In Defense of Permabears

A recent comment on my blog was submitted by Bob Kraus who writes:

“For the most part, the US economy has grown and grown and grown throughout its history with mostly only hiccups representing the breaks in growth. It seems that for every year of growth, you might only have a month of contraction. The problem is that most bears who’ve had any reasoning behind predicting that the US banking system would fail were permabears. While permabulls are right 90% of the time, permabears are wrong 90% of the time. Why are they willing to be wrong so much? It seems obvious to me – permabears WANT the US economy to fail (perhaps they are mostly communists, who knows). As a result, no one EVER listens to them. It was kind of like when the National Enquirer claimed that John Edwards was having an affair. No one listened because they have a history of sensationalizing everything. Bears are no different.”

Before I respond to Bob, I wanted to define some terms so that all readers could follow what we’re talking about. A bull is someone who feels optimistic about a particular form of investment. I am bullish on investing in gold, for instance, because I feel gold is going to go up. The converse of being a bull is being a bear. I am bearish on the US stock market and US Dollar. Sentiments can change from time to time as the value of various investments change in comparison to each other. The term permabull is someone, such as Ben Stein, who always seems to be bullish on the stock market regardless of current events or what PE ratio the stock market is trading at, just as a permabear is always down on the stock market.

Thus Bob is saying that the only people who predicted this downturn where people who were permanently pessimistic regarding the American economy. He speculates as to our motives, that we want the US economy to fail because we are Communists at heart and just hate the operation of the free market. In summation, Bob argues that permabears are to be ignored because they are wrong 90% of the time and the US economy will soon be back to expanding year after year.

Bob is wrong. Individuals such as Warren Buffett were saying that the US stock market was a bad deal a decade or so ago, and he is hardly a permabear or a Communist. Speaking entirely for myself, I am a permabear because I feel the American economy is doomed to fail. I have not adopted this view because I am a Communist, but because the modern economy simply doesn’t make sense to me. The way I look at it, Economics is about the exchange of goods and services. In order for a society to proper, it must allocate its resources and labor towards the efficient production of goods and services that people want. If a society succeeds in producing goods that another society wants, then they may engage in trade. But trade between societies must be a zero sum activity: one society can not consistently run a “trade deficit” to another society whereby it gives less in the trade value of goods and services than it consumes. How can a society continue to convince another to deliver less in value that it is itself offering except to make up the difference at some future date? Real goods and services are all that matter. I do not measure wealth in terms of dollars, but instead in terms or how many its “real” (commodity based) value. Similarly savings is properly measured in terms of unconsumed economic goods; I say goods because one can not “save” an unconsumed service.

I feel our society is doomed because we have moved away from this common sense approach. We have used fiat paper money to be used in place of savings. Instead of consuming fewer economic goods that we produce, we just introduce more paper money to finance our projects. Similarly, we seem to have convinced foriegn governments to go along with our scheme. Instead of demanding that we produce and deliver to them goods and services of the same economic value that they deliver to us, they have agreed to merely acquire our paper dollars.

And we have gone about our merry way as a society. This monetary inflation has taken the Dow Jones from 850 or so in 1980 to 14000 last year while the value of gold has performed dismally over the same time. Clearly, the last 20 or so years have been the domain of the permabull, while permabears such as myself have had little choice but to sit back and scratch our heads that an economy could seemingly prosper in the midst of every increasingly levels of debt and monetary inflation. But I believe we are now seeing the end of the era of the permabull.

Everything in permabull land is based on confidence: both at the consumer level and at the international level. Foreign governments wouldn’t take our inherently worthless bits of paper in exchange for their real goods and services if they did not have confidence of their value. I suppose it’s conceivable that they will continue to have confidence in our monetary system as the Federal Reserve pulls money out of thin air to aid failing banks, but it doesn’t seem likely.

So you see, it’s not the writings of Karl Marx that stir the souls of permabears, but instead those of Adam Smith. The permabulls may have been laughing at us for the last twenty years or so, but we were the ones laughing today., and I must confess that it felt really good.

