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  Quotations - Invest  
[Quote No.30461] Need Area: Money > Invest
"As the world slips into recession [late in 2008], it is also on the brink of a synthetic CDO cataclysm that could actually save the global banking system. It is a truly great irony that the world’s banks could end up being saved not by governments, but by the synthetic CDO time bomb that they set ticking with their own questionable practices during the credit boom. Alternatively, the triggering of default on the trillions of dollars worth of synthetic CDOs that were sold before 2007 could be a disaster that tips the world from recession into depression. Nobody knows, but it won’t be a small event. A synthetic CDO is a collateralised debt obligation that is based on credit default swaps rather than physical debt securities. CDOs were invented by Michael Milken’s Drexel Burnham Lambert in the late 1980s as a way to bundle asset backed securities into tranches with the same rating, so that investors could focus simply on the rating rather than the issuer of the bond. About a decade later, a team working within JP Morgan Chase invented credit default swaps, which are contractual bets between two parties about whether a third party will default on its debt. In 2000 these were made legal, and at the same time were prevented from being regulated, by the Commodity Futures Modernization Act, which specifies that products offered by banking institutions could not be regulated as futures contracts. This bill, by the way, was 11,000 pages long, was never debated by Congress and was signed into law by [U.S.] President Clinton a week after it was passed. It lies at the root of America’s failure to regulate the debt derivatives that are now threatening the global economy. Anyway, moving right along – some time after that an unknown bright spark within one of the investment banks came up with the idea of putting CDOs and CDSs together to create the synthetic CDO. Here’s how it works: a bank will set up a shelf company in Cayman Islands or somewhere with $2 of capital and shareholders other than the bank itself. They are usually charities that could use a little cash, and when some nice banker in a suit shows up and offers them money to sign some documents, they do. That allows the so-called special purpose vehicle (SPV) to have 'deniability', as in 'it’s nothing to do with us' – an idea the banks would have picked up from the Godfather movies. The bank then creates a CDS between itself and the SPV. Usually credit default swaps reference a single third party, but for the purpose of the synthetic CDOs, they reference at least 100 companies. The CDS contracts between the SPV can be $US500 million to $US1 billion, or sometimes more. They have a variety of twists and turns, but it usually goes something like this: if seven of the 100 reference entities default, the SPV has to pay the bank a third of the money; if eight default, it’s two-thirds; and if nine default, the whole amount is repayable. For this, the bank agrees to pay the SPV 1 or 2 per cent per annum of the contracted sum. Finally the SPV is taken along to Moody’s, Standard and Poor’s and Fitch’s and the ratings agencies sprinkle AAA magic dust upon it, and transform it from a pumpkin into a splendid coach. The bank’s sales people then hit the road to sell this SPV to investors. It’s presented as the bank’s product, and the sales staff pretend that the bank is fully behind it, but of course it’s actually a $2 Cayman Islands company with one or two unknowing charities as shareholders. It offers a highly-rated, investment-grade, fixed-interest product paying a 1 or 2 per cent premium. Those investors who bother to read the fine print will see that they will lose some or all of their money if seven, eight or nine of a long list of apparently strong global corporations go broke. In 2004-2006 it seemed money for jam. The companies listed would never go broke – it was unthinkable. Here are some of the companies that are on all of the synthetic CDO reference lists: the three Icelandic banks, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae, American Insurance Group, Ambac, MBIA, Countrywide Financial, Countrywide Home Loans, PMI, General Motors, Ford and a pretty full retinue of US home builders. In other words, the bankers who created the synthetic CDOs knew exactly what they were doing. These were not simply investment products created out of thin air and designed to give their sales people something from which to earn fees – although they were that too. They were specifically designed to protect the banks against default by the most leveraged companies in the world. And of course the banks knew better than anyone else who they were. As one part of the bank was furiously selling loans to these companies, another part was furiously selling insurance contracts against them defaulting, to unsuspecting investors who were actually a bit like 'Lloyds Names' – the 1500 or so individuals who back the London reinsurance giant. Except in this case very few of the 'names' knew what they were buying. And nobody has any idea how many were sold, or with what total face value. It is known that some $2 billion was sold to charities and municipal councils in Australia, but that is just the tip of the iceberg in this country. And Australia, of course, is the tiniest tip of the global iceberg of synthetic CDOs. The total undoubtedly runs into trillions of dollars. All the banks did it, not just Lehman Brothers which had the largest market share, and many of them seem to have invested in the things as well (a bit like a dog eating its own vomit). It is now getting very interesting. The three Icelandic banks have defaulted, as has Countrywide, Lehman and Bear Stearns. AIG has been taken over by the US Government, which is counted as a part-default, and Freddie Mac and Fannie Mae are in 'conservatorship', which is also a part default. Ambac, MBIA, PMI, General Motors, Ford and a lot of US home builders are teetering. If the list of defaults – full and partial – gets to nine, then a mass transfer of money will take place from unsuspecting investors around the world into the banking system. How much? Nobody knows, but it’s many trillions. It will be the most colossal rights issue in the history of the world, all at once and non-renounceable. Actually, make that mandatory. The distress among those who lose their money will be immense. It will be a real loss, not a theoretical paper loss. Cash will be transferred from their own bank accounts into the issuing bank, via these Cayman Islands special purpose vehicles. The repercussions on the losers and the economies in which they live, will be unpredictable but definitely huge. Councils will have to put up rates to continue operating. Charities will go to the wall and be unable to continue helping those in need. Individual investors will lose everything. There will also be a tsunami of litigation, as dumbfounded investors try to get their money back, claiming to have been deceived by the sales people who sold them the products. In Australia, some councils are already suing the now-defunct Lehman Brothers, and litigation funder, IMF Australia, has been studying synthetic CDOs for nine months preparing for the storm. But for the banks, it’s happy days. Suddenly, when the ninth reference entity tips over, they will be flooded with capital. It’s possible they will have so much new capital, they won’t know what to do with it. This is entirely uncharted territory so it’s impossible to know what will happen [as said above it 'could be a disaster that tips the world from recession into depression'], but it is possible that the credit crunch will come to sudden and complete end, like the passing of a tornado that has left devastation in its wake, along with an eerie silence." - Alan Kohler
Highly respected Australian financial journalist. Published in the financial newsletter and website, 'The Eureka Report', 19 Nov 2008.
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[Quote No.30463] Need Area: Money > Invest
"[Especially in recessions or other times when getting credit is difficult] Deep value and high quality alone are not sufficient conditions for investing in common stocks. Deep value pricing and high quality assets must be accompanied by creditworthiness [i.e. low debt to equity, good free cash-flow and interest cover, quality collateral, good management, a sound time-tested business model, financially strong suppliers and customers, pricing power, etc]" - Marty Whitman
Legendary, deep-value, fund manager of Third Avenue Funds.
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[Quote No.30477] Need Area: Money > Invest
"[The business and share market cycle always has a down period - a recession where the excesses are removed - and more!] In the beginning, there is The Bubble. Then, the bubble pops. Then, people look around and take fright. They realize they've got to stop spending. So, demand collapses. Then, stocks collapse too. And asset prices fall too - especially for speculative assets. As orders and asset prices tumble... merchants and manufacturers cut back too. Jobs are lost. And then, with less income... demand collapses some more. But then, eventually, the bubble is completely flattened. Weak companies have gone out of business. Good companies are holding on, but producing less. Many retail shops have closed. Many malls have gone out of business. Supplies of goods and services have fallen as far as they're going to fall. Then, with supplies tight, prices begin to rise again. The whole process takes time. There are millions of mistakes in need of correction. Each one has to be marked down, written off, worked out, and forgotten. We still have to see the show trials. And the perp walks. And the kvetching... the complaining... the whining... the wimpering. The bailouts and the payoffs... The bottles of whiskey and the loaded revolvers [allowing the dishonoured to do the honourable thing]. It's all still ahead! ... 'The only cure for a bubble is to prevent it from developing.' said [economist Dr.] Kurt Richebacher. In other words, you can't cure a bubble by cutting interest rates, easing bank lending requirements, running bigger government deficits, sending out 'rebate' checks, buying up Wall Street's stupid mistakes, or bailing out sinking businesses. You can't cure a bubble by reflating it. You can't cure a bubble at all. You have to let it pop... and then go about your business. Get it over with quickly; that's the best you can do. Think that will happen? Where have you been, dear reader? Out of Blackberry range? No, the feds are at work - with their patches, their rescues, their bamboozles and their swindles. In our brief moment of clarity ... we saw what was coming - the biggest financial bailout of history. It will be like WWII, without Betty Grable... like the New Deal without the wheelchair - and like nothing we've ever seen. Saving America from free-market capitalism will become the Great National Project of the [U.S. President] Obama years. Deficits will top $1 trillion... maybe $2 trillion. Brain dead businesses will be kept alive. Whole industries that should be allowed to go broke will be protected. Towns, states, and colleges that should go bust will be propped up. There will also be a huge building boom - in infrastructure. Bridges, trains, highways... ... it may be time to buy cement companies! The bailouts are just money down the drain. As for the bridges, who knows whether they are worth the money? But this massive program will achieve its real purpose - distracting and diverting Americans from their loss of wealth. If Olympic medals were given for consumer spending, Americans would have won the gold, silver and bronze every year for the last 20. But now, Americans may become champion savers. Savings could rise to maybe 10% of GDP. What will happen to all this money? It will be lent to the government... So do you see, dear reader, how the new financial system will work? Instead of squandering their money - as Americans have done for the last 20 years - now, the government will squander it for them. Here comes the Era of Conspicuous Thrift. Yes, you heard it here first. 'No more fancy pants,' is a headline at the New York Times. The gist of the accompanying article is that even expensive restaurants are now trying to look cheap. People who still have money to spend don't want to spend it... and when they do spend it, they don't want to look like they are spending it. So restaurants are putting on de po' bo'... that is, they're acting poor. Gone are the sumptuous drapes... gone are the plush carpets and marble tables... gone are the fancy pant waiters. 'Luxury is a dirty word,' said one of the designers. Don't get us wrong. People always look for ways to feel superior to their fellows. In the bubble years, they did so by spending wildly... trying to outdo each other with the extravagance of their purchases and the sans soucis of their budgeting. Young Wall Street pros... or rap musicians... would go out to a fancy restaurant and order a big bottle of Cristal - just to show off. But styles change. Now, people are showing off by NOT spending money. Sound unbelievable? Well, maybe. But our guess is that people are going to find more subtle... and less expensive... ways to wink at each other. Heavy spending is going the way of heavy drinking. It will be seen as vulgar. " - Bill Bonner
Founder and editor of the financial newsletter, 'The Daily Reckoning'. Quote published in the Australian version, 19th Nov, 2008.
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[Quote No.30478] Need Area: Money > Invest
"The only cure for a [share market, etc] bubble is to prevent it from developing." - Dr. Kurt Richebacher
Editor of 'The Richebacher Letter', was a world-renowned author, economist, and international banker.
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[Quote No.30480] Need Area: Money > Invest
"Commodities - Base metals have many uses: Iron is the primary ingredient of steel; nickel is also required to make stainless steel; zinc is required for auto parts; copper for electrical wires in electronics and housing; aluminium is important for many uses." - Unknown

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[Quote No.30481] Need Area: Money > Invest
"It is now clear that central banks were basing monetary policy in the first half of this year [2008] on the forward oil futures curve, which had the oil price stabilising at $US120 a barrel, as well as a continuation of the China boom. The collapse in the oil price since July to $US55 caught them by surprise. Suddenly they are no longer worrying about inflation, but deflation instead, and this switch has occurred with incredible speed. This morning comes news that consumer prices in the US fell 1 per cent in October, the largest ever fall. Yesterday the governor of the Bank of England, Mervyn King, said it was 'very likely' that inflation in the UK would turn negative next year and there was 'obviously' a risk of deflation, which is why the Bank of England cut interest rates by 1.5 per cent this month, its largest ever move. In speeches over the past 24 hours, various central bankers, including RBA [Reserve Bank of Australia] governor Glenn Stevens, have fingered the collapse of Lehman Brothers as the moment when the earth moved for them and previous monetary and liquidity policies had to change. But when the history of this time is written (and written, and written) it is likely that the unexpected collapse in the oil price will be seen as more important. Here’s what Glenn Stevens said in his speech to CEDA last night: 'What had been for over a year a serious dislocation in international financial markets, but one which seemed to be being managed, turned quite suddenly into a very serious crisis during the weeks following the failure of Lehman Brothers on 15 September.' 'In a breathtaking turn of events, the financial landscape changed dramatically, with the failure or rescue and effective nationalisation of a number of systemically important financial institutions in the United States, the United Kingdom and continental Europe. Share markets slumped, currencies moved abruptly, commodity prices continued their sharp decline and investors’ appetite for risk contracted further.' There was also a speech last night by the deputy governor of the Bank of England, Sir John Gieve, in which he said the collapse of Lehman Brother, led to a 'dramatic loss of confidence'. Note the word 'continued' by Glenn Stevens in relation to commodity prices: that it had already been happening. Lehman’s collapse might have devastated asset markets, but commodity prices were already in free fall. The tightening of the credit squeeze in mid-September reduced the effectiveness of monetary policy because market interest rates shot up and banks stopped lending. The official cash rate target became a sideshow. But it did not eliminate inflation. That has been achieved by the collapse in commodity prices, and in particular the oil price. Central banks are trying to fight consumer price deflation with the equivalent of a popgun. Their only weapon is the cash rate target’s impact on aggregate demand, but the actual interest rates that consumers and businesses are paying are not coming down to anywhere near the same extent and demand is still falling because banks are rationing credit and confidence is collapsing. The problem with consumer price deflation is that has a more immediate and devastating impact on the debt burden than asset price deflation. (The exception to that is where firms have to mark their assets to market in their balance sheets.) As prices and therefore incomes fall (not wages at first, but business incomes) debt doesn’t change. Its relative value rises and it becomes more difficult to service. During previous deflationary episodes, in particular the 1930s, there was much less household debt than there is now. In Australia household debt is now 160 per cent of disposable income – almost triple what it was just 12 years ago and many times what it was 80 years ago: in the 1930s depression few people actually owned their own home. The other problems with deflation are that it causes consumers to hold back and wait for lower prices later, and it redistributes wealth from borrowers to savers, reversing the intended affect of the reduction in official interest rates. All of these things are hard to reverse once they take hold, which is why it’s often referred to as a deflationary spiral. Japan had it in its 'lost decade' of the 1990s, and never decisively pulled out, so that deflation is threatening there once again." - Alan Kohler
Highly respected Australian financial journalist. Published in 'The Eureka Report', 20 Nov 2008.
