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Sometimes when I get an idea about something to post, I find that someone has said it infinitely better than I could.

This is one of those times.  Read this from Ron Paul – which I copied from a DailyReckoning.com email unashamedly because they took it from Paul’s website.  There’s a link to it at the bottom of the post.  (I voted for Dr. Paul, but not enough others did.  Just think about how great it would be if we had elected him!)

Enjoy!

gk

IN GOVERNMENT WE TRUST? (PARTS 1, 2 AND 3)
By Congressman Ron Paul

Many who agree with me on a lot of other issues, do not understand my enthusiasm for gold and sound money or why I spend so much time studying and talking about monetary policy. It’s true that I talk about money differently than most, but the fact is sound money offers many benefits. For example – peace.

Can sound money really bring about peace? Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade. History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.

Sound money, on the other hand, simply is what it is. Removing governmental power to manipulate money, removes the temptation for government to spend, print and cheat. Sound money ensures that our government’s spending priorities would be brought into sharp focus and reduced to only what we can afford.

Sound money also limits the ability to wage wars of aggression. Imagine how much more careful Washington would have to be about starting a war if they did not have this financial sleight of hand at their disposal! Fiat currency allows government do expensive things they should not be doing while paying the bills with cheap money. The Federal Reserve has lately been auctioning off large amounts of treasury bills as a way to finance the wars in Iraq and Afghanistan, and our crushing entitlement burden. The resulting devaluation of the dollar is quickly eroding our image as a good trading partner in the world. As a consequence, there is therefore more talk of economic isolation and war.

This vicious cycle of spending, fighting and inflating is not what Americans want. It is what the government wants, and it has had to deceive the citizens into allowing and supporting it. Sound money curbs the government’s ability to engage in these shenanigans and reduces the wars we fight to only truly defensive ones, for which Americans are more than willing to stand and fight. So in these ways, sound money is very conducive to peace.

Another benefit of sound money is financial security.

Can sound money give you financial security? There is something very comforting in knowing that what you earn today will retain its purchasing power in the years to come. Indeed, the same silver dime that bought a loaf of bread in the 1960’s can still buy a loaf of bread with its precious metal content – which is worth about $1.00 today. An ounce of gold has always been about evenly exchangeable for a finely tailored men’s suit, which these days is roughly $800. And in these days of fluctuating gas prices, when priced in gold, oil has been stable. Meanwhile, since the creation of the Federal Reserve, the fiat dollar has lost 94 percent of its purchasing power. The erosion of purchasing power rapidly accelerated when it was completely uncoupled from gold in 1971. This sort of fluctuation in the medium of exchange creates a lot of uncertainty in the marketplace and necessitates that you either take extraordinary defensive maneuvers, or face financial ruin. Trusting in government for financial security in retirement is not a safe option. Indeed, a recent study by the Consumer Bankruptcy Project shows that bankruptcies among those 75 and older has more than quadrupled since 1991. This represents wealth and savings that have been eroded by inflation, and trust in entitlement promises that were more fantasy than reality. Even with the pittance that social security pays to seniors, it is bankrupt and bringing the economy to its knees. It is no wonder that many in the younger generations want no part of it, and they should not be forced into a failed system.

On the other hand, holding physical gold can defend against aggressive government monetary policies that threaten to inflate away the value of your life savings. During the hyperinflation in post WWI Germany, what used to be a comfortable nest egg was suddenly the value of a postage stamp. If one held just a portion of their savings in precious metals, the crisis was greatly softened. Gold will never be worth nothing, even if the exact price fluctuates. There is a famous photograph, however, of a German woman during this time period burning piles of tightly bound banknotes to keep warm.

Imagine if the money you earned had honest, stable value, or even appreciated like an investment! No such special measures, like converting dollars to gold, would be required to ensure that your savings would sustain you in your golden years. That is the way it could be and is supposed to be. However, the government’s thirst for power will not be easily, or cheaply, quenched. Fiat currency is one tool governments have to extract wealth quietly from the working class. It is time for the people to wake up to this ruse and look to the Constitution to restore sound currency.

Sound money keeps government spending in check, keeps trade fair and honest, which reduces the temptations, and many underlying causes, for governments to wage wars. It also gives you the peace of mind of knowing that your savings will be able to sustain you in your retirement.

So if sound money is such a good thing, what is stopping people from simply trading with each other in gold and silver? Why are you still being paid in fiat dollars, and why can’t you pay for gas in gold? The answer is that the government has enacted policies that provide considerable stumbling blocks to such transactions.

One of the main stumbling blocks is Federal legal tender laws, which state that government-controlled fiat currency MUST be accepted for many kinds of monetary transactions. In light of this, Gresham’s Law takes effect. Gresham’s Law states that bad money drives out good money. Meaning, if someone is forced to accept your bad money, it is to your advantage to pass it off, like a hot potato, in exchange for something of value. Any good money you have, you will hoard. Eventually, real money is driven out of circulation and under people’s mattresses, so to speak. In the absence of legal tender laws, people are free to accept the medium of exchange of their choice, and are likely to insist on payment in something of real value.

Related to legal tender laws, contracts in gold are not enforced. Meaning if two parties agree to exchange goods or services for gold, and end up in a dispute, the courts will simply settle the dispute in Federal Reserve notes. While gold clauses have been legally enforceable since the late 1970’s the fact remains that disputes over gold clauses might well be resolved in court with a dollar figure calculated in terms of Federal Reserve Notes. In the recently decided case of 216 Jamaica Ave v. S&R Playhouse, which reversed a district court decision, the court upheld the enforceability of a gold clause, but sent the case back to the district court to decide what obligations the gold clause imposed on the defendant. It is not inconceivable that this will result in a decision that the value of the “gold coin” referred to could be valued by the court in terms of Federal Reserve Notes, not in terms of ounces of gold. Furthermore, given the federal government’s actions against Robert Kahre (the Nevada businessman who paid his employees at the legal tender face value of gold bullion coins) it is obvious that the government is still waging a war on gold. Whether either of these cases establishes a precedent remains to be seen. Additionally, because 31 USC 5103 establishes Federal Reserve Notes as legal tender, it would likely take a court challenge to determine whether a gold clause or legal tender law takes precedence.

