The Next Leg of the Crisis: Unavoidable Catastrophe

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.' There has never been any attempt to abandon the credit expansion. Indeed any crisis was simply an excuse to open the monetary spigots. This, then, is the beginning of the total catastrophe of the American dollar, indeed the entire world monetary and financial structure."

-- Ludwig von Mises

The more I read, the more appalled I become. I am so terrified of what's coming, but I look around at the general level of ignorance and hubris in the United States today, and I can’t help but thinking, yet again, that we deserve everything we’re going to get. I watch CNBC, FBN, and Bloomberg all day. I see "experts" and "specialists" and "veterans" recycle the same tired messages over, and over, and over. Politicians and economists defend quantitative easing and the Obama administration’s reckless policies. It’s like a nightmare I can’t wake up from.

And then, just when I think I’m going to throw a coffee cup at the television, someone like Jim Rogers or Peter Schiff makes an appearance, and I see a glimmer of hope.

I've been a victim of false optimism many times. It's an easy trap to fall into: you bet on an outcome, and you convince yourself that everything you see points to a positive result -- even in the face of changing premises. That, however, is dogmatism; it's poisonous, and it's the reason I spend so much time researching the issues facing us. I want clarity, and that requires enduring pointed criticism. But in the last year, the counterarguments haven’t been strong enough to convince me I’m wrong.

Here are some of the thoughts I’ve had this week:

1. Who really believes that wars and natural disasters are good for the economy? When did we become so stupid that we actually started to believe destroying things and killing people are beneficial? It's like saying burning down your own house will give you prosperity. Or imagine trying to get cancer so you can be healthier? Such notions couldn’t be more ridiculous, and yet this is exactly the type of mindset that socialism and Keynesianism require in order to exist. And – unbelievably -- the vast majority of people in the world subscribe to these absurdities.

In response to such thinking, the French economist Frédéric Bastiat created the Parable of the Broken Window – a scenario which demonstrates how preposterous it is to break windows in order to create jobs and encourage the circulation of money.

How can anyone possibly believe such nonsense is actually going to help improve things?

2. Massive Government programs -- like Social Security, Medicare, Medicaid, and farm subsidies, just to name a few in the innumerable list of value-destroying components in our economy -- are already insolvent. Now the Obama administration wants to implement socialized medicine on a massive scale. It’s the most farcical move, at precisely the wrong moment.

The government shouldn’t be creating more programs; it should be shutting them down! But that’s not what is happening, and we the people are allowing our elected officials to march us directly into insolvency. It’s a simple, exceedingly obvious transaction: politicians offer voters cash, and voters give politicians votes. It is the bane of democracy.

What most voters don't realize, however, is that the government knows all this, and it will certainly perpetuate these programs the quietest way possible: through inflation -- meaning it will print money and maintain easy credit, while increasing pay-outs at a much lower rate. This is just one more reason why I believe large-scale inflationary price-increases are on the way.

3. There has been a lot of talk about the role of mal-investment -- in the context of the economic collapse we’re enduring. But nobody’s getting it! When the government creates cheap, or even free money (even though it's neither "cheap" nor "free"), it encourages people to invest. And because people are investing in things they wouldn't normally consider, the investments they make are almost certain to be bad. Indeed, in this scenario, everyone in the economy dumps money into assets and services, after which, the prices of these assets and services become artificially expensive. Thus, in this scenario, if you spend money on anything (a home, a car, a computer, tuition, or medical care), it's impossible not to pay too much -- relatively speaking. Artificial demand creates artificial prices.

What results is the classic boom-bust scenario. And what does the government do when the inevitable bust occurs? It prints more "cheap" or "free" money, encouraging yet more mal-investment! And every time the process repeats, it gets more difficult to perpetuate. This cycle has destroyed empires for millennia -- including the Roman, British, and Soviet versions thereof. Guess who is next on the list?

Now you’re going to tell me about the low velocity of money – that currency isn’t getting into the economy, because banks aren’t lending. I’m going to reiterate my position on this subject: all that cash and credit is like an ocean pressing against a weak dam, and when it bursts, the tidal wave is going to drive the velocity of money toward the speed of light. The result? Price increases on a scale that developed economies across the globe have never seen. It’s going to be unprecedented. And it’s going to be catastrophic.

4. In 1971, Richard Nixon took the United States off the gold standard. That means the dollar is now fiat -- that is to say, it is backed by nothing more tangible than the "full faith and credit" of the United States government. One of the dangers of using fiat money is that the currency is more vulnerable to fluctuations in value. If the U.S. Treasury prints more dollars, the currency will decline in value, relative to everything else.

So, in times like these, if more currency and credit means inevitable price increases -- and it does -- then by extension, the economy will experience rising interest rates: there is no way to encourage people to buy debt if their rate of return isn’t outpacing inflationary price increases. And since bond prices move inversely to their yields – that is to say, bond prices go up, yields go down, and vice versa – then as inflation drives prices higher, bond yields will rise with them. As such, bond prices will fall.

If the dollar were backed by gold, it would create stability -- thereby preventing some of the volatility that might lead to the scenario I just laid out. In 1931, during the depths of the Great Depression, the dollar was pegged to gold, redeemable at a fixed price. And yet in that year -- when long-term bond prices were soaring, and their yields reached unprecedented lows (just as they have now) -- their prices suddenly turned.