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[Quote No.30482] Need Area: Money > Invest
"VOICES OF REASON STILL IN THE WILDERNESS: 'Karl Marx (1818-1883) originated the idea that recurrent crises [stock market and real estate crashes] are inherent in the unhampered (free) market economy. [Austrian economist, Ludwig von] Mises has shown that 'the trade [stock market, real estate and business] cycle is... on the contrary, the inevitable effect of manipulation of the money market' - Percy L. Greaves Jr., 'Mises Made Easier' Occasionally I hear the odd guest on CNBC or Bloomberg Radio who lays blame for the crisis in exactly the right place - the Federal Reserve System in the U.S....or central banking more broadly. These extremely influential institutions ostensibly exist to regulate prices, employment and interest rates by way of control over the money supply. They do this by inflating bank reserve credit, on which the banks can pyramid, thus essentially abrogating the role of interest rate determination by the market. That is, the central bank tries to determine interest rates as far as it can. The rationale for this policy is to attain full employment and price stability, and to otherwise manage economic affairs. Any economist whose lenses aren't blurred by the fatal errors of the neo-classical [econo-political] doctrines is immediately capable of spotting the problem with that policy foundation. Unemployment could scarcely exist on a free market, where the government did not interfere with the price of labor. Just like shortages of goods cannot really exist in a market where their price is free to adjust to the reality of existing conditions, there can be no excess labor unless the government intervenes to artificially boost its price. It's the same principle. It is a simple economic fact - free of political considerations. Labor is an economic good primarily because it is scarce. Moreover, whether we are talking about labor legislation or the central bank trying to manage growth, prices and interest rates, it amounts to economic management, even planning. The apparent effect of the policy is to bring about a boom in investment and consumption... the building up of bubble companies and uneconomic enterprises relying on the continued increases in the selling prices of the goods they deal in - be it widgets, homes or securities. These price increases are afforded by regular money debasement, which is one of the economic consequences of an increase in the supply of money in particular. So it is illusory. In reality, as [Libertarian] Rothbard points out, the boom 'is actually a period of wasteful misinvestment. It is the time when errors are made, due to bank credit's tampering with the free market'. So this policy, and the booms it engenders, crowds out real savings (by pushing rates below market), and investment comes to rely on the continued 'stimulus' of money creation or from borrowing overseas. Ultimately, it further lays the seeds of its own demise because the process invariably arrives at a point at which the central bank must desist if it does not want to prompt a run of confidence in its notes, leading to hyperinflation. This is why we say the policy is 'unsustainable.' Thus it tries to withdraw the stimulus or 'tighten' money and credit [monetary policy] - explaining that the overheated economy might produce inflation. The error in its thinking is that it is managing a delicate balance between price stability and growth...that it checks market failures, and can know the unknowable (the future). In fact, almost all economists would agree, it cannot produce growth. It's like the analogy of pushing on a string. The Fed's policy can only increase employment by decreasing the relative cost of labor through inflation (the expansion of money supply relative to demand, which reduces the cost seen as interest rates). And as one of the largest of interventions conducted by government policy, it only produces more instability - i.e. the boom-bust cycle as well as interest rate and foreign exchange volatility eventually. Technically, tampering with the rate of interest produces disequilibrium as a mismatch between consumer preferences and producers' investment plans - during the boom phases. Effectively, it taxes long run growth, and is but a massive redistribution of wealth from savers to borrowers and speculators. The bust, which often begins with the onset of a financial crisis, brings much pain, and threatens job losses on a wide-scale. But this is because the artificially low rate of interest produced by the previous policy, which could not be sustained, produced waste, a 'cluster of error' as Rothbard called it. This 'malinvestment' or uneconomic activity is essentially exposed as the subsidy is withdrawn. In his book, 'America's Great Depression', Rothbard posits the error in Marx's reasoning, 'In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors AT THE SAME TIME.' What you see then is basically the widespread failure of parasitic enterprises that could not survive on their own - without the handouts and support of the central bank. This is the empirical evidence that should indict any inflation policy. But, the bust still merely represents a return to natural market ratios. 'The 'depression' is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires. The adjustment process consists in rapid liquidation of the wasteful investments.' (Rothbard) It follows then, that 'Attempts to interfere with free and flexible prices, wage and interest rates prevent recovery and prolong the depression period.' (Percy L. Greaves Jr., 'Mises Made Easier') Efforts to stabilize the bust with even more inflation effectively prevent the liquidation of uneconomic enterprises necessary to return the economy to equilibrium, where markets reflect actual conditions. Now, I'm not a policy maker. I don't want to suggest the best way to fix the world or argue why these theories are true. My chief concern is the future. And the evidence that most people would side with Marx on this (over Mises et al) is all I need to predict more inflation, war and higher gold prices. Joe Public can't for the life of him figure out why it matters if interest rates are 1.5% or 1%. He cannot connect the escalating price at the pump to the process of money creation required to bring about such a modest change in the interest rate. The tech bust was the fault of irrational speculators, and greedy investment bankers. The housing bust is blamed on Wall Street's larceny, his mortgage and real estate brokers, or the thrust toward deregulation. The painful increase in commodity prices is caused by too much growth. The growing trade deficit is caused by new competition from foreign countries. And so on. For, Joe takes his cue not from Mises, but from the media and political classes under heavy influence by the progressive institutions. Political leaders in Europe, meanwhile [in 2008], are taking full advantage of Joe to wage a new war on capitalism from the left on grounds that American style capitalism is in dire need of more regulation. This is the great evil of the inflation policy. It is insidious. The great economists have all recognized this truth. It only produces the opposite of what it claims to accomplish. It also funds the growth of government and anti-capitalist sentiment, and other confused ideas that may lead, ultimately, to the general disintegration in the division of labor, the fabric of society. It promotes moral degradation and corruption, conflict, and finances wars. It is 80% of what's wrong with the world. But for the most part, the voices of reason that point to this cause are trampled over by the rhetoric of the larger political class, which fear mongers people into clamoring for more money and credit. This truth is evident in the Fed's actions. [In 2008] It has abandoned any remnants of conservatism, as have the other central banks worldwide. The helicopter blades are in full swing. So any enthusiasm about the world having reached this place where it is ready to turn a new leaf must be tempered by this fact. The voices of reason, though on the beltway, are still only voices in the wilderness. This alone suggests we are going to continue to see more inflation, taxes and government. The scary part is that this process is accelerating." - Ed Bugos
He is the editor of 'Gold & Options Trader'. Published in the financial newsletter, 'The Daily Reckoning Australia', 20th Nov, 2008.
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[Quote No.30483] Need Area: Money > Invest
"Karl Marx (1818-1883) originated the idea that recurrent crises [stock market and real estate crashes] are inherent in the unhampered (free) market economy... [Austrian economist, Ludwig von] Mises has shown that 'the trade [stock market, real estate and business] cycle is... on the contrary, the inevitable effect of manipulation of the money market." - Percy L. Greaves Jr.
From his book on the Libertarian-Austrian economics of Ludwig von Mises, 'Mises Made Easier'.
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[Quote No.30492] Need Area: Money > Invest
"The essential function of Wall Street [and all the other parts of the free market capitalist system] is to allocate capital — to decide who should get it and who should not. [its cost, etc in a Darwinian evolutionary survival of the 'fittest' sense]" - Michael Lewis
Former investment banker and author of 'Liar’s Poker', that chronicled his personal view of his experiences.
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[Quote No.30493] Need Area: Money > Invest
"There’s a simple measure of sanity in housing prices: the ratio of median home price to income. Historically, it runs around 3 to 1; by late 2004, it had risen nationally to 4 to 1... [However] In Los Angeles, it was 10 to 1, and in Miami, 8.5 to 1. And then you coupled that with the buyers. They weren’t real buyers. They were speculators. [so it was easy to know the housing market would bust but when was not clear! The housing market started to deteriorate in 2005 and was still falling in 2009, after creating a credit crisis and a stock market fall of over 50%.]" - Ivy Zelman
Housing-market analyst at Credit Suisse
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[Quote No.30495] Need Area: Money > Invest
"[In less than one year since 2007] The typical stock market investor has lost about half his money. He's looking for someone to blame - surely, it's not his own fault! And so now, poor Wall Street, the public is catching on to your scam... ...that the special knowledge you claimed was nothing but smooth talking claptrap... ...that you really didn't know any more than anyone else about what was actually going on... ...that what you were doing was skimming money from honest businesses with a lot of fancy shenanigans and unnecessary transactions... ...and selling stocks to naive lumpen - claiming that equities 'always go up in the long run' ...and loading up business and consumers with more debt than they could carry... ...and then greasing the debt over to investors, softly assuring them that 'our models show the risk of default is negligible...it won't happen, not in a thousand years.' That was only a few months ago. And now the debt has gone bad - trillions worth of it. And now, so many things that Wall Street promised have turned out to be lies and humbug that the whole world financial system has seized up... And here we switch from the 'innocent fraud' of Wall Street, as [the famous economist] Galbraith calls it, to the armed robbery of government. You see, the Obama Administration will have one overriding priority: to unblock the credit markets, put things back to 'normal,' and get the economy moving again. If he can do that - or even appear to do that (which is the only possibility) - Obama will go down in history as one of the nation's greatest presidents. Of course, everyone is rooting for him. When times are good...we like horror movies and terrorist threats. But when they are bad, we want flicks with happy endings. Obama's election was a landmark for many reasons. But he won largely because voters wanted a 'Hollywood ending' to the campaign. And now they want a Hollywood ending to the new national nightmare. Will they get it? Nah...but they might like the show anyway. Dan Amoss offers his two cents: 'Those fearing deflation assume that every American consumer is stereotypical: an overextended, credit card-addicted, house-flipping gambler. This is simply not the case. Many Americans don't have a mortgage. And most Americans with mortgages are still making their payments. They have, however, temporarily reigned in discretionary spending because of falling house and stock prices. 'Those fearing deflation also assume that demand for debt is low and falling. But demand for debt doesn't always come from businesses or households looking to invest more or spend more. Any business or household looking to refinance existing debt at lower rates - and there are many - is a source of demand for new debt. Banks borrowing at the Fed window at 1% or less will be looking to supply this new debt by make highly profitable loans to creditworthy borrowers. 'Once borrowers refinance, they may not be as aggressive about spending or expanding business as they used to be. But at least they will have access to credit. In the Great Depression, they did not. So the economy fell into a negative feedback loop of asset sales, bank failures, and rising unemployment. 'Treasury and the Fed will keep taking extreme measures to slow down the pace of credit contraction and housing prices - cutting off this deflationary feedback loop. This could include nationalizing Fannie Mae and Freddie Mac and using the Treasury's low borrowing costs to refinance hundreds of billions in existing mortgage debt into new 40- or 50-year mortgages with reduced principal balances. 'Sure, such an action would guarantee a decade or more of stagnation in housing prices, but it will also slow or flatten the rapid decline in prices. This is the essence of the Treasury and Fed actions: to stop the deleveraging from getting out of control - even at the cost of future economic stagnation. Like it or not, I think this is the most likely outcome from this crisis.' And now, let's look at what the Federal Reserve is doing... As you'll recall, the main man at the Fed, Ben Bernanke, has spent almost his entire life studying what went wrong in the United States in the '30s and in Japan in the '90s. He's determined not to let it happen again - not on his watch. And so, he's taking America's central bank where no central bank has ever gone before. From the day of its founding in 1913, the Fed's assets - the foundation capital of the U.S. banking system - grew, reaching $1 trillion on the 24th of September, 2008. But then, something extraordinary happened. Something breathtaking. And for a classical economist - something incredibly reckless. In the next six weeks, the Fed added another trillion. And the head of the Dallas Branch of the Fed said that he expected to add another trillion before the end of the year. How does the Fed get these 'assets?' Simple. It buys them. Where does it get the money to buy them? Simple again: it creates it. It makes it up. It conjures it out of nothing. 'If it comes from nothing,' you might wonder, 'what could it really be worth?' But we're not going to answer that question. We don't have time. Besides, it takes us in such a deep metaphysical swamp, we're afraid we may never slosh our way out...or at least not get out in time for lunch. Instead, we're going to answer this question: 'If it was that easy, how come the Fed didn't do it before?' The answer to that is simple: because when the Fed inflates the money supply it risks inflating consumer prices. People don't like that. They like it when asset prices go up. But not when gasoline and milk increase. But now, no one is worried about consumer prices. In fact, the Fed is worried about deflation...about falling prices. Bernanke knows what happens when consumer prices begin to fall. Consumers stop spending - knowing that they will be able to get a better deal in the future. That further depresses the economy...and pretty soon it's the '90s again and you're back in Tokyo. So the Fed has begun a huge program of monetary inflation, intended to offset Mr. Market's price-cutting. And now another question: Isn't there some risk that the Fed will overdo it? Oh, dear reader...that's a puffball of a pitch. If we can't hit that, you can take our laptop away...you can break our sword...and send us back to the dugout. Remember what happened in the slump of the early 2000s? Alan Greenspan panicked...cut rates to 1%...and left them there for more than a year. He gave the market the wrong medicine at the wrong time...and then delivered such a horse-sized dose, it set off the biggest bubble in mankind's whole bubbly history. Now, it's a different kind of slump...a credit slump. And once again, the Fed is on the scene, like a quack doctor at the side of a heart-attack victim. This time, he's giving stronger medicine...not just a 1% lending rate, but actual monetary inflation. Trillions of dollars worth of it. For the moment, Mr. Market is taking away dollars faster than the Bernanke Fed is replacing them. That could continue...for a few months...or even for several years. But it won't continue forever. And here, we affirm our unshakeable faith in the people who lead us. They are trying to cause inflation. Eventually, they will get the hang of it. They may shoot for 2% per year; but they are sure to overshoot. Money printers always do." - Bill Bonner
Founder and editor of the financial newsletter, 'The Daily Reckoning'. Published in the Australian version, 21st Nov, 2008.
