The Room – 03/06/2009

March 6, 2009

Dear Readers,

Of late, it seems as though I have gotten sideways with the technology deities.

First, as reported recently, was my accidental deletion of an hour-and-a-half recorded interview with trading gurus Dave Hightower and Terry Roggensack.

Then, yesterday, while waiting to put in a phone appearance on the U.S. Global Funds Webinar that many of you sat in on, I carefully put my speaker phone on mute (you can tell it's on because the button lights up) and set about trying to wolf down a chicken salad sandwich before it became my turn to talk.

This led to being reminded of several of life's little lessons. Including...

  • Eating quickly is never a good idea, because it can lead to aspirating, as opposed to swallowing, one's food.
  • Once aspirated, a fairly decent-sized piece of food – say, for example, chicken salad – can actually make its way up through one's sinus passages. In fact, with enough coughing, hacking, turning red, grabbing of the throat, choking and blowing, the aspirated morsel can actually traverse the nasal passages and exit through the nose.

  • And, finally, I was made to recall the fallibility of technology when I learned, after the fact, that a lit-up mute button is no firm guarantee that the phone is actually muted.

It was only when someone stuck their head into my office to let me know that my close run with lunch was being broadcast live that I became aware of the latter point. To which I whispered incredulously, "But that's impossible... I have it on mute, see!" In reply, I received a shrug and a statement that was as accurate as it was succinct, "Must be broken."

For those of you on the call, and especially my fellow presenters, whose carefully prepared presentation, I was later told, was disrupted on multiple occasions, my sincere apologies.

And to the technology gods, I supplicate in your general direction.

Before moving on to more substantive topics, a quick "thank you" to everyone who submitted entries for my growing category of dramatic music. While there were many excellent additions to the library – and I will share more in weeks to come – the hands-down winner this week was sent from Phil of our New Zealand contingent.

You may have seen this particular piece of music/video... because apparently over 1.5 million viewers have. But I hadn't and so really enjoyed the setup and the unlikely singer's powerful delivery. Real goose bump stuff, guaranteed to bring a smile to your day. Enjoy...

I might add that the humble phone salesman went on to become an acclaimed opera singer – according to PR Newswire, "his debut album ‘One Chance' stormed to the top of the charts in 13 countries and notched up an astounding 27 platinum and four gold awards." His second album "Passione" is due to being released in April. Proof that even in these days, which are often filled to the brim with hopeless-seeming news, dreams can and do come true.

And now, on to the decidedly less entertaining aspects of our modern world.

Desperate Measures

As I write, the U.S. stock market is not yet open, on Friday, March 6. Yesterday was yet another bad-hair day for stock investors, with the DJIA off 281 points and the S&P 500 off 30 points to 682.

At this point, it is hard to see what Team Obama will do, or even can do, in the attempt to stop the bleeding-out of equities markets.

I mean, consider!

  • They have announced increases in capital gains taxes, and that didn't work!

  • In tandem, they announced that the dwindling number of people who still have money to invest should rather give more of that money to the government in the form of higher taxes. And that didn't work.

  • Members of the Obama administration have gone out of their way in recent weeks to let the financial markets know that, in their expert opinions, the crisis is only going to worsen. In fact, just this week, Goldman Sachs's Secretary of the U.S. Treasury Mr. Geithner, speaking at yet another Senate hot-air festival, reminded potential investors that "this is still a deepening recession and a deepening credit crunch." Those sentiments were echoed by the president himself, who helpfully pointed out that, should the government fail to act with appropriate vigor, things could move from "crisis into a catastrophe."

And yet, the stock market stubbornly refuses to mount anything resembling a solid rally. Go figure.

    [Hold the phone! The market just opened and, despite the news that the U.S. unemployment rate has surged again, the DJIA is up a snappy 141 points! Give me a sec...

    Alright, I'm back.

    The nice thing about an online discount trading account is how quickly you can place a trade: in this case, buying an inverse S&P ETF, which I just did. We'll check in later to see how the trade works out.]