Governments should do very little, in my estimation, but it should enforce contracts and property rights through the courts. But in this instance it shirks this basic duty, when it comes to gold, as one way to keep control of our economy and the medium of exchange. One is also expected to pay sales tax on the purchase of gold. This is as ludicrous as if you paid sales tax at the bank when you converted dollars into quarters! The IRS also expects you to pay capital gains tax on gold, which is so backwards, since gains on gold really represent decline in the value of the dollar!

Legal tender laws should be repealed at the Federal level. Congress has the Constitutional duty to protect the integrity of our money. However, since it has passed this duty off, and the Federal Reserve has only debased our currency, Congress should no longer force Americans to do business in dollars if they would prefer to transact in gold, or silver, or cigarettes or seashells, for that matter. Free people should be free to associate and do business in ways that benefit them. Instead they are forced to use the unstable dollar to their own detriment, and the benefit the government.

Regards,

Ron Paul
for The Daily Reckoning

Editor’s Note: The above was reprinted from Congressman Paul’s weekly column, “Texas Straight Talk”. You can find this, and more, here.

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Great article in today’s Daily Reckoning by Bill Bonner entitled “Hoorah for Capitalism!”

Bill has a unique rambling style, and he ties it all together at the end.  Here are some choice bits from the article.

‘Capitalism has failed,’ they say. ‘We need government to fix the problems…’ The rich hate capitalism because it threatens to take away their money. The poor hate it because they think it keeps them from getting any money in the first place. And everywhere you look, the chiselers are offering bailouts, boondoggles and bamboozles. With so many people trying to improve on capitalism, it’s a wonder they’ve never come up with something better.

“Think about it this way,” says Ms. Moyo, “China has 1.3 billion people, only 300 million of whom live like us, if you will, with Western living standards. There are a billion Chinese who are living in substandard conditions. Do you know anybody who feels sorry for China? Nobody. Forty years ago, China was poorer than many African countries. Yes, they have money today, but where did that money come from?”

It didn’t come from bailouts, she points out. And it didn’t come from anti-capitalist claptrap-babbling demagogues. Russia, too, prospered only after it sent the Bolsheviks packing. Gorbachev introduced his perestroika program in June ’87.

In the control group, meanwhile, Americans made their own anti-capitalist mistakes. The central bank lent money at artificially low rates – distorting the value of all capital assets. Tax policies, government-backed lenders, and government’s banking regulations stimulated the housing bubble. And the use of the dollar as an international reserve currency created what was effectively an all-night party with an open bar. Instead of having to settle up in gold, as they did up until 1971, the U.S. could pay its bills by emitting more pieces of green paper. Then, local economies had to put out great quantities of their own paper money just to keep up. This liquidity created a series of bubbles…leading up to the great bubble in finance and housing that blew up ’07-’08…

“Today, it’s America that must have a perestroika,” says ex-Soviet boss Michail Gorbachev. “You don’t have to be a Nobel Prize-winning economist to understand that it’s not normal that the country with 20% of the world’s GDP consumes 40% of the world’s resources.”

Yes, Gorbachev is right about a number of things. The western, capitalist economies are in the midst of their own perestroika. They are being restructured. But not by the world-improvers. Instead, they are being restructured by capitalism itself… Leave capitalism alone and it will do the job far faster and far better than the meddlers could ever do.

I mentioned this the other day when I posted Less than nothing.  Get the government out of the economy and things work out just fine.  Entrepreneurs find a niche and create wealth, investors find productive uses for their surplus production (capital), and dumb people lose money – and blame everyone but themselves.

gk

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I saw this article today on CNN and had to save the link so I could comment on it tonight when I had time.  The headline reads Why saving is killing the economy.

To put it bluntly, this is one of the most inane, ignorant, and generally stupid stories I’ve read in quite some time.  The author evidently doesn’t quite get the concept that Capitalism requires capital – otherwise it’s just “ism” and that makes no sense at all. 

The savings rate, as calculated by the Commerce Department, hit 3.6% in December, or the equivalent of $36 for every $1,000 of after-tax income.

That’s up from 0.8% in August, or only $8 of every $1,000 of income. And since the average income for Americans is flat to slightly down during the past few months, the only way the savings rate can rise is for spending to fall.

“That’s a lot of spending that’s not happening,” said Mark Zandi, chief economist for Moody’s Economy.com. He said the jump in the savings rate since last summer is “the difference between an economy that is growing and one that is struggling mightily.”

Bullshit.

The definition of “savings” that they use is so broad that you could easily declare bankruptcy even though you may be “saving” 75% of your income each and every month!  No, I’m not kidding.  Here’s another quote from the story.

The government calculates savings by totaling up after-tax income and subtracting spending. The remainder is considered savings by the government even if consumers are using the leftover money for investing or paying down debt instead of saving it in a bank.

See what I mean?  They are calculating the official savings rate in such a way that every single dime you pay on a credit card bill is counted as savings.

Did you make a $400 car payment last month?  Whoo hoo – you saved money!  Did you make a $1200 mortgage payment?  Cha-ching!  More savings!  Did you pay Vinnie some of that money you borrowed from him at 8,726% interest?  You are saving waaay too much money dude – and Mark Zandi with Moody’s says you’re causing the economy to struggle mightily.

I have no explanation other than Mark Zandi is a total moron.