For many months, bond prices subsequently fell, and yields rose. With a relatively stable currency (backed by gold, as the dollar was), this was less prone to happen, so why did it? Yields rose because the Fed and the Treasury were flooding markets with debt and currency (just like they are now). This is, by definition, inflation. And that pushed interest rates higher.

The important thing to note is that, even if a currency is backed by gold, printing vast quantities is still inflationary. It's like issuing more shares of stock; it’s dilutive, and redemptions only put more pressure on the government's supply of bullion. But today, the dollar is not backed by gold, so its stability is much more questionable. As governments around the world print more money and sell more debt, there are no mechanisms to stem an upward push in interest rates, as well as yields. Given this context, the Treasury bubble only looks that much more precarious. You might want to think about shorting long-term Treasuries. Or use the double-short ETF, TBT, like I do. It's a no-brainer.

5. I wrote an article not long ago about the true definition of inflation. I also mentioned it above, and I want to expound upon it again here: most people believe inflation is defined as rising prices, but that is incorrect. Inflation, by definition, is an increase in the supply of currency and credit; any subsequent rise in prices result from inflation. Likewise, the definition of deflation is a decrease in the supply of currency and credit, and any subsequent decrease in prices result from deflation.

This distinction may seem subtle, and perhaps even tediously academic, but it's also very important. The government and the media are trying to make you believe that we are in a deflationary environment, and that simply is not true. The government is printing prodigious sums of currency right now, and that, as I pointed out, is inflationary.

I won't try to deny that many asset classes are falling, or have been falling for some time. But these prices aren't falling because of deflation. No, rather they are falling in spite of inflation. As I've said so many times, the U.S. has an unprecedented amount of debt, and the destruction of prices we're seeing right now has been a result of massive deleveraging -- that is, people and institutions selling assets in order to raise cash. In the meantime, the Fed is printing currency on a scale never seen.

So enjoy falling prices now, because they aren't going to last. We are in an inflationary hurricane; rising prices are coming -- and when they do, they will come hard and fast. Add to that an unemployment rate we haven’t seen in decades, and you begin to see how much we’re facing. And just when the government should be cutting spending and limiting printing and credit, it is doing just the opposite.

ANALYSIS

In anticipation of imminent inflationary price increases, as I said earlier, I think shorting long-term U.S. Treasuries (ETF: TBT) is a no-lose play at this point; no matter what happens, their prices are going to collapse, and their yields are going much higher. I also still believe many commodities can outpace inevitable price explosions, like agriculture (ETF: DBA), metals (ETF: DBP, as well as gold, silver, and platinum). I'm also still bullish on oil (ETF: UCO). Here's a technical analysis video of oil that convinces me the recent correction is short term:

In several articles, I’ve mentioned that I believe stocks will go higher in the near- and longer-term, but I don’t think they’ll outpace inflationary price increases. I believe the current economic crisis has now permanently diverged from the crisis in the 1930s, in that all asset-classes are soon going to turn abruptly. What will make this environment much more dangerous than previous economic catastrophes is that people will wrongly see increasing asset prices as a good indicator that conditions are improving. But conditions, for the most part, won’t be improving, because increases in the prices of most assets – including the stock market – won’t outpace collapsing global currencies. 

A lot of analysis lately has optimistically and fatuously pointed to a bullish stock market. I have been a value investor and a portfolio manager for almost twenty years, but I have no faith in stocks right now, and I think they should be avoided. Here's a technical analysis video of the S&P 500 that bears out a lot of my fear:

Here’s another thing to remember: when the Dow Jones Industrial Average first crossed 10,000, gold was at about $250 an ounce. Today (ten years later), the Dow is hovering in a trading range between 10,000 and 10,500, and gold is over $1100 an ounce. What does this mean? Well, precious metals have always been the most accurate harbingers of coming inflationary price increases. I think this interesting piece of information speaks for itself.

I’m going to leave you with this thought: the world is in a lot of trouble right now, and most people don’t even know it. You may be surprised to hear me say this, but our greatest enemies, aren’t inflation and unemployment. No, the most alarming issues before us are ignorance and apathy. So as you read this think about something… are you scared?

If you’re not, you may want to return to the beginning of this article and read it again.

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

The Death of the Dollar

"We have experienced asset bubbles, and we now have an economy that is more highly leveraged than it ever has been in the post-World-War II period. Greenspan has been instrumental in bringing about this high leverage."

-- Paul Kasriel

“A dollar saved is a quarter earned.”

-- John Ciardi

I have been an analyst, a portfolio manager, and a financial writer for more than 18 years, and until early last year my focus was almost exclusively on individual stocks and value investing. In my book Discipline, however -- which I completed in 2001 and published in 2007 – I took a more macro stance, predicting an economic collapse resulting in the failure of the U.S. dollar and a Soviet-style break up of the country. In early 2008 – as the content of the book started to mirror reality -- I shifted my focus exclusively to the global financial crisis, and since then I have written more than 50 articles (most of which are here) regarding the future of the United States dollar, and the world economy.