So, what's Team Obama to do? Besides taxing and trash talking the economy, that is? Well, that and promising to beggar our great-grandchildren by opening the spigots on a tidal wave of monetary Kool-Aid, served up by a new army of fresh-faced Obamacrats?

This is no idle question: while the voting masses will give the prez his 100 days and probably more, a systematic failure in the economy over the next few years is unlikely to be rewarded at the polls. Should such a failure continue to gain steam, Obama risks being labeled even by his own as a false messiah, at which point, out come the stones.

The fact is, despite its many powers and foot soldiers, there's only so much that government can do at this point... and none of it without the steep potential for unintended consequences and naked risk. In no particular order, here's a quick summary of the possible measures left to the increasingly desperate government:

  • Suspend Mark-to-Market Rules. On March 12, a House Financial Services subcommittee will be gathering for free lattes, donuts, and a chat about suspending mark-to-market accounting standards. Simply defined, financial institutions are now required to establish, for accounting purposes, the fair value of their assets, using as a basis the "price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."

    The problem, of course, is that there currently isn't a market for much of the toxic paper now clogging the pipes of banks and other financial institutions. By exposing the folly of past decisions made by these institutions, mark-to-market rules have required these giants of finance to regularly fess up to the huge losses they have incurred.

    Hypothetically, by suspending or modifying the rules, the operators of the many beggared institutions could straighten themselves up, adjust the old school tie, run a comb through their thinning but well-coifed hair, and announce that the toxic stuff was actually worth something. The "something" would, of course, be based on this model or that which imputes an elevated valuation at some distant point in the future.

    With their persistent capital problems relieved, the bankers would then entice investors back to their equity by speaking in their most stentorian tones while pointing to a fresh set of metrics designed with special appeal to "value" investors.

    Or, at least, that's how things are supposed to work out.

    The people I have spoken with on this topic have expressed opposing views on whether mark-to-market as it now stands will be nudged over the side of the sinking ship. One well-placed money manager told me that he thinks it's unlikely it will be dumped, but that, if it is, the stock market could stage a 60% rally from here.

    Another told me that there was no way that the government will tamper with it, because they would worry (correctly, in my view) that changing the rules in any material sense could be the final straw in destroying the thimbleful of credibility still retained by the financial institutions.

    Personally, I think the potential of a change to these rules is very real – with the rationale for doing so announced in double-speak that positively drips of good intentions and sound practices. As to the reaction of the market, who can say? If the changes coincide with a general fatigue among the bears, and are possibly supported by some encouraging buying from friendly parties, they could spark a rally, and maybe a big one.

    On the other hand, it could also put the match straight to the powder and result in an explosive collapse.

    I wish I could be a bit firmer in my opinion of how this could shake out, but conjecture is all that is possible at this point. I'll keep trolling around for informed opinions, but the key thing now is to watch the upcoming hearings closely, and to watch for the trial balloons that the government likes to send up before making its decision. Knowing what's coming is half the battle, even if only as a signal to run for even deeper cover.

  • Bad Bank. Speaking of trial balloons, the government has floated veritable blimps with the phrase "Bad Banks" emblazoned across their girths.

    A picture of the latest Bad Bank plan, snipped out of the Wall Street Journal, is shown here.

    Adding some context to the graphic, the idea is for the government, along with the private sector, to pony up as much as $1 trillion to buy distressed assets.

    As the graphic helpfully points out, "Investment managers who agree to put up a certain amount of capital would run the funds."

    That caption may be translated as "Goldman Sachs and JPMorgan and other Wall Street insiders will be able to borrow money from the government on extremely favorable terms, with no recourse for failing to repay, as long as they agree to invest it back into the Bad Bank fund. As a reward for providing cover for this operation, the banks would earn billions in fees earned off the bulk of the money deposited in the fund, which will come directly from the Treasury. Big party follows."

    Turning to the next caption over, we see that "Investors, such as pension funds, would be able to participate in the funds."

