Monday, December 19, 2005

12/19/05 Quotes, News and Views

All That Glitters...
...Ran across a couple of fascinating quotes today regarding gold - fascinating because of who made the quotes.

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves." .
"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard. "
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...The above quotes are from Alan Greenspan, believe it or not, in his 1967 essay Gold and Economic Freedom, as reprinted in the book Capitalism, The Unknown Ideal, by Ayn Rand in 1967. Mr. Greenspan was a disciple of Ms. Rand.
...What is even more remarkable, given his standing as Fed chairman, is this: Supposedly Ron Paul, the Congressman from Texas has an original copy of Mr. Greenspan's essay and asked the Chairman to sign it in 2002. He asked the Chairman if he still agreed with what he had written or whether he had changed his mind. Mr. Greenspan replied that he wouldn't change a single word of it. I consider that amazing, given Mr. Greenspan's position and our government's fiat money system and deficit spending.
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...More rumblings on the gold front from someone who thinks that Russia's central bank is preparing to buy a lot more gold.
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Wednesday, December 14, 2005

12/14/05 One Way To Make Sure You Are Getting An Honest Opinion

...Here is one tool I use that makes me confident I am getting an honest opinion from an institution. Get the quarterly reports for a mutual fund with a good track record. Then every quarter use a spreadsheet to record all changes since the last report. That way you can see all the new purchases, what they added to, what they trimmed, and what they dumped altogether.
...I use Oakmark, which is my favorite fund company. I am a long term investor in two of their mutual funds. Every quarter, I take the latest quarterly report and dutifully record every change. I use Oakmark because they have a good track record, I think they have integrity, and they are pretty open about their investment philosophy. For instance, when Oakmark makes a new buy, I know that they think the stock is at least 40% undervalued by the market; that they think the business is sound and has a good niche in its industry; and that it has a good management team that is shareholder friendly. Oakmark also typically has a 3-5 year time horizon on new buys, so I am confident that they will not buy during one quarter only to dump it the next. They won't dump it ahead of it reaching their general target areas unless they have changed their mind on it, something they don't do often, and they usually have a good reason when they do. And I have also noted over the years, they won't sell just because a pick has gone down. Often they will buy more!
...Not that I blindly use their picks. I don't. Once again, it is just one more tool I use when hunting for stocks. And the fact that I am much more short term oriented than they are makes a lot of their picks unsuitable for my trading portfolio. But then there are those magical moments that happen sometimes in the markets, too. I remember fondly the day that I was going through their report and found that they had just bought into XTO for the first time. I was already in XTO (wish I had just stayed in it from the very first time I bought in), but it made me feel good to see that Oakmark agreed on the pick, and that I had found it before they did. I felt even better much later when one of the Navellier Funds (I think it was NPMDX the one I used to follow) had bought into XTO enough that it was a top ten holding in that fund for them. I love it when my favorite value pickers (Oakmark) and a good growth picker (Navellier in my opinion) agree on a stock in which I already have a position. :)
...That strategy also makes me feel like I have a first rate professional staff doing research work for me, and I like that.

12/14/05 Difference of Opinions

A Difference Of Opinion Is What Makes Markets
...And my morning reading uncovers two very different opinions from two guys whose opinions I respect. MarketWatch's Mike Ashbaugh writes that the basically sideways price action of the markets over the past three weeks suggests a consolidation of the market's November gains, and is bullish. Remember also that in last week's MarketMail, Louis Navellier suggested that the current market environment was about as good as it gets.
...But there is always another side to the story, or I guess there wouldn't be a market. Up against those two bullish opinions from two market pros you may have heard of, let's hear from another precinct, from somebody you've likely never heard of, and in fact I don't know who he is either. He is a poster on the ClearStation bulletin boards who only goes by the handle 'dcb'. Dcb claims to be a hedge fund manager - I don't know if he is or not. That is one of the good and bad things about bulletin boards. The opinions are all out there, and you don't know who you are talking to, or whether they know anything or not. There are even people out there who use multiple aliases and hold entire conversations with themselves for their own nefarious reasons. But over the course of time you get to feel like you know certain personalities on the boards and whether they know what they are talking about or not. And dcb has shown himself to be very knowledgeable, IMO. I would not be surprised if he is indeed a fund manager. But that does not mean that I follow his or anybody else's advice blindly. I take opinions from people I have come to respect as one more data point when I am making my decisions. One of the biggest things that I had to learn as a trader was that I own my trading decisions. They don't belong to anyone else. If I lose on a trade that I went into because some expert said it was the thing to do, shame on me. The money is coming out of my account. And who knows? Depending on his reasons for making the recommendation, the money might even be going into his account. This is a tough game. Once I realized that the other big players at the table had a knife up one sleeve and an ace up the other, it actually made things fall into place for me and made me feel better. Things that had mystified me suddenly made sense. Now I could understand that there was really valid reasons behind strange and manipulated market action. Now that I could see the game in a different light, sharks controlling and manipulating everything from information to prices to extract money from us little fish, my choices were clear. Either walk away, or accept it for what it is, deal with it, and learn to profit from it. And that's what I have done from that point until now, though the roads still get very bumpy from time to time.
...Anyway, back to dcb. He looks at the exact same chart patterns as Mr. Ashbaugh and comes to a very different conclusion. He sees professional distribution. Dcb sees strong divergences between prices and the market internals, and to him, that is the sharks dealing out their holdings little by little to the little guys, but in a quiet manner so as not to spook them. And making soothing bullish pronouncements all the while.
...A couple of more comments on biases and opinions. One of the reasons that I read dcb's opinions, I suppose, is that they closely reflect my own. I tend to have a permabear mentality when it comes to the markets. It is easier for me to see the storm clouds than the silver linings. But the skittishness that comes from that mentality comes in handy sometimes, too. It enabled me to trade a $2k account actively for years without going under, something that at the time I had no concept of how difficult that is to do. Dcb believes that we are in a primary bear market, and the upswings we have seen since mid-2002 are actually just countertrend rallies occurring within the context of the primary bear market. Prices do not go straight up or straight down, although it seems they do sometimes when you are on the wrong side of a trade. The SPX is still about 200 points from its highs. Until it takes out those highs, we are still in a primary bear market - at least that's what we permabears think.
...While dcb and I tend to agree regarding major market themes, i find that we are often on the opposite sides on individual trades. But that is another concept of trading that seems to escape some people. Whether a particular chart pattern looks good to you or not can depend on what time frame you are trading. For example, some folks use weekly charts, some daily, some hourly, and daytraders even use one minute charts, maybe even less than that by now, I don't know. I remember the first time years ago I heard someone talking about the moving averages on the three minute charts, I thought he was kidding. But he was not. Charts are fractal in nature, and the same patterns can occur over and over again regardless of the time frame you are looking at. Someone trading on the basis of a weekly chart may see a bullish pattern, but an hourly trader knows that there can be wild peaks and valleys occurring within that same time frame.
...And there are differences in what kind of stocks to trade, and when to trade them. It's a big market. The realm of shorting stocks is another area that dcb and I almost always disagree on, it seems. I check his picks to see what he is doing. But almost always, what he regards as a short I wouldn't touch with a ten foot pole. He tends to short excessive strength that he believes cannot be maintained. When I am looking to go short, I look for weakness, not strength. There is an old saying that the market can remain insane longer than you can remain solvent, and I believe that one.
...For example, dcb shorted Google (GOOG) six times unsuccessfully before finally cashing in on the seventh time. But he is looking to get in on the exact turn and profit to the maximum when he gets it right. On the other hand, I usually look for stocks that are trading below their 200 day moving average when trolling for short candidates. Even though someone like dcb would say that stock such as that has already been trashed and the profit potential isn't there, I feel better shorting something that people have proved they don't want to buy.
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Tuesday, December 13, 2005

