The Daily Reckoning - An Eventual Inevitable Crisis (Marc Faber)

verfasst von Firmian, 15.07.2004, 18:05

-->An Eventual Inevitable Crisis

The Daily Reckoning

Boston, Massachusetts

Wednesday, July 14, 2004

Bastille Day

---------------------

*** The smell of fresh trash...urban streets...decaying
factories...we love it!

*** Gold down...dollar up...trade deficit narrows...

*** Mexico, Peru, Bolivia, Delray Beach, Georgetown...and
more!

---------------------

Nothing. Zero. Zip. Nada. That's what's happening on these
hazy, lazy days of summer on Wall Street. We leave the news
to Tom...and move on to other things.

More on education, Boston...and America's real estate
bubble, below:

---------------------

Tom Dyson, from the 'Big Smoke'...

- The lesser of your two evil Baltimore-based editors finds
himself back in London, his hometown. London hasn't changed
much in the last four months, but your editor has.

- He no longer enjoys commuting to work in packed trains
that look so old they might have gone out of style in the
'60s. He no longer enjoys the surly big-city cynicism that
Londoners always wear on their sleeves. And above all, your
editor no longer enjoys paying through the nose for the
privilege of grinding out an existence. In London,
everything is a struggle.

- Maybe it's because your editor has a new love, a love of
the smell of fresh trash, intimidating urban streets, and
of derelict factories...a love you only find in Baltimore,
and maybe Pittsburgh, and perhaps Newark or Trenton too.
Joking aside, Baltimore is a great city in a great country,
and for the next three weeks, we will miss her dearly.

- But enough of the sentimental musings. We need to get
back to musing about sentiment. Undoubtedly the most
important sentiment to gauge is that driving inflation.
It's not a new debate; in fact, the inflation/deflation
debate has already been flogged to a point beyond death and
well into a state of reincarnation. So now we flog it some
more...

- The U.S. financial system is acutely vulnerable to an
increase in the expected level of short-term interest
rates, we think. This vulnerability is a specific
consequence of the carry trade, explains Steve Saville in
his latest issue of the Speculative Investor."The closing
out of carry trades earlier this year in response to a
modest increase in short-term U.S. interest rates relative
to short-term euro interest rates precipitated some sharp
moves in the financial markets," he points out."However,
we suspect that many of these trades remain in place and
that the market action over the past 6 weeks has encouraged
the leveraged speculating community to initiate new carry
trades..."

- Unwinding these carry trades puts upward pressure on the
dollar as traders cover their short-term borrowings. Hence
the strong dollar-rally in April and May, which took the
euro from $1.29 to $1.17."[Once] the dollar starts to
rally," continues Saville,"it should set a self-
reinforcing trend in motion because a stronger dollar
results in reduced inflation expectations and, therefore,
higher REAL interest rates and a narrower yield-spread. The
increase in the real interest rate and the contraction in
the yield-spread, in turn, help boost the dollar."

- Keeping the carry-trade dynamic in mind, if one could
only predict inflation expectations - and thus the trend in
short-term interest rates - the rest of the markets ought
to fall neatly into step.

- In this upside down world, if inflation fears increase,
further unwinding the carry trade, we should see bonds and
gold sell off while the dollar rallies. Conversely, if
deflation starts to gain traction in the media, expect the
opposite. But which is it?

- Well, yesterday at least, the dollar was strong. It
gained almost a cent against the euro on news that May's
trade deficit was only $46 billion, $2.3 billion better
than had been expected. By day's end, the euro bought
$1.2314. Gold didn't fancy the news much, and fell $6.20 to
$402.

- On Wall Street, the markets were flat. The Dow added 9
points to 10,248, while the Nasdaq lost 5 points to 1,932.
The S&P gained, by less than 1 point, to 1,115. Ten-year
yields rose 3.6 basis points to 4.48%.

- Regular readers will be only too aware that your humble
editors rarely have the audacity to crawl out onto the
plank...the shark-infested waters below don't look too
appealing from our comfortable perch here at the Daily
Reckoning, whether it's in Baltimore, London or Paris. But
today, we feel like a punt...today, we feel like predicting
a continuation of the dollar's rally.

- Naturally, we make this unusually bold statement thinking
like short-term contrarian traders. Our long-term view is
unflinching...the dollar's value has been terminally
impaired and what's more, the Fed will continue to
prescribe its EZ-credit poison for the foreseeable future.
So what, then, is the substance behind our bias?

- Not very much, we answer to the discerning reader.
Sentiment-driven trends, we have learned, tend to last
longer than three months. Earlier this year, the shift in
the press, the Fed and the economic data towards an
inflationary bias was violent. The swing back to a
deflationary bias will inevitably follow, but in your
humble editor's opinion, it is too soon.