(Added 2/13/09 – As “Dufus” pointed out in a comment below, when they say “paying down debt” they are most likely referring to the interest portion of a debt payment and not the entire payment.  “Dufus” may be correct (I doubt it) but the story makes no mention of it.  I won’t infer a meaning that the story doesn’t mention.  Either way, it’s not “savings”.  To make this clear, if interest payments you make were a form of “savings”, you’d want the highest interest rate on any loans and credit cards you used – not the lowest.  That way you’d spend more on interest and you’d “save” more money.  I’m not buying it.)

I’m guessing that he’s the kind of economist who thinks that when he buys a 50 inch flat screen plasma TV for $900 at a 50% off sale, he just saved $900.  Idiot – he just SPENT $900, but he walks around bragging to his economist buddies that he saved a shitload of money.

These are the kinds of people that our government is taking advice from on how to “stimulate” the economy.  Do you wonder why we’re going to hell in a handbasket?

Hopefully, most readers of this will understand that the above “savings” are false.  If not, I don’t think I can help you.  Please go back and retake 1st grade math.  Simple addition and subtraction are all that’s required here, no “higher” math like multiplication or division is needed.

Ok, I’ve had fun with the misnamed “savings rate” but I haven’t addressed why these morons think savings is bad for the economy – and why they’re 100% wrong.  Here goes.

When you pay on a debt, you’re simply paying back the person (or institution) who loaned you the original money to buy that thing you didn’t have enough savings to buy at the time.  How did they get the money?  Someone had savings – otherwise known as capital – that they were willing to risk hoping that they would make money on their investment.

They didn’t spend it, they saved it.  Investment is also a proper term to use for this capital.

You borrowed it.  You spent money you didn’t have in order to get that widget today instead of waiting until you had enough of your own money. You spent someone else’s savings.  When you pay them back, you aren’t saving anything, you’re simply replenishing someone else’s savings.

But take it one step further – what are savings anyway?  In it’s simplest form, savings are the results of production that aren’t consumed immediately.

Here’s an example.  If I plant a garden and grow enough food to feed myself and to continue live, I haven’t saved anything.  I’ve consumed everything I produced and there’s a net gain of zero.  Much of the world lives like this on a daily basis.  They consume everything they produce and there’s nothing left over.  No savings.  Nothing to live on during the winter or dry season.

Now suppose I get to be really good at gardening.  I specialize in growing (for example) corn and potatoes.  I get so good at it that I produce double the food that I need to live.  Half of my crop each year is “extra” because I don’t need it immediately.  If I put it in a shelter for storage, I’ve saved it.  Real savings.  Something I can point at and say “I made it, that’s mine.”

Now what happens when winter or the dry season comes?  I continue to live while those who didn’t have savings die.  Brutal, but effective.  (And especially relevant on Darwin’s 200th birthday, but that’s a different story.)

Let’s say I still have corn and taters left over when my next harvest comes in.  What do I do with it?  I don’t need it to live.  It’s still my savings.  Hey!  What if I loan it out those idiots who aren’t as productive as I am?  What if I allow them to use it in return for them giving me something I want in return?  Maybe they get a bumper crop of oranges next year and I could sure use some citrus to add variety to my diet….  Or maybe I take their daughter in exchange. 

It doesn’t really matter what I exchange my saved corn and potatoes for – because I just invented Capitalism!

Please note how this happened:

1. I had produced more than I consumed (savings/capital)
2. I traded my excess production (savings/capital) for your excess production
3. We both live better than either of us did before – via free trade

There’s a more important concept coming.  I promise.  Bear with me.

The problem with the scenario above is that all of the excess production is perishable.  What happens if my potatoes or your oranges spoil?  In that case, we haven’t actually gained anything, and we’re right back where we started.

Hmmm…  What if we come up with something that doesn’t spoil that we both agree to take in trade as a token of our excess production?  It needs to relatively rare so everyone doesn’t get it and pretend they’ve produced more than they’ve consumed, and it needs to be easily transportable.  Cattle would work – but they can die and cause me to lose my excess produce just as if my potatoes had rotted.  How about gold?

That’s it!  We both agree that a set amount of gold is worth a certain amount of excess production.  I can give you my excess potatoes and corn for a few shiny pieces of non-perishable metal.  And you’ll take pieces of gold in exchange for your excess production of oranges when I want some variety in my diet.

We just invented money – actually a stable currency that we can exchange at any time for food – or for any other goods or services.  I don’t get any gold until I’ve produced more than I’ve consumed, and neither do you.  After all, you have to have something to trade, and you can’t trade if you haven’t yet produced anything.

Here’s that important concept I was talking about.  What are we actually trading?  Is it simply gold?  No, it’s our excess production/savings/capital.  Gold simply makes the transaction easier.

Now what happens if I have potatoes and you want/need them to survive the winter, but you haven’t yet produced anything that I want or need?  You don’t have any oranges/gold, because you haven’t produced anything in excess of what you’ve consumed.

There are only two possible outcomes here.

1. I keep the potatoes/gold and let you starve
2. I give you the potatoes/gold based on your promise to pay me back (with some interest for the risk I’m taking)

Hey!  Look at me!  I just became a fat greedy capitalist pig!

I actually just kept you alive and you should be breaking your back bending over to thank me for saving your worthless life, but because you’re in debt to me, you resent my wealth and hate my guts.  Sound familiar?

What’s actually happened is that I now have a claim on your future production.  You can no longer keep everything you produce, because you need to pay me back because I worked my ass off while you didn’t produce enough to feed yourself.  Stop sitting on your ass and bitching and go out and produce something!

Here’s an even more important concept that Mr. Zandi will never grasp.  It’s often said that “time is money” because time that you spend sitting around doing nothing is wasted time that you could be using to produce something of value.  But the reality is – wait for it – “money is time.”

