Owning Gold or Digging Gold

Everybody has some gold jewelry laying around the house.  For most people, that is all the gold investing they do.  However, when a person does decide to invest in gold, they usually buy it like they normally buy stock, i.e., in shares of a company that mines gold.  That has not been a good investment over the last few years.  Take a look at this graph:

While the amount of gold taken out of the ground has actually increased 14% over the last four years on a cumulative basis, the amount of gold mined on a per share basis has decreased 9%.  

More gold produced partially explains the recent weakness in gold prices, as increased supply of most anything weakens the price.

To finance greater production of gold, which is expensive, gold mining companies issued many new shares of stock, which has diluted the value of shares of stock, just as increased supply of gold stock weakens the price of gold stock.

The same supply & demand relationship works for the price of the raw gold and the number of dollars.  If the supply of dollars increases faster than the supply of gold increases, the price of gold will normally increase.  Monetarist economists like to say "too many dollars chasing too few goods chases up the price of those goods."

It is a real historical anomaly that quantitative easing by the Fed has not increased the money supply enough to drive gold prices through the ceiling.  It has not, because consumers have not been spending the newly-created money.  (That is called the "velocity of money" and measures how often a dollar is spent.)  As people lose the investment fear they've acquired since 2008, I expect money supply to increase significantly, and the price of gold to increase.

If the recent flood of money back into stock mutual funds (which is driving the market up right now) continues, then I expect the velocity of money to increase as well.  That would be a good time to be owning gold -- the metal and probably even the stock of companies digging it up.

Big Enough Pasture ?

Much has been written about the folly of trying to out-smart the market by market-timing, i.e., selling all stocks when the market is the highest and buying all stocks when the market is the lowest.  Of course, while that is a quaint idea, nobody has ever been able to do that on a consistent basis.

But, there is a nugget of wisdom to it  When risk rises, the percentage of the portfolio allocated to cash should also increase.  (Being 100% cash is not prudent.)  The nugget of wisdom is that we are looking at risk - not returns.

Does a person significantly reduce their upside potential if they shift heavily into stocks when the level of risk decreases?  Sometimes, they do, because the market has gotten ahead of them!  Sometimes, they don't!  Take a look at this chart:

In the past 112 years, the Dow has dropped a whopping 30% thirteen different times and been followed by a bull market each time.  Today, we're enjoying another bull market, but it is still a weak and short rally compared to averages (the gray diagonal line).  That tells me the bull probably still has lots of pasture to run in.

The economy still enjoys greater underlying strength than the market does.  Both are just waiting for the politicians to get out of the pasture . . . 

Drying Out . . .

Last year, I often wrote the U.S. economy was stronger than most people realized but was weighted down by three "wet blankets."  They were (1) the Presidential election, (2) the Fiscal Cliff/Crisis, and (3) the European financial crisis.

The first wet blanket created uncertainty, and the stock market hates uncertainty.  Historically, the market rises in November and December following a Presidential election, and it certainly did last year as well.  Since 2008, investors have taken out almost $587 billion from stock mutual funds.  That shifted after the election, and it is estimated that over $50 billion has flowed back since then.  That is a very bullish sign!

The other two wet blankets were more important, as they posed systemic risks, i.e., an actual risk of collapsing or seriously damaging world financial markets.  But, even those wet blankets are beginning to dry somewhat.  Just as you cannot yell "wolf" too many times before losing credulity, investors have seen the fiscal can kicked-down-the-road so many times that they are losing their fear.  Last week's wise decision by the Republicans to kick the Debt Ceiling can another three months down-the-road is an example.  The market was expecting that!  I am more optimistic that this impasse will be broken.  The market will rally stronger, no matter whether the Republicans or Democrats "win" the struggle.

However, I'm still worried about the European financial crisis - but less worried - for now.  The European Union  (EU) has been held together valiantly by Angela Merkel and Mario Draghi, head of the European Central Bank.  His job is safe.  Her job depends on her re-election in September.  For that reason, she cannot do much more to re-build the Union until the fourth quarter.  Until the budgetary authority is taken from individual nations and centralized into the EU, we are "wallpapering over the hole in the wall," but that acceptance by each nation, in some face-saving format, is coming.

Historically, the U.S. stock market sells about 15 times the earnings estimates for the next 12 months.  Today, it is selling for only 13 times, which suggests substantial upside . . . for awhile.  We may be seeing the backside of the Bear . . . for awhile.

$1,000,000,000,000 Coins ?

William Buckler is a brilliant libertarian from Australia.  Like most libertarians, he embraces Austrian economics and a return to the gold standard.  He is also required reading.  Fortunately, a good friend of mine is always kind enough to share his copy . . . Thank you!

The most recent issue discusses the heavy emphasis that politicians place on "laws."  They think they can solve any problem by merely passing some new law or interpreting some old law differently.  As an example, he cites the idea of the U.S. minting a platinum coin which would be legal tender for $1 TRILLION.

A politician can also pass a law suspending the law of gravity, which is great until he steps off a cliff.  Buckler is correctly highlighting the fact that physical laws cannot be over-ridden by man-made laws.  Sure, we can issue $1 TRILLION coins to "dress-up" our national balance sheet . . . but just wait until we try to pay a foreign creditor with a coin worth only about $2 THOUSAND in platinum.