- Besides, bullish sentiment towards the dollar dissipated
very quickly after June's disappointing payroll number.
Your contrarian editor reads strength into this particular
message.

---------------------

Bill Bonner, back in Boston...

*** Boston is an appealing city. But sometimes you forget
that it is an American city. You walk down the streets and
are as likely to hear Russian or Chinese spoken as English.
It must be the universities that attract them. In turn, the
foreigners push up real estate prices and make Boston a
lively place.

*** Americans have a strange attitude towards immigrants.
They are all descendants of immigrants themselves...and
depend on new ones to fund their retirement programs and
buy their houses at inflated prices. Still, they often
resent the newcomers.

An email received this morning:

"If there were a national referendum on immigration,
Americans would vote, overwhelmingly, to limit immigration,
protect the borders - particularly the southern border -
and deny citizenship rights to illegals...the American
public would also vote to increase the INS budget to
support these measures.

"But such severe measures would not be necessary if Mexico
privatized its mineral resources; entrepreneurs, business
and capital would all be enticed to Mexico in the search
for oil.

"The wealth that would accrue to Mexicans would be
sufficient for them to want to remain in Mexico.

"It seems we are trapped in 'an odd-bedfellows' situation
with Democratic elites desiring immigration to swell their
party's voting ranks and GOP elites desiring immigration
for the cheap labor it provides.

"The next immigration crisis from the south is likely to
come from Peru, Bolivia and Columbia and the rising
Synarchist movement...inheritors of the Shining Path.

"You might have heard it here first..."

*** And more travel notes from the 'lost continent'...

"If an apartment building costs $1.8 million, and you knew
you would have to spend 5% to cover costs - maintenance,
taxes, management, etc. - and it had 4 units, how much
would you have to rent each unit for in order to get a 5%
net yield?"

We posed the question to our children after stopping for
lunch at Stephi's on Newbury St. We were exploring Boston.
At least, we we're supposed to be exploring Boston. Half
the party seemed to think it was a shopping trip. We had
already stopped into Gap, Ralph Lauren, and Express. We
would visit many more retailers before the day was over.
Boston has plenty of them.

You go in with children at your own risk. You find things
you didn't even know existed...and then you discover that
you needed them.

"Twenty-nine dollars for a pair of flip-flops? You've got
to be kidding," said Pater Familias.

"But they're genuine leather," Sophia replied.

"Why does Edward need a new pair of shoes?"

"His old ones are worn through...and don't start asking a
lot of questions," Elizabeth continued."Henry needs a pair
of pants and a belt. And Jules needs a new pair of shoes
too."

"They look fine to me."

"But Jules is going for his college visits; he needs to
look better than he looked today."

"What's wrong with the way I look now," Jules wanted to
know, standing in front of us in a pair of worn blue jeans,
gray t-shirt, with flip-flops on his feet (the $4.95
variety).

The nice thing about America, dear reader, is that it makes
us feel good about ourselves. Half the population dresses
like Jules. The other half glories in a sense of
superiority, without actually doing anything other than
putting on a decent shirt and a pair of shoes.

But most amazing about modern America is that it provides
almost endless ways to spend money...without actually
making any improvement in the way you live or dress. In
Boston's retails shops, we found not only expensive flip-
flops and t-shirts, but designer jeans - already worn
through and in need of patching.

"They must pay someone in Thailand to wear holes in them,"
we told the girls."But why not just buy a new pair of
jeans and wear them out yourself?"

"Oh Dad," they said together, as if the question did not
merit a response. So we turned our attention back to Jules:

"How did your first visit to a temple of reason and higher
learning go," we asked. Earlier, Jules and his mother had
gone to visit Boston University.

"It wasn't bad," said Jules."This is not a bad town. I
wouldn't mind living here for a while. But Dad, guess how
much the tuition and room and board are?"

"I don't know...probably about the same as we paid at St.
John's...what was that...about $25,000 a year?"

"Guess again. It's $38,000."

"What? Now, you've got to be kidding."

"No, that's what it is. Seriously."

"What a rip-off. There's no way it can possibly be worth
$38,000 a year to send a kid to Boston University...even if
they guaranteed a place at Harvard Medical School and a
Nobel Prize."

"Oh shhhsssh..." said his better half."Education is
expensive. But a good education is worth it."

"Yeah...but paying $38,000 per year doesn't give you a good
education. It just opens the doors to beer parties and
football games. You still have to read and think to learn
anything. When you pay your money to a university, you're
paying for sports facilities and research installations and
professor's sabbaticals...and pensions for the maintenance
staff...and pool chemicals. All of that stuff may be
entertaining, but it's only the reading and thinking that
give you an education. And you can do that by walking into
a public library for nothing."

"No you can not. Good professors and good curricula help
guide you...they motivate you...and they help you
understand how things fit together. Trying to get an
education on your own is hopelessly difficult; that's why
people don't do it."

