This was one of my famous Corsetti housing doom-and-gloom articles. But the stuff on mortgage fraud was priceless at the time. I should have been paid for this stuff :)
So much has happened over the past few months, global equity markets have rallied, the housing bubble seems to be in jeopardy of collapsing, oil prices have come down, gold and silver have regained their footing, the US Treasury yield-curve has inverted again, and the US Dollar index has seesawed back and forth between 84-87 (this is a measure of dollar strength against a basket of currencies).
I will get into my views on the equity, bond, currency and commodity markets over the next few weeks, but I would like to note that there is a serious disconnect between each of these markets – with the bond and commodity markets forecasting a recession in 2007 and the equity market forecasting a “soft-landing” (meaning moderate growth and low inflation) followed by a pick-up in growth. The currency markets are confused and swing back and forth on each piece of economic data.
Cash-Back Loans
Over the past weekend, I have put together some research (see below) on a problem which I think could develop into a serious scandal in the mortgage industry: “Cash-back Mortgage Loans”. They seem to have become mainstream over the past 5 years, the idea being that a homebuyer borrows more than the value of the house so that they can finance “renovations” which theoretically increase the value of the house. Until recently, this type of lax lending standards would never have been allowed by risk managers, shareholders, or regulators – but like so many other things, it’s now a free for all, especially if it helps banks meet their quarterly earnings targets.
Over the past couple of years, a new scam has grown out of these lax lending standards: it seems real estate agents, appraisers, buyers, sellers and maybe even the bankers themselves have teamed up to perpetrate fraud. You can read how they do it and why in the articles below (note these articles are from local papers in at least 5 different parts of the country). If this turns out to be even a fraction as widespread as I believe it might be, this could deal a crippling blow to our banking system (making the S&L scandal of the late 80s look like a misdemeanor).
By the way, this is just one of many potential scandals that may come out of the whole ridiculous housing bubble that gripped the U.S. over the past few years. Also coming soon: Liar’s Loans (loans where you state your income with no verification), Interest-Only Loans (where you pay no principal for the first few years – these are usually adjustable rate), Negative Amortization loans (loans where for the first few years you pay NO principal and only a portion of the interest – the remainder is added back to the principal), and the big kahuna: Adjustable-Rate Loans (where the interest rate is variable – most of these were taken out in 2003-2004 when rates were 1-3%, not closer to 6%).
Unless the housing market can make a comeback over the next two years (I place a low probability on this – but you never know), all of the people taking out the loans above are going to be wiped out. The idea was that they bought places they could not afford using traditional loans (30 year – fixed rate) but figured they could “flip” the houses in a couple of years and make a huge profit. That does not even count the millions of people who became real estate “investors”, agents, mortgage brokers, title insurance, etc…… who were all riding the Easy Al Greenspan Housing Bubble Gravy Train.
It all worked for a while – but like I found out with my AskJeeves.com stock, the music eventually stops and someone gets left holding the bag.
One last comment on the housing market – I pulled this from a Wall Street Journal Article from 1932: “During a panic your home suddenly becomes worthless because nobody wants it.”
As promised – enjoy (or at least do not get too scared):
1. From the Denver Post: “In the Denver metro area alone, more than 1,000 homes sold for at least 110 percent of the original asking price in the 18 months ending in June, according to research.”
“‘It clearly is a problem,’ said Colorado Attorney General John Suthers. ‘We have been looking at house purchases over cost and money going back to the buyers.’ Suthers’ consumer protection chief, Jan Zavislan, said the office is investigating various participants in inflated sales, including buyers, sellers, appraisers, mortgage brokers, real estate agents and title companies.”‘
“We’re looking at potentially every participant in these transactions,’ Zavislan said. ‘We’re just seeing way too many of these things. 'The problem is bigger than all the law enforcement agencies in the state put together.’”
"Sonya Leonard, who owns a real-estate firm, said her own industry is guilty of various practices that can put a false value on a house, from counting basement space in the listed square feet to undercounting how long it has been for sale."
"She told Zavislan she had complained to several state agencies and the FBI when the prospective buyers of one house wanted her to raise the price from $499,000 to $625,000 and kick back the difference to a third party."
“Critics say mortgage companies have little incentive to ferret out inflated sales because they bundle and resell their home loans to Wall Street investors, taking their profits and diluting fraud losses in large pools of mortgage-backed bonds.”
“These securities get ’sold in little pieces all over the world,’ said Lou Barnes, a Colorado mortgage bank owner. ‘It makes it very difficult to figure out who, if anyone, bears any responsibility for the flow of Colorado’s foreclosures.’”
“Marc Loewenthal, a senior VP of New Century Financial Corp., says his company’s mortgage subsidiary financed and resold loans on four of the allegedly fraudulent villa purchases. But ‘the investor has the right to demand we repurchase the loan if there is fraud involved,’ he said. ‘We’re at risk. We do have an interest in keeping fraud down.’”
“New Century grew concerned enough about fraud to install a new screening technology early this year, he said. As a result, ‘we have stopped close to $1 billion in loans.’”
2. The Columbus Dispatch from Ohio. "The peculiar but tempting offers sometimes came a year or more after homeowners planted for-sale signs in their front yards. Interested buyers suddenly appeared, proposing to pay hundreds of thousands of dollars more than the asking price for houses in some of central Ohio's elite neighborhoods."
"The catch: the sellers must agree to immediately refund the difference between the asking price and the sale price. At least 14 such deals worth more than $11 million have closed since spring, and the offers continue."
"'We turned down five of them,' said Bryan Wing, executive VP of CV Perry Builders. 'Believe me, in this day and age, we could have used it.' Others couldn't resist."
"A lawyer for the central Ohio chapter of the Building Industry Association warned group members in October to steer clear of such deals. Even sellers could be held liable if deals turn out to be fraudulent, he said, reminding builders of the danger of lawsuits or criminal racketeering charges."
"'This has been a really recent phenomenon,' said David Martin, chief executive of Stewart Title, which refused some of the deals. 'It's like a whole new industry has formed overnight.'"
3. The Review Journal from Las Vegas : “Glenn Goodman has had his Las Vegas home on the market since March and eventually lowered the price to $379,000 from $430,000. Interesting, he said, that he now has in his possession an offer for the home at $460,000. ‘The buyer wants us to give her $57,000 cash at the close of escrow. Obviously this buyer will then just walk away from the house, leaving it to be foreclosed upon,’ Goodman said. ‘It smells like fraud all over it. The Realtor’s got to be in on it.’”
4. The Tampa Tribune. "A New York lender fears it is on the hook for millions of dollars in loans that now total more than the New Port Richey properties are worth. Lehman Bros. filed suit in Tampa on Tuesday against a group of investors, title companies, a mortgage company and an appraisal company involved in potential mortgage fraud at a Pasco County condominium complex."
"Fifteen defendants used overvalued appraisals in a 'scheme to defraud'
the bank, according to the lawsuit. The 13 properties each were appraised for $733,000. The lawsuit says the triplexes are worth 'barely one-third' of that value."
"Lenders across the country are investigating mortgages that may be worth more than the market value of the properties. Part of the problem, they say, is that lenders usually don't spot problem mortgages until buyers start missing payments."
"Lenders are discovering overvalued loans now for two reasons, said Doug Pollock, a mortgage investigator in Sanford. For one thing, fraudulent loans were easily overlooked during the past five years' real estate boom. Second, industry professionals may be tempted to participate in fraudulent deals to attract business, Pollock said."
5. Again from the Tampa Tribune. "State agencies are investigating potential mortgage and title fraud involving 36 unorthodox real estate deals in the Bay area. The deals aren't an anomaly. 'The reports we're getting are incredible,' said Doug Pollock, (who) investigates problem mortgages.
'This scheme is hitting every county in Florida. It's like people are going to classes to learn how to do this.'"
"How widespread are the inflated deals? The answer, industry experts fear, is that they're everywhere, but there's no way to determine the extent. 'This is prevalent in some areas,' said Brad Monroe, president of the Greater Tampa Association of Realtors. 'It just makes you wonder how many of these deals are going on that we don't know about yet.'"
6. And More from Tampa. “A year ago, Dawn L. Molen quit her job as a commercial loan officer and set out to become a real estate agent. With three months’ experience, the agent who had never listed a home closed her first sale Jan. 27 in a working-class neighborhood.”
“Her buyer paid $45,000 more than the asking price. It stunned her peers. From then on, Molen brought in contracts by the stack.”
“Molen found buyers willing to consistently pay $50,000 to $70,000 more than the original price, according to documents obtained by The Tampa Tribune. Collectively, the homes sold for at least $2 million more than originally listed.”
“But there was something her boss said he didn’t know: Some of the money wasn’t going to the sellers. It was going to a third party with ties to Molen, sometimes without the knowledge of the lenders or the sellers.”
“Molen’s deals have several similarities to cases that have surfaced recently across the nation, some of which have resulted in investigations or prosecution for illegal activity. As the torrid real estate market has cooled nationwide, more industry professionals may take chances to make a deal, experts say. Lenders say they are bracing for a fallout in which buyers ultimately default on their mortgages.”
“Local real estate agents fear future buyers in the neighborhoods involved in the transactions may not be able to afford homes or higher taxes as a result of inflated prices.”
“More than a dozen sellers and listing agents interviewed by the Tribune said they felt uneasy about the transactions but went along after employees at the title company assured them they were legal and not unusual. ‘As long as I got my $180,000, I didn’t care what they were doing,’ said John Dieumegarde.”
“Now, other appraisers are stumbling across Molen’s deals as they search for comparable home sales to help determine the value of nearby properties. On paper, the sales appreciation is astonishing, said appraiser Doug Nail.”
“‘This is not a $250,000 neighborhood,’ Nail said, referring to one in St. Petersburg.”
“Nail evaluated one of Molen’s sales for the Tribune, without relying on recent sales represented by Molen. He estimated the house’s value at about $145,000. One of Molen’s buyers paid $250,000 for the house in September.”
“Appraiser Caryn Blauser was astonished by what she found. Molen’s sales are not isolated. She has found many local homes selling for substantially more than the original price. ‘There’s some weird stuff going on,’ Blauser said. ‘The buyers may chalk it up to creative financing, but we may soon see a lot of mortgage foreclosures because everyone wanted to make a quick buck.’”
7. Northern California - Although he beautifully renovated it and priced it below market, the Oakland bungalow just wouldn't sell. Deals fell through repeatedly for bizarre and unrelated reasons: Buyers got cold feet or moved -- one was even arrested.
By the time the fourth deal collapsed, the developer was in a state of financial panic. So, when one of the mortgage brokers who had helped a previous prospective buyer called with a new one who would close the deal for -- get this -- $100,00 over the asking price, he naturally jumped at the offer.
"The catch was that I had to give the $100K back to them after the close of escrow," the guy told me, still looking shell-shocked. "I couldn't understand why they would want to do that. The place was completely remodeled."
(Most buyers who get cash back after escrow pour that money into repairs. Typically, though, lenders like to keep this amount to no more than 3 percent of the purchase price.)
The developer went through with the sale, wondering what his buyers (whom he never met) were up to. Because he wasn't lying about anything -- everything was disclosed on the purchase contract -- he didn't feel he was doing anything wrong.
A couple weeks later, another friend who is a real estate agent called me. "I think I have a scoop for you," he told me, his voice vibrating with gumshoe grit. He'd heard that a prominent East Bay company was training its agents to inflate properties by $50,000 to $150,000, then have sellers return the cash after the close of the deal.
Unlike the arrangement with the developer, these deals were concealed from lenders by adding the cash-back arrangement onto an addendum apart from the purchase contract.
How did my friend hear about this practice? A local manager of a prominent real estate company had tipped off my friend's broker over lunch. The manager, who had been shocked at the behavior, had then gone back and looked at his own agents' files to see whether the practice ever happened in his own office. "The guy said he found so many in his own files in the past couple weeks, he didn't want to look anymore," my agent friend said.
What exactly was happening here? The developer didn't think he was doing anything illegal, and the broker had no idea the inflation was happening on his watch. But in both cases, everyone involved probably would have been considered at least partially culpable if the lenders could mount a case that they were being deceived.
8. More From Denver - Denver attorney John Head, along with several Realtors and brokers in the audience, said the state isn't doing enough to crack down on mortgage fraud. James Spray of America's Mortgage LLC said bringing cases of mortgage fraud to the attorney general's office 'is like complaining to a black hole.'"