12/13/05 Sirius Satellite rant

...As I write this mid-session, shares of Sirius (SIRI) are down over 4% due mainly to a downgrade from the Banc of America analyst who lowered them from neutral to sell. First of all, I don't own any shares of SIRI or its main rival XM Satellite Radio (XMSR). If I were to own one, it would be XMSR because I think it is a better value, if either one of them is, and because I am uncomfortable with all the hoopla surrounding on-air personalities at Sirius and the expectation that they will be challenging the limits of indecency on the air in the future. But that's just me. There are thousands of stocks out there, and I don't have to own anything that makes me uncomfortable or doesn't suit me. I do follow SIRI on a semi-regular basis because I have two friends who are in it.
...As far as the valuation issue, and I agree with him on this, the BAC analyst lowered his price target for SIRI to $5.50. It closed last night $7.46, so you can see that would be quite a haircut. On the flip side, he has a target of $40 for XMSR, which closed last night at $29.96. He is advising investors to sell SIRI and buy XMSR. XMSR, he says, has about twice as many subscribers as SIRI, but its market cap is about 20% less. Here at mid-day, SIRI has already traded well over 50 million shares. According to Yahoo Finance it averages about 41 million shares a day in an entire session.
...Here's what I don't get. Why should anybody care about what an analyst says? If you are an investor in SIRI on a fundamental basis, you should already have known about these numbers. Otherwise, why were you in it? And if you already knew about the numbers, then why would you bail now or care what anybody says about it?
...As I stated a few days ago, Kiplinger's magazine was commenting about how some brokerage houses have an agenda when they make recommendations. Some won't recommend stocks for purchase unless they are paid to do so. I am certainly not saying that is what is going on here. I have no knowledge of BAC or this analyst and would not make any such accusation. He might be the best analyst out there for all I know. This rant is not about him.
...But even if he is the best, he might be wrong. So here's the point. You should be in a trade based on your own decisions, whether right or wrong. You should be doing your own homework. When somebody pumps or disses a stock, that doesn't mean that they are right. And you don't know if they are on the up and up or not, or whether they might have some sort of agenda. I'm constantly amazed by people who see somebody tout a stock (for free) on one of the cable shows, then run out and buy the stock, only to see it gap up the next day, then crash after all the lemmings get theirs. Day after day it happens, but it seems that people don't learn. They want a guru. I am dumbfounded when I listen to an expert guest tout a stock, meanwhile in this age of disclosure, the printed data on the screen carries the disclosure information that the guest doesn't own any of the stock he is touting, his company doesn't own any of it, his clients don't own any of it, his family doesn't own any of it, but he thinks it's a buy. Amazing. Wouldn't you rather hear him talking about something he does own? Wouldn't that be a better opinion? And just once I would like to hear the commentator ask the guest, "If you like it so much, why don't you or your company or anybody you know own any of it?" Now that would be good tv.
...Since I'm ranting (no more coffee today), SIRI also brings up another point. I am also constantly surprised by the number of people who love low priced stocks. Not inexpensive, they may be wildly overpriced at the cheap price, just a nice low single digit number, the lower the better. I have always thought that is one of SIRI's attractions to a lot of people. They don't realize that it is actually more expensive than XMSR - it just has so many more shares that the price of a single share looks lower.
...For the most part, when all things are equal, shares of a low priced stock are where they are for a reason. If there were a demand for those shares, they would trade higher. But everybody likes to feel like they are getting a bargain. This isn't Wal-Mart, folks. And a thousand dollars of a stock is a thousand dollars of a stock, whether its 10 shares of a $100 stock, 100 shares of a $10 stock, or 1000 shares of a $1 stock. As Mr. O'Neil of IBD fame puts it, if you were building a baseball team, would you want a bunch of .240 hitters because you could get them cheaper, or would you rather have some all-stars. Same thing in the market.
...One last thing regarding today's action in SIRI. It makes me wonder how many people are just in the trade because it is low priced (in their estimation) and hot, and they have had their fingers on the trigger, figuring they would try and make money now and race everybody for the exit door when the music stopped. If I were a true believer in SIRI, I would be using days like today to add to my position, not bail. But I'm not in it one way or the other, and won't be, so I just watch and enjoy the show.
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12/13/05 Notes: Bears Rubbing Their Paws In Anticipation?