The issues I’ve tackled have caused a lot of controversy and criticism – both positive and negative – but never more than the last two years. This week, however, it occurred to me that the biggest problem with reporting on a global economy by targeting specific aspects of that economy, is that one can’t help but neglect the picture as a whole; each article presents a piece of the puzzle, but none of them adequately addresses the entirety, nor the magnitude, of the crisis we face. So I’ve spent some time going over my work, and what I’ve created below is, I believe, a fairly concise summary of my concerns.

1. Before and during the 1930s, the United States was a creditor nation. As such, it issued a prodigious amount of debt to battle the Great Depression. While I disagree with such policy, at least the government was in a financial position to use debt as a tool to battle the crisis. Today, the United States is a debtor nation. It has entered the current financial crisis owing more – in real dollars -- than ever in history. And now it’s issuing even more debt.

2. Likewise, in the 1930s, The U.S. was a net exporter, as well as a manufacturing powerhouse. But all that has changed: the U.S. has been issuing debt for decades, while manufacturing very little. In fact, our entire GDP seems to derive almost entirely from service and retail industries. What, exactly, does the U.S. make? Cars?

Sure, we had a good run in technology, but for the most part, we don’t even manufacture that anymore. And on top of all of it, even a lot of the service industry jobs -- like customer service and support -- are being exported! And yet, for decades, we've propped up our retail and service industries by consuming! Think about it -- we've amassed almost incomprehensible amounts of debt to pay for our non-stop, gluttonous shopping spree.  Now seriously, how long do you think foreign governments are going to support this type of behavior by continuing to lend to the U.S.?

Don’t get me wrong: I’m no protectionist. I believe the U.S. deserves everything it’s experiencing, and I certainly don’t believe in limiting immigration or trade. But as long as we live in a world in which balance of trade and foreign debt so dramatically impact our everyday lives, well, someone needs to point out this glaring little chunk of reality.

3. The Fed is talking out both sides of its proverbial mouth: on one hand it is saying, "We’ll lower rates just long enough to stimulate the economy, create a little inflation, and get things moving again." Meanwhile it tells creditors, "Buy these Treasuries at historically low yields! You're safe, because we're in a ‘deflationary’ period, and so your real rate of return for the next 10 to 30 years (adjusting for falling prices) will be higher than the coupon.”

So which is it? Does the Fed not expect to succeed with its Zero Interest Rate Policy? Does it never expect prices to increase again? Ever? Look, if massive price increases do ensue – as many of us expect -- then the bond bubble bursts. And if all this printing doesn’t stimulate prices, then what? The Fed prints even more money? And then prices skyrocket (with more fury), and the bond bubble bursts anyway. No matter how you look at it, foreign investors and other creditors lose faith in the dollar and it fails. It's a no-win scenario.

4. Let's say you don't have a job. But let's also say you have a $20,000 limit on your credit card. And let's say that credit card is maxed out. So you do what any good American consumer would do: you call your credit card company and ask them to give you a $100,000 limit-increase. And what do you think they are going to say?

Would you lend money to someone with no job and a mound of debt, if you knew – presuming somehow he didn’t default – that the most you could get in return was four or five percent? So why would foreign governments continue to lend to the U.S. by buying Treasuries at low yields if our consumer is dead and our debt is at the highest levels in history? How long will this continue? As I’ve said so many times before, the Chinese, the Japanese, the UK, and the Saudis are not stupid. Neither are most other lenders of note.

So what will the Fed will do if creditors stop lending the U.S. money? That's right, it’ll print even more dollars…

5. Imagine you own the stock of a company whose price has been increasing for decades. Now imagine the management of that company suddenly piled on debt at an unprecedented rate. Imagine shareholders started selling the stock, and management's response was to issue yet more stock -- flooding the market with shares whose value is already being questioned. How is that going to make the stock more valuable? For years, this is how General Motors operated -- the company actually issued debt and more stock just to increase their dividend! Many of us saw the imminent collapse decades ago, and yet investors and analysts alike defended GM rabidly.

This is precisely what has been happening with the U.S. dollar for the last century. And now the government is piling on unprecedented amounts of debt while printing unparalleled sums of currency – perpetuating the largest Ponzi scheme ever. To make matters worse, every major economic power in the world is following suit. How is this going to end well? You can’t just print or borrow wealth. It doesn’t work that way.

6. In the 1970s, Fed Chairman Paul Volcker drove interest rates above 20% in order to battle the inflationary price increases that appeared because of the same sort of monetary policy the Fed is pursuing today. Even then, many economists believed it would fail; once prices get started to the upside, they’re almost impossible to stop. And yet, somehow, Volcker did it. But I think he got lucky... very lucky.

Even so, Volcker didn't have to face some of the challenges in our economy today -- namely massive credit card debt, and adjustable rate mortgages. In the 1970s, the primary source of consumer debt was in the form of fixed-rate mortgages; when prices started climbing, this was actually good for mortgage holders: while the values of their homes increased dramatically, so did their wages. But their mortgages remained fixed.

Today, a tremendous amount of debt is variable-rate. If the Fed starts raising rates to battle (imminent) inflationary prices-increases, it will cause monumental default as rates adjust upward, and consumers find themselves unable -- or unwilling -- to service their debt.

