THE UNSUSTAINABLE LIE OF INFLATION

“I continue to believe that the American people have a love-hate relationship with inflation. They hate inflation but love everything that causes it.”

--William E. Simon

“If you tell a lie big enough and keep repeating it, people will eventually come to believe it. The lie can be maintained only for such time as the State can shield the people from the political, economic and/or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State.”

-- Joseph Goebbels

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

-- John Maynard Keynes

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You are being lied to.

In fact, it has been going on for almost a century. Your government wants you to believe – based heavily on the work of John Maynard Keynes and his disciples – that the only way an economy can grow is by creating moderate inflationary price increases, through the use of monetary and tax policy.

Some of you will notice that I’ve used both the Keynes and Goebbels quotes, above, in past articles, and I hope you’ll forgive me; I felt they bear repeating because they are so poignant and germane to the way the global economy is being manipulated. You may or may not agree with me, but the propaganda being employed to scotch-tape this crisis at its swelling seams is nearly as imperceptible as it is astonishing.

The word propaganda, in its current accepted usage, has been around for centuries. And just for the sake of thoroughness -- and to avoid any misunderstandings -- I’m going to define what I mean by current usage:

propaganda |ˌpräpəˈgandə| noun. information, ideas, or rumors deliberately spread widely to help or harm a person, group, movement, institution, nation, etc. (Dictionary.com Unabridged. Random House, Inc. 07 Nov. 2009.)

Many historians agree that Joseph Goebbels was the “master” propagandist, and after reading the quote at the beginning of this article, it’s pretty clear he took his duty to his government seriously. But how hard was his job, really? I mean, come on… you plaster a few swastikas all over a well-pressed black suit, throw on some jackboots, put on a fancy military hat, and say something like, “Homosexuals, Jews, and Communists are evil. So we’re going to kill all of them.”

Then you point guns at your audience, at which point, its members shrug and say, “Okay.”

Goebbels was, of course, the antithesis of everything I hold dear and beautiful in this universe. But you’ve got to admire a man who has the stones to be so blatantly honest about the fact that he’s a liar. Granted, he did have brute force on his side. But still.

In terms of human rights, I’d like to think things are improving -- that the world is a better place than it was through most, if not all of the 20^th century. I’d like to think the governed have become smarter. At the very least, I’d like to think the average human being is more suspicious of, and cautious about his government. And maybe he is.

But then again, maybe he’s not.

The application of propaganda obviously didn’t stop with Nazi Germany. It has been applied with great success by Joseph Stalin, Mao Zedong, Pol Pot, and many others, to hide all measures of truth from the people these leaders suppressed and murdered. Thank God we live in the United States! Home of the Free and the Brave! Our government would never use propagandist techniques to persuade its population of anything! We don’t work that way. Right?

Wrong.

It’s time to wake up; even if the average human being has become a little more sophisticated and leery, governments (and their co-conspirators) have simply upped the ante -- taking propaganda to newer, subtler levels. In fact, the more I think about it, the more galvanized I am toward the tragic conclusion I used to start this article:

We are being lied to. And we still believe every single word of it. But the most revolting part of all this? Unlike decent German citizens forced to endure the tyranny and coercion of the Nazi regime, we actually have a choice not to believe the nonsense being crammed down our throats. And yet we do.

It’s not just governments anymore, either; it’s lobbyists, religious institutions, social movements, and advocacy groups of every sort. It seems like everyone has a sound byte these days. If you haven’t already figured it out, I’m the world’s most cynical skeptic, but some of these campaigns have even given me pause for a moment or two (just before I recognized them for what they were and became nauseated).

Before I bring this topic full-circle to its financial and economic implications – if only to illustrate the subtlety, sheer pervasiveness, and impact of some modern propaganda -- I want to share a few of my favorite contemporary phrases:

Ethnic Cleansing – This is a polite, yet important-sounding way of saying “If you don’t mind, we’d appreciate it if you, and everyone like you, would dig a ditch so we can shoot you and bury you in it. Thanks.”

Political Correctness – This phrase is just a haughty way of saying, “If you can’t say anything nice, don’t say anything at all.” Am I the only person in the world who finds this hackneyed little Clinton-era lyric to sound a lot like the noise a goat makes when it’s being slaughtered? I’m sorry, was that metaphor politically incorrect? I think I hear an angry PETA member throwing a computer monitor out a window somewhere.

Eminent Domain – This is an extremely sophisticated, legalistic way of saying, “We’re stealing your house. Get the hell out. Now.”

Intelligent Design – This is how a bunch of envious Christians respond to a concept as cool as Natural Selection. I’m still wondering what they’re going to come up with in response to The Big Bang. Maybe Provident Ejaculation? Whatever it is, I’m sure it will sound positively scientific and rational. I can’t wait.

And now for my favorite…

Quantitative Easing­ – This is government’s modern, scientific way of saying, “We’re going to print money and lower interest rates, making you think everything is worth ‘more.’ But in reality, everything won’t be worth ‘more,’ because we are systematically destroying your currency -- along with the economy – as we manufacture this illusion.”

It’s just a lot easier to say Quantitative easing. Plus it sounds sophisticated, which is important when Ron Paul is all but chewing his microphone off its base as he makes you accountable for your irresponsibility.

Propaganda is an art form. Yes it is.

I love the Keynes quote at the beginning of this piece. I really do. I mean, here’s the architect of so-called quantitative easing basically saying, “By making you think your house is going to be worth more every year, you’re government is stealing your money. And you don’t even know it!”

Again, this isn’t Murray Rothbard, or Jim Rogers, or Peter Schiff, or Milton Friedman! This is John Maynard Keynes telling you your government is stealing from you!

There was a time, believe it or not when price increases were the exception, and falling prices were the rule. As humanity has progressed, technology has always increased our standard of living, and created more efficiency. And this has almost always resulted in falling prices.

If you don’t believe me, think about how much bananas must have cost in Norway during the 16^th century. Or think about how expensive cinnamon must have been in England in the 10^th century. Most people would never even see these commodities – let alone be able to pay for them. Today, bananas and cinnamon are accessible globally, to anyone, at very low costs. Technology caused them to depreciate over time – not increase in price, as your government would have you believe should have been the case.

Or how about the most contemporary – and perhaps best example of all: the computer industry, and Moore’s Law. Prices of computers don’t increase over time -- they decrease with obsolescence and improved technology.

This is the way the economy should work. Instead, however, in order to create the illusion that everything is increasing in value, your government has created a monopolistic fiat currency and a central bank. No one can compete with the primary medium of exchange, and so the Fed prints currency and manipulates interest rates with reckless abandon.

In theory, it’s a great idea. You buy stuff, the Fed keeps inflation at about 3%, and in most cases, after a long period of time, your stuff seems more valuable. You can boast to your friends at work and at parties, “I bought my house for $50,000 in 1977, and today it’s worth $200,000! I’ve quadrupled my money!”

In reality, your annualized rate of return is a little less than 4.5%, and unless you paid cash, your interest rate was higher (and probably a lot higher) than your rate of return, so you’ve actually lost money on your house. And that doesn’t even take inflation into account.

Of course, you did write off all that interest you paid, and you had to live somewhere, but that doesn’t really diminish my point: considering everything I just said, along with the fact that inflation has – in the best case scenario – averaged 3%-4%, your house hasn’t really gained in value at all. And that goes for anything else you’ve bought, for the most part.

Yes, there are exceptions; Warren Buffett has averaged a purported 23% rate-of-return per annum during the decades of his career. But unless you were both lucky and smart enough to have picked up 100 shares of Berkshire-Hathaway (NYSE: BRK-A) when it was trading under $500, you probably haven’t been outpacing inflationary price-increases as much as you think you have – if at all.

But it sure feels like you have, doesn’t it? How many times have you heard this statement: “I can remember when [gas, a coke, a pack of cigarettes] was [insert really low price here]!”

And so the government perpetuates its myth. Why? Because it needs you to believe it’s doing a good job. And how does it achieve this? By creating the illusion that everything is going up in value, when in fact most things – in real terms – aren’t at all. In fact, most goods and services are actually falling in value, when you take into consideration the government policy of artificially perpetuating inflation.

And how does the government create inflation? Again, by printing currency and manipulating interest rates. Just to give you an idea of how consistently the government has been printing dollars since we went off the gold standard in the early 1970s, here’s a chart for you, courtesy of the St. Louis Fed:

Okay, I mentioned the gold standard before, but I want to be clear about something: if the United States dollar ever was truly and directly connected to gold (and this is contentious), it was a very, very long time ago. But whether or not the relationship was ever direct or not, certainly in the 20^th century while the dollar had some relationship with gold, the federal government – for instance, under Franklin Roosevelt – made it abundantly clear that it can, and will simply suddenly and arbitrarily announce how much gold is “worth” dollar-terms.

Or, worse still, the government can simply dissociate the dollar with gold completely – as it did under Nixon. And – as the chart above demonstrates -- since the 1970s (when Nixon took us off the gold standard), the government has been printing money at will, and at an ever-increasing rate -- in its futile quest to manipulate inflation. 

So what would the chart above look like if the dollar were tied directly and invariably to gold? It would be flat. And what would that mean? Simply put, goods and services during that period would rise and fall according to the principles of supply and demand only; there would be no distortions related to currency and rate manipulations. The fluctuations of goods and services would be pure, and their true value would be much easier to ascertain. This would mean more efficiency, more accuracy, and certainly fewer – and less dramatic – economic cycles.

Unfortunately, this has not been the case, and the government has persisted in its profligate and unrealistic quest to manipulate the dollar and the economy. The result? You’re living it: unemployment above 10% -- or, if you dismiss government statistics as unreliable (like I do), double that. Gold is breaking multi-decade highs. Oil and agriculture are climbing fast. These are the inevitable signs of inflationary price-increases, and the signs are huge.

In short, the dam before the Fed has 100 holes, but the Fed only has ten fingers to stop the leaks. The printing has been unprecedented. Rates are lower than ever in history. So what’s next? Well, it looks like the unsustainable myth is finally losing its power to persuade the multitudes, and that can only mean that the ultimate correction is looming before us. Some people call it “coming hyper-inflation.”

I prefer to think of it as the death of the dollar.

Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

THE INTRINSIC VALUE OF NOTHING, PART II

“There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were…”

“It is ultimately always the subjective value judgments of individuals that determine the formation of prices…”

-- Ludwig von Mises, Human Action

“During thousands of years, in all parts of the inhabited earth, innumerable sacrifices have been made to the chimera of just and reasonable prices.”

-- Ludwig von Mises, The Theory of Money and Credit

--

In my article from last week (Part I), I discussed the fallacy of intrinsic value – especially as it relates to the dollar, and the shell game the U.S. government has been playing for the last hundred years or so. In the tornado of debate, castigation, and general mayhem that ensued, some good points emerged – not the least significant of which was the observation that there is a difference between exchange value and use (or utilitarian) value.

Last week I only focused on the subjective nature of exchange value; within that context, I argued that labor (or anything else) only has value if a second party is willing to express a value for it. But, of course, exchange value doesn’t tell the whole story. Several readers pointed out that some goods or services have value only to the person or persons benefiting from them. In other words, besides exchange value, there is also utilitarian value. For instance, if I dig a potato out of the ground and eat it, who has found value in it besides me? There is no second party to offer any exchange value; it only has use value to me.

The distinction is important, but I have to ask: how is use value any less subjective than exchange value? Both require an interpretative perspective, and both would be meaningless in the absence of conscious perception. In other words, how much would my potato be worth if every sentient creature in the universe ceased to exist? Indeed, what would the word “potato” mean at that point?

I’m going to take it a step further: every single value we assign to the universe around us – from prices, to words, to titles, to units of measurement, to mathematical formulae – are all merely constructs we employ to help us better understand the nature of our environment. But all of these constructs are subjective – meaning, specifically, they’re interpretative and subject to falsification. There are no absolute truths. Every single idea or notion we have is subject to change – no matter how immutable it may seem.

I know. Last week I said Austrian Economics is self-evident. And now you think I’m a hypocrite. But let me just say this: the Austrian School of Economics – along with all its tenets and sub-theories -- is as subject to falsification as are the laws of physics.

What? How can the laws of physics be subject to falsification? That’s just nonsense, right?

Wrong.

And how does physics relate to economics… and ultimately, subjective value?

Bear with me…

It is true that most of the so-called “laws” of physics have not been falsified -- although many have. Newtonian physics took center stage until Einstein falsified much of its foundation. And since then, even some of Einstein’s theories have been falsified.

Does this mean I think gravity is about to go away? Well, no. But it also doesn’t mean I believe gravity couldn’t go away. Have you read anything about string-theory? Weird stuff…and it only lends to my already strong conviction (which is, admittedly, subject to falsification) that anything is possible – even in the mysterious world of the human perception of value. Indeed, this strikes right at the heart of the matter.

When I say something is self-evident – as I did in my last article -- I don’t mean it in the Declaration-of-Independence sort of way; rather, I’m saying there are certain aspects of reality that have so much evidentiary basis, that arguing against them is simply absurd. That doesn’t mean these aspects of our universe aren’t subject to falsification -- it just means I have better things to do with my time than try to prove the chair I’m sitting in right now doesn’t really exist. Because that would be a complete waste of time.

Everything you believe is subject to falsification, and it could be wrong. But here’s the best part: everything is theoretical…whether it has already happened or not. And that includes price structures.

Look, no matter how close you get to the thing around you called reality, your perception of it is just that – perception. It is interpretative; you cannot be the computer in front of you -- you can only perceive it. And your perception of it is almost certainly flawed to some degree or another. How many times a day do you trip, or drop something, or make a wrong turn…or even pay too much (or too little) for something? Do you know why these things happen? Because human perception of reality is always theoretical, and it is flawed.

And this is why prices change constantly.

THE ECONOMIC CALCULATION ARGUMENT

Ludwig von Mises established that, without price-structures, scarcity is impossible to ascertain. Prices – like everything else created or done by human beings -- are mere theoretical constructs, created subjectively from interpretation. And prices are definitely subject to falsification. The more participants there are in a market for a good or service, the more theories (prices) are created about the relative scarcity of that product, and thus we get closer to reality (availability) through the use of those prices. This is called discovery in some circles.

People do value scarce resources subjectively; value has no objective meaning, per se -- independent of human interpretation and thought. And it is this very human interpretation that helps us approach accuracy in determining scarcity.

Thus, Mises falsified collectivism. You can blame him for my unceasing assault on any silly theory that suggests people can just share stuff without the use of money, or that resources can be allocated by a centralized bureaucracy more efficiently than by the parties most interested in the resources, themselves.

Again, value is nothing more than an expression of need or desire by interested parties. The means of its expression is unimportant -- it might be in terms of commodities, or water, or shoes, or even currency. But the expression itself, by the interested actors, is as efficient as it can possibly be.

Why do people say, “Money is the root of all evil.” Why? It’s so imbecilic. Have you ever thought about what money is? It’s a medium of exchange! That’s it! And for that matter, it’s really just any medium of exchange.

A long time ago, humans engaged in barter economies: people exchanged stuff – like pigs, or cows, or eggs, or whatever. And those things were money – because, besides having utilitarian value, they could also be used as media of exchange. But in that capacity, they are extremely inefficient. Eventually everyone realized (or should have realized) that the easiest way to exchange goods and services is through the use of currency or credit – both of which are only forms of the broader concept of money.

You disagree? How, then, for instance, do you easily make change with (or for) a live pig, without using currency or credit? I suppose you could use chickens or corn. But is that efficient? And along those lines, let me just say that anyone who thinks money is the root of all evil simply doesn't understand how hard it is to fit chickens or pigs into a wallet.

Taking it a little further: would you say, “Pigs are the root of all evil?” No. That would be dumb. Pigs are not evil. Well, maybe some pigs are evil. I don’t really know. But that doesn’t diminish my point. And even the concept of evil, itself, is a just an interpretative construct – it’s nothing more than an expression of value, in and of itself -- equally subject to falsification. It would be just as meaningless and stupid to say that evil is the root of all evil.

Mises argued that, because money (as distinguished from currency or credit) is nothing more than a means of expressing value, it is best to leave such expression to the participants doing the expressing. If people know what they need -- and if other people are willing to produce -- then it’s simply best to allow all these people to come together, unfettered, to act upon their own knowledge and interests. Some folks need pigs. Some folks have pigs. Why not just let them do what they need to do?

But here’s where Mises really hit the ball out of the park: he identified what happens when prices are manipulated – or still more problematically, when prices are eliminated completely. As we’ve said, prices are simply a means of value-expression, and any manipulation of that expression inhibits the identification of scarcity. Put more simply: when you interfere with prices, you create shortages -- or, more appropriately, you fail to identify them before they even emerge.

