Those Irresistible Hearts of Darkness

The world is currently reveling in excess. From China to Las Vegas, the constant exchange of money is getting more and more outrageous. Bill Bonner explains why investors may be setting themselves up for failure by entering into the ever-darkening hearts of some very volatile markets.

"The horror! The horror!"
– Heart of Darkness, Joseph Conrad

The trouble with vacations is that they are much too serious. Instead of war, depression, bankruptcy, and hyperinflation, we are dealing with things where the stakes are really high. Instead of reflecting on trade deficits and subprime credit markets, we have to think about things we actually know something about, and issues over which we might actually have some influence.

One daughter has a boyfriend covered with an exterior of colorful tattoos, and an interior as dull as airplane cutlery. Another daughter has a boyfriend who seems gentlemanly and ambitious. The latter is almost too good to be true, while the former is almost too bad to be false. One son wobbles between medical school in the United States, and business school in France. The other is wondering whether to pursue a career as a bank manager…or a bank robber.

The point is, every decision is important; and every bit of parental advice has to be carefully considered…and judiciously administered. Even good advice is likely to be taken badly. The counselor has to be on guard; like a zoologist giving antibiotics to a sick polar bear, he is lucky to avoid having his limbs torn off.

So for us, it is a great joy to be back from our vacation, back in work-a-day world, where we can get some rest…and have a good laugh or two.

We noticed that the outrageous trends that were going on when we left, have become even more outrageous. Seeing a disaster coming…investors are rushing to get in on it before it is too late.

China is clearly in a bubble. Shanghai stocks are up 250% since 2005 – and 35% this year alone. Still, investors are so eager to get in at these prices – while they can still get hurt – that they take up Chinese bank IPOs at twice the PE ratios of banks in developed countries. And what do they actually get when they buy a share? What exactly is a bank chartered and regulated by communists? They haven’t a clue.

But so much foreign money is elbowing its way into China that, in 2007, the central bankers are getting bruised just trying to keep up with it. China is expected to accumulate more than half a trillion dollars in foreign exchange reserves – twice as much as last year. How does it get that money? It prints up currency of its own to buy the foreign currency from businessmen and investors – who are selling Chinese made goods (including stock certificates) to foreigners at a breakneck pace.

Everywhere, extravagant amounts of cash are flooding into overpriced investments in absurd places. Local central banks are printing money at a furious pace (lifting the great global tide of liquidity) to keep from increasing the value of their own currencies. This freshly minted cash comes into the world like a newborn baby – ready to claim its fair share of resources all its life while being a burden in the long run; but at the crib, it’s a joy to everyone.

And now we enter the dark heart of this whole cockamamie tale.

China is not the only place investors can get themselves into trouble. More than a third of the money that trades hands on the Brazilian stock exchange comes from overseas investors. Brazil has always been the ‘country of the future,’ but six years ago, Brazil’s future was so dismal it looked like it would default on foreign loans. Now, foreigners give it so much money it doesn’t know what to do with it all. At the present rate, Brazil’s dollar reserves could go up 100% this year.

Meanwhile, who would have thought that investors would scramble to buy Hugo Chavez’s paper? But, then again, why wouldn’t they? If they will buy banking stocks in a country organized on Marxist-Leninist principles, why not the slippery bonds of a Latin American strong man who professes to be a follower of Trotsky? Investors not only take up the Venezuelan bonds happily, they do so at less than 7% yield…barely 200 basis points more than the sovereign debt of the United States of America.

Officially, the Venezuelan Bolivar is quoted at 2,150 to the dollar. On the black market it trades for 3,750 to one. And it’s sinking fast – down 15% so far this year. No wonder. The money supply is increasing at 65% per year…while the inflation rate is, officially, 20%. And Chavez is still increasing government spending by 50% a year.