"(Realtor) Sonja Leonard said that in one case, a Denver home was purchased for $1.3 million in December, listed for $2.25 million in April, and the price was lowered to $2.15 million in June. Then in August, it was placed under contract for $3.1 million."
9. Liars Loans and Cash-Back juxtaposition - The last example I am including is perhaps the most striking. A 24-years-old real estate “investor” from California (here is his website: http://iamfacingforeclosure.com/). He discusses how he was able to secure financing of 6 homes for over $2.2 million dollars (all cash back at close) on which he has been able to sell only one house – at a loss.
At least one loan is from Countrywide Financial (although he is no longer publishing the names of the lenders) and he use “liar loans”, or stated income loans in which he admits that he lied (with lender knowledge) about his income and intent to live in the homes – both in order to qualify for the loan.
Monday, November 20, 2006
Sunday, June 11, 2006
Are we there yet?
I wrote my first commentary back in January about the pending decline in the fx value of the US dollar due to the large and growing macro-imbalances (current account and budget in the U.S.). Leon den Exter e-mailed me a very good (and in retrospect, right on target) question in response to my e-mail:
"Is it then conceivable that the Fed rate could be further (significantly) increased this coming year, despite what the current market expectations are based on the Fed comments? To further offset the trade deficit created by the import/export imbalance."
So my second commentary was my response to his question:
"You must have a lot of faith in Hellicopter (or Weimar) Ben Bernanke. As a side note, it will be interesting to see if our boy Benny is a serious public servant or yet another Bush administration crony. I am leaning towards the former, but only time will tell. At least they didn't try and stick us with Phil Gramm (former Republican senator who was a partisan hack) as Fed Chief.
The answer to the question is maybe. It would help the correct the imbalances in the U.S. economy. The problem is that if the Fed raises rates too high, it could bust the housing bubble. That would probably be a death blow to the U.S. economy.I actually think it would a positive, I think we need some pain (real pain) across the board in order to restore financial stability. In the long run, a short-term but severe recession could help avoid what I believe could be the next Great Depression.
I would say that there is a 75%/25% chance that once the economy slows from the Fed rate hikes, they will begin to cut rates (this seems to be what the bondmarket is forecasting). This will temporarily grease the economy and put us back towards the edge of calamity."
Are we there yet?
So now we are here: at the point mentioned in the question/answer above, or at least it is perceived that we are that point. The market seems to be impressed (even scared) by the manhood of Benny Bernanke, in his new role as an inflation-hawk. He has raised the Fed Funds rates twice to 5% since he took over from Easy Al Greenspan and is threatening (or promising) to raise them at least once more. In addition, central bankers around the world have done their part by raising rates, tightening the money supply, and talking tough on inflation. Please note that the actions of the Bank of Japan will also be a key driver of future events due to the potential for the unwinding of the yen carry trade - this is a huge and important topic in itself and I wouldn't do it justice in a one or two paragraphs. If you are interested in finding out more, send me an e-mail or comment on the blog site and I will point you to some readings).
In response, equity markets have tumbled, the yield curve has inverted and credit spreads have begun to tighten. Commodity prices have corrected back to two month lows (look at gold and silver over the past three weeks). By the way, I am still extremely bullish on metals as an inflation hedge as you will see at the end of this commentary.
My current view remains exactly the same as it did in January, this guy is not an inflation-hawk and probably would not even know what it would mean to be an inflation-hawk. As the convoluted, distorted, incomplete Core CPI rate has finally started to show the inflationary pressures from years of loose monetary policy (you see, the housing boom - and the commodity rally to a lesser extent - was really just an outgrowth of inflation but the CPI calculation does not use asset prices as an input) Bernanke has talked tough, his exact words were that these increases were "unwelcome" and "not consistant with a stable monetary environment".
So Wall Street is now worried that Bernanke is going to "go too far" in his fight against inflation and tip the economy into a recession (why did they not see this six months ago as everyone knows it takes somewhere between 6 - 12 months for a Fed tightening to make its way through the economy?). I think this has already happened as you can see the macro-environment weakening across the board from a collapsing housing market to a stalling job market (not unrelated to housing) to stagnant hourly wage increases. Inflation, at least Core CPI, is a lagging indicator - so by raising rates to combat the rise Core CPI, the Fed has probably already over tightened and will have to continue to raise rates at least one more time to maintain its credibility. So we won't see the impact of these latest rate hikes until late in 2006 when the economy will probably be in or near a recession.
So why do I say that this guy is not an inflation-hawk? Well, because I don't think it takes an inflation hawk to hike rates when the economy is still seen as strong (that is part of the problem of distorting growth and price statistics - look at the fake housing numbers - you get distorted decision-making). Everyone still talks about how strong the economy is and I'm sure that most of these people believe it, and this group includes Bernanke. So it is easy for him to stand up and talk tough on inflation - he thinks this is a free opportunity to establish his anti-inflation credentials.
However, the real test of an inflation-hawk (and this is where Greenspan failed) is their willingness to raise rates and tighten policy - or at least not loosen it - when the economy is slowing or even in recession. To inflate the money supply and increase credit everytime there is a blip in the economy makes you an inflationist. All these guys have been doing over the past eight years is postponing the inevitable and necessary economic corrections by printing money and pumping up asset prices (first equities, then bonds and real estate, and finally commodities).
However, while a severe recession would bring cleanse the system of waste and maladjustment, it would require a degree of pain and forbearance, a virtue in short supply in today's markets and society in general. Ben Bernanke, in particular, does not have the stomach or belief system for us to "take our medicine" and will lower rates and print money like there is no tomorrow when the economy turns the corner and heads down in a meaningful way.
Not sure if this will be in late 2006 or early 2007, but it will happen. This is what the bond market is telling us that much with its inverted yield curve. Market participants expect rates in the future to be lower than at the current time.
When Ben starts to loosen monetary policy and lower rates then the real fireworks will start. The dollar will fall (slowly at first), gold/silver will skyrocket and the stock market/housing prices will stabilize or even move to the upside. It will also put us firmly back on track for the 2008-2010 economic collapse which will finally wipe out the imbalances, distortions and malignancies in our economy and perhaps in society as a whole. This will be the topic of next week's commentary - the mass delusion of American consumers and whether an actual economic depression would actually be a good thing (in the long-run).
Sunday, June 04, 2006
Weimar Ben (Bernanke) and his helicopters full of money
Despite the subject header for this week's commentary, I am not actually going to discuss the current chief of the Fed or the predicament that he finds himself in. I will only say this, he has stated that he would fight deflation with unusual methods (think dropping money from helicopters among others). Well, there is a consequence to this type of irresponsible policy-making. History has proven this over and over again.
A great example is the post World War I episode of hyperinflation in Germany. If only Weimar Germany had an Office of OMB which came up with an official calculation for Core Inflation that showed the cost of living to be increasing by 2% - they could have contained inflationary expectations and avoided the Hyperinflation that is discussed below. Just think, the cataclysmic rise of the Nazi Party and World War II could have been avoided by the Substitution Effect, Owner's Equivalent Rent and Hedonic Price Modeling.
Ok, I am being sarcastic - but based on the level of credibility given to phony CPI, PPI, and GDP-calculations (among other widespread inflation indices) by the mainstream media and financial community, it seems to me that the official numbers are all that anyone looks at. If you talked to the average American and asked them if their living expenses have only been going up by 2% per year over the past 3 years - I am pretty sure most people would laugh at you.
btw/ I did not come up with this absurdly disrespectful nickname for Ben Bernanke. I have to give credit where credit is due - Jim Willie CB, who is the editor of the “HAT TRICK LETTER” (http://news.silverseek.com/SilverSeek/1149079490.php)
Enjoy:
The 1923 Hyperinflation of the Weimar Republic (Germany) (Excerpt from Paper Money by "Adam Smith," (George J.W. Goodman), pp. 57-62.)
Before World War I Germany was a prosperous country, with a gold-backed currency, expanding industry, and world leadership in optics, chemicals, and machinery. The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a heelbarrow full of money would not even buy a newspaper. Most Germans were taken by surprise by the financial tornado.
"My father was a lawyer," says Walter Levy, an internationally known German-born oil consultant in New York, "and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread." The Berlin publisher Leopold Ullstein wrote that an American visitor tipped their cook one dollar. The family convened, and it was decided that a trust fund should be set up in a Berlin bank with the cook as beneficiary, the bank to administer and invest the dollar.
In retrospect, you can trace the steps to hyperinflation, but some of the reasons remain cloudy. Germany abandoned the gold backing of its currency in 1914. The war was expected to be short, so it was financed by government borrowing, not by savings and taxation. In Germany prices doubled between 1914 and 1919.
After four disastrous years Germany had lost the war. Under the Treaty of Versailles it was forced to make a reparations payment in gold-backed Marks, and it was due to lose part of the production of the Ruhr and of the province of Upper Silesia. The Weimar Republic was politically fragile.
But the bourgeois habits were very strong. Ordinary citizens worked at their jobs, sent their children to school and worried about their grades, maneuvered for promotions and rejoiced when they got them, and generally expected things to get better. But the prices that had doubled from 1914 to 1919 doubled again during just five months in 1922. Milk went from 7 Marks per liter to 16; beer from 5.6 to 18. There were complaints about the high cost of living. Professors and civil servants complained of gettingsqueezed. Factory workers pressed for wage increases. An underground economy developed, aided by a desire to beat the tax collector.
On June 24, 1922, right-wing fanatics assassinated Walter Rathenau, the moderate, able foreign minister. Rathenau was a charismatic figure, and the idea that a popular, wealthy, and glamorous government minister could be shot in a law-abiding society shattered the faith of the Germans, who wanted to believe that things were going to be all right. Rathenau's state funeral was a national trauma. The nervous citizens of the Ruhr were already getting their money out of the currency and into real goods -- diamonds, works of art, safe real estate. Now ordinary Germans began to get out of Marks and into real goods.
Pianos, wrote the British historian Adam Fergusson, were bought even by unmusical families. Sellers held back because the Mark was worth less every day. As prices went up, the amounts of currency demanded were greater, and the German Central Bank responded to the demands. Yet the ruling authorities did not see anything wrong. A leading financial newspaper said that the amounts of money in circulation were not excessively high. Dr. Rudolf Havenstein, the president of the Reichsbank (equivalent to the Federal Reserve) told an economics professor that he needed a new suit but wasn't going to buy one until prices came down.
Why did the German government not act to halt the inflation? It was a shaky, fragile government, especially after the assassination. The vengeful French sent their army into the Ruhr to enforce their demands for reparations, and the Germans were powerless to resist. More than inflation, the Germans feared unemployment. In 1919 Communists had tried to take over, and severe unemployment might give the Communists another chance. The great German industrial combines -- Krupp, Thyssen, Farben, Stinnes -- condoned the inflation and survived it well. A cheaper Mark, they reasoned, would make German goods cheap and easy to export, and they needed the export earnings to buy raw materials abroad. Inflation kept everyone working.
So the printing presses ran, and once they began to run, they were hard to stop. The price increases began to be dizzying. Menus in cafes could not be revised quickly enough. A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. "If you want to save money," he was told, "and you want two cups of coffee, you should order them both at the same time."
The presses of the Reichsbank could not keep up though they ran through the night. Individual cities and states began to issue their own money. Dr. Havenstein, the president of the Reichsbank, did not get his new suit. A factory worker described payday, which was every day at 11:00 a.m.: "At 11:00 in the morning a siren sounded, and everybody gathered in the factory forecourt, where a five-ton lorry was drawn up loaded brimful with paper money. The chief cashier and his assistants climbed up on top. They read out names and just threw out bundles of notes. As soon as you had caught one you made a dash for the nearest shop and bought just anything that was going."
Teachers, paid at 10:00 a.m., brought their money to the playground, where relatives took the bundles and hurried off with them. Banks closed at 11:00 a.m.; the harried clerks went on strike.
The flight from currency that had begun with the buying of diamonds, gold, country houses, and antiques now extended to minor and almost useless items -- bric-a-brac, soap, hairpins. The law-abiding country crumbled into petty thievery. Copper pipes and brass armatures weren't safe. Gasoline was siphoned from cars. People bought things they didn't need and used them to barter -- a pair of shoes for a shirt, some crockery for coffee. Berlin had a "witches' Sabbath" atmosphere. Prostitutes of both sexes roamed the streets. Cocaine was the fashionable drug. In the cabarets the newly rich and their foreign friends could dance and spend money. Other reports notedthat not all the young people had a bad time. Their parents had taught them to work and save, and that was clearly wrong, so they could spend money, enjoy themselves, and flout the old.