When somebody buys a pig, all other participants in similar markets instantly have information that tells them about the scarcity of said swine. If the price of pigs is up, it’s an indicator it may be time to make more pigs.

But people aren’t thinking, “Hey, there’s a pig-shortage, I better do something about it!” No, they are thinking, “Hey, I could breed some pigs and make some money, because the costs of breeding haven’t changed, but prices of pigs are up!” It’s about identifying potential profit. Sitting around trying to predict shortages is moronic. What’s the point? Unfettered prices instantly identify these shortages for us. Why waste time?

Prices are an immensely efficient form of knowledge, and if you believe that efficiency and lower prices are good for eliminating things like, say… starvation, disease, and stuff like that, well, prices might just be most important form of knowledge in the universe.

Mises established that when price structures are manipulated or eliminated, these shortages are difficult, if not impossible to identify: in such contexts, there is little or no expression of value associated with goods and services, and therefore the identification of scarcity is impaired – or worse yet, eliminated completely.

If no prices exist, what’s to stop me from using gold to cover my counter-tops? Why wouldn’t I eat lobster every night? Who says I can’t use oak as the siding for my house? And so what if I want to bathe in milk? Prices identify scarcity, but if prices don’t exist, then why should I believe gold is rare?

And then comes the problem of distribution: without prices, we have no way of knowing where shortages exist, nor when they will exist. How does the tractor manufacturer know how many carburetors to order? How does the freight line know how many routes to maintain? How does the toilet-paper manufacturer know how many rolls to put out? People can moan and whine about their needs all day. They can whine for years. But how does anyone know -- in the absence of unimpeded prices -- whose whining is the most critical? How can anyone tell whose desperation is the very most desperate?

Just ask the Soviets…

In my last article, I told you that Ben Bernanke and Barack Obama depend on your perception of the value of the dollar. They have committed the U.S. government to $13 trillion in expenditures – an unprecedented sum of money – just to battle this economic crisis. And they have done so based on the notion that you and everyone else will continue to believe the dollar is valuable simply because the government says it is valuable. They want you to believe the dollar has intrinsic value.

But the dollar has no intrinsic value. And as more dollars become available – through printing, easing, or any other means -- people holding them are going to eventually begin to realize those dollars are becoming less scarce. And as that happens, the dollar will become less valuable. Barack and Ben would, of course, love for you to believe that the dollar does have intrinsic value, because they want to keep their jobs (and preserve the global economy). So I will end this paragraph by directing you to its beginning.

What we are all about to experience is price-inflation -- on an unprecedented scale – because we do not operate in free markets. Prices are manipulated – and nowhere is this more pronounced than at The United States Treasury and The Federal Reserve.

The shell game is about to end. The U.S. government is the largest debtor nation on earth, and it has just committed itself to the biggest batch of expenditures in all its history, combined. Its consumer is dead, and its creditors are dubious at best. The minute they stop lending is the minute the real nightmare starts. And to top it all off, nobody really knows what our currencies are worth, because we can’t know.

At least not at the moment…

Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

THE INTRINSIC VALUE OF NOTHING, PART ONE

THE INTRINSIC VALUE OF NOTHING

“Action is purposive conduct. It is not simply behavior, but behavior begot by judgments of value, aiming at a definite end and guided by ideas concerning the suitability or unsuitability of definite means. . . . It is conscious behavior. It is choosing. It is volition; it is a display of the will.”

-- Ludwig von Mises

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Reach in your wallet, and pull out a dollar bill. Look at it for a moment. Now ask yourself, “What is this worth?”

This isn’t a trick question. Don’t think about anything but that dollar in your hands. Don’t think about a soft drink. Don’t think about a bag of chips, or a handful of screws at the hardware store. Think about that dollar in your hands without thinking about what it can buy. Can you do that? It’s pretty difficult, isn’t it? That’s because a dollar, qua a dollar, isn’t worth anything more than the paper and ink on which it’s printed. And even the value of the paper and ink must be expressed in terms of some medium of exchange. Thus, we dive deep into the dark epistemological implications of the human perception of value.

Think about it. Do you really believe a dollar is valuable on its own? In other words, do you believe that a dollar is valuable, just as it is – simply because the government says so? Or do you believe a dollar is valuable because of the goods and services for which it can be exchanged?

You would be amazed at the vast number of people in the world who have never considered this question. As tautological as it may seem, most people believe currencies are valuable simply because they are valuable. That is to say, most people believe – explicitly or otherwise – that currencies are intrinsically valuable, for no other reason than governments decreeing them as such. And pardon me for saying so, but that’s just absurd.

And yet, this is precisely what Ben Bernanke and Barack Obama want you to believe about the currency in your wallet. In fact, their jobs depend on it, because if the majority of people stopped believing the dollar was valuable “just because,” we’d have some really big problems. I mean really big problems.

Allow me to expound: The United States Government – under Ben Bernanke, George W. Bush, and Barack Obama -- has committed to spending $13 trillion of your money to battle this, the worst economic crisis in 80 years. I know I’ve said it all before, but it certainly bears repeating: the $13 trillion to which I’m referring has been allocated to this crisis, alone. It’s not going to be used for historical obligations, nor will it be used for future budgets. It’s for this crisis. Period. That, my friends, is how the government has planned to solve this recession: by spending more money, in a shorter period, than ever in history.

According to the U.S. Census Bureau, about 308 million people are currently United States citizens. This means the United States would have to obtain just over $42,000 for every single man, woman, and child in the country (and abroad) just to cover the $13 trillion to which it has so recently committed. And I’m not talking merely about productive, working Americans; I’m talking about $42,000 from every single human being – comatose, bed-ridden, crawling, suckling, or paralyzed. Everyone.

Of course, you may be one of the multitudes of people who believe the crisis is over, and that we are currently experiencing an economic recovery – and that everything is magically going to fix itself. You may also believe in unicorns and leprechauns. If you are one of those people, please allow me to disabuse you of any notion that this crisis is anywhere near over.

Or, if you prefer, I’ll just get to the point: this entire, elaborate fiasco called quantitative easing that governments all over the world have foisted on the entire global human population is an illusion and a joke. It is based on nothing more than the common misperception that currencies have intrinsic value. And I hope you’re beginning to understand where I’m headed with this article: currencies do not have intrinsic value.

There are two theories of value:

1.     The Bad Theory. This is The Labor Theory of Value – which is most closely associated with Marxism and socialism. The Labor Theory maintains that anything involving labor has an intrinsic value. And, in fact, most egalitarians believe that everything has intrinsic value. So, maybe you sit in your back yard all day slapping a mule with a garden hose. According to the proponents of the Labor Theory, not only do the mule and the hose have value, but so does your labor. Intrinsically. No matter what.

2.     The Good Theory. This is The Subjective Theory of Value – most closely associated with The Austrian School of Economics. The Subjective Theory maintains that value can only exist because two or more interested parties involved in an exchange willingly participate. Thus, at that moment (and only at that moment) does true value exist. All other perspectives of the exchange are interpretative, and can only be used as general guides. So, to continue with our example: you can slap your mule as much as you want, but unless someone wants to pay you for your hard work, it’s not worth anything.

Nothing in this universe has intrinsic value; every single thing you possess, want to possess, use, can use, have used, can offer, have offered, or will offer is valuable only if someone else finds it valuable. I want you to try to imagine a universe in which no sentient creatures exist. How much would a “car” be worth? While you’re chewing on that, I’ll let you know that this is the general foundation of subjective value, and it is also the foundation of the most significant economic movement in history.

Welcome to Austria. I am an Austrian. I will be your guide.

I know what you’re thinking: Wow! For an Austrian, this guy speaks English really well! And his accent… my God! You can’t even detect it!

You’re reading this, by the way -- not listening to it. So you wouldn’t be able to detect an accent anyway. But just so you know, I do not have an Austrian accent. I’ve never even been to Austria. I wouldn’t know Vienna from Vietnam. I am, in actuality an American, but I am also a member of The Austrian School of Economics.

There are many varying schools-of-thought in the practical and academic economic communities around the world. For instance, there’s the Chicago School – perhaps made most famous by Milton Friedman. There are also the French Liberal School, the German Historical School, and the English Historical School. There are also other schools of economic thought -- like Keynesianism, socialism and communism. But those schools suck, so I guess they don’t get to put cities or countries in their titles (that’s just my theory -- I can’t say for sure).

But then there’s the Austrian School -- perhaps made most famous by Nobel Laureate, F.A. Hayek, as well as one of my heroes: Ludwig von Mises (they both had Austrian accents, by the way). The Austrian School is free-market. Really, really free-market.

I know. This is confusing. Just because one is a member of The Austrian School of Economics does not make one an Austrian. But, then again, it does. See? So, for the sake my own sanity, I’m just going to make this proclamation: from now on, when I use the word Austrian, I’m talking about The Austrian School of Economics. Okay? Can we just agree on that?

In an interview not long ago, Peter Schiff (Austrian. No accent.) was asked about Austrian Economics. His reply was as elegant as it was short: “…saying ‘Austrian economics’ makes as much sense as saying ‘Chinese physics.’ Austrian economics is economics, period!” And that’s the point of this article: some things are simply self-evident; there is no contemporary and obvious way to refute them. For instance, how does one go about replacing the theory of Natural Selection with something better? Wouldn’t replacement itself be Darwinian – at least in the Dawkins sense?

Sometimes epistemology just won’t give you a break…

The following statement is true.

The previous statement is false.

You’re starting to get it, aren’t you? Austrian Economics is economics; it is the most elegant and simple explanation of how resources can and should be used. Unlike other schools, it eschews dogmatism and absolutes, adopting instead tendencies, and trends. Austrians don’t actually get to the places we’re trying to reach – we merely approach them…places like equilibrium, and parity, and inflation aren’t fixed points in the universe, but rather, they are tendencies which we can only approach, and the closer we get, the more we affect the actual objective we are trying to achieve or observe – thereby changing not only the conditions, but also the outcome.

It sort of reminds you of another discipline, doesn’t it? One equally near and dear to my heart: subatomic physics. The similarities are so fascinating, in fact, they inspired me to write a book.

Unfortunately, the number of human beings within the District of Columbia and its surrounding areas (or anywhere else, for that matter) who have actually heard of The Austrian School is inversely proportionate to the number of times Michael Jackson’s image has appeared in the world since the day he died. Yes, it’s an asymptotic relationship, but it says a lot about our societal priorities.

By the way, Oprah cried when Michael Jackson died. I bet she didn’t cry when Murray Rothbard died. That’s just a little digression. Sorry.

Anyway, of the people who have heard of the Austrian School, still fewer truly understand its tenets. And that’s where I come in: now that the government has committed to spending $13 trillion – and probably a lot more than that – do you know what its biggest problem is? Again, this isn’t a trick question, and you already know the answer:

Where in the hell are they going to get $13,000,000,000,000?

They obviously can’t tax us for it; I don’t know too many people who are willing to write a check for $42,000 to the government “just because.” So I guess that leaves two choices: borrowing, and printing.

And therein lies the problem, because both borrowing and printing have mysterious ways of creating something called inflationary price-increases. And this is why Ben and Barack want you to believe the dollar is valuable -- just because they say so. You see, the more you believe the dollar is almighty, the longer they can put off the inevitable inflationary pressures that are marching on Washington like a pack of wild, angry activists.

With that thought, I’m going to end this week’s opus. Next week, for Part II of this subject, I will dive further into Austrian dogma – specifically the work of Ludwig von Mises and his Economic Calculation Argument, which should help you understand more clearly why all this quantitative easing garbage is going to be the dollar’s undoing – and maybe even that of the United States, as well.

Until then…

Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

And Then There's Phase Four

“Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge."

- Alan Greenspan, June 25, 2009

"The US economy may witness double-digit inflation in a few years unless the central bank tightens up its monetary policy… Unless we roll in this whole degree of expansion, we will be in trouble… I am not talking 3-5 per cent inflation, I am talking double-digit inflation in the US.”

- Alan Greenspan, September 9, 2009

--

Man, the Dow hit 10,000! Happy days are here again! Right?

Wrong.

Do you know what I loathe about the word "recovery?" It can mean whatever you want it to. It's sort of like using the word love. You might say you love sushi, or you love beef jerky, or you love Michael Jackson. Or whatever. But that's a whole lot different, for instance, than saying you love your child. We can agree on that, right? Children are way more important than beef jerky. And Michael Jackson.

I can't say I'm Alan Greenspan's biggest fan anymore. He did, after all, betray his roots not so many months ago, when he essentially proclaimed free markets to be flawed. Those of us who have studied his career -- and especially its beginnings -- know better, of course; poor old Alan was just reacting to a political environment that needed someone to whom it could point its ugly, bureaucratic finger. Who better than Alan? Somebody had to take the blame, right? You can't just have a financial meltdown without getting mad at somebody. My only beef with the poor man is that he actually agreed to do it. But then again, Alan Greenspan has been swimming in the Washington political sea for a very long time, so we really shouldn't be all that surprised, should we? And, after all, he did play the let's-create-the-illusion-of-wealth-by-making-money-cheapgame. No, he took the appointments, scratched his ticket, and came up a loser. Unfortunately, he took the entire U.S. housing market -- and subsequently the global economy -- down in the process. Thanks Alan.

No matter where you stand on the Greenspan issue, you still have to respect the man; he was, for better or for worse (I say worse), the architect of the longest protracted bull market of the 20th century -- and beyond. So when I read the quotes above, I can't merely dismiss them just because I think Alan is a sell-out, a turncoat, and a political lackey. And, of course -- as most of you know -- I happen to agree with Alan Greenspan on the particular point of coming inflation. Well, sort of. I actually think inflation is going to be a lot worse than "double-digit." Here's my favorite part of his observation:

"...unless the central bank tightens up its monetary policy... Unless we roll in this whole degree of expansion, we will be in trouble..."

To me, that says it all. There are literally trillions of components to the U.S. economy. How in the hell is the Fed going to know the precise moment it needs to reverse policy? I mean, who's going to argue against the fact that the success of its predictive power has been -- at its very best -- questionable. If Bernanke and his pride of dullards don't call this one right, we are all screwed. And in my mind, that means only one thing.

We are all screwed.

DOLLARS, EQUITIES, HOUSING, AND ALL THE REST OF IT

A lot of people sit in front of televisions all day, staring at Erin Burnett and Maria Bartiromo (and the people they talk to), believing that, because the stock market is moving up so rapidly, we are in the middle of an economic recovery. And that's just silly. One might argue we are in the middle of a stock market recovery -- and based on simple, raw percentages, that position might carry some weight. But then you think about the the first time the Dow hit 10,000 -- about a decade ago -- and you look at the relative prices of gold (about $250 per ounce in 1999, as opposed to almost $1100 an ounce today) and something starts to become clear: this so-called "stock market recovery" may not be all that recuperative after all. I mean, gold is the ultimate and most efficient harbinger of inflation -- is it not? And what is gold telling us -- in a loud, clear voice?

And what about oil? Since its recent bottom eight months ago, it has more than doubled in price. I've been trying to tell you that oil, gold, and agriculture are going to be the biggest winners when the dollar starts its slide. Did you listen? Well... some of you did. But, my goodness, there were certainly a lot of people telling me I was a fool, an idiot, and a traitor. I'm sure they're all still out there, as eager as ever to show me the errors of my ways. Unfortunately most of my dissenters and critics believe there are only three phases to this economic fiasco, and they wrongly believe we've completed both -- that the recession is over. But that's just more nonsense. Here's what the common wisdom is saying:

PHASE ONE: Collapse in the prices of nearly all global asset-classes.

PHASE TWO: Global quantitative easing -- meaning unprecedented rate-cuts, coupled with unprecedented currency-printing, borrowing, and spending.

PHASE THREE: Stock market recovery. 

And suddenly everything is fine, right?

No! Everything is not fine. A quick look at the prices of oil, gold, and agriculture tell a much different story -- they have been rising significantly. And perhaps the most powerful signal of all is the increase in long-term Treasury yields over the last nine months -- despite the Fed's repeated announcements that it intends to keep rates low by buying the long end of the yield curve! The evidence continues to mount -- we're not anywhere near the end of the pain. No, there is a fourth phase to this economic storm: foreign creditors begin to abandon U.S. Treasuries, driving yields higher. Unprecedented printing causes massive inflationary pressure, driving the prices of all asset-classes higher, as major world currencies fail. Most people become euphoric, proclaiming an "economic recovery." Others buy gold, oil, and agriculture and hunker down for the worst.

