sharing again. Consider this intriguing observation from portfolio manager Chris Dialynas of PIMCO:

“The Clinton and Bush administrations, as well as the Greenspan Fed, have relied upon many internal and external advisers. Without doubt, most of these advisers are of Ivy League vintage. It is particularly noteworthy to understand that the endowments of most of those universities – endowments that substantially accrue to the benefit of the respective professors – are primarily invested in very high-risk assets and high-risk strategies (as are numerous other investors in their quest for high returns in a low interest rate world). It is, consequently, of little surprise that policy advice has tended to aggressive stimulus. A disciplined, ‘take-your- medicine/rebalance-the-economy’ set of policies would most likely be detrimental to the endowments of many of this country’s leading educational institutions. As long as these institutions maintain high-risk portfolios, the policy advice from the ivory towers will be highly stimulative based upon new, bizarre economic ideas. The global imbalances will grow.”

“Professor Bernanke is a member of this fraternity… There is an extraordinary challenge for a very high-quality person. My concern is his presumed pro-reflationary bias.”

An extraordinary challenge, indeed. So challenging, in fact, that it must be asked: Why “take the medicine” at all, when one can simply wade further into the soup instead?

This is certainly the best choice from a short-term utilitarian perspective: It maximizes the distribution of happiness for an extended period of time. Look at it from Gentle Ben’s point of view, and backdoor reflation is the way to go. Your friends are happy… Wall Street is happy… the president is happy… trading partners looking a bit peaked, but are happy nonetheless… no one gets left out except those cussed Austrian types. (And there’s no satisfying them anyway, right?)

High-quality person that he is, Bernanke has chosen to be a stand-up guy and keep the taps flowing for his friends. As I type these words, and as you read them, “cash” is being turned into “trash” at a steady pace. The smart money is buying with abandon because it knows the paper bits floating around today will be worth less than the paper bits floating around tomorrow.

How long can this go on? No one really knows. It’s sort of like a game of musical chairs. As long as a veneer of psychological stability is maintained – i.e., as long as cash doesn’t become trash too quickly – we could continue to see an upward trend in nominal values, even as real values stall out, or even decline.

Sooner or later, gold is going to break its 1980 highs in nominal terms. (This could easily happen in 2007.) After that, it will break its 1980 highs in inflation-adjusted terms — which will prove a much more noteworthy feat.

It’s always been sort of assumed that the conditions in which gold does this would be very ugly. Equity markets will have crashed, all Hades will have broken loose, and so on. That could certainly still be the case.

But it could also be that the Dow marches steadily higher along with gold, calm as a flat and glassy sea; if the fiction of prosperity is maintained, investors might be content to keep riding the merry-go-round, smiling like mildly sedated children.

In this scenario, everyone stays happy except the poor man in the street, who doesn’t have enough paper asset holdings to cancel out the steady rise in day-to-day living expenses. A slow debasement of the currency, to the benefit of paper asset holders, is thus a rather ingenious way to rob hundreds of millions of unaware citizens. Not all at once, of course, but in dribs and drabs… a little bit at a time.

Currier’s “benign conspiracy” is perhaps not so benign after all.

Since we’re laying on the quotes this week, here is one more from Aldous Huxley, author of the dystopian classic Brave New World. The quote is twice as old as I am, but could have been written yesterday:

“There is, of course, no reason why the new totalitarians should resemble the old. Government by clubs and firing squads, by artificial famine, mass imprisonment and mass deportation, is not only inhumane (nobody cares much about that nowadays), it is demonstrably inefficient and in an age of advanced technology, inefficiency is the sin against the Holy Ghost. A really efficient totalitarian state would be one in which the all-powerful executive of political bosses and their army of managers control a population of slaves who do not have to be coerced, because they love their servitude. To make them love it is the task assigned, in present-day totalitarian states, to ministries of propaganda, newspaper editors and schoolteachers… The most important Manhattan projects of the future will be vast government-sponsored enquiries into what the politicians and the participating scientists will call ‘the problem of happiness’ — in other words, the problem of making people love their servitude.”

The problem of happiness. Hmmm. Sound familiar? Not the most pleasant thought, I know. The world can be a depressing place at times.

