The Common Thread in Nature, Investing - and Life!

Despite what some investing talking heads may say, the financial world is not exempt from natural law.

There's a natural flow to the way the world works - and it absolutely carries over into investing. One common thread is change - things are either improving, or deteriorating, but they are almost never stagnant. Nature, after all, hates a vacuum!

Guest author David Galland expands upon this topic as only David can do. Read on, to learn why the world, as we know it, is (always) wasting away in some way, shape, form...

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Entropy – Why the World as We Know It Is Dying

By David Galland, Managing Editor, The Casey Report

The concept of entropy is one of the most useful terms for understanding just about everything. While it has its origins in natural law – thermodynamics, specifically – the concept holds true pretty much across all closed systems.

In the simplest of terms, every closed system will ultimately degrade toward a state of maximum entropy.

I’ll use the current political system of the U.S. as a convenient example. When American democracy was first shoved out of the nest by the founding fathers, it was new, fresh, and energetic. It took the world’s breath away at its boldness and unlimited promise, and set the wheels turning on tangible change across much of the world.

Before the ink dried on the Constitution, however, the degradation began. From the beginning, the country’s political operations fell into the hands of a strictly limited number of parties, which quickly coalesced into just two. Since then, they have essentially shared power, with only minor differences in policies between the two. Simply, absent a disruptive external force, the closed political system quickly matured into an institutionalized “sameness” that all but assures no serious challenges – leading, ultimately, to the certainty it will degrade to only a shell of its former self.

It was, perhaps, because of his own understanding of natural law that Thomas Jefferson was heard to remark, “The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants. It is its natural manure.”

That doesn’t mean I am advocating revolution – just pointing out the fact that any closed system, no matter how well constructed, will degrade. To expect the United States of America to avoid this fate is to expect the impossible.

Switching to a corporate example, I used to be a regular buyer of Toyota cars. They were well made, innovative, and suited my changing needs over the years. And I wasn’t alone – in 2007 they became the world’s largest automobile maker, with a global manufacturing and distribution system that made them appear dominant. Behind the scenes, though, entropy was at work.

In 2008, when the time had come to lease a new car, I reflexively headed over to the local dealer fully expecting to drive off with yet another Toyota, just as I had done several times over the previous decade or more. But as I walked around the showroom, it was impossible not to notice that the company had lost its edge. The cars on offer were not only more expensive than the competition, but even the newest models had that “so yesterday” look about them.

Surprising even myself, I walked out and ended up leasing from another company. I remember vividly at the time saying to my wife that we should short Toyota’s stock. Of course we didn’t – but if we had, it would have been a good play, as you can see in the chart of the company’s stock price here. Note that Toyota’s share price peaked in 2007, almost concurrently with it becoming the world’s largest car company.

As I said at the onset, you can see entropy at work in virtually every closed system. Consider the U.S. dollar, which became the world’s de facto reserve currency as a result of Bretton Woods.

What an amazing advantage for the United States – this unique ability to provide the world’s central banks with their primary reserve component! And to have all the world’s commodities dealt in dollars. In short, the dollar became the centerpiece of the global economic system.

It was, of course, damned to entropy, with Nixon’s ending the dollar’s gold backing just being part of the natural progression. And if he hadn’t done it, one of his successors would have – due to some “emergency” or as a “temporary” measure, or some other flimsy political cover.

Regardless, the degradation of the currency gained speed and, systematically, it’s been all downhill since.

You may also want to think about entropy when pondering the Chinese miracle. No question, China is having a heck of a run. As James Quinn writes in his article “Is China’s Recovery a Fraud?” in the February edition of The Casey Report, in 1970 that country’s GDP was just $92 billion. Today it is $4.9 trillion!

“Unstoppable!” cheers the punditry. The Chinese leadership, whose capable hands are very much on the levers of the macro-economy, are cut from special cloth, they add.

In answer to that, Quinn points out that despite China being an export-based economy, purpose-built to supply goods to a U.S. population engaged in a mad rush to spend themselves into debt and default – which is to say, an economy now only a memory – there is currently 30 billion square feet of commercial real estate under construction in China.

I’m not sure if bowling is popular with the Chinese, but with all that spare space, some enterprising individual might want to consider promoting it as the coming thing. Roller rinks? Indoor laser tag centers?

Meanwhile, back in the U.S., we the people are no longer content with a free-market system that embraces periodically burning down the house in order to rebuild stronger and better – a system which has been proven to create wealth, and lots of it. Instead, we are hell bent on adopting the closed economic system of a socialist model where everything and everyone is tightly controlled.

On that point, a recent article in the Wall Street Journal titled “No Exit in Sight for U.S. as Fannie, Freddie Flail” sheds light on the continuing degradation in the free market that used to underpin the nation’s hugely important housing sector…

Fannie and Freddie, for their part, remain at the core of a housing-finance system that inflated a dangerous housing bubble. After prices collapsed, sending shock waves around the world, the federal government put America's housing-finance system on life support. It has yet to decide how that troubled system should be rebuilt.

On Dec. 24, Treasury said there would be no limit to the taxpayer money it was willing to deploy over the next three years to keep the two companies afloat, doing away with the previous limit of $200 billion per company. So far, the government has handed the two companies a total of about $111 billion.

