The 300 Club

From Dan Denning in St. Kilda

--You wouldn't get it from the lethargic vibe coming out of the news each day. But we get the distinct feeling that we're sliding toward an existential crisis for the Nation State as a competent, solvent institution for the 21st century. Enough of the carping about it, though. Today, we're going to begin doing something about it.

--First though, there's more evidence that a few of the world's governments are in over their heads. As we've said before, this is the year the global financial crisis becomes a sovereign debt crisis. It will put great strain on the bond market (rising yields, falling prices). That might be a nice boost for equities.

--But before you get really excited about the breakdown of the 20-year bull market in bonds and what it might do for stocks, remember we're talking the failure of a financial model for governments here. That is no small thing. No one really knows what it will mean, particularly if some of the bigger liberal democracies face ratings downgrades.

--Case in point, the United Kingdom of Great Britain and Northern Ireland. It faces an 80% chance of a credit-rating downgrade if it doesn't have more credible deficit reduction plans, according to PIMCO's Scott Mather. The UK is already on a "negative outlook" rating from Standard and Poor's, but still retains its AAA credit rating.

--The immediate problem for the UK and the US-aside from spending too much money-is central banks in both countries plan to remove their support for bond markets this year. This pushes up rates and raises the cost of servicing and raising new debt. And if you're economy isn't firing on all cylinders generating tax takings, your expenses rise while your income stays stagnant or falls.

--You don't have to be Nobel laureate to know that's not good for the national finances.

--But the results for investors are not so straightforward. Investment analyst Byron Wein reckons U.S. GDP will grow by 5% in 2010, unemployment will fall, the S&P 500 will rally to 1,300 in the first half of the year before closing at the same level, and that Fed funds rate will be pushed up from 0.25% to nearly 2%, giving the dollar a boost in the FX markets and pushing ten-year yields to 5.5%.

--Whew! That is a lot of predicting. But when you break it down it goes something like this: stocks up and then down, dollar up short term but probably down long term, bonds down. Japan, so-so.

--This begs the question of what time-frame you should be using for your investment decisions. Via our friend Dan Ferris we ran across an article in Forbes in which fund manager Whitney Tilson says the average holding period on the New York Stock Exchange is now six months. It used to be five years.

--One possible conclusion from this observation is that patience is still a virtue. Hold for longer and you'll avoid transaction costs. More importantly, you won't morph into a trader masquerading as an investor. You'll be focused on long-term value over short-term trends.

--The trouble with this idea is the market might smash it in the face. Higher volatility and more uncertainty about the future are both direct consequences of government manipulation of the cost of capital (the Fed setting interest rates). Investors aren't buying and selling more often because it's trendy, or fun, or more effective. They're doing so because Wall Street and Washington have made evaluating securities and their future earnings really difficult. How?

--Bad public policy and short-term corporate management have shortened the national time horizon to about five feet in front of the nation's face. That's not so good. We were discussing just this point with a wizened Uncle over a beer in the Colorado mountains last week.

--An essential piece of America's DNA is its short-term memory. The country began as a home to religious radicals and those fleeing the social and economic stasis of Europe. What they got and what they created-fuelled by an endlessly expanding frontier-is institutionalised revolution: constant change.

--That change-the chance to reinvent yourself by moving West and starting fresh-is what made the country so attractive to risk takers (and so ungovernable the further West you went). But that great virtue of reinvention has also led the nation to have a very short memory. And today that is a liability.

--America's heroes used to be frontiersman or traders or settlers. By definition, these people were literally at the margin of the national experience, pushing the country's borders West and encountering the native peoples and generating either commerce or friction and genocide. The violence of living and the margin (the frontier) also explains something of America's attitudes toward guns. You couldn't dial triple zero if you had to defend yourself from man or beast.

--But with such a short national memory, America today doesn't remember much about where it came from. Its heroes are what's on TV, mostly vacuous, over-fed, under-dressed celebrities famous for being pretty, or, even more superficially, for just being famous. The frontier of American experience has collapsed and falling in on itself. The nation now gazes at its fat belly, dirty with potato chips and barbecue sauce, and wonders where we're headed.

--Of course none of this has anything to do with Australia. We apologise for the diversion today. But we were asked about it last night by a stranger at the local pub who wanted to know more about America and what Americans thought of Aussies. We told him America is cheap right now. The cost of living is heaps lower than in Australia.