Sometimes, it is tiresome to read Buckler, as the sky-is-always-falling.  But, we are indeed watching a slow-motion train wreck in our fiscal policy, and there is plenty of time for the sky to fall.  I had hopes he suspected Obama would surprise the world and become a truly "transitional" President by curbing the growth in entitlements, but I see no evidence of that.

Separately, he takes the New York Times to task for a column suggesting we have outgrown the U.S. Constitution, calling it "flagrant contempt for the knowledge and reasoning power of the American people" or maybe the leaders of the American people anyway.  (The irony of an Australian lecturing the U.S. on the U.S. Constitution was not lost.)  And, I have often wondered in this space if we need Representative Democracy 2.0 and don't feel bad about questioning our current operating model for governing.  If we can improve upon our version of government, then we should.  Isn't that why the founding fathers permitted the Constitution to be amended?  Otherwise, we could end up like the impotent Japan.

While not recommended for the faint-of-heart, go to http://www.the-privateer.com/ for a chilling review of the world's fiscal condition.

Happy Bankers, Unhappy Regulators

Scratch a banker and they will tell you they have money to lend and are just looking to make new loans.  Without question, they are honest in that comment.  Of course, if they are candid as well, they will add that credit has to be absolutely 100% perfect to qualify for a loan, which is very different than the recent past.

But, the numbers don't lie -- total loans outstanding have not increased significantly.  Most of what bankers cite as new loans are merely renewals of existing loans, including those that cannot be repaid and are simply "rolled-over," which is called "extend and pretend" that they will be repaid.

But, there is also something more subtle happening . . . banks have been preparing to comply with the new requirements of the Basel Agreement.

Basel is a charming town in Switzerland, halfway between Zurich and Geneva.  It is home for the Committee on Banking Supervision, which is writing new capital requirements for banks worldwide.  In the aftermath of the global financial crisis, the committee quickly announced that capital requirements would be raised substantially.  Unfortunately, this decreases the profitability of a bank, because it can lend less -- if it must keep more of its balance sheet tied up in low-yielding capital.  The banks screamed "bloody murder" (whatever that is).

In addition to capital requirements, the Committee is responsible for setting minimum liquidity requirements for banks.  Last week, they reduced that amount from 5% of insured retail deposits over thirty days to only 3%.  Even worse, the acceptable collateral quality was loosened.  Lobbying does work.  Even better, it pays!?

Less capital and less liquidity in customers does NOT make banks happy.  Less capital and less liquidity in banks DOES make banks very happy.  The good news is that bank lending will probably increase slightly.  The bad news is that there is an old adage that the seeds of the next crisis are sown in the aftermath of the last one . . . Amen!

Looking Down the Pipleline

Frequently, I am asked whether I worry about inflation.  The answer is:  Yes -- all the time!  There is no doubt in my mind about serious inflation coming at us.  Theoretically, it doesn't matter that the Fed has "printed" so much money, as they can simply withdraw the excess money supply when necessary.  As a practical matter, it is politically difficult for the Fed to do that.  It has been described as "removing the punch bowl when the party gets started."  Because of that delay, serious inflation is out there . . . but it is WAY out there!

In this space, I've explained the Monetarist theories about the supply of money increasing faster than the supply of things to purchase, i.e., more money chasing fewer goods drives up the price of the goods.  Like most things, it is usually more complicated.  What happens if people don't spend the newly-printed money?  What happens if people save? What happens if banks don't lend?

The increased money supply created by this Fed is not being circulated or spent by Americans like normal.  Called the "velocity of money," it has slowed approximately 67%.  Serious inflation would return quickly if our normal spending and lending habits returned quickly.

I've also explained that inflation cannot sneak up on us.  It will be easy to see before it gets here.  Here is an example.

We measure inflation in prices at (1) the consumer level, (2) the wholesale level, and (3) the production level.  As we know, inflation at the consumer level (CPI) has been benign.  In fact, the Fed wants inflation at 2% and was lucky to get 1.7% over the past twelve months.  At the wholesale level (PPI), inflation was only 1.3% in 2012.  CPI was flat, and PPI was negative during the fourth quarter, primarily because of energy costs which fall at an annualized rate of 19.6%.  However, if you look further down the pipeline, you'll see that prices at the production level have been increasing.  Theoretically, the increased prices at the production level would pass to the wholesale level and then the consumer level.  Yet, the 2.3% increase in food costs at the wholesale level was compressed to 1.8% at the consumer level.  That shows me the consumer is fighting back, but that cannot be expected to last.  Wholesalers cannot keep absorbing the inflationary pressure.

All this suggests a modest build-up in inflationary pressure over the next twelve months.  But, there is no evidence of the serious inflation that I expect later.  When you see the Fed start raising interest rates, you should already be owning real estate and commodities.

Subject to the unemployment level, the Fed has stated they don't expect to raise rate through 2014.  So, you have plenty of time.

The Hi-Jacking of Ayn Rand

When I was nine years old, my father gave me my first gun.  As a child, I spent countless hours shooting birds for target practice (which I'm not proud of today).  As a result, it was no surprise when the Army qualified me as an Expert Marksman.  As a civilian, I have had a Concealed Weapons Permit for many, many years, because I find it comforting to keep a pistol in my car.  I was a member of the National Rifle Association.  If the government asked for weapons to be voluntarily turned-in to the police, I would not participate.  I do believe America is a safer place because I am armed.  So, I guess that makes me a gun-nut.

But, I'm not a ridiculous, paranoid gun-nut!