The most interesting part of all this to me is watching the business news channels, who focus 90% of their energy on equities. I know it's natural; audiences comprehend a share of Google a whole lot better than they do a barrel of oil. But the stock market is in trouble -- even as it continues to rise. And that seems to be the most difficult concept for anyone to grasp! Mark my words: in real terms, equities are going to underperform gold, oil, and agriculture for a long time, and this necessarily means stocks will underperform inflationary price increases. It's just math.

Don't get me wrong; I love Google and a dozen or so other companies just as much as the next guy. At my core, I'm a value investor. I just don't happen to think there is any value to be found in this economy. The American consumer -- who drove the vast majority of the economy up until two years ago -- is dead. How are companies going to make money? Sure, stock prices will fly higher as the dollar falls, but what does that mean? Just because the dollar is failing does not mean American corporations are necessarily becoming more productive. Can net income outpace inflationary dollar-destruction? The answer is, of course, no.

Let's return to Google. I think the company is going to be around for a long time, and I believe it's a great business model with a lot of room for growth. And when Google beats its numbers and the CEO says he's excited about the future, well I get just as warm inside as the next guy. For about twenty seconds.

Just because stocks are moving up -- and even reporting some good numbers -- does not mean this is an economic recovery. And don't forget that, for the last year or so, I've been predicting not only a rise in the stock market, but a meteoric rise. I think the Dow is going to 20,000 and beyond, and I think it's going to happen a lot sooner than anyone believes. I also have no doubt it will blow through that mark with all the euphoric and histrionic drama of every other media-driven bull market explosion in the last thirty years. Of course the stock market is going to go higher -- in dollar terms -- because the dollar is falling apart! Housing is going to do the same thing: if the government keeps rates artificially low and offers tantalizing tax-incentives for investing in real estate, of course prices will go higher! Why wouldn't they? And thus the next (bigger) bubble begins.

In fact all asset classes are going to go higher as the dollar disintegrates! That's the way inflationary pressure works! But again: just because asset-classes are moving inversely to the phony currency in which they are denominated (by definition) does not mean we are in the middle of an economic recovery! According to BusinessDictionary.com, an economic recovery is the "...phase in an economic cycle where employment and output begin to rise to their normal levels after a recession or slump." Yes, I know. Economists everywhere are saying the recession is over. Yes, CEOs everywhere are starting to become optimistic. But isn't this the same gaggle of pundits, academics, experts, and general know-it-alls that were prepared to deliver us the so-called "Goldilocks Soft Landing" three years ago? Yes. Smart group of folks, that.

On October 2, 2009, The United States Bureau of Labor Labor Statistics gave us the happy news: U.S. unemployment now sits at 9.8%. More specifically, it said this: 

"Since the start of the recession in December 2007, the number of unemployed persons has increased by 7.6 million to 15.1 million, and the unemployment rate has doubled to 9.8 percent."

Does that sound like an economic recovery to you?

Our foreign creditors -- like Japan, China, and Saudi Arabia -- are now talking about ditching the U.S. dollar in favor of another reserve currency. Do you really believe they're going to continue to lend to the United States at absurdly low rates, in perpetuity? Our government has committed itself to spending $13 trillion dollars on this economy. Where is that money going to come from? You can read any number of my articles over the last year to get the answer to that question. But I assure you, printing dollars in current quantities is the death knell of our beloved currency. And I equally assure you our creditors are neither naive nor stupid, and they are not going to simply keep dumping money into a debtor economy whose currency is in jeopardy, whose savings rate is almost zero, and whose consumer has run out of leverage. Why do you think the Chinese -- for instance -- have bought U.S. Treasuries for so long? Because they knew the American consumer would return the capital to the Chinese economy many times over! But the American consumer is out of fuel. So what now...?

I've been talking for months about the $13 trillion mistake, as well as its historical implications. The evidence only continues to mount: on Friday, October 16, The U.S. reported that the federal deficit just hit an all time high of $1.42 trillion. My favorite part is the annual percentage increase in government spending, up 18.2% -- the biggest jump since 1975.

So here's the deal. Just as every asset-class in the universe collapsed starting in 2007, the massive implementation of quantitative easing that ensued is going to ensure equally massive inflationary pressure on most -- if not all -- of the world's currencies. So your job, as an investor, is not to try to figure out which asset-classes are going to increase in value, because they all are -- relative to the currencies in which they are denominated. No, your job is to figure out which assets are going to outpace inflationary price increases. I've already given you one clue: this stock market surge you're seeing? It's an illusion. While equity prices will undoubtedly go higher, productivity and earnings are not going to outpace inflationary price increases -- simply because consumers are not going to have the power to fuel corporate profits as they once did. Sure, you'll get a good return from the stock market -- in nominal terms -- in coming years. And maybe that's enough to get you excited. I watch CNBC enough to know that there are a lot of people who believe this rally is authentic. But in real terms, it's unsustainable and unrealistic, because the dollar is falling, and its decline is accelerating. It won't be long before the smartest investors recognize stocks are not going to outpace inflationary price increases. And thus begins Phase Four.

So what asset-classes will outpace inflation? Do I have to say it again? Precious metals, energy, and agriculture. These assets are no longer mere hedges against inflation. Not only will they continue to elicit demand from investors seeking return, but many of them have industrial value, as well -- increasing the likelihood of increased demand and superior returns. And there's one more thing I have to add, which is probably going to cause me al sorts of grief from my more conservative readers, but I'm going to say it anyway: I'm not a huge fan of leverage -- for obvious reasons, considering the mess we're in. Nonetheless, if you can get into any superior-performing assets using leverage at a low fixed-rate of interest, you're rate of return is going to be exponentially higher.

Phase Four. The train is starting to pick up speed. If you weren't listening to me over the last ten months, I hope you will now...

Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novelDiscipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

DISCIPLINE Movie Update

VARIETY

Posted: Sun., Jul. 19, 2009, 8:00pm PT

Permut, Jones set 'Discipline'

Duo to bring sci-fi novel to the bigscreen

By DAVE MCNARY

David Permut and Steve Lee Jones will achieve a measure of "Discipline," producing a feature version of Paco Ahlgren's sci-fi adventure novel. Story, published last year as Ahlgren's first novel, centers on a man's psychological battle with an enemy he cannot see. The outcome determines the past, present and future of human existence.

Permut Presentations will produce with Jones' Bee Holder Prods. Permut Presentations VP Steve Longi will co-produce.

It's the second teaming for Permut and Jones, who are also working on a feature about the life of the late automaker John DeLorean.

Permut's in post-production on "Youth in Revolt," starring Michael Cera, Justin Long, Zach Galifianakis, Ray Liotta and Steve Buscemi for Dimension and is developing "Naked" at Gold Circle and "Brother Sam" at HBO. He produced Lifetime's "Prayers for Bobby," which received an Emmy nom in the made-for-TV-movie category last week.

Jones is in post-production with Foundation Films on the documentary "Kevorkian," about Dr. Jack Kevorkian's bid for a congressional seat. He's also developing HBO's feature "You Don't Know Jack," centering on Kevorkian's quest to legalize euthanasia, with Al Pacino starring and Barry Levinson directing.

Read the full article at:
http://www.variety.com/article/VR1118006172.html


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Short the USA

"By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

-- John Maynard Keynes

 

--

I am lucky. I have a lot of friends. But it's not merely the number of people I can count among their ranks that makes me lucky -- it's the sheer magnitude of their knowledge and experience that makes me so fortunate. And yet, at the same time, my friends, in the aggregate, exhibit such a wide array of beliefs and perspectives, that I take a lot of criticism from them for my own radical theories.

For instance, I have a lot of leftist friends who accuse me of being a Republican. They say things like, "All you care about is money and the stock market. You want to destroy the environment. You're a Republican."

Look, I don't want to destroy the environment. To be honest, I don't even really care about the environment. Don't get me wrong -- I like oxygen and trees and water just as much as the next guy -- but I think it's exceedingly arrogant for human beings to think
we can destroy the environment. That's like suggesting we can permanently rid the world of Michael Jackson. Sure, he can die and all that. But we can't really get rid of him.

As for the rest of it, yes, I love money and I wish I had more of it. Toward that end I shall pursue its acquisition with great enthusiasm. Of course, in that regard, I'm no different than anyone else on this earth – including my leftist friends; I'm just not ashamed to be honest about it.

In any case – and despite my love of money -- I have a message for my leftist friends: I am no Republican. Quit calling me that.

On the other side of this confusing equation, I have a rather impressive number of conservative friends who think I am a Democrat. They say things like, "You think the pot should be legal, and you think the gays should be allowed to get married, and you think the Mexicans should be allowed to cross the border at will and overrun this country. You're a Democrat."

Just so you know, I'm rolling my eyes right now.

Yes, it's true -- I do believe in the plight of "the" pot-smoker, "the" gay, and even
"the" Mexican. And yet, despite my subscription to such seemingly "horrifying" -- not to mention stereotypical -- social constructs, I'm afraid I have some troubling news for my many right-leaning brothers and sisters: I'm no Democrat either. You're wrong. Please stop calling me that.

I think Barack Obama is a fine statesman, an eloquent speaker, a rather handsome man, and a gifted hand-shaker. But he is a horrible economist, and since the economy is the most important thing in the universe right now – with the possible exception of the demise of the King of Pop – I'm going to focus on that. Further, since we are
talking about economics, I'm just going to lay it all out for you: Democrats are screwing things up. Bad. Of course, they're getting plenty of help from Republicans too.

For decades, the United States has been an arrogant and profligate nation, full of spoiled brats who borrowed as much as possible, fueling an insatiable collective desire to have more stuff. We have buried ourselves in designer clothes, new cars, houses, and boats. I admit much of the problem derived from a misdirected ethos for which we only have ourselves to blame. But every epistemological development has its roots, and it is not enough to say that the American people simply woke up one morning, got out their wallets, and suddenly found that they had become gluttonous consumers. No, there is always a catalyst, and in this case – as is so often true -- it was the government.

Washington D.C. is not full of people. It is full of politicians. Politicians need to be elected, and in order to do that, they must make their constituents happy. But in order to make those constituents happy, politicians must promise them stuff. And politicians have figured out that the most expedient way to make stuff accessible to their constituents is by manipulating the money supply. And so, the government makes money cheap, and the way it does that is by lowering interest rates and printing currency at an ever-increasing rate.

Think about it: what better way to become popular? You can't afford a home? Well we'll just monkey around with interests until you can! And then, we'll increase the money supply at a moderate rate – thus creating the illusion that otherwise relatively static asset-classes are actually increasing
in value – like, say, for instance… your house!

Hell, while we're at it, why not create programs that make tuition affordable for everyone? And if we're going to do that, why not just go ahead and create a national healthcare system everyone can afford? Are you worried about the cost? Don't! We'll just print more money and lower interest rates! That's how we do it!

Unfortunately, these "solutions" – which seem so elegant on the surface – actually form the very foundation of the enormous problem we're facing at this moment. When a government subsidizes any commodity, good, or service, it necessarily creates demand -- which in turn drives prices higher. But the prices aren't real – they're distorted constructs driven by false demand. Eventually the constant, steady increases sought by printing currency turn into explosive manias -- the bubbles with which we have become all too familiar.

Our government has perpetuated this terrible lie, creating artificial affordability and completely unrealistic valuations for almost every asset-class in the economy. But no Ponzi scheme can last forever, and the consequences of so many decades of financial mismanagement have descended upon us. Yet we haven't even come close to seeing the worst of it.

At the very moment when governments should be cutting spending, raising interest rates, and pulling currency out of the economy, they are doing the exact opposite – and this is true of every major economic power in the world. The United States alone has committed to spending almost $13 trillion to battle this economic crisis alone. And where will the money come from? Unfortunately, most of it is coming from the printing presses, and that means hyperinflation is on the way. I know some of you have a hard time believing that, so I guess we'll just have to wait and see. But I stand firm with my conviction. It's just math.

In the meantime, if you want my advice, put on your crash helmets and short U.S. Treasuries; the ride is going to be fast, furious, and very profitable for those of us who have been prescient enough to realize that the United States we know today has almost none of the qualities endowed to the government of the same name created in 1789.

With that, I will return to the place where I started today, because I'm sure you're simply aching to know where I actually do stand, politically. I suppose I could disappoint you. I could simply tell you I have no convictions -- that I refuse to take any position at all. But you're too smart for that…

So I'll tell you. But you're probably not going to like it. I am a champion of free markets, human rights, social progress, and the growth of knowledge. And I actually do like Mexicans, homosexuals, and pot-smokers. If you absolutely insist on ascribing a label to me, I suppose I would best be described as a classical Jeffersonian liberal.

And Mr. Jefferson would be as appalled as I am at what has become of the Great Experiment.

 

Disclosures: Paco is long TBT, UGL, UCD, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.   Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

 

 

An Ill Wind Indeed

I don't know what I did before YouTube. With just a few mouse clicks, I can pull up literally hundreds of interviews, editorials, and broadcasts about anything that suits my fancy. And lately, my fancy consists of interviews with some of the most vocal and compelling minds daring to speak out against the atrocious fiscal policies the U.S. is employing to battle this economic crisis.

I have seen Jim Roger dress down countless reporters and anchors bent on defending the status quo. I've seen Marc Faber confidently proclaim that 2009 is the year to "massively short Treasuries." I've seen Peter Schiff stand firm while being publicly jeered at by the likes of Art Laffer, as well as Ben Stein (who proudly proclaimed that investment banks were undervalued in late 2007), only to be vindicated within months.

And now, Ben Stein has even reversed course, jumping on the "Schiff Bandwagon," as it were, predicting nothing less radical than the possible breakup of the U.S. as we know it. Where were you, Ben Stein, when I proposed such a dissolution in 2001? Would you have jeered at me too?

Our critics call us pessimists, defeatists, and killjoys. They attack our characters and our intentions. They say we're trying to destroy the world. And yet nothing could be further from the truth. Yes, I do believe the dollar will soon be reduced to only a fraction of its former value -- and it certainly will lose its status as the world's reserve currency. It's also true that I believe other major currencies – like the euro and the yen – will suffer similar fates.

The United States used to be one of the largest manufacturing and creditor nations on earth. It exported vast amounts of goods. Over the last several decades, however, the U.S. has transitioned to being the largest debtor nation on earth, manufacturing relatively little, and consuming far more than any other nation in history. It has become soft.

Unfortunately, contrary to the popular belief -- that this is a mere secular economic correction -- what we are witnessing is only the beginning of an economic collapse deriving from decades of mismanagement and mal-investment; for over a century, the U.S. government has employed gimmickry and sleight of hand to prop up a bogus consumer class that couldn't, in any other context, afford the goods and services put before them in such quantities. The result has been a gluttonous spending-spree that has bankrupted the nation.

The Obama administration, along with Fed Chairman Bernanke, have committed an unprecedented amount of money – more than $12.8 trillion – to battling this economic crisis. You may be one of the multitudes still clinging to the Keynesian status quo, remembering relatively minor recessions of the recent and distant past, desperately clamoring that we got through it before, and we will get through it again.

Did you read what I just wrote? $12.8 trillion. I'll give it to you another way: $12,800,000,000,000.00. If you are a citizen of the United States, and you have a pulse, your share of the commitment is just a little over $42,000. And that sum has nothing to do with previous obligations, nor will it be included in future budgets. Your $42,000 share only applies to this economic crisis.

I'll say it again: the U.S. is now the largest debtor nation on earth. Credit card and housing loans have all but disappeared. The country has no savings. There are no more sources of capital left to feed the fires of consumption. We have only seen the beginning -- the U.S. economy has no option but to unwind – for a very long time. Add to this the fact that the government is "fighting" this crisis by using the same rotten policies that got us here in the first place, and the economic outlook only becomes gloomier.

You can see I'm not terribly enthusiastic about the prospects of the United States. But before you dismiss me as the quintessential pessimist, you should know that I actually do see a prodigious number of opportunities out there. I certainly don't believe the entire global economy is simply going to disappear; I simply cannot think in such absolute terms.

The first law of thermodynamics requires the conservation of energy – that is to say, that energy can neither be created nor destroyed. And this is perhaps the closest metaphor I can procure: capital is like energy; I don't see wealth simply drying up and blowing away so much as I see it transitioning to a new paradigm.


Who Wants a Job?

Where the United States is full of overweight union workers who believe it is their God-given right to work a mere thirty hours a week, collecting exorbitant wages, Asia is full of very thin, motivated people, who are not only willing, but actually want to work six or seven days a week -- for a mere fraction of the wages enjoyed by their western counterparts.

Almost every country in Asia boasts net savings. And while these countries may not be able to export to the U.S. and Europe in the mass quantities they have enjoyed in recent decades, they will make up for much -- if not all -- of the shortfall by fulfilling the needs of their own burgeoning middle classes. Compare it, if you will, to the U.S. from say, 1875 to 1925. As the financial center of power shifted from London to New York, The U.S. prospered in spite of England's downward slide.