Peter Bernstein Admits He Had No Answer to Current Crisis

For those of you who haven’t read it in the New York Times, it would seem that Peter Bernstein has added his voice to Ben Stein in saying that he’s not really sure what is to be done. Bernstein is a writer I respect, for he is one of the few people who talk about the economy today who has knowledge of the history that has come before it. I find that most economists or economic pundits seem to have no knowledge of history whatsoever, and thus have no means with which to test their theoretical knowledge (much of which came from Keynes) against actual historical events. Given that you can easily find many historical refutations of many aspects of macroeconomic theory, I can’t say it’s surprising that economics and history are treated as two separate disciplines with no actual overlap by most people.

Bernstein is an exception to all this. His books, such as Against the Gods are almost nothing but history. However, despite his historical frame of reference, Bernstein still marvels as the modern wonders of macroeconomic theory as though it were the culmination of all the experience gained from all prior events that he talks about in his books. Like virtually all people today, we have a bias towards are modern ways; surely they must be superior to the archaic way that people used to do things. This bias seems to have convinced Bernstein that the bailout plan that Congress is putting together is the correct thing to do. As far as he is concerned, it must happen, else we will revisit the times of the Great Depression when the streets of Manhattan were “filled with unshaven men in threadbare clothes, their coat collars turned up against the cold, their shoes stuffed with newspaper to plug holes in the soles.”

It seems clear to me that despite Bernstein’s historical knoweldge, he has not read any of the great works of the Economic Historian Murray Rothbard. Anyone reading America’s Great Depression would know that is was precisely these types of bailouts that President Herbert Hoover tried at the very outset. Dr. Rothbard clearly shows how the price support mechanisms that President Hoover put into place to maintain the prices of everything from wages to wheat all failed miserably and merely exacerbated the economic downturn and that the “banking holidays”, gold confiscation, and deficit spending of FDR also simply made things worse. After all was said and done in regards to The Great Depression, all that had been accomplished was to for the government to claim responsibility for the economy and to adopt previously unheard of authority to achieve a promised ends that it never could. Thus what we are seeing today is more of the same of what we have already seen before. It didn’t work then, and it won’t work now. 

But Bernstein seems oblivious to all of this, which is tragic given his historical knowledge. But he does analyze where today’s situation could lead if it should succeed- to an even more pronounced level of risk in the economy. You see when you provide insurance for something, you often provide an incentive to do the very thing you are insuring against. It’s called “moral hazard” in the insurance industry. For example, if you take out a insurance policy safeguarding your house against fire, you now have a motive to burn your house down and claim the cash reward.

The same problem is at work in today’s markets. By way of this bailout, the government is adopting what Bernstein terms a policy of “Thou Shall Not Fail” regarding the banking industry. So, by the logic of moral hazard, the banking industry now hse incentive to take even bigger risks because the government will always be there to bail them out should they go wrong. Much like the “Greenspan Put”, today’s bailouts done for market stability will lead to an ever increasing amount of risk and instability in the future. Anyone can see that this process can only continue until, inevitably, the entire system fails. Bernstein himself declares the absolute necessity of the bailout, but sees the moral hazard implications. Thus, he ends his NY Times piece by saying “As we move into the future, and as the crisis finally passes into history, how will we deal with this earth-shaking blow to the most basic principle of our economic system? I do not know how to answer that question. But we need to ask it.”

You can ask all you want Bernstein, it won’t change a thing. Markets will take on increasing risk until they exceed the guardian’s ability to stabilize it. When that point it reached, the collapse takes down the whole system with it. This points to why the bailout is merely an exercise in folly. History tells us it will do nothing but prolong the crisis and, should it actually succeed, it will only manage to insure that the next crisis is even more pronounced.

US Mint now out of gold coins

For those of you who have bought and read my book will have a hard time following some of my advice regarding acquiring gold coins. Apparently the US Mint has run out of them. It seems that during times of economic uncertainty, they have enough gold to meet demand. Well I suppose that’s the government for ya. Can you really imagine anyone in the private sector going, “Hey, demand for our product has been going through the roof in recent months. I guess we’ll need to pull it off the market!”

