Bear Case Overview
Strategist, American First Trust Financial Services
There is strong evidence that America's economic trends and outlook may
be far more serious than has been generally reported in the national
media. Prudent investors need to be aware of the full spectrum of bear
case arguments, even if it is hard to prove the validity of certain
trends or understand when or where they might reach a "tipping
point" where they could fully impact the economy and market. All of
that having been said, this report explains why I think it is likely the
market will continue to significantly decline over the next couple of
years or longer.
key macroeconomic indicators look bad
with no near term recovery in sight.
Debt is at historic highs and
keeps growing while credit quality is deteriorating.
According to Doug
Noland, author of "Credit Bubble Bulletin," Total indebtedness
(corporate, personal, and government) is currently about three times GDP
compared to 2.6 times during the Great Depression. Corporate and
individual bankruptcies are at record highs. Consumer spending, which
comprises about 75% of GDP, now appears to be slowing down as a result
of higher debt levels eating into discretionary funds, while credit
creation by Government Supported Enterprises such as Fannie Mae, GNMA,
and Freddie Mac outside the banking system continues to grow by as much
as 20% a year. The national strategy of outsourcing manufacturing and
emphasizing services through a very liberal approach to "free
trade" has distorted our economy in both directions. The mortgage
refinance boom has been an important element to provide consumers with
liquidity and keep the economy going, but this can not last forever.
The economic activity pulse is
Consumer sentiment is
low, production is in a slump, and hiring is at its worst point in
twenty five years. The U.S. personal savings rate has dropped to nearly
zero. cf. Jim Puplava "What
Ails Our Economy."
The balance of trade deficit is
over the 5% of GDP "danger zone" and keeps growing.
The U.S. has gone from
being the net creditor of the world to the world's greatest debtor
nation. In the recent past, foreigners have used their excess dollars
generated by the balance of trade deficits to buy around 15% of
America's stocks and about 40% of its Treasuries. America consumes 6% of
the world's savings to finance its deficit.
Dollar slide trend shows no sign
The dollar has lost
about 20% of its value against the Euro in the last year, and looks
likely to continue sliding much further. Normally a dollar slide could
be simply a cyclic corrective process that will make exports cheaper and
imports more expensive, decreasing imports and increasing exports to
bring things back in balance. Bears fear that something more ominous has
taken place; that is, America has exported so many jobs and facilities
overseas that it has seriously hollowed out its manufacturing base and
does not offer enough quality products to eliminate its trade deficit
problem even at lower prices. In classical economics, over the long run,
a strengthening currency is a good sign that a country is increasing its
manufacturing base, productivity, innovativeness, standard of living,
and quality of its products (from this viewpoint, a unit of currency is
roughly like holding a share of stock in an entire country). Countries
such as Argentina that went from being a first world country at the
beginning of the 20th century to a third world country by its end suffer
from continuing currency slide problems.
A sliding dollar tends
to scare foreign investors, encouraging sell-offs of their shares in the
U.S. equity markets and their holdings of U.S. bonds. If the dollar
continues to slide, the Fed may need to raise interest rates to attract
foreign investors to help finance America's burgeoning deficits. Rising
interest rates can crimp business recovery and reduce stock values
Earnings growth for American
companies is still lackluster.
Analysts continue (as
they have since 2000) to revise earnings growth estimates downward from
initial rosy projections such as a 20% growth rate looking forward a
year to well below 8% as the projected time periods arrive. High tech
companies complain again that inventory channels are backing up.
The global economy is still
stalled out with no near term turn around in sight.
There is no major
advanced industrial nation around to act as an "global economic
engine." Japan and Europe are both in recession. If the Japanese
economy becomes more distressed and Japanese start pulling investment
funds out of the U.S, that could hurt the dollar and U.S. markets
further. China has the world's fastest growing major economy with a
large balance of trade and currency surplus, and the national media
usually portrays this as wonderful news. But there is an important dark
side to the "free trade" miracle of China that American
business magazines and business school professors rarely mention in
their discussions about free trade. (On the benefits side, the basic
idea is that if all nations focus on their comparative advantage through
free trade, a global version of the division of labor concept will
supposedly make nations wealthier, and wealthier peoples tend to be
happier and friendlier to each other). The Chinese work force is
effectively engaged in a labor price war with American, Japanese, and
European workers, working long hours for almost nothing to gain global
manufacturing market share. India is trying to play the same game as
China, but is not nearly as significant.