"No it isn't. They don't do it because you don't get a
diploma from a public library. And they think that without
a diploma you can't get a good job. Which is all nonsense.
Maybe the government cares about diplomas, but real
businesses just want people who can think and take
responsibility...and act. And everyone knows that most
college graduates can't think at all. And they don't know
anything. They can't think or write because they've spent
their college years drinking and getting up late and
missing classes...and taking things like psychology and
gender studies and environmental appreciation...where you
don't have to know anything. Which is a good thing, because
the more of that claptrap you know the dumber you are.

"They would have been better off getting a job in the real
world...where they might have learned something...and saved
themselves $100,000."

"Look, Jules is getting ready to go to apply to college.
It's going to be hard enough for him to get into a good
school without you undermining the whole process by telling
him he'd be better off not going at all!"

"I'm not saying he would be better off. I don't know. But
I'll bet that the average goof-ball student would be better
off. Bob never went to college. And did very well. He
became an accountant. And then went into publishing. He
read. He thought. He wasn't afraid of ideas. And he wasn't
the least bit impressed by college degrees.

"That's the way it is in real life...or the way it ought to
be. In the publishing business when someone comes in for a
job, you don't bother asking if he has a degree. You just
want to know if he can do the job."

"But how do you know?"

"Well, you don't. So you ask for a writing sample. If it's
good, he gets the job. If it's not, he doesn't. It doesn't
make any difference what school he went to...or what
degrees he got. Of course, when you get a candidate who
just graduated from Yale...you at least can presume the guy
is smart, or he never would have been admitted. But
then...on the other hand...look at George W. Bush."

"Bush must not be as dumb as he seems, or he never would
have graduated from Yale and never would have been elected
president."

"Maybe...I don't know. But what I do know is that you don't
need a college education to be well educated...or to do
things. And since most college educations are little more
than further indoctrination in the latest silly ideas, a
man probably has a bit of a head start if he doesn't go."

"Oh...you're really over-doing it now."

"No I'm not. Galileo didn't go to Boston University or any
other modern school of higher learning. Neither did Abraham
Lincoln. Or H.L. Mencken. Or Napoleon Bonaparte. Or Henry
Ford. Come to think of it, almost none of the great men of
history ever went to anything like a modern university.
Jesus Christ never set foot in a school, as far as we know.
And Bill Gates is a college dropout. Alexander the Great
was schooled for a few years by Aristotle, but even the
greatest philosopher of his time probably didn't charge
$38,000 a year.

"It's all part of the monumental fraud," we went
on...revved up."Nearly everybody goes to college now...and
now we think we are so much smarter than those who went
before us. But the average college graduate probably knows
less than the average person who finished the 8th grade in
the last century. It's just another form of inflation. A
dollar is worth about 5% of what it was back then. So is a
college degree. We study sociology and the interpretation
of dreams...and gender stereotypes and modern soap
operas...and now we know a lot more about nothing...and a
lot less about everything that matters."

"$3,750," said Henry.

"What...?"

"That's how much you'd have to rent each apartment for in
order to get a 5% return on your investment."

"Oh...well, see there..." Dad continued."Apartments around
here rent for only about $1,500 for a one-bedroom. If you
buy that apartment building, you won't even be able to
cover your costs. Looks like the real estate bubble has
reached Boston."

"That's nothing," said a friend over a drink last night.
"You should see what is happening in Miami. It's nuts. I
bought an apartment down on South Beach six years ago. I
paid $360,000 for it. Now, the one above me just sold for
$1.1 million.

"Now if you want to buy an apartment down there you have to
put your name in a lottery. They sell them 'pre-
construction.' They just put up a sign on an empty lot and
people line up to buy the things. And the prices go up
while you're waiting in line to buy them. It's insane."

"Yeah...it's gotten crazy," said another Florida friend."I
bought a house in Delray Beach, not a great house, for
$175,000...I guess it was about 8 years ago. A couple of
years went by. I probably spent another $50,000 on it. And
then I sold it for $395,000. I remember telling someone
that 'this has got to be the top of the market.' Well, I
saw that it sold again about 6 months ago for $899,000."

"And in Georgetown [an up-market section of Washington,
DC], you remember that house I bought," the first friend
recovered the floor."Well, it's been a royal pain in the
[derriere] because I've had to deal with all the historical
preservation boards and local committees...but I finally
got permission to put on a second floor. I spent $2 million
for the house...and I'll spend another $2 million making it
the way I want it. But listen to this, a guy came along
just last week and offered me $7 million for it even before
I do the renovations. Apparently, you just can't find big
houses like that - it's on a half-acre lot in Georgetown.