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[Quote No.30496] Need Area: Money > Invest
"[In 1944, as World War II was coming to a close, world leaders converged on a New Hampshire hotel to hammer out a world monetary system. The currency chaos that had begun in 1931, and which continued through the 1930s, had proved intolerable. It was called the Bretton Woods system. Could a system like that be decided upon again?] In 1944, the world leaders that gathered in New Hampshire decided on a system based on gold. This was no innovation, as monetary systems for the past few centuries had also been based on gold. In the Bretton Woods system, the dollar was pegged to gold at $35/oz., and other currencies were pegged to the dollar. Currencies didn't float in those days. Floating, manipulated currencies were considered an abomination. Exchange rates remained fixed. This stable, gold-linked system formed the foundation for a wonderful worldwide expansion of wealth in the 1950s and 1960s - even among the war's losers, Germany and Japan. Unfortunately, there was a flaw in this plan. Interest rate manipulation, as practiced by the Fed[eral reserve], was surging in popularity. It was hoped this currency tomfoolery would prevent another Great Depression, and every other little recession along the way. This 'monetary policy' and currency manipulation was contrary to the simple, automatic currency board-like mechanisms by which gold standard systems should be operated. The result was that the fixed exchange rates and gold link came under constant pressure. For a while, governments attempted to have it both ways. They imposed various capital controls to keep exchange rates fixed - while at the same time their central banks played games that caused exchange rates to diverge. The dollar/gold peg was not maintained by judicious supply adjustment, as a currency board would operate, but by heavy-handed intervention in the gold market in London. Eventually, the conflict between manipulative central banks and the gold link became overwhelming. In January 1970, Richard Nixon installed his friend Arthur Burns as Chairman of the Federal Reserve. Burns immediately opened the monetary floodgates to help offset the recession of the time - following the day's conventional wisdom. In August 1971, the conflict between Burns' manipulation and the gold link became too great, and, rather than abandoning Burns' currency games, it was decided to abandon the gold link instead. The dollar had become a floating currency. By 1973, all the major currencies floated. An economic catastrophe ensued, the inflation of the 1970s. Even in the 1980s and 1990s, as currencies were stabilized somewhat, economies never regained the health they showed in the 1950s and 1960s. Emerging markets, in particular, were beset by regular currency disasters. The environment of monetary chaos that we have lived in for the past thirty-seven years has finally produced a political willingness to fix the problem. Governments sense that, if they do not take action now, a worldwide crisis may ensue. Just as in 1944, governments want to return to the monetary stability upon which capitalism was founded. On November 15, governments will gather to talk about a 'New Bretton Woods.' There is even some talk that gold will play a part. The creators of this New Bretton Woods, if they are able to agree on anything at all, would do well to recognize the successes and failures of the original Bretton Woods. Bretton Woods was, overall, a great success. This was due to the link with gold, and the fixed exchange rates worldwide. Capitalism since the Industrial Revolution had been based on this monetary principle, and it worked again as it had in the past. The reason that the Bretton Woods gold standard did not persist indefinitely was not government deficits, or insufficient gold bullion reserves, 'current account imbalances' or any other such thing. The only reason that governments decided to abandon the gold link was that they preferred to play central bank games with their currencies. A New Bretton Woods must wholly and completely abandon such practices. Without these guiding principles, this month's discussions are likely to devolve into an unworkable hodgepodge of currency baskets, CPI targets, promises likely to be broken, and rhetorical vagaries. Certainly no usable system would emerge, although an unusable system might. A New Bretton Woods, of gold-linked currencies worldwide, would be very easy to create. It could be done in a weekend, and wouldn't cost a dime. It is merely a decision to manage currencies one way - a gold link - rather than another way. [The loss of the ability of the currency to absorb global financial shocks through a floating exchange rate would have to be weighed in relation to a currency that, by being fixed to gold, would stop governments from: 1- printing money [increasing the money suppy] whenever they decided to implement or increase another welfare program or increase the size of government bureacracy when their political constituents would not accept the necessary increased taxation and/or; 2- manipulating their currency's value thereby implementing the 'secret tax' of inflation which robs the value of the savings of hard working citizens (while reducing the burden of debt) and causes tax bracket creep so more people find themselves paying a higher tax rate in those countries with a progressive rather than a flat tax system.]" - Nathan Lewis
Author of 'Gold: the Once and Future Money'. Published in the financial newsletter, 'The Daily Reckoning - Australia', 21st Nov 2008.
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[Quote No.30501] Need Area: Money > Invest
"The cardinal rule [of hedge fund or any other investing is] protect capital during down markets." - George Soros
Chairman of the hedge fund firm, Soros Fund Management
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[Quote No.30521] Need Area: Money > Invest
"A capitalistic system overshoots, it overshoots in markets, it overshoots in terms of leverage and all kinds of things. But it works very well over time." - Warren Buffett
Highly successful value investor, Chairman of Berkshire Hathaway and one of the richest men in the world.
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[Quote No.30525] Need Area: Money > Invest
"[In recessions the demand for and the price of art falls, along with the stock market and real estate prices.] Sotheby's sold just 59.5 per cent of art work offered for sale at its November 2008 auction. The sale grossed $A2.7 million, despite analyst expectations of between $A3.3 million and $A4.4 million." - The Australian Financial Review

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[Quote No.30527] Need Area: Money > Invest
"A T-Bond [fixed interest investment from the US Treasury] Bubble Waiting to Burst: Remember when the Dow Jones industrial average touched 14,000 a year ago? When gold reached $1,000 per troy ounce in May, and Moscow's RTS market index was trading above 2,500? Or when a barrel of oil cost $147 in July? When the bubble in the U.S. housing market deflated in mid-2007, a massive wave of money began sloshing around the world, quickly inflating and then bursting a series of speculative bubbles in various markets. Now, it is up to the final bubble - the U.S. government debt bubble. Treasury bond yields have been falling steadily over the past year and a half, as investors looked for safety amid collapsing markets and economic uncertainty: The yield on the 10-year Treasury bond fell from more than 5 percent to 3 percent. Falling yields mean that bond prices have skyrocketed; the price of the 30-year T-bond is at a record high. But T-bonds may no longer offer the traditional safety on which investors have usually counted. On the contrary, bond prices may plunge just as spectacularly as house prices, commodity prices and stock prices have in recent months. What's remarkable, Russia may end up playing a key role in the deflation of the U.S. government debt market. True, Russia has a small economy, accounting for no more than 3 percent of global gross domestic product, and its financial markets are no match for the world's financial hubs. It is a major player in only two areas - commodities and natural resources. Nevertheless, Russia nearly dragged down the global financial system when it suffered a debt default in 1998, and it may do so again now. Although the Central Bank's gold and foreign currency reserves have decreased from their August high of $600 billion, they are still the world's third-largest, at $484 billion. Over the past decade, the Russian government has been one of the world's most important buyers of dollar-denominated securities. According to U.S. Treasury Department data, Russia bought about $65 billion worth of T-bonds since the start of 2007, but sold about $5 billion in September alone. Overall, Central Bank reserves shrank by $122 billion by early November - mainly to fund the bailout programs and to support the ruble. This suggests that the government sold even more Treasury securities over the past six weeks to come up with the cash. Moreover, the holdings - and sales - of T-bonds by Russian official entities and private investors have been underestimated, since many Russian companies and wealthy individuals hold their assets in Luxembourg, the Caribbean and other offshore centers. Russia has been hit by the current financial crisis harder than most other emerging economies, which means that the liquidation of its U.S. Treasury holdings will continue, and may even accelerate in coming months. This may be the start of a global avalanche, since other central banks have been drawing down their reserves as well, albeit by smaller amounts. Further down the road looms China's $586 billion fiscal stimulus package, which will be financed by the liquidation of U.S. Treasury securities that the country's government and central bank hold. Even as world central banks stop buying U.S. T-bonds and start selling them, demand for funds in Washington is escalating. The federal budget deficit reached a record $237 billion in October alone. In fiscal year 2008, which began Oct. 1, it will widen to at least $1 trillion. Washington will need to raise $1.5 trillion in the current year, according to U.S. Treasury Secretary Henry Paulson. It is safe to assume that Paulson's estimate is a conservative one. Driven by rising supply and falling demand, [prices may fall and therefore] yields on U.S. government bonds may spike. This will cause interest payments, which currently measure some $450 billion per year, to skyrocket. The worst-case scenario would be if the United States finds that it can't borrow what it needs at any price - the same situation many consumers and companies already face in the current credit crunch. Unlike private borrowers, however, the government has a solution. It can simply print money to meet its financial obligations. This is an old trick. The printing press is the last resort of any government that discovers it can no longer raise money from lenders or taxpayers. It was used by the German government after World War I and, more recently, by such debtor nations as Argentina and Brazil. Printing vast quantities of money inevitably produces higher inflation, but, on the other hand, inflation has the advantage of reducing the real value of debt and, in countries with a progressive taxation system, of boosting government revenues, since it pushes more taxpayers into higher income brackets. Since the dollar is a reserve currency, the problem with printing dollars is that the subsequent inflation will be instantly transmitted abroad. At the start of this decade, for example, no nation could escape a liquidity bubble once the U.S. Federal Reserve began pumping dollars into the world financial system. If Washington starts printing extra dollars, foreign central banks will either be forced to revalue their currencies sharply against the greenback - and thus worsen the already nasty recession at home - or issue more domestic currency to match the depreciating dollar. For now, most economic forecasters around the world still expect falling prices next year. Consumer prices in the United States fell by a dramatic 1 percent in October. But this will change quickly if the Treasury bubble bursts and the U.S. government is forced to start up the dollar printing presses. Russia, as usual, has the most to fear from this turn of events. Russia has not been able to defeat inflation this decade, when inflationary pressures elsewhere in the world were benign, and its consumer prices continued to rise at double-digit rates for most of the period. The World Bank sees inflation increasing to as high as 14 percent next year. The current crisis has shown that the negative developments in world financial market affect Russia sooner - and harder - than most other emerging economies. If the United States suffers a bout of high inflation, Russia - and its long-suffering savers - may face something similar to the hyperinflation the country experienced in the early 1990s. [This is the reason many financial advisors are recommending buying gold at today's price of about U.S. $800 an ounce. This is a similar situation to the 1970's when commodity prices crashed, dollar printing caused inflation and then to bring this under control Federal Reserve Chairman, Paul Volcker raised interest rates into double digits.]" - Alexei Bayer
a native Muscovite, is a New York-based economist. Published on the Moscow Times website, 24 November 2008
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[Quote No.30528] Need Area: Money > Invest
"I have been saying for a long time that we would be dealing with deflation next year [2009], and that has been met with a lot of reader skepticism. And when inflation hit 5.6% last July [2008], that skepticism was understandable. But this would be a strange world indeed if you had the twin bubbles of housing and credit burst and didn't see a whiff of deflation. Recessions and the bursting of bubbles are by definition deflationary. And I have been giving thought to the idea that we may have seen a mini-bubble in the price of many commodities, and that bubble has been bursting as well. And since commodity prices were the main cause of inflation, as they retreat the rise in the inflation rate is retreating. This week the latest inflation numbers showed a drop to 3.7% on a year-over-year basis. But the Consumer Price Index (CPI) fell by a full 1% in October. You have to go back to the 1930s to find a one-month drop as large. And I don't think this is just a one-month anomaly caused by falling energy prices. The housing component, which is 32% of the index, is based on Owners' Equivalent Rents (OER). As I have written elsewhere, over very long periods of time this works as well as actual housing prices. You simply have to pick your basis for comparison and stick with it. If, for instance, we had been using house prices for the last ten years, we would have seen large increases in inflation up until a year ago, and since then the index would have been in outright (and serious) deflation. But we use OER, so prices in the CPI have been more stable. But that looks like it could be changing. OER has been rising steadily over the last decade as rents went up. The index showed a 3% rise in 2007, for instance. The recent trend has been down from there, and last month there was no rise in the cost of shelter. Given the number of houses for sale and a weakened economy, I think it is likely we will see outright reductions in the cost of rent, which will translate into a much lower inflation number. Lower prices are a two-way street. When they result from improved productivity and efficiency, that is considered to be a good thing. But when they are the result of lower demand, that can be problematic. There is the likelihood that the Fed will lower rates to 50 basis points, and some major and very seasoned economists are now predicting a zero percent Fed funds rate early next year. Given that Fed funds are actually trading at 38 basis points, a drop to 50 basis points would change nothing on a practical level. (Can we say Japan?) With that in mind, let's revisit [Federal Reserve Chairman Ben] Bernanke's speech. Every central banker is mindful of Japan and the 1930s in the US. Deflation is something that will not be allowed. But what if the Fed lowers interest rates to zero and demand does not pick up, along with a little inflation? Quoting Ben: 'To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system -- for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.' Just a thought here. We could see real drops in the CPI next year. We could also see a US government deficit approach $1 trillion and go right on through that heretofore unthinkable number. As I wrote last week, a reduced trade deficit means that there will be fewer dollars abroad to buy our debt. The difference will have to be made up by either increased savings in the US or higher rates to attract buyers OR the Fed monetizing the debt. I think the Fed would be highly reluctant to monetize debt in a period of inflation like we have been in, no matter what problems we face. But in a period where we could be facing deflation? It is very possible they would consider monetizing the debt, as will central banks all over the world. We are in unprecedented times. A (1) deep recession coupled with (2) financial institutions deleveraging, added to (3) a consumer who is going to be forced to save more and spend less while (4) commodity prices are falling, on top of (5) a serious slowdown in the velocity of money, and you have the makings of a perfect deflationary storm. The Fed would be forced to fight it. What would they do if lowering the Fed rate to zero was not enough? As Bernanke stated, they would simply set the rates for 1- and 2-year notes and further out the curve if they felt they needed to. And if Goldman Sachs is right in its latest revised forecast, the economy is going to need some help: 'Goldman said it now expects U.S. GDP to fall 5 percent in the current quarter, with unemployment rate reaching 9 percent in the fourth quarter of 2009. It also forecast the 10-year yield to fall to 2.75 percent by the end of the first quarter of 2009, as compared to previously estimated 3.5 percent.' ''The combination of weaker real activity and slower inflation means that profits of U.S. companies will fall even more sharply than we had previously expected,' Goldman said in a note to clients. Goldman now sees economic profits falling 25 percent in 2009 on an annual average basis, the biggest drop since 1938. It had earlier expected a fall of 20 percent. Goldman expects unemployment rates to further go up in 2010 as well, as there is little chance of the economy returning to trend growth by that year.' Other mainstream economists think GDP might fall this quarter by as much as 5%. That does not bode well for retails sales this Christmas." - John Mauldin
President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states.
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[Quote No.30529] Need Area: Money > Invest
"[Beware of times when speculation is rampant and the market is booming. The legitimate need for speculation to provide a way to increase liquidity for illiquid assets can create incorrect assumptions about future behaviour of prices. Remember the past doesn't indicate the future.] Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." - John Maynard Keynes
Famous economist
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[Quote No.30535] Need Area: Money > Invest
"As economies deteriorate [going into and during recessions] so do company profits [earnings] and so do valuation multiples [pe's] on the share market. [so the price drops can be very steep]." - Rudi Filapek-Vandyck
Editor of FNArena [Financial News Arena]
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[Quote No.30564] Need Area: Money > Invest
"Change is like a train. It can either run over you, or you can catch it to the future." - John Mauldin
President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states.