The publisher Leopold Ullstein wrote: "People just didn't understand what was happening. All the economic theory they had been taught didn't provide for the phenomenon. There was a feeling of utter dependence on anonymous powers -- almost as a primitive people believed in magic -- that somebody must be in the know, and that this small group of 'somebodies' must be a conspiracy."
When the 1,000-billion Mark note came out, few bothered to collect the change when they spent it. By November 1923, with one dollar equal to one trillion Marks, the breakdown was complete. The currency had lost meaning.
What happened immediately afterward is as fascinating as the Great Inflation itself. The tornado of the Mark inflation was succeeded by the "miracle of the Rentenmark." A new president took over the Reichsbank, Horace Greeley Hjalmar Schacht, who came by his first two names because of his father's admiration for an editor of the New York Tribune. The Rentenmark was not Schacht's idea, but he executed it, and as the Reichsbank president, he got the credit for it. For decades afterward he was able to maintain a reputation for financial wizardry. He became the architect of the financial prosperity brought by the Nazi party.
Obviously, though the currency was worthless, Germany was still a rich country -- with mines, farms, factories, forests. The backing for the Rentenmark was mortgages on the land and bonds on the factories, but that backing was a fiction; the factories and land couldn't be turned into cash or used abroad. Nine zeros were struck from the currency; that is, one Rentenmark was equal to one billion old Marks. The Germans wanted desperately to believe in the Rentenmark, and so they did. "I remember,"said one Frau Barten of East Prussia, "the feeling of having just one Rentenmark to spend. I bought a small tin bread bin. Just to buy something that had a price tag for one Mark was so exciting."
All money is a matter of belief. Credit derives from Latin, credere, "to believe." Belief was there, the factories functioned, the farmers delivered their produce. The Central Bank kept the belief alive when it would not let even the government borrow further.
But although the country functioned again, the savings were never restored, nor were the values of hard work and decency that had accompanied the savings. There was a different temper in the country, a temper that Hitler would later exploit with diabolical talent. Thomas Mann wrote: "The market woman who without batting an eyelash demanded 100 million for an egg lost the capacity for surprise. And nothing that has happened since has been insane or cruel enough to surprise her."
With the currency went many of the lifetime plans of average citizens. It was the custom for the bride to bring some money to a marriage; many marriages were called off. Widows dependent on insurance found themselves destitute. People who had worked a lifetime found that their pensions would not buy one cup of coffee.
Pearl Buck, the American writer who became famous for her novels of China, was in Germany in 1923. She wrote later: "The cities were still there, the houses not yet bombed and in ruins, but the victims were millions of people. They had lost their fortunes, their savings; they were dazed and inflation-shocked and did not understand how it had happened to them and who the foe was who had defeated them. Yet they had lost their self-assurance, their feeling that they themselves could be the masters of their own lives if only they worked hard enough; and lost, too, were the old values of morals, of ethics, of decency."
The fledgling Nazi party, whose attempted coup had failed in 1923, won 32 seats legally in the next election. The right-wing Nationalist party won 106 seats, having promised 100 percent compensation to the victims of inflation and vengeance on the conspirators who had brought it.
A great example is the post World War I episode of hyperinflation in Germany. If only Weimar Germany had an Office of OMB which came up with an official calculation for Core Inflation that showed the cost of living to be increasing by 2% - they could have contained inflationary expectations and avoided the Hyperinflation that is discussed below. Just think, the cataclysmic rise of the Nazi Party and World War II could have been avoided by the Substitution Effect, Owner's Equivalent Rent and Hedonic Price Modeling.
Ok, I am being sarcastic - but based on the level of credibility given to phony CPI, PPI, and GDP-calculations (among other widespread inflation indices) by the mainstream media and financial community, it seems to me that the official numbers are all that anyone looks at. If you talked to the average American and asked them if their living expenses have only been going up by 2% per year over the past 3 years - I am pretty sure most people would laugh at you.
btw/ I did not come up with this absurdly disrespectful nickname for Ben Bernanke. I have to give credit where credit is due - Jim Willie CB, who is the editor of the “HAT TRICK LETTER” (http://news.silverseek.com/SilverSeek/1149079490.php)
Enjoy:
The 1923 Hyperinflation of the Weimar Republic (Germany) (Excerpt from Paper Money by "Adam Smith," (George J.W. Goodman), pp. 57-62.)
Before World War I Germany was a prosperous country, with a gold-backed currency, expanding industry, and world leadership in optics, chemicals, and machinery. The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a heelbarrow full of money would not even buy a newspaper. Most Germans were taken by surprise by the financial tornado.
"My father was a lawyer," says Walter Levy, an internationally known German-born oil consultant in New York, "and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread." The Berlin publisher Leopold Ullstein wrote that an American visitor tipped their cook one dollar. The family convened, and it was decided that a trust fund should be set up in a Berlin bank with the cook as beneficiary, the bank to administer and invest the dollar.
In retrospect, you can trace the steps to hyperinflation, but some of the reasons remain cloudy. Germany abandoned the gold backing of its currency in 1914. The war was expected to be short, so it was financed by government borrowing, not by savings and taxation. In Germany prices doubled between 1914 and 1919.
After four disastrous years Germany had lost the war. Under the Treaty of Versailles it was forced to make a reparations payment in gold-backed Marks, and it was due to lose part of the production of the Ruhr and of the province of Upper Silesia. The Weimar Republic was politically fragile.
But the bourgeois habits were very strong. Ordinary citizens worked at their jobs, sent their children to school and worried about their grades, maneuvered for promotions and rejoiced when they got them, and generally expected things to get better. But the prices that had doubled from 1914 to 1919 doubled again during just five months in 1922. Milk went from 7 Marks per liter to 16; beer from 5.6 to 18. There were complaints about the high cost of living. Professors and civil servants complained of gettingsqueezed. Factory workers pressed for wage increases. An underground economy developed, aided by a desire to beat the tax collector.
On June 24, 1922, right-wing fanatics assassinated Walter Rathenau, the moderate, able foreign minister. Rathenau was a charismatic figure, and the idea that a popular, wealthy, and glamorous government minister could be shot in a law-abiding society shattered the faith of the Germans, who wanted to believe that things were going to be all right. Rathenau's state funeral was a national trauma. The nervous citizens of the Ruhr were already getting their money out of the currency and into real goods -- diamonds, works of art, safe real estate. Now ordinary Germans began to get out of Marks and into real goods.
Pianos, wrote the British historian Adam Fergusson, were bought even by unmusical families. Sellers held back because the Mark was worth less every day. As prices went up, the amounts of currency demanded were greater, and the German Central Bank responded to the demands. Yet the ruling authorities did not see anything wrong. A leading financial newspaper said that the amounts of money in circulation were not excessively high. Dr. Rudolf Havenstein, the president of the Reichsbank (equivalent to the Federal Reserve) told an economics professor that he needed a new suit but wasn't going to buy one until prices came down.
Why did the German government not act to halt the inflation? It was a shaky, fragile government, especially after the assassination. The vengeful French sent their army into the Ruhr to enforce their demands for reparations, and the Germans were powerless to resist. More than inflation, the Germans feared unemployment. In 1919 Communists had tried to take over, and severe unemployment might give the Communists another chance. The great German industrial combines -- Krupp, Thyssen, Farben, Stinnes -- condoned the inflation and survived it well. A cheaper Mark, they reasoned, would make German goods cheap and easy to export, and they needed the export earnings to buy raw materials abroad. Inflation kept everyone working.
So the printing presses ran, and once they began to run, they were hard to stop. The price increases began to be dizzying. Menus in cafes could not be revised quickly enough. A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. "If you want to save money," he was told, "and you want two cups of coffee, you should order them both at the same time."
The presses of the Reichsbank could not keep up though they ran through the night. Individual cities and states began to issue their own money. Dr. Havenstein, the president of the Reichsbank, did not get his new suit. A factory worker described payday, which was every day at 11:00 a.m.: "At 11:00 in the morning a siren sounded, and everybody gathered in the factory forecourt, where a five-ton lorry was drawn up loaded brimful with paper money. The chief cashier and his assistants climbed up on top. They read out names and just threw out bundles of notes. As soon as you had caught one you made a dash for the nearest shop and bought just anything that was going."
Teachers, paid at 10:00 a.m., brought their money to the playground, where relatives took the bundles and hurried off with them. Banks closed at 11:00 a.m.; the harried clerks went on strike.
The flight from currency that had begun with the buying of diamonds, gold, country houses, and antiques now extended to minor and almost useless items -- bric-a-brac, soap, hairpins. The law-abiding country crumbled into petty thievery. Copper pipes and brass armatures weren't safe. Gasoline was siphoned from cars. People bought things they didn't need and used them to barter -- a pair of shoes for a shirt, some crockery for coffee. Berlin had a "witches' Sabbath" atmosphere. Prostitutes of both sexes roamed the streets. Cocaine was the fashionable drug. In the cabarets the newly rich and their foreign friends could dance and spend money. Other reports notedthat not all the young people had a bad time. Their parents had taught them to work and save, and that was clearly wrong, so they could spend money, enjoy themselves, and flout the old.
The publisher Leopold Ullstein wrote: "People just didn't understand what was happening. All the economic theory they had been taught didn't provide for the phenomenon. There was a feeling of utter dependence on anonymous powers -- almost as a primitive people believed in magic -- that somebody must be in the know, and that this small group of 'somebodies' must be a conspiracy."
When the 1,000-billion Mark note came out, few bothered to collect the change when they spent it. By November 1923, with one dollar equal to one trillion Marks, the breakdown was complete. The currency had lost meaning.
What happened immediately afterward is as fascinating as the Great Inflation itself. The tornado of the Mark inflation was succeeded by the "miracle of the Rentenmark." A new president took over the Reichsbank, Horace Greeley Hjalmar Schacht, who came by his first two names because of his father's admiration for an editor of the New York Tribune. The Rentenmark was not Schacht's idea, but he executed it, and as the Reichsbank president, he got the credit for it. For decades afterward he was able to maintain a reputation for financial wizardry. He became the architect of the financial prosperity brought by the Nazi party.
Obviously, though the currency was worthless, Germany was still a rich country -- with mines, farms, factories, forests. The backing for the Rentenmark was mortgages on the land and bonds on the factories, but that backing was a fiction; the factories and land couldn't be turned into cash or used abroad. Nine zeros were struck from the currency; that is, one Rentenmark was equal to one billion old Marks. The Germans wanted desperately to believe in the Rentenmark, and so they did. "I remember,"said one Frau Barten of East Prussia, "the feeling of having just one Rentenmark to spend. I bought a small tin bread bin. Just to buy something that had a price tag for one Mark was so exciting."
All money is a matter of belief. Credit derives from Latin, credere, "to believe." Belief was there, the factories functioned, the farmers delivered their produce. The Central Bank kept the belief alive when it would not let even the government borrow further.
But although the country functioned again, the savings were never restored, nor were the values of hard work and decency that had accompanied the savings. There was a different temper in the country, a temper that Hitler would later exploit with diabolical talent. Thomas Mann wrote: "The market woman who without batting an eyelash demanded 100 million for an egg lost the capacity for surprise. And nothing that has happened since has been insane or cruel enough to surprise her."
With the currency went many of the lifetime plans of average citizens. It was the custom for the bride to bring some money to a marriage; many marriages were called off. Widows dependent on insurance found themselves destitute. People who had worked a lifetime found that their pensions would not buy one cup of coffee.
Pearl Buck, the American writer who became famous for her novels of China, was in Germany in 1923. She wrote later: "The cities were still there, the houses not yet bombed and in ruins, but the victims were millions of people. They had lost their fortunes, their savings; they were dazed and inflation-shocked and did not understand how it had happened to them and who the foe was who had defeated them. Yet they had lost their self-assurance, their feeling that they themselves could be the masters of their own lives if only they worked hard enough; and lost, too, were the old values of morals, of ethics, of decency."
The fledgling Nazi party, whose attempted coup had failed in 1923, won 32 seats legally in the next election. The right-wing Nationalist party won 106 seats, having promised 100 percent compensation to the victims of inflation and vengeance on the conspirators who had brought it.
