Financial topics

[John]

From a web site reader:

> "I sincerely appreciate the time you spend writing articles. I
> try to read them as often as I can. I am a construction worker
> and am often on the road without access to a computer.

> I started reading your weblog after I became convinced my
> retirement was in jeopardy. I transferred my 401-k from equities
> to Principle Preservation (Treasuries) two years ago. I am glad I
> did. You are partially responsible for saving me 30-40%. Thank
> you."

Thanks for letting me know.

> Are you familiar with Kondratieff?
> http://www.kwaves.com/kond_overview.htm

> I became aware of him and his theory about the same time I began
> reading your weblog. I see some very similar ideas: yours
> generational, his mathematical.

The following article has a brief discussion of Kondratiev cycles:

** System Dynamics and the Failure of Macroeconomics Theory
** http://www.generationaldynamics.com/cgi ... acro061025

The following chapter contains a lengthier theoretical discussion:

** Chapter 6 - Kondratiev Cycles and Generational Dynamics
** http://www.generationaldynamics.com/cgi ... ok2.cycles

Sincerely,

John

[John]

From a web site reader:

> I know that you are very negative on the stock market, for
> obvious reasons. I started reading your column in June, and have
> sold most of my stocks, so I can definitely thank you for saving
> me some significant money.

> The market has recently sold off, but I realize that it has
> significantly further to fall to become undervalued. However, I
> have been looking for some bargains, based on P/E.

> One example would be Freeport McMoran, with a P/E of around 4.7
> and dividend of close to 6%. If the general market would reach P/E
> levels like this, I would certainly find it buyable, being below
> previous major bottoms of 6-7. What do you think of buying a stock
> like this and holding for the long term?

In a generational stock market panic and crash, even good stocks
suffer. The reason is forced selling -- investors who are in trouble
are forced to sell off their good stocks, in order to meet margin and
collateral calls for their bad stocks. The result is that everything
goes down.

I do not know anything about Freeport McMoran, but I do know that a
lot of brokers and pundits lie through their teeth about P/E ratings.
Make sure that you check all these figures for yourself.

Sincerely,

John

[jordana]

Thank you very much for your great insights and posts; i would appreciate your views on whether, contemperaneous with the "big event", gold/silver would experience, at least a temporary, flight to safety upsurge?

[mosullivan]

In a generational stock market panic and crash, even good stocks
suffer. The reason is forced selling -- investors who are in trouble
are forced to sell off their good stocks, in order to meet margin and
collateral calls for their bad stocks. The result is that everything
goes down.

Sincerely,

John[/quote]

This can be seen by the end of the day selling that takes place in the last 5-10 minutes. Margin clerks "clean house (calls) if not sold by the client...as it is all in the brokerage's margin agreement. This has been happening for weeks now. Just pull up a DJIA live feed at about 3:56PMEST and watch.

[mosullivan]

John,

I found this site somewhat enlightening as it explained deflation much more thoroughly than any "gold bug" or inflationist out there. I have noticed that when I try to explain to gold bugs or inflationists that the amount of money is leaving the system much faster than anything the Fed is doing, they say usually say that "this" is the deflation prior to the reflation or coming hyperinflation. Here's a response I received from a well known Silver newsletter writer when I posed the facts re: deflation.

"When stocks go down in value is it deflationary?

If yes, then ask this;

If the money goes down in value, is that deflationary?

No. That's called inflation.

So, just think, ok?"

Does this person just totally miss that deflation is causing the value of the US Dollar to go up via net supply is lower? Or, perhaps just defensive? The point isn't to pick on the post but I see a real defensive stance in the PM community. They've been told for so long that we'd turn into a Weimar Experience. But when you mention that Weimar wasn't debtor nation and we are, I get blank stares or nada.

Best, MOS

[mannfm11]

First of all that was a very good expose on the main board John. You seem to be hitting home with some of these readers in what you write. Inflation is a tough game to understand, but the creation of money and credit is even more difficult to understand and it is this process and its reverse that has to be understood to understand about all this discussion.

I noticed someone brought up Freeport McMoran. That is a huge mining company. Its earnings are about to go to crap for a long time so its PE really is irrevalent. In fact all PE's are irrevalent because of the fact the credit bubble created the earnings growth and the earnings in general in the market and its effect are now being reversed. Earnings will decline, then dividends will decline. The return on a stock over time is its dividends plus dividend growth and its price is related to the 2. Thus, if required risk is inflation plus 5% and you have a growth rate of inflation plus 2%, then the dividend yield has to be 3%. In this case, lets say inflation is also 3%, so total return is 8%. This would be the capitalization rate, or K. So, P=D/(k-g). Let say the dividend is $3. So, $3/(.08-.05)=P, $3/.03=$100. This is not normal, but it would be pretty bullish if you showed it to the modern porfolio investor,mainly because portfolio theory has turned the return on stocks into a risk free return, thus if you get 2% over normal, you are taking on risk that is actually 2% above the normal risk on stock. The risk premium on stock is so low that a stock that is priced to yield 2% above normal actually is price higher than it would be priced in a normal market, even though it had significantly higher risk.