(Full story here.)

Can’t you just smell the entropy? The results are not just predictable, they are evident – just look around.

As investors, it is, I would contend, important to understand the notion of entropy – and to watch for it in your portfolio companies, in your bureaucracies, and, on a more personal level, your relationships and your health. On that last point, the human body is very much a closed system and so, as we all are too painfully aware, will degrade until it ceases to exist.

You can slow the degradation by taking care of yourself. But it’s also worth remembering that it’s a one-way slope, so enjoy yourself while you are fit and able to.

While it’s impossible to halt entropy, what you can do is take action to protect yourself and your assets from its effects. That’s what the editors of The Casey Report do best: recognize and examine emerging trends in the economy and markets, and help investors take advantage of the opportunities that arise from them. And profits are everywhere if you know what to look for – even in the worst economic crises. Click here for more…

Ed. note - I am a Casey Research subscriber, and affiliate, and I highly recommend their stuff.

A "New Look" Government Motors? HAHAHAHA

We now find our fallen (past) hero, Government Motors, nestled under the protective wing of the United States Government, sheltered from the harsh conditions of the "free market."

Some folks actually believe this cover from reality is all that GM needs in order to right the ship, and, to borrow a phrase from REO Speedwagon and GM's 2001 commercials, "Keep on Rollin' " once again.

I'm sure you're stunned to hear that I'm a bit skeptical of this whole rouse! But lets go in with an open mind...could us free market snobs be wrong? Can GM remake itself?

Guest author Olivier Garret dives into the early "new" GM to see what the future may hold for the fallen giant...

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A “New GM”?
By Olivier Garret, CEO, Casey Research

A friend of mine mentioned to me that he was surprised that “bankrupt GM” was spending some serious advertising dollars to try to lure customers to its website.

My comment to him: It makes sense, if it is done properly!

Yes, it is often necessary for a distressed company to communicate with its customers (advertise) and assure them that the future is brighter. That said, GM appears to have it all wrong once again.

What brought GM to where it is today is a lack of focus on what mattered to its customers – while it was losing market share to competitors that built higher-quality cars at competitive prices and strived to anticipate what customers needed. GM tried to remake its image several times over the past 20 years… without ever changing.

You might remember the slogan “An American Revolution.” The fact is, GM was led by insiders and bureaucrats. They climbed to the helm of the corporate ladder, not because they were good leaders but because they were effective at corporate politics and financial management. While GM employs scores of very competent and dedicated mid-level managers and union workers, they never got a clear signal or a commitment from the top that the company’s culture had to change in order to survive. People then did what they do best: they tried to protect the status quo and retain their perks. It worked for many years.

Unfortunately, the world of manufacturing has changed, and the strategies that made GM the world leader between the ‘40s and ‘60s have not worked since then. The company has needed a complete makeover for decades, and yet it has failed to embrace real change.

In this respect, bankruptcy could be an incredible opportunity for General Motors to get a fresh start and leave the chains of its legacy behind once and for all. It would be able to focus on building a successful company around its best assets (many great people, some good products, and physical assets). If the company could commit to doing much more than just a financial reorganization, it would have a bright future ahead.

So I looked for visible signs of change at the “New GM,” its first post-bankruptcy communication with its customers.

But let me first summarize the key elements of a “crisis” communication campaign. To be successful, it needs to be:

• Reassuring. Show that the company is in control of its destiny.

• Focused on the customer. What is the company doing for them (more exciting cars, more reliability, financing programs, excellence in service)? The message needs to be credible and – in the case of GM – should demonstrate how the new GM is different from the old one:

- Focused on fewer models – the best – to make them even better;

- Committed to improved productivity, as it means more value for the same price;

- Run by people that truly love cars vs. accountants – Henry Ford was an industrialist that knew cars, lived and breathed them; Wagoner never inspired the same passion).

• Truthful. Unless the company is committed to meaningful changes, why bother? Customers will be disappointed by the message if they find out that the reality does not match expectations built by the campaign. This will lead to failure, as customers don’t forgive disingenuousness.

• Vibrant and exciting. Why should a customer come back to GM? While “vibe” won’t be successful by itself, it is an essential differentiation tool to keep people interested in the rebirth of an American icon.

So, what is the initial verdict?

After I let the ads entice me to visit the new GM website, I landed on a page titled “Our Mission.”

Here are my impressions: The page I landed on was cold and boring, almost amateurish. Also, I did not get their “mission.” There was a bold statement saying, “Reinventing the company,” yet they talked about a new battery lab, the SAAB spin-off, and the Penske purchase of Saturn. No sign of excitement, passion, or true change. Note to GM: Talking about yourself does not engage your customers.

Alright, maybe I didn’t land on the page where GM meant for me to go first. So I checked the “Our Company” page… with the same sinking feeling.

Couldn’t GM marketers find a better picture of Fritz Henderson or a more engaging subject matter to tell me what they are going to do for me, their potential customer? By the way, Mr. Henderson has been with GM since 1984. Is he the guy that will change the culture of the company? Can he really make GM a leading carmaker after being part of the management team that took it on a downward spiral for a quarter of a century?