Ayn Rand is the most influential author in American history that few people know about.  As a refugee from the Communist revolution in Russia, she saw the government confiscate the wealth of the successful and/or lucky (read:  rich) and, in many cases, execute them.  The more fortunate got deported, such as Ayn's parents.  When she came to this country, during that period of American history when unions were gaining power, she logically connected-the-dots and assumed the U.S. government would someday confiscate the wealth of the successful and/or lucky here, before executing or imprisoning them.

That may or may not be a legitimate fear, but the NRA seized on that argument to increase paranoia among their members and to increase their lobbying influence.  It was an easy sell to a relatively young nation that fought for its independence from an oppressive government.  Today, the NRA is regarded as the strongest lobbying organization in America.

As much as I appreciate my guns and admire Ayn Rand, this free-floating anxiety is ridiculous!

Suppose the Federal government decides to confiscate all guns in America. And, suppose you're sitting at home one night when jack-booted storm-troopers kick in your front door to remove any guns in your house.  First, they have to look in all the obvious places, like the nightstand beside your bed.  Then, they must remove the drywall covering your interior walls, to check for guns.  Then, they need to tear up the floors, to check for guns.  Then, they need to dig up your backyard, to check for guns.  Then, they need to dig up any forests that you have visited.  Where does it end?  How many storm-troopers do you need to scour a huge country for 300 million guns and over 100 million residences and apartments?  Who is going hire, train, and pay all those storm-troopers?  If you utilize existing police (most of whom are also gun-owners and may choose to ignore any guns found), what functions will they no longer perform?  Will they no longer investigate crime or monitor traffic or patrol schools?  If you utilize the military, what functions will they no longer perform?  I could keep going, but you see the point.

The logistics of removing 300 million guns from 300 million people in 100 million homes is over-whelming.  Even Ayn Rand would agree that Czarist Russia did not pose so many logistical problems.  Confiscating our guns in America would be a greater effort than World War II in Europe, as our far-right gun-nuts would certainly and quickly become snipers.

It would also be an enormous drain on the economy, diverting resources from other badly-needed services or projects.  Knowing the impending armed fight in America that would break out quickly, the stock market would drop markedly, signalling its disapproval.  This is just NOT going to happen!  Stop worrying about the impossible!

As a responsible, experienced gun-owner, I look forward to increased gun-control!  My Second Amendment rights are NOT being threatened . . .

A Seven-Minute Perspective on Medicare

My favorite cousin and lifelong buddy is a registered nurse who has a perspective on Medicare that is somewhat different from mine.  She understandably sees it through the prism of medicine, while I see it through the prism of economics.  I think she sees it as the delivery of necessary social benefit, while I see it as something that crowds-out other spending programs.

Anyway, she sent me an excellent short video on the history of Medicare, which can be found at:

http://www.kff.org/medicare/medicare-timeline2.cfm

I encourage you to take a few minutes to view it.  After you do, ask yourself how Medicare would be different if it was designed by nurses and economists, instead of lawyers and politicians?

On the News Stands

Readers know I also write a quarterly column for Inside Business on the economy and investing.  I enjoy writing it, because it allows me to group subjects that I think are important.  The latest was published yesterday and is on news stands today.  It can also be found at:

http://insidebiz.com/news/making-it-through-q4-and-around-cliff

The columnist does not control what accompanies the written part of the column, but I never expected to see a photo of Redskin fans and Cowboy fans sitting together in a column I wrote.  Apparently, the editor has a sense of humor, which I do appreciate.  (Unfortunately, it does not appear in the online edition.)  It will make sense after you read the article . . . I promise!

Good Intentions Are Not Enough

With my interest in health care issues aroused recently, I noticed the Centers for Medicare and Medicaid Services (CMS) just issued their report on 2011 expenditures, reporting that the U.S. spent $2.7 trillion or about $8,680 per individual. That is a whopping 17.9% of the economy, as measured by GDP.  The government's share of expenses was 45%.

Looking at trends, the increase is only 3.9% -- still twice the rate of inflation but much lower than normal.  It is thought this is due to the increased number of unemployed and uninsured who received less medical attention during 2011.  The CMS estimates government expenditures will increase 7.4% in 2014 when ObamaCare offers health insurance to another 22 million Americans, before averaging 6.2% growth in expenses each year from 2015 to 2021.

Also, while the government's share of healthcare expenses was 45% in 2011, it was only 30% in 2002.  This rapid growth was before ObamaCare and the Baby Boomers entering Medicare.  The government's share can be expected to continue rising.

Paul Ryan's plan to end Medicare by giving everybody a $7,000 voucher to shop for their own insurance would still leave the average Medicare patient with a "pay cut" of $1,680.  (Frankly, shopping for health insurance was one of the most difficult, complicated purchases I ever made -- far more complicated than buying a house or car or even picking a spouse!)

Who was the rocket scientist that said "that which is unsustainable cannot be sustained?"  While I'm delighted to see more Americans getting medical attention, the cost curve must be bent . . . soon!

It is not fair to say the government does not try to control the costs.  Medicare imposes strict limits on the price they will pay for drugs.  According to an FDA report, the number of drug shortages increased from 61 in 2005 to 251 in 2011, because companies won't invest more capital into making drugs with artificially low prices.  (Companies will always allocate capital where they can make the most profit, not the least.)

Choices have to be made.  Recently, I heard an elderly Medicare recipient, who has never worked, argue that a certain infrastructure improvement should not be made, as the money should be saved for Medicare spending.  I just shook my head.  Choices do have to be made, indeed.