7. We’ve talked many times about how The United States government has committed more than $13 trillion to battling this crisis, alone. We’ve also talked about the historical implications of that decision. My detractors claim that I just don’t understand – that our fractional reserve system justifies the printing of such astronomical sums of money. This argument eludes me: velocity won’t remain low forever, and when these mounds of cash finally burst the dam and get into the economy, how is a multiplier going to mitigate massive price increases? Fractional reserve banking is nothing more than the imposition of economy-wide leverage, amplifying the effects of printed currency exponentially.

Look, this isn't about being right. In fact, I really want to be wrong. Sure, I'm short Treasuries, and I stand to make a lot of money if I'm correct. In fact, this is one of the few times in my career I actually believe I'm in a no-lose position: no matter what happens, rates are going to rise.

I would prefer a scenario in which rates rise slowly, and the dollar -- as well as the economy -- stabilize gently; while the alternative makes me wealthy, unfortunately, its actualization necessarily means I will be forced to watch everyone around me suffer. And that’s a troubling thought.

No matter how much I don't want to believe in the worst-case scenario, however, I do; the dollar is doomed, and I believe the transition is going to be fast, and very painful. Furthermore, even if I'm wrong now, I don't think I will be next time. Maybe the smoke and mirrors will work a little longer, but the game is ephemeral. Our government has been destroying the foundations of our currency for generations.

Despite the fact that I've been researching this for a long time, and my conviction is strong, I'm not absolutely married to my conclusions; I would love to be slapped in the face with strong evidence that irrevocably destroys these theories. Not that any of you would ever dream of holding back, but please don't hesitate to share your thoughts. Because, again, I would love to be wrong.

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

Consumer-driven Deflation? Not Even Close

“Inflation is the senility of democracies”

-- Sylvia Townsend Warner

--

If you ask the average person to define inflation, you get this response: “Rising prices.” Similarly, the same person would likely define deflation as falling prices. But both answers are incorrect -- in fact, they’re gross misrepresentations of the words, and this simple, but popular misconception is the root of every single economic problem we face today.

Rising prices do not cause inflation, nor are they inflation. On the contrary, rising prices are the result of inflation. Specifically – speaking in terms of the entire economy (as differentiated from individual goods and services) -- rising prices always result from an increase in (or inflation of) the money supply – through printing currency, and/or the manipulation of interest rates by any entity controlling the money supply (like the Fed, The ECB, or whatever).

Simply put, inflation is always monetary. Likewise, pulling currency out of circulation constitutes the deflation of the money supply. Falling prices are not, in and of themselves, deflationary. Indeed, if prices are falling, but the government is printing more money, then the economic environment is properly described as inflationary. Remember, inflation is defined as the printing of money, not as rising prices. 

And so here we are.

You may be unaware of the fact that the authorities controlling the status quo – namely Ben Bernanke, Barack Obama, and all their little elves – actually want you to use the words inflation and deflation incorrectly. You might also make the claim that I’m merely splitting semantic hairs – that these definitions are insignificant in the grand scheme of things. But that’s not really a good argument, because if the majority of people believe we are in a deflationary period, despite the fact that the Fed is printing money at the fastest rate ever, well, then we’re not preparing for the inevitable. We are certainly not in a deflationary period – nor have we been for many, many decades. And the “inevitable” to which I am referring is an incalculably rapid rise in prices across the globe.

If you think about it, it makes sense: more dollars in the economy mean less valuable dollars. Money is just like everything else -- it has value, and the laws of supply and demand are every bit as applicable to currencies as they are to everything else: the larger the supply of money, the lower its value.

In the midst of all this misapplied talk about deflation, one of the main arguments I keep hearing is that the main reason prices are dropping -- on everything from real estate to electronics – is that consumers are waiting for bargains; as such, they won’t spend now.

In the last twelve months, I’ve heard and seen my share of specious arguments, fantastical predictions, moronic conclusions, and positively farcical objectives -- from all measures of wannabe (and practicing) politicians and economists. But this idea that consumers aren’t spending because they are waiting for lower prices is just absurd. And the ensuing leap of logic, that consumers are responsible for a so-called “deflationary” environment is positively imbecilic -- for at least two reasons.

First, it’s a misapplication of the word deflation -- as I pointed out above. Second, while it is true that the average consumer isn’t (and won’t soon be) spending as much as he used to, it’s not because he’s waiting for bargains. No, it’s because he’s out of credit, he’s unemployed, his house, car, motorcycle, boat, and plasma television have all either been repossessed or foreclosed upon, and his wife just left him. He’s not exactly in the mood for shopping. He’s not waiting for bargains. He’s waiting for a miracle. And I don’t think they sell those at the mall.

You think consumers really stop spending in anticipation of lower prices later? Really? Ever heard of Moore's Law? The one that says the price of technology will be halved every 18 months? Buy a computer today, it will be worth 50% of that value in a-year-and-a-half. So, in an industry like technology -- where real prices consistently fall -- do you really believe that most people put off buying products in anticipation of lower prices? I mean, it happens, but it’s not the exception, not the rule.

Consumers, for the most part, do not postpone purchases -- even in an industry like technology. This is only borne out by the fact that the technology industry has been one of the fastest growing and profitable in our economy for decades. People will pay today – even in the face inevitable obsolescence.

So let the pundits talk about deflation all they want, but we know (or should know) the truth: the money supply is not shrinking. And even if the prices of most asset classes are still falling – which is arguable, at best, in real dollars -- consumers do not postpone purchases in anticipation of lower prices. And they are not causing “deflation.”