Oh wait! I can see that GM just appointed a new chairman: Edward Whitacre. He must be the inspiring new leader. Interestingly enough, Mr. Whitacre is a retired chairman of AT&T. He spent 43 years in the telecom industry; he hardly looks like a man whose life’s passion is cars.

A quick googling of Mr. Whitacre’s background tells me that he brings with him a real passion for technology (he didn’t even have a computer in his office at AT&T), the Boy Scouts of America (he was their national president from 1998 to 2000), and M&As (the highlights of his career in telecom). Not exactly the profile I had in mind for GM’s leadership at this point… oh well.

Further down on the page is an article on the GM/Segway joint venture. Clearly the new PUMA must be the answer to GM’s customers most pressing needs. To me, though, it looks like a rolling coffin that will at best serve a small niche of yuppies, or airport security staff, or municipal police force. Hardly what GM needs for a makeover.

(Photo: Reuters)

The next article tells me that the era of combustion engine vehicles is just about over. (If that’s true, why should I buy a car now?) But rest assured, even though the “New GM” may not have what I need today, it is working on tomorrow’s vehicles.

Well, if I remember correctly, GM’s competitors were the ones that produced the first commercially successful hybrids, while GM was promoting monstrous, gas-guzzling Hummers. Why should I trust that these guys now have a“feel” for the market? Do they truly understand where the future lies for this industry?

Maybe it is because President Obama stated that the American car industry will lead the green revolution and bring us the solution to the U.S. energy dependency problems. If I were Mr. Henderson and my job security were contingent on serving the wishes of my largest shareholder instead of the needs of my “potential” customers, my best strategy would be to pursue an all-electric vision. All I really needed anyway would be another five years before I could get full pension benefits guaranteed by the U.S. taxpayer.

My conclusion: Unfortunately, the first piece of communication from the “New GM” is all but reassuring; it fails all the tests for a successful crisis management campaign, leaving the visitor anything but excited about the struggling company. It leads me to believe that the “New GM” may have to file again shortly after emerging from its current “pre-packaged” bankruptcy. Alas, by that time, there will be a lot more job losses, and the brand will probably never recover.

I have been convinced for years that bankruptcy could save our domestic auto industry. However, I never had in mind a politically driven process like this – Washington technocrats and union leaders getting together and concocting this kind of an ill-conceived “solution.”

What I envisioned was a much more standard process where all the stakeholders put their claims in front of a restructuring team and a bankruptcy court. Then they collectively try to find the best compromise to move forward. They generally end up accepting significant losses but will vote in support of a plan that highlights a clear path to recovery and hope for future upside. In the absence of such a plan, they will push for liquidation and try to preserve the few assets they still have.

In some cases, the company cannot “remake” itself. Liquidation may then turn out to be the best thing that can happen. New owners pick up the pieces for ten cents on the dollar, and with a low-cost investment, they can start a truly new company focused on well-defined opportunities/customer needs. These new companies could again become icons of American entrepreneurship.

In either case, the American taxpayer would not be on the hook for tens or hundreds of billions of dollars, and the “New GM(s)” might have a chance to survive and thrive. Of course, this is not what is happening here. So, speaking with the legendary Mogambo Guru… second note to GM: You’re all freakin’ doomed.

All things considered, GM will most certainly not save the U.S. economy… or even be a part of it in the long run. And if you want to preserve and even multiply your assets, we wouldn’t recommend investing in GM – or any “blue-chip stock” – at this time. Instead, take a look at our Chief Economist Bud Conrad’s favorite investment of 2009… a play that is almost guaranteed to pay off handsomely this year. Click here to learn more.

Recovery.gov Transparency a "Significant Failure" Says Watchdog Group

Recovery.gov, the resource setup by the Obama administration to provide full transparency of the squandering and misallocation of tax dollars, is reported to actually be more translucent than transparent.

Watchdog organization Sunlight Foundation, described as "normally polite" by ReadWriteWeb, referred to Recovery.gov's data transparency as a "significant failure." And not just once!

Sunlight co-founder Ellen Miller writes:

"By not including raw data at Recovery.gov, transparency is dramatically reduced. Sunlight has argued strongly for raw data in machine readable formats as the starting point for Recovery.gov. This is a significant failure by the Administration to live up to its promise for full and complete disclosure. Significant failure."

I'm sure you are flabergasted, dear reader, at this rare government shortcoming.

Related reading:

• Initial coverage of the Recovery.gov farce
• What if...there had been no government bailouts?

Great Quote on Why Government Can't Create Wealth

"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

Editor's note - Guess what percentage of our country is a net receipient from the Federal Government...meaning they receive more in handouts than they pay in taxes?

Over 50% (!)  Uh oh...

Does the thought of government handouts make your stomach turn?  You'll love The Market For Liberty, which we reviewed here earlier this week.

The Market for Liberty - Book Review

The Market for Liberty, by Linda & Morris Tannehill, is an extremely thought provoking book that asks the outrageous question:

Is government itself an unnecessary evil?

The Tannehills do not just make the case for smaller government...for less government in our lives. They make the case for NO government!

This was a challenging concept for me to grasp. Regular readers know that I'm of the mindset that less government is usually better...but no government? Isn't that...anarchy?

It's tough to imagine no central authority whatsoever. Who will settle disputes? Who will protect us from foreign aggression? Who will protect justice and keep the peace?

