The Rules Don't Change

Winter is here. The little squirrels look to their hoard of nuts to see them through the cold times. But what’s this? The sorry squirrels of North America hunt around…where are the nuts? Uh oh…they forgot to put any away!

U.S. consumers enter a recession in the worst shape ever. It’s a richer world than it was in the ’30s. There’s no danger of starving. We don’t imagine that people will have to stand in line to get a bowl of soup. But when it comes to money…never have so many people owed so much to so many. And when the creditors try to collect – there’s going to be Hell to pay.

On Friday, the Dow fell another 59 points…ending a very depressing week for stock market investors.

“What is going on?” investors ask themselves. “Many investors will begin the week asking whether they need to add worries about an equity bear market to their fears of economic recession,” explains the International Herald Tribune.

Nobody knows anything…so let us help the clueless investor: Yes. Worry about a bear market. Because it is almost surely here.

The Russell 200 Index, a gauge of mainly smaller U.S. companies, is already down more than 20%. The mid-cap FTSE 250 in Britain is down more than 20%. And the Japanese index – the Nikkei 225 – is down 24% since its high in July. The S&P 500 is only off 16% – but it’s catching up.

From California, we learn that the jobless rate has jumped to over 6%. Oh, those poor little squirrels. Nothing in the nut-bin. And now, the nuts on the ground seem to have disappeared.

You’ll recall the argument we entertained a couple of years ago. “The boom is a fraud; it’s making people poorer,” said we. “No, it’s real…people are getting richer,” said our opponents. Something grand and barely comprehensible had happened, they claimed. People had gotten so smart that the old rules no longer applied. You no longer needed to save, for example, because modern information technology and sophisticated financial instruments could provide growth and protection without savings. Besides, the Asians were saving more than enough for the whole world…and, as for a rainy day, what are credit cards for?

Well, now this New Era is being tested. Now we’re going to find out who was right.

But why pretend? We already know the answer. We were right; our opponents were wrong. New Eras don’t come along very often, not in economics. Bet against them and you are almost sure to win.

Why? Because the rules don’t change. It’s the circumstances that change – in ways the rules dictate… Which brings us back to the nuts and the squirrels.

The rules tell us that if you spend more than you earn you must get poorer. The difference between spendings and earnings is subtracted from your net worth. While the spending spree was going on, it didn’t seem to most Americans that they were really getting poorer. They thought they were getting richer, mainly because their houses were going up in price.

But there is nothing like a hanging to focus a man’s attention. Last year, house prices went down about 10%. Suddenly, the average homeowner finds himself dangling at the end of a rope…and the last five years flash before him with crushing clarity: He sees that he spent too much. He sees that he bought more house than he could afford. He sees that his earnings have actually gone down in real terms…while his cost of living has gone up. In short, he sees that he’s been had.

Even newspaper columnists are beginning to get the picture. Americans need to “get back to saving rather than leveraging assets in a phony consumption boom,” writes Roger Cohen in the International Herald Tribune.

Naturally, this insight is making its way onto the political stage. A few weeks ago, the war in Iraq was Americans’ number one concern. Now, “It’s the economy, stupid.” The trouble is, the economy is something that neither the candidates, nor the man who currently lays his head on the White House pillow, know anything about. President Bush is pushing a plan to give the country a “shot in the arm” – at a cost of $150 billion. If Congress would just get behind this thing, he says, we could have rebate checks in the mail in just a few weeks.

Our president misses the point. He, like all the White House hopefuls, wants to keep the phony boom alive – in the worst possible way, by providing more “stimulus” to consumers…that is, by helping them spend even more money they haven’t got on things they don’t really need. What this perverse economy really needs is not a shot in the arm, but a shot in the head.

Meanwhile, Mitt Romney is proposing a $20 billion bailout of Detroit – as if what Motown, smack dab in the richest auto market in the world, needed all along was more money.

And Rudolph Guiliani, asked in October whether he thought a recession might be coming, reminded listeners that he still believes in the promise of the New Era. What with America’s modern, sophisticated market – and the freedom to do any damned thing it wants – “the sky’s the limit.”

Well, yes…the sky’s the limit. Whether you are building something up…or blowing it up.

*** There is much disagreement among analysts and commentators: will there be a recession…how bad will it be? But one thing that all agree on is that, “inherent U.S. vitality remains enormous,” and that the U.S. economy will “bounce back.”

Oh yeah?

When everyone thinks the same thing, no one is thinking at all. And everyone now seems to think that whatever is ailing the United States, it will pass. We disagree.

The rules don’t change. Instead, the rules determine how circumstances change. And circumstances can change for a very, very long time.