Money is time because money represents the “stuff” I’ve produced in excess of what I consumed.  Because of my “excess” production, I have “time to spend” because I can use the money I’ve saved (from my excess production) to sustain me while I do other things.  Maybe I sit around and do nothing while using up my savings.  If so, I’ve gained nothing in the end.

But maybe I continue to produce more than I consume, and I continue to loan my excess production to others who haven’t yet produced enough to support the lifestyle they’ve chosen.  I’m investing my excess production in you in the hope that you’ll eventually produce some excess of your own and pay me back.

Do you get it yet Mr. Zandi?  You cannot have capitalism without capital.  And capital is simply another term for savings.  And savings is simply another term for excess production – it’s stuff I’ve produced in excess of what I need to live.

And you aren’t saving a damn thing if you’re simply paying me back.  Especially if you’re paying me back with oranges you borrowed from someone else because your crop failed again because you’re an idiot who doesn’t know how much water an orange tree needs to thrive.  Or you borrowed gold from your brother to pay me back.  Neither one is saving.  Or investing.

There’s a lot more to this story, but it’s now after midnight and I have to get up and produce something of value tomorrow so I can contribute to the savings rate.

Money is time Mr. Zandi.  When I’ve produced and saved enough money, I can spend my time doing other things besides work.  But I’m not at that point yet, because throughout most of my life I’ve tended to consume just about as much as I’ve produced.  It doesn’t help that the advice you’re spewing consists of a claim on part of my future production via taxes – it just means I need to produce more to make ends meet.

You can call my mortgage payment savings if you wish – but I know better.

gk

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Ron Paul knows economics.  He knows how the free market system is supposed to work.  I say “supposed to” because we haven’t had a free market system in the US for almost 100 years.

And yet people say the dumbest things, like “this proves the free market system doesn’t work without regulation” and “we need more regulation of the banks” like they have a clue what they’re talking about.

Yes, this rant has a point.  I’ll get there.

As a country, we have now spent over $3 trillion on bailing out idiots – both individual and corporate – with absolutely nothing to show for it.  Now Obama is saying that any delay in passing his almost $900,000,000,000 bailout plan is “inexcusable and irresponsible“.

Please look at the balloon tags on the right of this web page.  By far the largest (which shows that it’s been used more than any other tag) is “Bush is an idiot”.  I’ve made dozens of posts where I detail why Bush sucked as President.  I wanted to mention that before I get flamed by Obamaniacs saying that I’m a pissed off Republican.

I’m not.  I’m a pissed off US Citizen who can’t believe that this is the path that people of our country want to go down.  I wonder whatever happened to individual responsibility.  I wonder whatever happened to the free market economy.  I wonder if we can ever eliminate the thousands of areas of government interference in our daily lives.  I wonder if we can ever again have a federal government that governs within the rules set forth in the Constitution – no more, no less.

I wonder all this because I happened upon the text of a speech tonight.  It’s a speech that Ron Paul made on the floor of the US House of Representatives on February 3rd, just 3 short days ago.  None of it is new – Dr. Paul has been talking about it for years – but I think it speaks to the problems we are facing today (Feb 6th, 2009) better than any blatant pandering by Obama or the Republicans.

His speech is available online here, but I’m going to quote it in it’s entirety because it’s part of the public record, and I support what he says 100%.   I fear that it’ll be a cold day in hell before anything Ron Paul proposes is adopted into law, but who knows – maybe one day the people of this country will wake up and demand a real solution – not simply rhectoric and irresponsible spending.

Here’s the speech.  Enjoy!

gk

Statement of Congressman Ron Paul

United States House of Representatives

Statement on Federal Reserve Board Abolition Act February 3, 2009

Madame Speaker, I rise to introduce legislation to restore financial stability to America’s economy by abolishing the Federal Reserve. Since the creation of the Federal Reserve, middle and working-class Americans have been victimized by a boom-and-bust monetary policy. In addition, most Americans have suffered a steadily eroding purchasing power because of the Federal Reserve’s inflationary policies. This represents a real, if hidden, tax imposed on the American people.

From the Great Depression, to the stagflation of the seventies, to the current economic crisis caused by the housing bubble, every economic downturn suffered by this country over the past century can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial “boom” followed by a recession or depression when the Fed-created bubble bursts.

With a stable currency, American exporters will no longer be held hostage to an erratic monetary policy. Stabilizing the currency will also give Americans new incentives to save as they will no longer have to fear inflation eroding their savings. Those members concerned about increasing America’s exports or the low rate of savings should be enthusiastic supporters of this legislation.

Though the Federal Reserve policy harms the average American, it benefits those in a position to take advantage of the cycles in monetary policy. The main beneficiaries are those who receive access to artificially inflated money and/or credit before the inflationary effects of the policy impact the entire economy. Federal Reserve policies also benefit big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state. It is time for Congress to put the interests of the American people ahead of special interests and their own appetite for big government.

Abolishing the Federal Reserve will allow Congress to reassert its constitutional authority over monetary policy. The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy.

In fact, Congress’ constitutional mandate regarding monetary policy should only permit currency backed by stable commodities such as silver and gold to be used as legal tender. Therefore, abolishing the Federal Reserve and returning to a constitutional system will enable America to return to the type of monetary system envisioned by our nation’s founders: one where the value of money is consistent because it is tied to a commodity such as gold. Such a monetary system is the basis of a true freemarket economy.

In conclusion, Mr. Speaker, I urge my colleagues to stand up for working Americans by putting an end to the manipulation of the money supply which erodes Americans’ standard of living, enlarges big government, and enriches well-connected elites, by cosponsoring my legislation to abolish the Federal Reserve.