All of these questions are answered in a very well thought out manner in The Market For Liberty. The Tannehills describe a Laissez-Faire society that, to be honest, sounds pretty damn good. No bureaucratic regulation. No politics. Everyone is accountable to the free market, not to a central authority which can be lobbied and swayed.

If you have any libertarian leanings, I'd urge you to read this book. (And if you don't - don't bother, you won't be able to follow). For me, this book was a real tipping point in my thinking about government and the free market. To be honest, I had put off reading it for a little while, because I didn't think I was ready for it.

The entire case for the free market is very intellectually engaging and energizing. The Tannehills wrap up by asking: How can we go from government to laissez-faire? The answer may surprise you, as they do not advocate government overthrow, or even peaceful disobedience.

I'll let you read it for yourself, and then we can circle back at this space and compare notes. The book is out of print, but there are some copies available on Amazon - I've got a link below. And even better - if you don't mind reading this on your computer - here's a free PDF version (thanks to Doug Casey for finding this link).

I believe this book is more important now than ever before - and critical to our investing success.  With the amount of government intervention in the markets at levels never seen before in the US, I'm trying to figure out when we'll reach the "tipping point"...when the public sectors basically chokes or crowds out the private sector, and the economy is permanently disabled.

Why The Government Will Have To Monetize The Federal Deficit

Seems like the government has never made a deficit projection it couldn't miss.  Well believe it or not, things are about to get a lot uglier than any of us had expected.  

Casey Research's David Galland, one of the very best investment writers and thinkers in my opinion, writes that falling tax revenue is going to force the government's hand very soon.  What does it mean for your investments...and livelihood?  Read on to find out...

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Tax Revenues Tanking
By David Galland, Managing Editor, The Casey Report

While everyone else has been focused on the banks’ stress tests and how much government is spending to bail out troubled “too big to fails,” a disturbing trend on the other side of the equation is now emerging: how much (or rather, how little) the U.S. government is receiving in tax revenues.

After combing through the past 25 editions of the “Monthly Treasury Statement of Receipts and Outlays of the United States Government,” which is compiled and published by the Treasury Department’s Financial Management Service, we created the following chart.

Here’s what’s going on:

• In 2007 and 2008, government tax revenues averaged about $633.15 billion per quarter. For the first quarter of 2009, however, the numbers just in tell us that tax receipts totaled only about $442.39 billion -- a decline of 30%.

• Looking to confirm the trend, we compared the data for April – the big kahuna of tax collection months – to the 2007-2008 average, and found that individual income taxes this year were down more than 40%. The situation is even worse for corporate income taxes, which were down a stunning 67%!

• When you add in all revenue from all sources (including Social Security revenue, government fees, etc.), the fiscal year-to-date – October through April – revenue shortfall comes to 19%, vs. the 14.6% projected in Obama’s budget. If, however, the accelerating shortfall apparent year-to-date, and in April in particular, continues, the spread between projected and actual tax receipts will widen considerably.
  

Tellingly, for the first time since 1983, the U.S. government posted a deficit in April. That’s a big swing in the wrong direction, as the bump in personal tax collections in April historically results in a big surplus -- on average about $68 billion.

What are the implications of this tanking tax revenue?

For starters, it means the federal government deficit is going be as bad or worse than the $2.5 trillion Bud Conrad, chief economist of Casey Research, projected it to be last year.

If the shortfall in individual and corporate tax revenue persists -- and we expect it will -- then the deep hole the government is already digging for itself will be that much deeper.

Using the government’s own expense projections, the revenue shortfall, even if it doesn’t worsen further, would push the fiscal 2009 budget deficit up to about $1.958 trillion. For reasons we’ve discussed at some length in The Casey Report, those expense projections are likely to be significantly understated.

Case in point, in January the government projected a $1.2 trillion deficit for fiscal year 2009… in March, just three months later, they upped the projection to $1.8 trillion. That $600 billion “adjustment” alone totaled more than any full-year budget deficit in the nation’s history.

Yet, the real fly in the ointment is that the actual borrowing by the Treasury is likely to be at least half a trillion dollars more than the deficit.

That’s because the Treasury is buying toxic paper (mortgage, credit card loans, etc.) and putting them on the books with a higher value than the market is willing to assign. While that makes the budget deficit appear smaller, it doesn’t negate the fact that the government still must borrow the money needed to buy the toxic paper in the first place. The additional revenue shortfall means they have to raise that much more money. Based on the struggle they had pushing the $14 billion in long-term notes at the latest auction, it becomes increasingly apparent that when push comes to shove, the only way the government is going to come up with the money needed to meet its aggressive spending is to print it up.

In other words, events are rolling out almost exactly as we have been anticipating. Below, for example, are some useful excerpts from an April 3 article titled “Widening Deficits” by Casey Research CEO Olivier Garret. To quote…

In the midst of the Great Depression, the 1931 federal tax revenues had fallen by 52% from their 1929 highs. While we do not expect anything that dramatic in 2009, it would not be unrealistic to see a 20% to 25% reduction in cash flow from tax collections this tax season. Such a drop would pose significant challenges given that spending commitments are off the charts and climbing.