But Venezuela has oil; and it is to the black goo, not to Hugo Chavez, that investors look for security. But just as investors often search for ways to turn a silk purse into a sow’s ear, so do governments more than occasionally strive to turn their good fortune into national catastrophe. Caracas seems to be doing so in classic manner, spending more than even his country’s oil revenues will permit. What will happen when the Venezuelan treasury runs out of cash and credit? Will Hugo Chavez cinch up the nation’s belt in order to honor his commitments to the foreign capitalists he despises? Two months ago, Ecuador threatened to default on its bonds; Chavez cheered it on.

Even long-dated dollar-denominated bonds issued by Iraq, trade at yields less than 10%. In that heart of darkness, too, investors are counting on oil to make sure they get their money. The trouble is, whether in the jungles of South America or in the deserts of the Middle East, the politicians above the ground can destroy a nation’s credit faster than the oil below ground can salve it.

Back in the U.S.A., one of the good things investors are intent upon getting too much of, is in Las Vegas. ‘Excess’ is an old word, but it seems to have been invented in anticipation of modern Las Vegas. Nothing about the city is modest or restrained.

Over on The Strip, Goldman Sachs (NYSE:GS) is buying Carl Icahn’s four casinos…for $1.3 billion. The city had a total of 35,000 hotel rooms in the 1970s, which seemed like more than enough to us. Now, it has five times as many – 151,000. But ‘too much,’ as we noted earlier, has dropped from the English vocabulary in Nevada, and perhaps in the rest of the world too. The Venetian alone is adding 3,200 new rooms. And the owners of the old Stardust Casino judged it too small, so they blew the place up last month to build a new development, Echelon Place, with more than 5,000 rooms. Meanwhile, MGM’s new City Center development is supposed to cost $7 billion, making it the most expensive development in Las Vegas history.

Everywhere you look, it is the same. Intrepid investors push deeper and deeper into the jungle…exploring…searching… reaching…for some way to ruin themselves in style.

Bill Bonner
The Daily Reckoning
April 27, 2007

Editor’s Note: 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).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

Empire of Debt

We read the IHT news just to find out what our fellow countrymen are thinking about. If we want a laugh, we turn to the editorial pages.

But today’s financial news practically caused a ruptured spleen. This is a headline from International Herald Tribune:

"Bringing hedge fund-style investments to the masses".

Ha…ha…ha…oh stop it, please…our stomach muscles can’t take much more of this.

About the only financial edge the lumpeninvestoriat has enjoyed recently, is that it has not been able to get into hedge funds. But along comes an entrepreneur who plans to eliminate that saving grace; Mr. Christian Baha proposes to do for the middle classes’ financial needs, roughly what subprime lenders did for their housing needs.

"Merrill pioneered the retailing of stocks," says the CEO of Superfund; "Fidelity did the same thing with mutual funds. One day Superfund will be a household name."

We don’t doubt it. Superfund could easily become as popular and well known as New Century Financial (OTC:NEWC). And Christian Baha’s name, too, could go right up there in the great financial headlines, along with Charles Ponzi.

"If hedge funds are good for the rich, they are good for everyone," says Baha, carefully covering himself. For, of course, if hedge funds were good for the rich, we wouldn’t be laughing so hard. What hedge funds are really good for is making hedge fund managers rich. Sooner or later, nearly everyone else takes a bath.

Investors are almost sure to lose money. Because even if the odds of making a profit in the typical fund – over the long run -were better than 50/50, they couldn’t be very much over 50/50. So, when the hedge fund manager takes 2% of the capital and 20% of the gains – and none of the losses – the investor is likely to end up (be it suddenly or gradually) with less money than he started with.

In the present Age of Money Madness, the ‘less’ they are going to end up with could be a spectacular loss.

Here’s the CEO of Black Rock (SEA:BLR), who says, "lenders to highly indebted companies are making the same mistake that subprime lenders made." Well, what mistake did subprime lenders make? They lent money to people who couldn’t pay it back. And who’s making that mistake now?

Hedge funds.