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Last January I was beginning to get tired of reading stuff like “kitchen sink quarter” and “this is a great time to buy real estate” and “this is the time to buy stocks”.  One evening I happened to read a post by Doug Kass entitled “Buy the Financials. Yes, Buy” in which he made a case that it was a good time to buy the financials using XLF as a proxy.

You can read my original post here, and Doug Kass’ article here.

Anyhoo, I happened to be looking at XLF today, because I’m interested in FAZ – a 3x financial bear ETF that I sometimes use – and I decided to revisit my original post and update the numbers.

Mr. Kass mentioned the S&P 500 estimated earnings as one of the basis for his buy call.  At the time of his post, the estimated earnings for 2008 were $80.  2009 earnings estimates were at $85, and 2010 earnings estimates were at %90.

2008 earnings aren’t totally in yet, but S&P is now estimating them (clicking on the link will open an Excel file from S&P with these numbers) at $65.73 – which I think will turn out to be too high.  As to 2009 earnings, S&P has the current estimate at $81.52.

I’ll bet anyone as much money I can scrounge up that the 2009 earnings estimate of $81.52 is too high.  Does any rational thinker actually have reason to believe that 2009 earnings will come in 24% HIGHER than 2008?

My guess (and it’s only a guess) is that 2009 will come in closer to $40 or $50 than $81.  In other words, I think the current price for the S&P 500 is almost double what it should be if investors are looking at the earnings.  So no, this isn’t the bottom.

I didn’t think it was anywhere near the bottom last January when I said “I think it’s waaay to soon to be looking at this sector.  Personally, I think we’ll see a couple of big bank failures before the financial house of cards has collapsed fully.  No, I don’t know who it will be, but I do know that you don’t make money in the long run by borrowing money (especially at today’s higher rates) to pay down debt”

Side note – A few years ago my brother had an email signature line that said “Tis a vain man who quotes himself”.

Since I wrote the prediction of “a couple of big bank failures” last January, we’ve all seen the collapse of Bear Stearns, Lehman Brothers, IndyMac, and Washington Mutual.  We’ve all seen the trillions wasted on bailouts of Citi, Bank of America, AIG, and even GM and Chrysler.

I’ve previously posted who has been bailed out by the taxpayers.  The list includes Citi (multiple times), Goldman Sachs, Bank of America, Capital One (What’s in YOUR wallet?), Wells Fargo, Morgan Stanley/Dean Witter (We make money the old fashioned way), US Bancorp, and Regions Bank.

I think my prediction of “a couple of big bank failures” has been vindicated….

A year ago I said “we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.  Another 20% to 30% decline from here is not out of the question, so sell some stocks and put the proceeds into simple money market funds or commodities. ”

So how did that prediction turn out?  Here are some numbers:

So you can see that basically every asset class has lost money during 2008 – but absolutely nothing has lost more value than the financials as measured by XLF.

Don’t misunderstand my intent in posting this – I’m not claiming to understand how everything works.  I thought that commodities would take off during 2008 as the dollar weakened because of all the debt we were taking on.  In fact I still think that the dollar is way over-valued and the slide towards zero will soon resume.  But it didn’t happen like I expected it to happen last year.

We did have a very nice commodities boom in mid 2008 – but that turned out to be a bubble.  I still think that commodities are going to go up long term, but I “misunderestimated” (to borrow a term from our idiot President) the world-wide slowdown that happened in 2008. Oil was especially hard hit when worldwide demand fell off a cliff.

Long term, the US dollar is toast and commodity prices (as measured in dollars) must eventually go up to reflect the worthlessness of the dollar.  This is being exacerbated by the Fed’s insistence on printing up boatloads of worthless currency to use to bail out banks.  My advice is still to buy gold and silver.   Physical gold and silver – not the ETF’s.  Because when I say the US dollar is toast, I mean it.  You’ll want physical metal in your hand when our currency starts to look like Zimbabwe.

That’s a bit of an exaggeration to make the point, but inflation is going to take off at some point – it’s simple supply and demand.

I’m very happy that I moved money from stocks to a money market fund early last year.  I left 20% in US stocks, bonds, and overseas funds, and I kept putting my new 401K money into an S&P 500 index fund, so I still lost about 10% in my 401K last year.

So what’s going to happen this year?  In my opinion, the financials will drop more.  Their share values are being diluted every time the Fed does another round of bailouts – and that won’t end anytime soon.  Earnings will follow the same trend they did in 2008 – and stock prices will reflect the lower earnings.

Another side comment.  Have you noticed that stock prices tend to rise during earnings season?  No matter how bad the earnings actually are?  That’s because investors still want to believe that this is finally the “kitchen sink quarter”, they want to believe that all the writedowns and bad news are finally out there for everyone to see.  But they’ve been wrong for 5 straight quarters, and they’ll be wrong for at least a few more quarters.

After all the earnings have been reported, stocks tend to drop because everyone starts thinking that maybe it is that bad.  That the next quarter earnings are going to be even lower.  And prices drop until the next quarter reports when the cycle starts again.

If you’ve been to a mall, car dealership, or hardware store lately, you know that traffic in those stores are way down.  So are sales.  Which means profits will also be down.  So I don’t think this will turn around anytime soon.  4th quarter 2009 is the earliest that I think could bring an improvement in earnings – but that may change depending on how deep this recession turns out to be.

IF my earnings estimate ($40 to $50 for the S&P 500) turn out to be close to correct, you can expect to see the DJIA around 5000 and the S&P 500 around 500 sometime this year.  That’s another 40% drop from current levels.  So I think you’ll come out ahead by selling stocks (even after the big loss you might have taken in 2008) and putting your money into a money market account for now.  And I think putting it into gold and silver now will pay big benefits when (not if) inflation takes off.

gk

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Just ran across this while taking a quick scan of the news headlines before going to bed.  The headline on CNN says “BofA may need billions for Merrill“.