Sunday, May 28, 2006
Smells Like 1987
Its been over two weeks since my last posting, I have been off-island for work and for holiday and just got back in last night. Lots of developments in the markets over the last couple of weeks. We saw a slight panic in all asset markets as stocks, bonds and commodities all sold off in unison before recovering last week. We have also seen the Yield Curve threaten to invert once again, but I will spare everyone from another yield curve lecture (for the people more recently added to the list, I sent out a couple of commentaries a few months back which focused on the then-inverted yield curve and what it meant for the economy - if anyone is interested, I can send those commentaries to you).
Back to the markets, while I never really thought that this correction might be the beginning of the asset price crash that I have been calling for, the thought did cross my mind a couple of times. Most notably, while in New York, the managing partner of the fund manager that we were reviewing - by the way, this guy is a Wall Street legend - was heard saying that it "Smells like 1987". While I don't think he meant that he expected a market crash in the ensuing weeks (or maybe he did), I think he, along with many others, have noted that there a lot of similarties between today's market environment and that of 1987 (I was in 9th grade, so I will exclude myself from that group).
Most notably, in 1987:
1) There was a severe correction (crash?) in the USD - which actually required a concerted effort by the G-7 to stop - this is the key factor today as well
2) You had the rare concurrence of rising interest rates and rising equity markets - this also happened in 1994 with no market dislocation
3) The U.S. budget and trade deficits were increasing rapidly (some might say spiraling out of control) - much like today
4) You had a new Fed Chief - ok, this is more of a coincedence.
While I am sticking to my projection that there will be no dislocation in the near future, there are some worrisome signs that should not be ignored. And of course any event-driven problems (Iran?) could bring the mounting imbalances to a head.
While I get back into the flow, I thought I would throw in a few random thoughts from the last couple of weeks:
Most of the risk in the U.S. stock market has been due to inflation - For the past 80 years, the risk in the Dow Jones has barely outpaced the rise in the value of gold, which serves as a good proxy for the loss of purchasing power in the USD since it was taken off the gold standard in 1913.
Look at these numbers:
Gold
October 10, 1929 - $20.63
Today - $651
Gain - 3056%
Dow Jones
October 10, 1929 - 352.86
Today - 11,278
Gain - 3096%
Of course, the Dow Jones would pay dividends (avg over time around 3.5 - 4%, but that is pre-tax and tax rates for most of the past 80 years have been quite high - up to a max rate of 90% in the 1950s). However, this return does not factor in brokerage costs for the Dow stock strategy.
Also, as Bill Fleury pointed out, the Dow suffers from survivorship bias. Meaning that as companies begin to decline in market capital, it is removed from the Dow in place of a younger, higher growth company. Therefore, a buy and hold strategy on the old 1920s Dow stocks would have given you a MUCH lower return than the one noted above.
For the sake of curiosity, here is the original list of Dow companies from 1896, only GE remains today:
· American Cotton Oil Company, a predecessor of Bestfoods, now part of Unilever
· American Sugar Company, now Amstar Holdings
· American Tobacco Company, broken up in 1911
· Chicago Gas Company, bought by Peoples Gas Light & Coke Co. in 1897 (now Peoples Energy Corporation)
· Distilling & Cattle Feeding Company, now Millennium Chemicals
· General Electric
· Laclede Gas Light Company, still in operation as The Laclede Group
· National Lead Company, now NL Industries
· North American Company, broken up in the 1950s
· Tennessee Coal, Iron and Railroad Company, bought by U.S. Steel in 1907
· U.S. Leather Company, dissolved 1952
· United States Rubber Company, changed its name to Uniroyal in 1967, bought by Michelin in 1990
Fannie Mae report - Please read the following story about the Office of Federal Housing Enterprise Oversight report on Fannie Mae which was released last week. Why has this not hit the mainline news. This is a grossly scandalous story that has received almost no media attention. Tens of millions of dollars were paid in bonuses to executives of Fannie Mae based on fraudulent accounting records. Even more so, the report showed that the IT, risk management and internal control structure of this company were neglected.
Don't people realize the implication of this, as a Government-Sponsored Entity, Fannie Mae has an implicit guarantee from the government. Any disasters at this company and it would have to be bailed out by taxpayers. Even worse, Fannie Mae is so large and so entrenched in the U.S. structured mortgage market, a failure of this company could literally cause a global financial meltdown. I don't think I am exaggerating when I say that.
May 24:Operational Risk - Report Finds Fannie Mae Criticized for Earnings Manipulation
Author: Corinne Russell and Stefanie Mullin
Date: 2006-05-24
James B. Lockhart, Acting Director of the Office of Federal Housing Enterprise Oversight, yesterday released its Report of the Special Examination of Fannie Mae. The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.
James B. Lockhart, Acting Director of the Office of Federal Housing Enterprise Oversight (OFHEO), yesterday released its Report of the Special Examination of Fannie Mae.
The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.
The report also prescribes corrective actions to ensure the safety and soundness of the company.
“The image of Fannie Mae as one of the lowest-risk and ‘best in class’ institutions was a facade,” said Lockhart. “Our examination found an environment where the ends justified the means. Senior management manipulated accounting; reaped maximum, undeserved bonuses; and prevented the rest of the world from knowing. They co-opted their internal auditors. They stonewalled OFHEO,” Lockhart said.
“Fannie Mae’s executives were precisely managing earnings to the one-hundredth of a penny to maximize their bonuses while neglecting investments in systems internal controls and risk management,” Lockhart said. “The combination of earnings manipulation, mismanagement and unconstrained growth resulted in an estimated $10.6 billion of losses, well over a billion dollars in expenses to fix the problems, and ill-gotten bonuses in the hundreds of millions of dollars.”
The OFHEO report is the product of more than two years of in-depth review involving nearly 8 million pages of documents. The report includes the following key findings:
=> Fannie Mae senior management promoted an image of the Enterprise as one of the lowest-risk financial institutions in the world and as “best in class” in terms of risk management, financial reporting, internal control, and corporate governance. The findings in this report show that image was false.
=> A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (GAAP). The Enterprise also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by a currently estimated $10.6 billion.
=> During the period covered by this report—1998 to mid-2004—Fannie Mae reported extremely smooth profit growth and hit announced targets for earnings per share precisely each quarter. Those achievements were illusions deliberately and systematically created by the Enterprise’s senior management with the aid of inappropriate accounting and improper earnings management.
=> By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders. Earnings management made a significant contribution to the compensation of Fannie Mae Chairman and CEO Franklin Raines, which totaled over $90 million from 1998 through 2003. Of that total, over $52 million was directly tied to achieving earnings per share targets.
+> Fannie Mae’s Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its chairman, Franklin Raines, and other senior executives, failing to exercise the requisite oversight over the Enterprise’s operations, and failing to discover or ensure the correction of a wide variety of unsafe and unsound practices, even after the Freddie Mac problems became apparent.
=> Senior management did not make investments in accounting systems, computer systems, other infrastructure, and staffing needed to support a sound internal control system, proper accounting, and GAAP-consistent financial reporting. Those failures came at a time when Fannie Mae faced many operational challenges related to its rapid growth and changing accounting and legal requirements.
=> Fannie Mae senior management sought to interfere with OFHEO’s special examination by directing the Enterprise’s lobbyists to use their ties to Congressional staff to improperly generate a Congressional request for the Inspector General of the Department of Housing and Urban Development (HUD) to investigate OFHEO’s conduct of that examination and to insert into an appropriations bill language that would punish the agency by reducing its appropriations until the Director of OFHEO was replaced.
“As a government-sponsored enterprise, Fannie Mae has a unique position among American corporations and an extremely important mission,” said Lockhart. “It is also the second largest borrower in the world, only behind the U.S. government. As such, Fannie Mae has a special mandate and position of public trust. The previous management team violated that trust and did serious harm to Fannie Mae,” Lockhart said.
The report ends with recommendations from OFHEO’s staff to the Acting Director, which he has accepted. Some of the key recommendations include:
=> Fannie Mae must meet all of its commitments for remediation and do so with an emphasis on implementation – with dates certain – of plans already presented to OFHEO.
=> Fannie Mae must review OFHEO’s report to determine additional steps to take to improve its controls, accounting systems, risk management practices and systems, external relations program, data quality, and corporate culture. Emphasis must be placed on implementation of those plans.
=> Fannie Mae must strengthen its Board of Directors procedures to enhance Board oversight of Fannie Mae’s management.
=> Fannie Mae must undertake a review of individuals currently with the Enterprise that are mentioned in OFHEO’s report.
=> Due to Fannie Mae’s current operational and internal control deficiencies and other risks, the Enterprise’s growth should be limited.
=> OFHEO should continue to support legislation to provide the powers essential to meeting its mission of assuring safe and sound operations at the Enterprises.
Back to the markets, while I never really thought that this correction might be the beginning of the asset price crash that I have been calling for, the thought did cross my mind a couple of times. Most notably, while in New York, the managing partner of the fund manager that we were reviewing - by the way, this guy is a Wall Street legend - was heard saying that it "Smells like 1987". While I don't think he meant that he expected a market crash in the ensuing weeks (or maybe he did), I think he, along with many others, have noted that there a lot of similarties between today's market environment and that of 1987 (I was in 9th grade, so I will exclude myself from that group).
Most notably, in 1987:
1) There was a severe correction (crash?) in the USD - which actually required a concerted effort by the G-7 to stop - this is the key factor today as well
2) You had the rare concurrence of rising interest rates and rising equity markets - this also happened in 1994 with no market dislocation
3) The U.S. budget and trade deficits were increasing rapidly (some might say spiraling out of control) - much like today
4) You had a new Fed Chief - ok, this is more of a coincedence.
While I am sticking to my projection that there will be no dislocation in the near future, there are some worrisome signs that should not be ignored. And of course any event-driven problems (Iran?) could bring the mounting imbalances to a head.
While I get back into the flow, I thought I would throw in a few random thoughts from the last couple of weeks:
Most of the risk in the U.S. stock market has been due to inflation - For the past 80 years, the risk in the Dow Jones has barely outpaced the rise in the value of gold, which serves as a good proxy for the loss of purchasing power in the USD since it was taken off the gold standard in 1913.
Look at these numbers:
Gold
October 10, 1929 - $20.63
Today - $651
Gain - 3056%
Dow Jones
October 10, 1929 - 352.86
Today - 11,278
Gain - 3096%
Of course, the Dow Jones would pay dividends (avg over time around 3.5 - 4%, but that is pre-tax and tax rates for most of the past 80 years have been quite high - up to a max rate of 90% in the 1950s). However, this return does not factor in brokerage costs for the Dow stock strategy.
Also, as Bill Fleury pointed out, the Dow suffers from survivorship bias. Meaning that as companies begin to decline in market capital, it is removed from the Dow in place of a younger, higher growth company. Therefore, a buy and hold strategy on the old 1920s Dow stocks would have given you a MUCH lower return than the one noted above.
For the sake of curiosity, here is the original list of Dow companies from 1896, only GE remains today:
· American Cotton Oil Company, a predecessor of Bestfoods, now part of Unilever
· American Sugar Company, now Amstar Holdings
· American Tobacco Company, broken up in 1911
· Chicago Gas Company, bought by Peoples Gas Light & Coke Co. in 1897 (now Peoples Energy Corporation)
· Distilling & Cattle Feeding Company, now Millennium Chemicals
· General Electric
· Laclede Gas Light Company, still in operation as The Laclede Group
· National Lead Company, now NL Industries
· North American Company, broken up in the 1950s
· Tennessee Coal, Iron and Railroad Company, bought by U.S. Steel in 1907
· U.S. Leather Company, dissolved 1952
· United States Rubber Company, changed its name to Uniroyal in 1967, bought by Michelin in 1990
Fannie Mae report - Please read the following story about the Office of Federal Housing Enterprise Oversight report on Fannie Mae which was released last week. Why has this not hit the mainline news. This is a grossly scandalous story that has received almost no media attention. Tens of millions of dollars were paid in bonuses to executives of Fannie Mae based on fraudulent accounting records. Even more so, the report showed that the IT, risk management and internal control structure of this company were neglected.
Don't people realize the implication of this, as a Government-Sponsored Entity, Fannie Mae has an implicit guarantee from the government. Any disasters at this company and it would have to be bailed out by taxpayers. Even worse, Fannie Mae is so large and so entrenched in the U.S. structured mortgage market, a failure of this company could literally cause a global financial meltdown. I don't think I am exaggerating when I say that.