How Will the Money Go?

As technology has improved in recent decades, capital flows that might have -- only forty years ago -- taken days to move from one point to another can now occur in a fraction of a second. The ability for people to transfer wealth from medium to medium has grown exponentially faster, and as the world's major currencies disintegrate, people and institutions will quickly find alternatives – some public, and some private – with which to make transactions.

So what will be the world's new reserve currency? Well, as I said, it won't be the euro or the yen – or any major fiat currency, for that matter. One of my astute readers reminded me this week that no fiat currency has ever survived for very long in this world, and yet every major currency on the planet today holds that status. The people who use these currencies are about to get burned – and burned badly; we're going to see a massive return to currencies backed by assets, and that probably means gold, primarily.

People laugh and say silly things like, "Have you ever tried to by soap with a gold coin?" And I throw my head back and laugh with them. For a moment or two. And then I remind them that it doesn't take much effort to put gold in a vault and issue a piece of paper representing a fixed amount of that stockpile. In fact, it's not difficult at all.

As I said, capital is more efficient today than ever in history, and I see no reason why private institutions wouldn't issue currencies backed by their own assets. Why shouldn't they – especially in the wake of demonstrable failures by governments charged with protecting their citizenry's wealth? It's going to be profitable as hell, and how much credence do you think people are really going to give legal tender laws after this party is over? My guess is not much.


Where Will the Money Go?

Asia, of course – for all the reasons I've already listed, and more. And everyone on earth knows it.

Once the most powerful sources of capital in the world recognize that efficiency, innovation, and productivity are going to create colossal rates of return in Asia, the mass exodus will be unstoppable. We will finally see the return of real investment and true wealth creation – nothing like this fraudulent house of cards that's been perpetuated in the United States for so long. Further, I believe the shift is coming soon, and that it will be explosive and unrestrained.

Asia will be the world's next financial center, and I am a strong believer that any investment in these economies will provide superior returns over the next 50 to 100 years. But equity investment in the east is by no means the only place where I see huge returns.

There are two reasons why I'm extremely bullish on energy and agriculture. First, people are never going to stop needing these commodities. Demand may continue to wane a bit as we transition into the new economic paradigm, but as major currencies fall, energy and agriculture will not only keep pace with inflationary price increases, but they will outperform – if for no other reason, simply because investors tend to overshoot intrinsic value when they become exuberant. And when the bottom falls out of world currencies, investors are all but certain to become exuberant about energy and agriculture.

As I'm sure you are well aware, loans are extremely difficult to come by these days, and the second reason I'm so optimistic about these sectors is that farmers and energy producers are no exceptions to this difficult truism. It doesn't take a Nobel Laureate to recognize that, if producers can't produce, then supply will suffer, and prices will go higher. Coupled with my reasoning in the previous paragraph, I see nothing but upside in these commodities.


The Ill Wind…

Over the last few nights, I've been watching a documentary about Benjamin Franklin. I was surprised to find out that he remained a loyalist for so long -- despite the fact that many of his fellow Americans were already starting to rebel. Finally, however, he recognized that change was inevitable, and that his perception had been flawed. He thus became a champion of the American cause – even at the expense of his relationship with his son -- the person to whom he was arguably closest in the world.

Gloom-and-doom may be unpalatable, but sometimes, no matter how much it hurts, it represents the state of the universe. And when these conditions arise, we would do better to acknowledge them and face them with courage, rather than to simply ignore them – or worse still, waste valuable resources trying to "fix" them. Sometimes the only way to deal with a fire is to simply let it burn itself out.

The other side of this equation is the immutable fact that with every tragedy, there is opportunity. It might be easy to blame the people whose perspectives offer the most accuracy, but it is likely more prudent to simply listen to the message, and then to react appropriately by finding those opportunities.

No matter how you choose to see it, there's no question that for the last year members of the Austrian School of Economics – of which I am a proud and vocal member – have been correct at almost every turn. Every day that passes only offers more evidentiary confirmation of our theories. And yet, despite the pain that comes with the actualization of our predictions, there are still bright spots in this story.

Unfortunately, finding those bright spots is going to take the courage and conviction to admit that the U.S. government not only caused this crisis, but that it is only perpetuating it by employing the same rotten policies that got us here in the first place. There are ways to ride this out, and even prosper, but clinging desperately to the broken ideas -- based only on the tattered shreds of empiricism -- is a sure means to financial devastation.

Pledging allegiance to the flag and eating apple pie aren't going to get us out of this one. The only way to prosper is to embrace change. And change is surely coming.

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

Don’t Kill the Messenger

 

"If we win another such battle against the Romans, we will be completely lost"

-- Plutarch, Pyrrhus 21,14

 

I have a friend who is some sort of a project manager at BioWare. He is one of the most brilliant people I've ever known; for fun, he studies subatomic physics. In Russian. He's also a bona fide cynic and drinks copiously. So we get along just fine.

For those of you uninitiated, BioWare designs video games, and last night, my friend showed me a two-minute trailer for a new Star Wars game he is involved with. I was impressed.

"It cost us a million dollars to make it." He looked concerned -- as though he might have gone over budget. "And we're making three more in the next month."

"Don't worry," I said. "If you discount back the true future value of the project -- based on the inevitable inflationary price explosions marching at us like an army of angry Storm Troopers -- it's probably justifiable."

Another moment of silence ensued. "You know," I said. "I'd give anything to have your job."

He pulled his head back. "Why? It's just a huge load of stress."

"Yeah, but you believe in what you do."

"And you don't?"

"No." I thought about it for a moment, and then said, "I'm going against everything I've ever believed in. I'm a value investor, and yet I haven't held any stocks for over a year. I'm short the entire U.S. economy, and I'm making a lot of money, but it's a pyrrhic victory; every single day I hate being right that much more."

A lot of you obviously liked my last article – to which this is a follow-up -- and I want to thank you for your praise. But judging from the spectrum of attacks I've also received in the last week – ranging from "you're stupid," to "I hope God kills you," I'm guessing some people aren't terribly excited about my mathematics -- nor, perhaps, my Jeffersonian propensity to decry unjust governments. Nonetheless, $12.8 trillion is a lot of money, and in case you missed it the other 22 times I posted it, here's a link to an article that epitomizes -- in real dollars -- just how much trouble we're in. The only inaccuracy I can find in it is the premature estimation of how much the government has actually committed to this train wreck of an economy; a piece that appeared in Bloomberg on March 31 more realistically depicts how deep in the quicksand we've really sunk.

Again, for the record, I do not like the fact that the United States is losing its status as the premier financial power in the world. Likewise, I do not like the fact that the U.S. dollar is losing its
status as the world's reserve currency. Nonetheless, the absolute worst thing any of us can do during a paradigm shift is shove our fingers in our ears and start singing the Star-spangled Banner at the top of our lungs; I am not going to sit idly by while "what-used-to-work" disintegrates around me, nor am I going to simply remain silent – for two reasons:

1. If I can help even one person make better decisions in this crisis, I'm going to.
   
2. Publishing my findings generates criticism, which can help refine the theories behind those findings.
   

 

Unfortunately, most of the criticism I've received over the last week has been more of the ad hominem variety than it has been of the constructive type. And that's a shame, because I know many of you read what I write hoping to gain perspective and insight into what's happening around us. Nothing facilitates that process more than healthy dialogue. I hope this week we can get closer to that objective.

 

THE FOUNDATION OF THE CRISIS: PAST, PRESENT AND FUTURE

I've discussed a lot of these points in earlier articles, but they bear repeating here. When governments create easy money, they necessarily distort demand – and by extension, prices. You want to know why tuition is so high? The government has created a market full of decidedly cheap student loans, driving demand for education exponentially higher in recent decades. And when demand increases, so do prices. There are other sectors of the economy that can thank governmental intervention for ballooning prices, as well – namely, healthcare and, you guessed it: housing.

Most people only see the housing bubble – and its ultimate collapse – as a self-contained crisis. In other words, when the deleveraging of the housing market stops, then the entire economy will correct itself and we can get back to business as usual. Unfortunately nothing could be further from the truth; the housing bubble was only the first phase of an economic crisis whose magnitude we can't even yet begin to fathom.

In battling the crisis, instead of taking the necessary steps to correct the very things that caused the bubble in the first place, the government has instead ramped up its policy of easing – driving rates almost to zero -- encouraging still more mal-investment
by people who wouldn't otherwise consider placing borrowed capital into the economy. Toward this objective, the government has committed the $12.8 trillion dollars I referred to earlier. And its sole purpose? To confront this crisis – and this crisis, alone; the money won't be used for any historical obligations, nor will it be earmarked for any future budgets.

Do you know where the money is going to come from? I can say with a great degree of confidence that almost none of it will come from taxation, because there's absolutely no way the government could get even a fraction of that sum from its citizens.

Will it come from debt? How could it? Will foreign nations continue to lend to the United States, despite the fact that it is the largest debtor nation on earth? Why would they? In years past, the loans were justifiable because the American consumer bought so many foreign goods. But the American consumer seems to have lost his heretofore insatiable appetite for material things – specifically because he has nowhere to get the money! He can't borrow against his house. His credit cards are either maxed-out, or else the card companies themselves have reduced limits so severely that they're next to useless. So how will Americans continue the gluttonous shopping spree they have enjoyed for the last few decades? The answer is, of course, they won't. And there is absolutely no incentive for foreign nations to continue to loan money to the U.S. if Americans have no means by which to return those funds to the source.

So the United States will simply try to print itself out of this mess – and indeed, the presses are already smoking and groaning from the strain. But the government can't just print trillions of dollars, and lower rates to unprecedented levels, without expecting massive inflationary price explosions in the near future. Further, the Fed is not run by wizards; it is manned by human beings who are both fallible and politically motivated. Instead of cutting rates, Bernanke and his sycophants should have been raising them. Instead of printing money and buying long-term Treasuries, they should have been pulling currency out of circulation by selling the long-end of the yield curve. Unfortunately, the point of no return has come and gone, and we're all going to have to weather the coming storm together. I'm doing it by shorting Treasuries, and buying commodities. So far, I couldn't be more pleased with my returns since December. Of course, all of this is offset by the fact that I'm going to have to watch a lot of people suffer in the coming years. That prospect certainly doesn't thrill me.

I encourage you to take a long hard look at your commitment to your government and its currency. If you believe I'm wrong, ask yourself why you've come to that conclusion. Then carefully lay out your argument, because I assure you, I want to hear it. But if your reasons for defending the "almighty dollar" and the government that prints it derive from blind patriotism, dogmatism, and/or irrepressible empiricism, all I can do is wish you luck. I want no part of it. You can wave the stars and stripes until your arms fall off, for all I care. You can even call me a traitor (you won't be the first). But I say our corrupt government deserves its fate, and the tyrants (and their supporters) who are systematically destroying our currency much more aptly fit the description than do I.

Remember, I'm only one of many messengers who are presenting an extremely cogent and dire warning. Calling me names isn't going to affect the outcome – one way or another – and you certainly aren't going to hurt my feelings enough to make me stop writing. If anything, you're simply wasting your time, because the next article is just around the corner, and barring some miracle, I doubt its contents are going to be any more optimistic than its recent predecessors.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

 

The Last Drink Before the Weekend Ends

"Are you going to gamble while you're in Vegas?" The woman asking the question was one of my post-workshop straggler's, bent on extracting every last shred of evidence leading to my conclusion that the dollar really is going to fail. She had followed me out of the lecture hall to question me in the foyer – apparently oblivious to the fact that I was both psychologically and emotionally "done" imparting my bleak and macabre message to the world for the day.

Done.

I took a long pull from my glass of bourbon. Her accent bled slowly a thick, nasal Scandinavian root, shouting, "FUCK YOU, I'M FROM THE MIDWEST!" like a premium billboard aimed at rush hour traffic. I stared at her for a moment -- neutral on the outside, but positively roiling on the inside. I raised my eyebrows and we continued to stare at one another until I simply couldn't resist glancing at a girl in a tiger-striped dress standing shoulder-to-shoulder with another girl -- both speaking enthusiastically, yet cautiously to a couple of young Hispanic men. Or boys. Or whatever.

The badges around the boys' necks told me they were part of the convention in the hall next to us -- in town to absorb the delicate intricacies of franchising a Pizza Hut. My guess was that their day was done, and now they were going after these two kittens. Their badges bore the bold word "ARIZONA." The girls were laughing and nodding, in that sort of polite yet frantic I just want to go have about ten shots of tequila and get laid by someone hot kind of way. I'm probably not the best judge, but I'm good enough to know the boys from Arizona weren't making the cut.

"Mr. Ahlgren?"

I looked back at the woman. "I'm sorry. I'm very tired. I need to get back to my hotel."

"Oh! Where are you staying?" She smiled with an eagerness that terrified me far worse than the prospect of the dollar's failure. Her boingy-bouncy accent affected me like screeching metal, and I noticed the wedding ensemble on her left hand. I found myself wondering what it would be like to spend my life listening to that accent, and suddenly the Swedish Chef from the Muppet show took center stage in my brain, after hibernating for decades, and I had to suppress what would have only come across as a condescending guffaw.

I closed my eyes. I opened them again. She was still there. I took another sip of bourbon and said, "I'm staying at Hooters."

"Excuse me?"

I leaned forward a bit. "Hooters."

"Oh."

Normally I would have lied. But somehow I was beyond that here. Another moment of silence passed before she finally said, "Well, you didn't answer my question."

I smiled patiently. "What question was that?"

"Are you going to gamble?"

I let my smile broaden a little, and the bourbon took the moment. "As soon as I find the right prostitute."

In 1990 I took a tour of William Faulkner's estate in Oxford, Mississippi. At the time, I had written little more than a few dark pop songs about abandonment and broken love. I found it strange that the last stop on the tour was Faulkner's bedroom, in which a dresser stood -- a quarter-full bottle of Jack Daniels resting on its surface.

I stared at it for a moment, almost mesmerized. "Why is that there?" I asked the guide.

She smiled gently. "We don't talk about it."

Somebody else said, "Why not?"

More firmly, the guide said, "We just don't."

Three or four years later, a historian from Mississippi told me the bottle is original. "They keep it there," he said, "because it was both the source of Faulkner's brilliance, and the catalyst for his demise…" He let the words trail off dramatically, and for years, I thought it was simply a tactic to immortalize a legend.

It turns out on the night of his death, Faulkner reached for that bottle and begged the paramedics charged with transporting him to the hospital in Memphis to let him bring it along…

When I finally got out to the strip, I became aware of one inescapable truth: I needed to get to a fucking keyboard. Fast. But first, I needed more bourbon.

I walked quickly, chewing on this abject loneliness sitting in the pit of my stomach like a piece of rotten fish. The nearly inconceivable number of tragedies over the last month played in my mind, looping infinitely, reminding me just how the universe works.

Remember when you were on top of the world? Remember? Remember when you thought you were cool, and you had more money than you knew how to spend, and you didn't have to worry about shit anymore? Remember? Remember when you didn't have a daughter whose very existence makes you ache with emotions you never knew existed? Hmmm? Yeah, well we fixed that little snap of haughty fatuousness, didn't we?

I stopped and looked at the Vegas skyline as the sun melted into the horizon, and suddenly I was stricken by how much it had changed since the last time I was here. And I thought about how much everything has changed.

I slowed my pace, watching the sun disappear, wondering how this oasis of pure decadence in the middle of the Nevada desert was even moderately sustainable in light of the current economic crisis. And yet here it was, full of all the same throngs of fat, tattoo-covered bovines plugging up the walkways as they ambled to the next casino, dumping endless sums of money in ceaselessly flashing, dinging machines sporting themes ranging from Dale Earnhardt, Jr., to EBay. Yes, that's right. EBay.

What is the appeal? And why do these herds of cattle continue to pay five dollars for a small bottle of water, or $15 for a barely palatable cheeseburger? Why?

For my part, I was here by invitation to speak to a
group of investors -- many of whom still refuse to acknowledge that the U.S. government has just printed the dollar into its immortal place in history. They accepted my presentation with cautious skepticism, and I can't say I blame them; after all, who really wants to face the fact that everything we have ever known about our society is about to disintegrate? The whole world is coming apart at the seams; it has become imbalanced, and somehow I'm in the middle of it – inexorably and irrefutably. And here I was in Vegas. Confused. Scared. Angry. Tired. And driven…

In the last 36 hours, I've been cornered by brilliant people turning to me for advice on which leveraged ETFs will protect their portfolios most effectively… I've been approached by prostitutes better endowed than I am – which, granted, isn't difficult to achieve. A 21-year-old biology student from some college in California seduced me, only to abandon me, leaving me writhing in my passion like a hungry infant. I have walked miles and miles and miles in the unrelenting Nevada heat. And last night, I blew my chances with a 23-year-old supermodel because I refused to pay $32 for a drink, along with the privilege of wearing a fur coat in a glorified cooler containing a bar made of ice.