Say it with me: we are in an inflationary environment. How do you think the government is going to pay for all of the trillions of dollars it has promised to spend over the next two (or more) years? I'll tell you how: it’s printing dollars. Lots of them. The money supply has been increasing for decades -- lately, at a faster clip than ever. In fact, the line just went vertical -- as you may remember from a chart I posted in another article about inflation, earlier this month.

And what did we just say about supply and demand? That's right -- the value of dollars is going down, not up. It may not feel like we're in an inflationary environment, but I promise you we are, and even if you don't feel it now, you will. You can rest assured, the very nanosecond Ben Bernanke suspects that the effects of this rapidly increasing money supply are causing upward pressure on prices in our economy, he and his gang of calculator-toting dandruff eaters are going to start jacking up interest rates every way they know how. Then they’re going to huddle in the middle of the room and start praying it works. Which it won't.

Welcome back to the early 1980s, everyone. Only it’s going to be a lot worse this time. Do yourself a favor. Short Treasuries. Now. You can thank me later.

Still not convinced? Have you seen what precious metals, agriculture, and oil have been doing for the last twelve months? They’ve been going up. And it isn’t because consumers are expecting prices to fall. Commodities are the best predictors of future prices. I don’t care what the Dow 30 are doing; look at commodities. That’s where the story is.

The Fed – by way of John Maynard Keynes -- is the main instigator of this preposterous idea that we must fight falling prices with everything at our disposal. Lately, they've even attacked the long end of the yield curve by buying long-term Treasuries in the open market. Some of you may not understand the implications of this behavior, so I'll give you a little help: if the Fed thinks it can maintain lower long-term rates by buying Treasuries, it's going to have to use dollars, and those dollars will have to come from somewhere. Can you hear the printing presses groaning?

So this brings us to four final questions (as well as their answers, which I am thrilled to provide at no extra charge):

1.     If the Fed is going to (attempt to) hold down long-term rates by using printed money to buy Treasuries, isn't that going to cause downward pressure on the value of the currency? (Yes!)

2.     And as the dollar loses value, won’t U.S. creditors be reluctant to loan us more money – or even to hold existing American debt? (Yes!)

3.     And won't that necessarily mean rising interest rates? (Yes!)

4.     So how, exactly, is that going to keep long-term Treasury rates lower? (It won’t!)

Look, if you ignore everything else I’ve said, try to remember this: the Fed is comprised of a decidedly small number of people, who make decisions that will affect you, your job, your family, and your life for years to come. They are not gods; they are human beings, and their perception of reality is just as subject to error as yours and mine. Your currency is more vulnerable than at any other time in history, and you should be scared. Actually, you should be terrified. I know I am.

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

ARTIFICIAL ECONOMY? YES. ARTIFICIAL INFLATION? NO.

"Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion. . . . To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection — a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end. . . . It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression. We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers. It is high time that their influence, which has already done harm enough, should be overthrown."

-- Friedrich August von Hayek (1932)

--

Your government is creating bubbles all around you. It’s like Ben Bernanke knocked back a couple of handfuls of amphetamines and decided to have a big dance party with a bubble machine. Lawrence Welk would be leading the orchestra if he wasn’t dead. Bubbles. Everywhere. Man, what a bash.

I know we’ve talked a lot over the last year about the $13 trillion obligation the U.S. government has created to fight this economic crisis (and only this economic crisis). Governments around the globe are printing, borrowing, and easing rates with unprecedented fervor, eagerly employing the outmoded and nightmarish Keynesian economic policy now commonly known as quantitative easing.

But none of this is really new. I mean, Japan has been doing it for years. Right? Well, yes… at a time when the rest of the world was in the biggest economic boom -- ever. Smart investors borrowed for nothing in Japan and then invested elsewhere, “risk-free,” at 7.5% (or more). Is it any wonder the Japanese economy never improved?

But now the whole world is doing it. Where are these smart investors going to take their free money now? Nowhere. And so velocity remains nearly at zero… for now.

Because of all this theoretical academic chicanery, however -- even as my nubby little fingers passionately peck out this article -- a bubble, the likes of which we have never seen, is expanding around us. Rates hover at historic lows. Bailouts abound. The federal government is printing more money than ever in history, lending it to itself, and then giving it to banks. As the cash presses against the proverbial dam, and credit eases further, precious metals, agriculture, and oil move ever higher. Treasury yields continue to creep up – despite the Fed’s best efforts to hold down the long-end of the yield curve.

Have you ever seen Monty Python’s The Meaning of Life? Funny movie. Remember the fat guy who exploded in the restaurant? Well that’s what this bubble is going to look like when it blows. But we’re not there yet. Not quite.

And yet, just because this is the ultimate bubble does not mean it’s the only bubble. No, this is but the last in a long line of relatively smaller bubbles your government has manufactured for decades, right under your noses.

Want a few examples?

1. Student loans.

2. Health care.

3. (Everybody's favorite) mortgages.

Do you want to go to school? Are you poor? Well guess who's going to guarantee a loan for you? Yep. Uncle Sam. Cheap, easy money. More demand. Higher prices.