May 24:Operational Risk - Report Finds Fannie Mae Criticized for Earnings Manipulation
Author: Corinne Russell and Stefanie Mullin
Date: 2006-05-24
James B. Lockhart, Acting Director of the Office of Federal Housing Enterprise Oversight, yesterday released its Report of the Special Examination of Fannie Mae. The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.
James B. Lockhart, Acting Director of the Office of Federal Housing Enterprise Oversight (OFHEO), yesterday released its Report of the Special Examination of Fannie Mae.
The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.
The report also prescribes corrective actions to ensure the safety and soundness of the company.
“The image of Fannie Mae as one of the lowest-risk and ‘best in class’ institutions was a facade,” said Lockhart. “Our examination found an environment where the ends justified the means. Senior management manipulated accounting; reaped maximum, undeserved bonuses; and prevented the rest of the world from knowing. They co-opted their internal auditors. They stonewalled OFHEO,” Lockhart said.
“Fannie Mae’s executives were precisely managing earnings to the one-hundredth of a penny to maximize their bonuses while neglecting investments in systems internal controls and risk management,” Lockhart said. “The combination of earnings manipulation, mismanagement and unconstrained growth resulted in an estimated $10.6 billion of losses, well over a billion dollars in expenses to fix the problems, and ill-gotten bonuses in the hundreds of millions of dollars.”
The OFHEO report is the product of more than two years of in-depth review involving nearly 8 million pages of documents. The report includes the following key findings:
=> Fannie Mae senior management promoted an image of the Enterprise as one of the lowest-risk financial institutions in the world and as “best in class” in terms of risk management, financial reporting, internal control, and corporate governance. The findings in this report show that image was false.
=> A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (GAAP). The Enterprise also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by a currently estimated $10.6 billion.
=> During the period covered by this report—1998 to mid-2004—Fannie Mae reported extremely smooth profit growth and hit announced targets for earnings per share precisely each quarter. Those achievements were illusions deliberately and systematically created by the Enterprise’s senior management with the aid of inappropriate accounting and improper earnings management.
=> By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders. Earnings management made a significant contribution to the compensation of Fannie Mae Chairman and CEO Franklin Raines, which totaled over $90 million from 1998 through 2003. Of that total, over $52 million was directly tied to achieving earnings per share targets.
+> Fannie Mae’s Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its chairman, Franklin Raines, and other senior executives, failing to exercise the requisite oversight over the Enterprise’s operations, and failing to discover or ensure the correction of a wide variety of unsafe and unsound practices, even after the Freddie Mac problems became apparent.
=> Senior management did not make investments in accounting systems, computer systems, other infrastructure, and staffing needed to support a sound internal control system, proper accounting, and GAAP-consistent financial reporting. Those failures came at a time when Fannie Mae faced many operational challenges related to its rapid growth and changing accounting and legal requirements.
=> Fannie Mae senior management sought to interfere with OFHEO’s special examination by directing the Enterprise’s lobbyists to use their ties to Congressional staff to improperly generate a Congressional request for the Inspector General of the Department of Housing and Urban Development (HUD) to investigate OFHEO’s conduct of that examination and to insert into an appropriations bill language that would punish the agency by reducing its appropriations until the Director of OFHEO was replaced.
“As a government-sponsored enterprise, Fannie Mae has a unique position among American corporations and an extremely important mission,” said Lockhart. “It is also the second largest borrower in the world, only behind the U.S. government. As such, Fannie Mae has a special mandate and position of public trust. The previous management team violated that trust and did serious harm to Fannie Mae,” Lockhart said.
The report ends with recommendations from OFHEO’s staff to the Acting Director, which he has accepted. Some of the key recommendations include:
=> Fannie Mae must meet all of its commitments for remediation and do so with an emphasis on implementation – with dates certain – of plans already presented to OFHEO.
=> Fannie Mae must review OFHEO’s report to determine additional steps to take to improve its controls, accounting systems, risk management practices and systems, external relations program, data quality, and corporate culture. Emphasis must be placed on implementation of those plans.
=> Fannie Mae must strengthen its Board of Directors procedures to enhance Board oversight of Fannie Mae’s management.
=> Fannie Mae must undertake a review of individuals currently with the Enterprise that are mentioned in OFHEO’s report.
=> Due to Fannie Mae’s current operational and internal control deficiencies and other risks, the Enterprise’s growth should be limited.
=> OFHEO should continue to support legislation to provide the powers essential to meeting its mission of assuring safe and sound operations at the Enterprises.
Tuesday, May 09, 2006
The Zombie Currency
Definition of a Zombie company: In Japan, one way that banks get around the problem of writing off bad loans is by providing troubled companies with debt waivers or swapping their debt for equity. This method has been used to help the country's largest supermarket chain Daiei Corp. Analysts say this type of support is risky because it simply disguises the problem by shifting it from the company to the bank, keeping dying companies alive on minimal nourishment, and ultimately hurting competitiveness. Companies like Daiei are called "zombie companies" as it muddles along without any vigor or aim.
Now all you have to do is substitute Daiei with the USD, debt waivers with foreign currency reserves and Japanese banks with the Bank of Japan (quite possible the least competant of all Central Banks - now that is saying something). The USD perfectly fits the definition of a zombie currency.
The price action on the USD over the past 4 years (temporarily interrupted in 2005 by the Fed's tightening campaign) shows that foreign investors are losing their appetite for USD holdings. The last couple of weeks with the skyrocketing price of gold and silver along with a quick deterioration in USD in the fx markets may be warning us of an impending market dislocation.
Due to the $800 billion annual U.S. trade deficit, the global investment community has to purchase a net $2 billion + per day, every day, just to keep the USD from falling. Therefore, a slow, downward drip in the USD simply means that foreign investors are simply accumulating USD assets more slowly. If they were to actually start selling USD, then look out.
So who are these "foreign investors" that come to the rescue of the USD each and every day? Since the demand for USD assets from private investors is clearly slowing, it leaves the foreign central banks and governments. In fact, a term has been coined for these public sector investors, called "Non-Economic Players" (NEPs) - which is a euphimism for currency manipulators. These are mainly China and Japan, but include many other countries in the Middle East along with Russia, Brazil, and South Africa; maybe even Canada, the U.K. and Europe in smaller amounts.
The theory goes something like this. If the USD were to fall precipitously causing inflation, higher interest rates, lower real estate prices and general financial carnage - American consumers would no longer be able to live above their means and buy "stuff" on credit from foreign companies. This "stuff" ranges from cars to flat-screen TVs, to t-shirts, to oil, to any other gadgets or conveniences/necessities in our daily life.
To avoid this scenario where people actually have to pay for the stuff they buy, the NEPs "lend" a huge chunk of their export earnings back to the U.S. in the form of bond, equity, and real estate purchases (amongst many other types of investments). By buying these USD denominated assets in such gargantuan numbers, they artificially prop up the fx value of the USD.
And thus a zombie currency was born and perhaps a zombie economy with it.
The problem is that they are interfering with the adjustment process of the foreign exchange markets and have created unsustainable bubbles - which show up in the form of burgeoning U.S. trade deficits and the foreign reserve holdings of the NEPs. The larger the manipulations, the larger the imbalances grow - which in turn require even more manipulation.
What is the endgame? We will now see if the NEPs are willing to continue throwing away the money earned from the blood, sweat and tears of their citizens to prop up the zombie USD currency.
Of course, I have GROSSLY oversimplified this story and have not even mentioned the FED's role in this scheme. But the point of this commentary is highlight the Asian practice of creating and maintaining Zombies - besides I have hammered on Big Al and Hellicopter Ben (Bobby) enough over the past few months.
By the way, last week's article generated an amazing response. I had 25 e-mails by the time I woke up in the morning, mostly about my comments re: the housing market. This is clearly an emotional topic for many people. For further discussion, here is an article written by Mike Shedlock(http://globaleconomicanalysis.blogspot.com/) :
Now all you have to do is substitute Daiei with the USD, debt waivers with foreign currency reserves and Japanese banks with the Bank of Japan (quite possible the least competant of all Central Banks - now that is saying something). The USD perfectly fits the definition of a zombie currency.
The price action on the USD over the past 4 years (temporarily interrupted in 2005 by the Fed's tightening campaign) shows that foreign investors are losing their appetite for USD holdings. The last couple of weeks with the skyrocketing price of gold and silver along with a quick deterioration in USD in the fx markets may be warning us of an impending market dislocation.
Due to the $800 billion annual U.S. trade deficit, the global investment community has to purchase a net $2 billion + per day, every day, just to keep the USD from falling. Therefore, a slow, downward drip in the USD simply means that foreign investors are simply accumulating USD assets more slowly. If they were to actually start selling USD, then look out.
So who are these "foreign investors" that come to the rescue of the USD each and every day? Since the demand for USD assets from private investors is clearly slowing, it leaves the foreign central banks and governments. In fact, a term has been coined for these public sector investors, called "Non-Economic Players" (NEPs) - which is a euphimism for currency manipulators. These are mainly China and Japan, but include many other countries in the Middle East along with Russia, Brazil, and South Africa; maybe even Canada, the U.K. and Europe in smaller amounts.
The theory goes something like this. If the USD were to fall precipitously causing inflation, higher interest rates, lower real estate prices and general financial carnage - American consumers would no longer be able to live above their means and buy "stuff" on credit from foreign companies. This "stuff" ranges from cars to flat-screen TVs, to t-shirts, to oil, to any other gadgets or conveniences/necessities in our daily life.
To avoid this scenario where people actually have to pay for the stuff they buy, the NEPs "lend" a huge chunk of their export earnings back to the U.S. in the form of bond, equity, and real estate purchases (amongst many other types of investments). By buying these USD denominated assets in such gargantuan numbers, they artificially prop up the fx value of the USD.
And thus a zombie currency was born and perhaps a zombie economy with it.
The problem is that they are interfering with the adjustment process of the foreign exchange markets and have created unsustainable bubbles - which show up in the form of burgeoning U.S. trade deficits and the foreign reserve holdings of the NEPs. The larger the manipulations, the larger the imbalances grow - which in turn require even more manipulation.
What is the endgame? We will now see if the NEPs are willing to continue throwing away the money earned from the blood, sweat and tears of their citizens to prop up the zombie USD currency.
Of course, I have GROSSLY oversimplified this story and have not even mentioned the FED's role in this scheme. But the point of this commentary is highlight the Asian practice of creating and maintaining Zombies - besides I have hammered on Big Al and Hellicopter Ben (Bobby) enough over the past few months.
By the way, last week's article generated an amazing response. I had 25 e-mails by the time I woke up in the morning, mostly about my comments re: the housing market. This is clearly an emotional topic for many people. For further discussion, here is an article written by Mike Shedlock(http://globaleconomicanalysis.blogspot.com/) :
Wednesday, April 05, 2006
European Demographic Time Bomb
Another old post from 2006 - I have to admit this is a pretty darn good call re: the Republican party. The party has imploded since 2006 and immigration helped split the party in two (admittedly the economy was the bigger issue in 2008).
This week's commentary comes to you on a night that I should be finishingmy tax return. It reminds me a little bit of college when I would use anyexcuse to procrastinate from finishing one of my papers or study for an exam. I've always done my best work late at night – that is how I always justified wasting time.
Last week's political work aroused some emotional responses. I really doappreciate people writing me back even if they don't agree with my views andwant to tell me about it. A couple things I want to clarify from lastweek's article:
1) Last week's article was supposed to be about the rift in theRepublican party – with immigration just being the tipping point, not thewhole point of the article. I wanted to emphasize that the old GOPbusiness wing really messed up when they went to bed with the Christian right back in the 70s. It is now going to blow up in their face.
2) Since the article – and certainly the responses that I got – turned outto be about immigration, I would like to emphasize that I do not believethat people should just ignore the problem of illegal immigration (althoughthat is still better than mass deportation), I certainly hope that I didn'timply that I did. I simply would like to see legal immigration expanded to the point that only criminals and terrorists would not be allowed in.
3) I should have taken care to be more balanced in my commentary andincluded more of the "other" side of the argument. The financial andsocial strain that is placed on the host community – especially whereillegals are large in numbers. While these costs are real and need to beaddressed – regardless of how new legislation progresses – the pale incomparison to the benefits to American society and the economy as a whole.This is not even close – especially when you consider that our whole entitlement system (primarily Social Security and Medicare) will collapsewithout huge numbers of young immigrant families.