And I miss my little girl so much…

I guess my priorities are just all fucking out of whack. But as the day drew to a close, I knew one thing with a conviction so near certainty that my blood veritably boiled with a passion I have not felt for a very, very long time. Most of us know what it's like to experience that erotic perfect storm – that moment when you meet someone to whom you are so attracted, and from whom the attraction is so requited, that you almost can't get to a secluded place fast enough to shred the fabric from each other's bodies, like dog's scratching at the entrance of some elusive rodent's home. And when this happens, oddly enough, it's the unqualified, unquenchable desire that etches itself forever in our memories, whereas the inevitable sex itself results in an anticlimactic debacle that usually embarrasses everyone involved.

If you know what I'm talking about, then you know how I felt about getting to a place where I could write.

Now. This minute…

I needed to get this out of me… to spill it to the world… to offer one last temporary explosion before I launched into the sequel with all the strength I have left.

I marched into the Hooter's gift shop with all the confidence of an Oscar-winner traversing the void between his precarious membership in the audience, to his sacred place at the podium -- where his position in history is guaranteed, and his acceptance speech graduates from an insurance policy to a declaration of greatness.

The fat woman in front of me wore white socks beneath her Crocks, and some sort of shiny pink tracksuit that would have embarrassed Elvis Presley. She had a cigarette dangling between her lips which bobbed up and down as she counted coins in a pile next to her Michigan driver license, trying to achieve the exact cost of the bona fide Hooters golf ball, shot glasses, and bottle of Jose Cuervo. My guess was that she buying this crap for her family back in Kalamazoo – or whatever shitty hovel she came from.

The cellulite that composed the majority of her upper arm bore a tattoo that might have been a butterfly at one point. Or it could just as easily have been a likeness Nikki Sixx. There was just no way of knowing.

The clerk seemed as impatient as I was. She sighed and turned her eyes to me. "What can I do for you?"

I nodded once at the shelf behind her. "Bourbon."

She stared at me, and I felt something familiar. The faintest smile touched her lips, and involuntarily, one thought stampeded my mind: she knows…

She turned slowly – only pulling her eyes away from mine at the last possible instant. She turned back and handed the bottle to me in exchange for the cash I gave her.

"Keep it," I said.

She narrowed her eyes and smiled a little more…

I finally made it back to my room, where poured a quick, sloppy drink and tore off my clothes. I fumbled with the zipper, pulled out my laptop, and fell onto the bed. What you're reading is what came next…

Nine years ago, it took me three months to write the first draft of Discipline. Those three months followed the worst year I had ever known – up to that point. But compared to the last two years, that time of my life seems like a goddamn day at the carnival.

I'm trembling right now, because the ghosts are back, and they are angrier than I ever remembered. They are screeching at me, forcing me to see things I didn't think I'd ever have to look at again. This place is so black, and it hurts so much, and yet this is what it takes. This is where I have to go, and I was a fool for thinking I could ignore it forever.

But, of course, there's something new now. She is the most beautiful thing in the universe. So fuck it. It's not like I have any choice anyway. Let's see what happens this time.

As the Dollar Continues to Collapse, Where Will You Put Your Money?

 

Before, I launch into this article, I want to thank Seeking Alpha and The Money Show for allowing me to present my workshop not long ago at Mandalay Bay in Las Vegas. I'm always nervous when I speak to crowds about the inevitable failure of the dollar and Treasuries – I never know how safe I am, playing the role of messenger. The response, however, has been overwhelmingly positive; it seems the most astute investors are beginning to accept – and even prepare for – the advancing collapse.

I also want to make a quick point about my intentions: I have very little to gain, financially, by convincing any of you that I'm "right." I do have a novel on store shelves that subtly incorporates many of the epistemological constructs that have gone into my research, but these articles are by no means part of a massive campaign to sell copies of Discipline; my objective is to disseminate these theories to as large an audience as possible in order to generate debate and criticism. More than anything, if I am right, I want people to prepare for what's coming, so we can all minimize the shock and pain that will ensue. As a species, we will have to find a new way of doing things, because the consequences of the old ways are descending upon us like a maelstrom. And if I'm wrong, well, I'd just like to know it as soon as possible. But I obviously don't think I am.

This piece follows a previous article, in which I warned against shorting equities -- despite the fact that I believe the stock market is going to fall dramatically, at least in real terms (which I'll again expand upon later). As usual, my cautious outlook prompted a flurry of emails from readers asking what they should be doing with their money in order to prepare for the impending firestorm of rising prices that will derive from the inflationary printing and unprecedented credit-easing governments worldwide are foisting on their citizens.

It's important to note that, although I refer to "the" collapse of the dollar and Treasuries, these events are not going to happen in one minute, or one day, or even one week. Indeed, since I started writing about this scenario in December, the government has done so much to try to reverse the course of this trend, and yet the cracks have widened, and the dollar and Treasuries continue their inexorable march downward. Even though I don't believe, however, there will be any particular event that will trigger the collapse, I do believe it will accelerate with time -- ultimately exploding in a quick, catastrophic climax.

I am forever an analyst, but I am no longer an adviser or manager, and I want to encourage anyone investing money to do a prodigious amount of research before committing funds to anything – especially in this environment. Having said that, the best and safest place to start discussing my own opinions about capital allocation is to reiterate what you shouldn't be investing in: stocks, Treasuries, and dollars. As I said in my last article, although the stock market may trade sideways or even go higher from here, once the consequences of the unparalleled governmental printing spree and credit-easing of the last few years finally do hit the economy, earnings and dividends growth -- which are the main drivers of stocks – will never be able to keep pace with the inevitable and substantial inflationary price increases in the general economy. And this highlights what I consider to be the most dangerous part of this environment: your portfolio will appear to be going higher, but in real terms, you'll be losing money – on a scale greater than, I believe, even that of the 1929 to 1932 collapse. The only thing I can imagine worse than watching the market fall the 90% or so that it did 80 years ago is watching a stock market rise in a period in which it is vastly underperforming inflationary price explosions. The drop from 1929 to 1932 may have been painful, but at least it was an honest market.

So where do you go to survive, or even to outperform?

 

SHORTING THE DOLLAR INDEX?

The dollar index is merely a gauge of the dollar against a handful of the rest of the world's major currencies – leading to a general misperception that I call "currency relativity." Unfortunately, the fact is that every other central bank on earth is employing the same quantitative easing principles as the U.S., and so their currencies are equally doomed. If you short the dollar index, you are merely taking a position that the dollar is going to be weak relative to other major currencies, and that probably isn't going to be the case; they're all trapped in the same burning house.

On a related note, you may want to pay attention to the fact that Treasuries and gold seem to be decoupling from their heretofore nearly direct inverse relationship with equities. What does this mean? Mainly, in my eyes, it decries the old notion that, just because the stock market goes down, people will run to Treasuries as a safe haven; apparently the so-called "risk-free" rate of return isn't so risk-free anymore. Likewise, it would seem that, just because the stock market is going up, people aren't necessarily dumping gold. And this lends credence to my theory that investors not only expect inflationary pressures to drive stocks higher in nominal terms (but not real terms), but also that, in order to really survive rising prices, gold is one of the best places to be.

 

REAL ESTATE?

Have we hit the bottom, and are prices going to rebound from here? My best guess is that -- again in nominal terms -- we are near a "bottom," but as with the stock market, what does that mean? Yes, housing prices might rebound, but will those prices outperform inflationary pressure in the entire economy? Probably not. I will say this, however: when rates and prices are shooting skyward, having a personal residence with a relatively low interest-rate fixed-rate mortgage is a great position to be in – assuming you have a job, and you are going to be able to keep it. First, there's the tax deduction on the mortgage interest. But more importantly, a fixed-rate is just that: fixed. Even as all other prices and rates move higher, the mortgage payment doesn't – making it a progressively smaller part of a household budget.

To illustrate the way fixed-rate mortgages work with inflationary trends, think about the house your parents or grandparents bought for $20,000 several decades ago. Their monthly payment remained fixed at around $200 per month for thirty years, and yet their wages undoubtedly increased dramatically in that time. At the beginning, $200 was likely a hefty part of their budget, but toward the end, it was probably insignificant. Now, imagine how much that effect would be amplified by a hyper-inflationary economy – which, unfortunately, our government has all but guaranteed in the coming years. Remember, we all have to live somewhere, and if part of your cost of domicile is going toward equity, and the interest you're paying is fixed -- in an environment of rising rates and prices -- well, I guess it doesn't get much better than that. The alternative is to rent -- and leases escalate with inflationary surges.

In general, however, the reason I believe housing won't outperform inflation is that credit is all but gone; no matter what any of the pundits say on CNBC, the stark reality is that people can't get loans. It doesn't take much to recognize that, if the consumer can't borrow, then he can't buy a house. And if that condition has become the status quo – and I believe it has – then what will drive the housing market?

 

COMMODITIES?

People call me a gold bug. I'm going on the record here -- I am not a gold bug. I am, however, a huge fan of commodities right now -- and gold is hovering near the top of my list. Gold has almost no industrial value, but I follow it anyway, because it is nearly a perfect metric for the anticipation of future inflationary price-increases. Why? Gold has a psychological component that it shares with almost no other thing on earth -- it literally packs eons of historical consistency and value; people have always been passionate about gold, and it has unfailingly been the ultimate measure of economic and financial stability. As such, when people are frightened, they fly to the one thing that embodies that stability in order to protect wealth, and this means that gold will react to inflation faster and more accurately than just about anything else. Further, its overall popularity means it is more liquid than other scarce metals and stones. All of these variables come together to convince me that, when the bottom falls out of the dollar and Treasuries, not only will gold keep up with prices, but it will outperform as people flock to its empirical safety. Remember: during a panic, everything tends to overshoot intrinsic value – to the upside and to the downside. Gold's universal nature will undoubtedly put it at the head of the pack, all but guaranteeing a above-average rate of return – at least until everything stabilizes. Unfortunately, however, I think we are sitting on the cusp of a colossal crisis, the likes of which we've never seen. At this point, economic stabilization seems like little more than a distant dream.

For many of the same reasons I like gold, I also like oil and agriculture. Let's face it -- getting a loan these days is almost impossible for anyone, and farmers and oil-producers are no exceptions to this troubling rule. Yes, I understand a slowing economy means slowing demand for commodities. But demand for food and oil will not simply cease; 2 billion Chinese and Indians may not be buying at the Gap this season, but they aren't about to stop driving and eating. So -- unlike gold -- oil and agriculture do have practical aspects to their demand that ensure more than a mere "safe store of wealth." As currencies falter, prices of oil and agriculture will keep pace; the fact that producers in these industries can't borrow should limit supply in a world in which demand probably won't fall all that significantly – relative to everything else. All this will almost certainly equate to better-than-average performance.

 

SHORTING TREASURIES?

Shorting long-term Treasuries at this moment may be my favorite investment of all time. I love how the Fed commits to buying $300 billion worth of 10- to 30-year Treasuries in order to keep down the long end of the yield curve, and yet those rates go up anyway. This is just more evidence that the United States government is rapidly losing its ability to manipulate the economy, as well as further testimony that now is the time to bet against the Fed – and to bet against it big. I know, I know, I'm a doomsday prophet and a conspiracy theorist. Believe me, I've heard it all. Try to remember, though -- if you can see through that fog of skepticism and doubt -- that people were also ridiculed for predicting the failures of the Roman, British, and Soviet empires. And yes, you are correct -- anyone can make a general prediction, but timing is everything. Let me be clear on this point, however: I am not making a vague prediction; I am predicting, specifically, that the dollar is going to weaken to the point of collapse – along with many other global currencies – and that it's going to happen sometime in the next two years (probably sooner). Try to bear in mind that the U.S. has committed itself to almost $13 trillion -- just to battle this financial crisis alone -- and that figure is 50% more than the government has spent on every single project, war, or undertaking since the country's inception, in real dollars -- combined.

Despite what you may or may not believe about my prediction, shorting long-end Treasuries continues to be a no-lose proposition. If by some miracle, the Fed manages to pull some proverbial rabbit out of its hat and fix this incomprehensible mess, then part of its solution, ipso facto, will necessarily be raising rates to maintain the integrity of the dollar. On the other hand, if my prediction is correct and the dollar fails, well, Treasuries are going to follow it all the way down. Yields have been hovering near all-time lows for months. There's no place to go but up.

 

HOW DO YOU GET INVOLVED?

The obvious and inevitable question is: what vehicles offer the easiest and most practical way to participate in some of these moves? Until recently, the only way the average investor could profit from such events was to use futures contracts or to take physical positions – both of which are cumbersome, complicated, and involve a great deal of maintenance. Fortunately, however, times have changed. In recent years, many companies have introduced electronically traded funds (ETFs) – some of which even offer two- or three-times leverage. There are a lot of them out there, and I again encourage you to do thorough research before diving headfirst into any investment vehicle. In my own portfolio, I am using some of these ETFs, which I have disclosed below.

 

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

 

Nothing About this Economy Should Surprise You

"Insanity: doing the same thing over and over again and expecting different results."

-- Albert Einstein

 

The Einstein platitude above is so overused that I'm almost disgusted with myself for planting it at the beginning of this article. Almost. But then I think about how utterly applicable it is to this piteous disaster we're still calling an economy, and I really have no choice.

For nearly two decades, I have been writing about free markets and how important they are to progress – to the growth of knowledge, as the philosopher Sir Karl Popper would call it. I am by no means alone; minds far more advanced than mine -- along with groups like Cato and the Mises Institute, to name a couple -- have been defending market liberalism since long before I took my first breath. Yet, for all the effort, the arguments have met with phenomenal resistance – often ferocious and virulent. Politicians and academics have been blaming markets for our collective problems for ages, and yet I fail to see their reasoning.

Wall Street, for instance, is the favorite whipping boy for the housing crisis that has descended upon us like a poisonous fog, and yet it was created not by banks, but by government programs that all but demanded these banks loan money to anyone with a pulse. And do you know why the government did this? Because people with poor or no credit can still vote, and if you get them into houses – regardless of their ability to make payments each month – they're going to see you as a hero, and they're going to put you in office.

Now what do the banks have to do with that, except for acting as facilitators for the transactions? Let me put it another way: if you were a banker, and the government told you it was okay to lend money to people who shouldn't qualify, and told you that you would be paid handsomely for the transaction, would you say no? At best, you might say to yourself, "Is this smart?" But then you would, as everyone did, justify it by reminding yourself that if Uncle Sam says it's all right, well then it must be all right! Hey, we've all got to put food on the table!

In any case, the point of this piece is not to defend investment banks, per se, but it is rather to point out that large, centralized governments are irresponsible, inefficient monsters that destroy innovation and productivity; they are the source of all our economic woes at this moment in time (or, really, at any moment in time), and yet I firmly believe we could have done things differently -- much differently. Below are some major points that free market economists have been making for decades (or longer), and I believe that, if the world had taken them to heart, we could not only have averted this crisis, but we would be existing in an era of unprecedented prosperity.

1. F.A. Hayek – the Austrian economist, author of The Road to Serfdom, and 1974 Nobel winner in economics – observed that centralized bureaucracies lack the resources and meticulous insight to manage an economy's trillions of components. This tenet inspired the following analogy in an piece I wrote several years ago: imagine your brain trying to manage the decisions made by every cell in your body. How long do you think you would survive? Well that's what Washington has tried to do with the U.S. economy for almost a century, and we are now paying the price, yet again. Only this time, it's going to be far worse than ever before – and, indeed, may be insurmountable (see any number of my previous articles if you want to learn more about the death of the dollar and the U.S. economy).
   
2. In his milestone work Socialism, another Austrian, Ludwig von Mises – after whom the above-mentioned institute was named – proposed what I consider to be the most powerful economic axiom ever posited. It is called the Economic Calculation Argument, and it essentially states that any manipulation of price structures distorts the ability to perceive scarcity. In other words, scarcity is the product of every individual actor in an economy casting his or her vote, through transactions, for the relative value of any good or service. The value the collective places on goods and services is the result of these miniature "votes." When the government tinkers with the money supply, it necessarily distorts price structures and creates inefficiency. But more than that, it destroys any possibility of understanding true scarcity, and when that happens, our ability to discern who needs what, and where, becomes impaired.
   