...It's cold here in the frozen north, and going through the financial news this morning is enough to make an old bear zip up the fur suit and go roll out in the snow for a while. Some interesting links out there today for those of you who might be interested in getting other takes on the stories that you hear from the cheerleading talking heads all day. And most of these links, interestingly enough, are not from permabear types who regularly see the sky falling.
...For example, Jim Jubak, who writes a regular column for the MSN Money site, frets that there are at least five trends that appear to be converging nastily and could impact the markets next year. I think this article, titled '5 Big 'Ifs' Investors Face in 2006', is a must read, as most of Jubak's articles are. Of the five, one of them is a theme that I have pounded on here ad nauseum, and that is if China and India don't slow their rate of growth, investors will have to contend with runaway commodity prices. But all five of the threats he mentions should at least be considered when making investment decisions in the coming year. He also has an update to an earlier column, '5 Reasons The Fed Will Fumble In 2006', that is worth the read. In his update, he notes that consumer credit, which is info provided by the Fed showing how much consumers borrow each month, fell by $7.2 billion, the biggest amount on record, in October. The Street had been expecting an increase of over $5 billion.
...The above two articles may make it seem as if Jubak is a permabear type, but that is not the take I've gotten over the years. He is a very good stockpicker, and as I have said before, folks could do worse than use his model portfolios as a part of their investigative processes when looking for stocks.
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...In today's MarketWatch, Paul Farrell's Last Christmas Before Next Recession is kind of scary, but interesting, as is Farrell. I usually read his stuff, even though I often am on the other side of his arguments. For example, he is virulently opposed to market timers and insists that market timing can't work, and has gotten into very spirited debates with folks on the other side of that issue. In today's article, Farrell also quotes four heavyweights in the financial arena, including our own Fed chairman, Mr. Greenspan, who has been quoted as saying, "Our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. The consequences for the U.S. economy of doing nothing could be severe."
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...And then there's a couple of articles regarding the gold rush that has been taking place in the markets of late. As I stated a few days ago, I used to be something of a gold bug, but don't trade it anymore. I try to make trades where I make money, not lose it regularly, and I came to the conclusion that there were some very big players with vested interests in making sure that gold was suppressed and was never considered currency again. It turns out that theory may not be quite as crackpot as it might seem at first glance to 'normal' folks.
...MarketWatch's Peter Brimelow discusses the gold rush and the varied opinions he got from most of the old time gold bugs. In short, many of them are as nonplussed about the freight train advance as everybody else.
...And over at Jim Puplava's Financial Sense Online site, Rob Kirby writes in the daily Market WrapUp Column about the strange fact that since August gold and the dollar have both advanced, a fact that contradicts all the traditional wisdom that is constantly trotted out in the mainstream press. Gold is supposed to be the anti-dollar. This article and the quotes it contains are very interesting. The gist of the article is that a lot of folks may be short gold a lot more than they should be, and as a result, the chickens are finally coming home to roost and they are hung out to dry. How's that for mixing a bunch of metaphors? And maybe not so coincidentally, the article notes that the in-tandem march of both gold and the dollar started back about the time when GATA (the Gold Anti Trust Action Committee) held a landmark conference on August 8 and 9.
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...Another precinct heard from regarding the runup in gold prices. Russia just announced that they increased their gold and currency reserves increased by $40 billion dollars through the first ten months of 2005.