    I think I have this part straight. What they are saying is that now that the Friends Of Obama (previously known as Friends of Bush) are well positioned, the investment managers are going to search the world over for the last of the really stupid pension and money managers, a moniker aptly applied to anyone willing to invest in a toxic soup of bad-asset-backed securities. They may find a few who can both drool and write a check at the same time, but not many.

    In reality, what will likely happen is that (a) the government will print up another trillion to buy the bad assets, then (b) pay their buddies billions to "take a meeting" at a posh eatery a few times a week. Meanwhile, the financial institutions who sold the toxic stuff off to the Bad Bank fund will be able to sally forth to greener pastures, leaving the taxpayers with the bill for the bailout... and the bankers' many lunches.

    Do I think we'll see a Bad Bank? Almost certainly. Will it solve the problems besetting the economy? No. Rather, it will just continue the process of transferring the liabilities from where they belong onto the back of the already overburdened taxpayer.

    But it could result in a stock rally, if only for a limited time, and only for the stocks of the companies doing the dumping of the toxic stuff.

    As for the overburdened taxpayers: as Doug Casey writes in his Casey Report lead article this month, "Street Fighting Man," taxes are a strong possible trigger for social unrest. It may already be starting, with the first proverbial (for now) shots fired this week in Hoboken, New Jersey, when a mob tarred and feathered the mayor in effigy for refusing to deal with oppressive levels of taxation. More on that story here.

  • Fed Buys Long-Term Treasuries. The Fed has, periodically, floated the idea of stepping into the market to buy long-dated Treasuries, should the need arise.

    We think the need will arise, because of (a) the sheer scale of the government financings that will be required this year, and (b) the fact that foreigners are running out of cash due to domestic spending need and falling exports to the U.S., and maybe even running out of patience with the now official U.S. policy of monetary prolificacy. As foreigners have been about the only buyers of long-dated U.S. Treasuries in recent years, the shortfall caused by their reduced participation can only be made up by taxes – but tax revenues are plummeting right along with the engines of commerce that throw those off as byproduct – or by printing fresh dollars.

    Which means, simply, printing is the only answer that will pop to officialdom's mind (the others require inconvenient free-market solutions).

    So, what happens when the Fed is forced to begin buying up the longer-term paper?

    For a time, interest rates might go down – simply because the primary buyer, the Fed, won't demand higher yields on its money. But rates won't stay down, because nothing will say inflation louder than the Fed becoming the lender of last resort to the Treasury, the self-described spender of last resort. At that point, the price of gold begins to soar, with interest following along in fairly short order.

As I am moving fast, I'm glossing over a new round of stimulus spending, and another after that – but those are pretty much taken as givens for now. And I'm sure I'm overlooking other desperate measures the government might take – for example, exchange controls or the creation of a dual currency system (one for the locals and one for the foreigners) -- but those will be more of a reactive nature following the broader collapse and the return of price inflation.

Of course, the government has the option of calling the whole thing off and turning their attention to supporting the free market... scraping the convoluted and counterproductive tax system in favor of a flat tax... reducing regulations... cutting government spending... but that's just silly talk.

In any event, if you have any thoughts on the topic, drop them my way at [email protected] In the meantime, the above seems a good list of trial balloons to keep a watch out for in the darkening skies.

Kindle Two

As readers of any duration are aware, my recent run-ins with technology aside, I have a fixation of sorts about Amazon's Kindle reading device. As I have described in far too much detail in prior missives, I think the K-I-N-D-L-E spells D-O-O-M for anything other than children's and coffee table book publishers, and I'm not so sure about the former.

Given that the other members of my immediate family agree on the many merits of the Kindle, most nights a scuffle of the friendly sort for the use of it occurs. That, and because I didn't need any other encouragement, really, caused me to rush out and buy the new Kindle as soon as it became available.

While I didn't think it possible, Amazon has outdone itself, smoothing out every first-generation bump and producing a truly elegant new reader.