In reading the story, I saw this nugget: Bank of America, which had been viewed as one of the strongest banks in the country, may be buckling as the nation’s economy worsens.

It has also taken over two ailing companies that thrust it deeper into the most troubled sectors of the financial system. Not only did it take a big gamble on its $24 billion acquisition of the faltering brokerage titan, but it also bought battered mortgage lender Countrywide Financial early last year.

How many trillions are we (the US government) going to print up in funny money to bail out these stupid people?  BoA tried to catch a falling knife when they bought Countrywide and Merrill Lynch.  They overpaid in order to expand because they thought they were in good shape.  They weren’t.  And BoA is in worse shape today because they bought crap companies with crap assets.

Now they want us to bail them out.  Screw them!  Have you ever heard the phrase “throwing good money after bad?”  With all these bailout programs, we’re actually throwing bad money after bad.

Face the facts people – the US government is broke.  We don’t have a dime to bail out anyone.  And the result of running the printing presses overtime to make money out of thin air is gonna be an inflationary disaster.

Let these bad companies and banks go under.  Yes, it’ll be a painful mess, but it’s going to happen sooner or later anyway.  I say we let it happen now and keep the dollar from becoming worthless in the near future.  The only way I see to protect your assets is to buy gold.  (You’ll thank me for this advice a year from now.)

gk

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Stop me if you’ve heard this one before….  The dollar and financial stocks fall, while gold and oil rise.  Damn, you already heard that one somewhere else? 

It’s a familiar refrain that seems to keep repeating, just like an obnoxious Barry Manilow song or that annoying dog commercial that goes “there might be bugs on some of you mugs but there ain’t no bugs on me”.  (Ha – now you’ve got it stuck in your head too!)

The reason that oil and gold continue to trend higher while the dollar and financial stocks continue to trend lower is one and the same – the Federal Reserve. 

The Fed continues to flood the system with cheap and/or free money.  It’s simple supply and demand.  There are more and more dollars but there hasn’t been a corresponding increase in the demand for those dollars.  So the amount of stuff a dollar will purchase continues to fall.

It’s called inflation, and it’s always CAUSED by the same thing – too much money chasing too few goods.  The classic way to explain inflation is that inflation “is always and everywhere a monetary phenomenon” (Milton Friedman) but it’s saying the same thing.

Even though this is nothing new, I’ve found that damn few people actually understand it.  And the more involved they are in the stock market, the less likely they are to understand it.  They blame inflation on rising wages, or rising oil prices, or the rising cost of (insert commodity here). 

They don’t understand that rising prices are CAUSED by too much money.  When the Fed injects billions of dollars into the money supply (without a real demand for the money) prices HAVE to go up. 

Pretend I have a blog that lots of people read (we’re pretending!) and visit everyday.  Now I take the blog posts that I write and post them on 7 other sites as well.  Assuming more people don’t want to read what I have to say, the number of people visiting each site would go down – even though the total number may stay the same.

Ok, maybe that isn’t the best analogy…. Try this one.  8 people are standing around a barrel of oil.  They all need that barrel of oil, and they’ve all got about $5 to use to purchase it.  Guess what the price of that barrel of oil will be?  Yup, about $5.

Now imagine that Uncle Sam gives (or lets them borrow cheaply) each one of them another $5.  There’s still only one barrel of oil, and all of them still need it.  How much will that barrel cost now?

Does that help?  That’s what the Fed is doing with dollars.  Helicopter Ben is doing everything he can to keep the over-leveraged financial institutions afloat, but he’s simply buying time.  Borrowing money to pay off debt never works – it simply delays the inevitable.

As the dollar loses value (because there are more of them in circulation) the amount of “stuff” each dollar can buy MUST go down.  So things like oil and gold go up BECAUSE the dollar is worth less. 

This sometimes isn’t obvious because with commodities like oil and gold (and corn and soybeans and wheat and rice and pork bellies) demand can also fluctuate and cause price movements, but the underlying cause is the same.  Too many dollars in the system.

Anyhoo, the major financial institutions all owe waaay more than they own.  And they’re finding out that as the value of their assets (and the payments they receive from those assets) fall, they suddenly can’t make the payments on their debt anymore.  But then the Fed comes riding in and lets them borrow more money (using the same assets which are falling in value as collateral) and suddenly everything is supposed to be ok…. Brilliant! (Not!)

There was a report by Reuters today saying “Federal Reserve Chairman Ben Bernanke told Freddie Mac chief Richard Syron that his company and Fannie Mae could take advantage of the emergency discount window, according to a source familiar with the conversation.” 

Since it’s pretty obvious to everyone that Fannie Mae and Freddie Mac are insolvent and going under unless someone steps in, this report was a catalyst for a huge rebound in the market today.  Investors were grasping at straws looking for something, anything to save the sinking financial ship.  They grabbed onto this report and stocks reversed course over 200 points and were even briefly into positive territory today.

Then they realized that even if the report was true, it didn’t change a damn thing.  So the market sold off again into the close. After the markets closed, the Fed denied the story – but I won’t be surprised if the Fed takes action over the weekend like they did with Bear Stearns. 

They know the companies are technically bankrupt, and they’ve got to act at some point.  I don’t know what they’ll do, but they won’t stand by while the ship sinks.  They’ll continue to bail water, only to eventually figure out that the water is coming in much faster than they can bail it out.  The ship will still sink, but they can drag out this soap opera for months. 

In my opinion, they should let it sink now so we can start building the new ship.

gk

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Back in January, I posted a short article basically saying that it was way too early to call a bottom in financial stocks.  I had been reading an article on TheStreet.com by Doug Kass where he made the case that it was time to buy the financial sector, via XLF.  