Do you need healthcare or living assistance? Step right up! Your saviors have provided you with a cornucopia of options -- from Medicare, to Medicaid, to everyone's sweetheart: Social Security! And now Our Lord and Savior Barack Obama is promising healthcare “reform.” Do you know what that means? You guessed it. Cheap, easy money. More demand. Higher prices.

Listen, friend. Do you make at least $7 an hour? Do you need a new doublewide? Do I have news for you! Your government, in all its munificence and magnanimity has, for over 70 years, been putting high-risk borrowers like you in their own prefab slices of the American dream! Ask and you shall receive! And now, if you’re a first-time homebuyer, you’re going to get a massive tax credit! Yes! It’s true! Cheap, easy money! More demand. Higher prices. And isn’t that exactly what we want? Really?

This is what happens when money becomes abundant and easy to get! People spend. And when people spend, they create demand for the goods and services on which they spend. And demand creates higher prices. Now think about this… when money becomes abundant for a specific set of goods or services, demand only becomes more focused, and prices within that particular sector or industry rise.

Your government gives away money for many purposes, but perhaps the most publicized and controversial are the areas of student assistance, healthcare, Social Security, and mortgage assistance. Oh, and Cash-for-clunkers. How could I leave that one out?

When your government makes money available, it creates artificial demand for the products and services tied to the industries in focus. The results? Prices in these industries rise. And continue to rise. And continue to rise. Until a bubble forms.

So here's the bad news:

You want to blame Wall Street for the recent housing bubble? Try again. Your government created it (along with so many other bubbles) by encouraging lenders to dole out cheap money to people who couldn't afford the homes they were buying. Now you've seen the results.

Social Security, student lending, and healthcare subsidies are next. Come on. Do you really think the Obama health reform plan is going to make health care cheaper and more abundant? Right. The same day Amtrak becomes solvent.

Barack Obama is an eloquent speaker, and my goodness does he ever exude dignity and poise. And I’m sure his intentions are pure as water from a mountain stream. But I don’t care how well he comes across; he and his new girlfriend Ben Bernanke are going to perpetuate these broken policies, because they have to do something. Right? That’s the political imperative.

So here’s the worst news of all: no longer is the government only creating cheap, easy, abundant cash for specific purposes – like student loans and mortgage assistance. No. Now the government is doing it for the entire economy. That alone is enough to make the Consumer Price Index throb like a toe, freshly stubbed. But then you add to this reckless and profligate mess the fact that the money supply graph has gone vertical in the last year, well…you better believe we’re in trouble.

Do you hear that rumbling noise? The one that sounds like 14 freight trains heading right at you? Yeah. That noise. Well that’s inflation. It’s coming, and it’s got more energy and ire than any hurricane you’ve ever seen.

So board up your windows and doors, because this time it’s for keeps. Even Paul Volcker, in his prime, with a magic wand, a unicorn, a leprechaun, and three eager inflation-fighting little fairies wouldn’t be able to fix this mess.

And Helicopter Ben? Hell. He doesn’t stand a chance.

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

BANNING DERIVATIVES?

"Knowing a great deal is not the same as being smart; intelligence is not information alone but also judgment, the manner in which information is collected and used"

-- Dr. Carl Sagan

--
 

There are a surprising number of people in the world today who believe derivatives are nothing more than gambling instruments, whose only function is to deprive innocent and uninitiated investors of their hard-earned money. And then there are those of us who know better.

When I was much younger, we had a family friend -- a brilliant neurosurgeon, who made a lot of money. It’s typical for neurosurgeons to do well, financially; tinkering with brains and spinal cords is a whole lot more complicated than replacing a carburetor. As such, none of us were unduly astonished by his lifestyle or wealth.

What was somewhat perplexing was the turn his life took later.

I lost touch with the doctor when I left home to begin my own adventures, but when I was in my early twenties, I learned that he had been financially ruined. He had become involved with commercial real estate in Texas, and the subsequent market collapse wiped him out. About two years later, more news came: his misfortunes had taken an enormous toll on his health – to the extent that he was unable to continue his career as a surgeon. His condition declined and he died relatively young -- in his late-forties.

Why am I telling you this story? To illustrate a vital point: sometimes smart people venture from their areas of specialty, and do not-so-smart things. The man I'm telling you about was a great surgeon, but he was a terrible commercial real estate speculator. Please don't think I'm being insensitive; he was a nice man, and I was sad to hear of his catastrophe. But he deviated from his expertise -- undoubtedly driven by a misapplied confidence that came from his success as a surgeon.

As difficult as it is to see one person suffer from the effects of his own miscalculation, there's an even more dreadful form of this phenomenon – which I’m going to label the disease of over-confident intellect. And the consequences are far-reaching, indeed. It happens when successful professionals – like doctors, lawyers, scientists, and captains of industry -- abandon their professions to seek public office. The problem derives from the fact that we gravitate like lemmings to their charisma and success -- allowing them to make decisions for all of us, in areas far outside their realms of specialty.

This is the tragedy of democracy, and yet it is a mistake we willingly make -- over and over -- to our collective detriment. Are some politicians stupid? Sure. Are most politicians stupid? Almost certainly not. Does a politician’s intelligence, however, guarantee he or she will make sound decisions?