Most churches I know would love to take care of every poor person they can find but are constrained by the cold, hard reality of economics.  So is the government!

Tapping My Fingers . . . Impatiently

I think I took my first course in Principles of Investment in either 1970 or 1971.  At the time, there were two dominant schools of thought.  One was the "fundamental approach" founded by Benjamin Graham and popularized by Warren Buffett.  It emphasized detailed analysis of the company financial statements, especially the footnotes.  Critics allege it is "bottom-up," putting too much emphasis on the arcane statements and not enough on the sector or the competition or the overall economy.

The other dominant school was the "technical approach," whose followers are called "chartists."  Many even brag that they don't know the name of companies they buy and sell, because their decisions are driven by the chart action alone.  Critics allege it is too simplistic and ignores too much that matters.  My thinking is that charts are only useful in timing decisions.  Now, take a look at this chart:

The Russell 2000 is a popular index for the price performance of smaller companies.  This shows that the long term trend line (green) for these stocks has broken above the resistance line (red), which is that price level where the index has bounced off before.  This is important!  It could mean the bulls are getting ready to run!

It is not unusual to see a stock or index pierce the resistance line briefly and then fall back below.  However, when it pierces it the second time shortly afterwards, it suggests the bulls are getting ready to run -- BIG TIME!

Now, if Congress would just resolve the debt ceiling and budget issues . . . quickly, please!

Back On The Road . . . to recovery!

Readers know I am endlessly fascinated with the permutations of portfolio management and the impact of myriad economic data on different portfolios, along with the politics that thread them together.  However, those subjects become less entertaining when laying awake at night with your throat burning and your lungs rattling.  It has even been hard to care whether people see economics as a suit, rather than a wardrobe to mix & match.  Or, that most stock analysts don't understand the relationship between earnings-per-share and growth rates.  Or, that the Tea Party would rather capsize an aircraft carrier than change course slowly.

Not being one who prefers hope instead of action, I've been to three doctors in six days, i.e., my family doctor, an ENT specialist, and the local Urgent Care.  You guessed it . . . the local "doc-in-a-box" finally diagnosed and treated the problem correctly.  By the way, they don't accept Medicare.  Does that suggest anything about ObamaCare?

The visit to the family doctor cost me nothing.  The visit to the ENT specialist cost me nothing.  Medicare paid 100% of both.  However, I paid 100% of the visit to the doc-in-a-box, which was only $150 and included a chest X-Ray, after a mere ten minute wait.

Countless polls tell us that Medicare is the most appreciated entitlement program in our country.  As a result, politicians are understandably loath to cut any funding for it.  They're too afraid of us!  This is one Medicare patient who begs for change.  Make us pay larger co-pays.  Increase our monthly premiums.  Set up ways to  decrease end-of-life costs when there is no hope.  But, most of all, find a way to pay for results.

It is not time for the perfect solution.  It never is.  It is time for a first tiny step, Mr. President!  Please think about that during the upcoming spending negotiations.

Anyway, the worst is over for me, I hope, and it will soon be time to start thinking again . . . finally!

GOP's New Year's Resolution

I like Lindsay Graham, the Republican Senator from South Carolina, and agree with him that President Obama has won a great political victory and should, of course, be congratulated on his victory.  Enough said!

My New Year's Resolution should be to attend the next meeting of the Republican National Committee and to nominate Mr. Spock as the new Chairman of the Grand Old Party.  You'll remember he was the half-human, half-Vulcan on the television classic Star Trek.  He was forever trying to control the emotions from his human side and think logically like any good Vulcan.

When Republicans lost control of their emotions, they lost the message-campaign, allowing Obama to win this victory.

I know many, many Democrats who detested Bush 43.  However, I know even more Republicans who absolutely hate Obama!  I know that is a harsh word, but I find it accurate.  Not only do many of my friends tell themselves that Obama is actually a Muslim-Socialist, I have one friend who believes Obama is the apprentice to the Devil himself in case he retires . . . no, seriously . . . he believes Obama is conspiring with the Devil.  Where did the logic go?  It was consumed by emotion.

This put the Party into the position of disagreeing with anything and everything Obama said.  So, when Obama said he wanted the successful and the lucky to pay more in taxes, the Republicans reacted with protecting the "rich," instead of saying "yeah, but how are you going to cut spending, especially entitlements?"  The Republican message became merely anti-Obama, instead of advocating for real lasting Change.

Of course, when we negotiate the debt ceiling increase, there will be another opportunity to control spending.  If they can control their emotions, Republicans will stay focused on controlling the deficit.  If they don't control their emotions, they will find themselves arguing the poor and the elderly don't need any help.

The market should stabilize for awhile, as uncertainty has been reduced.  Given that we lost our AAA credit rating following the last debt ceiling debate, I expect the market to lose value if the debate becomes another debacle.

And, by the way, what is YOUR New Year's Resolution ??

Gold's Complex Relationships

Given that the world was supposed to have already ended this month, according to the long-dead Maya, and given that America is supposed to end in a few days from stumbling over the Fiscal Cliff, according to the way-too-lively Media, it is a wonder that gold has declined in value over the past few months.  After all, it is supposed to be the refuge of last resort.  Financial advisors have long argued that gold will always have some value -- no matter what!

The standard drivers of all commodities are, of course, supply and demand.  However, the nation buying the most gold per person is India, whose economy has taken a pronounced swoon.  To a lesser extent, the same is true for China.  Reduced demand for gold therefore reduced the value of gold.