Ok, enough about last week and on to this week.
*EUROPEAN DEMOGRAPHIC TIME BOMB*
My wife and I have visited various parts of Europe three times over thepast 4 years and have each time asked each other the questions: "Where are all the kids?" (by the way, this excludes London where you see babystrollers everywhere).
It's almost as if sometime in the 1970s and 1980s, that European couples have simply decided to stop having children en masse. The numbers area stounding, here are the statistics from the CIA World Factbook.
*European Union*<http://www.cia.gov/cia/publications/factbook/geos/ee.html>
1.47 July 2005 est.
And European Union (EU) 25 members make up 14 of the bottom 25 countries andthe EU average places it in the bottom 15 of non-EU countries. Outside of Japan, South Korea and the Northern Mariana Islands, all of lowest reproductive countries are European, if not in the EU.
It is common sense that for a country's population to remain stable, the number of children per woman needs to be at least 2.0 (the actual numberis around 2.2 dependent on various other societal factors). So the EU average of 1.47 and countries with numbers around 1.2 is nowhere near thenumber to maintain 0% population growth (without significant immigration flows) over the medium-to-longer term. But even the numbers above aremasked by the fact that immigrant families still average 3-5 children which brings the overall national figures higher than they would otherwise be(more on this later).
By the way, the U.S. figures are somwhat better (2.08) but remain below thecrucial 2.2 mark – despite the influx of immigrant families with larger numbers of children. Slower immigration would bring eventually bring thenumbers down to more European-type levels.
So what is causing this phenomenon and what are the implications of thistrend if it is not reversed in the immediate-term (once the median womanhits the age of 45 or so, the trend becomes virtually irreversible – at the current time, the median age per woman is around 40 years old).
*Reasons*
In my years of exploration and research around this topic, I have put together the following list of reasons for the current European Baby Bust(by no means do I think this list is comprehensive, if anyone has different or better ideas – I would love to hear them):
1) Taxes are too high/wages are too low – the argument that it is simply too expensive and not economically possible for the average European couple to bear the expense of raising multiple children.
There is some merit to this theory as the European families that live here in Cayman – where there are no direct taxes – seem to be having plenty of babies.
2) Young Europeans are simply too selfish and don't want the commitment of marriage and the burden of families.
3) Years of warning about the threat of world overpopulation finally sunk in and changed societal behavior. My father told me that in the 60sand the 70s, people were warned about the dangers of overpopulation and theEarth's ability to maintain such population growth.
4) The problem of the "Mama's Boys", don't laugh – this is actually a big problem in Italy (less so in other parts of Europe – but not nonexistent), many men simply refuse to leave their parents' home. Theylike the lifestyle of being pampered by their mother's and do not want to go it alone – or even with a wife who may not be as pampering as Mommy. Even worse, many of these men don't even work full-time and live off the pensions of their parents.
My personal theory is a longer term view which deals with two broad changes in society over the past 50-100 years. The rise of pension plans and a shift away from an agrarian workforce. This is another topic I would eventually like to more fully explore, perhaps as a PhD thesis. But in a nutshell it goes like this, the main reason that people had largefamilies in past generations is that (1) children/relatives represented your pension plan and medical care – if you didn't have enough children to support you in your old age, you simply died once you were too old to work or if you got sick. (2) Agrarian society requires large amounts of labor to work the fields, etc. As people were much less mobile and could not import labor from other areas, you had to have children for the system to work.
This also helps explains why the former communist countries, many of which remain poor, have the lowest birthrates. The governments in those countries provided for 100% of retirement needs. I know there is more to it than just this, so given time and resources I think I could put together a more complete theory for this trend.
*Implications*
Most people will think this is another doom and gloom prediction, but my honest opinion is that this demographic crisis equals the threats from communism and fascism as the biggest threat to face Europe since the Plague from the 1300s. The populations of many European countries are projected to decline by 25% over the next 50 years. In some regions, the numbers look even worse.
The most recent forecasts that I have seen predict that Germany's population could fall from around 82 million to around 65 million by 2030 and to under 60 million by 2050. On a more local scale, the population of Sicily is projected to fall from the current level of 5 million to 3 million by 2030 – some of this due to migration as well, another by-product of population shrinkage due to the reduction of economic opportunities in hard hit areas.
As I said earlier, the numbers above do not reflect the whole story. The population numbers would look worse if not for the large numbers of immigrants currently flowing into Europe, mainly from North Africa and the Middle East. In addition, these immigrant groups are having a greatly disproportionate number of the children being born in Europe.
In some countries, by 2030 the Arab and Muslim population of the younger age segments (ages 30 and under) will outnumber people of European descent. I don't want this to come off as anti-Arab or anti-Muslim in any way, shape or form. The problem is NOT where these people are from, but how they fit into their new countries. In Europe, unlike the U.S. and Canada, immigrant communities have not – in the past - been well-integrated into society.
While in North America, the children and most-definitely the grand-children of immigrants are considered to be fully American or Canadian. People of different backgrounds are rarely ever accepted as fully German or Italian, for example. This is not to blame only the host countries, resistance from the immigrant communities themselves have played a large factor in this. I will say that this is changing (at least among younger people in the larger cities) but it will be a while before this change is complete.
Therefore, you end up with a situation where large, and growing, segments of the community feel as though they are second-class citizens. You do not have to look any further than the recent riots in France and the murder of filmmaker Theo Van Gough in the Netherlands as examples of this. Even in Britain, which has been the most successful European country in assimilating immigrants, there were riots from South Asian youths a few years back.
The implications of this growing problem are many and are very serious, both from a political and economic standpoint. I will get more specific in later paragraphs.
Economic Implications
European countries tend to have very generous pension, health care and welfare states. Most Europeans are very proud of these programs as they contrast them with the less civilized "Anglo-Saxon (meaning the U.S. and Britain) economic model".
Well, this is just common sense, but with a declining population base and less children to work, I have one question: Who is going to pay for these programs in the future? You need young workers if you want to have a pension plan, there is just no other way. The Europeans use mainly pay-as-you-go financing for their entitlement programs – just like in the U.S. (think of Social Security). This is nothing more than a fancy name for a Ponzi scheme – except that instead of needing new investors to pump in capital, new workers are needed to pay in contributions.
In fact, I recently read The Kok Report, which warned that by mid-century the ratio of pensioners to active workers will double. Broadly speaking, that means the burden on the working population of supporting those who have retired will also double. And here is where the problem of increasing numbers of disenfranchised immigrants comes in.
*[Just to reiterate, I am using the term "immigrants" as a generic term for people of non-European heritage living in Europe – even as some families have now been their for 2 or 3 generations. I do this partially to drive home my earlier point that many Europeans do not, and probably, will not see these people as European.]*
Will these young immigrant workers (whatever their ethnic background) be willing to shoulder massive tax burdens to pay for pension and health care benefits for aging Europeans – particularly the same people who made their families them feel like second class citizens? I don't know the answer – but I wouldn't want to have my future financial health be dependent on an affirmative answer to that question.
As any attempts to reform these programs are met with fierce resistance, like massive strikes and changes in government, I don't see any resolve for making the painful choices needed to save these programs. Just look at the reaction in France (as mentioned earlier) to a relatively minor change in labor law, where employers will be able to more easily fire young workers in their first two years of employment – five massive strikes and countless protests. Do you really think that there is the political will necessary to make the severe and painful restructuring of the massive entitlement programs?
This is going to be a disaster and it will bankrupt most of the governments of the E.U. successively. Non-E.U. member Norway and Switzerland are in better shape. I could actually write a whole commentary on the responsible behavior of the Norwegian government (they use their oil proceeds to set up a massive public trust – for use in a rainy day, or to pay for their pensioners in the coming decades).
There are other economic problems that will be caused by the plunging birthrate. Declining spending, increased health-care costs (whether funded by the government or individuals), labor shortages and declining tax base, political radicalization (see below) among many, many others. When you add up these problems, it is not going to be an enticing situation for the young entrepreneurs and other talented young people. Therefore, you can expect a brain-drain on top of all the other problems as many young people will move to countries where they have better opportunities awaiting them.
Keeping this brief and simplistic, the economic consequences of this trend will be devastating. This, in turn, will fuel political discourse which could boil over into something worse.
Political implications
As this has already been a long newsletter, I will keep this part short and ugly. My view is that the political spectrum of Europe is going to get much more radical than it has been in recent decades.
You will see radical parties on both the right (probably anti-immigration type platforms) and the left (anti-globalization and anti-American). Both will try to blame others for their country's ills. Be it immigrants, E.U. beaurocrats, the United States, Britain (just for old times sake), the rich capitalists, China and other Asian countries, or some combination of all.
This movement has already started in countries such as Austria, the Netherlands, and even a bit in France (where an extreme right-wing candidate finished second in the last Presidential election).
Summary
An economic meltdown, and the loss of the cherished, but no longer practical, welfare state would not help the situation and may possibly be a tipping point towards right and left-wing movements. A return to radical politics in Europe would be a destabilizing force globally – both economically and politically. I don't mean to continuously make such broad and sweeping statements and then moving on – but this is truly a whole thesis in itself – so it will have to be left for a future week.
Moving forward, this is quite obviously a long-term negative for the EUR, if it even still exists in the long-term. However, I am still quite bullish on the EUR in the short-to-medium term as it is being seen more and more as a "back-up" reserve currency for the USD.
Later in 2006, when the USD gives up the remainder of its 2005 gains and continues its freefall, the EUR should be set to benefit. Specifically, the European Central Bank looks poised to raise rates several more times in their current tightening cycle as they (unlike the Fed) seeing rising asset prices for what they are – inflation.
In addition, despite the economic malaise seen in Europe over the past 5 years (although things seem to be picking up), people still believe in saving money. Euroland savings and investment rates have remained stable, and have even increased in some countries, even as U.S. consumers have seen their savings rate plunge into the negative for the first time since the Great Depression.
To summarize, in the short-term, I will continue to buy EUR, along with a basket of other currencies. For the long-term, I will continue to accumulate commodities and resources as an inflation hedge. Anything, but the USD.
This week's commentary comes to you on a night that I should be finishingmy tax return. It reminds me a little bit of college when I would use anyexcuse to procrastinate from finishing one of my papers or study for an exam. I've always done my best work late at night – that is how I always justified wasting time.
Last week's political work aroused some emotional responses. I really doappreciate people writing me back even if they don't agree with my views andwant to tell me about it. A couple things I want to clarify from lastweek's article:
1) Last week's article was supposed to be about the rift in theRepublican party – with immigration just being the tipping point, not thewhole point of the article. I wanted to emphasize that the old GOPbusiness wing really messed up when they went to bed with the Christian right back in the 70s. It is now going to blow up in their face.
2) Since the article – and certainly the responses that I got – turned outto be about immigration, I would like to emphasize that I do not believethat people should just ignore the problem of illegal immigration (althoughthat is still better than mass deportation), I certainly hope that I didn'timply that I did. I simply would like to see legal immigration expanded to the point that only criminals and terrorists would not be allowed in.
3) I should have taken care to be more balanced in my commentary andincluded more of the "other" side of the argument. The financial andsocial strain that is placed on the host community – especially whereillegals are large in numbers. While these costs are real and need to beaddressed – regardless of how new legislation progresses – the pale incomparison to the benefits to American society and the economy as a whole.This is not even close – especially when you consider that our whole entitlement system (primarily Social Security and Medicare) will collapsewithout huge numbers of young immigrant families.
Ok, enough about last week and on to this week.
*EUROPEAN DEMOGRAPHIC TIME BOMB*
My wife and I have visited various parts of Europe three times over thepast 4 years and have each time asked each other the questions: "Where are all the kids?" (by the way, this excludes London where you see babystrollers everywhere).
It's almost as if sometime in the 1970s and 1980s, that European couples have simply decided to stop having children en masse. The numbers area stounding, here are the statistics from the CIA World Factbook.
*European Union*<http://www.cia.gov/cia/publications/factbook/geos/ee.html>
1.47 July 2005 est.
And European Union (EU) 25 members make up 14 of the bottom 25 countries andthe EU average places it in the bottom 15 of non-EU countries. Outside of Japan, South Korea and the Northern Mariana Islands, all of lowest reproductive countries are European, if not in the EU.