Friday, December 09, 2005

12/9/05 News, Views and Notes

Big Bullies Taking Our Lunch Money...
...While waiting at the doctor's office yesterday, I read through the September 2005 issue of Kiplinger's magazine. Their managing editor in his piece at the front of the magazine was basically recounting some recent sins of some big market insiders and how they profited at the expense of us little guys.
...Among the things he mentioned were several big mutual fund companies allowing other institutional traders to purchase shares of their funds hours after the market close, at the closing price for the day, after those investors checked out how other markets were performing. In other words, they were giving them an edge intentionally, something that they would not do for you.
...Another issue he raised was the practice of some brokerage houses not recommending a stock for purchase unless they were paid to do so. How's that for an honest opinion?
...And last, but certainly not least if you are a trader, is the practice of some market specialists of violating their fiduciary duties in handling orders. Some of them actually front run their customers orders. Imagine that! One example of how they do this: Say a stock is trading at $29.90 bid and $30.00 ask. The specialist receives market orders from a buyer and a seller. Instead of matching them up, he fills the buy order at $30.00, and the sell order at $29.90 and pockets the dime on each transaction. Doesn't seem like much, but it adds up.
...According to the article, these crooks made off with about $19 million dollars over the past few years at their customers expense via this practice. That number sounds low to me. The article wondered how this could be going on. Isn't there someone out there watching out for us?
...He laments that the solution of the overseers seems to be to videotape some of the specialists some of the time in order to keep them on the up and up. His solution: Get rid of the specialist system and use electronic trading to match up all buy and sell orders. Sounds logical to me, although I'm sure somebody can come up with a good argument for keeping specialists. One would be that they are supposed to be buyers and sellers of last resort - at least when they are doing what they are supposed to do - I seem to recall that a lot of them didn't answer their phones on the fateful crash day in 1987.
...I can see that being a buyer or seller of last resort would be a lousy deal on a particularly bad market day, but look at what a sweet deal it is the other 99%+ of the time. The specialist sees all orders out there. He can see when there is buying or selling coming into a stock. And he or she is allowed to trade for their own account. How would you like to be trading with that edge? He can see where all the stops are placed, and has the ability (so I hear) to run the prices in one direction to clean out all the stops just before allowing the market to run back the other direction.
...He can even take one side or the other in a trade, all the while seeing all the information available while his opponent in the trade doesn't. How sweet is that? Here's an example I read in a daytrading book years ago. Suppose the marketmaker (MM) has a 100,000 shares of market buy orders and 40,000 shares of market sell orders that came in overnight. Remember, he gets to pick the price at which the stock will open for the day. Now he can adjust the opening price to a point where he sees that there are sufficient sell orders out there at higher prices to basically match the buy and sell orders.
...Or, he could set the price at a place where there will be a total of 80,000 sell orders matched up against the 100,000 buys. And he could then go short out of his own account the other 20,000 shares. If he does that, would you feel safe in betting that the stock is going to be opened at a higher price than it closed, and then is going to sell off after the open? Think about it. He gets to pick the opening price. He is going to go short 20,000 shares at whatever price he decides to open the stock. Do you think the stock is going up or down after the open? What would you do if you were the MM? That's right, and it's legal. Does that explain at lot of the severe up and down intra-day spikes you see day after day in the stocks you follow?
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Define 'is'....Nice article on MarketWatch today by Mark Hulbert. The gist of the article is that some of the information we receive is sleight of hand when it comes to P/E ratios. Hulbert points out that "...some advisers are playing fast and loose with the historical data to make it appear as though the stock market's price-earnings ratio isn't as above-average as it really is."
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Gold rush?...
Gold has been making quite a move recently for whatever reason. There's a lot of opinions out there. And the gold bugs have been slobbering all over themselves on the bulletin boards. I read an article today in the mainstream press about gold being a possible alternative currency. I have a hard time believing that, but we'll see.
...I used to be something of a gold bug years ago, but became disillusioned after getting whacked on gold trades on a too regular basis. I came to the conclusion that gold is one of the more manipulated markets out there. IMO, gold is never going to be officially recognized as currency by most of the world's economic powers. It would be disastrous for them. When the U.S. officially cut its last ties to the gold standard in 1971, that changed things forever.
...IMO, the central banks of the world have a vested interest in making sure that gold is not considered currency. Take our example here in the U.S. We use fiat money. Our notes are currency because our government says it is. And our masters at the Federal Reserve can expand or contract the money supply as they wish, since there is nothing as restrictive as a gold standard to compel them to do otherwise. So when you go long gold as a fundamental investment in the belief that gold is going to be money again, you are betting against the central banks of the world. You are betting against unbelievable power and money. There are better odds elsewhere.
...I will say, though, that there appears to be something going on out there this time. But I am still betting on the real world powers to squash it at some point. They have been able to do that every time for over twenty years, and I'm thinking they will again.
...What might be out there that would be different this time? Not sure. Some folks think that it might be the Iranian oil bourse next year. From what I understand, they will not be using the U.S. dollar as the unit of exchange for oil transactions. And from what I hear, that is a very big deal to us. Here's an opinion (not mine) on that, presented just to give you another side of a potentially big story that doesn't seem to get much mention in the mainstream press. And here's another.
...I also hear that there is increased Chinese demand. Here is just one article on that. And IMO the Chinese are the whale in any pond they enter.
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...Winter here in the frozen north. Be careful. It's slippery out there.


Monday, December 05, 2005

12/05/05 Tools and Links

...I subscribe to Louis Navellier's free weekly market newsletter MarketMail. Navellier sends it out every weekend, or when there is extraordinary movement in the market averages. Mr. Navellier is generally optimistic and can find the silver lining in nearly every scenario, it seems to me, but I think this newsletter is worthwhile. You can sign up at Navellier's website if you are interested.
...In the latest MarketMail, Mr. Navellier gushes about how the current market environment is about as good as it gets. For an exactly opposite view, see The Comstock Partners Market Commentary. I like these guys, too, but sometimes I think they have called 10 of the last 2 market crashes if you know what I mean. But I like getting different opinions.
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Tools: Here's a couple of free tools that I find very useful when checking out stocks. The first is Navellier's Stock Grader. It issues proprietary grades for each stock in 10 different categories, and an overall grade. It's a neat tool in my opinion.
...The other is MSN's StockScouter. It issues an overall stock score on a scale of 1-10, and letter grades A-E on four different subcategories, such as fundamentals for example. Another excellent tool.
...It is interesting to see how different folks grade stocks. Last week, I came across a couple of articles about railroads, and I saw a report where an analyst, it seemed to me, mentioned and recommended about every major railroad company left in the country except for the one I am in, Burlington Northern Santa Fe (BNI). So, just for fun, I decided to see what Stock Grader and StockScouter had to say at the time (The Stock Grader site is updated with new scores weekly, not sure about StockScouter.)
...Stock Grader had BNI as an A; CNI, NSC and CSX all as B's. But StockScouter had BNI as a grade 7 (pretty good), but the other stocks as 8's and 9's. I think it's because Navellier gives more weight to growth type stocks and isn't concerned about high valuations as much as other raters, who sometimes think a stock is overbought simply because it is higher priced than its competitors. Mr. Navellier seems to think that some stocks justifiably command higher prices because they are the ones people want to own.
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12/05/05 Quotes