But in spite of all the chicanery and deceit, there is much to be joyful for and much to be grateful for. If you see all this madness as a game – a game you are forced to play, but a game nonetheless – it becomes easier to take things less seriously. Best of all, with a little skill and determination, it is a game you can win.


Justice Litle
for The Daily Reckoning
December 7, 2006

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).

Justice Litle is also a member of an elite group that meets occasionally to debate and discuss the new trends in the financial world and investment ideas – among other things. This monthly gathering includes the cream of the crop of financial minds – and for a limited time, the Agora Financial Reserve is open to the public.

‘Well, we’ve had a great run,’ we thought to ourselves as we drove into Bombay (now, officially, Mumbai) from the airport.

The richest 1% of the world’s population owns 40% of its wealth, we read in the Hindustan Times this morning. And where does this 1% live? In America, Japan, and Europe, of course. More than a third of them live in the United States; that’s about 20 million people who are among the richest 1% in the world. Almost another third live in Japan – 27%. The United Kingdom and France, between them, have another 11% or so.

Why did all that wealth end up in those countries, rather than in the countries with the largest populations? Countless books and doctoral dissertations have been written on the subject. We have no easy answer ourselves, except to point out the obvious – Europe (and America) stole a march on the rest of the world when it had its industrial revolution.

Japan, an oddball nation in many ways, figured out what was going on in the west after Admiral Perry bullied his way into Yokohama harbor in the 19th century. Japan realized that it would be at the mercy of western imperialists unless it too figured out how to use modern machinery. It went about the task with great energy and resolution and soon had one of the most modern armies on the planet. This, of course, sent it down an unfortunate path in the early 20th century…leading to the complete destruction of its military, many of its cities, and its industrial capacity by 1945. But the Japanese picked themselves up, dusted themselves off, and by 1990, Japan had the most modern, most advanced, and most successful economy on earth.

But now, here we are in Bombay. All around us we see apartment buildings and office towers. People here know how to mix cement. They know how to make nuclear bombs and internal combustion engines. Gone is the class struggle. Gone are the anti-colonial wars. Gone are the ‘isms’ that so bedeviled so many people for so long.

Why didn’t the Chinese get rich along with the Japanese? Because they got caught up in a civil war…and then succumbed to various fashionable modern ‘isms’ – Communism and Maoism, for starters And poor India…it was such a hopeless mess of classes, castes, languages and cultures. Then it had English colonialists to deal with…and then…it was loaded down for years with Soviet-style regulations.

But now…things have changed. The whole world seems fixed on the same objective – getting rich. The ‘isms’ don’t seem to matter so much. Even India’s many different peoples all seem to be breathing in and out all together…aspiring to join the rich of the world…toiling night and day…sending its best and brightest to the world’s best schools…building factories…reaching out…stretching.

“The study found that India figures low in the distribution of global household wealth,” the Hindustan Times continues. Average wealth in India is only $1,100 per person. “But it is catching up fast!” the paper concludes.

And now the great lead…the great run…the great luck that the United States and Western Europe have enjoyed for so long…might be ebbing away. It’s over…at least, that is the way it looked last night.

More on Bombay below…

Meanwhile, the dollar has bounced. Is the worst over for the greenback? It has been on a slide for the last four years – down about 25% against the rest of the world’s money since February ’02.

Has it now bottomed out? We doubt it. There are problems, imbalances, absurdities, irregularities, and contractions that must be cured. Foreigners hold more than $13 trillion worth of U.S. dollar assets – and must continue to add to their holdings at the rate of $800 billion per year. For the time being they do so with no gun to their heads. And yet, every one of them knows that the dollar is in a vulnerable position. It rests on the ‘faith’ of the world’s people…a faith that could be shaken at any minute.

Today, for example, brings news that Iran will try to diversify more of its international commerce away from the dollar – following a trend that is now well established. Half the world seems to want to back away from the greenback.

And soon, the biggest American financial policy makers – Ben Bernanke and Hank Paulson – will journey to China. They must tell the Chinese to let the yuan rise, says Nancy Pelosi and the other dough-heads. What does that mean? It means that the Chinese would stop adding to their U.S. dollar assets – bonds, stocks and cash. And what would that mean, dear reader? It would mean that the dollar would fall.