   The Soviet Union -- which is inarguably the biggest joke of a planned economy ever -- perpetually failed to ascertain scarcity, and its people had to stand in lines, ad infinitum, just to get toilet paper. For my part, I thank the stars every day for the Soviet Union, because it established, irrefutably, the veracity of Mises' theory (although I do feel sorry for the people who couldn't get toilet paper).
   

   Unfortunately, other folks – like, oh, say, most academics, along with every single politician in Washington (except Ron Paul) – do not see the irrefutability of Mises' Argument. No, they have kept doing the same things, over and over, for a century, because what feels good gets votes. Who cares about the eventual consequences? And so it goes -- as the rest of us suffer day after day through this economic version of the Black Death.
   

   What is insanity again?
   

3. I don't care how fancy Ben Bernanke's helicopter is; a government cannot print money to solve economic problems. Printing money creates economic problems. It's called inflation, and it sucks. If you don't believe me, would you believe the Romans? How about the Spanish? The Portuguese? The British? What about those aforementioned "geniuses" in the Soviet Union?
   

   Do you really think the U.S. is somehow different than all those empires of yesteryear, who so recklessly manufactured their own currencies -- ultimately whittling themselves to a mere fraction of their former, majestic selves? No. The U.S. is subject to the same economic principles that every other foolish empire has had to face, and printing $12.8 trillion isn't going to do anything but ensure that our children better learn to speak Chinese. And they better learn to speak it real good, because that big groaning sound you hear in the sky – yeah that one – that's the sound of the center of economic power heading east.
   

So here we are – wallowing in the filthy muck created by generations of politicians and central bankers. You would think global governmental establishments would finally see the light, right? Surely it's time to stop this cycle! Isn't this the hour to listen? Hail Mises! Hail Hayek! Take us back to sound money and true liberty!

Well, apparently listening isn't part of the equation, because governments everywhere are
printing unprecedented sums of money. They are creating still more easy credit. They are doing all the same things – on the largest scale ever -- that got us here in the first place. Above everything else, though, they are fulfilling Einstein's famous dictum.

For the entire world is now truly and incontrovertibly insane.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco will be giving a workshop entitled The Death of the Dollar: How We Can Survive the Coming Collapse at the 21st annual Las Vegas Money Show, Mandalay Bay Resort, Tuesday, May 12, 2009, at 11:30 a.m. He hopes to see you there. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

Equities Are Headed Down, but Shorting Isn’t the Answer

 

"Inflation is the senility of democracies."

-- Sylvia Townsend Warner

 

In my last article I observed that, in a poor economy, bear market traps are driven primarily by a collective flawed perception of current and future corporate earnings. I pointed repeatedly to the lagging earnings trends of the 1929 to 1932 correction, as well as to the sheer number of times reckless investors were drawn to deceptively attractive price-to-earnings ratios and high dividend yields, only to see those numbers destroyed by an ever-worsening economy. And that's exactly where we are right now – in the middle of yet another bear market rally driven by faulty earnings and dividend expectations. How do I know this? Because corporations depend on consumers, who have lost almost all ability to borrow money. The spending-spree is inarguably over.

Let me give you a working example of the sort of optimism that might get an investor in trouble. Pfizer (PFE) is a great company – a value investor's dream – sporting a history of consistent and stable earnings, well-managed debt, and strong, albeit relatively similar dividend yields to other strong large-cap stocks. After the crash last November and December, however, Pfizer's dividend yield jumped to over 9%, while it's p/e collapsed! I did all the usual research, salivating profusely, almost completely convinced that Pfizer at a price of $17 per share, was a steal. I took a significant position, and yet a little voice in the back of my mind told me to look deeper, and after doing still more research – which inspired this article, as well as the last one -- I unloaded the position, fortunately at a slight profit. Almost immediately thereafter, Pfizer reported lower earnings, and it slashed its dividend. The stock price tumbled accordingly.

Since writing my last article, I have been inundated with emails asking the same question: in light of my findings, is it time to short equities? And the answer might seem obvious – if earnings are going to fall further, and companies are cutting dividends, wouldn't the best move be to short an index or two? Things, however, are never as simple as they seem. I've said it many times before, but it might surprise you to know I actually believe the stock market is going to go up from here – if only moderately. The reason? Inflation.

From 1929 to 1932, the U.S. government was significantly impaired by the gold-standard, and wasn't able to manipulate the money supply with anything even approaching the current printing spree we're witnessing. As one reader pointed out, the government did re-set the price of gold, in dollars, in the early 1930s, but in real terms that move was so insignificant as to be non-existent -- compared to the $12.8 trillion the government is going to have to print to cover its budget for the next two years (this article should put the magnitude of that sum in perspective for you).

What this means is that a savvy investor could have shorted the market during just about any bear market trap during the 1930s collapse and fared very well – in real terms – because prices were falling as people deleveraged. The specter of inflation was nowhere to be seen. Today, however, although we find ourselves in the same deleveraging environment, inflation is a colossal threat, and it is only a matter of time before prices skyrocket.

This is why I believe the stock market will probably go up a little bit from here, in nominal terms. In real terms, however, I believe the stock market is going to do much worse than even the 90% or so that it lost from '29 to '32, and this makes our current environment so much more dangerous to those uninitiated: it's one thing to see the market falling, and to know how much money is actually being lost. It's quite another thing when the average investor sees the market rising and believes he or she is actually getting rich -- when in fact the losses, in real terms, are staggering.

The truth is, you could short the market here, and even if it goes up, you'll probably make a little money in the end -- after adjusting for inflation. But as I see it there are three problems with this strategy:

1. I have no idea how long it will take for prices to start rising (and neither does anyone else). If my theory is correct, the market will probably hover at current levels for a while.
    
2. Once prices do take off, the stock market will probably rise with them -- although at a slower rate. You'll be left in the uncomfortable position of having to battle the psychology of reverse-mathematics – constantly reminding yourself that even though it looks like you're losing money, you're not. In other words, you'll be short the market, which will start to climb with the rising prices of goods and services -- but at a slower rate. Any short positions will appear to be losers, but since they'll be beating inflation, they'll actually be making money, in real terms. Frankly, that's just confusing as hell, and it certainly doesn't sound pleasant to keep track of.
   
   
3. I still believe in the productivity and innovation that defines many U.S. companies, and eventually they're going to turn around. When they do, I believe their bull run will be as unprecedented as the horror that precedes it. Being short -- no matter how cogent my arguments for the coming storm – means betting against the aforementioned productivity and ingenuity, and that means you'll have to pick the bottom. For my part, I suck at timing markets, and I don't want to have anything to do with trying to find that nadir.
   

I think there are better strategies, including buying gold and oil, and shorting Treasuries. These positions stand to outperform inflationary pressure by a wide margin, and yet offer relatively little downside risk – at least in this environment. Yes, the time will come to offset short Treasuries, as well as to sell gold and oil, but that time is a long way off. I can't say the same for equity markets.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco will be giving a workshop entitled The Death of the Dollar: How We Can Survive the Coming Collapse at the 21st annual Las Vegas Money Show, Mandalay Bay Resort, Tuesday, May 12, 2009, at 11:30 a.m. He hopes to see you there. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

The Beginning of the Next Bull Market? History and Earnings Say Probably Not.

“[It is] an ill wind that bloweth no man to good.”

-- John Heywood 

I’ve heard a lot of discussion in recent months about the future of the dollar and the economy. Some people think this is just a typical downturn – that we’ll get through it and then everything will be just fine. Housing prices will rise again. The stock market will recover. The United States will prosper. Everything will be as it was. Similarly – and more recently – there has been a plethora of talk about whether the recent rally in the stock market is the beginning of a new, long-term bull market.

I hate to yet again be the harbinger of bad news, but this is not the beginning of a new bull market, and things are not going to be as they were.

Have a look at this chart comparing the stock market collapse of the 1930s to our current downward spiral, created by Mark Lundeen:

 

Mark has consistently painted a cogent argument that we are nowhere near the bottom. If you haven’t already, you would do well to read his articles going back a year or two. He predicted everything we’re going through in a humble and patient manner. Even if you’re determined this market is going to turn around and return to “normal,” I’d think twice before simply dismissing his research. In any case, no matter what your outlook is for the future of markets and the economy, the focus of this article is the current stock market rally. And the thing that should be jumping out at you, regarding the chart above, is the red plot – explicitly, the sheer number of false rallies the market endured from 1929 to 1932.

Before we go further, I want to remind you that I found my success in the financial world as a value investor. I believe wealth-creation is a long-term prospect, and if an investor wants to do well, he or she must find undervalued enterprises that create abundant free cash flow. But more than anything, that investor must enter the position at a discount to intrinsic value. So what is intrinsic value? It is a discounted measure of a firm’s ability to create wealth for its owners, over time. And in my world, wealth is measured explicitly by free cash – loosely derived from a company’s earnings.

The problem with the current economic environment is manifold. Sure, in terms of simple aggregate stock prices, global markets have been crushed, and on the surface -- to less scrutinizing eyes -- the whole thing probably seems like a giant orchard full of low-hanging fruit. It’s simple, right? You have earnings. You have price. If the price goes down, the company is worth more, intrinsically, because the price-to-earnings ratio has collapsed. Simple, right?

The question is rhetorical, and you’ve undoubtedly guessed that my answer is a resounding no. When the market took its first harrowing dive in 1929, reported earnings remained intact, driving price-to-earnings ratios much lower. To a novice value investor, this might have seemed like the opportunity of a lifetime. Of course, we know now that it was anything but the opportunity of a lifetime; over the ensuing few years, as conditions worsened, earnings reflected the true nature of the economic environment and melted accordingly. Stocks continued to fall accordingly, with very short-lived respites offered by the painful bear market traps I referred to in the chart above.

What caused these traps? The exact same mistakes would-be value investors always make after every downward move in a collapsing market driven by a faltering economy: stocks fall, but earnings do not follow immediately, and this makes everything look “cheap.”  Unfortunately, earnings always lag the market, so when equities fall, the real economic conditions aren’t reflected by historical reporting.

Of course, in a prospering economy, this all becomes moot because earnings will continue to grow despite any market downturns. In October of 1987, for instance, the market shed 23% of its value in one day, but the economy was booming. Anyone picking up equities the day after the crash found some incredibly undervalued companies -- because earnings were increasing throughout the economy. But there is absolutely no comparison between the 1987 crash and its economy with either the 1929-1932 crash, or the 2007-2010 crash, and anyone foolish enough to even consider buying equities at this point needs to take a long, hard look at the economic conditions underpinning our current depression:

1.       The housing and credit markets are terminal. To bring it into perspective, consumers drove 67% of the economy until a year or two ago, and they got the money from their houses and credit cards. That party, however, is over, and the spending has come to a halt. Is this fully reflected in company earnings? Absolutely not, and the worst is yet to come.

2.       The depression of the 1930s was the worst economic catastrophe the U.S. has ever seen (yet), but even in the midst of that torturous environment, the nation was a net lender, and it had a huge manufacturing base. Today, the U.S. is the largest debtor nation on earth, with a relatively small manufacturing base. Whether you agree it was the best move or not – and I don’t – the United States essentially borrowed its way out of the Great Depression -- simply because it could. That, coupled with its powerful manufacturing sector of the time, allowed the country to muddle through some extremely painful years. In the current environment, however, the government’s debt-load is at record levels, and its ability to borrow is severely limited. If you believe that China and Japan are going to continue to lend to the United States at yields between zero and three percent, indefinitely, I would like to know why. Are they really so reliant on the U.S. consumer to buy their exports? And that leads inevitably to the question: what consumer? Please see my previous bullet point.

3.       In the 1930s, the United States dollar was tied to gold, thereby limiting the government’s ability to flood the market with printed currency. I have no doubt that Franklin Roosevelt and his henchmen would have loved to print money to battle collapsing prices caused by the same deleveraging forces we are seeing all around us today. Unfortunately they couldn’t – at least not the way the Fed is doing it now --  and the country was spared the runaway price-increases that would have certainly ensued if the government had been able to print money at will. Today, there is no gold standard. The U.S. government is running wild -- printing money like a child with carte blanche in a candy store -- and that money will have to be soaked up somehow when the deleveraging stops. How will the government do that? By selling Treasuries? To whom, and at what yields? Please see my previous bullet point.

When you compare our current situation to the Depression of the 1930s, the outlook is certainly grim. And yet, in terms of the stock market and its close relationship to corporate earnings, the prognosis is even worse; in the 1930s, the government’s ability to inflate the dollar was impaired, and so, at the very least, prices continued to fall – giving the consumer at least one thing to be happy about. Sure, corporate earnings fell, but at least money retained its value. In today’s economy, however, inflation is the name of the game, and runaway price-increases loom like the darkest storm on the horizon. At this point, it isn’t a matter of if, but rather when the nightmare begins; its inevitability is simply terrifying to those of us who refuse to bury our heads in the sand and trust the very government that created this hopeless fiasco in the first place.

I suppose some would argue that rising prices will be good for corporate earnings, and this will undoubtedly be so in nominal terms. But if the consumer is feeling the pain now, how is he going to feel when the prices of milk and eggs start moving up exponentially? The truth is, in nominal terms, the whole stock market might actually rise a little, but as a long-time value investor, I’m here to tell you that will not mean that wealth is being created for shareholders. If the consumer isn’t spending now, what is his budget going to look like in a hyperinflationary environment? No, in real terms, corporations are facing years of unprofitability -- thanks to the profligate and reckless actions by the United States federal government, among others -- and stock prices are going to reflect that, in real terms.

So when you’re thinking about “buying the dips,” or dollar-cost-averaging into equity markets, try to remember that we are in uncharted territory. The U.S. consumer-driven economy simply has no more fuel, and nothing will change that – at least not for many years. Likewise, the onset of inflationary price-increases is indisputable and inevitable; a country cannot wantonly commit itself to $12.8 trillion and simply print its way to its objective without suffering the enormous consequences of massive price-escalation. Further, this condition will hang in direct contrast with the economy of the 1930s, which was, to say the least, bad enough. I can only imagine how bad an inflationary depression is going to feel.

Ultimately, corporate earnings are headed for disaster, and that won’t be good for anyone. But it certainly doesn’t bode well for the prospects of true value investors.

If you want to know more about when I will be interested in equities again, see my article on the Dow-to-gold ratio.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco will be giving a workshop entitled The Death of the Dollar: How We Can Survive the Coming Collapse at the 21st annual Las Vegas Money Show, Mandalay Bay Resort, Tuesday, May 12, 2009, at 11:30 a.m. He hopes to see you there. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

 

You Want Healthcare Reform? Well How About This?

"A foolish consistency is the hobgoblin of little minds."

-- Ralph Waldo Emerson

 

I've been waiting a long time to use that Emerson quote in one of my articles. Alas, it looks like I've finally found my chance.

Are there any issues more banal and worn out than healthcare reform and Bernie Madoff? There probably are, but I can't think them off the top of my head. In any case, you should probably know that I wouldn't lose a minute of sleep if I never heard the words "Bernie" and "Madoff" in the same sentence on CNBC again. The same goes for "healthcare" and "reform." But since that's not going to happen, and since these two topics are bringing me dangerously close to the brink marking the boundary between sanity and abject lunacy, I've actually canceled my cable subscription. Yes, it's true: I have decided to rely exclusively on the internet for information that I can custom-tailor to never mention healthcare reform or Bernie Madoff. Ever.

Having made my confession, however – and Bernie Madoff aside -- I nonetheless feel as though I would be remiss if I didn't at least make a small effort to put forth my own solution to the healthcare "crisis" before I permanently eradicate it from my daily media diet. I doubt anyone is going to listen to me, but in the end, that doesn't really matter. Because I do have a solution. And, in fact, it is a very good solution.

If you don't know it already, I'm going to make this as clear and succinct as possible: I loathe collectivism at all but the most local levels, and I'm not a big fan of it even there. So the idea of having to be identified by anything at the federal or state level, other than my name – like a Social Security number (for instance) – is absolutely abhorrent to me. Likewise, I think huge government programs are wasteful, foolish, and inefficient.

I know, I know. Some of you are frothing at the mouth, positively perfervid with the desire to sink your socialist fangs into my free market hide. All I can say is this: dissent if you like, but history has my back on this one, and I'm probably not going to engage you in some drawn out debate about how wonderful (for instance) Social Security is, and how it's not going to break our children. Mostly, I'm not going to argue the point because the dollar is going to fail long before Social Security has a chance to break our children, but that doesn't absolve the program from its complete inefficacy. And as for the dollar -- well, I'll resume my inexhaustible tirade about its impending failure soon enough. Don't you fret.