Well fear not dear reader. There is still gold out there to be had. You’ll just need to buy foreign coins such as the South African Krugerrand. It’s available at a lower cost over spot anyway, so it’s a good deal. Unfortunately, you don’t get all the tax benefits that the American gold coins carry (also talked about in my book), but it’ll do in a pinch. Besides, if the government collapses, a one ounce gold coin is a one ounce gold coin and no one’s going to worry about the tax ramifications.

The one thing I find curious though, is that physical demand for gold seems to be at an all time high, yet the actual per ounce price of gold had been well below it’s all time high set back in March. What gives?  Some of my more conspiratorial friends believe that the government and central bankers are playing a hand in depressing gold prices so that investors will not see them as attractive investments during times of economic uncertainty. Their logic then suggests that the prices has been depressed too far for the US Mint to actually make a profit on the coinage, and so they stopped producing the coins. It’s an interesting theory and it does explain a few things, but I’m not so sure that’s the real story. 

One thing is for sure though, gold coins are going to become increasingly scarce as this crisis wears on. Get yours now!

Ben Stein’s Money Bet on the Wrong Things

For market Bears like me, the current market environment is absolute heaven. I’ve been making money off of my short positions, but I decided to close those today (which should make the government happy) because gold stocks are starting to look very attractive to me. Specifically I’m thinking of backing up the truck and buying Barrick Gold (Ticker Symbol ABX). Gold stocks have been down quite a bit in the last few weeks and considering how much money the government has decided to throw at the financial bailout this week I’m thinking gold miners are going to make out like bandits. You see, the government doesn’t actually have any money to bailout anything. As I’ve been telling my friends, America is broke. And I’m not sure that foreign lenders are going to want to line up to loan another Trillion or so to us given how indebted we are and how our financial system seems to be imploding. Inquiring minds suspect that the government may have to resort to just printing the money for the bailout, and that would be VERY good for gold and even better for gold miners. 

GRRRR! Bear market profits are the best kind. But what can be even more satisfying is reading Ben Stein’s latest offering. For those of you who don’t follow him (and I recommend you don’t), Mr. Stein is known as a permabull for his perpetually sunny outlook on the American economy. So it is with special satisfaction that I read Mr. Stein as he tried to explain how exactly the US economy got into such a pickle, and I most confess a few moments of self-congratulatory laughter as he explains why exactly he was so wrong in saying a year ago that subprime mortgages were not capable of sinking the American economy. You see he reasoned that subprime mortgages were only $250 billion or so and could not sink a multi-trillion dollar economy. He is now admitting that he neglected to figure in the Credit Default Swaps that DID run into the trillions of dollars and how all of these unregulated debt instruments floating around that were pyramided on top of that debt are in fact causing a real problem. Oh well, Ben. I guess we all get them wrong from time to time.

Except it seems like all Ben would have had to have done to avoid having to scrap egg off of his face now would been to have visited some bear market sites and read what the bears were saying. Heck, even if he wanted to write us all off, he could have listened to Warren Buffett saying that credit derivatives were financial instruments of mass destruction. It’s not like nobody knew this was going to happen. I specifically remember reading Mr. Stein’s work a year ago in absolute astonishment that he did not seem to comprehend the ripple effect that these defaults would have.

Mr. Stein closes his financial advice column by asking what it is that we should all do. Which isn’t really any advice at all. Well, I’ve already told you what to do. Load up on gold miners. If you’re looking for more advice on how we got into this mess, how you can save money, and the best ways to invest for your future, why not buy a copy of my book.





I promise it doesn’t end with “What the heck is to be done?”