I'm not going to go into any detail here, because there are now numerous articles on version two, but I will give it my wholehearted endorsement. It is more streamlined, functional, and just all around better than V.1, and that was already best of class, in my firmly held opinion.

Coincidently, this morning subscriber, correspondent, and fellow Kindle aficionado Ryan D. wrote in to suggest that we make our publications more Kindle-friendly (there is a function that allows you to email yourself documents to read on the Kindle, and apparently our letters currently don't "translate" very well). Jumping on the idea, I sent Ryan's email on to our production team, and they have already answered that this seems a task we can manage. And so, if I have anything to do with it (and I do), we will.

Not sure how long it will take, but we'll keep you posted.

Letters from You

I received a couple of letters this week that I thought worth sharing. In the first, D. White takes Jerry C. to task for the ditty on taxation he provided for last week's edition of this missive.

As I read D. White's comments, I chuckled -- but in a chagrined sort of way -- because I had entirely failed to register the point of contention to which she refers, and I near simultaneously remembered that the week before, I had shared the song "It's a Man's World" by James Brown and Pavarotti. Am I a subconscious sexist? I hope not... because I'm certainly not a conscious one.

In any event, here's the letter...

    Dear Dave,

    I've been reading your newsletter for years – and always enjoy it ; I don't always agree with everything, but it's good to hear all points of view, and refreshing not to have just the usual suspects' opinions in the echo chamber. However, "Jerry C's" little ditty and especially these final lines were both absurd and misleading.

    "Not one of these taxes existed 100 years ago and our nation was the most prosperous in the world. We had absolutely no national debt, had the largest middle class in the world, and Mom stayed home to raise the kids."

    Well, let's see – there were no cars – so there goes the motor vehicle taxes, license taxes, gas taxes, etc. Of course, at that time, most people couldn't even afford a horse, streets were polluted by equine waste, a trip of 20 miles was a major production, and many people rarely or never left the town they were born in. I guess you think that we were all better off that way. The country may have been the most prosperous in the world (the Brits of that time probably disagreed), but life expectancy was lower, infant and maternal mortality higher, and the standard of living much, much lower. Read "The Jungle" for more details on how swell things were.

    Mom had no choice but to stay home and raise the kids. And if anything happened to Dad, they were all likely to wind up in the poorhouse or county farm (they still existed), because she had no opportunity for decent employment. I think most women are grateful for their expanded horizons, Jerry – but perhaps you are the barefoot-and-pregnant kind of guy. If that's the case, let's hope that medical science (funded by the government) quickly gives you a chance to try being Mr. Mom. I'll be happy to personally chain you to the stove – which 100 years ago was much more dangerous than today and the cause of many house fires and women's deaths when their long skirts went up in flames.

Then, to liven up my day, I received this...

    Man, you need to open your eyes, get off your negative band wagon, and get with reality...

    Do you really want us all to stand around preaching about free markets and government intervention while everything around us is crashing? I certainly don't. They already did that in Japan...

    All I can say is, thank god Obama is willing to try to do something to unstick the system. Sarcastic philosophical rantings aren't doing it for me... nor do they help our country.


Here's the response I hastily dashed off in Richard's direction...

    To set the record straight, this isn't about Obama. The Republicans, along with their Democratic counterparts, have left this nation in shambles.

    It is about economics, pure and simple.

    So, let me ask you a straight-up question. What is the economic theory – the past examples, if you will – of a government spending and taxing its way out of trouble? How exactly does that work?

    The nation is bankrupt and, as would be the case with an individual, it has to come to grips with that fact. Grabbing another handful of credit cards and heading back to the mall solves nothing. It just makes things worse.

    I can, and will, comment in whatever tone I see fit when I see a continuation of the same stupid and dangerous policies that got us here in the first place. Hell, I'd even happily go for the extra 40% tax increase that I will have to pay if Obama's budget passes, if it was part of a plan that actually had a chance of working.