I'd like to preface my proposal by pointing out that there are several reasons healthcare is so expensive. First, at every available juncture, the government destroys competition in the industry as much as it can. Second, because so many people fail – or refuse – to obtain health insurance, the losses healthcare providers incur when the uninsured get sick have to be spread out among those who can pay. Third, subsidies and entitlements have inflated healthcare prices astronomically, because when the government gets involved in facilitating transactions, prices go up. If you don't believe me, take a look at the roles Fannie Mae and Freddie Mac played in creating easy money for unqualified homebuyers. Simply put, the government caused the housing bubble. Similarly, it is largely responsible for ever-increasing tuition costs. And yes, it is a major factor in the skyrocketing costs of healthcare.

I don't know how things are done in other states, but here in Texas, anyone seeking to renew his or her license plates, or trying to get a new driver license has to show proof of automobile insurance. It's the way the state makes sure everyone carries at least liability insurance on his or her vehicle, and it mostly works. So my question is this: why couldn't such a system be applied to the healthcare industry? I'm obviously not a fan of fat bureaucratic programs, but if the government has to get involved, why can it not play the role of forcing consumers to provide proof of health insurance as a prerequisite to buying goods and/or services that might not be considered… well … absolutely necessary.

Here is a short list of expenditures that might require the would-be consumer to procure such proof:

1. Budweiser. In any quantity.
   
2. Admission to strip clubs.
   
3. Spinners. (For those of you uninitiated, spinners are those absurd, excessively garish rims that continue to move even when a car is stationary.)
   
4. Pornography.
   
5. Body modifications of any sort, including -- but not limited to – tattoos, piercings, embedded fingernail art, hair extensions, liposuction, and nose jobs.
   
6. Southern Comfort.
   
7. Cable.
   
8. NFL, NBA, NASCAR, and NHL paraphernalia.
   
9. Guns.
   
10. Harleys.
    
11. Cigarettes.
    
12. Prostitutes.
    
13. Crocks.
    
14. Trunk woofers.
    
15. Anything made by Nike.
    
16. Small, purebred canines.
    
17. Any article of camouflage clothing.
    

 

Of course, there is one other possible solution to this whole mess. We could just sentence Bernie Madoff to reform healthcare. That seems fair.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco will be giving a workshop entitled The Death of the Dollar: How We Can Survive the Coming Collapse at the 21st annual Las Vegas Money Show, Mandalay Bay Resort, Tuesday, May 12, 2009, at 11:30 a.m. He hopes to see you there. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.DisciplineNovel.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

Some Austrians Aren’t Being Tough Enough

"A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them."

-- John C. Maxwell

The war between socialism and free market capitalism has been raging for almost 200 years – and far longer than that, if you toss aside those particular monikers and go straight to the ideological conflict that has pitted economic and financial entrepreneurs against collectivists since the dawn of human history. But never has the war been more pronounced – nor more critical – than in the current economic crisis in which the world finds itself mired.

For decades, proponents of the famed Austrian School of Economics – to which I proudly subscribe – have predicted that, as huge central governments, like the bloated United States federal bureaucracy, increase deficits and spending, attempting to control the economy, they will have to continuously find new and creative ways to manipulate debt and currency-creation in order to maintain the illusion. Indeed, many great economists have agreed that, even though the game can continue for a very long time – even decades or more – eventually the scheme will run out of resources, at which point the government will have to return to sound fiscal and monetary policy, or else print more money and destroy its currency, and by extension, the economy.

For many years all of this was largely based on theory; Keynesians and Fed proponents printed and spent with reckless abandon. And why shouldn't they? They had time and history on their sides. After all, didn't taxing and spending get us out of the Great Depression? Weren't World War II expenditures the catalysts for enormous economic growth thereafter? No, the Austrians absolutely had to be wrong, and even if they weren't, what self-serving politician in his right mind was going to ignore his "children" clamoring for someone – anyone -- to do something? That's no way to attract votes. Keynesian policies were jus t the panacea for any gloomy economy. Or so it would seem.

Unfortunately, Austrians were right – albeit patient: Government spending is not the solution. Oh, sure, it might work for a while – just like living off credit cards with no job might work for a while. But the government can only play these silly games for a time, until eventually the immutable economic law mandating that resources are indeed scarce will catch up to even the mightiest of empires. And so here we are – not just a single nation in peril, but an entire globe staring into the abyss, telling ourselves it can work again…if we only believe…

But it won't work again. With the recent addition of Fed's strategies, The U.S. government has now committed itself to $8.8 trillion in expenditures over the next two years. Some economists predict the number will actually easily exceed $10 trillion. In real terms, even a conservative appraisal still exceeds all of the major projects the U.S. has undertaken in its entire history, combined.

I'll say it again. We face two choices: we can suffer now and return to sound monetary and fiscal policy, or we can print money and inflate our problems away – postponing the suffering until a later date. Of course, if we do choose postponement, the suffering will be much more severe and much more difficult to endure. Yet the truth is we really don't have two options, because we live in a paternalistic democracy run by politicians who cannot possibly risk angering an irresponsible and undisciplined constituency, and therefore, a return to sound monetary and fiscal policy is about as likely as the sun burning out tomorrow. Sure, it could happen. But it's not going to. Thus, we arrive at the focal point of my article.

I have a confession to make. I used to be a socialist. I have read with breathless passion the dogma – from Marx to Proudhon, to Bakunin, to Chomsky. And while I have long since rejected all of it – having been persuaded initially and irreversibly by Mises' Economic Calculation Argument, and subsequently by so many others – I am luckier than most of my fellow free market advocates in that I truly know my enemy. But I have also spent a great deal of time reading and listening the proponents of free-market capitalism -- both classical and modern -- and I find myself convinced more than ever by the theoretical and practical maxims of the Austrians, that we are indeed on the verge of an economic and socio-political tragedy whose magnitude is almost unfathomable.

I find myself devouring anew the works of great minds like F.A. Hayek, David Boaz, Murray Rothbard, and David Friedman, reviewing the entreaties to reign in the federal government before it's too late. And too often these days, I lift my head and sigh, realizing the warnings no longer mean anything -- it's already too late. Beyond my resignation that it really is "different this time," and all the concomitant fear that comes with the acquiescence, I also find myself frustrated by some of the contemporary voices carrying the flag of free markets.

Case in point: Peter Schiff. Please don't misunderstand me – I have read everything I can get my hands on by Mr. Schiff, and I listen and watch his interviews with eager focus. Here is a man who, like me, predicted almost everything that is happening around us – in print, years before the fact -- and I have nothing but the deepest respect for his insight, born from deep Austrian roots. But time and again, when asked about the solution to the problem, Mr. Schiff launches into a brilliant effusion about eliminating debt, lowering taxes, soaking up excess currency, and raising interest rates. Again, it's not that I disagree with him, in that doing all these things would solve the problem. But my question is this: why on earth eat up valuable airtime discussing such moot points? The government isn't going to buy down debt. It isn't going to lower taxes. It isn't going to stop printing money. And it certainly isn't going to raise interest rates anytime soon. So are these really solutions?

Peter Schiff is a rock, and when he's under pressure on national television – taking heat from the likes of Ben Stein and Art Laffer – he exudes equanimity, and he sticks to his guns. He is an inspiration in this era of the super-status quo, driven by egalitarian-media propaganda that expects only the appropriate conditioned responses from anyone with makeup and a set of vocal chords. I admire Peter Schiff for his cool and his conviction, and I certainly don't know that I could maintain my composure in such environments. And yet, his "solutions" pack no real punch because they fail to reflect realistic outcomes in any kind of meaningful way. I am disappointed, because I think this is Mr. Schiff's only weakness.

Even Jim Rogers -- whose no-nonsense, blunt approach to the crisis has me nearly jumping out of my seat in applause – fails to present any viable strategy for the government. When a reporter asks what he would do if he were appointed Chairman of the Federal Reserve, he answers without hesitation: "I'd fire everyone. Then I'd resign." And in the midst of my laughter, I realize his strategy would be brilliant – if he were appointed Chairman of the Fed. Of course, he has about as much chance of getting that position as my 16-month-old daughter.

In my mind, the identification of the problems is now something for the history books: people like Peter Schiff and Jim Rogers – and their Austrian predecessors -- called it right, and with every passing day, they only get more right. But now is not the time to propose outlandish, unachievable strategies. We can't fix the mess the government has created over the last century; it has sealed its own fate, and the only thing we can do now is watch it unravel and collapse before us, as it delivers the final blows to our weakening currency.

But there are things we can do – realistic solutions that will become more viable as inflationary price-increases return with so much vengeance. We, as individuals, can move our assets away from the dollar, and other weakening currencies. We can invest in commodities and instruments that allow us to profit and thrive in the coming economic hurricane. We can also support politicians and business leaders who understand that we are on the cusp of a revolution not unlike the one that occurred over 200 years ago.

What will it look like? What will the outcome be? Who knows, but as with every revolution, the outcome will be extreme and radical. I, for one, would rather be a part of the new paradigm than a voice attempting to salvage the old one.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

Dow, Dollar, and Gold Parity: What Does It Mean for Value Investors?

 

Over the past year or so, I have been paying a lot of attention to the relationship between The Dow Jones Industrial Average and the price of an ounce of gold – which is commonly expressed by the Dow-to-gold ratio. On the surface, the ratio seems simple enough; if the Dow is at 10,000 and gold is at $1000 an ounce, the Dow/gold ratio is 10. Likewise, if the Dow is at 2000, and gold is at $2000 an ounce, the Dow/gold ratio is 1. But if you think about it, the relationship contains more than the two obvious components -- the DJIA and gold; the equation also employs component most people tend to overlook, which is the dollar. And once you consider the Dow/gold ratio from this perspective, the added dimension has all sorts of thought-provoking, and even frightening implications.

For an historical perspective, I've borrowed a chart of the Dow/gold ratio from a brilliant article by a talented analyst named Steve Saville, from December, 2008:

Before we delve further into the Dow/gold ratio -- and the somewhat concealed role the dollar plays in its formation -- I want to talk about the performance of the Dow, alone, over the last 80 years. Many analysts and economists have been comparing our current economic fiasco to the Great Depression, suggesting that this downturn may be as bad, or even worse than that period's. On that note, I want to point out that, in 1932, the DJIA bottomed after losing almost 90% of its value; as of the close of business on March 20, 2009, the Dow is down 49.5%. If the stock market is heading for a bottom similar to the 1930s crash, we have a long way to go; the Dow's high, in October of 2007, was around 14,150. If it loses 90% of its value, it will stand at a value of 1415. A lot of people believe that is precisely where the DJIA is headed, and philosophically, I agree. But, as with everything else in this terrifying time, nothing is as simple as it looks, and searching for an absolute value of 1415 on the DJIA could be a costly mistake.

In recent months, I've pointed out some fairly startling differences between this economy and the Great Depression. For starters, in the 1930s, the U.S. was a creditor nation; it essentially borrowed its way out of the Depression, and while I believe that was a mistake -- only prolonging the pain -- it was, nonetheless, one (very costly) solution. Unfortunately, the country's current status as the world's largest debtor nation precludes it from employing that strategy again – although Ben Bernanke, along with Barry Obama's economic toadies, would have all of us believe it can work. If you buy into that theory, however, I want to remind you that the government is printing money and easing credit at an unprecedented rate. Sure, the prices of most asset-classes are falling, but that's part of the solution, not part of the problem. The U.S. government, however, wants you to believe that the only cure to this disease, brought on by decades of inflationary money-printing and easy credit – which inevitably led to malinvestment, unprecedented economic volatility, and ultimately, several horrific economic collapses – is yet again to expand the money supply and to further ease credit until the U.S. consumer resumes his relentless and irresponsible plight to spend, rather than to save. I'm at a loss as to how anyone of a sound and rational mind can honestly believe that the solution to this type of economic catastrophe is yet more borrowing and spending. It's like saying the cure for heroin addiction is an overdose. It's preposterous.

Granted, I am a dyed-in-the-wool Austrian economist, and our definition of inflation is always the printing of money coupled with the creation of easy credit. Some of you are, of course, aching to extinguish my fire with a hose-full of Keynesian dogma, and to that I say, do your worst. But remember this: Keynesian theory – which its own author repudiated – has been around less than a century, but empires have been crushing themselves under the weight of their own reckless piles of printed money for eons. Bernanke claims he can tame rising prices when they return – and they will return, with a vengeance. But how on earth can he possibly believe he can control rising prices? How will he reel in the dollars he and his gaggle of sycophants are so capriciously printing? Will he sell Treasuries? To whom, and at what yields? Does he really think that he can simply offload trillions of dollars of debt to the world at constant low rates? If so, he's a fool; if he sells bonds, he's going to drive their prices down hard, and that can only mean increasing yields! How is that going to help "tame" rising prices?

Here are a few more differences between the 1930s and our current calamity: in the 1930s, the U.S. had a significant savings rate. Today that rate swings between negligible and negative. In the 1930s, the U.S. had a huge manufacturing base; it exported far more than it imported. Today, the U.S. is, for the most part, a service economy. Its automobile industry – once world's paradigm – is now crumbling under the weight of debt, bureaucracy, and union demands. Everything from computers to apparel is made by foreigners. Until recently, the U.S. consumer bought those manufactured goods with the money he or she borrowed from houses and credit cards – creating an economic house of cards. The house, however, has now imploded; the U.S. consumer is tapped out and cannot drive nearly 70% of the economy as it once did. And, to continue the comparison, in the 1930s, the U.S. dollar was backed by gold, which is no longer the case.

That brings me to perhaps the most important disparity between the Depression and our current situation. In the 1930s, because of all the factors I just mentioned, the United States found itself in a state of sustained falling prices. The government couldn't print money at will – it had to adhere to the gold standard to which it was obligated. Yes, the Great Depression was horrific, but at least prices fell, and continued to fall. Today, the vast sums of money the government is printing, coupled with the unprecedented easy credit it has put in place, ensure that falling prices are only a temporary phenomenon; indeed, the government is trying to create inflation! And as bad as the Great Depression was, I don't think any of us can imagine how much worse it would have been if the country had had to face 25% unemployment and rising prices. It's almost unthinkable.

Almost.

In the early 1930s, after the stock market hit its nadir, it rebounded to the tune of 150% in about a year. That would suggest that a savvy investor who gets in at or near the bottom of this bear could stand to make a fortune on the rebound. Is the stock market going to lose 90% of its value? I believe it will lose that much, or maybe even more. Does that mean a DJIA of 1415? Probably not.

Let's talk about the Dow/gold ratio again. If you look at the chart above, you can see that a ratio around 1 or 2 normally signals a bottoming of the Dow, as well as a top for gold. I say "normally" in the context of the last 80 years, in which the U.S. government has manipulated the economy and its currency successfully, time after time. Unfortunately, because of all the factors I mentioned earlier in the article – the country's status as the world's largest debtor nation, its status as a service economy, its savings rate, et cetera – the government has finally painted itself into a proverbial corner from which there is no escape. Skyrocketing prices are inevitable, which means – if you let thousands of years of history be your guide – gold is going much higher.

In nominal dollars, I do not believe the DJIA is going to lose 90% of its value, but in real terms, I believe it will probably lose considerably more than that. If we differentiate this economy from the 1930s in terms of the direction of prices, and we agree that, unlike the 1930s, rising prices are inevitable, then the Dow/gold ratio could approach 1 (or even go lower) even if the DJIA maintains its current level, or goes higher! In fact, if Bernanke is unable to "tame" rising prices caused by his inflationary mischief, it's very likely gold could surpass its real-dollar peak over $2000 in the early 1980s by a tremendous margin.

So, in the 1930s, because prices fell sustainably and continuously, the DJIA did lose 90% of its value, in real dollar terms. But if inflation causes explosive price increases this time, it's likely that, in real terms, the Dow will lose 90% or more of its value without actually falling much beyond current levels. And remember – the CPI is not the true measure of price-increases. Keep your eye on gold, as well as on things like gasoline, eggs, milk, and other agricultural products; these are the true measures of costs in our economy, and when those prices begin to increase rapidly, you will know Bernanke has failed.

As far as returning to stocks, well, my theory goes something like this: we need a way to calculate the real-dollar loss of value in the DJIA, as it relates to impending inflation, as measured by gold, and what better way to do that than the Dow/gold ratio? As bearish as I am on the U.S. economy right now, I still believe U.S. companies will be among the most innovative in the world once this all shakes out. To illustrate my point, consider some of the great German companies that survived world wars and the destruction of the Weimar mark: BMW, Bayer, and Daimler are among many more that withstood incomprehensible political and economic changes.