It is common sense that for a country's population to remain stable, the number of children per woman needs to be at least 2.0 (the actual numberis around 2.2 dependent on various other societal factors). So the EU average of 1.47 and countries with numbers around 1.2 is nowhere near thenumber to maintain 0% population growth (without significant immigration flows) over the medium-to-longer term. But even the numbers above aremasked by the fact that immigrant families still average 3-5 children which brings the overall national figures higher than they would otherwise be(more on this later).
By the way, the U.S. figures are somwhat better (2.08) but remain below thecrucial 2.2 mark – despite the influx of immigrant families with larger numbers of children. Slower immigration would bring eventually bring thenumbers down to more European-type levels.
So what is causing this phenomenon and what are the implications of thistrend if it is not reversed in the immediate-term (once the median womanhits the age of 45 or so, the trend becomes virtually irreversible – at the current time, the median age per woman is around 40 years old).
*Reasons*
In my years of exploration and research around this topic, I have put together the following list of reasons for the current European Baby Bust(by no means do I think this list is comprehensive, if anyone has different or better ideas – I would love to hear them):
1) Taxes are too high/wages are too low – the argument that it is simply too expensive and not economically possible for the average European couple to bear the expense of raising multiple children.
There is some merit to this theory as the European families that live here in Cayman – where there are no direct taxes – seem to be having plenty of babies.
2) Young Europeans are simply too selfish and don't want the commitment of marriage and the burden of families.
3) Years of warning about the threat of world overpopulation finally sunk in and changed societal behavior. My father told me that in the 60sand the 70s, people were warned about the dangers of overpopulation and theEarth's ability to maintain such population growth.
4) The problem of the "Mama's Boys", don't laugh – this is actually a big problem in Italy (less so in other parts of Europe – but not nonexistent), many men simply refuse to leave their parents' home. Theylike the lifestyle of being pampered by their mother's and do not want to go it alone – or even with a wife who may not be as pampering as Mommy. Even worse, many of these men don't even work full-time and live off the pensions of their parents.
My personal theory is a longer term view which deals with two broad changes in society over the past 50-100 years. The rise of pension plans and a shift away from an agrarian workforce. This is another topic I would eventually like to more fully explore, perhaps as a PhD thesis. But in a nutshell it goes like this, the main reason that people had largefamilies in past generations is that (1) children/relatives represented your pension plan and medical care – if you didn't have enough children to support you in your old age, you simply died once you were too old to work or if you got sick. (2) Agrarian society requires large amounts of labor to work the fields, etc. As people were much less mobile and could not import labor from other areas, you had to have children for the system to work.
This also helps explains why the former communist countries, many of which remain poor, have the lowest birthrates. The governments in those countries provided for 100% of retirement needs. I know there is more to it than just this, so given time and resources I think I could put together a more complete theory for this trend.
*Implications*
Most people will think this is another doom and gloom prediction, but my honest opinion is that this demographic crisis equals the threats from communism and fascism as the biggest threat to face Europe since the Plague from the 1300s. The populations of many European countries are projected to decline by 25% over the next 50 years. In some regions, the numbers look even worse.
The most recent forecasts that I have seen predict that Germany's population could fall from around 82 million to around 65 million by 2030 and to under 60 million by 2050. On a more local scale, the population of Sicily is projected to fall from the current level of 5 million to 3 million by 2030 – some of this due to migration as well, another by-product of population shrinkage due to the reduction of economic opportunities in hard hit areas.
As I said earlier, the numbers above do not reflect the whole story. The population numbers would look worse if not for the large numbers of immigrants currently flowing into Europe, mainly from North Africa and the Middle East. In addition, these immigrant groups are having a greatly disproportionate number of the children being born in Europe.
In some countries, by 2030 the Arab and Muslim population of the younger age segments (ages 30 and under) will outnumber people of European descent. I don't want this to come off as anti-Arab or anti-Muslim in any way, shape or form. The problem is NOT where these people are from, but how they fit into their new countries. In Europe, unlike the U.S. and Canada, immigrant communities have not – in the past - been well-integrated into society.
While in North America, the children and most-definitely the grand-children of immigrants are considered to be fully American or Canadian. People of different backgrounds are rarely ever accepted as fully German or Italian, for example. This is not to blame only the host countries, resistance from the immigrant communities themselves have played a large factor in this. I will say that this is changing (at least among younger people in the larger cities) but it will be a while before this change is complete.
Therefore, you end up with a situation where large, and growing, segments of the community feel as though they are second-class citizens. You do not have to look any further than the recent riots in France and the murder of filmmaker Theo Van Gough in the Netherlands as examples of this. Even in Britain, which has been the most successful European country in assimilating immigrants, there were riots from South Asian youths a few years back.
The implications of this growing problem are many and are very serious, both from a political and economic standpoint. I will get more specific in later paragraphs.
Economic Implications
European countries tend to have very generous pension, health care and welfare states. Most Europeans are very proud of these programs as they contrast them with the less civilized "Anglo-Saxon (meaning the U.S. and Britain) economic model".
Well, this is just common sense, but with a declining population base and less children to work, I have one question: Who is going to pay for these programs in the future? You need young workers if you want to have a pension plan, there is just no other way. The Europeans use mainly pay-as-you-go financing for their entitlement programs – just like in the U.S. (think of Social Security). This is nothing more than a fancy name for a Ponzi scheme – except that instead of needing new investors to pump in capital, new workers are needed to pay in contributions.
In fact, I recently read The Kok Report, which warned that by mid-century the ratio of pensioners to active workers will double. Broadly speaking, that means the burden on the working population of supporting those who have retired will also double. And here is where the problem of increasing numbers of disenfranchised immigrants comes in.
*[Just to reiterate, I am using the term "immigrants" as a generic term for people of non-European heritage living in Europe – even as some families have now been their for 2 or 3 generations. I do this partially to drive home my earlier point that many Europeans do not, and probably, will not see these people as European.]*
Will these young immigrant workers (whatever their ethnic background) be willing to shoulder massive tax burdens to pay for pension and health care benefits for aging Europeans – particularly the same people who made their families them feel like second class citizens? I don't know the answer – but I wouldn't want to have my future financial health be dependent on an affirmative answer to that question.
As any attempts to reform these programs are met with fierce resistance, like massive strikes and changes in government, I don't see any resolve for making the painful choices needed to save these programs. Just look at the reaction in France (as mentioned earlier) to a relatively minor change in labor law, where employers will be able to more easily fire young workers in their first two years of employment – five massive strikes and countless protests. Do you really think that there is the political will necessary to make the severe and painful restructuring of the massive entitlement programs?
This is going to be a disaster and it will bankrupt most of the governments of the E.U. successively. Non-E.U. member Norway and Switzerland are in better shape. I could actually write a whole commentary on the responsible behavior of the Norwegian government (they use their oil proceeds to set up a massive public trust – for use in a rainy day, or to pay for their pensioners in the coming decades).
There are other economic problems that will be caused by the plunging birthrate. Declining spending, increased health-care costs (whether funded by the government or individuals), labor shortages and declining tax base, political radicalization (see below) among many, many others. When you add up these problems, it is not going to be an enticing situation for the young entrepreneurs and other talented young people. Therefore, you can expect a brain-drain on top of all the other problems as many young people will move to countries where they have better opportunities awaiting them.
Keeping this brief and simplistic, the economic consequences of this trend will be devastating. This, in turn, will fuel political discourse which could boil over into something worse.
Political implications
As this has already been a long newsletter, I will keep this part short and ugly. My view is that the political spectrum of Europe is going to get much more radical than it has been in recent decades.
You will see radical parties on both the right (probably anti-immigration type platforms) and the left (anti-globalization and anti-American). Both will try to blame others for their country's ills. Be it immigrants, E.U. beaurocrats, the United States, Britain (just for old times sake), the rich capitalists, China and other Asian countries, or some combination of all.
This movement has already started in countries such as Austria, the Netherlands, and even a bit in France (where an extreme right-wing candidate finished second in the last Presidential election).
Summary
An economic meltdown, and the loss of the cherished, but no longer practical, welfare state would not help the situation and may possibly be a tipping point towards right and left-wing movements. A return to radical politics in Europe would be a destabilizing force globally – both economically and politically. I don't mean to continuously make such broad and sweeping statements and then moving on – but this is truly a whole thesis in itself – so it will have to be left for a future week.
Moving forward, this is quite obviously a long-term negative for the EUR, if it even still exists in the long-term. However, I am still quite bullish on the EUR in the short-to-medium term as it is being seen more and more as a "back-up" reserve currency for the USD.
Later in 2006, when the USD gives up the remainder of its 2005 gains and continues its freefall, the EUR should be set to benefit. Specifically, the European Central Bank looks poised to raise rates several more times in their current tightening cycle as they (unlike the Fed) seeing rising asset prices for what they are – inflation.
In addition, despite the economic malaise seen in Europe over the past 5 years (although things seem to be picking up), people still believe in saving money. Euroland savings and investment rates have remained stable, and have even increased in some countries, even as U.S. consumers have seen their savings rate plunge into the negative for the first time since the Great Depression.
To summarize, in the short-term, I will continue to buy EUR, along with a basket of other currencies. For the long-term, I will continue to accumulate commodities and resources as an inflation hedge. Anything, but the USD.
Monday, January 30, 2006
Gold, Silver and "MAD" Money
For the past two months, I have been distributing commentaries of my
views on the current state of the financial markets. Part of this
effort has been to proliferate information that I read or listen to from
the financial press or through my own experiences in the asset
management industry. This is mainly directed at my friends, colleagues,
and acquaintances (and now - friends of friends) that would not
otherwise be privy to this information - or they just wouldn't care -
many of them still don't care.
The reason that I'm doing this is that I fear that we - as a society,
perhaps even globally - are headed towards a cliff. The cliff is still
in the distance but it is there, so we have a choice - we can try to
avoid going off this cliff, or we can plow full steam ahead and take our
chances. While I can't force every American to save 10% of their income
and diversify their portfolios across industry, currency and asset class
- I can at least try to get this message across to some of the people
closest to me.
GOLD
So this brings me back to a subject that I have been harping on for a
while now - GOLD. If you would have told me five years ago that I would
be advocating that people invest their hard earned savings into gold, I
would have laughed, cried and thought you were crazy. However, it
appears that I was the crazy one, along with the other millions of
people caught up in the "New Economy" now known as the Tech Wreck. I
was wrong and now I have completely changed my mind and proudly consider
myself a gold bug. I can admit that unlike the idiot politicians that
run our country, and every other country for that matter, when the facts
change - or at least my interpretation of them - I can change my mind
and admit that I was wrong.
Why gold? There are so many reasons that I can only touch on a few of
the ones that have hit home with me. Here we go:
1) Historical staying power - Since the time of the
Egyptians/Persians/Romans etc. gold has been used as a means of
exchange and measure of wealth. During that time, thousands of fiat
(paper) currencies have come and gone - all worthless in the end. So
yes, hundreds (and maybe thousands) of years from now gold will probably
still be used as means of exchange and measure of wealth, I have less
confidence in the USD or any other fiat money run by government
beaurocrats with ties to politicians.
Our current experiment with fiat money only started in the early 70s
when Richard Nixon severed the link between the USD and gold (for people
in my generation and younger, you used to be able to get gold for each
dollar that you owned). This ended Breton Wood I (BW I) which was a
fixed exchange rate system between the U.S. and the other industrialized
countries of the post-World War II era. Most of the European countries
ended their use of the "gold" standard during World War I. See below
for how BW I ended - as we are currently in a less formal arrangement
called BW II with the Asian countries.
Here is a chart of the value of the USD against other currencies (A) and
against gold (B) over the past 45 years and 100 years, respectively (can
you figure out when BW I went bust and Nixon closed the gold window) .
(Charts constructed by Dr. JP Bonardi - Richard Ivey School of Business)
(A) chart not available
(B) chart not available
Every defunct currency has a similar story to tell, some fall faster and
other take longer to fall. I would get into a long and sordid history
of Roman Imperial currency, but the moral of the story is that the
Romans debased their currency and the chart of its value against gold
would look a lot like (B).
2) The CPI is a fraud - Back in college I remember that in one of my
economics classes they told us that Alan Greenspan was trying to get
Congress to change the calculation of the CPI. The reasoning had
something to do with holding down spending on entitlements that were
calculated using the CPI. I wasn't too bothered at the time since at
that point in my life I was more worried about maintaining my GPA rather
than actually learning something or questioning the current thinking.