..."No generation can contract debts greater than may be paid during the course of its own existence." Thomas Jefferson in a letter to James Madison.
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..."Today, the child born in America practically has an electronic ankle tag put on him immediately. He’s got his share of about $50 trillion in obligations to pay; they need to make sure he doesn’t get away. As far as we can tell, no other generation in history has ever been burdened to such an extent with the expenses of its parents." Bill Bonner in today's Daily Reckoning.
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...“America’s debt will not be paid by those currently working, nor even by those currently breathing. It will be pushed on to the next generation…and the next. One generation consumes, the other pays. What the first enjoys as a blessing comes to the next as a curse.” Bill Bonner in today's Daily Reckoning.
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...Today's Daily Reckoning is a recommended read. I check them out on a regular basis. I don't always agree with their assessments, and I certainly don't appreciate some of their opinions, but I usually find them interesting. I like getting a viewpoint that is often the polar opposite of the mainstream media. And I think that Bill Bonner turns a phrase as well as about anyone out there, so I tune in sometimes just for his writing.

...Here's some tidbits from the article: American households spent $531 billion dollars more than their after tax income in the 3rd quarter 2005... According to the Heritage Foundation, national debt is expected to be $16 trillion by 2017.
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...Above is a repost from my other blog, but this is all data that likely will impact the stock market at some point in time.

Saturday, December 03, 2005

12/02/05 Mr. Greenspan speech

...Following is the speech that Mr. Greenspan delivered at the Advancing Enterprise Conference in London, England. I list it here for future reference since he discusses some important topics that could impact not only the markets, but also the daily lives of most Americans at some point in the future.
...Mr. Greenspan has a reputation for being vague. People joke about listening to his speeches, then scratch their heads and say, "What did he say?" But I have found over the years that not only is he a little more direct than given credit for, but he also is surprisingly forthright at times about systemic risks. He has made a lot of pointed comments over the years, but many times those comments are either not reported in the mainstream twenty second soundbite mentality, or they are displayed and then forgotten.
...Here's the link to the entire speech from the Federal Reserve website.
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Excerpts (highlights and emphases are mine):

In November 2003, I noted that we saw little evidence of stress in funding the U.S. current account deficit even though the real exchange rate for the dollar, on net, had declined more than 10 percent since early 2002. Inflation and inflation premiums embedded in long-term interest rates--the typical symptoms of a weak currency--appeared subdued, and the vast international savings transfer to finance U.S. investment had occurred without measurable disruption to international financial markets. Two years later, little has changed except that our current account deficit has grown still larger. Most policy makers marvel at the seeming ease with which the United States continues to finance its current account deficit.

Of course, deficits that cumulate to ever-increasing net external debt, with its attendant rise in servicing costs, cannot persist indefinitely. At some point, foreign investors will balk at a growing concentration of claims against U.S. residents, even if rates of return on investment in the United States remain competitively high, and will begin to alter their portfolios. In addition, efforts by U.S. residents to address their domestic imbalances will presumably contribute to a move away from current account imbalance.

In all instances, a current account balance essentially results from a wide-ranging interactive process that involves the production and allocation of goods, services, and incomes among the residents of a country and those of the rest of the world. The outcome of the process is reflected in the full array of domestic and international product and asset prices, including interest rates.

The array of bilateral exchange rates between the dollar and foreign currencies appears to be particularly important to the current account balance, although, of course, exchange rates, like all other prices, are determined interactively and simultaneously. As I note later, to the extent that an economy harbors elements of inflexibility, so that prices and quantities are slow to respond to new developments, the process of current account adjustment, besides affecting prices of goods and financial assets, is also more likely to adversely affect the levels of output and employment as well.

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The rise of the U.S. current account deficit over the past decade appears to have coincided with a pronounced new phase of globalization that is characterized by a major acceleration in U.S. productivity growth and the decline in what economists call home bias. In brief, home bias is the parochial tendency of persons, though faced with comparable or superior foreign opportunities, to invest domestic savings in the home country. The decline in home bias is reflected in savers increasingly reaching across national borders to invest in foreign assets. The rise in U.S. productivity growth attracted much of those savings toward investments in the United States. The greater rates of productivity growth in the United States, compared with still-subdued rates abroad, have apparently engendered corresponding differences in risk-adjusted expected rates of return and hence in the demand for U.S.-based assets.

Home bias implies that lower risk compensation is required for geographically proximate investment opportunities; when investors are familiar with the environment, they perceive less risk than they do for objectively comparable investment opportunities in far distant, less familiar environments.

Home bias was very much in evidence for a half century following World War II. Domestic saving was directed predominantly toward domestic investment. Because the difference between a nation's domestic saving and domestic investment is the near-algebraic equivalent of that nation's current account balance, external imbalances were small.1

However, starting in the 1990s, home bias began to decline discernibly, the consequence of a dismantling of restrictions on capital flows and the advance of information and communication technologies that has effectively shrunk the time and distance that separate markets around the world. The vast improvements in these technologies have broadened investors' vision to the point that foreign investment appears less risky than it did in earlier times.