Bush’s Plea for $700 Billion

I’ve often considered George W. Bush to be one of the most arrogant Presidents of my lifetime. A Republican friend of mine argues that it was William Clinton, and I do have to concede that Clinton certainly had his arrogant moments, but he came off humble when he had to be. By comparison, Bush has always seemed to me to be someone who was reveling in the fact that people intensely disliked him. Maybe it was the way he would tend to give a half-smile to his own jokes when he thought he had told a zinger, or maybe it was the way he won by both of his elections by very thin electoral margins yet seemed convinced that he had a mandate from the people in favor of what he was doing. Whenever I hear him speak, I feel I can hear him telling me that he doesn’t care whether he’s popular with the people or not, he’s going to do with this country whatever he and his cronies decide and the rest of us will just have to live with it. 

Consequentially, on occasions like last night where he comes on national TV to convince us all that *gasp* the economy’s not going so well and desperately needs a bailout, I really wish there was a service that could show me the speech complete with those robots from Mystery Science Theater at the bottom to make snaky comments. President Bush’s speech included a description of exactly how our economy got in such dire circumstances to begin with- that cheap credit caused a housing boom and that now both the loans made to the homeowners as well as the value of the underlying real estate are all in question. As I read his description, the feeling I get must be the same as a parent who is listening to his teenager tell him that somehow the idea to sneak out, go to a friends house, and get hammered somehow didn’t turn out so well. I mean, if it really is as simple as credit inducing a inflationary boom which later came crashing down, why didn’t President Bush call a halt to the easy credit terms that lead to the inflationary boom to begin with?

It’s not like he didn’t know it was going on. In fact, it was a point of pride for the President who in 2003 crowed that low interest rates had given rise to a record level of home ownership in the United States. In fact, President Bush went on to say that he goal was to increase home ownership further by reducing the purchasing price of the home via tax credit, the interest rates one would have to pay, and the amount of paperwork one would need to go through to get approved for a mortgage. Looks like all those chickens are coming home to roost, eh George?

That’s the real kicker about macroeconomists and politicians; when the economy is booming because it’s being force feed credit like a goose being fattened for a French delicacy, they want to talk about how amazingly healthy the economy is. When it finally all comes crashing down, they act as though they had nothing to do with it. It’s strange, but of all the individuals involved in the current Presidential race, I think I agree with Sarah Palin the most when she said that America was facing “another Great Depression.”  Although it’s hard for me to admit that, because she’s probably my least favorite person of the four, but I think she may have accidentally nailed it. We’re not just talking about a recession anymore, we’re talking about a depression. And it’s probably not going to be the complete slow down of commerce that the 1930s was, but instead the Japanese type of downturn that never seems to end. America is about to have it’s own “lost decade” or two, and that’s unfortunately turn regardless of which party you vote in for President. 

As I council my friends, there’s nothing that can be done to stop the fall of the Pax Americana, nor is there anything that can be done to stop the oncoming depression. Perhaps certain politicians can help to make it a harder or softer depression, but it’s going to come. Make yourself ready.

Waiting for the bailout shoe to drop

The markets started this week with quite a fall on Monday with the Dow down over 4% and gold up strongly. Tuesday and Wednesday have been a good bit more calm with stock prices falling slightly along with gold. It seems investors want to hold onto cash until things become more certain. Everyone seems certain that the government will bail out Wall Street from this situation, but there seems to be some disagreement about the details. 

 

I’m sure that there are a legion of Wall Street lobbyists right now working furiously to try to get Washington to pay top dollar for all of the dead assets currently sitting on so many balance sheets. And if this were anything but right before an election, they’d probably get their way. But Senators McCain and Obama are no doubt wondering how this bailout is going to look to the voters if Wall Street makes out like bandits on taxpayer money.  So now Wall Street is uncertain as to what the terms of the plan are going to be.

The American voter, much like the American consumer, is expected to have a very short attention span. They aren’t suppose to be able to really understand what’s going on for themselves, you see, so this bailout plan has to be turned by the political pundits to become something so easy that your average voter could understand it. “Wall Street is bailed out by your money after a long period of making money off of you,” is just the kind of thing to work up voter ire. It is, as Bill Bonner suggests, just one grand spectacle. 