When you figure normal for a BBB bond is probably 5% above inflation and the work I have done over history on Shillers SPX data shows growth in dividends of less than 1% above inflation means that a 4% dividend is very minimal in an average growth market. When growth turns negative or we have deflation, it stands to reason that the dividend actually has to be higher in order to induce you to put your money into the stock. Thus if an uninvested dollar was worth 4% more next year than if it was invested, you would have to pay 4% to break even. IN this case, it would be expected a $100 stock would be worth only $96 in a year for 2 reasons. One, the dividend payment would be likely to decline 4%. Second, the money would appreciate 4% and one or the other would reduce the price, maybe both. If 4% was all one would get for putting their money into a stock once that procedure became operative, then you might as well put the money in the matress. Thus the dividend yield might be 8% and a PE of 10 is really a PE of 16 because you have to get the 4% somewhere. When you start running negative inflation, the valuation models go crazy,thus the prices look cheap and returns high. But the chances of getting your money back in any form starts looking slimmer.

Most people don't understand that credit is what creates earnings growth, more so than reinvestment of income. They also fall into this idea that the Fed creates the credit,but it really only facilitates inner bank transactions and creates currency in exchange for collateral. There is no free printing of money in the banking system. Banks don't lend money so much as they create credit and work for its return to the banks in the form of deposits. If we ever go to electronic money entirely, there will never be a dime come out of the banks and there won't be a case for lending anyones money, it will all be credit from one account to another as it is used. Deflation happens when the creator of the money and the surety cannot fulfill their obligation to the receiver of the funds. Thus if I borrow $1 million and buy something from you for $1 million, you have it in your account. The bank has agreed to make it good. I default and if enough me's default, the surety, the bank is not any good. Of course, a bank in order to act as surety has to have enough of its own funds to be a valid surety. This is what the government is trying to do is prop up the surety capacity of the banks. I believe Paulson covered up how broke the banks that were taking in the other banks were and used this bill to smuggle money into these insolvent entities. You haven't seen any of them refuse it yet have you?

[mannfm11]

John, you might try reading some of the writings of Von Mises on the mises.org site where you got that Bubble that broke the world book. Mises actually goes into what follows a period of unusually cheap money, in that the players begin to think they can do anything. I don't believe the Austrians really cared what was called money and only favored gold in the sense that it enforced dicipline. I have yet to read any Austrian stuff that waged war against paper in the sense that every paper currency went to zero. They believed in the business cycle and they believed it to be a credit phenomenon. Some of the greatest inflation in US history went on between 1895 and 1915, most of those years were without a Central bank and with gold as the lawful US money. Only a portion of that was due to gold rushes and most of it was due to bank credit and a long boom. Look at the long range capital investment going on right now around the world and how suddenly the cost of credit has gone through the roof. Von Mises business cycle is on that site and worth a read.

[malleni]

John,

...

They've been told for so long that we'd turn into a Weimar Experience.
But when you mention that Weimar wasn't debtor nation and we are, I get blank stares or nada.

Best, MOS

Sorry Mos,

I think that you have missed something.

The Weimar Germany - WAS a debtor nation.
The biggest at this time.
(Even John talking each day about similarity between USA- Germany 1929 and China-USA today)

[malleni]

...
Inflation is a tough game to understand, but the creation of money and credit is even more difficult to understand and it is this process and its reverse that has to be understood to understand about all this discussion.
...

I do not agreed that "Inflation is a tough game to understand" - but it is understandable from you further text.

I try already with very simple example to describe - "inflation"....
It would be god if you (or anybody) try it too.
"What people saying" - is absolute irrelevant.

The things are simple as this:
- If you like to "measure" something - you need an "reference". (For length we using meters you feet for example. The etalon (reference) for 1m - is at the beginning of SI system positioned in Paris)
You need it - to measure "the length".

Same is with - money.
"Something" must be "the reference", since you need this to "measure the wealth"...
"The wealth" is for example the amount of somebody - work! (I saying somebody, because because it is different for different works)
"The reference" could be gold, cows, hamburgers, or what ever the parts in trading - agreed.

As long as "the wealth" has the covering in "the reference" (gold, cows, hamburgers....) according "the agreement" - the inflation is impossible.
As soon as "the wealth" - loosing its connection to the "the reference" - i.e. you have more "the reference" than the REAL "the wealth" - you have INFLATION.
(opposite is - "the DEFLATION". The amount of the REAL "the wealth" is more than "the reference")



In modern days we have - Central banks and commercial banks.
The commercial banks giving - "the credits" (as we know it)... Of course they MUST have "the covering" for this credits in some "the reference" (REAL money - make for example by hart work people).
By giving "the credit" with some interest - the commercial banks earning additional "the reference" (money in our days)
Since it is not always that all hard working people would like to take out own money from these banks - it is obvious that (because of it) they can "leverage" amount of "the reference" little bit.
This "the leverage" - is NOT REAL "the wealth" (money - from hard working) - but it is produced by "printing, or just with adding of some 000000.....
If people panicked - and try to get their REAL money (hard working) from the bank - everybody at the same time, it is also clear that the "commercial bank" - will collapsed, since it has NOT so much REAL money.