Accordingly, the weighted correlation between national saving rates and domestic investment rates for countries representing four-fifths of world gross domestic product (GDP) declined from a coefficient of around 0.97 in 1992, where it had hovered since 1970, to an estimated low of 0.68 last year.2

To be sure, international trade has been expanding as a share of world GDP since the end of World War II. Yet, through the mid-1990s, the expansion was largely a grossing up of individual countries' exports and imports. Only in the past decade has expanding trade been associated with the emergence of ever-larger U.S. trade and current account deficits, matched by a corresponding widening of the aggregate external surpluses of many of our trading partners, most recently including China and the OPEC countries.

Indeed, the increasing dispersion of current account balances is closely tied to the shrinking degree of correlation of country shares of saving and investment.3 Obviously, if domestic saving exactly equaled domestic investment for every country, all current accounts would be in balance, and the dispersion of such balances would be zero. Thus, current account imbalances require the correlation between domestic saving and investment--which reflects the ex post degree of home bias--to be less than 1.0.

Home bias, of course, is only one of several factors that determine how much a nation actually saves and what part of that saving, or of foreign saving, is attracted to fund domestic investment. Aside from the ex ante average inclination of global investors toward home bias, the difference between domestic saving and domestic investment--that is, the current account balance--is determined by the anticipated rate of return on foreign investments relative to domestic investments as well as the underlying propensity to save of one nation relative to that of other nations.

Indeed, all these factors working simultaneously determine the extent to which domestic savers reach beyond their borders to, on net, invest in foreign assets and thereby facilitate current account surpluses and the financing of other countries' current account deficits.

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This afternoon, I should like to raise the hypothesis that the reason the historically large U.S. current account deficit has not been placing persistent pressure on the exchange rate of the U.S. dollar, at least to date, is that the deficit is a reflection of a far broader and long-standing financial development in the United States and elsewhere.

An ever-growing proportion of U.S. households, nonfinancial businesses, and governments, both national and local, fund their capital investments from external sources, rather than, for example, household self-finance or corporations' internal funds. Early on, almost all of that financing originated with U.S. financial institutions, and the debt of U.S. residents to foreigners was small.

The uptrend in unconsolidated deficits of individual U.S. economic entities relative to GDP has been evident for decades, possibly even emerging during the nineteenth century. For most of that period, those deficits were almost fully matched by surpluses of other U.S. economic entities. What is special about the past decade is that the decline in home bias, along with the rise in U.S. productivity growth and the rise in the dollar, has engendered a large increase by U.S. residents in purchases of goods and services from foreign producers. The increased purchases have been willingly financed by foreign investors with implications that are not as yet clear.

Typically, current account balances, saving, and investment are measured for a specific geographic area bounded by sovereign borders. Were we to measure current account balances of much smaller geographic divisions, such as American states or Canadian provinces, or of much larger groupings of nations, such as South America or Asia, the trends in these measures and their seeming implications could be quite different than those extracted from the conventional national measures of the current account balance.

The choice of appropriate geographical units for measurement depends on what we are trying to ascertain. I presume that in most instances, we seek to judge the degree of economic stress that could augur significantly adverse economic outcomes. To make the best judgment in this case would require current account measures obtained at the level of detail at which economic decisions are made: individual households, businesses, and governments. That level is where stress is experienced and hence where actions that may destabilize economies could originate. Debts usually represent individual obligations that are not guaranteed by other parties. Consolidated national balance sheets, by aggregating together net debtors and net creditors, accordingly can mask individual stress as well as individual strength.

Indeed, measures of stress of the most narrowly defined economic units would be unambiguously the most informative if we lived in a world where sovereign or other borders did not affect transactions in goods, services, and assets. Of course, national borders do matter and continue to have some economic significance, an issue to which I shall return.

The process of growing trade and financing imbalances has been developing within the borders of the United States for some time. The dispersion of unconsolidated current account balances of individual economic entities relative to nominal GDP may be expected to exhibit similar trends to the dispersion of saving-investment imbalances among the seven consolidated nonfinancial sectors measured in U.S. macroeconomic statistics: households, corporations, nonfarm noncorporate business, farms, state and local governments, the federal government, and the rest of the world.4 This measure exhibits a rise over the past half-century in the absolute sum of surpluses and deficits that is 1-1/4 percentage points per year faster than the rise of nominal GDP.5

The increase in the dispersion of the balances of unconsolidated economic entities was presumably even greater.6 Indeed, in a more detailed calculation employing more than five thousand nonfinancial U.S. corporations, the absolute value of surpluses and deficits as a ratio to a proxy for corporate value added exhibits an average annual increase of 3-1/2 percent per year.7

The apparent increase in the dispersion of the imbalances of the economic entities within our national borders appears to have flattened out over the past decade, according to calculations using the balances of the six domestic sectors. The continued expansion of the dispersion of the balances, relative to GDP, of individual households, nonfinancial businesses, and governments during the past decade is arguably related to the shift in trade and financing from within the borders of the United States to cross-border trade and finance.

In simple terms, competing with easome U.S. domestic businesses previously purchasing components from domestic suppliers switched to foreign suppliers. These companies generally view domestic and foreign suppliers as competitive in the same way that they view domestic suppliers as competing with each other. Moving from a domestic to a foreign source altered international balance bookkeeping but arguably not economic stress.8 Such transactions may, of course, take into account exchange rates in the adjustment process, similar to the manner in which prices of purchased components presumably are taken into account when one domestic supplier is substituted for another.

