You Gotta Have Faith

“Today, anyone who is a bull on the dollar (or on the pound or the euro, for that matter) has to be a bull on human nature…and on economics too. Economics is merely the study of man and his money. But reported in the International Herald Tribune was the curious finding that people who had studied economics for 6 months scored no better on tests of basic economic principles than people who had never opened an economics book. The researchers were too timid, in our opinion. A follow-up study will show that those who go on to study economics at an advanced level will actually score lower than those who never studied it at all. It is a value-subtracting discipline. The longer you study it, the less you know.

“Still, this week, the whole world seemed to hold its breath, wondering what a committee of economists would say. Would the US central bank lower rates? Or raise them. Economics itself has been in a bull market for many years. Now, economists control our money and get their faces on our news magazines.

“But we live in a world of remarkable wonders. Improbably, even the Iraqi currency – the dinar – is going up against the US dollar. In January, 2004, it took 1,480 dinars to buy a dollar. Now, Iraqis willing to stand in line in a public place can buy them for just 1,240. While the inflation rate was recently clocked at 30% per year, the Iraqi central bank nevertheless lends out money at 20%. Last week, at an auction in Texas, a bookstore owner reportedly paid $100,000 for a lock of Che Guevara’s hair. And in Argentina, this past April, it rained spiders.”

Bill Bonner
November 5, 2007

Now over to Short Fuse reporting from Los Angeles…

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Views from the Fuse:

Last Thursday, New York’s attorney general sued a leading mortgage appraisal management firm for doing something we’ve long suspected: inflating home values. You didn’t really think that mobile home down the street from you was really worth $1.5 million, did you?

“Pressure on appraisers reaches pandemic proportions,” David Hutton, senior editor at a research company told the San Francisco Chronicle. “The New York lawsuit…may just be the tip of the iceberg.”

This practice has been widespread across the nation in the last few years – and most would agree that these inflated home values have added to the already disastrous housing crunch. In California especially, where no one believed that home prices would ever go down, this has become an especially big problem.

“We get pressured every single day to inflate our values,” said Dan Tosh, principal at Tosh & Associates, an appraisal firm in Brentwood. “We get people telling us we’ll never work again, or they won’t pay us because we won’t play ball.”

“When Enron executives faked revenue, they went to jail,” quips the Survival Report’s Mike “Mish” Shedlock. “This hasn’t been the case with the banks pulling these scams.”

Many new laws are coming into play right now, to try and put a stop to this – but many homeowners have already been affected…and used “phantom equity” to pay for their granite countertops and plasma TVs.

Mish has an idea of how you can protect yourself as this unravels – think of it as a different kind of home insurance.

“Citigroup laid an egg over the weekend,” write Addison and Ian in today’s issue of The 5 Min. Forecast. “CEO Chuck Prince announced the country’s biggest bank would have to write down $8-11 billion in addition to the $5.9 billion reported in early October. Thus, Citi’s subprime tab more than doubles to the tune of up to $17 billion dollars…in the past month alone. Citi’s $5.9 billion write down helped the bank shed some 57% in third quarter profits…seems as though the fourth quarter is off to a bit of a rough start.

“If Citi tops Merrill Lynch’s recent $8.9 billion write down, they’ll set the new subprime record and get a nice set of steak knives. Along with Prince’s surprising disclosure came his own not-so-surprising resignation. Former Treasury Secretary Robert Rubin has been asked to leave his cushy job as the chairman of Citi’s executive committee to help repair the damage done by subprime exposure.

“Good luck.”

You know things are bad when a supermodel starts dumping dollars.

The highest paid model in the world, Gisele Bundchen, is insisting to be paid any currency – but the U.S. dollar.

Not such a terrible idea, especially when you consider the fact that most experts believe the dollar could fall to $1.50 per euro by the end of the year.

“We’ve told all of our clients that if you had one idea, one investment, it would be to buy an investment in a non-dollar currency,” said Bill Gross.

What about stocking up on the anti-dollar: gold? The yellow metal, on Friday, rose to over $800 for the first time since 1980. Outstanding Investment’s Byron King thinks that gold will continue higher for the rest of the year – and there’s no reason you should miss your chance to get in on the action.

We’re back at home…back in Merry Ol’ England…back in our London office, after a long trip that took us to South America, Germany and France.

What’s new in England?

The British pound (GBP) hit a 26-year high against the dollar while we were gone. It now costs $2.07 to buy a pound; which means, our breakfast (coffee and two pieces of bread with butter and jam) cost us more than $10.

Pull out a dollar bill in Europe today and shopkeepers are likely to snicker. Moneychangers check the news regularly, just to make sure they are not short-changing themselves.

How come the pound is so strong? The English are spendthrifts too – just like Americans. They’ve loaded themselves up with debt – just like their yankee cousins – and now have the lowest disposable (after debt service) income in 10 years. Britain even has a current account deficit of 3% – not as much as the United States, but still not very healthy.

So why is the pound so robust?

Our answer: because it is not the dollar.