Of course, the foreigners are trapped. If they sell the dollar…or merely stop adding to their holdings…the dollar will fall. But so will the value of their huge dollar holdings.

“A 30 percent drop in the dollar, could cost foreign investors an easy $3 trillion in lost purchasing power, not to mention the loss to U.S. citizens who own over $46 trillion in dollar net worth assets,” writes Richard Benson. “Our leaders must find a way to lower the U.S. Trade Deficit, or risk the dollar losing its unique position as the World’s Reserve Currency.

“America’s currency problem is a very sad day for the Republic. It used to be that the Federal Reserve policy was set simply with domestic economic policy in mind. In years past, we could virtually ignore the dollar in setting monetary policy because it was totally secure in its role as the World Reserve Currency. But today, because of our country’s profligate fiscal and over-easy monetary policies, the dollar has been undermined.”

What is ahead for the dollar? We don’t know. But we see a lot of downside risk…and little upside potential. It could go way down, in other words. It is not likely to go way up.

More news:


Chris Mayer, reporting from Gaithersburg, Maryland…

“…Financial train wrecks like these can make interesting reading over boiled eggs and coffee – as long as your dollars weren’t riding on the train. For investors, though, it’s more than something to digest over breakfast…”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening


And more thoughts…

*** “Have you seen this little turn around in oil prices lately? Oil’s climbed nearly $4 since mid November – up 6.5%,” writes Material Profits Sara Nunnally.

“It’s this type of momentum that can push oil prices out of its two-month trading range, and back into its long-term uptrend.”

“That’s good news for oil bulls…but it’s also good news for gold bugs because of something called the gold-to-oil ratio. It’s based on the historical purchasing power of one ounce of gold in relation to barrels of oil. For the past 60 years, one ounce of gold has bought 15.2 barrels of oil.

“So, if one ounce of gold should by 15.2 barrels of oil at $63 a barrel, then gold prices should be…$957.60, and according to this historic ratio, gold is severely undervalued.”

*** The Iraq Study Group, a ten-person panel that has been charged with assessing the “situation” in Iraq, released its findings to the public yesterday.

Our friends at Strafor called the study group’s findings “underwhelming” and their suggested resolutions “far-reaching.”

“What the group set out to do – and what Washington desperately needs it to do – was to devise a cogent, attainable solution and make specific strategic recommendations,” they continued. “We therefore suspect that a separate, classified report – the real report – was placed on the president’s desk some time ago.”

“The ISG has no real power. These recommendations will be implemented by the White House, operational commanders and, to some extent, Congress. They can be implemented enthusiastically, grudgingly or not at all. However, specific pieces of the report could hint at coming changes in Iraq.”

*** Bombay takes your breath away – literally. We went out of the hotel, briefly…and were soon gasping for air. We’re not used to the humidity, the heat…and the air (if there is any air). Mind you, this is the cool season.

In the newspaper, we find ads for all the usual consumer items…along with notices about new office buildings, new residential areas, new apartments. Newer, bigger, more modern and more luxurious – the place seems to be booming.

From what we can gather, property prices are soaring…along with the wealth of the middle and upper classes. The ads speak of ‘luxury this’ and ‘exclusive that’; there’s a lot of money here.

But coming in from the airport was a shock. We have never seen so many people living on the streets. There were thousands of them asleep on the sidewalks. They have no mattresses. No pillows. They just seem to put a towel down on the pavement and a light cover over themselves. Where do they keep their stuff? Do they have any stuff? What do they do during the day?

We don’t know…but we’ll find out and report back

*** Meanwhile, the papers report the end of an eighteen-year-old case. Cricketer and current BJP MP Navjot Singh Sidhu has resigned from the legislature after being given three years in jail by the Punjab High Court on December first. What did he do? He and a mate seem to have had a bit of a scuffle with an old man over a parking space…and in a fit of temper, they beat him to death. So if you’re driving in India, dear reader, be careful – the car you cut off might be driven by a member of parliament.