Later in that same article, Olivier continued,

In the absence of sizeable increases in tax revenues, it is quite clear that the lion’s share of the planned sales of Treasuries in 2009 cannot be met by demand from the market. Either the Treasury will have to raise interest rates significantly, or the Fed will need to step in very aggressively to support the planned auctions. Our expectation is that both will happen. Auctions will fail and the Fed will step in. The market will react to more printing by anticipating inflation and demanding higher interest rates. Once the cycle starts, it will be very hard to pull interest rates back.

We continue to stand by our December forecast that the 2009 budget deficit is more likely to widen to levels between $2.5 and $3 trillion rather than the CBO’s $1.8 trillion forecast. We also believe that inflation could start setting in as early as Q3 of 2009 and will accelerate sharply by 2010. Treasury Rates will start climbing and the era of cheap money will end, making it harder for overleveraged consumers, businesses, and governments to service their debt.

Olivier’s forecast of failed auctions and rising interest rates on Treasuries proved more prophetic as a May 7th story from Bloomberg reported:
Treasury 30-year bonds fell the most in four months as investors demanded higher-than-forecasted yields at today’s auction of $14 billion of the securities with the U.S. slated to sell a record amount of debt this year.

“This is a problem,” said Chris Ahrens, head interest-rate strategist at UBS AG in Stamford, Connecticut, one of 16 primary dealers required to bid in Treasury auctions. “The market required a fairly significant discount to buy the bonds.”

Thirty-year bonds have lost investors 20.9 percent this year, Merrill Lynch & Co. indexes show, as the Treasury increases securities sales to help fund a swelling budget deficit. Yields climbed to a six-month high today as the auction drew a yield of 4.288 percent, higher than the 4.192 percent average forecast in a Bloomberg News survey of seven primary dealers. Demand was below average, judging by total bids.

The benchmark 30-year bond yield climbed 23 basis points, or 0.23 percentage points, the most since Jan. 5, to 4.316 percent, at 5:25 p.m. in New York, according to BGCantor Market data. It was the highest yield since Nov. 14. The 3.5 percent security due in February 2039 dropped 3 15/32, or $34.69 per $1,000 face amount, to 86 3/8.

The 10-year note yield increased 16 basis points to 3.345 percent, the highest since Nov. 24.

Two-year notes yielded 1 percent for the first time since March 18, while the rate on the three-month Treasury bill was 0.18 percent.

So, what does all this mean?

As per above, the rock-and-the-hard-place scenario we have been predicting is unfolding before our eyes. At this point, other than sharply changing course and letting the free market cope with the crisis through a brutal “survival of the fittest” scenario, the government is left with no other option than to accelerate its buying up of its own debt.

Which is to say, it must push even harder on the levers of its printing presses, further setting the stage for the massive period of inflation we continue to see as inevitable… and for the stunning rise in interest rates we are now positioning ourselves for in The Casey Report (and, you can too… learn more).

Ed. Note - I subscribe to the Casey Report myself...it's my favorite of all investment newsletters that I have.

Richard Russell Blasts "Government Sachs"

Great rant from Richard Russell today on the company that runs our Federal Government - Government Sachs:

It's now obvious that the Fed and the Treasury want, above all, to save the banks. Everything else is secondary. It's also increasingly obvious that the bankers own the nation and that Goldman Sachs runs the nation and the banks. The whole thing is so flagrant that my head spins. And what Goldman doesn't control, the Pentagon controls.

Click here to read the whole rant at The Daily Crux...

Marc Faber: We've Begun a 15-20 Year Bear Market in Bonds

Here's Dr. Doom himself, Marc Faber, giving one of his usual insightful and thought provoking interviews for Bloomberg.

What really caught my ear was around the 4:30 mark, he proclaimed the bull market in long dated bonds to have ended as of December 18, 2008.  (He also pinpoints the start of the bull market at September 21, 1981).  Faber believes we're now in the beginning of a long term bear market for these bonds, which he expects to last 15-20 years.

This really is a fantastic interview - be sure to check out Faber's answer to how Geithner and company can locate the bad apples in the financial system...I'll save the punch line for you.  It's around the 7:20 mark.

Other quick notes:

• Gold "could" dip back down to $750-800 (before heading higher)
• He likes the Canadian, Australian, and Singapore dollars better than the US dollar

Here's the full interview:

More recent coverage of Faber:

• Peter Schiff Interviews Marc Faber
• Faber Says This Rally May Have Some More Legs

Ed. note: If you love Faber, you'll also get a real kick out of Doug Casey.  Check out his piece about how we're in the early innings of the Greater Depression.

Doug Casey on Government Motors

Great essay by Doug Casey, as he muses on the debacle that is Government Motors.  Here's the start of his piece, and the rest can be found on DailyWealth.com, which republished the piece over the weekend.

An Inside Look at One of the Biggest Scams in America
By Doug Casey

I don't feel I've said enough about the class of professional American corporate executives in the past, partly because it's impossible to say enough about this generally despicable class of empty suits.

Once upon a time, most large companies were run by the men who founded them, and those men were almost always the controlling shareholders. Their interests were aligned with those of the other shareholders.

Few, if any, of today's execs in big corporations have major share positions (and if they do, it's strictly because they were granted cheap options), and few, if any, have actual technical expertise with the products their companies produce.