The Athenians have been waiting 2,300 years for their empire to “bounce back.” The Egyptians have been waiting even longer. And the Seleucids? The Mongols? The Incas? The Romans? Rome is a nice city but the Rome of Berlusconi is hardly the Rome of Augustus. The city never bounced back. And the list of empires that never bounced back is as long as the list of empires. Once they are history, they are history.

When you spend more than you can afford, you get poorer. That’s the rule. So, it should come as no surprise that Americans are getting poorer…though they are just beginning to realize it. Now, when they need money…they have to turn to foreigners…to their imperial competitors.

In the last couple of weeks, some of America’s biggest financial firms have turned to Asians for multi-billion-dollar infusions. The Asians – who’ve been following the rules – working…saving – now have trillions to put to work. The Gulf States, too, have trillions in oil revenues. In the Gulf, they’re building new cities. In Asia, they’re building new industries.

And in America?

The foreigners are putting their money to work – buying up key industries.

“For much of the world, the US is now on sale at discount prices,” says the International Herald Tribune. “Last year, foreign investors poured a record $414 billion into securing stakes in US companies, factories and other properties through private deals and purchases of publicly traded stock.”

We hasten to add that we’re not agin’ it. Politicians will rant and rave about the “loss of US capital and industries.” But it’s a little late for complaining. The loss has been going on for a long, long time. As Americans spent more than they had, the foreigners built up credits. Now, they’re cashing them in. What else can they do? And what would you expect? The falling dollar has reduced Americans’ earnings…and it has cut prices on their assets, too. Now, people with money are taking advantage of the situation.

If you have a factory or a business…you might consider selling to the top bidder – probably a foreigner. If you have no business to sell, well, maybe you can shine the foreigners’ shoes.

There’s no denying what it all means…America’s edge in the world is slipping away. Americans are getting poorer – relative to others. This is an adjustment that probably won’t stop anytime soon. The United States will probably never bounce back to the heights it enjoyed in the ’80s and ’90s.

*** And here’s something else to worry about. Bill Gross, head of PIMCO, the world’s biggest bond fund, calls it the “shadow banking system.” He’s referring to the way money and credit fly around the globe, courtesy of the very same “sophisticated” and “free” institutions that created such prosperity for so many people in the financial industry.

Banks recognize that not all their loans will be repaid. They operate on margins of safety, with reserves set aside for when things go wrong. But in the worlds of swaps, hedge funds and derivatives…slick operators can invest billions with no margins of safety…and no reserves. The result, Gross says, could be catastrophic:

“But today’s banking system, as pointed out in recent Investment Outlooks , has morphed into something entirely different and inherently more risky. Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever. Financial derivatives of all descriptions are involved but credit default swaps (CDS) are perhaps the most egregious offenders. While margin does flow periodically to balance both party’s accounts, the conduits that hold CDS contracts are in effect non-regulated banks, much like their hedge fund brethren, with no requirements to hold reserves against a significant ‘black swan’ run that might break them.

“According to the Bank for International Settlements (BIS), CDS totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks.”

Until tomorrow,

Bill Bonner
The Daily Reckoning
London, England
Monday, January 21, 2008

The Daily Reckoning PRESENTS: The Mogambo has long been a proponent of holding gold as a hedge against inflation. So, what else could possibly come into the Great Mogambo Portfolio (GMP) that would kick gold from the top spot on his investment list? To quote the Rolling Stones – take gold, and “paint it black…”

by The Mogambo Guru

There are many of you who are skeptical of my claim that not only will gold and silver go up like they have in all the rest of the last 4,000 years of economic history when a government started creating excess money and credit like the stupid buttheads that they are, and I get tired of arguing with them because it is so hard to be convincing when it is obvious that I have no idea what in the hell I am talking about.

But while it is obvious that since gold and silver are going up because the Federal Reserve has debased the dollar so much, it is less intuitive that oil is on its way up, too.

That is why I am pleased to present part of an interview between Matt Simmons and Bud Conrad of Casey Research, which was published in the August 2007 edition of the Casey Energy Speculator, which has never interviewed The Mogambo, so that proves that they are a class act.

Anyway, they say that Matt Simmons has been an investment banker for 40 years, is founder and chairman of the world’s largest energy investment banking company Simmons & Co. International, and that in 2005, he published Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, a book that, as they say, “has galvanized the peak oil debate.” So he probably knows what he is talking about.