I am a value investor, and I believe earnings have a long way to fall before we're finished with this debacle. Nonetheless, I'll be watching the Dow/gold ratio carefully. Once it approaches 1 – whether that means a DJIA of 7000 or 700 -- I'll be looking at stocks very carefully.

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

And You Thought It Was Bad Before?

On top of the $8.5 trillion dollars the U.S. Federal Government has obligated itself to spend in the foreseeable future, now the Fed has also committed to spending another $300 billion to buy long-term Treasuries over the next 12 months. That's $300 billion. That's just under one-third of a trillion dollars. And where will the Fed get this money?

The pundits would have you believe that taxation is the only option to raise this vast sum of capital, but the reality of the situation is that unless these pundits are utterly incapable of doing basic arithmetic – which they aren't -- they are simply trying to scare you. And perhaps rightly so, because there is only one way the U.S. government can fund $8.8 trillion in spending, and taxation is only a small part of the "solution."

To illustrate the mathematics of what I'm talking about consider this: there are about 304 million people in the United States, which means that the government would have to extract $29,000 in tax revenue from every man, woman, and child to come up with such a staggering sum of money. Even if the government didn't spend one dime beyond the $8.8 trillion, and taxed everyone at the same rate, it would still have to extract $29,000 from every human being in the U.S. in order to cover the debt it is creating.

As an aside, I had to perform these calculations in a spreadsheet, because my BA II Plus wouldn't allow me to enter that many zeroes. And I still made a mistake, which a reader promptly pointed out. These numbers are hard to understand, much less work with, and that's what makes this so terrifying.

Over the years, I have collected a fairly impressive collection of skeptics, adversaries, and opponents who delight in criticizing my "radical" theories, and I'm sure that contingency will be out in droves to respond to this article. But before you naysayers get to firing on all eight cylinders – wearing the letters off your keyboards with furious strokes of merciless rebuttal -- I'm anxious for you to consider the cold, hard math I've just laid in your lap. Consider that a large portion of those citizens are retired, or children, or people otherwise incapable of or disallowed from working, and that $29,000 per person starts to get bigger very fast. How on earth can the U.S. government hope to squeeze that much money out of its citizenry? 

Of course, the question is rhetorical, and since this is my article, I'll just go ahead and answer it. The U.S. government plans to "deal" with this unprecedented load of debt through the inflationary destruction of the U.S. dollar. It cannot tax enough to service the debt, so it will print the money.

But there's a part of the equation that leaves me scratching my head and chuckling a little, in a wry, disturbed fashion -- sort of like the way I chuckle when I see a dog chasing its own tail – and it's this: the United States government will print all of this money, and then it will turn around and loan that money to itself. That would be like me taking a paycheck, having a lawyer draw up loan documents, signing the check over to myself, and making monthly payments back to me. Now why would I do something like that? Absurd.

Perhaps the most troubling aspect to the whole sordid mess, however, is something I've brought up before: Chinese and Japanese people are not stupid. They know the U.S. cannot hope to suck $29,000 out of each and every warm body within its reach and domain without creating massive inflation. So, yet again, I pose this question: why would the Chinese, the Japanese, or anyone else for that matter, continue to lend massive amounts of money to the U.S. government, at absurdly low rates, if the only possible outcome is steep inflationary price increases and interest rate explosions?

The simplest answer is usually the best answer. They won't. Unemployment will continue to rise, the American consumer will continue to falter, credit card defaults will race skyward, and the Fed will print insane amounts of cash. Foreign governments will get wise to the situation and stop lending, and the Fed will face rapidly rising prices while trying to keep interest rates low. But how will it attract capital if it doesn't increase yields? Oh the conundrum…

For my part, I predicted the Fed would finally buy the long-end of the yield curve – although I didn't think it would be this aggressive. Nonetheless, I lightened my short position in Treasuries significantly at the end of January. I believe the herd will follow Treasuries higher for a while, but sometime in the next 3 to 6 months, shorting Treasuries is again going to continue to be the position of the century.

The other day, I was watching CNBC's Smart Money, during which several of the network's elite pondered the "mystery" of gold's advance in tandem with stocks. They batted the question around like a beach ball for a minute or two before there was a pronounced silence. Then one of them tentatively said, "Could it be because people are scared that inflation is coming back?"

Do you think?

 

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

 

How Long Will It Take the Dollar to Fail?

"You cannot afford to wait for perfect conditions. Goal setting is often a matter of balancing timing against available resources. Opportunities are easily lost while waiting for perfect conditions."

-- Gary Ryan Blair

 

I have always made it a policy not to try to time markets, and while my outlook for the dollar is bleak, I don't feel comfortable making an exact prediction about its demise. Having said that, in December -- when the Fed implemented zero-interest-rate-policy and announced its intention to employ quantitative easing -- they galvanized my conviction that the dollar and Treasuries are doomed, and I started building a public case against the United States Government and its ability to sustain its decades-long policies of borrowing and printing. Nevertheless, when I predicted Treasuries would fall, I didn't expect the 30-year bond to gain more than 100 basis points in less than two months! But after that surprise, my time-horizon for the life of the dollar has shrunk considerably. I still think the Fed might try to defend the long end of the yield curve, but every single day, my faith in its ability to maintain low yields wanes, and I increasingly believe things are going to unwind sooner rather than later.

I am not an alarmist, and I used to roll my eyes at people who talked about burying guns, potable water, and canned food in the backyard. But if hyper-inflationary price increases are coming – and I certainly believe they are – buying durable goods now is not only smart, it's necessary. Anything that lasts and provides future utility is going to be a good investment, and if I have a choice of buying a can of beans now for 89 cents, or five years from now for $12, well, it doesn't exactly require a financial calculator to establish how good that rate of return is – even if the things I buy merely keep pace with rising prices as a whole.

A lot of people will call me an alarmist for my previous statement, but it really just boils down to the same questions I've been asking for weeks now: do you believe the United States can continue to borrow at the same pace it has for decades? Do you believe the number of dollars in the system, along with the unprecedented easy credit the Fed is creating, won't lead to runaway price increases? For me it's like Pascal's wager: If I'm wrong, I can always eat canned goods later -- laughing at my miscalculation a little harder with each subsequent forkful of tuna. But if I'm right, my family may be able to weather an extremely nasty storm in relative comfort.

Another thing to remember – something I pointed out in a recent article – is that it is far more important to look at the dollar versus commodities than it is to look at the dollar versus other currencies. Quarter-hour updates on financial news networks discuss the "strength" or "weakness" of the dollar, but this metric is misleading; it is a measure of the dollar against a basket of other currencies, not against commodities. And even the government's gauges of the dollar's efficacy – like CPI – are so misleading and vague that I just don't trust them. In any case, it may be that, as prices begin to rise against the dollar, they may also be rising against other major currencies, and the dollar could show relative strength against those currencies – if it is not falling as fast. Still, copious printing and easy credit will cause prices to rise, and any other assessment of dollar "strength" will be an illusion. In other words, when you're trying to ascertain the value of your currency, don't measure it against the yen, measure it against milk and eggs at your grocery store.

Every presidential administration in the 20^th century conspired – wittingly or not -- to destroy our currency. It has been like a subtle cancer – not readily apparent on the outside, but slowly eating away at the body from within. Now, at the zenith of this crisis, just when the government should be tightening credit, strengthening the currency, encouraging saving, cutting taxes, and reducing spending, the Obama Administration is doing just the opposite: it is taxing precious capital, along with the most productive and innovative members of our economy – thereby redistributing wealth to the least productive and innovative members of our economy. It is increasing spending to the tune of $8.5 trillion over the next two years, while encouraging unprecedented printing and easy credit. Our government is relying on the continued generosity of our lenders, namely China and Japan, but I have made cogent arguments that those countries are not likely to continue to support our voracious and insatiable appetite for new capital at current yields – especially capital that will be allocated and invested poorly.

I have said this before, but it warrants repeating: we were a creditor nation in the 1930s, with a massive manufacturing base. Not that I think it was the correct solution, but we borrowed our way out of the Great Depression. Today we are the largest debtor nation on earth, with a relatively small manufacturing base. Jim Rogers claims to be the worst market-timer on earth, and I disagree with him only in that he can't be worse than me. As such, I can't tell you exactly what day the dollar will collapse – or if it will even be that sudden. But one thing is for sure: the cancer has metastasized, and there is no hope of recovery; my instinct tells me that the sheer lack of vision, coupled with the absence of any substantive acumen in Washington is going to ensure that the failure comes sooner, rather than later.

 

Disclosures: Paco is long gold, UGL, DXO, and TBT. He has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. If you have questions or thoughts, leave a comment or write to Paco at questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.

How Treasuries and ETFs Work

I have become so comfortable writing about Treasuries and the dollar recently, I have forgotten that not everyone is as intimate as I am with some of the terms and abstract thoughts I use. In the last week, however, I've been inundated by requests from people asking me to explain some of these concepts in more detail, so I have decided to periodically highlight questions from readers and try to expand on that particular idea. If you would like me to clarify something, please don't hesitate to leave a comment, or write to me at questions@pacoahlgren.com.

A few days ago, a reader contacted me regarding TBT -- which is the ProShares Ultra short long-term Treasuries EFT. Michael asks:

"How come the TBT is only up 22% YTD, while the 30-Year Bond's Yield has increased 31%? Moreover, ProFunds has a Mutual Fund (RRPIX) that is supposed to be 1.25X leveraged to the 30-Year, and that Fund is only up 18%!"

This is a fairly common problem people have when analyzing exchange traded funds – especially those that are leveraged like TBT. And while this particular conundrum can entail some complex math, I'm going to try to offer a simple, general explanation.

Before we get started, it's important to note that bond prices move inversely to bond yields – that is to say, when bond prices go up, their yields go down, and vice versa. Most confusion stems from the fact that change in yield does not correspond exactly to change in price. Here's something from an article at leftbusinessobserver.com that illustrates my point:

"Say the U.S. government sells Treasury bonds when prevailing market interest rates are 8%. So, a bond with a face value of $1,000 on issue would pay $80 a year in interest - usually in two half-yearly installments of $40. But if market interest rates were to rise to 10%, then who would want to buy such a bond? So, the market price of the bond would have to fall to a level where that fixed $80 annual payment were the equivalent of a 10% annual yield - in this case, the price would have to fall to $800, so that the annual $80 payment would equal 10% of the purchase price of the bond. (Obviously, this matters only if the holder of the bond wants to sell it in the open market; if he or she wants to keep the bond to maturity, the price fluctuations exist only on paper.) Since bond prices are usually expressed at a percent of face (or "par") value, the price of the bond would be quoted at 80."

In this example, the bond's yield increased 25%, but the bond's price fell only 20% -- due to the fact that correlation between yield and price movements isn't absolute. If you look at it from that perspective and you're willing to do a little research, you should be able to figure out the way it works. Here's a page at learningmarkets.com that teaches how to calculate a bond's yield, given various inputs. That should be a good place to start!

Another thing you need to remember is that TBT is designed to approximate, inversely, the changes in prices (not yields) of longer-term Treasuries -- with maturities of 20 years or more. Also remember that the change in TBT is designed to achieve twice that of the change in the underlying bonds – again, inversely. If you take the time to calculate an average price-change of long-term Treasuries over a given period, and you compare that average to the inverse price-change of TBT (multiplied by two), they should roughly mimic each other.

There are other considerations: changes in the publicly-traded market price of TBT (or any ETF) differ slightly from in-house, managed changes in the securities' net asset value (NAV) -- although the two prices do move very closely. In order to maintain an appropriate NAV, however, ProShares must react to changes in markets and manually maintain their positions. In other words, the change in NAV isn't automatic, and while the managers undoubtedly try to mimic their targets as accurately as possible, none of this is an exact science. Finally, don't forget that ProShares charges a management fee.

I hope this helps!

 

Disclosures: Paco is long gold, DXO, and UCD. He holds no TBT. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. If you have any thoughts or questions, please leave a comment or write to Paco at questions@pacoahlgren.com. While he can't guarantee he'll get back to everyone, he will do his best! Copyright 2009, Paco Ahlgren. All Rights Reserved.

Voting and Spending Our Way Into the Fiery Depths of Hell

"A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine."

-- Thomas Jefferson

 

"Democracy consists of choosing your dictators after they've told you what you think it is you want to hear"

-- Alan Coren

 

Lately, I've been predicting some pretty catastrophic stuff – like the United States defaulting on its debt, and the failure of the world's major currencies. And every day that passes seems to bring us closer to the inevitability of those predictions.

None of this makes me happy, by the way; I would really like to be wrong this time.

At any rate, I have received a great deal of gratitude and praise for my theories, but I have also been inundated with comments like, "You're stupid," and "You're immature," and "No way," and "Gold is bad," and "Go back to Russia." And things like that. Which is all fine, I guess.

Look, I've been writing for a long time, and yes I think it's reasonably safe to say that some of my theories are radical. And, of course, if a person decides to promote radical theories, he better be ready to absorb some heat for it. Luckily, over the years I've pretty well inured myself to the barrage of criticism that descends upon me like a swarm of ravenous mosquitoes every time I publish something, and I guess I owe my proverbial calluses to a simple maxim: popular people get elected because they regurgitate the status quo, whereas dissenters get ridiculed because they challenge it. Now, does this mean dissenters are always right? Of course not, but I'm hard-pressed to think of one technological, medical, social, or academic innovation inspired or created by mere popularity. And I find it equally difficult to count the number of breakthroughs that have erupted from the minds of dissidents.

"But," you say, raising your eyebrows and sticking your finger in the air. "Einstein was popular." And that's true. But it doesn't diminish the veracity of my conclusion; popularity is rarely an ingredient in progress, and even then, it's not causal. I would wager that Einstein's popularity (or lack thereof at the time) didn't inspire his special theory of relativity.

Every day, I watch Barak Obama speak and I find myself as impressed with his style and eloquence as everyone else seems to be. But then I hear the "substance" of his messages and I cringe. For hundreds of years, classical economists have been trying to save us from ourselves, warning us that -- regardless of their intentions -- governments don't solve problems, they create them. So why do political leaders keep making such bad decisions? And more importantly, why do we keep putting so much faith in our elected officials?

It's simple, really. Most people make poor decisions, because most people are like children. Allow me to illustrate my point by asking you a simple question: which is better for the human body – broccoli or ice cream? Now, if we put 1000 children in a cafeteria, and we give each of them one bowl filled with broccoli, and another bowl filled with ice cream, what do you think is going to happen? And what if we perform the same experiment every day for a year? Would the results differ? Probably not.

Now let's talk about some common behavior exhibited by "adults." Adults smoke. They drink too much. They abuse drugs. They don't educate themselves. They play video games all day. They talk on their cell phones while driving. They spend incomprehensible amounts of time, money, and energy watching pornography. Yes, adults do lots of stupid and unproductive things.

I'm in quite an analogous mood right now, so I wonder if you might indulge me as I offer yet another hypothetical. Let's say the economy is suffering one of the worst recessions in a century. And let's say you're a dyed-in-the-wool free market economist with an I.Q. upward of 160. Let's also say you want to be elected to the office of President of the United States. Are you going to tell people that, in order to get out of the recession, the government must do nothing? Are you going to tell people that it's better for the government not to print money? Are you going to tell people it's better for the government to reduce its debt? Of course you're not – at least not if you actually want to get elected. Why? Because people want ice cream, not broccoli.

If you want to be a politician, you must lie. You must promise the people that the government will do something – even if you know that anything the government does will only cause more damage. For the last century, this is precisely the recipe that has caused policy maker after policy maker to implement programs that have damaged economies and currencies time and again. And the resultant peaks and troughs are neither purely cyclical, range-bound, nor predictable. Debt has increased exponentially. Productivity has collapsed. The charade has been maintained through burgeoning easy credit and an ever-expanding amount of currency. The economy is a top, forced to spin faster and faster by politicians eager to be elected, but eventually the laws of physics are going to tear the entire thing apart. The conditions we face are unprecedented on so many levels, and I am afraid the catastrophe is looming.

I certainly welcome any criticism I get, because approaching the truth is far more important to me than defending a broken theory. Yes, I want to be wrong, but more importantly, I want to know why I'm wrong. And yet I fear I am not, because the old rules aren't working anymore, and most of the counterarguments fail to provide much substance.

So I will continue to dissent, because it is a dangerous time to be an empiricist.

 

Disclosures: Paco is long gold, DXO, and UCD. He's getting excited about the recent rise in Treasuries, but he hasn't acted on that excitement yet. Paco has been a financial analyst and a portfolio manager for 18 years. You can buy his novel Discipline wherever books are sold. Or visit www.disciplinebook.com. Email your questions or comments to questions@pacoahlgren.com. Copyright 2009, Paco Ahlgren. All Rights Reserved.