--But at the same time, there's a nationwide amnesia about the virtues of a free country: risk is rewarded, effort leads to results, thrift is prudent, and conspicuous consumption is wasteful. People know these things intuitively. They are just going to have relearn them from personal experience.

--In any event, great changes in social mood are afoot in 2010. And we're trying to sort out what that will mean for changes in personal financial behaviour. Will the Baby Boomers double down on stocks and try to rebuild the retirement kitty? Or will the evident failure of the Federal government to do anything well cause people to become a lot more conservative, favouring cash and bonds?

--Our revelation over the break was that we didn't really care either way what direction public policy was headed. The main thing is to be in control of your own financial future. You have to have a macroeconomic view in order to prepare and allocate your assets correctly.

--But after talking with family and friends we're convinced that this is the year you need to launch your financial lifeboat into the sea. Granted a storm is coming. But the big ocean liner we've been placidly cruising on is creaking ominously. More on what to put in the boat tomorrow.

And now over to Bill Bonner in Baltimore, Maryland:

"It's amazing...I love it!"

Elizabeth is rediscovering life in the USA. After 15 years, most of it in Paris, we are now living in the suburbs of Washington, DC...more below...

First, the financial goings-on.

How was the first day of 2010? Well, most commentators would say it was a good day. The Dow rose 155 points. Oil closed over $81. The dollar fell. And gold shot up $22.

Is that a good day, or what?

'Or what' is probably the best answer. Stocks rose. But are they forecasting a booming economy? Or more EZ money from the feds? Are they signaling the end of the slump? Or, no end to the feds' rescue efforts?

Here at The Daily Reckoning, we will stick with our view. We're in a depression. It won't end until it has done its work. And, with the feds trying to block it, prevent it, hold it off, deflect it and retard it, it could take years before this depression has finished its job.

Martin Feldstein, an expert on business cycles:

"The recession isn't over." In a Bloomberg Radio interview on December 17th.

David Rosenberg explains that 90% of the 'growth' in the third quarter came from stimulus measures. And that still only produced a 2.2% annualized GDP increase, far below the rates typical at the end of a recession.

"What is normal is that the first quarter of post-recession growth is that real GDP expands at a 7.3% annual rate; 2.2% is really nothing to get excited about - it's actually quite worrisome.

"Never in recorded history has growth coming out of a string of declines been as weak as what we just witnessed. Considering all the government efforts to usher in a V-shaped recovery, what we saw unfold in the real economy in Q3 - admittedly quite divorced from the action in financial markets - was, in a word, sad."

What is happening? How come so much government 'stimulus' produces so little real stimulation?

Well, because an economy is so heavy...you can only push it downhill!

Monetary stimulus only works when it pushes the economy in the direction it wants to go. When people want to buy, you can make them buy more by giving them more credit. But when they don't want to buy, extra credit doesn't help. Extra credit is what people don't want. Offering them more of it doesn't make it more attractive.

But government spending on the other hand - fiscal stimulus - is a more effective imposter. People see the feds spending money and they mistake it for genuine, economic activity. The government hires people. The government spends money. It looks just like the real thing!

Heck, it's better than the real thing. Because the feds pay better. And they don't have to worry about showing a profit either; the whole idea is to lose money...that's what fiscal stimulus is all about. Want a fiscal stimulus program? It's easy. Replace honest business activity with phony federal make-work. And replace honest workers with parasites!

Our friend Marc Faber writes that Congress has just voted the biggest health care initiative of all time - forcing everyone in the nation to participate, except Congress itself. The parasites have a better plan, naturally.

The number of federal employees making big money is growing fast. In the Defense Department, for example, "civilian employees earning US $150,000 or more increased from 1,868 in December 2007 to 10,100 in June 2009, the most recent figure available..." writes Marc.

Marc sees the US rapidly becoming a banana republic, in which elites use positions of influence to feather their own nests. Federal employees, lobbyists, politicians, government contractors, favored groups - all of them connive to strip assets from the public and use them to cushion their own fat derrieres. Typically, the banana republics have nice weather and bad money. They borrow too much...run their printing presses when they get in a jamb...and then go broke.

The world turns, doesn't it? While the US slips into banana-ism, the world's biggest banana republic, Brazil, is booming. It has the number one position for stock markets in 2009 - up 145%.

