Secrets of the Near Dead

In line with his true contrarian nature, Bill Bonner believes that the more out of touch with the current thinking an investor is, the more valuable his opinions.

If the dead have secrets, what about those who are almost dead?

We read an interview with Sir John Templeton. The great old man said he thought shares and houses in America were too expensive and that the United States was cruising for trouble with its trade deficit and U.S. federal deficit. He said he anticipated a long bear market in shares, falling residential real estate prices and a serious slump in the economy. Implicitly, he advised investors to hold cash.

The person who wrote the article then asked local analysts and stockbrokers what they thought of Templeton’s opinion. One challenged Templeton’s competence, saying that because of his advanced age (Templeton was 92), he might be "out of touch" with current thinking. Templeton was not even dead yet, and already they were shoveling the mud on his face. But being out of touch is precisely what made his opinions valuable.

We like old things. Old buildings. Old ideas. Old trees. Old rules. Old investors. The older the investor, the more confidence we have in him. He has seen good times and bad times. He has seen bulls and bears.

People who have been around for a long time have had an opportunity to see several cycles. An American born after 1960, on the other hand, barely came of age when the 1982 to 2002 boom began. He has never seen a sustained bear market or a period when the nation was downcast or desperate.

Templeton was a young man when Wall Street crashed in 1929. He was an adult in the Great Depression. He recalls the dark days of World War II, when it looked as though the allies might lose. During his life span, there have been booms and busts, mass murders, the worst wars in history, famines, hyperinflation, and national bankruptcies. Dozens of currencies and at least five empires have gone defunct. Dozens of coups and revolutions have taken place. Ideologies have come and gone. Thousands of banks and businesses have gone bust. Prominent careers have been ruined and reputations lost.

Sir John Templeton: The Unsuccessful Innovations Have Disappeared

A man who has seen so much and still has his wits about him is a great treasure. If he is still solvent, that is even better. Somehow, he must have avoided the bad ideas, bad investments, and bad advice. Innovations are like genetic mutations. Most of them are mistakes. Most fail. Old people tend to reject new ideas, new styles, and new things. This is not simply because these dogs are too old to learn new tricks. What the oldsters know – from experience – is that the new tricks are probably not worth learning. What we have around us are only the innovations that succeeded. Companies, products, ideas, governments, clubs, styles – all that we see are the successful ones. The unsuccessful innovations – thousands and thousands of them – all disappeared.

Even wildly successful innovations, such as heavier-than-air flight, are not successful for everyone. It is plausible to think that if you had owned the entire airline industry from the moment after Orville and Wilbur made the first flight, right up to the day the Concorde made its last flight, you scarcely would have made a dime. Many other industries are the same. There are companies quoted on Wall Street that make money in those industries.

But they are the survivors. Many others failed long ago. Nassim Nicholas Taleb explains it in his book, Fooled by Randomness: "Mathematically, progress means that some new information is better than past information, not that the average of new information will supplant past information, which means that it is optimal for someone, when in doubt, to systematically reject the new idea, information, or method . . .

"The Saturday newspaper lists dozens of new patents of such items that can revolutionize our lives. People tend to infer that because some inventions have revolutionized our lives that inventions are good to endorse and we should favour the new over the old. I take the opposite view. The opportunity cost of missing a "new new thing" like the airplane and the automobile is minuscule compared to the toxicity of all the garbage one has to go through to get to these jewels (assuming these have brought some improvement to our lives, which I frequently doubt)."

A young man has access to information. With the Internet, he can get all he wants. What he lacks is the "high-proof " distilled information – the wisdom – that comes with age.

Mr. Taleb continues, "A preference for distilled thinking implies favoring old investors and traders, that is, investors who have been exposed to markets the longest, a matter that is counter to the Wall Street practice of preferring those that have been the most profitable and preferring the younger whenever possible . . ."

Testing the proposition using a mathematical model, Taleb "found a significant advantage in selecting aged traders, using, as a selection criterion, their cumulative years of experience rather than their absolute success (conditional on their having survived without blowing up)."

Sir John Templeton: Distilled and Undistilled

Distilled information tends to be expressed as moral interdictions. Don’t steal. Don’t lie. Don’t buy expensive stocks or sell cheap ones. Don’t expect to get something for nothing. Don’t neglect your spouse. Don’t forget St. Patrick’s Day. Don’t spend too much. Don’t eat too fast. Don’t drink before 6 PM. Don’t mess around with the boss’s wife. Each don’t represents lessons learned by previous generations. For every moral, there must be a million sorry souls burning in Hell.

Undistilled information, on the other hand, is nothing more than noise – newspaper headlines, TV babble, cocktail chatter, the latest innovation, the latest business secret, the latest fashion. It is public information, backed by no real experience or private insights. It is not useless. It is worse than useless, for it misleads people into thinking they know something.