"Well, I was thinking about selling it...even though it was
supposed to be our dream home. But I talked to my real
estate agent. He told me to stick with it. When I finish
the work, he told me it will be worth $10 million. It's
nuts!"

---------------------

The Daily Reckoning PRESENTS: When we last saw Dr. Marc
Faber, he was sitting on Barron's roundtable, the bi-annual
gathering of the world's top investment minds. Today, he
tells us where to put our money...

AN EVENTUAL INEVITABLE CRISIS
by Marc Faber


Whereas the bulls are convinced that the market will rise
strongly for the rest of the year on the back of what they
perceive to be"great economic news", the bears feel that
the market is on the edge of a collapse.

There is a third possibility, which would be particularly
unfavorable for the hedge fund industry. The markets could
enter a long and tedious trading range. I am leaning
towards the view that, for most markets, including
developed and emerging stock markets, as well as for bonds
and commodities, we saw the highs for this year in the
January to March period.

From here on, I think that additional gains will be minimal
and that the rewards will not compare favorably to the
eventual downside risk. But, as was the case in Asia where
most markets peaked out between 1990 and 1994, and were
then followed by a trading range with a downward bias until
the real collapse occurred in 1997/98 (a full seven years
after most markets had topped out, and the final collapse
manifesting itself in a devastating asset and currency
slump), it is also possible that U.S. asset prices (homes
and stocks) can continue to hold on to their gains for some
time. It's even possible that they make marginal new highs
given the monetary conditions currently in place and the
willingness of the U.S. monetary authorities to take
extraordinary measures to prevent asset deflation from
spreading.

Still, I believe that, as John MacKay stated,"legislators
are as powerless to abrogate moral and economic laws as
they are to abrogate physical laws". Therefore, I am
convinced that only a very serious crisis can correct some
of the blatant imbalances that our global economic system
has created. In other words, what we are dealing with at
present is a battle between the economic policymakers and
the"market." Guess which side I would bet on in the final
battle!

So, at the very least, investors should gradually take out
some insurance against what, in my opinion, is an eventual
inevitable crisis, by being well diversified in every
aspect of the investment universe.

The reason I am advocating diversification is that when
quoting Leo Tolstoy's description of the situation in
Moscow when Napoleon reached the outskirts of the city,
both inflationists and deflationists were right at the same
time. Naturally, I am leaning towards an overweight
position in hard assets over paper money and financial
assets, knowing full well that, in a crisis, hard assets
might also decline in value (except possibly for gold and
other precious metals), but likely less so than financial
assets.

Being diversified in terms of the"investment universe"
also means holding assets in different jurisdictions. I
have repeatedly advised our American readers to hold
accounts outside the U.S. I am well aware that this has
become increasingly difficult, and, under pressure from the
U.S. authorities, some Swiss banks are extremely reluctant
to accept such accounts. (If they do accept such accounts,
they must not give U.S. residents advice by telephone, fax
or e-mail; therefore, almost full discretion or periodic
visits may be advisable.)

Singapore is, however, a viable and safe alternative to
Switzerland. Still, the fact that the U.S. authorities have
made the opening of overseas accounts so difficult should
serve as a warning signal of things to come - that is,
foreign exchange controls.

In terms of financial assets, I would overweight Asian
equities, due to their lower valuations when compared to
U.S. equities and the relatively favorable macroeconomic
conditions in Asia (current account surpluses and
undervalued currencies).

But, as I have pointed out before, whereas Asia may
eventually de-couple economically from the U.S. business
cycle, there is still a very close financial connectivity
in place, with the result that at present the Asian markets
track the movement of the S&P rather closely. Moreover, the
overheated Chinese economy will have to slow down
considerably at some point and could lead to some
disappointments among the perennially bullish Asian
investors.

In terms of commodities, I would be careful about buying
markets where there are large speculative positions
outstanding. In a recent issue of the outstanding Global
Equity Strategist report, James Montien of Dresdner
Kleinwort Wasserstein argues that"despite the talk of
unwinding of the global reflation trade, we have only seen
the tip of the iceberg", and that"outstanding positions
and leverage remain enormous." Montien warns that,"when
these trades finally snap, the devastation is unlikely to
go unnoticed", and that"oil looks like it might become the
next 'China'". I concur with James Montien's views and I am
now also concerned that, despite long-term favorable
fundamentals, the oil market could, in the near term, sell-
off quite badly.

The only commodities I still like are coffee, which has
recently broken out on the upside, sugar and orange juice,
which is extremely depressed. In particular, sugar and
orange juice would seem to offer a favorable ratio between
potential returns and risks.

Finally, every investor should consider that, the longer
the monetary- and credit-driven speculative party lasts,
the worse the eventual outcome will have to be. So, the
higher the markets soar and the more speculative they
become, the more precautions will be advisable.


Regards,

Marc Faber
for The Daily Reckoning

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