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[Quote No.30565] Need Area: Money > Invest
"Short sellers typically keep open a position for less time than those that are long. This is because there is a cost to maintain the position, and if the stock pays a dividend then the short seller has to fund this from their own funds in order to pay the institution it has borrowed the stock from." - Kris Sayce
Editor of financial newsletter, 'Money Morning'.
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[Quote No.30569] Need Area: Money > Invest
"'You can understand how fraudulent most economic analysis is,' Nassim [Taleb, financial analyst and author] explained, 'just by looking the life of the turkey. The animal is fed for 1000 days...and then it is killed. So, if you plotted out the turkey's life on a chart, it would look great for 1,000 days...each day, the food arrived reliably, and each day, the turkey gained weight. The turkeys would look around and say they were enjoying growth and a bull market. Momentum investors would see it as an opportunity. The quants would run linear regressions on the data and prove that the risk was minimal.' Ben Bernanke [Federal Reserve Chairman] would describe the turkey's life - with no setbacks - as the product of a 'great moderation.' Turkey stockbrokers would assure their clients that nothing had ever gone wrong in the turkey's life. Turkey econometricians and theorists would come up with explanations for why the turkeys' growth would continue forever and they'd pat each other on the back for having finally mastered the 'turkey cycle.' Turkey politicians would run for re-election on the grounds that they had helped create a better world. And turkey economists would project further weight gains...until the turkey was the size of a hippopotamus. Then, come Thanksgiving, and all of a sudden, something goes wrong. Alas, all the turkeys' theories, models, and conceits were for the birds. 'Rare events can't be modeled,' Nassim continued. 'Because they are too rare. You can't get a statistically reliable sample. Alan Greenspan recently explained that he 'had never seen anything like this before.' Well, of course he had never seen it before. It never happened before.' 'Because these events are so rare, they are also completely unpredictable...and usually much worse than you can expect. Like Thanksgiving Day for the turkey.'" - Bill Bonner
Founder and Editor of the financial newsletter, 'The Daily Reckoning'. Published in the Australian version, Thursday 27th, 2008.
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[Quote No.30573] Need Area: Money > Invest
"Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. [So only buy when the price is so far below its intrinsic price that you have a big margin of safety and a built in profit]" - Warren Buffett
Highly successful value investor, Chairman of Berkshire Hathaway and one of the richest men in the world.
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[Quote No.30586] Need Area: Money > Invest
"Analysts at Goldman Sachs JB Were have written a remarkably honest confession to their clients about why analysts keep getting profit forecasts wrong in a downturn like this. And it contains the first public admission I have seen from any analysts that it is hard to reduce earnings forecasts because they need to 'curry favour' with company management. The confession was contained in last Friday’s daily to clients from GSJBW and was written by Sam Ferraro and Matthew Ross. It seems they had a series of meetings with portfolio managers the week before and found that 'there is some frustration' with the fact that they have been slow to reduce their earnings forecasts since the onset of the financial crisis. Ferraro and Ross point out that GSJBW’s equity strategist, Chris Pidcock, is currently forecasting a decline in industrial earnings per share in 2009 of 15 per cent. However the 'bottom up' analysts (that is, those who look at individual companies) are, in aggregate, still forecasting profit growth next year of 3 per cent and 11 per cent for 2010. One can just imagine the fund managers barbecuing the hapless bottom-up analysts on a slow rotisserie when they see this sort of thing. To their credit, the GSJBW analysts have confronted the problem head-on, and very candidly, in the essay in Friday’s daily. Here is a summary of the four reasons they cite: – They haven’t seen anything like this before – that is, 'the paucity of financial crises ... in recent history' means they tend to 'underestimate the effects of systematic or top-down developments'. – The companies haven’t seen anything like this before. A survey of analysts reveals that 25 per cent of companies that used to provide profit guidance no longer do (and guidance is all-important – see the next point, below). CEOs, they say, are chosen for their 'left brain skills: optimism, ambition, hard work, focus and decisiveness. Patience and an appreciation of history are not considered virtues for these individuals'. – Analysts 'seek to curry favour with management in order to preserve their information networks'. Everyone knew this already, but it’s the first time I’ve seen it admitted. – Analysts need to manage their 'reputational risks', so they 'engage in herding behaviour'. That is, the costs of getting a big call wrong far outweigh the benefits of getting a big one right. The bottom line is that analyst profit forecasts are virtually useless. Fund managers have known this for a long time, which is why they do their own forecasts. Broker research is more read for ideas and insights, and for subtle hints about companies that are written in code. But pity the poor retail investor who doesn’t understand the code and simply believes the profit forecasts and recommendations. Occasionally an analyst will break out and speak plainly, as Sanjay Magotra of Citigroup did last month when he flipped from Buy to Sell on Asciano, dramatically reducing his price target. Last week Sanjay Magotra cleared his desk and left Citigroup. He wasn’t sacked apparently, but he certainly didn’t 'manage his reputational risk' or 'curry favour with management', and now he is out of a job. Back to Ferraro and Ross: more amazing, perhaps, than their confession is that they don’t expect things to improve. 'Our expectation is that sector analysts’ forecasts will continue to not accurately reflect deteriorating operating conditions for many companies.' They conclude by suggesting that clients stick with analysts that have 'long track records', rather than their 'less seasoned counterparts'. They don’t, however, mention the big salaries that analysts get to produce decent research for their firms’ clients, when in fact they are just managing their reputation risk and currying favour with corporate management." - Alan Kohler
Highly respected Australian financial journalist. From the financial newsletter and website, the 'Eureka Report', 2nd Dec 2008.
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[Quote No.30589] Need Area: Money > Invest
"[Markets are both about businesses and people's perceptions about future performance. Therefore the best approach to investing is a blend of value investing, which focusses on business performance and technical trading, which focusses on the market's perception of future performance by studying charts that show the actual behaviour of the market participants. Some of the rules of technical chart investors are:] -1. Never, under any circumstance add to a losing position.... ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin! -2. Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand. -3. Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital. -4. The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is 'low.' Nor can we know what price is 'high.' Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed 'cheap' many times along the way. -5. In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many. -6. 'Markets can remain illogical longer than you or I can remain solvent,' according to our good friend, Dr. A. Gary Shilling. Illogic often reigns and markets are enormously inefficient despite what the academics believe. -7. Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones. -8. Try to trade the first day of a gap, for gaps usually indicate violent new action. We have come to respect 'gaps' in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important. -9. Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In 'good times,' even errors are profitable; in 'bad times' even the most well researched trades go awry. This is the nature of trading; accept it. -10. To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we, trade. -11. Respect 'outside reversals' after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more 'weekly' and 'monthly,' reversals. -12. Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds elegance. -13. Respect and embrace the very normal 50-62% retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen... just as we are about to give up hope that they shall not. -14. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights. -15. Establish initial positions on strength in bull markets and on weakness in bear markets. The first 'addition' should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements. -16. Bear markets are more violent than are bull markets and so also are their retracements. -17. Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are 'right' only 30% of the time, as long as our losses are small and our profits are large. -18. The market is the sum total of the wisdom ... and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom. If we learn nothing more than this we've learned much indeed. -19. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold. -20. The hard trade is the right trade: If it is easy to sell, don't; and if it is easy to buy, don't. Do the trade that is hard to do and that which the crowd finds objectionable. Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then. -21. There is never one cockroach [problem in a company]! -22. All rules are meant to be broken: The trick is knowing when... and how infrequently this rule may be invoked!" - Anirudh Sethi

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[Quote No.30590] Need Area: Money > Invest
"For those interested in technical trading one of the best intoductions is Stan Weinstein's 'Secrets For Profiting in Bull and Bear Markets'. It provides a very solid basic long-term strategy that can be integrated with value investing methodologies." - Seymour@imagi-natives.com

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[Quote No.30610] Need Area: Money > Invest
"Chief executives who themselves own few shares of their companies have no more feeling for the average stockholder than they do for baboons in Africa." - T. Boone Pickens
American oil tycoon
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[Quote No.30620] Need Area: Money > Invest
"A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation. Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high - despite policy rates close to zero - leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors' problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions." - Nouriel Roubini
Economics Professor, New York University. Quoted 6th December, 2008.
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[Quote No.30621] Need Area: Money > Invest
"In economics there is what you see and then there is what you don't see. [The more important of the two items is what you don't see.] " - Frederic Bastiat

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[Quote No.30623] Need Area: Money > Invest
"What I do is prepare myself until I know I can do what I have to do." - Joe Namath

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[Quote No.30637] Need Area: Money > Invest
"What happened in 2008 [stock market and real estate crash and credit crisis]? Chances are you can't succinctly express your views on that complex question. But the American public will settle on one of four catch phrases over the next several months. Whatever bit of conventional wisdom wins out will have an impact on the economy. The contenders are as follows. 1-Free markets ran amok. The broad deregulatory trend of the past 30 years finally went too far. Financial geniuses cooked up new ways to buy, slice, dice, reconstitute, and sell mortgages as novel securities that no one really understood but that investors were willing to buy because rating agencies - clueless, conflicted, and unregulated - said they were solid. Mortgage brokers were permitted to confuse and deceive prospects. Supposedly stabilizing the whole system was a multitrillion-dollar market in credit default swaps that was totally unregulated. When government fails to police the financial sector strictly, that is what happens. If this version wins out, watch for heavy new regulation of risk markets and financial institutions - leading to reduced innovation, profitability, and market values in the sector. 2-Greenspan did it. In the late 1990s, when former Federal Reserve chairman Alan Greenspan knew that stock prices were irrational, he failed to put the brakes on, and then, trying to rescue the economy after the resulting market bust from 2000 to 2002, he cut interest rates too far too fast. Credit became insanely easy throughout the economy, and everybody but him could see it. He even reassured the nation that there wasn't a housing bubble, and such words from the maestro emboldened hapless homebuyers to continue down their doomed path of paying and borrowing ever more money. When one person gains so much influence over the financial system and screws up, the result is disaster. Expect little structural change but intense new congressional and media scrutiny of the Fed if this explanation triumphs. 3-Bill Clinton spawned the subprime epidemic. To gain favor with the lower-income voters who are an important part of their base, the Democrats heavily revised the Community Reinvestment Act in 1995 and took other measures that virtually forced lenders to give mortgages to subprime borrowers. Remember the outcry over redlining, the practice of refusing to lend for homebuying in certain neighborhoods? Congress sure fixed that, and now those neighborhoods are the hot zones of the foreclosure crisis. Banks that refused to lend to those borrowers weren't evil, they were prudent - until Clinton and Congress made that illegal. Even if Democrats have come to believe this now, they will be hard pressed to narrow the scope of homeownership. So expect little change. 4-Americans lost their self-discipline. Lenders, borrowers, and investors - everybody forgot that financial life requires hard work and is filled with risk. Mortgage lenders had good reasons for demanding that borrowers submit mountains of paperwork and make a 20% down payment, and borrowers quite rightly felt their hearts in their throats when they signed the note. All that disappeared from 2002 to 2008. Millions of us in every part of the system chose to believe that we could get rich quickly, easily, and safely, that work and risk assessment no longer mattered. When a whole society decides to abandon basic virtues, large-scale trouble is certain. Wide embrace of this view would strengthen financial companies as Americans became bigger savers and would create new businesses as economizing became more chic. It's fine to argue that the real answer is a nuanced combination of these and other factors, but that won't do. By this time next year, public opinion will have settled on a one-sentence explanation. (If you doubt our propensity for reducing complex economic maladies to blurbs, think of how the Great Depression is now remembered as something Herbert Hoover got us into and F.D.R. got us out of.) So what happened in 2008? Of course I like the nuanced combination of factors, but if forced to order off the menu above, I'd say that answer No. 4 is the most nearly correct. My prediction is that answer No. 1 will win. I hope I'm wrong." - Geoff Colvin
senior editor at large, Fortune Magazine, December 8, 2008.