Take Rick Wagoner, the ex-CEO of GM. This suit basically has zero interest in cars; he's an expert mainly in the infighting and bootlicking it takes to climb a corporate ladder. He's a political hack, like all the managers that preceded him for the last 40 years. And he's typical of top management in most large public companies.

Read the rest of Casey's article here.

Also from Doug Casey:

• Doug Casey on 2009: Another Year of Shock and Awe
  
• Foundations of Crisis

How Bad Will The Financial Crisis Get?

How bad can the current financial crisis get, and how long will it last?  Casey Research's Chief Economist, Bud Conrad, tackles this question, crunching the numbers produced by two leading economists who took a broad sampling of banking crises.  The information is presented in an insightful and informative way as only Bud can.  I hope this helps round out your thought process about the depth of the current crisis.

Bad, Worse, or Worst?

An assessment how serious the current crisis is likely to get

By Bud Conrad, Chief Economist, The Casey Report

It’s time to call the global crisis what it is: the worst financial collapse since 1929. That’s no surprise to subscribers of The Casey Report, who have been amply warned over the last five years. But now even government officials, after trying to ignore the facts on the ground for the last couple of years, are admitting the truth of the matter.

Now that it’s here, we turn our attention to trying to discern, “How bad can it get?” and “How long can it last?”

While such questions can never be answered with anything approaching absolute certainty, there are methods that can be used to assess what may lurk over the horizon. With that goal in mind, this article focuses on – and then expands upon – the recent work of two economists who painstakingly analyzed a substantial number of previous banking and currency crises in an attempt to derive potentially useful lessons. I have then taken their data and applied them to the current circumstances to see where we are, relative to those other experiences.


The Data

The data are from a study called “The Aftermath of Financial Crises” by Carmen M. Reinhart of University of Maryland and Kenneth S. Rogoff of Harvard University. In their study, the authors summarize the results of a broad sampling of banking crises, with between 13 to 22 crises analyzed for each of the variables.

The Reinhart/Rogoff study is based, in turn, on data extracted from an even more comprehensive study of events in 66 countries, titled “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises,” by the same authors.

I’ve summarized the findings from the latest study in the table below:

The economic measures in the left column show how far the U.S. situation has deteriorated so far. The next columns show the average historical deterioration and the worst case of the crisis analyzed.

I then applied these data to calculate the levels that the U.S. could reach if it followed the path of the historical examples. The projected level is based on the measure analyzed, either from the peak prior to the downturn (e.g., the S&P 500) or from the bottom prior to the downturn (e.g., the lows in unemployment). Thus, as you can see in the table here, the S&P 500 has already dropped from its October 2007 peak of 1565 down to 766. If this crisis were to end up being only “average,” then it would drop to 690.

If, however, the worst case of a 90% drop were to occur, as it did in Iceland last year, then the S&P 500 would trade down to the shocking level of 157. For further reference, if the current crisis were to cause the stock market to fall as sharply as in the Great Depression, the S&P would touch 469.

Duration of Crisis

As you can see in the summary table below, it took 3.4 years, on average, for the stock market to fall from the peak to the bottom. In the worst case, it took five years. With the recent peak in the S&P 500 occurring in October 2007 – just one and a half years ago – the crisis is likely to have some time to go before reaching even an average duration. More specifically, if this crisis turns out to be just “average,” we would not expect to see the low before the first quarter of 2011.

Crisis Horizon: Some Conclusions

The global economic situation continues to deteriorate on all fronts (see charts below).

Housing prices are down 28% from their bubble peak in 2006 but still have a ways down to go to get back to their pre-bubble levels. Even an average downturn will mean that housing remains a problem for several more years. Unless, of course, the government steps in to stave off those resets… a “solution” that carries with it a separate set of problems, making things worse. We continue to expect very serious problems in the commercial real estate sector.

The stock market is approaching a 50% decline, the average of what has been observed in past crises. Further slowing in U.S. corporate activities and profits means additional increases in unemployment, establishing a negative feedback loop that pushes corporate profits – and stock prices – even lower.

The only growth trend at this point is in government bailouts, which are in high gear, indicating we’ll experience the serious growth of outstanding debt seen in other crises. The elevated levels of government borrowing required to fund that spending are absorbing all available credit from foreigners, directly competing with business in need of the new financing that will be required to expand the economy. The combination of declining business activity, coupled with declining levels of household income, will result in declining tax revenues, increasing the budget deficit beyond the size of the new bailout programs. State and municipal governments across the nation are already being confronted with large shortfalls in their budgets, shortfalls that will only widen as the crisis worsens.

The combined business slowing and jobs contraction assure that the GDP will decline. Components of GDP having to do with necessities like food and shelter will continue to bump along regardless of the economic conditions, but the lack of growth in GDP could extend for years as it did in Japan and as it did after the 1929 stock crash.

Inflation/Deflation

Given that we are currently in a deflationary phase, it is easy to dismiss the case for inflation – and many do. We think that is a mistake. Even a summary tabulation of the unprecedented increases in government debt at this relatively early stage in the crisis make a compelling case for higher inflation, if for no other reason than that it shows clear intent on the part of the government to spend “whatever it takes” to offset the deflationary forces now stalking the land.