In the old days, before funds came along, it was the banks that arranged financing for companies in need of it. But one innovation leads to another. First came sophisticated machine guns in World War I and then came the tanks. From the Somme to the Blitzkrieg, the history of warfare is one innovation after another. And in finance, after subprime mortgage lending blasted the ranks of America’s middle and lower middle classes…along comes the Superfund to mop up the survivors.

When it comes to supplying funds for dodgy corporate deals, hedge funds rush in where banks fear to tread. And here we turn to Rob Peebles to tell us how…and why, using an example from the Wall Street Journal, July 25, 2006:

"First, Burger King paid the private equity folks $22.4 million in ‘professional fees,’ apparently for shepherding the company from the public wilderness into the loving arms of private equity owners. Then, after three years of restructuring and other voodoo, and three months before releasing Burger King back to the public, Burger King paid the investors a $367 million dividend…

"Burger King borrowed the money for the dividend, the sort of thing that apparently is possible at the late stage of a credit bubble.

"Finally, as a parting gift of sorts, Burger King paid the investors $30 million to terminate their agreement, because after all, there is only such improvement an operating company can take.

"All in [all], according to the Wall Street Journal, the private equity investors squeezed $448 million in dividends and fees out of The King before the company went public again…

"New York Times columnist Floyd Norris recently put a number on the private equity dividend mania, and that number – the amount of money companies borrowed to pay dividends to their owners – was $26.9 billion – in the first quarter of this year. At that rate, RFP this year will easily surpass last year’s $56 billion, a figure that towers over the less than $20 billion borrowed for dividends as recently as 2003.

"The beauty of RFP, as Mr. Norris points out, is that the private equity investors can make money even if the company itself goes under, or has to layoff scads of employees. But who would loan money to a company that borrows money at one end and pays it to its owners out the other?"

We elaborate. Who would be so stupid as to lend to borrowers who use the money merely to impair the lenders’ collateral?

Mr. Peebles answers the question as we do – hedge funds, of course.

And why? Because they can earn high fees currently, while pushing the potential losses onto their investors eventually.

But let’s return to Mr. Baha. In fairness to him, the Superfund does no such thing. Instead, his two main funds "invest in more than 100 markets, including oil, coffee and currency and index futures," according to the IHT report, using "a computer program that is maintained by a team of 35 people."

"Baha said the program exploits trends in commodity prices that go consistently up or down, using models of past price movements. Once a trend is identified, Superfund’s ‘black box’ issues a buy or a sell order.

"’The charts never lie,’ said Baha."

Ba…ha ha ha ha….

Oh, stop it…you’re killing us…Wall Street would never try to pull the wool over our eyes – would they?

More news:


Addison Wiggin, with some info from our very own Maniac Trader…

"’Corn farmers are languishing in an ethanol dream world,’ commodities pro Kevin Kerr reported. Kevin just got back from a whirlwind tour of the Midwest. He wanted to get up close and personal with the so-called ethanol boom.

"’Long-term, I’m bearish on corn. But in the short-term…look out!’ The Maniac Trader was crossed-eyed and astounded as he saw Indiana farmers importing their seed corn from Brazil…and unable to get it into the ground because of wet weather. ‘The farmers have an adage: knee-high by July,’ Kevin said. ‘This year, they’ll be lucky to be knee-high by October.’"

For the rest of Kevin’s assessment read today’s issue of The 5 Min. Forecast

————-Bill Bonner, with more views:

*** The dollar (USD) hit an all-time low against the euro (EUR), and then bounced back slightly. It’s hard to keep your wits about you under any circumstance, but particularly hard for an investor when there’s so much noise and distraction. You don’t know what’s important and what’s not.

The important fact, at least as we see it through our glass darkly, is that the world is gushing dollars. And here we connect anklebone to leg bone. Dollars are the main export of the world’s biggest economy. But that economy is the economy of the world’s most debt-ridden nation. And it’s the same nation that sets the value of the dollar, the paper in which the debts are measured.