David M. Walker, Comptroller General of the United States, clarified America’s debt situation in late 2004: "The Federal government’s gross debt – the accumulation of its annual deficits – was about $7 trillion last September, which works out to about $24,000 for every man, woman and child in the country," he announced. [Ed. Note: According to the national debt clock, as of Tuesday, December 27, 2005 the gross debt is now over $8 trillion – that’s more than $27,000 for each citizen.]

"But that number excludes items like the gap between the government’s Social Security and Medicare commitments and the money put aside to pay for them. If these items are factored in, the burden for every American rises to well over $100,000."

We add to Walker’s lament: as we will see $7 trillion is chicken feed. The real debt is far higher. Plus, one out of every four dollars spent by the federal government is borrowed. And for every dollar that comes in the door from income taxes, the feds borrow another 80 cents. Economists used to worry about government using up the nation’s savings. But now Americans have no more savings to use. Still, the nation that can’t save a dime sets out to save the entire planet.

The cost is as monumental as the project. Taking out Social Security surpluses, federal deficits are expected to be about a half trillion dollars each year for the next 10 years – or $5 trillion in total (half of gross domestic product, or GDP). We put no exclamation point following that last sentence, because the numbers shriek without one. Still, America’s economists are deaf to the problem, just as its policymakers are dumb to any solution. After all, in the words of Dick Cheney: "Deficits don’t matter."

Meanwhile, the private sector also has been running up immense debts. In 2005, for every $19 Americans earned, they spent $20. This difference was recorded in the trade deficit figures, measuring the speed at which Americans raced down the road to ruin. Top speed as of this writing was $58.3 billion. That was the figure for January when the nation was clocked overspending at a rate of almost $2 billion per day. It was the difference between what Americans sold to foreigners in the month of January and what they bought from them. It was a negative number. On a chart of the nation’s accounts, it would be in red. Or in brackets. Or preceded by a minus sign.

If it were divided among the nation’s families, it would come to about $600 for each one. This represents only a single month’s trade deficit, so we should multiply it by 12 to get the measure of damage on an annual basis: $7,200 per family per year. Compared with the average family’s income, it is such a big number that we wondered if we had done the arithmetic correctly. On a macroeconomic scale, the shortfall was rising to 6 percent of GDP.

Sir John Templeton: As Good as Gold?

In the old days of the gold standard, the nation on the plus side of this exchange would pile up its excess foreign currency and take it to the other nation’s central bank. Gold was the common reference and an uncommon restraint. It was real money. If a nation ran out of gold, it ran out of money. It could no longer borrow. It could no longer run trade deficits, because when the foreign currencies were presented to it, it would have no means of settling up. It would have to declare bankruptcy, which happened from time to time.

But it has been 34 years since the United States settled its overseas obligations in gold. Since then, it has found it far easier to offer U.S. dollar denominated Treasury bonds.

Remarkably, the foreigners have accepted them as if they were as good as gold. More remarkably, for most of that time the bonds were not only as good as gold – they were better. Gold fell in price for two decades following Ronald Reagan’s first presidential election.

Overseas central bankers took the Treasury bonds and felt grateful, even lucky, to have them. The United States was just too lucky. It could spend without really paying. It could borrow without ever really paying back. It could dig itself into such a deep hole of debt, it could find no easy way out.

Among the noisy headlines of 2005 was the remarkable information that China – a Third World nation – lends the United States $300 billion per year. Without Chinese support, the dollar would have already collapsed, bond yields would have soared, and the U.S. economy would be in a recession, if not a depression.

Where does the money come from? The Chinese get the dead presidents from selling products to live Americans, who seem ready to consume anything that comes their way. First, the dollars come rolling off U.S. printing presses, then they make their way into the hands of Chinese and other manufacturers, and finally, they are returned to their birthplace as loans.

China is fast becoming America’s "company store," to whom we owe our standard of living and maybe even our soul. By the end of 2004, two central banks – Japan and China – held almost a trillion dollars’ worth of U.S. Treasury bonds. On their willingness to save and to recycle savings into American Treasury bonds stood the U.S consumer economy. A single word from either central bank could send the U.S. economy into a severe slump: sell.

And thus comes an even more remarkable curiosity: "In an era of free trade," began a complaint from Treasury Secretary John Snow, "we should not have to confront the issue of countries distorting their currencies to gain unfair trade advantages."

Sir John Templeton: Manipulating the Yuan

The specific country to which Snow referred was China. The trade advantage the latter enjoyed was that it sold much more to the United States than the United States sold to it, by a ratio of 5 to 1. And the unfair distortion was that China pegged its own currency to the dollar. In the spring of 2005, the exchange was called "manipulation"; the United States demanded that China revalue by 10 percent.