A less understood relationship driving the value of gold is the value of the dollar.  With rising economic anxiety, investors worldwide have been buying dollars as a refuge of last resort, which drives up the value of the dollar.  No matter what happens to America, the belief is that dollars will still command respect and retain value overseas.  When the dollar rises in value, the value of gold decreases in this country.

When America resolves its current fiscal crisis and when Europe resolves its current financial crisis and when it is more clear that China is resuming its economic growth, the dollar will fall in value, and the price of gold should increase.

However, there is another relationship that should be examined.  Take a look at this graph:

It suggests that you should continue to hold gold as an investment as long as you believe our debt level will continue to rise.  After all, borrowing money to pay entitlements -- puts more dollars into the economy -- without putting more gold into the economy.  According to the Monetarist school of economics, that means more dollars chasing the same amount of gold; strongly suggesting that gold will resume its rise.

Now, if sequestration actually takes place, our deficit should decrease.  Does that mean our national debt level would eventually decrease, pushing down the price of gold?  If it does, I'll sell it then . . . not now.

Gripping Reality

Like most people, I remember when President Kennedy was shot.  It was a terrible tragedy, indeed!  But, America grieved, pulled itself together, and continued to be America.

I also remember when America cared about "who shot JR?"  It was a manufactured media event and made the word "media-hype" commonplace.

Shooting the President was horrible, while shooting JR was a simple marketing ploy by advertisers of the Dallas TV show.  Now -- how does the 24/7 hoopla about the Fiscal Cliff compare to those two past events?

The Fiscal Cliff is very real and contains genuine drama.  However, because of the need to find advertisers for the TV news, the media coverage is frantic 24/7, suggesting that chaos is coming -- little old ladies in nursing homes will be thrown into the street, milk will turn sour before it reaches the grocery store and dogs will chase cats.

Right now, economists are doing a lot of hand-wringing about this week's report that there was a large, unexpected drop in consumer confidence from 71 to 65 -- duh!  Who didn't expect it?  Only economists who don't watch the news didn't expect the drop.

As I write this, the futures market indicates the Dow will lose over 300 points when it opens Monday morning.  Compare that with the 777 point loss the day Congress failed to approve TARP.  This tells me investors still hold out some hope for a deal.  (Of course, if there was a "grand bargain" that was permanent and included curbs on entitlements, I would not be surprised to see the Dow rise 1,000 points.  A deal to kick the can a short distance will not impress the market).

My expectation is that America will be embarrassed, slip into a slight recession if the fall is prolonged, and then it will continue to be America.  This is a time to discuss Democracy 2.0 -- NOT a time to panic.

Going over the Fiscal Cliff is a stupid body-blow -- NOT a death-blow.  Think of it as an excuse to have a drink on New Year's Eve . . . like you really needed an excuse.

Paratroopers and Idiots

It was a cold February morning in 1968 that I jumped out of a perfectly good airplane.  As an officer, I had to be the first one to jump out, ostensibly to show my men I was not afraid.  Of course, that was not true.  I was very afraid, but I was completely resolute to do my job -- no matter what!

Standing alone in the doorway, waiting to jump, I put my hands outside the door on the skin of the plane.  (When I looked down and noticed the toes of my boots were sticking over the edge, I confess a certain passing queasiness.)  The door was just behind the engine props, where it was very cold, very noisy, and very turbulent from the prop-blast.

It was too loud to hear anything, so the jump-master simply slapped my backside when it was time to jump.   I fell for a few long seconds before feeling the sudden jerk of my parachute, which was a beautiful sight when I looked up.  Looking down, the view was also beautiful.  But, the big difference was the quiet.  It doesn't take long for the airplane to be far enough away to be out of ear-shot.  It was downright pleasant -- a beautiful view, quiet, and a new-found sense of accomplishment!

So, what could be wrong?  Oh, yeah . . . the ground was coming up to me at 18 feet per second, which focuses the mind.  After the initial rush of panic, the paratrooper will begin guiding his parachute to a safe landing spot, quickly turning the chute to face into the wind just before impact, arrange his body into a "parachute-landing-fall" or PLF position, and wait to react quickly at impact.

It will be a cold January morning in 2013 when the United States stupidly jumps over The Cliff.  As the three sides (Republicans, Democrats, and Tea Party) step to the edge, none has the courage to go first, but all are resolute that they will pander to their political base -- no matter what!

At first, the fall will be almost pleasant, because nothing apparent is happening.  All three sides will have a new-found sense of accomplishment!  After all, they did stand on some principle important to their partisan base.  At some point, they will look down and see reality approaching them rapidly.  But, will they know what to do?

Paratroopers often joke that only an idiot would jump out of a perfectly good airplane.  If that is the case, Congress certainly has a lot of paratroopers!

Over a month ago, I wrote about my surprise at how angry voters are about this self-inflicted wound and actually felt some slight sympathy for the poor, ignorant, elected-idiots.  Hopefully, they spent a few days at home over the Holiday and heard from enough of us -- to realize wisdom does not lie in a political platform.

Of course, the nation will survive this.  Even if we endure another recession, it won't be the last one.  What may not survive is our pride or our sense of accomplishment.  Our forefathers designed and built a wonderful system of governance, which worked for centuries . . . until we elected Puritans who by definition always know the correct way to do everything and cannot compromise on anything.

Economists on Sesame Street ??