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[Quote No.30647] Need Area: Money > Invest
"Economic Depressions: Their Cause and Cure: We live in a world of euphemism. Undertakers have become 'morticians,' press agents are now 'public relations counsellors' and janitors have all been transformed into 'superintendents.' In every walk of life, plain facts have been wrapped in cloudy camouflage. No less has this been true of economics. In the old days, we used to suffer nearly periodic economic crises, the sudden onset of which was called a 'panic,' and the lingering trough period after the panic was called 'depression.' The most famous depression in modern times, of course, was the one that began in a typical financial panic in 1929 and lasted until the advent of World War II. After the disaster of 1929, economists and politicians resolved that this must never happen again. The easiest way of succeeding at this resolve was, simply to define 'depressions' out of existence. From that point on, America was to suffer no further depressions. For when the next sharp depression came along, in 1937-38, the economists simply refused to use the dread name, and came up with a new, much softer-sounding word: 'recession.' From that point on, we have been through quite a few recessions, but not a single depression. But pretty soon the word 'recession' also became too harsh for the delicate sensibilities of the American public. It now seems that we had our last recession in 1957-58. For since then, we have only had 'downturns,' or, even better, 'slowdowns,' or 'sidewise movements.' So be of good cheer; from now on, depressions and even recessions have been outlawed by the semantic fiat of economists; from now on, the worst that can possibly happen to us are 'slowdowns.' Such are the wonders of the 'New Economics.' For 30 years, our nation's economists have adopted the view of the business cycle held by the late British economist, John Maynard Keynes, who created the Keynesian, or the 'New,' Economics in his book, 'The General Theory of Employment, Interest, and Money', published in 1936. Beneath their diagrams, mathematics, and inchoate jargon, the attitude of Keynesians toward booms and bust is simplicity, even naivete, itself. If there is inflation, then the cause is supposed to be 'excessive spending' on the part of the public; the alleged cure is for the government, the self-appointed stabilizer and regulator of the nation's economy, to step in and force people to spend less, 'sopping up their excess purchasing power' through increased taxation. If there is a recession, on the other hand, this has been caused by insufficient private spending, and the cure now is for the government to increase its own spending, preferably through deficits, thereby adding to the nation's aggregate spending stream. The idea that increased government spending or easy money is 'good for business' and that budget cuts or harder money is 'bad' permeates even the most conservative newspapers and magazines. These journals will also take for granted that it is the sacred task of the federal government to steer the economic system on the narrow road between the abysses of depression on the one hand and inflation on the other, for the free-market economy is supposed to be ever liable to succumb to one of these evils. All current schools of economists have the same attitude. Note, for example, the viewpoint of Dr. Paul W. McCracken, the incoming chairman of President Nixon's Council of Economic Advisers. In an interview with the New York Times shortly after taking office [January 24, 1969], Dr. McCracken asserted that one of the major economic problems facing the new Administration is 'how you cool down this inflationary economy without at the same time tripping off unacceptably high levels of unemployment. In other words, if the only thing we want to do is cool off the inflation, it could be done. But our social tolerances on unemployment are narrow.' And again: 'I think we have to feel our way along here. We don't really have much experience in trying to cool an economy in orderly fashion. We slammed on the brakes in 1957, but, of course, we got substantial slack in the economy.' Note the fundamental attitude of Dr. McCracken toward the economy – remarkable only in that it is shared by almost all economists of the present day. The economy is treated as a potentially workable, but always troublesome and recalcitrant patient, with a continual tendency to hive off into greater inflation or unemployment. The function of the government is to be the wise old manager and physician, ever watchful, ever tinkering to keep the economic patient in good working order. In any case, here the economic patient is clearly supposed to be the subject, and the government as 'physician' the master. It was not so long ago that this kind of attitude and policy was called 'socialism'; but we live in a world of euphemism, and now we call it by far less harsh labels, such as 'moderation' or 'enlightened free enterprise.' We live and learn. What, then, are the causes of periodic depressions? Must we always remain agnostic about the causes of booms and busts? Is it really true that business cycles are rooted deep within the free-market economy, and that therefore some form of government planning is needed if we wish to keep the economy within some kind of stable bounds? Do booms and then busts just simply happen, or does one phase of the cycle flow logically from the other? The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late eighteenth century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: That these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention. There are, however, some critical problems in the assumption that the market economy is the culprit. For 'general economic theory' teaches us that supply and demand always tend to be in equilibrium in the market and that therefore prices of products as well as of the factors that contribute to production are always tending toward some equilibrium point. Even though changes of data, which are always taking place, prevent equilibrium from ever being reached, there is nothing in the general theory of the market system that would account for regular and recurring boom-and-bust phases of the business cycle. Modern economists 'solve' this problem by simply keeping their general price and market theory and their business cycle theory in separate, tightly-sealed compartments, with never the twain meeting, much less integrated with each other. Economists, unfortunately, have forgotten that there is only one economy and therefore only one integrated economic theory. Neither economic life nor the structure of theory can or should be in watertight compartments; our knowledge of the economy is either one integrated whole or it is nothing. Yet most economists are content to apply totally separate and, indeed, mutually exclusive, theories for general price analysis and for business cycles. They cannot be genuine economic scientists so long as they are content to keep operating in this primitive way. But there are still graver problems with the currently fashionable approach. Economists also do not see one particularly critical problem because they do not bother to square their business cycle and general price theories: the peculiar breakdown of the entrepreneurial function at times of economic crisis and depression. In the market economy, one of the most vital functions of the businessman is to be an 'entrepreneur,' a man who invests in productive methods, who buys equipment and hires labor to produce something which he is not sure will reap him any return. In short, the entrepreneurial function is the function of forecasting the uncertain future. Before embarking on any investment or line of production, the entrepreneur, or 'enterpriser,' must estimate present and future costs and future revenues and therefore estimate whether and how much profits he will earn from the investment. If he forecasts well and significantly better than his business competitors, he will reap profits from his investment. The better his forecasting, the higher the profits he will earn. If, on the other hand, he is a poor forecaster and overestimates the demand for his product, he will suffer losses and pretty soon be forced out of the business. The market economy, then, is a profit-and-loss economy, in which the acumen and ability of business entrepreneurs is gauged by the profits and losses they reap. The market economy, moreover, contains a built-in mechanism, a kind of natural selection, that ensures the survival and the flourishing of the superior forecaster and the weeding-out of the inferior ones. For the more profits reaped by the better forecasters, the greater become their business responsibilities, and the more they will have available to invest in the productive system. On the other hand, a few years of making losses will drive the poorer forecasters and entrepreneurs out of business altogether and push them into the ranks of salaried employees. If, then, the market economy has a built-in natural selection mechanism for good entrepreneurs, this means that, generally, we would expect not many business firms to be making losses. And, in fact, if we look around at the economy on an average day or year, we will find that losses are not very widespread. But, in that case, the odd fact that needs explaining is this: How is it that, periodically, in times of the onset of recessions and especially in steep depressions, the business world suddenly experiences a massive cluster of severe losses? A moment arrives when business firms, previously highly astute entrepreneurs in their ability to make profits and avoid losses, suddenly and dismayingly find themselves, almost all of them, suffering severe and unaccountable losses – How come? Here is a momentous fact that any theory of depressions must explain. An explanation such as 'underconsumption' – a drop in total consumer spending – is not sufficient, for one thing, because what needs to be explained is why businessmen, able to forecast all manner of previous economic changes and developments, proved themselves totally and catastrophically unable to forecast this alleged drop in consumer demand. Why this sudden failure in forecasting ability? An adequate theory of depressions, then, must account for the tendency of the economy to move through successive booms and busts, showing no sign of settling into any sort of smoothly moving, or quietly progressive, approximation of an equilibrium situation. In particular, a theory of depression must account for the mammoth cluster of errors which appears swiftly and suddenly at a moment of economic crisis, and lingers through the depression period until recovery. And there is a third universal fact that a theory of the cycle must account for. Invariably, the booms and busts are much more intense and severe in the 'capital goods industries' – the industries making machines and equipment, the ones producing industrial raw materials or constructing industrial plants – than in the industries making consumers' goods. Here is another fact of business cycle life that must be explained – and obviously can't be explained by such theories of depression as the popular underconsumption doctrine: That consumers aren't spending enough on consumer goods. For if insufficient spending is the culprit, then how is it that retail sales are the last and the least to fall in any depression, and that depression really hits such industries as machine tools, capital equipment, construction, and raw materials? Conversely, it is these industries that really take off in the inflationary boom phases of the business cycle, and not those businesses serving the consumer. An adequate theory of the business cycle, then, must also explain the far greater intensity of booms and busts in the non-consumer goods, or 'producers' goods,' industries. Fortunately, a correct theory of depression and of the business cycle does exist, even though it is universally neglected in present-day economics. It, too, has a long tradition in economic thought. This theory began with the eighteenth century Scottish philosopher and economist David Hume, and with the eminent early nineteenth century English classical economist David Ricardo. Essentially, these theorists saw that another crucial institution had developed in the mid-eighteenth century, alongside the industrial system. This was the institution of banking, with its capacity to expand credit and the money supply (first, in the form of paper money, or bank notes, and later in the form of demand deposits, or checking accounts, that are instantly redeemable in cash at the banks). It was the operations of these commercial banks which, these economists saw, held the key to the mysterious recurrent cycles of expansion and contraction, of boom and bust, that had puzzled observers since the mid-eighteenth century. The Ricardian analysis of the business cycle went something as follows: The natural moneys emerging as such on the world free market are useful commodities, generally gold and silver. If money were confined simply to these commodities, then the economy would work in the aggregate as it does in particular markets: A smooth adjustment of supply and demand, and therefore no cycles of boom and bust. But the injection of bank credit adds another crucial and disruptive element. For the banks expand credit and therefore bank money in the form of notes or deposits which are theoretically redeemable on demand in gold, but in practice clearly are not. For example, if a bank has 1000 ounces of gold in its vaults, and it issues instantly redeemable warehouse receipts for 2500 ounces of gold, then it clearly has issued 1500 ounces more than it can possibly redeem. But so long as there is no concerted 'run' on the bank to cash in these receipts, its warehouse-receipts function on the market as equivalent to gold, and therefore the bank has been able to expand the money supply of the country by 1500 gold ounces. The banks, then, happily begin to expand credit, for the more they expand credit the greater will be their profits. This results in the expansion of the money supply within a country, say England. As the supply of paper and bank money in England increases, the money incomes and expenditures of Englishmen rise, and the increased money bids up prices of English goods. The result is inflation and a boom within the country. But this inflationary boom, while it proceeds on its merry way, sows the seeds of its own demise. For as English money supply and incomes increase, Englishmen proceed to purchase more goods from abroad. Furthermore, as English prices go up, English goods begin to lose their competitiveness with the products of other countries which have not inflated, or have been inflating to a lesser degree. Englishmen begin to buy less at home and more abroad, while foreigners buy less in England and more at home; the result is a deficit in the English balance of payments, with English exports falling sharply behind imports [a trade deficit]. But if imports exceed exports, this means that money must flow out of England to foreign countries. And what money will this be? Surely not English bank notes or deposits, for Frenchmen or Germans or Italians have little or no interest in keeping their funds locked up in English banks. These foreigners will therefore take their bank notes and deposits and present them to the English banks for redemption in gold – and gold will be the type of money that will tend to flow persistently out of the country as the English inflation proceeds on its way. But this means that English bank credit money will be, more and more, pyramiding on top of a dwindling gold base in the English bank vaults. As the boom proceeds, our hypothetical bank will expand its warehouse receipts issued from, say 2500 ounces to 4000 ounces, while its gold base dwindles to, say, 800. As this process intensifies, the banks will eventually become frightened. For the banks, after all, are obligated to redeem their liabilities in cash, and their cash is flowing out rapidly as their liabilities pile up. Hence, the banks will eventually lose their nerve, stop their credit expansion, and in order to save themselves, contract their bank loans outstanding. Often, this retreat is precipitated by bankrupting runs on the banks touched off by the public, who had also been getting increasingly nervous about the ever more shaky condition of the nation's banks. The bank [credit] contraction reverses the economic picture; contraction and bust follow boom. The banks pull in their horns, and businesses suffer as the pressure mounts for debt repayment and contraction. The fall in the supply of bank money, in turn, leads to a general fall in English prices. As money supply and incomes fall, and English prices collapse, English goods become relatively more attractive in terms of foreign products, and the [trade] balance of payments reverses itself, with exports exceeding imports. As gold flows into the country, and as bank money contracts on top of an expanding gold base, the condition of the banks becomes much sounder. This, then, is the meaning of the depression phase of the business cycle. Note that it is a phase that comes out of, and inevitably comes out of, the preceding expansionary boom. It is the preceding inflation that makes the depression phase necessary. We can see, for example, that the depression is the process by which the market economy adjusts, throws off the excesses and distortions of the previous inflationary boom, and reestablishes a sound economic condition. The depression is the unpleasant but necessary reaction to the distortions and excesses of the previous boom. Why, then, does the next cycle begin? Why do business cycles tend to be recurrent and continuous? Because when the banks have pretty well recovered, and are in a sounder condition, they are then in a confident position to proceed to their natural path of bank credit expansion, and the next boom proceeds on its way, sowing the seeds for the next inevitable bust. But if banking is the cause of the business cycle, aren't the banks also a part of the private market economy, and can't we therefore say that the free market is still the culprit, if only in the banking segment of that free market? The answer is No, for the banks, for one thing, would never be able to expand credit in concert were it not for the intervention and encouragement of government. For if banks were truly competitive, any expansion of credit by one bank would quickly pile up the debts of that bank in its competitors, and its competitors would quickly call upon the expanding bank for redemption in cash. In short, a bank's rivals will call upon it for redemption in gold or cash in the same way as do foreigners, except that the process is much faster and would nip any incipient inflation in the bud before it got started. Banks can only expand comfortably in unison when a Central Bank exists, essentially a governmental bank, enjoying a monopoly of government business, and a privileged position imposed by government over the entire banking system. It is only when central banking got established that the banks were able to expand for any length of time and the familiar business cycle got underway in the modern world. The central bank acquires its control over the banking system by such governmental measures