This is obviously a rhetorical question, but I’ll answer it anyway -- just in case any stupid politicians happen to be reading this: no, it does not.

Case in point: a proposed ban some months ago by Minnesota Congressman Collin Peterson on about 80% of all credit default swaps. I'm not ignorant of the role CDSs played in the current financial crisis, but I'm also not oblivious to the fact that CDSs also play an important role in creating liquidity and facilitating price-discovery.

I'm sure Congressman Peterson is a smart person. His proposal, however, was just stupid. But hey, so are salary caps, short-sale bans, “too-big-to-fail” schemes, forcing children to learn Creationism in school, Cash-for-clunkers, same-sex marriage bans, and even the minimum wage.

The sad fact of the matter is that most politicians just don’t know any better. These men and women represent the collective finger being point haphazardly in every direction by their constituencies – desperately looking for anything, or anyone to blame. For everything.

Politicians, however, are not the only societal leaders who – with good intentions or not -- try to foist upon us ridiculous “solutions” to problems that may or may not even exist. It seems to be the imperative of every successful human being: “My achievements are monumental! Therefore I am brilliant! Society has problems! It is my duty to fix those problems! That’s how I’m going to ‘give back!’”

If any successful people are reading this, can you do us all a favor? Please don’t “give back.” Just keep doing what you do best. We’ll all be a lot better off.

Consider Warren Buffett. For twenty years, this man has been one of my most important role models. When I began gravitating toward finance, I became fascinated by Buffett and the people who influenced him – like Ben Graham, Phil Fisher, and Charlie Munger. I read all the Berkshire-Hathaway (NYSE: BRK-A) annual reports, and meticulously picked apart every single book I could find offering insight into the methodology of this brilliant investor and his ilk. I adopted their principles, and I found a great deal of success for myself and my clients in subsequent years.

My respect for Warren Buffett, however, has its limits. In other areas of thought, Buffett is a borderline fool. Economically and politically, he is a rabid leftist -- often denouncing the very system from which he has profited so handsomely, for so long. He has condemned futures and options markets, for instance, and even proposed a 100% capital gains tax on any security sold within a year of purchase. I understand that Buffett's acumen as an investor is nonpareil, but how on earth can he not see the damage his proposals would do to market liquidity -- and ultimately to the economy as a whole?

I have never understood why derivatives and derivatives speculators are so vilified. Yes, they have been responsible for extreme moves in markets – like the technology, housing, and oil bubbles. Nonetheless – and I apologize for being trite –what goes up does come down, and the same speculators who cause these anomalies in the first place are invariably responsible for (and subject to the perils of) the subsequent collapses. Warren Buffett's ire isn't required to elicit their penitence; market backlash is quite sufficient, and there can be no question that many, many speculators have met their financial demise in the reckless turmoil necessarily accompanying any grossly mispriced market.

Buffett is by no means the only billionaire with misguided social, philosophical, political, and/or economic ideas. George Soros actually studied with my all-time biggest inspiration – Sir Karl Popper. And yet, somehow, after Soros made his fortune, he became the antithesis of everything Popper stood for. And the most troubling thing about Soros’s imperative? He actually uses Popper’s work to justify his distorted and ill-founded concepts.

The thing that seems to elude people like Peterson, Buffett, and perhaps even George Soros (the latter two being – paradoxically -- quintessential capitalists) is the fact that speculators create tremendous liquidity in markets – dramatically narrowing spreads, and encouraging price discovery. Supply and demand do not cross at some constant, absolute point in space and time as your high school economics teacher would have you believe; the intersection is an amorphous, dynamic point, floating elusively through markets -- teasing us, but never revealing the precise scarcity of a particular good or service.

As some of you know, I like to compare so-called economic equilibrium to subatomic physics; it is impossible to ascertain both the velocity and position of a particle -- whatever you use to measure the particle actually changes its position and speed. We can know one or the other, but not both.

Likewise, the very price structures we use to gauge the scarcity of goods and services necessarily change the nature of supply and demand with every new transaction. We cannot know market equilibrium -- we can only approach it. The liquidity provided by speculators is precisely the mechanism needed to approach market equilibrium – to get as close as possible. And yet, people whose intelligence we respect denigrate these speculators unceasingly. Unfortunately, no matter how smart the critics may be, they do not fully understand the nature and complexity of markets. Surprisingly, people like Buffett and Soros – both of whom capitalized handsomely from specific expertise in extremely focused segments of the industry – are often the most vociferous critics of capitalism, as a whole. And they somehow they remain ignorant, despite having immersed themselves in the system.

This is an almost perfect demonstration of how deviation from an area of expertise by only a very small amount – in Buffett's case, from understanding corporate wealth creation, to understanding the mechanics of liquidity – can generate colossal erroneous conclusions. And bear in mind that Buffett, himself, has often criticized companies for deviating from their own areas of expertise!

To expound, Buffett exemplifies only a small deviation from expertise: a value-investor criticizing derivatives markets. He clearly understands futures and options at a fundamental level -- and even employs them on a limited scale. Nonetheless, he lacks the complex knowledge of these specific markets to understand how critical they are to price-discovery. Again, the gap in Buffett’s knowledge is small: derivatives and equities are merely different segments of the same industry, and the leap shouldn’t be a difficult one for him. Yet it is.