In 1946, Dr. Benjamin Spock published his classic book on child-rearing and raised my generation.  In 1969, Jim Henson came on the television with his classic show Sesame Street and raised my daughter's generation.  One of the most annoying characters on that show was Count von Count, who insisted on counting everything and then telling everybody about it.  Examples would be bricks in a wall or clouds in a sky . . . like, who cares?  Count von Count is the role model for almost every economist, who start with counting everything and then feel compelled to explain it . . . like, who cares?

One example would be Opportunity Cost of an aircraft carrier.  Count von Count would count the dollars and tell you what it cost, say, $2 billion.  An economist might say the aircraft carrier cost 2.1 hospitals and 3.7 nursing homes.  Or, which would you choose:  another war machine or a college education for ten thousand kids?  Of course, opportunity cost choices have to be made at the personal level as well.  Suppose you can send your kid to college and retire at age 67 or you can retire at 62 but your kid won't have a college education.  Count von Count cannot make those decisions, because he only counts.  But, economists insist we try to understand what we won't have . . . when we choose what we will have.

Now consider the idea of Capacity Utilization.  It measures how fully the existing factories are being used to produce things.  It got down to 67% during the recession and is now about 78%.  It is commonly used as an advance indicator of inflation.  When it approaches 85%, say hello to inflation.

I just finished reading a report on our manufacturing industrial capacity, which is only 63% of what it was five years ago!  Now, think  about that -- we have reduced the capacity by at least a third, while increasing utilization of the remaining only ten or eleven percent!  While there has been much media coverage about the rebirth of the manufacturing sector since the recession, it has flattened since the first quarter of 2012.  Businesses are sitting on almost $2 TRILLION in cash, waiting for the smoke to clear and they know how to invest it.

Lastly, think about the Output Gap.  Not even Count von Count could give you the size of the Output Gap, which measures the difference between what we do actually produce and what we could produce.  Economists might estimate the average income for a family of four would increase from $47,000 annually to $60,000.  Average education would increase.  Retirement age for the non-self-employed might drop.  Think about it -- how would our world be different, if Congress would get out of the way and we could produce all we are capable of doing?

So, what is the Opportunity Cost of our system of government?

And, by the way, who is raising the current generation anyway . . . ???

WinterFest 2012

At the end of another long, exhausting year and facing yet another cold, dark winter, it is not surprising that the first type of clinical depression cataloged by psychologists was seasonal depression, occurring this time every year.  Different societies have long recognized the extra need for merriment at this time of year.  So . . .

  To my Christian friends . . . . . . . . . . . Merry Christmas!

     To my Jewish friends . . . . . . . . . . . .   Happy Hannukkah!

 To my black friends . . . . . . . . . . . . .  Happy Kwanzaa!

To my politically correct friends . . . .  Happy Holidays!

I do believe this time next year will be a better time.  After all, this is the time of year when we identify ourselves as either "glass half-full" or "glass half-empty" people.  Choose wisely!

2013 Christmas Wish

What is the most powerful business or industry in this country?  No, it is not the defense industry, even though it can blow everything into tiny pieces whenever it likes.  No, it is not the political business, even though it can destroy everything we love and cherish.  No, it is not the religion business, even though it can send us on a lifetime of guilt trips.

The most powerful industry in the country is the advertising business.  It tells us what to buy.  It tells us what to eat.  It tells us who to vote for.  It even tells us what to believe.  It is so strong that it has destroyed our privacy without as much as a whimper of complaint from us.  (Of course, they say they needed to destroy it -- in order to get us advertising we are interested in and sparing us from other advertising -- in order to charge sellers higher fees for placing the ads.)

But, 65% of every advertising dollar spent buys time on television.  Therefore, the advertising industry will destroy anything that threatens its domination of our television sets.

For years, the over-whelming number of complaints received by the Federal Communications Commission involved the excessively-loud and intrusive commercials.  For years, the advertising industry would allow the FCC to do nothing.  Finally in 2010, Congress passed the Commercial Advertisement Loudness Mitigation Act (the CALM Act).  For over two years, the advertising industry has been "litigating" the new law line-by-line to slow down implementation.  Even conservative pundits have sympathetically referred to the campaign as "regulator-abuse."

Last Wednesday, the FCC announced it needs yet another year to study how to turn down the volume.  It would be good for America if one industry did not have so much power!  Maybe, Santa Claus will bring us some peace & quiet . . . some CALM sanity next Christmas . . .  but I doubt it!

The Serenity of Falling ??

In our rush to fall over the Fiscal Cliff, I took a wrong turn onto Memory Lane and ran into the classic 1991 video by Chris Isaak called "Wicked Game" -- where he was so blissfully serene about falling . . . in love . . . if not into recession, like us?  If the temporary state of falling is so blissful, America could use some more of it!

Here are some of my current thoughts on falling:

Q -- Will the United States of America go over the Fiscal Cliff?
A -- Yes!

Q -- Does it matter?
A --  Yes, but the world will not end (despite what the Mayans predict).  However, this failure demonstrates our continuing inability to govern ourselves and makes it almost certain we'll receive our second credit downgrade.

Q -- What will happen after year-end?
A -- If a deal is reached in the first week or so, there will be minimal impact on the economy.  If there is no deal until the latter part of January, the risk of causing a recession increases dramatically.