The US is fast becoming the worst kind of banana republic...one with ice storms and no bananas.

And more thoughts...

"You can buy practically anything at practically any time of the day or night. In France, shopping can be a major effort. The salespeople have no interest in selling you things. The stores aren't open. And they don't have what you want.

"But I just got back from Tyson's Corner. Look at this...I bought a television screen for $99. And a printer for the computer. And a whole set of sheets and towels. Everything is made in China or Vietnam, of course. But you can buy anything you need at that mall. Anything. I went into one store and there were 4 clerks waiting to help me. In France, you never find a clerk...and when you do they don't want to help you. These guys kept asking how they could help me. And then I went to Fresh Foods. First, it is amazing how much they have...the variety of things...and all of it looks so good... And then, when you go to check out, they have people who pack your bags for you...and take them to your car.

"It really is wonderful."

This morning, we hitched a ride into town with our daughter. Then, we needed to buy a vehicle to get home. We could live perfectly happily in Paris without a car, but you have to have wheels if you're going to live in the suburbs.

Not wanting to spend time looking, we asked an assistant to call around, find the best deal on a Ford F-150 pickup and buy it.

"I just don't have much time," we told her. "So try to make it as smooth as possible..."

She set to work at 10AM. At 3:25PM a young man appeared in our office with car keys in his hand.

"Mr. Bonner? Here are the keys to your new truck."

Sure enough, he was the low bidder. He got the sale and brought the truck to our door. Silver, with a bench behind the driver's seat. A full bed. Perfect for farm work on the weekends...and for Elizabeth to pull her horse van.

"Thanks for your business," he continued. "It's hard to find any customer these days. Business is very slow. At least, that's how it looks to me. A customer with a check in his hands is a real pleasure. Here's my home number. You call me if you have any questions or problems. Oh...and I filled it up with gas for you."

What a great country! It's probably easier to part with cash in the USA than any nation in the world.

Eric Fry, reporting from Laguna Beach, California
by Eric Fry

In today's edition of The Daily Reckoning, we turn our attention to the "Decade of No Returns" - aka, the "Lost Decade." Students of recent financial history may recall that our friends over in Japan have already logged a couple of "lost" decades. Japanese workers still punch time clocks every day, but the national economy barely seems to notice. Meanwhile, the Nikkei Index has surrendered 73% of its value during the last twenty years.

Here in the States, things are a little bit better. We've only lost ONE decade so far...

The S&P 500 Index posted a total return of MINUS 9% during the first ten years of the new millennium. And THAT was the "strong" index. The NASDAQ Composite tumbled 40% during the same 10-year span.

Stocks are not exactly synonymous with economic vitality, of course. And we know that US GDP increased during the decade. So maybe the US economy isn't as lost as the stock market suggests. But based on the nearby chart, the economy looks so disoriented that no GPS device on the planet could lead it back to the path of productivity. In terms of job creation, the last 10 years were a complete bust.

Despite an abysmal 10-years of zero wealth creation and zero job growth, betting on a second consecutive Lost Decade seems like a bad wager. And yet, it happened in Japan...

But let's not dwell on the negatives so early in this promising New Year. Instead, let's consider the potential positives - the upside of the downside. According to Patrick Cox, editor of The Breakthrough Technology Alert, adversity truly is the mother of invention:

"Historically, downturns have been enormously creative times technologically. Our current economic mess will be no exception. Economic pressures are forcing reassessments and hard, creative choices. The result will be an explosion of breakthrough technologies...

"In the early 1400s, German goldsmith Johannes Gutenberg invented the movable-type printing press. This invention did far more than facilitate book production and increase the availability of knowledge. It started an information technology (IT) revolution that continues to accelerate even today.

"In Gutenberg's era, his advances in lithography not only increased access to the world's greatest thinkers, they also put practical business and technical knowledge in the hands of commoners. This seemingly insignificant invention smashed monopolies of thought and political power. The result was exponential growth in science, technology and democratic ideals. The Renaissance and the Enlightenment followed, on up to our present era.

"We've already seen a series of printed circuit lithography technologies revolutionize the electronics industry. Every electronic device you own - from your television to your mobile phone - contains a lithographically printed circuit board of one form or another. Like many of the transformational technologies of the last century, it was invented during the Great Depression. The timing was not a fluke."

Eric Fry
for The Daily Reckoning Australia