Now I actually get physically nervous and stay awake at night thinking
about stuff like this. The whole point of any macrostastic is not that
it is correct down to the last penny, but that it is actually
consistent. The importance in these statistices is comparing current
data to the past so that we have a yardstick for our current economic
situation and a information base for future projection.
The amendment to the CPI calculation has two main components:
a) Hedonic Price Indexing - If a new computer that is twice as powerful
as an old computer is launched at the same price as the old computer,
then the CPI is "adjusted" to reflect the added value of the new
computer. Therefore, even though you are paying the same amount for a
computer, your cost of living has just decreased.
b) The substitution effect - The premise of this is that when the cost
of one good moves up, the consumer will substitute a lower cost good.
The CPI only reflects the difference in cost between the original good
and the lower cost substitute good. So if the price of beef increases,
then it is assumed that people will start buying chicken. If chicken
increases in price, then it is assumed that people will start buying
tofu (ok - that is a cheap pop). Do people really change their buying
habits so easily, I don't know but I have never actually seen or heard
of someone doing this. Doesn't mean it doesn't happen.
But this is not why I am calling the CPI a fraud, here is my reason:
from the year 2000 to the year 2005, the component of CPI related to
housing (which represents around 25% of CPI) actually a showed a
decrease!!! How can that be in the years of a real estate and housing
boom? Well, an assumption was made that as home prices have increased,
that more and more people have decided to rent - even their own homes
(which is called "owners' equivalent rent"). The cost of renting has
actually decreased over the past five years (yet another sign of a
runaway housing bubble) - so housing has actually become more affordable
over the past 5 years. This is a distortion so serious that I consider
it an outright fraud. Everyone knows that home ownerhip is at a record
level and that housing prices have soared in recent years. This is a
travesty and yet no one cares. Just to throw some more dirt on this
one, as the price of buying/leasing a new car has gone up, an assumption
was ma!
de that people are now buying/leasing used cars.
Here is a chart on the CPI, using the "old" and "new" calculations:
Why is this so important, because all major government statistics use
the CPI as a direct or indirect input into their calculation. A
systematic under-estimation of CPI means that GDP and productivity
growth have both been over-reported for the past 10 years or so. Has
the market fully incorporated this data - hard to say, but I can say for
sure that people's psychology has not yet incorporated this data.
3) Growth of money supply over the past 4 years - This is taking much
longer than I anticipated and I still have a ways to go. So I am going
to make this quick. Growth in money supply in recent years has been
growing exponentially. More USD have been created in Greenspan's tenure
(since 1987) than the first 74 years of the Federal Reserve System
(1913-1987). Also, more money (not just paper currency - but also
dollars held electronically) has been created in recent decades than all
the gold ever mined since the beginning of time. Don't have the exact
numbers in front of me, but I think you get the message. Buy gold even
though the price has been skyrocketing in recent months. If it corrects
down to $500 or lower, then buy more and forget about it. I think that
gold will be at $1,000 at some point in the next 10 years.
4) OPEC and Russia - One of the main drivers of the price of gold over
the past 6 months has been the conversion of petrodollars into gold.
Russia and Saudi Arabia have led this movement and Russia has stated
that it plans to continue accumulating gold reserves. This trend could
spread to the Asian central banks if they begin to look for an
alternative to holding USD. Yes, this adds some uncertainty to the
current bull market in gold (if commodity prices crash - gold could be
hurt), but you know my views on commodities - so this will not deter me
from accumulating gold over the long run. In fact, a short-term
correction in commodities and gold would be a fantastic buying
opportunity.
This issue has the potential to be a whole commentary - perhaps I will
investigate further in the next few weeks. I need actual data - does
anyone know where I can find info on central bank purchases of gold?
SILVER
My basis for investing in silver is not as well founded in research,
however, I still feel strongly about it. Silver has also been used
historically as a means of exchange - although not to the same extent as
gold. Also, gold and silver tend to rise and fall in fairly strong
positive correlation. Two factors that could actually make silver a
better investment right now than gold: 1) It has not run up quite as
much in recent years, 2) Silver has more use as an industrial metal -
meaning that there is actual demand for silver outside its use as an
investment.
Finally, and here is the main reason why I have been investing in silver
mining companies: Barclays is currently in the process of establishing a
silver ETF. My research shows that the current supply of silver is at a
precariously low level. If Barclays is able to successfully launch an
ETF, they will have to buy physical silver for each share of the ETF
that is issued. This will further increase demand and hopefully drive
the price up. Also, silver has a large short interest and the ETF could
act break the backs of the short sellers - forcing them to cover and
further increasing the price.
Yes, this is a technical argument, which I usually don't go for - but I
think its a good investment nonetheless. Buy silver.
views on the current state of the financial markets. Part of this
effort has been to proliferate information that I read or listen to from
the financial press or through my own experiences in the asset
management industry. This is mainly directed at my friends, colleagues,
and acquaintances (and now - friends of friends) that would not
otherwise be privy to this information - or they just wouldn't care -
many of them still don't care.
The reason that I'm doing this is that I fear that we - as a society,
perhaps even globally - are headed towards a cliff. The cliff is still
in the distance but it is there, so we have a choice - we can try to
avoid going off this cliff, or we can plow full steam ahead and take our
chances. While I can't force every American to save 10% of their income
and diversify their portfolios across industry, currency and asset class
- I can at least try to get this message across to some of the people
closest to me.
GOLD
So this brings me back to a subject that I have been harping on for a
while now - GOLD. If you would have told me five years ago that I would
be advocating that people invest their hard earned savings into gold, I
would have laughed, cried and thought you were crazy. However, it
appears that I was the crazy one, along with the other millions of
people caught up in the "New Economy" now known as the Tech Wreck. I
was wrong and now I have completely changed my mind and proudly consider
myself a gold bug. I can admit that unlike the idiot politicians that
run our country, and every other country for that matter, when the facts
change - or at least my interpretation of them - I can change my mind
and admit that I was wrong.
Why gold? There are so many reasons that I can only touch on a few of
the ones that have hit home with me. Here we go:
1) Historical staying power - Since the time of the
Egyptians/Persians/Romans etc. gold has been used as a means of
exchange and measure of wealth. During that time, thousands of fiat
(paper) currencies have come and gone - all worthless in the end. So
yes, hundreds (and maybe thousands) of years from now gold will probably
still be used as means of exchange and measure of wealth, I have less
confidence in the USD or any other fiat money run by government
beaurocrats with ties to politicians.
Our current experiment with fiat money only started in the early 70s
when Richard Nixon severed the link between the USD and gold (for people
in my generation and younger, you used to be able to get gold for each
dollar that you owned). This ended Breton Wood I (BW I) which was a
fixed exchange rate system between the U.S. and the other industrialized
countries of the post-World War II era. Most of the European countries
ended their use of the "gold" standard during World War I. See below
for how BW I ended - as we are currently in a less formal arrangement
called BW II with the Asian countries.
Here is a chart of the value of the USD against other currencies (A) and
against gold (B) over the past 45 years and 100 years, respectively (can
you figure out when BW I went bust and Nixon closed the gold window) .
(Charts constructed by Dr. JP Bonardi - Richard Ivey School of Business)
(A) chart not available
(B) chart not available
Every defunct currency has a similar story to tell, some fall faster and
other take longer to fall. I would get into a long and sordid history
of Roman Imperial currency, but the moral of the story is that the
Romans debased their currency and the chart of its value against gold
would look a lot like (B).
2) The CPI is a fraud - Back in college I remember that in one of my
economics classes they told us that Alan Greenspan was trying to get
Congress to change the calculation of the CPI. The reasoning had
something to do with holding down spending on entitlements that were
calculated using the CPI. I wasn't too bothered at the time since at
that point in my life I was more worried about maintaining my GPA rather
than actually learning something or questioning the current thinking.
Now I actually get physically nervous and stay awake at night thinking
about stuff like this. The whole point of any macrostastic is not that
it is correct down to the last penny, but that it is actually
consistent. The importance in these statistices is comparing current
data to the past so that we have a yardstick for our current economic
situation and a information base for future projection.
The amendment to the CPI calculation has two main components:
a) Hedonic Price Indexing - If a new computer that is twice as powerful
as an old computer is launched at the same price as the old computer,
then the CPI is "adjusted" to reflect the added value of the new
computer. Therefore, even though you are paying the same amount for a
computer, your cost of living has just decreased.
b) The substitution effect - The premise of this is that when the cost
of one good moves up, the consumer will substitute a lower cost good.
The CPI only reflects the difference in cost between the original good
and the lower cost substitute good. So if the price of beef increases,
then it is assumed that people will start buying chicken. If chicken
increases in price, then it is assumed that people will start buying
tofu (ok - that is a cheap pop). Do people really change their buying
habits so easily, I don't know but I have never actually seen or heard
of someone doing this. Doesn't mean it doesn't happen.
But this is not why I am calling the CPI a fraud, here is my reason:
from the year 2000 to the year 2005, the component of CPI related to
housing (which represents around 25% of CPI) actually a showed a
decrease!!! How can that be in the years of a real estate and housing
boom? Well, an assumption was made that as home prices have increased,
that more and more people have decided to rent - even their own homes
(which is called "owners' equivalent rent"). The cost of renting has
actually decreased over the past five years (yet another sign of a
runaway housing bubble) - so housing has actually become more affordable
over the past 5 years. This is a distortion so serious that I consider
it an outright fraud. Everyone knows that home ownerhip is at a record
level and that housing prices have soared in recent years. This is a
travesty and yet no one cares. Just to throw some more dirt on this
one, as the price of buying/leasing a new car has gone up, an assumption
was ma!
de that people are now buying/leasing used cars.
Here is a chart on the CPI, using the "old" and "new" calculations:
Why is this so important, because all major government statistics use
the CPI as a direct or indirect input into their calculation. A
systematic under-estimation of CPI means that GDP and productivity
growth have both been over-reported for the past 10 years or so. Has
the market fully incorporated this data - hard to say, but I can say for
sure that people's psychology has not yet incorporated this data.
3) Growth of money supply over the past 4 years - This is taking much
longer than I anticipated and I still have a ways to go. So I am going
to make this quick. Growth in money supply in recent years has been
growing exponentially. More USD have been created in Greenspan's tenure
(since 1987) than the first 74 years of the Federal Reserve System
(1913-1987). Also, more money (not just paper currency - but also
dollars held electronically) has been created in recent decades than all
the gold ever mined since the beginning of time. Don't have the exact
numbers in front of me, but I think you get the message. Buy gold even
though the price has been skyrocketing in recent months. If it corrects
down to $500 or lower, then buy more and forget about it. I think that
gold will be at $1,000 at some point in the next 10 years.
4) OPEC and Russia - One of the main drivers of the price of gold over
the past 6 months has been the conversion of petrodollars into gold.
Russia and Saudi Arabia have led this movement and Russia has stated
that it plans to continue accumulating gold reserves. This trend could
spread to the Asian central banks if they begin to look for an
alternative to holding USD. Yes, this adds some uncertainty to the
current bull market in gold (if commodity prices crash - gold could be
hurt), but you know my views on commodities - so this will not deter me
from accumulating gold over the long run. In fact, a short-term
correction in commodities and gold would be a fantastic buying
opportunity.
This issue has the potential to be a whole commentary - perhaps I will
investigate further in the next few weeks. I need actual data - does
anyone know where I can find info on central bank purchases of gold?
SILVER
My basis for investing in silver is not as well founded in research,
however, I still feel strongly about it. Silver has also been used
historically as a means of exchange - although not to the same extent as
gold. Also, gold and silver tend to rise and fall in fairly strong
positive correlation. Two factors that could actually make silver a
better investment right now than gold: 1) It has not run up quite as
much in recent years, 2) Silver has more use as an industrial metal -
meaning that there is actual demand for silver outside its use as an
investment.
Finally, and here is the main reason why I have been investing in silver
mining companies: Barclays is currently in the process of establishing a
silver ETF. My research shows that the current supply of silver is at a
precariously low level. If Barclays is able to successfully launch an
ETF, they will have to buy physical silver for each share of the ETF
that is issued. This will further increase demand and hopefully drive
the price up. Also, silver has a large short interest and the ETF could
act break the backs of the short sellers - forcing them to cover and
further increasing the price.
Yes, this is a technical argument, which I usually don't go for - but I
think its a good investment nonetheless. Buy silver.
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