While I agreed with much of his analysis, I didn’t think the financials were anywhere near a bottom – most banks and brokerages simply hadn’t taken into account the full impact of the sub-prime mortgage debacle.  Those relatively few bad mortgages were so highly leveraged that just a few percent failure rate is enough to make the whole house come tumbling down.

Despite the best efforts of the Fed, Bear Stearns has disappeared.  It took a $30 billion taxpayer backed guarantee to do it, and I think the buyout simply swept the underlying problems under the rug and out of sight – for a few months.

The last few months are looking more and more like a rehash of the Internet bubble and the resulting bear market from 2001 through 2003.  during that time, I lost count of how many times I heard things like “buy and hold”, “stay the course”, “this is a great buying opportunity”, etc. 

The people who listened “to the experts” back then STILL aren’t back to even on their investments, while those who got out and waited for the smoke to clear are way ahead.  Those of us who are conservative investors, who follow broad trends and don’t move in and out of the market very often know that this isn’t the time to buy back in.

Could this be the bottom?  Sure – but I don’t think so.   I move in and out of the market in my 401K based on the crossover of the 75 day EMA and the 200 day EMA.  I usually go with an S&P 500 index fund, and here’s what the chart looks like today.

The 75 and 200 day EMA’s are nowhere near signaling the start of another bull market, so my retirement money is 80% in cash and 20% in overseas funds.  I’m down about 4% for the year – how’s your 401K YTD? 

If you’re still fully invested (like the “pro’s” tell you to be) you’re down over 12% YTD, and you’re right back where you where in July of 2006.  If you’re retired and you’ve been fully invested for the last decade, you’re right back where you were in March of 1999. 

9 plus years and zero return – how’s that “buy and hold” strategy working for you?

Anyway, it’s time for a check on Mr. Kass’s buy call on XLF.  I normally don’t make a big deal about stuff like this – after all, analysts make bad calls everyday – but he titled his original analysis “Buy the Financials. Yes, Buy” to emphasize what a great opportunity it was.  So, let’s see how XLF is doing since Jan 14th.

XLF closed at $27.88 on Jan 14th.  It closed today at $20.57.  That’s down $7.31 – or about 26% in about 6 months. 

Great timing on the “Buy the Financials.  Yes, Buy” call Mr. Kass!  I hope you haven’t screwed over too many investors with your advice.

In my original post, I made this prediction: “In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.”

Since I recomended investing in commodities instead of stocks, let’s see how my pick (gold) is doing.  Gold closed at $903.40 on Jan 14th, and it closed today at $931.30.  That’s up $27.90 – or about 3% in 6 months.

Yup, gold is up just a tad, and it’s actually off the highs of a few months ago.  It’s also just come back up over $900 after being stuck in the $860 to $890 range for a while – I mention that because it just came back up this week, and I don’t want to appear to be trying to hide that it’s been lower.

But as long as the Fed keeps printing extra money (inflating the supply) the dollar will keep falling, so gold will continue to hold its’ value for now. 

Only if Bernanke gets serious about fighting inflation and ensuring a stable dollar (which is the Fed’s primary purpose – read the Fed website if you don’t believe me) will the dollar rebound and gold fall.  And “Helicopter Ben” isn’t Paul Volker, so it ain’t gonna happen anytime soon.

For you too young to remember the late 70’s, inflation was high and the economy was stagnant – the term “stagflation” was coined to describe it.   We’re in the early stages of it now, and unless we get the Fed to grow a pair of brass balls, it’ll be 1980 all over again.

Raising rates and restricting money supply killed the stagflation, but it also caused a deep recession.  But that recession led to one of the greatest bursts of prosperity this country has ever seen.   We can do it again – if the Fed would administer the medicine.

As is stands, Bernanke is simply trying to keep a sinking ship afloat.  He doesn’t want a deep recession (or worse) to mar his tenure.  After all, he is an “expert” on the Great Depression, and he know’s what he’s doing.  Just like the experts calling repeated bottoms in the stock market.

I didn’t come up with any of this on my own.  Read  Warren Buffett’s annual letters to shareholders.  Read Phil Town’s “Rule #1″.  Read damn near anything by anyone who isn’t a Wall Street “expert”.  Their jobs are going away as the companies they work for are revealed to be a highly leveraged house of cards.  They’re running scared and are trying anything to keep up the pretense of the 80’s and dot com years.

What about the next 6 months?  I don’t see the financials (banks and brokerage houses) coming clean with their books yet – many are still pretending that their “level 3″ securities are still worth a lot of money.  Until they ‘fess up and take the losses they’ll just be on a long slow bleedout. 

This part is simply a guess, but I think Goldman Sachs is priced way too high.   At some point I think they’ll come down to earth just like the rest of the investment banks.  This might sound “out there” but I would not be suprised to see GS lose 50% (or more) of their value over the next 2 years.   Maybe sooner.  Something is fishy in their financial statements, but I can’t put my finger on what.  Just doesn’t smell right….

Back to the “hard vs soft stuff” that started this.  Don’t take my word for it – read and look at the situation for yourself.  Decide where to put your money because YOU want to put it there – not because some so-called “expert” on TV or the Internet said “Buy the Financials.  Yes, Buy”.

gk

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Read this.  Please.  It’s the annual report from the Social Security and Medicare trustees, and it has bad news for anyone who doesn’t already have one foot in the grave.

If you pay taxes, you will be paying more – a lot more – sometime soon.  The annual report contains all the numbers in black and white, and all that money has to come from somewhere. 

Medicare will pay out more than it brings in starting this year.  For 2008, Medicare is only projected to be $8 billion in the red, but that translates to a $16 billion increase in the deficit.  Why?  I’m glad you asked!

For years the government has been taking the “excess” revenues from Social Security and Medicare and “investing” them “in special non-marketable securities of the U.S. Government on which a market rate of interest is credited.” 

