Agora Financial’s Rude Awakening

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Laguna Beach, California

• Markets slip again as bear market rally loses momentum,
• U.S. recession vs. Japan’s lost decades – four ominous charts,
• Capitalism’s false incrimination and plenty more…

Eric Fry, reporting from Laguna Beach, California…

“Little else is required,” Adam Smith, author of The Wealth of Nations, once remarked, “to carry a state to the highest degree of affluence from the lowest barbarism but peace, easy taxes and a tolerable administration of justice; all the rest being brought about by the natural course of things.”

But this quintessentially laissez-faire perspective gains very little traction in modern-day America. In fact, it gains no traction whatsoever, except in a few fringey financial publications. Instead, America’s political elite conspires with the Wall Street bourgeoisie to lead the nation from the highest degree of affluence to the lowest barbarism.

The process begins innocently enough in the name of “crisis management,” as the political elite provides multi-trillion-dollar guarantees and bailouts to the Wall Street bourgeoisie. The proletariat embraces these bizarre, counterintuitive remedies because they genuinely believe these “remedies” contain curative powers. In other words, the proletariat believes that bureaucrats and politicians, following the self-serving recommendations of inept finance company executives, can deploy taxpayer dollars to the benefit of the masses.

Include us out.

The bureaucrats and politicians lack the requisite skills; the Wall Street bourgeoisie lack the requisite morality. Like a meeting between coyotes and butchers, nothing good could ever come from close interaction between Washington and Wall Street. If the butchers suggested converting all felines into meal, the coyotes would simply yelp and howl their approval

Your editors here at the Rude Awakening would prefer that the coyotes and butchers not conspire with one another. No one benefits….other than the coyotes and the butchers.

But what’s the use of complaining. We try never to complain, merely to understand. We try to identify and anticipate the key influences that are operating upon the financial markets. Identifying the key influences is usually not that difficult. But determining the effect of these influences is often very difficult.

During the last several months, for example, investors have been greeting the daily barrage of bad economic news as GOOD news for the stock market. We are not exactly certain why this would be so, but we are familiar with the daily banter of various financial news media. Therefore, we have encountered, ad nausea, phrases like, “better than expected,” “green shoots of recovery,” and “credit markets improving.”

We have encountered these phrases, and we have thoroughly and completely rejected them. We do not believe these phrases contain a single atom of validity, nor a single molecule of data that will produce a profitable investment result. That said, we should point out to the newest readers of the Rude Awakening that your editors have been wrong before…and may be again.

But we won’t let that stop us. The stock market’s splendid rally during the last three months was a classic bear market rally. The S&P 500, the Dow Jones Industrials and the NASDAQ Composite all rallied more than 40%. But great big rallies like these are not rare during great big bear markets.

As we pointed out last week, Japan’s Nikkei 225 Index rallied more than 40% on ten different occasions during the last two decades. And yet, the Nikkei remains more than 50% below the all-time high it established in 1989.

Could a version of this sorry scenario unfold here United States? Sure. Why not?

The nearby charts place the recent rally on Wall Street in a “Japanese context.” The chart above compares the first 20 months of our current American bear market to the first 20 months of the Nikkei’s bear market. The chart below places this 20-month period in a 20-year context. If the American stock market were to have the misfortune of mimicking the Nikkei, the road ahead would be long and painful.

Your California editor is not predicting such a scenario. But neither does he believe that “Happy days are here again.” The road ahead – both for the economy and for the stock market – is likely to be long and painful. How long and how painful is anyone’s guess. Our guess would be: Not as bad as Japan’s experience, but much worse than most Americans currently expect.

The chart above may contain a helpful glimpse into the future we fear. Despite the fact that most investors believe the worst of the recession is behind us, the nation’s employment situation is far worse than anything we have endured during the last five recessions.

So you tell me, are things getting worse or are things getting better?

The only thing we know for certain is that government intervention increases by the day, Wall Street’s malevolent influence increases by the day, the pressure to raise taxes increases by the day, the nation’s monstrous indebtedness increases by the day, threats to the dollar’s vulnerabilituy increases by the day, and therefore the long-term viability of America’s legendary capitalistic dynamism DE-creases by the day. For more on this topic, please read the column below.

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The Death of American Capitalism
by Dr. Marc Faber

When I consider that prosperity is created by “peace, easy taxes and a tolerable administration of justice,” I begin to fear that the U.S. and other Western governments are doing their very best to impoverish their countries.