The one question that I’m sure will never be asked by either of the candidates or anyone, is “Where is this $700 Billion supposed to come from?” Much like the war in Iraq, it’s just expected that someone will be nice enough to front us the money for us to continue down the path of spending far more than we’re making. That someone has increasingly been foreign investors, and I’m not sure how well they’re going to react to our asking for another Trillion or so. They probably think that it’s a shame that they don’t get a voice in this election, but if things keep going like this it’s a good guess that their time will come. 

After all, a politician may get elected promising to keep us safe from terrorism by “fighting them over there, so we don’t have to fight them over here”, but when the American people have to actually start paying the real bill for these military misadventures, we may suddenly find that we’ve lost our taste for blood. Let’s not forget that we asked a lot of foreign investors to buy these same toxic credit derivatives in the first place, and no government has been nice enough to step forward and bail them out.

SEC Decision to Hinder Short Sellers

The first stock market to develop after the fall of the Roman Empire found it’s home in The Netherlands. The Dutch East India Company’s shares of ownership became traded amongst Dutch citizens in coffee houses and soon an exchange was born. To buy a share in the Dutch East India Company was to hope that the company’s health and revenues would be higher in the future and that you would therefore own a piece of a more valuable company. But not long after this first stock market came about, did other kinds of stock transactions come about. Among them was the “short sale”. 

A short sale is where you borrow shares of stock from someone else and enter into a contract to replace those borrowed shares at some future date. You would then sell the borrowed shares on the open market and look for an opportunity to buy them back at some point in the future. If you could buy them at a lower price, then you would have realized a profit on the difference between the price you originally sold it at and the price you were later able to buy it at. It’s a twist on the old axiom of buy low and sell high; you sell high and then buy low. 

Since the practice first came about, short selling has not been popular. Buying stock in a company is basically betting on the company’s future success while shorting stock in a company is betting on the company’s future failure. It’s akin to playing craps and putting your money on the “Don’t Pass” line; you just don’t make friends betting on other people’s failure. And unpopular figures often find themselves the scape goats during a crisis, which is what we’re seeing now. 

For those of you who don’t follow the financial news everyday, the SEC has been taking an increasingly aggressive stance against short sellers. Back in July of this year, the SEC banned a practice called “naked” short selling against a handful of financial firms. A naked short sale is when you sell the stock without having to borrow it first. The strange thing is that this practice is already against the law. So in essence the SEC came out in July and outlawed an already outlawed practice, but only against a select handful of financial firms such as Freddie Mac and Fannie Mae. Clearly this was an attempt to bolster the price of the stock of financial firms who were perceived as vulnerable. 

Fast forward to this month, and the collapse and bailout of Fannie Mae and Freddie Mac. The SEC once again took the bizarre step of banning the already illegal practice of naked short sales, but this time around they extended it to the entire market. Then came the bankruptcy of Lehman Brothers and the bailout of AIG last week. As part of the bailout proposed by President Bush, there are two provisions which specifically target short sales:

1. All investment managers must publicly disclose whatever short positions they have. 

2. Short selling has been out-and-out banned for financial firms.

Clearly the SEC are taking a more aggressive stance against the short sellers in an effort “to maintain stability.” It’s also clear that the SEC is acting on concert with both the Secretary of Treasury Hank Paulson as well as Chairman of the Federal Reserve Ben Bernanke to try to prop up the market. 

Blaming short sellers for market collapses or having the government ban the practice altogether is not an old tactic. Historically it would seem every time a market collapses, the government comes down against short sellers. The US Government outlaws short sellers after that market collapse of 1929, but found that the stock market only continued it’s decline. Similarly, the moves against short sellers this year has done nothing to stem the tide of stock market loses for people who were shareholders in Fannie Mae, Freddie Mac, and Lehman Brothers. 