In other words, the government takes the money, writes an IOU (promising to pay it back with interest) to Social Security and Medicare, and spends it as part of general revenue.

That’s your trust fund.  There’s no money in a bank account drawing interest, there’s no gold in a vault, there’s no stock certificates.  There’s just a huge pile of government bonds (IOU’s) in the administration building.

Maybe that doesn’t make it clear so let me try explaining it this way….  You deposit $500 into an account (let’s call it a trust fund just for the hell of it) then – promising to pay yourself back – you transfer it to another account and spend it. 

You could even print out your IOU to yourself and stick it in a pretty box.  You do the same thing the next month.  And the next.  And the next….

After a year, how much money is in your trust fund?  Exactly nadda, nothing, zip, zilch, squat. 

You can’t take money out of one pocket, put it into the other pocket, and spend it.  Well, technically you can, but you haven’t saved anything.  And there’s no money left (you spent it on other things) to put back into the first pocket.

I hope that clears up the mystery of the Social Security and Medicare trust funds.  To put it bluntly, there’s no money in them.  Zip.

But the government stills owes that money to itself – or more accurately, they owe it to the designated recipients who have paid into the “trust fund.”  That’s you and me.

So where do they have to go to get the money they’ve promised to pay?  There are only three ways for the government to get money; taxes, borrowing, or printing more money – or a combination of these. 

Which one should they use?  Let’s take a quick look at the choices:

1) Taxes.  The government can raise taxes to cover their expenses.  Since we’ve run a deficit for years, I don’t think they’ll do this – which is actually the option which would cause the least pain for all. 

2) Borrow: This simply means they sell more bonds to foreigners.  We get to use their money and simply make payments on our national interest only loan.  Hey, it’s working out great for homeowners!  Right?

3)  Print more money:  Sounds, good – after all, the government makes a profit on each dollar they print.  It costs less than a cent to print a dollar bill, and it’s worth $1 – before inflation anyway.

See, there’s this little thing called supply and demand that refuses to go away.   When you make more of something without a corresponding rise in demand, each one of them is worth less.  Make too many, and each one is worthless.

That’s why we have inflation – we print dollars with nothing standing behind them.  The money supply (the supply part) rises faster than the economy grows – the demand side.   Rising prices for “real” stuff like oil, gold, wheat, and milk don’t cause inflation – they’re caused by inflation.

Read that paragraph again, it’s important.  Most people (even bankers and some of the fed board) don’t “get” this basic fact of life.

Anyway, the government will need to get the money to pay Social Security and Medicare benefits from somewhere, so my bet is that taxes, deficits, and inflation will all be a big part of the years to come. 

And if you think the deficit is big now, you ain’t seen nothing yet.  You can ignore those “pull the numbers out my ass” deficit projections from the government – because they actually assume that the money from the Social Security and Medicare trust funds are there!

I don’t know what “real” stuff will be worth in a week or a month, but gold, oil and silver will be a lot higher 10 years from now.  That’s where my money is.

gk

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As regular readers know, I think that the price of “stuff” will go up long term as the dollar continues to fall – and the dollar will continue to fall long term, as our governemnt prints more pretty green pieces of paper.   So why have commodities (gold, silver, oil, wheat, etc.) dropped so much over the past 2 days?

The short answer is that I don’t know.  How’s that for sticking my neck out? 

From what I’ve read and heard, it’s a combination of two distinct factors:

1) The market had priced in a 1% drop in interest rates, and the Fed only dropped 3/4%.  So traders think that the Fed is now hawkish on inflation.  (Yup, I think it’s weird too.)

2) The US is definitely going into a recession.  That means that demand for commodities will drop as consumers spend less. 

Of the two reason given for the drop, I’m inclined to think that #2 has more validity than #1.   Not that I think that’s a bad thing!  The US needs to spend less.  The average US consumer is in over their head with debt.  Collectively we need to stop spending more than we earn – and the same goes for the US Government.  If the dollar is to rise long term, we need to stop spending more than we make.

We need to pay off old debt and stop taking on new debt for awhile.  We need to accumulate capital so that our banks don’t have to drop their trousers and bend over for money from Sovereign Wealth Funds in order to stay in business.  A little actual capital would have prevented Bear Stearns from being bought out for $2/share.  Of course, that was us (the US) doing the “buying”, but now we’re all on the hook for $30 billion of Bear Stearns’ over-valued mortgages.

I don’t know what the next shoe to drop will be – or how the markets will react to it.  In spite of the fact that CIT Group (not to be confused with CitiGroup as I did at first!) today announced that they didn’t have any money on hand and needed to borrow $7.3 billion to stay afloat, the US stock markets all went up today.  And the commodities all dropped. 

Side note:  I like the headline on the CNN article I linked to – “CIT Borrows $7.3 Billion to Repay Debt“  I’m still trying to figure out how borrowing money to repay debt works….

Anyway, despite the news of yet another financial company having problems, the stock market shrugged it off and the DJIA soared 261 points.  XLF (an ETF that tracks all the financial stocks in the S&P 500) was up an astounding 6%!  But I think that we’ll see this sector plumet at some point as this mortgage inspired credit crisis unfolds.

Remember that very few of the ARM’s and Option ARM’s that were handed out at the peak of the housing bubble (2005 through 2007) have reset to higher rates yet.  A lot of those mortgage holders are making minimum payments on their interest only loans.  This is far from over, and I’m hanging on to my gold ETF.  I’m also buying silver when I find it cheap on eBay.

In other words, I’m using this drop in commodities as a buying opportunity.  I don’t know about oil, wheat, or corn (they depend too much on the economy) but I expect to see a big rebound in precious metals sometime soon.  And when that happens, I’m betting that the rebound in precious metals will coincide with a drop in the financials.

gk

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