All the Trouble in the World

(excerpt from Doug's lead article in the International Speculator of July 2007)

It's been said that if you spend 15 minutes a year trying to figure out the direction of the economy, you're wasting 13 minutes. First, it's impossible to predict the future. Second, most successful stock speculators concentrate much more on individual stocks than on "the market." They look to find the bargains that are always present regardless of where the overall market is headed.

The general stock market's very long-term trend has always been up, yet there are setbacks along the trend, ranging from the brief but brutal, such as the 90% drop in stock prices from 1929 to 1932, to centuries-long declines, such as the Dark Ages. The problem is that you can't count on the long-term trend to send you a check every month - or even every decade.

It seems to me that, with the exceptions of resource stocks for speculation and certain foreign real estate for diversification, gold is really the only place to be at the moment. And it's likely to stay that way for years. That's because I suspect we could be at the edge of a financial/economic precipice.

The Greater Depression

People don't seem to grasp that we've had a historically long (since 1982), broad (every asset class in the world) and steep (e.g., the DJIA from under 1,000 to over 13,000, interest rates from 15+% to 5%) economic and financial boom. It's gone on so long that everyone pretty much feels that prosperity and profit are just the way the world works.

But if you credit Austrian School economic theory, which I certainly do, you're forced to believe that the Business Cycle exists. The Business Cycle is driven largely by government intervention in the economy, in the form of taxes, regulation and, most importantly, currency inflation. These things give false signals to businesses and investors, which cause distortions and misallocations of capital. When, inevitably, the errors start to be corrected, the result is an economic downturn. It will be called a "recession" if the government succeeds in preventing widespread bankruptcies and unemployment through one more dose of inflation. Or it will be called a "depression" if things slip out of the government's control.

Am I predicting the Greater Depression may be upon us? Well, I'm not a fortune teller. But my gut feel is: yes. There's a lot that's likely to go wrong besides the central problem of the Business Cycle. The problem is that all of these things are related, so it's likely that when one of them starts running out of control, they all will.

The Other Things...

War-In recent years, I've done several long articles detailing my views on this. And things have only gotten worse since then. What is really going on, under the ridiculous monicker of the War on Terror, is a major conflict between Islam and the U.S/Israel. I'm no fan of Islam (or Christianity, for that matter), but I fear the fault lies mostly with us. People don't like foreign troops in their country, nor do they like foreigners setting up puppet governments to rule them. My belief is that the only way the war will end is if we do two things: 1) Sincerely and publicly apologize for our invasions, interventions and other meddling, and 2) Immediately withdraw U.S. troops, military contractors and spooks from the over 100 countries where they have a substantial presence. But there's no way that's going to happen.

The average American believes his government is 100% righteous in its endeavors to educate/reform/democratize the natives/heathens. And all of the candidates with the potential to become the next president appear at least as warlike as Bush (who sold himself as a dove in 2000, lest we forget... no nation-building adventures for him).

My expectation is that there will be another event comparable to, or worse than, 9/11. At that point we're looking at something like WW3. It will change life in many places in the world, but certainly in the U.S., and dramatically for the worse.

Political Controls-For decades, the federal government has cranked out volumes of new laws and regulations per year. The American public appears to approve. Sometimes a law is passed to punish a small sub-group but is later applied to almost anyone; RICO being an example. But since 9/11 the game has changed. A huge, centralized bureaucracy has been set up as Homeland Security and, like any bureaucracy, it has a life of its own. When the next serious "event" occurs, I expect they'll lock the U.S. down like one of their numerous new federal prisons, in the name of "national security." Guantanamo's shadow will reach everywhere, and the effect on the economy will be devastating.

Social Unrest-Only an immense amount of borrowing on their credit cards and against the inflated value of their houses has kept the average American's standard of living where it is. Meanwhile, the rich really have gotten richer. Will there be a serious social backlash?

Take the immigrant situation. The Aspen metropolitan area, where I spent most of my summers, is estimated to be about 50% Latino; this is the case in hundreds of communities, large and small, in the Southwest and California. Most Americans appear outraged by new immigrants, at least if listening to Lou Dobbs' fulminations on CNN is any indication. On the other hand, I can't see young Latinos, who are a substantial plurality in most southwestern states, paying 25% of their income in Social Security and Medicare in the not-too-distant future for the benefit of elderly white ladies in the northeast. The potential for racially and culturally based conflict exists.

Peak Oil-This theory, developed by M. King Hubbert in the 1950s, correctly predicted that U.S. conventional oil (light, sweet crude) production would go into irreversible decline in the early 1970s. Which it did. The theory also predicts that this will be the case for world production some time between now and five years from now. Meanwhile, the fact that the world population has doubled since 1969 - with much of that growth occurring in China, India and the rest of the Third World where three billion people use a tiny but growing fraction of what Americans use per capita - means demand is set to continue growing rapidly.

We're never going to run out of oil. But its price is going much higher, and that's going to bring a massive readjustment in the way people produce and consume. The adjustment will be the most wrenching in the U.S., simply because we use by far the most oil per capita, and at the lowest prices.

The Dollar-You've heard this story here many times before. There are about six trillion of the things floating outside the U.S., and they're increasingly treated as hot potatoes. The current $800 billion trade deficit is wonderful for Americans' standard of living; generous foreigners ship us valuable goods in exchange for fiat dollars. When the trade deficit eventually starts turning around, as it must, those dollars will start flooding back into the U.S., and real wealth will flow out; the U.S. standard of living will drop precipitously. As will the value of the dollar.

Interest Rates-The weaker a currency is, the more the market compensates with higher interest rates. Bond prices fluctuate in exact proportion to interest rates. As do, indirectly, stock and real estate prices. At this point it's hard to see why interest rates shouldn't start heading up in earnest, even beyond the levels of the early '80s.

And the first hole in the dike portending the end of the current Business Cycle? For all we know, it may be the bankruptcy of the $6 billion Bear Stearns hedge fund dealing in low-quality mortgage paper. Six billion dollars is a reasonable sum, even in today's context, but the real problem is that rates are just starting to adjust up, housing prices down, and the economy is slow. There could be hundreds of billions more in losses. And it's impossible to say which firms that are bankrupted by the default may in turn default on debts to others, like a string of dominoes. If not contained by the Fed, through the creation of hundreds of billions of new dollars, the result could be a catastrophic deflation - similar to what began in 1929.

What will, in fact, happen? Nobody knows, including myself. But I'm quite afraid we're in for truly stormy weather in the next few years. Most people aren't adequately, or even at all, aware of this prospect.

I suggest you stay with the approach we advise in the International Speculator. And that approach has a foundation in gold.

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Posted 08-21-2007 10:46 PM by Doug Casey