as: Making its own liabilities legal tender for all debts and receivable in taxes; granting the central bank monopoly of the issue of bank notes, as contrasted to deposits (in England the Bank of England, the governmentally established central bank, had a legal monopoly of bank notes in the London area); or through the outright forcing of banks to use the central bank as their client for keeping their reserves of cash (as in the United States and its Federal Reserve System). Not that the banks complain about this intervention; for it is the establishment of central banking that makes long-term bank credit expansion possible, since the expansion of Central Bank notes provides added cash reserves for the entire banking system and permits all the commercial banks to expand their credit together. Central banking works like a cozy compulsory bank cartel to expand the banks' liabilities; and the banks are now able to expand on a larger base of cash in the form of central bank notes as well as gold. So now we see, at last, that the business cycle is brought about, not by any mysterious failings of the free market economy, but quite the opposite: By systematic intervention by government in the market process. Government intervention brings about bank expansion and inflation, and, when the inflation comes to an end, the subsequent depression-adjustment comes into play. [which is just one example of why libertarians believe government interference in the free market must be kept to the minimum possible]. The Ricardian theory of the business cycle grasped the essentials of a correct cycle theory: The recurrent nature of the phases of the cycle, depression as adjustment intervention in the market rather than from the free-market economy. But two problems were as yet unexplained: Why the sudden cluster of business error, the sudden failure of the entrepreneurial function, and why the vastly greater fluctuations in the producers' goods than in the consumers' goods industries? The Ricardian theory only explained movements in the price level, in general business; there was no hint of explanation of the vastly different reactions in the capital and consumers' goods industries. The correct and fully developed theory of the business cycle was finally discovered and set forth by the Austrian economist Ludwig von Mises, when he was a professor at the University of Vienna. Mises developed hints of his solution to the vital problem of the business cycle in his monumental 'Theory of Money and Credit', published in 1912, and still, nearly 60 years later, the best book on the theory of money and banking. Mises developed his cycle theory during the 1920s, and it was brought to the English-speaking world by Mises's leading follower, Friedrich A. von Hayek, who came from Vienna to teach at the London School of Economics in the early 1930s, and who published, in German and in English, two books which applied and elaborated the Mises cycle theory: 'Monetary Theory and the Trade Cycle', and 'Prices and Production'. Since Mises and Hayek were Austrians, and also since they were in the tradition of the great nineteenth-century Austrian economists, this theory has become known in the literature as the 'Austrian' (or the 'monetary over-investment') theory of the business cycle. Building on the Ricardians, on general 'Austrian' theory, and on his own creative genius, Mises developed the following theory of the business cycle: Without bank credit expansion, supply and demand tend to be equilibrated through the free price system, and no cumulative booms or busts can then develop. But then government through its central bank stimulates bank credit expansion by expanding central bank liabilities and therefore the cash reserves of all the nation's commercial banks. The banks then proceed to expand credit and hence the nation's money supply in the form of check deposits. As the Ricardians saw, this expansion of bank money drives up the prices of goods and hence causes inflation. But, Mises showed, it does something else, and something even more sinister. Bank credit expansion, by pouring new loan funds into the business world, artificially lowers the rate of interest in the economy below its free market level. On the free and unhampered market, the interest rate is determined purely by the 'time-preferences' of all the individuals that make up the market economy. For the essence of a loan is that a 'present good' (money which can be used at present) is being exchanged for a 'future good' (an IOU which can only be used at some point in the future). Since people always prefer money right now to the present prospect of getting the same amount of money some time in the future, the present good always commands a premium in the market over the future. This premium is the interest rate, and its height will vary according to the degree to which people prefer the present to the future, i.e., the degree of their time-preferences. People's time-preferences also determine the extent to which people will save and invest, as compared to how much they will consume. If people's time-preferences should fall, i.e., if their degree of preference for present over future falls, then people will tend to consume less now and save and invest more; at the same time, and for the same reason, the rate of interest, the rate of time-discount, will also fall. Economic growth comes about largely as the result of falling rates of time-preference, which lead to an increase in the proportion of saving and investment to consumption, and also to a falling rate of interest. But what happens when the rate of interest falls, not because of lower time-preferences and higher savings, but from government interference that promotes the expansion of bank credit? In other words, if the rate of interest falls artificially, due to intervention, rather than naturally, as a result of changes in the valuations and preferences of the consuming public? What happens is trouble. For businessmen, seeing the rate of interest fall, react as they always would and must to such a change of market [price] signals: They invest more in capital and producers' goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge. In short, businessmen react as they would react if savings had genuinely increased: They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods. Businesses, in short, happily borrow the newly expanded bank money that is coming to them at cheaper rates; they use the money to invest in capital goods, and eventually this money gets paid out in higher rents to land, and higher wages to workers in the capital goods industries. The increased business demand bids up labor costs, but businesses think they can pay these higher costs because they have been fooled by the government-and-bank intervention in the loan market and its decisively important tampering with the interest-rate [price of money] signal of the marketplace. The problem comes as soon as the workers and landlords – largely the former, since most gross business income is paid out in wages – begin to spend the new bank money that they have received in the form of higher wages. For the time-preferences of the public have not really gotten lower; the public doesn't want to save more than it has. So the workers set about to consume most of their new income, in short to reestablish the old consumer/saving proportions. This means that they redirect the spending back to the consumer goods industries, and they don't save and invest enough to buy the newly-produced machines, capital equipment, industrial raw materials, etc. This all reveals itself as a sudden sharp and continuing depression in the producers' goods industries. Once the consumers reestablished their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods and had underinvested in consumer goods. Business had been seduced by the governmental tampering and artificial lowering of the rate of interest, and acted as if more savings were available to invest than were really there. As soon as the new bank money filtered through the system and the consumers reestablished their old proportions, it became clear that there were not enough savings to buy all the producers' goods, and that business had misinvested the limited savings available. Business had overinvested in capital goods and underinvested in consumer products. The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The 'depression' is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed. Since the workers receive the increased money in the form of higher wages fairly rapidly, how is it that booms can go on for years without having their unsound investments revealed, their errors due to tampering with market signals become evident, and the depression-adjustment process begins its work? The answer is that booms would be very short lived if the bank credit expansion and subsequent pushing of the rate of interest below the free market level were a one-shot affair. But the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production. Thus, the Misesian theory of the business cycle accounts for all of our puzzles: The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, the far greater intensity of the boom and bust in the producers' goods industries. Mises, then, pinpoints the blame for the cycle on inflationary bank credit expansion propelled by the intervention of government and its central bank. What does Mises say should be done, say by government, once the depression arrives? What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom. Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands off, 'laissez-faire' policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue. The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget. It has today been completely forgotten, even among economists, that the Misesian explanation and analysis of the depression gained great headway precisely during the Great Depression of the 1930s – the very depression that is always held up to advocates of the free market economy as the greatest single and catastrophic failure of laissez-faire capitalism. It was no such thing. 1929 was made inevitable by the vast bank credit expansion throughout the Western world during the 1920s: A policy deliberately adopted by the Western governments, and most importantly by the Federal Reserve System in the United States. It was made possible by the failure of the Western world to return to a genuine gold standard after World War I, and thus allowing more room for inflationary policies by government. Everyone now thinks of President Coolidge as a believer in laissez-faire and an unhampered market economy; he was not, and tragically, nowhere less so than in the field of money and credit. Unfortunately, the sins and errors of the Coolidge intervention were laid to the door of a non-existent free market economy. If Coolidge made 1929 inevitable, it was President Hoover who prolonged and deepened the depression, transforming it from a typically sharp but swiftly-disappearing depression into a lingering and near-fatal malady, a malady 'cured' only by the holocaust of World War II. Hoover, not Franklin Roosevelt, was the founder of the policy of the 'New Deal': essentially the massive use of the State to do exactly what Misesian theory would most warn against – to prop up wage rates above their free-market levels, prop up prices, inflate credit, and lend money to shaky business positions. Roosevelt only advanced, to a greater degree, what Hoover had pioneered. The result for the first time in American history, was a nearly perpetual depression and nearly permanent mass unemployment. The Coolidge crisis had become the unprecedentedly prolonged Hoover-Roosevelt depression. Ludwig von Mises had predicted the depression during the heyday of the great boom of the 1920s – a time, just like today, when economists and politicians, armed with a 'new economics' of perpetual inflation, and with new 'tools' provided by the Federal Reserve System, proclaimed a perpetual 'New Era' of permanent prosperity guaranteed by our wise economic doctors in Washington. Ludwig von Mises, alone armed with a correct theory of the business cycle, was one of the very few economists to predict the Great Depression, and hence the economic world was forced to listen to him with respect. F. A. Hayek spread the word in England, and the younger English economists were all, in the early 1930s, beginning to adopt the Misesian cycle theory for their analysis of the depression – and also to adopt, of course, the strictly free-market policy prescription that flowed with this theory. Unfortunately, economists have now adopted the historical notion of Lord Keynes: That no 'classical economists' had a theory of the business cycle until Keynes came along in 1936. There was a theory of the depression; it was the classical economic tradition; its prescription was strict hard money and laissez-faire; and it was rapidly being adopted, in England and even in the United States, as the accepted theory of the business cycle. (A particular irony is that the major 'Austrian' proponent in the United States in the early and mid-1930s was none other than Professor Alvin Hansen, very soon to make his mark as the outstanding Keynesian disciple in this country.) What swamped the growing acceptance of Misesian cycle theory was simply the 'Keynesian Revolution' – the amazing sweep that Keynesian theory made of the economic world shortly after the publication of the 'General Theory' in 1936. It is not that Misesian theory was refuted successfully; it was just forgotten in the rush to climb on the suddenly fashionable Keynesian bandwagon. Some of the leading adherents of the Mises theory – who clearly knew better – succumbed to the newly established winds of doctrine, and won leading American university posts as a consequence. But now the once arch-Keynesian London Economist has recently proclaimed that 'Keynes is Dead.' After over a decade of facing trenchant theoretical critiques and refutation by stubborn economic facts, the Keynesians are now in general and massive retreat. Once again, the money supply and bank credit are being grudgingly acknowledged to play a leading role in the cycle. The time is ripe – for a rediscovery, a renaissance, of the Mises theory of the business cycle. It can come none too soon; if it ever does, the whole concept of a Council of Economic Advisors would be swept away, and we would see a massive retreat of government from the economic sphere. But for all this to happen, the world of economics, and the public at large, must be made aware of the existence of an explanation of the business cycle that has lain neglected on the shelf for all too many tragic years." - Murray N. Rothbard
(1926 – 1995), economist, libertarian and author. He wrote 'Man, Economy, and State', 'Conceived in Liberty', 'What Has Government Done to Our Money', 'For a New Liberty', 'The Case Against the Fed', and many other books and articles. He was also the editor – with Lew Rockwell – of The Rothbard-Rockwell Report, and academic vice president of the Ludwig von Mises Institute. This essay was originally published as a minibook by the Constitutional Alliance of Lansing, Michigan, 1969. Copyright © 2008 Ludwig von Mises Institute
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[Quote No.30654] Need Area: Money > Invest
"Academics will agonise over the causes of the [2008 credit crisis and banking liquidity and solvency] catastrophe for years to come. Suffice it to say that leverage, speculation and lax regulation were broadly to blame - the major culprits being [government's economically irrational but politically useful interference,] the Wall Street banks and the kowtowing US Federal Reserve. Tinker, then kaboom: One obscure change in legislation, barely reported at the time, has proved momentous. And that was the decision by the Securities & Exchanges Commission (SEC) to revoke long-standing rules in 2004 which required broker/dealers to keep their [capital adequacy] debt-to-net-capital ratio to 15-1 [Bank leverage is made possible by government law relating to creating a fractional reserve banking system that allows banks to ignore normal business liquidity and solvency requirements which dramatically increases their risk of default and all the accompanying problems to customers and the economy. Governments promote/accept this because they incorrectly believe it allows them to 'manage' - Austrian economists and libertarians would say 'mismanage' (interfere in for political gain) - the free market, money supply and demand (monetary policy), inflation, employment, gross domestic/national product, etc]. In other words, for every $15 of debt, the banks were required to have $1 of equity. Thanks to quiet lobbying from Wall Street however, this ceiling was dropped and the likes of Bear Stearns soon ran up a gross debt ratio of 33-1. Then kaboom. There was no adequate capital cushion in the event of default and the orgy of structuring, selling and speculation in the likes of mortgage backed securities, combined with a bubble in real estate markets ensured a nasty denouement." - Michael West
Quoted from the 'Sydney Morning Herald' newspaper, December 11, 2008
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[Quote No.30656] Need Area: Money > Invest
"Capitalism provides rewards and penalties. When the penalties are artificially removed by central bank intervention, the system can no longer be called capitalism. Perhaps ‘regulated free market socialism’ is a better definition for the new paradigm... Faith in the capitalist system to self-regulate overlooks one very important factor. The very thing that makes the capitalist system superior to a centralised collective system is also the cause of its downfall in listed entities. While providing the monetary incentive to succeed, capitalism also punishes failure by loss of capital. This is fine when the owner of the business runs the business. When management is also the provider of capital, their fortunes go hand in hand with the success or failure of the business. There is a tendency for the listed public company model to provide the opposite. In publicly listed entities, management and the providers of capital are different parties with different agendas. Management’s incentive to earn bonuses and high salaries based on achieving short-term targets is usually in conflict with the capital provider’s objective to achieve reasonable long-term returns with preservation of capital the overriding consideration. [This is called 'agency risk'.] Remuneration arrangements allow management to share in the upside with no downside risk. [This makes their interests different from the owners of the company and therefore often explains behaviour that has short-term benefits, but causes long-term problems.] Not unlike giving someone a large sum of money to bet at the race track and allowing them to keep a percentage of the winnings. Actions taken when using other people’s money for our own benefit are likely to be quite different when our own money is put at risk. What loan originator would be crazy enough to put his or her money into a Ninja [No Income, No Job Application] loan? [This is why it is important to consider management incentives for good performance and punishments for bad performance before supporting any company through loans or buying shares.]" - Brian McNiven
Financial author and developer of Stockval software.