The pound is not going up against the euro (EUR)… or against gold…or against oil. It is going up against the dollar, which is to say…the dollar is going down; it makes everything else look like it is going up. Almost every foreign currency, with the exception of the Zimbabwe dollar, is going up against the American money. And so are things that aren’t made from trees – such as coal, wheat, steel, shipping prices, health care insurance, tuition, and gold.

Over the last eight years, we have made a number of suggestions…and given out a number of ideas…here at The Daily Reckoning. Dear Readers might recall how we thought Canada was a good buy…and Argentina…and even Japan. We also have liked commodities, generally, and oil. But we have made only one recommendation: buy gold.

This is because we are not clever enough to know any better. You might have made more money by investing in a go-go emerging market – such as China or Brazil. But what do we know about Chinese stocks? You would have made a lot more by buying Google when it went public, too. But what do we know about technology? Individual stock research is hard work. You can’t buy Starbucks stock just because you just had a good cup of coffee. And you can’t buy a health care stock just because you notice that people are getting older. No, you have to do a lot more research. You have to study the business, study the finances, get to know the industry and the people in it. That is, of course, what Warren Buffett does. It is why he is perhaps the greatest investor who ever lived. And it is precisely not what most people do…and why they are not investors at all – but merely yahoo speculators, hoping that prices go up.

That’s why we stick to the big picture. And the big picture circa 1999, 2000, 2001…and so on…told us to buy gold.

We urged Dear Readers to buy gold when it was $300…when it $400…when it was $500…and when it was $600. Yesterday, the price shot up $14.80 – to over $808 per ounce. And guess what, dear reader? It’s probably not finished.

Uh…long-term Daily Reckoning sufferers will notice that slippery word – ‘probably.’ Yes, Dear Reader, we weren’t born yesterday. We know that there is more under heaven and earth than is contained in our philosophy. Our guess is that gold has a lot further to go…a lot further. But let us pause a moment and look at how things might go in a different direction.

Last week, the stock market quaked. The Dow fell more than 350 points on Thursday. Commentators said investors were ‘disappointed’ with the Fed’s quarter-point cut. We don’t believe it. They saw that cut coming a mile away. Instead, stocks sold off because that’s what stocks do…occasionally. And they could have sold off a lot more. The Dow could go down 500 points in a single day…or more. Then, it could keep going down. No law says it couldn’t. And there are plenty of examples of similar crashes. We keep our “Crash Alert” flag flying over The Daily Reckoning headquarters, just in case.

A crash in the stock market would knock down the only solid pillar still holding up American wealth. Residential housing is already down a little more than 4% according to Case/Shiller. No one knows how much more it could go down…but 10%, 20% or 30% are reasonable numbers. This alone represents trillions of dollars worth of ‘wealth’ that people thought they had – vanished!

Could the stock market go down 10% too? It not only could…it will. The only question is ‘when’. But when it does, it too will take trillions of dollars out of Americans’ wealth.

And then, there’s the dollar. Already this year, the greenback is down about 10% against major currencies. The estimate we remember is that all the stocks, property and other wealth of Americans – quoted in dollars – is worth about $50 trillion. Take 10% off that number and you have a loss of “implied wealth” of $5 trillion.

This, dear reader, is flation with a capital ‘D’ in front of it. Deflation, at least according to our definition, means that people just don’t have as much money one day as they had the last. Then, their whole outlook quickly changes. Where once they were bold, they quickly become fearful. Where once they foolishly trod, they now are afraid to rush in. Where once they spent, now they leave their money in their pockets.

The pollsters tell us that Americans are growing more pessimistic. They’re afraid things aren’t working out – neither in Iraq, nor in Washington, nor on Wall Street. It is as if they had awoken from a long sleep. They find themselves with a long gray beard…and no money in their pockets. For thirty years, their hourly earnings have not really increased. Now, because their expenses and debt service have gone up, they find themselves with less discretionary income than they had during the Carter administration. What is going wrong, they ask themselves?

No ready answer comes to them. But a gloomy sentiment creeps upon them. “No…” they say to themselves. “Maybe we won’t buy a new car this year…”

And now, Dear, Dear Reader…consider this:

One out of every five dollars of consumer spending worldwide is spent by an American.

So you see, it is not just the U.S. economy that depends on U.S. consumers; it is the whole world economy. Everything depends on the willingness of people who don’t have any money to keep spending it. When they stop spending it, the world economy enters a new phase…a Japan-like phase of slump and deflation.

Ah…there’s the rub. At least, there’s the possibility of a rub. Consumer prices in Japan are, believe it or not, still going down. People in Japan do not need to buy gold as protection against inflation. Their own currency is protection enough. And if the world were to enter a Japan-like funk, the bull market in gold would be over. The bear market in the dollar would be over too.

Gold is a traditional measure of wealth. It took about an ounce to buy a toga during the Roman era. It takes about an ounce to buy a nice suit now. (Actually, since new supplies of gold are running behind GDP growth rates, you can reasonably expect to be able to buy two or three suits for an ounce. But it depends where you shop.) Gold will not really go down…but its price in dollars may vary. And if the dollar stops going down, it will look as though the price of gold is no longer going up.

Do we expect this to happen? Not exactly. Not soon, anyway. And not for long.

Until tomorrow,

Bill Bonner
The Daily Reckoning