Well, I don’t know for sure whether it galvanized the Peak Oil debate or not, but Mr. Conrad asked, “If I can just interject, when you look at the big picture, and try to get to the big numbers of 342 million barrels of oil equivalent per year from all energy types that the world will demand for its energy needs by the year 2030, you need huge increases not only in the production of oil, but you need the other kinds of energy. And you need a huge investment. I’ve seen numbers like $10 or $15 trillion in the infrastructure to get there. My question when looking at the big picture is – how are we going to fund that sort of investment?”

At the prospect of spending $15 trillion on oil infrastructure alone, I was instantly on my feet, shouting, “Yeah! Where? You got $15 trillion freaking dollars, pal? You do? Well, how about handing a few thousand down here? You won’t miss it!”

Well, I am not sure to which question he was responding, probably both, but Mr. Simmons replied, “the odds of that happening are less than one percent.” Naturally, even a bonehead like me knows that a one percent chance is not very good, and I saw that my chances of him coming across with that cool thousand bucks was now slipping away. But I cleverly figured that I could up the percentage if I sort of, you know, made vague threats of physical violence against him and his family (which is so popular around the globe these days), but I have to be careful since the judge came up with his, “This is the last time, you Vicious Mogambo Moron (VMM)! The next time you assault somebody, you’re going down, whether or not, in your Stupid Mogambo Opinion (SMO), you think they deserve it,!” and I remember thinking, “I’ll bet you wouldn’t say that if I came up there and beat the hell out of you, you halfwit, loser, piece of judicial dog crap!”, which I did not say out loud, which turned out to be a good thing, just like my lawyer said it would be!

But it turns out he was not even talking to me! He was responding to the suggestion that a mega-infusion of capital could save us from Peak Oil Armageddon, which everybody thinks is more important only because it wasn’t THEY that was getting the thou!

Anyway, he says, “If we were lucky enough to open up the entire outer continental shelf and then we were lucky enough to invent quickly enough seismic equipment to start doing some sort of a high-grading of where we should drill, and then we were lucky enough to have a growing fleet of newer offshore rigs that could drill wells and we just discovered two new North Seas, then there’s grounds that we could basically spend four or five hundred billion dollars and maybe end up ten years from now with six million barrels a day of fresh supply. But the problem is that each one of those things that I said, ‘If we were lucky enough’, we don’t have. And to create each one of those is going to take ten to fifteen years to do. And ten to fifteen years from now, our 73 million barrels a day of current crude production could easily be down to 50 or 45. So you say even if you had another 6 million barrels per day, you can’t climb back out of the hole.”

But climbing out of holes is no problem for those who have gold, as is explained by Ross B. Hansen of Northwest Territorial Mint in his essay, “The Price of Gold Doesn’t Matter”. He writes, “After the past two months, it’s difficult to remember that the year began with gold trading at $636.30, silver at $12.96, palladium at $335, and platinum at $1,139.50.”

Now things are different, of course, but it is not just about gold. It’s also about energy, and he notes that it is also hard to remember that “gasoline cost $2.38 on January 1 of 2007, according to the US Dept of Energy’s Energy Information Agency. On December 31, that same fuel cost $3.10. That’s an increase of 30%.”

As an example, he says, “If in January of 2007 you had $637.50 to buy an ounce of gold, you could have bought 1 ounce of gold, or 267 gallons of gas. With that same $637.50 today, you could only buy about three-quarters of an ounce of gold, or 205 gallons of gas.”

So why doesn’t the price of gold matter? He explains, “If you were using gold as your standard, you’ll discover that you can buy about the same amount of gas (actually, a little more) with the same ounce of gold you had on January 1”, thus effortlessly demonstrating gold’s “store of value” as it preserves buying power!

And for a guy who just wants a little gas in his car so that he can go out, have a few drinks with his hoodlum friends and make a creepy nuisance of himself by flirting with the waitresses until they get the bartender to come over and make me stop, then I agree; the price of gold doesn’t matter, as all I want is a little gasoline! And a pizza. And some beer to wash it down with, too.

Until next time,

The Mogambo Guru
for The Daily Reckoning

The Mogambo Sez: Life is sweet, indeed, for those who hold gold, silver and oil, and life will get sweeter yet, as the Fed and the Congress have not even gotten started cooking up their inevitable monetary and fiscal stupidities to “do something” to save the economy from their previous monetary and fiscal stupidities that have caused gold and commodity prices to get as high as they are.

And thus gold, silver and oil (and indeed all commodities) will make you and me rich without our lifting a finger, or even getting up off of our fat, stupid butts. And if you are even remotely like me, then you think, like I think, as all lazy people think, that this is the absolute best way to make money! And it is! Whee!

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

The Daily Reckoning