That same nation – and you know which one it is, dear reader – shows no sign of paying down the debt. In fact, the debt has begun to feed on itself; now, more money has to be borrowed to pay the interest on previous borrowings.

Currently, 80% of the U.S. fiscal deficit is financed by foreigners; one hundred percent of the U.S. trade deficit is financed by foreigners; and all over the world, the piles of dollar bills…dollar credits…dollar shorts…dollar bets…and dollar-based debts…are mounting up. China alone is expected to have more than $1 trillion U.S. dollars in reserves by the end of this year. In short, many of the people with the most to lose from a falling dollar are people who can perfectly well get along without it.

The foreigners don’t all speak English; but they can say ‘euro’ or ‘yen’ or ‘gold’ probably as well as they can say ‘dollar.’ And, if and when they feel that the dollar is wobbling, they are quite likely to want to lighten up on their dollar holdings.

*** As we mentioned just yesterday, what is so flabbergasting about Thomas L. Friedman’s work is that it is a piece of boundless naïveté wrapped in a monumental conceit.

The man has been jabbering for many years…but thinking for none of them. Could he really believe that this old world…sweated over so feverishly by so many gods and men for so many generations…is still so trivial and transparent that an abject simpleton such as he could not only understand it, but improve upon it?

We stand back in awe…not only of the great world itself…but also of the extraordinary creature in it – the New York Times journalist who has so captured our attention. Oh, if only he could think! Then, he could explain what goes on in that wooden noggin of his. If only he had some imagination! Then, he might begin to appreciate the complex and intricate webs of private plans, hopes, dreams that his own Public Policies and Programs interrupt. If only he had eyes! Then, he could open them and stare at the yawning jaws of Hell that await him and other pious meddlers.

But Thomas L. Friedman is only a journalist. He is like a junior officer in the Charge of the Light Brigade. His role is not to think about things…and certainly not to ask questions. He looks neither to the left, nor to the right. But only ahead…and only in order to get the troops moving.

Oswald Spengler described the part played by the modern media:

"The press today is an army with carefully organized weapons, the journalists its officers, the readers its soldiers. But, as in every army, the soldier obeys blindly, and the war aims and operating plans change without his knowledge. The reader neither knows nor is supposed to know the purposes for which he is used and the role he is to play. There is no more appalling caricature of freedom of thought. Formerly no one was allowed to think freely; now it is permitted, but no one is capable of it anymore. Now people want to think only what they are supposed to want to think, and this they consider freedom."

One of the things they are supposed to think is that democracy is the most perfect form of government. Reading El Pais yesterday, (we read the news in Spanish in order to try to learn the language), we found a columnist who praised this week’s French elections as a "triumph of democracy," because so many people voted. Why did so many people vote? The answer is simple – because so many people had a dog in the fight.

In France, it is hard to find a family that doesn’t get some form of revenue from the government (which is to say, money that doesn’t belong to them) – farm subsidies; government jobs; jobs with the quasi-governmental corporations such as utilities, railroads, airlines, health care, education and automobile industries; welfare payments; pensions; health care; and so on. One candidate offers more of the same. The other candidate offers even more of the same. With a lot at stake, the French went to the polls to decide how the stolen goods will be divvied up.

And Americans? Obama…or Hillary? John…or John?

This little item comes to us from our old friend, Doug Casey’s newsletter, Big Gold:

"On April 16, the Christian Science Monitor published the results of a study showing that a majority of Americans – 52.6%, to be exact – now receive ‘significant income’ from government programs. At the same time, the percentage of the working population ‘not employed in a government reliant job’ has fallen below 29%.

"Now consider the implications. Fewer than 30% of workers are airmailing large portions of their paychecks to more than half of the rest of the population. And as the Baby Boomers retire, the latter number is inexorably headed up; it’s projected to close in on 60% by 2030."

When wolves and sheep sit down to dinner the menu has already been decided.



The Daily Reckoning