Now let’s talk about what happens when a neurosurgeon decides to become involved with a completely foreign industry – like commercial real estate? Or worse still, let’s talk about the implications of a career politician – with no practical real-world experience of any sort -- deciding to start a crusade against derivatives.

What the hell does a career politician know about derivatives?

Imagine a world in which children dictate terms to their parents, and have the power to fire them if they don't provide results the children demand. That's the way democracy works; but as flawed as it is, the negative consequences of group-think are often compounded by the fact that our leaders are often so intelligent that they fail to recognize the limits of their own abilities. Sometimes "smart" just isn't enough, and when you couple ego-driven intelligence with irrational demands from a constituency of spoiled brats -- wielding the power to destroy political careers -- the problems snowball.

If the ideas of Warren Buffett, George Soros, and Collin Peterson genuinely stem from their ignorance of the consequences, then they really are just fools to be pitied. On the other hand, if such men make these absurd -- and even dangerous -- proposals with full knowledge of the consequences, then they are evil.

Either way, their theories should be dismissed as specious nonsense before they can affect the kind of change that causes massive price distortions, and still more widespread economic calamity. This entreaty would be urgent in any environment – but none more fragile than this.

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

THE UNSUSTAINABLE LIE OF INFLATION

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

--William E. Simon

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

-- Joseph Goebbels

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

-- John Maynard Keynes

--

You are being lied to.

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

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

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

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

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

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

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

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

But then again, maybe he’s not.

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

Wrong.

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

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

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

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

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

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

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

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

And now for my favorite…

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

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

Propaganda is an art form. Yes it is.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

THE INTRINSIC VALUE OF NOTHING, PART II

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

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

-- Ludwig von Mises, Human Action

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

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

--

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

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

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

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

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

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

Wrong.

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

Bear with me…

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

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

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

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

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

And this is why prices change constantly.

THE ECONOMIC CALCULATION ARGUMENT

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Just ask the Soviets…

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

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

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

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

At least not at the moment…

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

THE INTRINSIC VALUE OF NOTHING, PART ONE

THE INTRINSIC VALUE OF NOTHING

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

-- Ludwig von Mises

--

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

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

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

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

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

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

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

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

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

There are two theories of value:

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

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

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

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

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

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

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

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

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

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

Sometimes epistemology just won’t give you a break…

The following statement is true.

The previous statement is false.

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

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

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

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

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

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

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

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

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

Until then…

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

And Then There's Phase Four

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

- Alan Greenspan, June 25, 2009

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

- Alan Greenspan, September 9, 2009

--

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

Wrong.

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

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

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

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

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

We are all screwed.

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

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

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

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

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

PHASE THREE: Stock market recovery. 

And suddenly everything is fine, right?

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

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

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

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

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

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

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

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

Does that sound like an economic recovery to you?

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

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

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

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

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

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

DISCIPLINE Movie Update

VARIETY

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

Permut, Jones set 'Discipline'

Duo to bring sci-fi novel to the bigscreen

By DAVE MCNARY

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

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

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

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

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

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


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Short the USA

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

-- John Maynard Keynes

 

--

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

 

 

An Ill Wind Indeed

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

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

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

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

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

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

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

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

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

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

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


Who Wants a Job?

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

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


How Will the Money Go?

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

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

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

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


Where Will the Money Go?

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

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

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

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

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


The Ill Wind…

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

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

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

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

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

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

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

Don’t Kill the Messenger

 

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

-- Plutarch, Pyrrhus 21,14

 

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

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

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

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

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

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

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

"And you don't?"

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

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

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

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

 

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

 

THE FOUNDATION OF THE CRISIS: PAST, PRESENT AND FUTURE

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

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

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

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

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

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

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

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

 

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

 

 

The Last Drink Before the Weekend Ends

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

Done.

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

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

"Mr. Ahlgren?"

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

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

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

"Excuse me?"

I leaned forward a bit. "Hooters."

"Oh."

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

I smiled patiently. "What question was that?"

"Are you going to gamble?"

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

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

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

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

Somebody else said, "Why not?"

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

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

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

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

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

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

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

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

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

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

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

And I miss my little girl so much…

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

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

Now. This minute…

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

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

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

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

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

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

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

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

"Keep it," I said.

She narrowed her eyes and smiled a little more…

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

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

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

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

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

 

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

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

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

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

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

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

 

SHORTING THE DOLLAR INDEX?

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

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

 

REAL ESTATE?

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

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

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

 

COMMODITIES?

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

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

 

SHORTING TREASURIES?

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

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

 

HOW DO YOU GET INVOLVED?

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

 

 

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

 

 

Nothing About this Economy Should Surprise You

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

-- Albert Einstein

 

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

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

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

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

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

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

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

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

   What is insanity again?
   

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

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

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

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

For the entire world is now truly and incontrovertibly insane.

 

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

 

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

 

"Inflation is the senility of democracies."

-- Sylvia Townsend Warner

 

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

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

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

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

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

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

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

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

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

 

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

 

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

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

-- John Heywood 

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

 

You Want Healthcare Reform? Well How About This?

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

-- Ralph Waldo Emerson

 

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

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

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

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

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

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

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

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

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

 

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

 

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

Some Austrians Aren’t Being Tough Enough

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

-- John C. Maxwell

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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