The research paints a dismal story of years of economic stagnation. In our view, the trend is now firmly established for dollar debasement, a debasement that will eventually overwhelm the deflationary pressures from collapsing asset values. Therefore, don’t listen to the happy faces on CNBC spouting off, for the umpteenth time since this crisis began, that now is the time to jump back in and buy stocks. It isn’t.

Be extremely skeptical when you hear some pundit pronouncing that this piece of short-term good news or another is an “all clear” signal. Until we start seeing a systematic improvement in the economic fundamentals – for example, an upward movement in consumer confidence – the only signal the economy will be hearing is that of a runaway train coming straight at it.

The numbers paint a dark picture… but it is in crises like today’s where unusually good opportunities arise for investors. Take our investors, for example, who made money shorting financials over the last year. The Casey Report focuses on recognizing and analyzing market trends way ahead of the investing crowd – a strategy that has already provided its subscribers with up to four-digit returns. The latest edition includes an update on the analysis you’ve read above. Try it risk-free for 3 full months, with our 100% money-back guarantee: click here to learn more.

Also by Bud Conrad:

• Battle of the Flations: Which Will Prevail?

What if...There Had Been No Government Bailouts?

Oh what a wonderful economic world it may be right now, had the government not felt the compelling need to "do something."  Casey Research's Terry Coxon reviews the government's "helpful" actions over the past couple of years, and asks the question - what would have happened if they had done nothing?

Nothing
By Terry Coxon, Editor, The Casey Report

We don’t yet know how many trillions will be swallowed up by the government’s rapidly breeding herd of stimulus-bailout-help!help! measures. But additional bold steps are sure to come, some already in R&D and others to be invented on the fly to answer each new wave of bad news. Expect price tags suitable for proving how serious and determined the authors are.

The doubts that meet each new plan – does it really need to be that big... hasn’t something like that been tried before... is it smart to keep wrong-headed decision makers in high places... isn’t too much debt at the heart of the problem... if you don’t know what causes inflation, are you sure you know what causes babies – are all answered with the same rhetorical question: “We can’t just do nothing, can we?”

Yes, we can. But we won’t, because the decisions about our wealth and our freedom are being made by career politicians, for whom stepping aside is the only truly unacceptable plan. Nonetheless, even though the idea of government doing nothing in the face of credit crisis, bank insolvencies, and recession has been reduced to a hypothetical, such a policy deserves a little exploring, since it can tell us something about where all the big-dollar solutions coming out of Washington are likely to lead.


Background

It’s possible to train people to be crazy. If you’re acquainted with a psychotherapist (socially, of course), ask him to explain how it’s done. Training people to be crazy wasn’t what the U.S. government set out to do when it ended the dollar’s convertibility to gold in 1973. But it turned out to be one of the results.

Untethered from the gold standard, the Federal Reserve was free to create new dollars whenever it saw fit. But the policy it drifted into wasn’t steady inflation, day in and day out, it was rescue inflation. The Fed would step up the expansion of the money supply whenever it saw a risk of widespread defaults in credit markets. The unintended effect was to train both lenders and borrowers, by repeatedly rescuing them from damaging defaults, to appraise financial risk unrealistically and to regard what is in fact a source of danger as a manageable nuisance. It made the managers of financial institutions functionally crazy, and the longer rescue inflation continued, the worse they got. (When you read about investment bankers running a business with 30-to-1 leverage and tell yourself, “Those people must be crazy,” you’ve got it about right. But they weren’t born that way. They were trained.)

That’s how the credit crisis was nurtured. And here is what the government has done about it so far.

August 2007. The credit crisis is just going public. Commercial banks, investment banks, and other financial institutions are waking up to the reason they were getting such great returns on junk paper – it really is junk. To ease the shock, the Federal Reserve begins a vast and unprecedented program of swapping out Treasury securities from its own sizeable (nearly $1 trillion) investment portfolio in exchange for the embarrassing and worrisome securities that seem to be paralyzing the lending departments of the banks that own them. A novel approach, and not really inflationary, since no new cash is produced.

September 2008. Lehman Brothers informs the Federal Reserve that the novel approach, admirable though its inventiveness might be, isn’t working and drops dead in front of Ben Bernanke’s desk. The Fed abandons the hope of a non-inflationary remedy and begins a vast and unprecedented program of expanding the monetary base (buying Treasury securities and other IOUs in the open market with brand-new dollars).

October 2008. President Bush signs a vast ($700 billion) and unprecedented bailout bill. It has been sold to Congress as a measure to help banks survive and keep lending, but the details are vague in the extreme, leaving the secretary of the Treasury with the authority to use the money for almost anything, including, if he should find it advisable, “for carrying on an undertaking of great advantage; but nobody to know what it is.”

Other vast and unprecedented programs have followed, including tens of billions for any car company willing to drive (not fly) to the teller window, hundreds of billions to get messy home mortgages house-trained, and unspecified mega-billions for Timothy Geithner’s proposal to unburden banks of bad assets through a plan of great advantage but nobody to know what it is.

And today, 21 months after the doctors started scribbling prescriptions, most markets continue down, the economy is still shrinking, and worries are still growing.