Implicit in a widening dispersion of current account surpluses and deficits of individual economic entities is the expectation of increasing cumulative deficits for some and, hence, a possible rise in debt as a share of their income.9 Unconsolidated debt of private nonfinancial U.S. entities as a ratio to GDP has, indeed, risen at nearly 3 percent per year, on average, over the past half-century.10 From 1900 to 1939, nonfinancial private debt rose almost 1 percent faster per year on average than GDP. The debt-to-GDP ratio fell in the wake of the inflation of World War II and its aftermath, which inflated away the real burden of debt. The updrift in the ratio, however, shortly resumed.

As I noted earlier, the trend toward intra-country dispersion is likely occurring not only in the United States but in other countries as well. The existence of this trend is suggested by the rise in unconsolidated nonfinancial debt of the major industrial economies, excluding the United States, over the past three decades, which has exceeded the growth of GDP by 1.6 percentage points annually.

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The apparent increase in the dispersion of the surpluses and deficits of U.S. economic entities over the past half-century and more is likely an extension of the growing specialization of the economy and the financial system within the United States. I suspect data would confirm similar trends among many of the other developed economies as well.

Increasing specialization goes back to the beginnings of the Industrial Revolution. Movement away from economic self-sufficiency of individuals and nations arose from the division of labor, a process that continually subdivides tasks, creating ever-deeper levels of specialization and improved productivity. Such specialization fosters trade.11

Trade, especially intertemporal trade--that is, the trade of goods and services today in exchange for goods and services at some future date--tends to give rise to a range of surpluses and deficits across individuals and nonfinancial businesses. And in all likelihood those imbalances have been increasing faster than income. As a result, the dispersion of such imbalances relative to incomes, or national product, can be expected to increase as the scope of trade expands from within regions, then nation-wide, and finally across national borders.

That surpluses and deficits of residents of the United States have indeed been rising relative to incomes over the past century is indicated by a similar rise in assets of financial intermediaries relative to the total of nonfinancial assets and to nominal GDP. It is these financial institutions that have largely intermediated the surpluses and deficits of U.S. residents, and hence the size of these institutions can act as an alternative proxy for such surpluses and deficits. Indeed, one can argue it has been the need to intermediate the surpluses and deficits that has driven the development of our formidable financial system over the generations.

Since 1946, the assets of U.S. financial intermediaries, even excluding the outsized growth in mortgage pools, have risen 1.8 percent per year relative to nominal GDP. From 1896, the earliest date of comprehensive data on bank assets, to 1941, assets of banks, by far the predominant financial intermediaries in those years, rose 0.6 percent per year relative to GDP.

The increase in the ratio of deficits of individual economic entities to GDP, as I noted earlier, is reflected in an ever-rising ratio of unconsolidated levels of debt to GDP. Facilitating the ability of residents of the United States and, presumably, other economies to accumulate this debt with limited stress has been the rising ratio of the market value of nonfinancial assets to GDP. The rise in those asset values in the United States reflects, in part, an increasing ratio of real capital assets to real GDP, which has helped to support the rise in U.S. productivity.

Hard data documenting these global developments at the appropriate microlevel are regrettably sparse. Yet anecdotal, circumstantial, and some statistical evidence is suggestive that the historically large current account deficit of the United States may be part of a broader set of rising unconsolidated deficits and accumulated debt that is arguably more secular than cyclical. The secular updrift in deficits and debt doubtless has been gradual. However, the component of those broad measures that captures the share of net foreign financing of the balances of individual unconsolidated U.S. economic entities--our current account deficit--has increased from negligible in the early 1990s to more than 6 percent of our GDP today. The acceleration of U.S. productivity, which dates from the mid-1990s, was an important factor in this process.

Accordingly, it is tempting to conclude that the U.S. current account deficit is essentially a byproduct of long-term secular forces, and thus is largely benign. After all, we do seem to have been able to finance our international current account deficit with relative ease in recent years.

But does the apparent continued rise in the deficits of U.S. individual households and nonfinancial businesses themselves reflect growing economic strain? (We do not think so.) And does it matter how those deficits of individual economic entities are being financed? Specifically, does the recent growing proportion of these deficits being financed, net, by foreigners matter?

If economic decisions were made without regard to currency or cross-border risks, then one could argue that current account imbalances were of no particular economic significance, and the accumulation of debt would have few implications beyond the solvency of the debtors themselves. Whether the debt was owed to domestic or foreign lenders would be of little significance.

But national borders apparently do matter. Debt service payments on foreign loans, for example, ultimately must be funded disproportionately from exports of tradable goods and services, whereas domestic debt has a broader base from which it can be serviced. Moreover, the market adjustment process seems to be less effective across borders than domestically. Prices of identical goods at nearby locations, but across borders, for example, have been shown to differ significantly even when denominated in the same currency.12 Thus cross-border current account imbalances have implications for the market adjustment process and the degree of economic stress that are likely greater than those for domestic imbalances. Cross-border legal and currency risks are important additions to normal domestic risks.

But how significant are those differences? Globalization is changing many of our economic guideposts. It is probably reasonable to assume that the worldwide dispersion of the balances of unconsolidated economic entities as a share of global GDP noted earlier, will continue to rise as increasing specialization and the division of labor spread globally.

Whether the dispersion of world current account balances continues to increase as well is more an open question. Such an increase would imply a problematic further decline in ex ante home bias. Even in that event eventually the U.S. current account deficit would likely move back toward balance.