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[Quote No.30657] Need Area: Money > Invest
"[In stock market crashes fear and stress can have significant impacts:] The whole story of how humans deal with stress is really interesting, but there's one facet worth emphasizing. When people get stressed, they tend to dramatically shorten their time horizons. If you're a zebra being pursued by a lion, turning off systems for digestion, reproduction, immunity, and growth makes all the sense in the world because the chase will be done, or you will be done, in short order. But humans, who have many of the same physiological responses, are not dealing with a short-term threat, but rather a long-term system called the stock market. So taking a long-term view is absolutely crucial, although really hard." - Michael Mauboussin
chief investment strategist at Legg Mason Capital Management
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[Quote No.30660] Need Area: Money > Invest
"In my view [in late 2008], U.S. stocks are still not attractive. Historically, you buy stocks when they're yielding 6% and selling at eight times earnings [at the bottom of the business and share market cycle]. You sell them when they're at 22 times earnings and yielding 2% [at the top of the business and share market cycle]. Right now U.S. stocks are down a lot [DJIA has fallen from 14000 to 8000], but they're still very expensive by that historical valuation method. The U.S. market is yielding 3% today. For stocks to go to a 6% yield without big dividend increases, the Dow will need to go below 4000. I'm not saying it will fall that far, but it could very well happen. And if it gets that low and I'm still solvent, I hope I'm smart enough to buy a lot. The key in times like these is to stay solvent so you can load up when opportunity comes." - Jim Rogers
Highly respected share and commodity investor
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[Quote No.30669] Need Area: Money > Invest
"[Here is an article that sheds more light on the process whereby the cost of money - the interest rate, was kept so low that a super-liquidity cycle developed that when it crashed in 2007-9 it caused a catastrophic credit crisis and a global recession] In recent years, money was cheap and other assets were expensive. As each of the global economy’s credit creation engines breaks down and systemic leverage reduces, money becomes scarce and expensive triggering adjustments in asset prices in a reversal of this process. In the current financial crisis, the quantum of available capital, the munificent resources of central banks and sovereign wealth funds and the globalisation of capital flows may be some of the accepted 'facts' that are revealed to be grand illusions. As Mark Twain once advised: 'Don't part with your illusions. When they are gone you may still exist, but you have ceased to live'. --Reserve Illusions: In recent years, there has been speculation about the amount of capital or liquidity available for investment globally. The substantial reserves of central banks and, their acolytes, sovereign wealth funds were frequently cited in support of the case for a large pool of 'unleveraged' liquidity, that is 'real' money. In reality, the available pool of money may be more modest than assumed. For example, China has close to $2 trillion in foreign exchange reserves. The reserves arise from dollars received from exports and foreign investment into China that are exchanged into Renminbi. The central bank generates Renminbi by printing money or borrowing through issuing bonds in the domestic market. On China’s 'balance sheet', the reserves are essentially 'leveraged' using domestic 'liabilities'. In order to avoid increases in the value of the Renminbi that would affect the competitive position of its exporters, China undertakes 'currency sterilisation' operations where it issues bonds to mop up the excess liquidity. China incurs costs – effectively a subsidy to its exporters - of around $60 billion per annum (the difference between the rate it pays on its Renminbi debt and the investment income on it reserves). The dollars acquired are invested in foreign currency assets, around 60% in dollar denominated US Treasury bonds, GSE [Government Sponsored Enterprises] paper (such as Freddie and Fannie Mae debt) and other high quality securities. China is exposed to price changes in these investments and currency risk because of the mismatch between foreign currency assets funded with local currency debt. Deterioration in the US economy and the need to issue additional debt to support the financial sector may place increasing pressure on the US sovereign rating and the dollar. US Government support for financial institutions is already approaching 6% of GDP compared to less than 4% for the Savings and Loans crisis. Deterioration in the credit quality of the United States results in losses on investment through falls in the market value of the debt and a weaker dollar. The credit default swap ('CDS') market for sovereign debt is increasingly pricing in increased funding costs for the US. The fee for hedging against losses on $10 million of Treasuries was about 0.58% pa for 10 years (equivalent to $58,000 annually) in December 2008. This is an increase from 0.01% pa ($1,000) in 2007 and 0.40% pa ($40,000) in October 2008. It is also not easy to tap this liquidity pool. Given the size of the portfolios, it is difficult for large investors like China to rapidly mobilise a large portion of these funds by liquidating their investments and converting them into the home currency without substantial losses. This means that this money may not, in reality, be available, at least at short notice. If the dollar assets lose value or cannot be accessed then China must still service its liabilities. It can print money but will suffer the economic consequences including inflation and higher funding costs. The position of emerging market sovereign investors with large portfolios of dollar assets is similar to that of a bank or leveraged hedge fund with poor quality assets. China’s Premier Wen Jiabao recently expressed concern: 'If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital...' In December 2008, Wang Qishan, a Chinese vice-premier, noted: 'We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US.' There are other factors affecting the availability of the reserves at central banks and sovereign wealth funds. In recent years, sovereign wealth funds have also suffered losses on some of their investments, most notably in US and European financial institutions. Some central banks have been forced to utilise some of the reserves to support the domestic economy and banking system. For example, South Korea has used a portion of its reserves to provide dollars to banks unable to re-finance short-term dollar borrowings in international money markets. Russia has similarly used a significant portion of its reserves to support financial institutions and also its domestic markets. Russia’s reserves, which rank third after China’s and Japan’s reserves in size, have fallen $122.7 billion, or 21 percent, since August 2008. The reserves, including oil funds that exclusively act as a safety cushion for the budget, stood at $475.4 billion on November 2008. --Capital Illusions: The substantial build-up of foreign reserves in central banks of emerging markets and developing countries, as identified by David Roche (see David Roche and Bob McKee (2007) New Monetarism; Independent Strategy Publications), is really a liquidity creation scheme that relies on the dollar's favoured position in trade and as a reserve currency. Many global currencies are pegged to the dollar at an artificially low rate, like the Chinese Renminbi to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. Large, liquid markets in dollars and dollar investments capable of accommodating the very large investment requirements and the historically unimpeachable credit quality of the US sovereign assets facilitated the process. The recycled dollars flow back to the US to finance the spending. This merry-go-round is a significant source of liquidity creation in financial markets. It also kept US interest rates and cost of capital low encouraging further borrowing to finance consumption and imports to keep the cycle going. This process increased the velocity of money and exaggerated the level of global liquidity. The large build-up in reserves in oil exporters from higher oil prices and higher demand from strong world growth was also re-cycled into US dollar debt. The entire process was reminiscent of the 'petro-dollar' recycling of the 1970s. The central banks holding reserves were lending the funds used to purchase goods from the country. In effect, the exporter never got paid at least until the loan to the buyer (the vendor finance) was paid off. As the debt crisis intensifies and global growth diminishes with increased defaults, it is increasingly likely that this debt will not be paid back in it entirety. This liquidity circulation process supported, in part, the growth in global trade. This too may have been an illusion as the underlying process is a gigantic vendor financing scheme. --Trade Illusions: An accepted article of economic faith is that failure of economic co-operation and resurgent nationalism in the form of trade protectionism (for example, the Smoot-Hawley Act) contributed to the global financial crisis of the 1930s. The stock market crash of 1929 and the subsequent banking crisis caused a collapse in financing and global demand resulting in a sharp of the US trade surplus. Smoot-Hawley was passed in 1930 to deal with the problem of over-capacity in the U.S. economy through higher tariffs designed to increase domestic firms’ market share. The higher US tariffs led to retaliation from trading partners affecting global trade. The slowdown in central bank reserve re-circulation affects global trade through the decrease in the availability of financing for purchasers to buy goods and services. This is apparent in the sharp slowdown in consumer consumption in the US, UK and other economies. The availability of cheap finance also helped drive up the prices which, in turn, allowed excessive borrowing against the inflated value of these assets that fuelled consumption. Weakness in the global banking system (in particular, loan losses, the lack of capital and concerns about counterparty risk between large financial institutions) contributes to restricted availability of trade letters of credit, guarantees and trade finance generally. This exacerbates the problem. The restrictions, in turn, further impact on the level of trade flows and capital re-circulation resulting in a further decrease in trade activity that in turn further slows down international credit creation. It is not easy to fix the problem. Redirection of capital held in central banks and sovereign wealth funds to domestic economies affects the global capital flows needed to finance the debtor countries, such as the US and re-capitalise the banking system. Maintenance of the cross border capital flows to finance the debtor countries budget and trade deficits slows down growth in emerging countries and also perpetuates the imbalances. Trade has become subordinate to and the handmaiden of capital flows. As capital flows slow down, global trade follows. Indirectly, the contraction of cross border capital flows and credit acts as a barrier to trade. In each case, de-leveraging is the end result. This opens the way to 'capital protectionism'. Foreign investors may change their focus and reduce their willingness to finance the US. Wen Jiabao, the Chinese Prime Minister, indicated that China’s 'greatest contribution to the world' would be to keep it’s own economy running smoothly. This may signal a shift whereby China uses its savings to invest in the domestic economy rather than to finance US needs. China and other emerging countries with large reserves were motivated to build surpluses in response to the Asian crisis of 1997-98. Reserves were seen as protection against the destabilising volatility of short term capital flows. The strategy has proved to be flawed. It promoted a global economy based on 'vendor financing' by the exporting nations. The strategy also exposed the emerging countries to the currency and credit risk of the investments made with the reserves. Significant shifts in economic strategy are likely. Zhou Xiaochuan, governor of the Chinese central bank, commented: 'Over-consumption and a high reliance on credit is the cause of the US financial crisis. As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.' More ominously Chinese President Hu Jintao recently noted: 'From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies.' There is also the risk of 'traditional' trade protectionism. The end of the current liquidity cycle, like the one in the 1930s, may cause a sharp fall in exports. Exporting countries, seeking to maintain domestic growth may try to boost exports by devaluation of the currency or subsidies. Import tariffs are less effective unless there is a large domestic market. Recently the governor of the Chinese central bank, Zhou Xiaochuan, did not rule out China depreciating its currency. The change in these credit engines also distorts currency values and the patterns of global trade and capital flows. The current strength in the dollar particularly against the Euro reflects repatriation of capital by investors and the shortage of dollars from the slowdown in the dollar liquidity re-circulation process. It is also driven by the reliance on short-term dollar financing of some banks and countries and the need for re-financing. This is evident in the persistence of high inter-bank dollar rates and dollar strength. The strength of the dollar is unhelpful in facilitating the required adjustment in the current account and also financing of the US budget deficit. The slowdown in the credit and liquidity processes outlined may have long-term effects on global trade flows. As Mark Twain also observed: 'History doesn't repeat but it rhymes.' --End of 'Candy Floss' Money: Gillian Tett of the Financial Times coined the phrase (see 'Should Atlas still shrug?' (15 January 2007) Financial Times) 'candy floss money'. New financial technology spun available 'real' money into an exaggerated bubble that, like its fairground equivalent, collapses ultimately. The global liquidity process was multi-faceted. There was traditional domestic credit creation system built on the fractional reserve system that underpins banking. The leverage in the system was pushed to extreme levels. Losses and renewed regulation are forcing this system of credit creation to shut down. The foreign exchange reserve system was another part of the global credit process. Dollar liquidity re-circulation has also slowed as a result of reduced trade flows (driven by falls in US consumption and imports), losses on dollar investments, domestic claims on reserves and the inability to readily mobilise large amount of reserves. Another credit process - the export of Yen savings (via the Yen carry trade and acquisition of foreign assets by Japanese investors) - has also slowed. The focus of the November 2008 G-20 meeting was firmly on financial sector reform. Stabilisation of global capital flows in the short term and addressing global imbalances over the medium to long term barely merited a mention. It may well come to be seen in coming weeks and months as a major missed opportunity to address these issues. Markets placed great faith in the volume of money available to support asset prices and assist in alleviating shortages of liquidity. The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows. As the financial system de-leverages, it is becoming clear, unsurprisingly, that available capital is more limited than previously estimated. As Sigmund Freud once observed: 'Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.' There is an apocryphal story about a disgraced rock star who ended up in bankruptcy court. When asked what happened to his fortune of several million dollars, he responded: 'Some went in drugs and alcohol, I gambled some of it away, some went on women and the rest I probably wasted!' Financial markets have 'wasted' a staggering amount of money that ironically probably did not exist in the first place." - Satyajit Das
risk consultant and author of 'Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives'. Published in the RGE Monitor, Dec 9, 2008.
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[Quote No.30677] Need Area: Money > Invest
"In these matters the only certainty is that there is nothing certain." - Pliny The Elder

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[Quote No.30680] Need Area: Money > Invest
"[Gold demand and therefore its price usually increases in periods of inflation and economic instability. When it doesn't, some people believe that the price is being manipulated.] This dualism in gold price formation distinguishes it from other commodities and makes the movements in the price sometimes so enigmatic that market analysts need to invent fantastic intrigues to explain price dynamics. Many have heard of the group of economists who came together in the society known as the Gold Anti-Trust Action Committee [GATA] and started a number of lawsuits against the U.S. government, accusing it of organising an anti-gold conspiracy. They believe that with the assistance of a number of major financial institutions (they mention in particular the Bank for International Settlements, J.P. Morgan Chase, Citigroup, Deutsche Bank, and others), some senior officials have been manipulating the market since 1994. As a result, the price dropped below US$300 an ounce at a time when it should, if it had kept pace with inflation, reached US$740-760..." - Oleg V. Mozhaiskov
Deputy Chairman of the Bank of Russia - from a speech he gave at The London Bullion Market Association Bullion Market Forum, Baltschug Kempinsky Hotel, Moscow, June 3-4, 2004.
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[Quote No.30681] Need Area: Money > Invest
"An individual who is bullish on gold is often called a 'gold bug'. Gold bugs believe that gold is still a stable source of wealth like it was during the years of the gold standard international currency system. A gold bug invests in gold for what he or she perceives as financial security [to preserve purchasing power] in the event of a currency devaluation [and/or massive increases in the money supply from 'printing money' to stimulate/reflate the economy and to pay off government debt], and often also believes that the price of gold will continue to rise in the future. The term also refers to analysts who consistently recommend gold buys. Gold bugs view gold as a safe investment that will protect them from currency fluctuations or downturns in the financial markets. Although gold is widely known as a standard of value, its price - like that of any other precious metal or commodity - fluctuates widely. For example, the price of gold declined from more than US$800/oz in the 1980s [when inflation was very high] to less than US$350/oz in the 1990s [when inflation was low]. This is a point frequently brought up by critics, who view gold as a standard of wealth from the past. [Critics also make the points that it costs money to store physical gold, although possession is not required if gold E[xchange] T[raded] F[unds] are bought, and that neither gold bullion/coins nor gold ETFs pay a dividend, although gold producers/companies do although their share price may not move with the price of gold as they may have hedged/sold their future gold production, currency movements may negate any rise in the price of gold which is denominated in US currency and/or the company's producion costs may rise reducing their profit.] However, while there is no consensus, the market does continue to view gold as the traditional 'safe harbor' during times of economic crisis. For example, following September 11, 2001, [when America experienced the Twin Towers terrorist attacks] gold prices saw sharp increases as investors sold what they believed were riskier assets." - investopedia.com
Definition of the term 'gold bug' from this website, downloaded on 15th December, 2008.
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[Quote No.30682] Need Area: Money > Invest
"Every share market boom eventually goes 'kaboom!'" - Seymour@imagi-natives.com

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[Quote No.30684] Need Area: Money > Invest
"Theories that go counter to the facts of human nature are foredoomed." - Edith Hamilton

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[Quote No.30689] Need Area: Money > Invest
"A headline in yesterday's paper tells us that more and more of the economy is directed by the government. As private spenders grow reticent, public spenders become more bold [in accordance with Keynesian economic theory - where government spending - from money borrowed locally or from overseas (which must eventually be paid back by increased taxes) or 'printed' - should try to compensate for the lack of aggregate demand/spending from the private sector/consumers and business investment, during a recession/stock market crash/end of the business cycle]. They're talking about a massive public health system...new roads, bridges, trains. Mr. Market surprised us in 2008 [with the credit crisis, 40-60% stock market crash and incipient global recession]. He hit harder than almost anyone expected. What's his surprise for 2009? Investors are expecting a slump. They're afraid of bankruptcies, defaults and deflation. Trying to avoid losses, they're buying Treasury paper. Treasury bonds, notes and bills are said to be the safest investments they can make. [The demand is so great the prices have skyrocketed and yields are dropping dramatically to 0% for three month notes and 3% for ten year bonds] What if they turned out to be the most dangerous investments you could make? There are two ways in which Treasuries could lose value. Most obvious, the Treasury market could go down. The law of supply and demand has not been repealed...at least, not as far as we know. It requires that when supplies increase, ceteris paribus, prices will go down. Of course, ceteris is not always paribus. And right now, people seem desperate to buy Treasuries in order to protect themselves from the bear market in all other asset classes. But the supply of Treasuries is set to soar as government borrows more and more money for its spending plans. And with spreads between corporate paper and government paper at record lows already, it seems very unlikely that investors' will become even more desperate in the months ahead. That is, it seems unlikely that they'll favor Treasuries even more than they do now. According to the latest estimates, the U.S. Treasury is expected to borrow $1.5 trillion nest year - in addition to the existing debt it rolls over. This puts a huge supply of new debt on the market. Will there be new demand to meet it? Not likely. In fact, the demand is probably going to drop. One reason: the foreigners are borrowing too - hugely - for the same reason. They want to bail out their own economies. Another reason: Americans are spending less on foreign goods - putting less money in the foreigners' hands that they could lend back to us. Of course, the feds are ready with a solution...and as usual, the fix will make things worse. Fearing a loss of private demand, the feds are already talking about selling Treasury debt directly to the Fed. But that brings us right to the other way Treasury values can go down - the dollar can lose value too. Not only are bonds themselves subject to the law of supply and demand, so is the currency in which they are calibrated. The more dollars; the less each one is worth. Normally, it is a no-no for central banks to buy Treasury bonds directly. 'Monetizing the debt' is what it is called [or sometimes 'quantitative easing']. It inflates the money supply directly and immediately. So, while Fed buying of Treasuries would help support the market for treasuries, it would undermine the value of the dollar itself. [possibly causing gold to rise with the consequential serious inflation in a year's time - but the Fed is more worried about deflation at present. The other issue is that with inflation and the difficulty in getting people to buy the bonds the interest rates may need to be set higher to control inflation and entice bond buyers, which would be another negative for the stock market and business.] Either way...Treasuries - thought to be the safest investment you can make - could turn toxic quickly." - Dan Denning
The Daily Reckoning Australia - Monday, 15 December 2008.