Now roll the tape back to August 2007. What would have happened if the U.S. government had simply kept its long-standing commitments (in particular, protecting FDIC-insured deposits and preventing the money supply from shrinking) and otherwise had done nothing? No good-asset-for-bad-asset swaps, no wild expansion in the monetary base, no bailouts, no arranged marriages with taxpayer-financed dowries for failing institutions.

Nothing.

If that sounds extreme, perhaps you’ll find it a little more acceptable if I put it this way: what would have happened if George Bush, Ben Bernanke, Nancy Pelosi, Harry Reid, Barney Frank, and Barack Obama had done nothing?

It would have been spectacular, a mass die-off of the incautious. Bear Stearns, Morgan Stanley, and other practitioners of ultra leverage, including perhaps Merrill Lynch, would have folded. When you borrow to carry $30 of investments for each $1 of company capital, it only takes a 3.4% drop in the prices of your assets to put you under water. And when you’re getting that 30-to-1 leverage through overnight borrowing, even a whiff of doubt can make it impossible to roll over your financing from one day to the next. Either way, you’re out of business.

From there, the trouble would have fanned out. The firms just pronounced dead were counterparties to trillions of dollars in derivatives. The investors on the other side of all those deals (largely banks, insurance companies, and other brokers) would have been left holding the bag. Some of them would have failed, and all that survived would have been left weakened and living in fear.

Growing mortgage losses would have forced Fannie and Freddie (and also Countrywide Financial) into bankruptcy, which would have turned their trillions in outstanding bonds into junk debt, doing great injury to the banks, insurance companies, and other investors that held them. Citibank and Wachovia would have gone under. And with Fannie, Freddie, and Countrywide gone, the biggest sources of mortgage money would be unavailable, which would have turned the housing market from a corpse into a mutilated corpse. AIG, which had turned itself into a sink of follies by insuring other companies against losses on junk debt, would also have joined the departed – and the companies that had been depending on AIG credit insurance would have gotten sorted out between the failed and the merely damaged.

Bank of America, having been spared the irresistible invitations to acquire Countrywide and Merrill Lynch, might be in much better shape than it is today.

With a hundred-car pile-up in the financial sector, lending to businesses and consumers would have shriveled, and the rest of the economy would have slipped into a depression. No more General Motors. No more Chrysler. Ford maybe.

And those are just the big names. Tens of thousands of other companies would have gone out of business. Most others would have laid off workers. The unemployment rate would have moved deep into double digits. With so many companies cutting inventories to raise cash for survival, the wholesale price index would have gone off a cliff, and the consumer price index also would have slumped.

It’s an ugly picture, with pain and hardship for millions of people and grave worries for the rest. But before you start preparing thank-you notes for the good people in Washington who’ve acted so boldly, consider this:

If they had done nothing, the whole sorry business might be over by now. Without the promise of rescue and blow-softening, events would have moved quickly. The collapse of the overleveraged financial companies would have started soon after credit market jitters began in August 2007. (Leverage built on overnight borrowing invites swift justice.) The disaster in the financial sector might have been over by the end of that year or soon after. The year 2008 would have seen the wave of layoffs and bankruptcies in operating companies and the fall in wholesale and consumer prices.

A simple process would have brought the contraction to an end. With the prices of most things falling, the real value of the money in everyone’s pocket would be rising. That would continue until large segments of the population came to feel cash rich and started spending. Dollars appreciated in value, not dollars newly printed, would finance the recovery.

And it would be a thoroughly healthy recovery, because the bankruptcy proceedings that came before it would remove the billion-dollar bunglers of recent years from positions where they can make expensive mistakes. Decision making about the allocation of capital would fall to the survivors, who, by their survival, had proven their ability and readiness to decide wisely.

There is precedent for this. In the depression of 1920-1921, for example, wholesale prices fell by nearly one half, and most of that fall occurred in a period of just six months. It was a violent experience, with widespread bankruptcies, but it was over in a year and a half. It ran fast because the government did so little to try to stop it. Nancy Pelosi hadn’t been born yet.

So much for the hypothetical. Instead, with all the government efforts to make things right, we have:

• An economy that continues to contract;

• A continuing mystery as to which banks are solvent and which are not;

• Financial institutions still under the control of individuals who’ve proven they should be doing something else;

• Car companies on apparently permanent life-support at taxpayer expense;

• A retarded decline in housing prices that is extending, by years, uncertainty as to how severe mortgage losses are going to be;

• A flock of new government programs that will continue to soak up billions of dollars per year long after the recession is over;

• A vast and unprecedented (that again) increase in the basic money supply, which is jet fuel for price inflation;

• A vast and unprecedented increase in peacetime government borrowing, which, when the recovery begins, will trap the government in a choice between letting interest rates rise (and risk choking off the recovery) and continuing to inflate the money supply (and kiss runaway price inflation on the mouth).
  

Yes, it does seem cruel to do nothing when disaster is unfolding. But consider the likely consequences of the alternative.

Doing nothing might be appropriate for Washington at this point in time… but it is not what you should do as an investor. Making the trend your friend is the strategy that will get you through tough economic times like this and provide you double- and triple-digit returns.

The Casey Report focuses on emerging trends to profit from even in highly volatile markets – whether it’s shorting stocks squarely in the way of the accelerating economic avalanche or investing in commodities that stand to gain big in the coming months. Test it now risk-free with our 3-month, 100% money-back trial… click here to learn more.