Now we are coming to the - Central bank.

The Central banks - must control the commercial banks - AND DO NOT permit for those to make "the leverage" more than Central banks permitted. (NOTICE: - "permitted!" - since CB obviously has control of the "money supply")

So CB - DO NOT "printing money"... They "just" permitted it (or not!).

So simple it is.

[malleni]

Dear Steven,

> I also read the article by Ambrose Evans-Pritchard.

> The most important sentence to me was the following:

> I’m afraid this is going to have a very deflationary effect on
> the economy of Western Europe. It is almost guaranteed that
> euroland money supply is about to implode.

> If the money supply is about to implode, doesn't that imply that
> the euro in real terms will become more valuable?

That sentence leapt out at me as well, so I included it in the
excerpt but didn't comment on it.

However, the real question is whether the euro will survive at all.
The present crisis is creating enormous strains by widening the
differences between individual countries, which is likely to force
some countries to return to their national currencies. Where this
leaves the euro currency remains to be seen.

> The Austrian School doesn't rule out a deflationary spiral.

> People like Peter Schiff are a little bit obsessed by
> hyperinflation.

> A quote from a book on Austrian Economics:

> >The third type of deflation we will consider results from the
> >tightening of credit which normally occurs in the crisis and
> >recession stage that follows all credit expansion. Just as
> >credit expansion increases the quantity of money in
> >circulation, the massive repayment of loans and the loss of
> >value on the assets side of banks' balance sheets, both caused
> >by the crisis, trigger an inevitable, cumulative process of
> >credit tightening which reduces the quantity of money in
> >circulation and thsu generates deflation. This third type of
> >deflation arises when, as the crisis is emerging, not only
> >does credit expansion stop increasing, but there is actually a
> >credit squeeze and thus, deflation, or a drop in the money
> >supply, or quantity of money in circulation.

> Sounds familiar?!

Very good!

And yet, whenever anyone writes to me about the Austrian school, it's
always in the context of a statement like "the dollar has been a fiat
currency since 1972 and will soon become worthless."

Sincerely,

John

Dear Steven,
For sure EURO zone will collapse, and those are the reasons:
1. A 26% (justifiably called a "crash") drop in the DJIA since the start of October
2. Another, emergency rate cut by the "CEB" – down to 1.5%.
3. Nationalization of mortgage giants EUnnie/EUreddie.
4. The EU. government's takeover of the world's largest insurance company, EUIG.
5. Major EU commercial and investment bank failures.
6. The EU governments bailout of EU stocks– with EU taxpayer money.
7. The EU governments fighting two big wars (and prepare third) – with EU taxpayer money.

Yes.
Than you have right.


But it is obviously - since money supply is not just currency trade in which traders can react with "feelings and momentary" - you need to have at least "something" (some "hard base") as cover behind a currency.
This "something" can also defined if your currency is to deflate or to inflate.


Today we (the World) have an sick system with "dollar as world currency".
This allowed just ONE single government to print, speculate and issue the "value".

Bretton Woods agreement - is the one of the biggest sickness of today's system.
It is not strange that all nations around the World now thinking to - change it (or to try to cure this sickness!):
http://www.marketwatch.com/news/story/b ... 5E3BFE253F}

...and "economic experts" like those really make me laughing:

" ...
"Bretton Woods was about exchange-rate management and setting up facilities for country-to-country lending under duress, and that actually hasn't worked bad in this crisis," said Roger Kubarych, chief U.S. economist at UniCredit MIB and a senior fellow at the Council on Foreign Relations.
"It's mainly a banking crisis. It's not a currency crisis," Goldstein agreed. ..."


Bretton Woods agreement - IS the reason that "people escaping now to the "value"".
It is obvious - that this "value" (from the first 7 points) - are for sure NOT in the US and in the currency which this country has to "cover" - the dollar!
Destroying of huge amount of mainly dollar denominated shares on the stocks - caused something which just LOOKS like "deflation"... But - in the real life - there are almost not possible to see this kind of phenomena on the all over prices! Even worse - the situation is just opposite!

Soon or later - with "strong" or "weak" dollar the US government will be on the bank - with just only ONE question:
- How to pay back at least 10 trillions of "value" to the creditors?
Since the government amount of money is determined (AND limited!) ONLY by - taxes, debt or printing... we can play ONLY with those 3 (three) factors.

(For explanations of type: - "to believe" that creditors will find the way to bail out us" - we have definitely not enough arguments)



But I thing - you have right about "value of EURO".
(At least - as you look the explanation of the deflationists here)

The Austrian Economics for sure - have right.
The only question is - if other circumstances are fulfilled for this explanation.

Probably we need not to wait too long - to see and understand it.

Best regards
malleni