    But I am indignant at the idea that government should do "something" just "because," with zero basis in even rudimentary economics.

    I hope that his rigorous actions give you a lot of personal comfort – that temporary comfort will be paid for by your great-grandchildren.

I include that last correspondence not to show that I can get my hairs up when pushed to it, but rather to stress that the skeptical comments I make now and again really aren't about Obama, per se... but rather, about his administration's clear willingness to stay the course -- the same course but even accelerated – as his predecessors.

Unlike, apparently, the often-contradictory Mr. Limbaugh (who, for instance, called for drug dealers to be shot at the same time he was a secret drug addict), I have no desire to see Mr. Obama fail... provided, of course, that we first define "success."

If in "succeeding," the Obama administration turns the nation into a socialist paradise, trapping my capital with exchange controls, and then slowly (or not so slowly) confiscating it for the "greater good," then I guess I'd prefer him to fail.

On the other hand, if his financial shell game somehow managed to get the country through to greener pastures and better days, then clearly that is an outcome I'd have to salute.

The problem is that, using history as our guide and seeing a litany of new initiatives that hardly help, and in many cases, actively hamper the enterprising individual, the only realistic conclusion I can come to is that the government remains stubbornly on the road to ruin.

The sign post for Bush's road read "To Baghdad." Obama's reads "To a Perfect World."

Both lead off a cliff.

On That Topic...

Thanks to subscriber Matt F. for sending this along...

    You cannot legislate the poor into freedom by legislating the wealthy out of freedom.

    What one person receives without working for, another person must work for without receiving.

    The government cannot give to anybody anything that the government does not first take from somebody else.

    When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that, my dear friend, is about the end of any nation.

    You cannot multiply wealth by dividing it.

    Dr. Adrian Rogers


  • Get Well Soon, Bud. In addition to his never-ending quest for truth in economics, our own Bud Conrad likes to engage in somewhat dangerous sports... like windsurfing off the coast of Northern California and, apparently, riding ten-speed bicycles too fast on city streets. Fortunately, it was his left arm he broke in three places, and not his right. Get well soon, Bud.

  • Phyle News.

    • Alex C., who runs the first-ever Casey phyle at his coffee shop in Calgary, is looking to hold a get-together at some point in March.

    • John is looking to start a phyle in the Minneapolis/St. Paul area.

    As usual, if you are interested in participating in these or other gatherings of Casey subscribers around the country – and the world – drop us a note at [email protected]

And that, dear readers, is that for this week.

As I sign off, I see that the stock market has reversed rather sharply from its early enthusiasm and is now down 35 points. More to the point, the short position I put on as I began to write you today is about $800 to the good.

To be clear, I am definitely not a day trader. But given the news that greeted the opening bell this morning, that U.S. unemployment is at 8.1%, the highest in 25 years, the early rally made no sense. Ergo, the quick application of a short position.

Importantly, I was comfortable allocating a modest portion of the speculative corner of my portfolio to shorting the broader market, figuring that even if I do badly today, the stream of bad news is certain to continue into next week, and likely next month, and even next year. So, provided I can afford to weather a setback, which can happen at any time, then I am pretty confident I'll be able to close out the position within the week for a nice gain. And if the bottom falls out again this afternoon, then I'll make this a day trade after all and bank the short-term gain. At which point, I might take the family out to a nice dinner, enjoyed without any undue haste.

Adding a little frosting to the cake, I see that gold once again refuses to be pushed down and has bobbed back up to $939. While it is certainly not inconceivable – and maybe inevitable – we'll see it back in the 800s again before the final lift-off, there is no question we are showing firm support in here. And, as hard as we look, we can't see anything in the way of a serious obstruction to it holding up and going higher. Ditto, silver is starting to get pretty interesting, but that is a topic for another day.

Until next week, thank you for reading and for subscribing to a Casey Research publication.

David Galland
Managing Director
Casey Research, LLC.

Posted 03-06-2009 11:22 AM by David Galland