The reason that banning short sellers is ineffective is that they are not really the cause of the market decline. Short sellers did not force the bankruptcies that have occurred this year. They did not entice prospective home owners with adjustable rate mortgagees they couldn’t afford, nor did they convince Wall Street Firms to buy securities associated with these repackaged mortgage loans. They did place a wager that the enterprise wouldn’t turn out well, and that has allowed them (including myself) to profit off of the demise of others as markets have collapsed this year. But so what? 

It’s the height of hypocrisy for the government to try to protect Wall Street firms, who has always been motivated by profit before anything else, by banning the very tools that many of them are still using to this day to earn a profit. When Goldman Sachs disclosed last year that it had a strong quarter because it had placed short sales against the very credit instruments it was selling to its customers, no one batted an eye. But now that Goldman finds itself the target of the short sellers, it gets bailed out by the government.  And it’s particularly ironic that the this government is run by Republicans who have long been advocates of the “free market”. 

It would seem that President Bush’s free market policies are similar to his policies of against nation building; a convenient sound bite to give out when times are good, but quickly forgotten when it might actually matter.

The Week of the Bailout

Well. This certainly has proven an exciting week for anyone with money in the stock market. It started off on Sunday with the announcement that Lehman Brothers was going to declare bankruptcy. Many had thought the bank “too big to fail”, but it seems that US Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke felt otherwise.

The stock market fell quite a bit on Monday, as people began to wonder if AIG was next. Then on Tuesday, Bernanke announced that there was no need to cut rates, because the US economy was strong enough to weather the current crisis.

And the result?

A rally of roughly half the losses suffered Monday as Wall Street figured that this ‘tough love’ was a good sign; then, the next day, it’s announced that Bernanke was offering a loan of $85 billion, or so, to bail out AIG and, in so doing, take over the company. So much for tough love!

What was really peculiar here was Wall Street’s reaction: a huge sell-off of all stocks across the board — and that gold rallied $89 an ounce; the biggest one-day rally ever! This bailout suddenly prompted people to lose faith in the system. The next day was more of the same as the stock market continued to rout and gold continued to rally.

That is, until President Bush announced the biggest bailout in history.

The results are still sketchy, but essentially, the government is going to “buy” all of the bad, toxic, or dubious “assets” off of everyone’s balance sheet. The details are a bit shaky at this point, but the plan sounded bold enough for the stock market to stage a huge late-day rally that’s continued on into today. It would seem the market is nothing if not confused as to whether it wants tough love, or the mother of all bailouts.

Like most bold promises made by politicians, it leaves most of the important questions unanswered:

Just how bad does an asset have to be for the government to buy it?

What price is the government going to purchase it for?

How much is itgoing to cost the US taxpayer?

And, my personal favorite:

Where exactly is the government going to get the money for all of this?

But no one seems to care about all of that right now. Wall Street traders breathe a huge sigh of relief as President Bush pledged taxpayer dollars to cover the sins of their gross excesses. It’s as if the Pope had suddenly visited a whorehouse and not only forgiven all of the sinners, but agreed to pick up the tab.

Truth, as they say, is stranger than fiction and this week proves that yet again. No work of fiction would have all of its major characters be so fickle from one day to the next. Can you imagine if Romeo and Juliet seemed to sway between all-consuming passion and a sober coolness? Or if their warring families had similarly gone from feuding one day to offering an alliance the next? I’m pretty sure that if Shakespeare had penned such a tale that it never would have made it to the big stage, much less become a timeless classic.

Yet, this week we see all the authority figures vacillate wildly between the stances of needing to be cruel to be kind, and offering outright martyrdom for the American taxpayer to cover the sins of the financier’s bad beats. And we’ve seen the market all over the place — going from hating it on Monday, to loving it on Tuesday, hating the bailout on Wednesday, to then loving it on Thursday and Friday.

What remains the biggest mystery of them all is the US Dollar is rallying today on the bailout news. Why a currency would rally when its sponsor government just pledged to spend an extra half-trillion dollars or so that it doesn’t have is truly mystifying, but it seems to go with the carnival-like insanity that we’ve seen the rest of this week.

Until next time,

Preston Poulter