Q -- How bad will the recession be?
A -- It depends on how long we continue to fall before a deal is struck.  Early resolution minimizes economic damage.  Econometric models have predicted as much as a 6.4% GDP decrease, similar to the 2008 recession.  Unemployment would quickly pass 10% again.

Q -- You don't seem particularly concerned about taxes increasing?
A -- Increasing any taxes certainly will not help the economy in the short run, but I believe any tax increases will be limited to "the successful and the lucky," allowing the vast consuming middle class to continue the recovery.  There is no shortage of capital at this time.

Q -- How will the stock market handle all this?
A -- It will continue to leak value until it smells a deal, when I expect a strong rally.  

Q -- Why do you seem so sanguine about it?
A -- The market is telling me there is considerable underlying strength.  After the Republican "Plan B" was pulled late on Thursday night, Dow futures immediately dropped 297 points.  By the time the market closed on Friday afternoon, it was down only 120 points.

Q -- Will history be kind to Obama about all this?
A -- I doubt it, because he ignored his opportunity to be a "transformational" president by not aggressively curbing entitlements.

Q -- What is the "lesson-learned" for you?
A -- While politicians complain about what regulators do to business, they should also complain about what the politicians do to the economy!

If you don't feel blissfully serene yet, just Google that video . . . and think about what's really important!

. . . Worth 1,000 (misleading) Words!

If a picture is worth a thousand words, how much is a cartoon worth?  Take a look at this one, which has more humor than truth:

It shows Fed Head Ben Bernanke shoveling a huge pile of existing cash into a fire, where it is destroyed forever.  It makes the point that the average American is unaware the problem is increasing, just as a frog will be peacefully cooked-to-death when the water temperature rises slowly enough.

It is true that the average American is not panicking.  (But, then again, the average American doesn't over-react nearly as much as the average investor does.)  

However, is it fair to say Bernanke is destroying a existing pile of cash or wealth?  To answer that, it is necessary to look at the accounting.

The Treasury (not the Fed) needs to spend money for Social Security payments, as an example.  Of course, the Treasury needs cash to cover all those checks.  To get cash, they issue Treasury bonds.  (Normally, investors like pension funds were the biggest buyers.  China has also bought about $1.2 TRILLION of Treasury bonds.  Today, the Fed buys about 75% of all bonds issued by the Treasury Department.)

When the Fed buys the bonds from the Treasury, it credits its books with new assets purchased (the bonds) and credits the checking account of the Treasury with cash.  So far so good -- the Fed has bought AAA-quality bonds, and the Treasury now has brand-new cash to pay Social Security checks.  However, note there was no huge pile of existing cash.  The Fed simply manufactured or "printed" it.

Someday, the Fed will want to start reducing the amount of cash it has put into the economy.  To do that, they will start selling the bonds it holds on its balance sheet -- selling them to more traditional investors or foreigners.   The accounting is that the Fed debits bonds owned on its balance sheet and debits cash owned by the new bond buyer -- sucking cash out of the bond buyer's checking account and therefore out of the economy.

Of course, that will not happen until the Treasury stops selling more bonds than there is demand for those bonds from those same traditional investors and foreigners.  (It is a theoretical but inconceivable scenario that the Fed would attempt to sell them too soon, which would cause chaos in the market - don't worry about that scenario!)

But, why has the already huge increase in the money supply NOT raised the temperature enough to cause inflation or at least to start warming-up the frog?

Skipping the formulas, the reason is that nothing is being done with the new money.  It is not being spent and has no "multiplier" effect.  According to the Keynesian economists, the increased saving by consumers reflects how shell-shocked consumers were during the last recession.  According to Monetarists, it is the banks who are not lending, instead of the consumers who are not spending.  Of course, the data suggests both are right, but the trend is changing. Consumers are now showing more interest in spending than banks are in lending.

When this newly-created money by the Fed is no longer "dead money," the frog will be in trouble!

Stay tuned . . . I'll let you know before that happens . . .

Declinology

As a boy, I remember my parents fretting over whatever I was reading -- fearful I suppose that I would read something that would send me careening down that "broad and well-traveled road."  Yet, there was no shortage of reading materials that "all is lost," and  America is lost!  There were relentless parallels between the fall of Rome and the fall of Washington.

About twenty years ago, I started reading one of those dryly intellectual magazines, called The Futurist and published by the World Future Society.  I still remember an article in 1993 that "Western culture was in crisis, marked by increasing pessimism about the future . . . intractable economic difficulties, widening social gulf, and worsening environmental degradation . . ."

Fortunately, the author of that article has just updated himself with "Whatever Happened to Western Civilization?"  He points out that such warnings usually say "the sky will fall" within the next decade, and he then lists the reasons that his predictions of cultural collapse did not occur over last nineteen years.  He concludes by saying it will just take another two decades for America to collapse.

Having never lived without a prediction of America's collapse, I'm wondering if such predictions always exist in all cultures?  Or, is free speech the only needed ingredient to predict collapse?  Did such predictions exist in the old Soviet Union where there was no First Amendment to protect free speech?  Do human beings have a need to believe collapse is imminent?  Are they just the "glass-half-full" crowd?

I don't know!  But, the need to believe in decline needs to be studied . . .

I do know economic collapse awaits this country if we don't resolve the rapidly growing national debt, primarily by curbing entitlements.  I do know that the free enterprise system, which is combining the economic system of capitalism with the political system of democracy, is the greatest intellectual invention of all time.

I don't know about cultural collapse.  If we can watch twenty children get massacred and then do nothing, maybe we deserve to collapse?