A friend of mine, Michael Berry, whose missives I always read, could not have phrased this idea better than in “Importance of the Individual”, a recent report in which he quotes Milton Friedman in a 1979 interview by Phil Donohue.

Berry writes: “On February 11, 1979, Milton Friedman took two and a half minutes to explain the critical importance of the individual and choice in the free enterprise system to a doubting Phil Donohue…The individual’s freedom and ability to choose and take risks to create value are, of course, all-important life elements and a cornerstone of our country…

And yet, Berry continues, “Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual…This is not, ‘Change We Can Believe In.’ It is ‘change we must be wary of.’ Where is Milton Friedman when we really need him? Think carefully about the following interview which was conducted 30 years ago:

‘Phil Donohue: When you see around the globe the mal distribution of wealth, the desperate plight of millions of people in underdeveloped countries. When you see so few haves and so many have-nots. When you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism? And whether greed is a good idea to run on?

‘Milton Friedman: Well first of all tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fella that’s greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kind of societies that depart from that.

‘So that the record of history is absolutely crystal clear, there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.

‘Phil Donohue: Seems to reward not virtue as much as the ability to manipulate the system.

‘Milton Friedman: And what does reward virtue? You think the Communist commissar rewards virtue? You think a Hitler rewards virtue? Do you think… American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of political clout? Is it really true that political self-interest is nobler somehow than economic self-interest? You know, I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don’t even trust you to do that.’”

Certainly, you won’t find any angels at central banks around the world or in the Economics faculties of universities. I needed quite a stiff drink after reading a recent Wall Street Journal article by Harvard Professor Gregory Mankiw, who advocates creating negative real interest rates through inflation and seems to have great sympathy for the outright expropriation of savers’ capital.

Professor Mankiw declared his faith in the curative powers of inflation in February 1, 2000 article in the dead Wall Street Journal. “When you look at the mistakes of the 1920s and 1930s,” he said, “they were clearly amateurish. It is hard to imagine that happening again – we understand the business cycle much better.”

The current Federal Reserve Chairman, and of a very large number of US economists, share Mankiw’s perspective – a perspective that he reiterated in a very recent Wall Street Journal piece, entitled, “It May be Time for the Fed to Go Negative” (Wall Street Journal, April 19, 2009).

“With unemployment rising and the financial system in shambles,” Mankiw observes, “it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. [He means negative interest rates]…Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

Inflation is the answer says Mankiw – a Goldilocks style of inflation that is neither too hot nor too cold.

“Ben S. Bernanke, Fed chairman, is the perfect person to make this commitment to higher inflation,” Mankiw concludes. “Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.”

Unfortunately, inflation is a wolf in sheep’s clothing. It seems relatively tame and friendly. But it is quite the opposite. Inflation leads an economy down the path of impoverishment. If a government is determined to create inflation, there is really nothing standing in the way of its doing so.

Nevertheless, an investor can – and should –take precautions. When governments speak openly about creating inflation as a cure for macro-economic ills, the seeds of economic malaise are already germinating.

Gold anyone?

Joel’s Note: You can catch Dr. Faber at this year’s Agora Financial Investment Symposium in Vancouver, British Columbia. This year’s event promises to be the best on record, and it is already 70% sold out…so secure your ticket now. Get all the information you need right here.

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[Rude Endnote: As mentioned above, U.S. markets extended Monday’s losses yesterday. Both the Dow and S&P 500 finished the session down 1.25% while the Nasdaq managed a 1.11% decline.

Markets across Europe look to be following in Wall Street’s footsteps again today with measures from London to Berlin in the red early on. The City’s FTSE was off by just over 1% last we checked while France’s CAC and Germany’s DAX were down nearly 1.3%.

Here in Asia Hong Kong’s Hang Seng ticked down about half a per cent while Japan’s Nikkei 225 actually managed to gain almost a full per cent for the day. The Aussie’s lost 1.45% on their All Ordinaries index.

In the crude pits, a barrel of the globe’s grease still hovers just above $70. Gold, meanwhile, seems to be holding somewhat steady for now around $935 per ounce.

We’ll be back with more Rude views tomorrow, including a few field reports from our myriad unpaid Rude correspondents. (A big thanks for everyone who wrote in, by the way. Your emails kept this editor well entertained while convalescing from his recent back injury.)

Until tomorrow…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com

P.S. We’re down to less than 200 of Byron King’s “Laughing Gold” Reports. Unlike U.S. dollars, we can’t print more when they’re done. Final copies available here.