How were the Chinese manipulating the yuan? By fixing it to the imperial currency! Oh, that was clever, wily, diabolical. The Chinese insisted on maintaining their 10-year-old policy of pegging the yuan to the dollar. The United States counts on a steady devaluation of its money. It buys from overseas and pays in dollars. Then, in effect, it prints up more dollars to replace those it has shipped overseas. The resulting inflation of the currency – reflected in the increase in prices of oil, gold, and other internationally traded goods – is a form of imperial tribute. It is America’s only way of making the empire pay. As the dollar goes down, the trillions of dollars held in foreign accounts become less valuable.
An "exorbitant privilege," said Charles de Gaulle. But the Chinese refused to play along.

As the dollar went down, so did their yuan. Instead of raising prices on Chinese goods and lowering the value of Chinese dollar holdings relative to its own currency, everything remained even. The Chinese weren’t paying their tribute. Americans were indignant. A Senate committee said it would rewrite the law of the land to make what the Chinese were doing qualify as currency manipulation. Bush administration off icials gave the Chinese a deadline to shape up. In the summer of 2005, the Chinese finally announced that they were giving up the dollar peg, or at least widen "the channel" a little. But the problem was never caused by China.

An entire American generation has grown up being told that it could spend its way to prosperity. Snow, McTeer, Greenspan, Bernanke – they all still believe it. Debt is no problem, they say. Spend, spend, spend.

American spending created a boom in China, where the average person works in a sweatshop, lives in a hovel, and saves 25 percent of his earnings. Americans had come to believe there was something unfair about China’s trade practices, that they must be stealing jobs with a distorted currency, instead of competing for them fair and square.

Meanwhile, in the United States, the average man lives in a house he can’t pay for, drives a car he can’t afford, and waits for the next shipment from Hong Kong for distractions he can’t resist. He saves nothing and believes the Chinese will lend him money forever, on the same terms.

That this cannot go on forever hardly seems worth pointing out. Whether it will go on much longer, we cannot say. But that it will end badly seems a cinch.

We can barely wait to find out how it all turns out. Maybe a year from now. Maybe 2 …5 …10 years. We want to know the precise date on which the imperial consumer credit economy stops muddling through. For it must shake, rattle, and roll over some day. Everything does.

The day may come and go without notice. The world created in the pax dollarium era may end with scarcely a whimper and no bang whatsoever. But it will end. Then the dead will cluck: ‘I told you so’.


Bill Bonner
The Daily Reckoning

P.S. Every hour of every day, the United States racks up another $80 million of debt. The renowned Levy Institute estimates that the United States will owe foreigners $8 trillion by 2008 – a breathtaking 60% of our gross domestic product. Think about it this way: $6 out of every $10 that you and I earn in America will go to pay off a loan in China or Japan or South Korea or the rest of Asia. That’s the kind of mortgage nobody can afford, including you, me, the U.S. government and our kids.

That’s why Addison and I decided to write our latest book, Empire of Debt. We want people to know that there are specific steps you can take to protect yourself from the massive debt buildup and the secret funneling away of your funds.

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).

"Check out the spread between Coach and Wal-Mart (COH / WMT)," suggests Dan Denning.

"Coach sells $300 flip-flips, Wal-Mart sells $3 flip-flops."

Who earns more per pair of flip-flops? Whose stock is going up?

Dan thinks he sees something more than passing consumer preferences. What he sees is a New World.

In this holiday season, the average man went out and spent 8.7% more than he did the year before. Where did they get the money? The figures show that spending rose most for ‘home furnishings.’ People have bigger houses; they have to decorate them.

But who has money to buy expensive flip-flops and drapes? The figures also show that the average family has less spendable income this year than it had the last…and less last year than the year before. Is this the New World to which Dan refers?

Yes, dear reader, it is. We thought about it as we walked along the beach last night.

"There is something really rare and remarkable about this place," we had explained to Padre Walter the other day. "You can look all up and down the coasts of North America. You won’t find anything this nice. On the East Coast the beaches are flat and boring. On the West Coast, even as far south as San Diego, the water is cold. And where actual beachfront is available, it is frightfully expensive. Here, the beach is beautiful, the days are sunny and the water is warm. This is the sort of place where America’s retiring baby boomers are going to want to live."

But among the 70 million baby boomers, how many will be able to afford to retire to such places? How many of their children will be able to retire at all?

In this New World – this post-industrial society in America – the average working man is losing ground. He has no way to force employers to pay him more money. They can just move his job to Asia! For the last 20 or more years, he has hidden this horrible truth from himself and his family – by going further and further into debt. He goes shopping at Christmas time…and each year he brings home more iPods, PSPs, home entertainment centers and other paraphernalia he doesn’t need and can’t afford. He pays on credit…counting on rising house prices to keep him going.