It could be the study of history has just made us too aware that America's time on center-stage is probably limited, but it is not a law. After all, there has never been a free enterprise system on center-stage before!

Enough about decline already . . . please!

Stupid Simplicity in a Complex World

The stock market is more than computers and concepts.  It is a living, breathing source of energy and wealth.  I never tire of studying of it.  It is a rare occasion indeed when I watch anything other than CNBC or Bloomberg.  Yesterday was one of those days.

Watching the horror of Newtown was gripping.  So much pain and so much heartbreak and so  utterly senseless!  My heart goes out to the family and friends of the dead and wounded.

Because Americans are a "fix-it" people, there will be debate about how to preclude similar tragedies in the future.  The National Rifle Association (NRA) has already requested a hiatus from any such "policy" discussion right now.  Of course, they would . . . out of respect for the dead, I'm sure.

I am not a registered-Republican nor registered-Democrat, but I am a registered "gun-nut" -- as I have a concealed weapons permit.  I have lots of guns and know my family and friends are safer because of my guns.  I fully support the Second Amendment.

That said, the NRA does America a great disservice when it insists on maintaining the simplicity of the Second Amendment in an increasingly complex world.  Scratch an NRA member and he'll warn "slippery-slope" --  because any regulation on guns will inevitably lead to the confiscation of all guns and our complete surrender to the jack-booted storm-troopers in black helicopters.

Is it really too inconvenient to change the "gun-show" loophole, where any psychopath can buy a gun without a background check?  Is it really too expensive to have a psychologist meet anyone attempting to buy a $1,000 automatic weapon?  Are there no limits on the weaponry necessary to guard my home?  How about a field of fire laid down by a ring of Claymores?  Is every restraint on gun ownership by definition unreasonable?  In order to get my concealed weapons permit, I only had to pay $35.  I could easily have been another post-traumatic stress veteran, but nobody asked.

It is not simply a question of how many guns are necessary.  Switzerland is a peaceful nation, not known for such tragedies as Newtown, but it has more rifles per capita than any other nation.  After 2-years of required national service, each soldier returns home with his rifle, which makes sense for a small, mountainous nation that is easily over-run from all sides.  Are we really so arrogant that we cannot learn anything from other nations?  What is the NRA really afraid of?

 While the stock market is a living, breathing source of energy and wealth, discussion of the Second Amendment remains fossilized in 1776.  Just as there are no guaranties in the stock market, there are no guaranties that any 21st century discussion of an 18th century worry would preclude a single future tragedy. But, it is a long overdue discussion!  The paranoid NRA should be ashamed!

My right to bear arms should not trump your right to discuss the "slippery-slope!"

Choosing Greatness . . . I hope!

When he was running for the Democratic nomination in 2008, President Obama said he wanted to be a "transformational President" like Reagan, i.e., one who changes the trajectory of history.  I hope he still wants that, because he now has the opportunity.

It is now clear that taxes will increase for both the successful and the lucky, but that is what is expected from Democrats.  That helps the revenue side of the problem.  But, there has been almost no information about his plans to control the spending side of the problem, especially entitlements.

Just as nobody could have opened up trade with China except a China-hater, such as Richard Nixon, nobody can attack the entitlement problem except an an entitlement-lover, like most any Democrat.

If Obama wants to be just another "tax & spend" Democratic president, he can just raise taxes on the successful and the lucky. However, if he truly wants to be a transformational president, he now has the opportunity . . . by reigning in the explosive growth in entitlement spending.

Only he can make that choice . . . let us pray that Barack Obama is indeed a transformational President!

Favorite Professor

When I was studying at Wharton, my favorite professor was Dr. Jeremy Siegel, author of The Future for Investors, and I have followed him closely ever since.

In his latest commentary, he thinks that, while there are problems with the latest Jobs Report, it is clear that the economy continues to improve.

More interestingly, he believes the odds of resolving the Fiscal Cliff before December 31st are 2-1 in favor of resolution and a 90% probability of resolution before January 31st -- before damage to the economy becomes significant.

Dr. Siegel is also a well-known bull and believes the Dow could jump 500-1,000 points, if there is "a deal that comes half way to Obama's tax rates."

There is a certain euphoria building about resolution of the Fiscal Cliff problem.  Both the Finance Minister of Australia and Jamie Dimon, CEO of JP Morgan, have predicted the U.S. will return to its traditionally dominant role in the world economy, with our "fiscal and moral authority restored" -- when, not if -- we avoid the Fiscal Cliff without "kicking-the-can."  So close . . . yet, so far!

I am beginning to lean in that direction as well.  A few months ago, I wrote about the uncertainty of three wet blankets on the U.S. stock market, i.e., the election, the Fiscal Cliff, and the European Financial Crisis.  (Uncertainty keeps the stock market down.)  We have now survived the election, and it looks increasingly likely we can avoid the Fiscal Cliff.  In addition, while it is very subtle, the European Financial Crisis is morphing from a scary financial crisis into a routine recession.  If so, we will have thrown off the three wet blankets -- finally -- and may be ready to grow again.

The irony is that 92 companies in the S&P 500 have already lowered their profit estimates for this quarter, compared with only 25 that have raised them.  That ratio of 3.7 to 1 is the worst in eleven years -- hardly a bullish sign.  So, who is right -- all those corporate officers or my old professor?

Keep your fingers crossed that my old professor is right and the Dow jumps 500-1,000 points!