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[Quote No.30690] Need Area: Money > Invest
"History will record that the Bubble Epoque began soon after the Plaza Accords in 1985. The immediate problem confronting the finance ministers and central bankers at the Plaza Hotel in New York was what to do about the dollar. After having gone down in the late '70s, it went up so much in the early '80s that there seemed no stopping it. The strong dollar had its advantages of course. American tourists visiting London in the early '80s could leave their calculators at home. A dollar was a pound. A pound was a dollar. But the strong dollar was a threat to America's commercial interests. Japanese imports, in particular, were undermining America's competitive position. So the assembled economists came up with a solution. It was decided that the yen should be revalued, upwards, so as to tilt the playing field a little more in the Yankees' advantage. With a higher yen and a lower dollar, products from Japan would have to roll uphill if they were to reach U.S. markets. Since Richard Nixon had closed the gold window at the U.S. Treasury, in 1971 dollar, not gold, was the bedrock of the new financial system. But the dollar was hardly granite. It was more like gas. Foreign nations bought dollars from their local merchants and exporters, and paid for them with their own currencies. The more greenbacks America emitted, the more money of all shades and colors expanded all over the planet. If central banks failed to keep up with rising supplies of dollars, their local currencies would rise against the greenback, hurting sales to everyone's favorite customer, the USA. The banks also used dollars as reserves; as their capital increased, so did their lending. The system was absurd; but it wasn't unpopular. The more Americans spent, the more money foreigners had available to lend them. Readers should be grateful; if this column were not so short we would give you more of the details. But there is no need. The facts are not in dispute. The Plaza Accords was followed by the first major bubble of the bubble era - in Japan. The Nikkei Dow, rose from 12,000 in 1985 to over 39,000 in 1990. Property prices in Tokyo soared. The Japanese bubble found its pin in January of 1990. It brought about a bust that has lasted longer than marriages and refrigerators. The Bubble Epoque was only beginning. A few years later came bubbles in Asia, Russia, and an oft-rehearsed one in LongTerm Capital Management. LTCM was the blow-up not heard around the world. Investors should have listened more carefully. The fund had two Nobel prize winners on its payroll. Their theories of risk management and mark-to-model pricing were clearly wrong. Pity no one noticed. Instead, the authorities learned exactly the wrong lessons. When one bubble blew up...the feds pumped in more hot air - inflating a new bubble somewhere else. When the dot.com bubble exploded, they pumped overtime. Pretty soon, they had inflated huge bubbles - in emerging markets, housing, consumer credit, the financial industry, commodities, food, and even art. Private debt - used to fund the asset bubbles - was the biggest bubble of all. And now, with all those bubbles flattening, along comes another one. A bubble in public debt. It's inflation they want. And inflation they shall have. Of course, Mr. Bernanke is as keen to avoid the 'hyper' modifier. 'Just a little bit' would be plenty, he says to himself. He aims for 2%...maybe 5%. And if inflation rises to 10%...20%...or more...he won't be the first central banker to miss the mark." - Bill Bonner
Founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers 'Financial Reckoning Day: Surviving the Soft Depression of the 21st Century' and 'Empire of Debt: The Rise of an Epic Financial Crisis'. He has also written with co-author Lila Rajiva 'Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics'. Quote published from 'The Daily Reckoning - Australia', 15th December, 2008.
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[Quote No.30695] Need Area: Money > Invest
"The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait." - G.K. Chesterton

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[Quote No.30696] Need Area: Money > Invest
"[While not all economists agree with Keynes, Keynesian economic theory says that at the end of a business and stock market cycle, when private aggregate demand/spending falls, government spending (fiscal policy) should increase to compensate and this is what the U.S. government and many other governments around the world are trying to do in 2008, as well as loosening monetary policy (i.e. lowering interest rates or, in extreme cases and the country has a fractional reserve banking system, reducing banks' capital adequacy/asset ratios), due to the credit crisis, falling real estate values, share prices, GNP (Gross National Product), velocity of money and government tax revenue, rising unemployment/social unrest and incipient global recession:] Like a giant laxative in the world's monetary system, the Federal Reserve's quantitative easing is starting to have an effect. You wouldn't necessarily call it the desired effect. After all, we're talking about the eventual destruction of the U.S. dollar and the global monetary system upon which it's based. But it's an effect nonetheless. Both the Aussie and New Zealand dollars were up against the greenback. These two are probably not rising because they are commodity currencies. The strength of commodities versus the U.S. dollar is only relative at the moment. But the interest rate differential might be a factor. The Federal Reserve Open Market Committee meets in America today. Economists surveyed by Bloomberg expect the U.S. central bank to cut short-term rates to just twenty five basis points. That will put them at just 0.25%. Though pathetic, the move is largely symbolic. The Fed is prepared to go 'into the wild' if Ben Bernanke [its Chairman] is to be believed. Consider the facts. U.S. government debt is already at $10.5 trillion. The Fed's balance sheet assets are at over $2 trillion and growing. America's deficit spending set to explode in 2009. The Fed HAS to go unconventional and pursue some kind of fourth generation monetary warfare against deflation. Here's what you can expect. The Fed's next move will be adding other assets to its balance sheet. It will pay for these assets with new money borrowed by the Treasury or brand new money altogether [How is new money created? For example when the borrowing from the market's domestic and foreign savers gets tough, the Fed creates liquidity by buying U.S. Treasury bonds/government debt itself. In other words, instead of borrowing from savers - thus leaving the net money supply unchanged - the Treasury will borrow from the Fed. Where will the Fed get trillions of extra dollars? It will create them out of thin air]. Sometime in 2009 this will lead to an exodus out of the U.S. dollar. Fortress Treasury Bonds will crumble. The popping of the bond bubble will drive up oil and gold. Both were on the move yesterday. But what to your wondering eyes will appear as the Fed charts its new course into the monetary wild? Well, the first..ahem...assets the Fed may pursue are securities backed by U.S. mortgages. Remember, the Fed is trying to drive down short and long-term rates in the U.S. to bring mortgage rates down. [make housing more affordable and stop the decline in their prices which have dropped over 30% in the last two years, making many home owners motgages greater than the current price of their homes.] If mortgage rates come down and bank balance sheets are sufficiently repaired, then the Fed hopes the entire manoeuvre will engineer a bottom in the U.S. housing market. The collapse in residential real estate is at the epicentre of the whole wealth destroying phenomenon to begin with. The Fed strategy is both direct and indirect strategy. Let us compare it to military strategy for just a moment. In his book 'Strategy', British historian B.H. Liddell Hart suggests that the key to unlocking the stalemate on the Western Front in World War One was an indirect attack through Turkey and the Balkans. Attempts at decisive, game-changing confrontations (like the battle at Verdun) only resulted in massive casualties. The only way the British and the French could really threaten Germany was by opening up a new front in the East, which meant going 'round the long way. This puts Gallipoli in an interesting strategic light. Hart was a big advocate of the indirect strategy, attacking your enemy where he least expects it and achieving the element of surprise. Other military strategists and historians like Clausewitz and Victor Davis Hanson believe that direct, decisive major battles have played a more important role in history than the indirect approach. So what does this have to do with the Fed and gold? The Fed has already tried the indirect approach to reliquefying capital markets and arresting the fall in U.S. home values. It's tried interest rates and a whole array of lending programs. The indirect approach has failed. So the direct approach is what remains, although by Fed standards, it is not a tactic the Central Bank often resorts to. It is crude. It relies on brute force and money printing. [running the risk of eventually causing dangerously high inflation] The direct method is to support security and asset prices by buying them. If you can't make a market work, make the market. Be the market maker. The Fed will start buying mortgage backed bonds. And it probably won't stop there. Though it is bound by the number zero when it comes to interest rates, the boundaries of quantitative easing are theoretically limitless. As long as the appetite for U.S. bonds grows, the Treasury can keep selling them and feeding the proceeds to the Fed. With this money, in theory, the Fed could buy anything it wanted to and put it on the balance sheet...baseball cards, pin ball machines, expensive paintings, or even discount mulchers from Wal-Mart (to turn all that new green paper into something truly useful). Does all this mean anything for Aussie investors? Of course! While the bounds of Fed borrowing are theoretically limitless, investors will eventually not support the U.S. government's monetary and fiscal policies. Interest rates in the U.S. will go up [to encourage people to buy bonds/government debt] and the dollar will go down. With the U.S. dollar retreating against other currencies, it will also retreat against commodities. In fact, the dollar's move this week doesn't look so much like a retreat as it does a gradual losing of the ground it claimed in the last few months [as foreign investments are repatriated to the U.S.]. Perhaps the strategic tides are turning. If they are, it means the market's bias is shifting away from recession fears in 2009 toward inflationary fears now. Equities have priced in recession. No commodities will price in inflation. That should lead to higher commodity prices. And for those commodities that are also money (gold, and to a lesser degree, silver) it should be good news. What might hurt Aussie investors in this respect is a stronger Aussie dollar [as the U.S. dollar falls] -unless the U.S. dollar price of gold rises faster than the AUD/USD... That is the trouble with the world of paper money. Everything is relative. Nothing is completely rational (although nothing ever is). The Fed may give the appearance of acting with due measure. But it probably has no idea what it's doing. It's using exact methods and theories for an inexact world. Or, as G.K. Chesterton put it, 'The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.' " - Dan Denning
'The Daily Reckoning Australia', 16 December 2008.
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[Quote No.30697] Need Area: Money > Invest
"The airline industry has been a nightmare for several years now, with dozens of airlines going bankrupt ... That is often the sign of a bottom [for a falling share market]" - Jim Rogers
Famous share and commodity investor
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[Quote No.30701] Need Area: Money > Invest
"Economists in the Keynesian tradition believe that government spending spurs short-run economic growth [and therefore should be done by governments at the end of a business and stock market cycle when consumer demand/spending and business investment slows to compensate for this drop in aggregate demand]. Economists in the monetarist tradition believe that any such positive effects would be short-lived. Yet other economists in the 'rational expectations' tradition argue that a Keynesian stimulus would have no effect at all on output. In truth, economists do not have an accurate or agreed-upon model of the short-run economy, and their advice is often in error. Politicians should be more humble about their ability to control short-term economic ups and downs. Legislative action based on incomplete information risks destabilizing the economy further. Efforts to fix short-term problems often create long-term damage — such as by putting the nation further into debt." - Chris Edwards
Director of tax-policy studies at the Cato Institute and the co-author of 'Global Tax Revolution: 'The Rise of Tax Competition and the Battle to Defend It'. Quote from the 'National Review' (Online) on December 15, 2008.
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[Quote No.30706] Need Area: Money > Invest
"Half of being smart is knowing what you're dumb at." - Solomon Short

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[Quote No.30711] Need Area: Money > Invest
"The world is in the midst of a classic boom-bust cycle. These cycles start when central banks push interest rates below where they would have been set in a free market. The artificially low interest rates set off a credit boom in which businesses and households take on more debt and leverage up. In consequence, the ratio of debt to assets (or equity or income) increases and asset markets boom. When leverage and debt reach unsustainable levels, the boom ends and a bust ensues. As businesses and households sell assets to deleverage and reduce their debt levels, booming asset markets shift into reverse. At present, balance sheet repair dominates. Regardless of how low the Fed pushes interest rates, businesses and households are not inclined to take on more debt. Instead, they want to reduce their leverage and debt burdens. This process will come to a halt, but only after asset prices reach bargain basement levels and leverage ratios become sustainable. The current deflationary forces are strong. Since July [2008], the Fed has been attempting to counter them. Indeed, the Fed's balance sheet has more than doubled in less than five months (see accompanying chart) but this has not been enough to stabilize the credit system. To better understand the forces at play and the rough magnitudes involved, we use a credit triangle. The triangle's architect is John Greenwood. Recall that he was also the architect of Hong Kong's modern currency board system... The credit triangle depicts a modern fractional reserve banking system - one in which a small quantity of reserves (capital) is multiplied into a much larger volume of loans and deposits. At the tip of the triangle is the Fed. It provides reserves to banks and the non-bank public. This so-called high-powered money is multiplied into $7.9 trillion of deposit liabilities held by traditional banks in the US. These banks are represented in the layer directly above the Fed. The deposits of firms and individuals at these banks represent money, as measured by M2. Many people think the credit story ends here. But to understand the boom-bust cycle, we must include non-bank credit, as well as bank credit. Shadow banks represent the next layer in the triangle. These include investment banks, mortgage finance companies, private equity pools, structured investment vehicles, etc. They issue credits that total $14 trillion. These shadow banks rely on deposits held at banks for their reserves. Shadow banks have less capital relative to assets (higher leverage) than traditional banks. In addition, they are not subject to the same level of prudential regulation as traditional banks. Banks and other financial institutions outside the US accept US dollar deposits, issue dollar-denominated debt and make dollar- denominated loans and investments. This segment does not hold reserves at the Fed and is more leveraged than its onshore counterparts. At $39 trillion, it is large and important. Indeed, it plays a critical role in supplying credit (letters of credit) to those who engage in international trade. The top layer of the triangle represents over-the-counter derivatives. They have a nominal value of $596 trillion and a gross value (the replacement cost of all outstanding contracts if they were settled) of $14.5 trillion. The credit triangle is a top-heavy structure. At each higher level in the triangle, there is more leverage (less capital to assets) and more credit. When a bust arrives, banks and other financial institutions scramble to reduce their exposure to risky assets and the layers of the triangle contract, with the upper layers contracting relatively more than the lower ones. Even though the Fed has engaged in a massive expansion of its balance sheet, the weight of the deleveraging and compression of the upper layers of the credit triangle have more than offset the Fed's moves. Until the deleveraging process runs its course, bet on the Fed to continue the rapid expansion of its balance sheet. Then, to avoid a burst of inflation, the Fed will have to rapidly deleverage its own balance sheet. This contraction promises to be more difficult than the current expansion." - Steve H. Hanke
Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C. Published 18th December 2008 at cato.org.
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