But the rich are making real progress – all the numbers show it. They’re buying $300 flip-flops and $3 million beach condos. They can do it…because their own sources of revenue are less threatened by Asian competition. They are judges and lawyers…managers…hacks and bureaucrats…entrepreneurs…psychologists and political fixers… They are the people the average man will come to hate. But they are the ones who benefit from the New World. They are able to keep up with the international class of rich people, while their slower countrymen fall behind. It doesn’t seem to matter where they live; their work is protected from low-priced competition…and their financial assets become more valuable. The companies they own (at least theoretically) can hold down labor costs and become more profitable. Their land and houses rise in price. So they bid against each other for prestige and bragging rights – for seats in fancy restaurants…for designer flip-flops…for exclusive beach houses…expensive sports cars and ugly modern art. Luxuries are soaring in price…while Wal-Mart continues to offer the lumpen Everyday Low Prices…

Justice Litle describes this New World as a kind of "Cyber Feudalism":

"- Feudalism was a system of Lords and Serfs… the Lords were Knights who could afford the expense of expensive horses, stables, armor etc. The ‘Lord’ equivalent today is the capitalist who can afford a rapidly increasing cost of living in an inflationary global environment.

"- The feudal Lord / Knight’s mastery of fighting on horseback is comparable to modern day mastery of intellectual property concepts / abstract commerce.

"- The serfs of old were trapped by a lack of skills and a lack of base from which to build assets. The same is happening to today’s left-behinds, who are forced to mortgage their lives and souls to the banks.

"- In the feudal system, the Lords were collectively more powerful than the King – and the King thus had to deal with the Lords gingerly, bargaining whenever possible. In modern parlance, the Kings are governments. Today’s Lords wield their power via globetrotting companies, which are growing ever more powerful.

"- Cyber Feudalism is a global phenomenon. In developing world countries, you are starting to see small concentrations of ‘Lords’ – those able to master abstract commerce and leverage its value – surrounded by vast seas of serfs. This is happening in America too…"

This is the New World. We’re not sure we like it. But we know which class we want to be in.

More news, from our team at The Rude Awakening…


Aussie Joel, reporting from Baltimore:

"I am not here in the U.S. of A to praise or condemn Bush, but merely to earn a few dollars, pay the taxes I owe…and visit New York City as often as possible. Nevertheless, I am inquisitive…"


Bill Bonner, with an update from the beach…

*** "Jessica, would you bring me a cup of tea? I’ll be on the terrace…"

We are getting used to life in the Third World. In our little house we have a staff of six people. We don’t need six people. "But what else would they do?" asks Antonio.

Antonio believes we should employ as many of the local people as we can.

"They need jobs. They need money. Besides, they don’t cost very much."

The going rate is $5 per day. Even six people at $5 per day each is only $30 a day. That is about what it would cost us to get a cup of coffee and two shirts ironed in London. So, we have four women busying themselves about the house…and two men outside watering the lawn. Why does it take two men to water the lawn? We have never quite figured it out. Why does it take four women in the house? That too, is a mystery.

But it makes for a lively household. No one seems to know what to do. And we are not quite equipped to tell them.

"What’s the Spanish word for ‘plunger’?" Henry asked yesterday.

"What? What do you want with a plunger?"

"Well, what do you think I want it for? The toilet is clogged up. I was going to get a plunger to fix it."

We never did figure out the Spanish word…but Dad went up and had a look…and soon resolved the situation. That’s what dads are for.

We waited a quarter of an hour for our tea…we could have made it ourselves, to our liking in three minutes. But it would have been selfish of us to make it ourselves. What would Jessica do! When Jessica eventually brought the tea it was too watery. And she had put in so much milk that an Englishman would have found it undrinkable. She had also taken it upon herself to put in a half a cup of sugar. Now, even your editor found it undrinkable.

"If we stay here long enough we’ll eventually get things organized the way we want them," Elizabeth sighed.

We had come with a stack of books. We imagined ourselves spending long, lazy hours reading in a deck chair. But lo…that is not life at Casa Bonner. In addition to the maids and the gardeners, there is an army of contractors, visitors, errand runners and miscellaneous people coming to the door. One man comes to install an Internet connection…another comes to fix the plumbing. A contractor comes to tell us that the man who did some work in the gardens did a terrible job; the whole mess will wash away in the next rainy season, he tells us. Another comes to remove wasp nests…and here comes a truck with food and drink! Instead of the calm repose that we imagined, we find ourselves living the most hectic Christmas vacation ever! A couple of years ago, there was no one on this beach – except an occasional fisherman. The caretaker lived in a wooden shack on what is now a $500,000 lot…and had the beach all to himself! … Now, people drive up every few minutes. Last night, some guy came with a half dozen trees to plant – big trees. All day long a sweaty man hammered on the concrete to imbed an electric line.

The Daily Reckoning