Regrettably, we do not as yet have a firm grasp of the implications of cross-border financial imbalances. If we did, our forecasting record on the international adjustment process would have been better in recent years. I presume that with time we will learn.

In the interim, whatever the significance and possible negative implications of the current account deficit, maintaining economic flexibility, as I have stressed before, may be the most effective initiative to counter such risks.

Whether by intention or by happenstance, many, if not most, governments in recent decades have been relying more and more on the forces of the marketplace and reducing their intervention in market outcomes. We appear to be revisiting Adam Smith's notion that the more flexible an economy the greater its ability to self-correct after inevitable, often unanticipated disturbances. That greater tendency toward self-correction has made the cyclical stability of an economy less dependent on the actions of macroeconomic policy makers, whose responses often have come too late or have been misguided.

Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset. The impressive performance of the U.S. economy over the past couple of decades, despite shocks that in the past would have surely produced marked economic disruption, offers clear evidence of the benefits of increased market flexibility. In the United Kingdom, as well, a quarter-century of progress toward dismantling controls and increasing reliance on market forces evidently has resulted in a stronger and more flexible economy.

Although the business cycle has not disappeared, flexibility has made the United States and the United Kingdom, and much of the remainder of the global economy more resilient to shocks and more stable during the past couple of decades. Nonetheless, the piling up of dollar claims against U.S. residents is already leading to concerns about concentration risk. Although foreign investors have not as yet significantly slowed their financing of U.S. capital investments, since early 2002, we have observed a decline in the value of the dollar and a reduction in the share of dollars in global cross-border portfolios.13

If the currently disturbing drift toward protectionism is contained and markets remain sufficiently flexible, changing terms of trade, interest rates, asset prices, and exchange rates will cause U.S. saving to rise, reducing the need for foreign finance and reversing the trend of the past decade toward increasing reliance on it. If, however, the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy.


Footnotes

1. National income accounting establishes that the gap between domestic saving and domestic investment is equivalent to net foreign saving; net foreign saving is a close approximation of the current account balance.

2. Doubtless, part of the increasing ex post gap between nations' domestic saving and their domestic investment reflects the exogenous rise of competitive risk-adjusted rates of return in the United States, which would have attracted cross-border investments even without a change in ex ante home bias. Nevertheless , even excluding the United States, the correlation coefficient declined from 0.96 in 1992 to 0.58 last year. Of course, excluding the United States from the calculation does not also exclude the growing ex post non-U.S. surpluses, which were drawn to high U.S. rates of return.

3. Because domestic saving less domestic investment is equal, with small adjustments, to the current account balance, the dispersion of domestic saving less domestic investment among nations is a very close approximation to the dispersion of current account balances.

4. I include the "rest of the world" sector because it measures surpluses or deficits of U.S. residents even though they reflect the accumulation of net claims on, or of obligations to, foreigners. The other six sectors reflect net claims on or obligations to domestic residents only.

5. Disregarding statistical discrepancies, the net of deficits and surpluses of these seven sectors is, of course, zero.

6. Consolidation of any group of economic entities reduces dispersion. Full consolidation of the entities eliminates it.

7. The surpluses (and deficits) are measured as income before extraordinary items, plus depreciation, minus capital expenditures. The proxy for corporate value-added is gross margin, or sales less cost of goods sold.

8. Of course, domestic firms and workers that lose sales will be adversely affected, at least until they can be reallocated to more competitive uses.

9. Cumulative deficits of individual economic entities will increase net debt, i.e., gross debt less financial assets. But in the large majority of instances gross debt will rise with net debt.

10. Part of this rise possibly reflects a growing proportion of income generated by GDP accruing to debtors. In recent decades, however, the proportion of economic units with no debt has been relatively small. Nominal GDP, of course, is net value-added and is not affected by consolidations of accounts.

11. There is no necessary reason, of course, why such trade need be imbalanced.

12. The persistent divergence subsequent to the creation of the euro of many prices of identical goods among member countries of the euro area is analyzed in John H. Rogers (2002), "Monetary Union, Price Level Convergence, and Inflation: How Close is Europe to the United States?" Board of Governors of the Federal Reserve System, International Finance Discussion Paper 740. For the case of U.S. and Canadian prices, see Charles Engel and John H. Rogers (1996), "How Wide Is the Border?" American Economic Review, vol. 80, pp. 1112-25.

13. Of the more than $30 trillion equivalents of cross-border banking and international bond claims reported by the private sector to the Bank for International Settlements for the end of the first quarter of 2005, 41.8 percent were in dollars and 39.8 percent were in euros. Adjusting for exchange rate changes, the dollar's share was 4 percentage points less than three years earlier, and the euro's share was more than 5 percentage points greater. Monetary authorities have been somewhat more inclined to hold dollar obligations. At the end of the first quarter of 2005, of the $3.8 trillion equivalents held as foreign exchange reserves, more than three-fifths were held in dollars and approximately one-quarter in euros. Since early 2002, the dollar's .

share has been little changed after adjusting for movements in exchange rates.

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...Ok, it was long and tedious. But there's a lot of important stuff in there relating to the new global village economy. But how will that affect the lives of ordinary American citizens? Time will tell.
...By the way, this is from the main web page of the Fed: "The Federal Reserve, the central bank of the United States, was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system."
...How's that been working out? From what I understand, a dollar back then is now worth a nickel today in terms of purchasing power. Is that stability?
...Did you know that the Fed is not really a government agency? It is a private corporation.
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