In one sense, this really is a
"war," that is, rather than operate in muddy trenches while
sacrificing lives, the contestants work grueling hours under substandard
conditions with low paychecks to achieve the same ultimate goal as in
most shooting wars, that is, gain market share or command of natural
resources that translate into enhanced national economic, military, and
political power. Please remember that a manufacturing base is part of
the total power equation, which is why Sherman's troops in the Civil War
and Allied bombers in World War II leveled every manufacturing facility
they could strike at. If being an American citizen is comparable to
belonging to an American "union;" Chinese workers are
analogous to "strikebreakers" in the global economy. As a
point of fact, the Chinese "miracle" has had a
militaristic/nationalistic struggle tinge to it, to the extent that the
Chinese government has made it a practice to place active duty Red
Chinese Army officers in charge of newly privatized industries. A
Chinese firm controls both ends of the Panama canal, and American
"free trade" goods have gone into Chinese ICBMs that can now
incinerate our major cities. (c.f. the video interview of global
investment gurus Jim Rogers, Marc Faber, and Daniel Yergin which
validates many of the key points in this Bear Case Overview, and
includes an extensive, albeit "gushing" discussion of China.
Marc Faber claims the U.S. dollar has to drop 80% before the U.S. will
become competitive with the Chinese RMB currency. Click to the "Riverside
Conversations" interview. Although this has a Dutch language
introduction, the interviewees speak in English.)
The overall U.S. stock market
valuation remains high.
Despite the S&P's
decline by nearly half since March 2000, according to State Street
Global Advisor strategist Diane Garnick, the S&P 500 still trades at
30.4 times trailing GAAP earnings, well above its 53-year average of
16.2. Most prolonged bull markets have been followed by bear markets
that are proportional to them. From 1982 to 2000 the U.S. had the
longest secular bull market in its history, capped by the greatest mania in
history from 1995 to 2000. We are only two and a half years on the
backside of all this. Please note the PowerPoint presentations "Buy
& Hold?" and "Why the Bear Market Is Not Over" (Prudent
Bear Library) Also, Bill Gross, head strategist of PIMCO Funds,
thinks the Dow must drop below 5000 before it is positioned to offer
reasonable risk-adjusted returns. (c.f. "Dow
The stock market decline has
hurt business and government.
A further downward
market spiral could threaten to increase the "negative wealth
effect" in which eroding portfolio values reduce consumer
confidence and consumer spending. The "negative wealth effect"
is already impacting corporations, for example IBM now has to devote 20%
of its cash flow for the last year to bringing its pension plan back up
Kasriel) Lack of capital gains tax revenue and recession is now
causing about half the states in America to talk about raising taxes: http://www.nytimes.com/2003/02/14/national/14TAX.html.
This could threaten to choke off business profits and capital investment
required to create jobs and sustain economic recovery.
Interest rates are at historic
lows and seem to have no way to go but back up.
So far dramatic drops in
interest rates by the Fed have been "pushing on a string" to
revive the economy. The problem is that if interest rates start moving
back up, rising debt service could help push America into a liquidity
trap. (Fed Chairman Alan Greenspan voiced concerns about reaching a
"point of no return" in his recent Congressional testimony,
discussed at CBSMarketWatch.
America's money supply is
growing at torrid pace threatening to ignite serious inflation.
According to Jim Puplava
the money supply grew at 16% in the 4th quarter of 2002. Its growth has
averaged at least two to three times the officially reported inflation
rate of 2-3% over the last five years. Historically, inflation runs
parallel to money supply growth. From 1995 to 2000 the U.S. was able to
ramp up the money supply and run balance of trade deficits and get away
with it, largely because foreigners were willing to sop up excess
dollars as a global reserve currency or invest their dollars in
America's roaring stock market. Now the global demand for dollars is
holding constant or even reversing, and meanwhile the money pump keeps
going. Russians have started dumping dollars for Euros, and many Islamic
countries plan to dump dollars for a revival of the ancient Arab gold
coin the Dinar as a reserve currency. Dollars washing back at the U.S.
would encourage inflation. Critics voice concern that by ramping up the
money supply to stave off the impact of the Asian crisis beginning in
late 1997, followed by similar actions regarding the Russian default and
LTCM crisis in 1998, followed by the Y2K concerns of 1999, followed by
efforts to stave off a U.S. market and economic collapse since 2000, the
Fed has created additional bubbles in the economy besides the stock
market bubble, such as bubbles in consumer finance, the bond market, and
the mortgage finance/real estate market.
Risks of "shocks" is
high, particularly related to oil, terrorism, and financial system
Oil shocks helped to
induce the stagflation of the 1970's. Marshall Auerbach explains how we
might see higher overall oil prices even if the U.S. quickly occupies
Iraqi and its oil fields. (See)
Oil prices are sensitive to relatively small supply disruptions, and
last year the Alaska pipeline was shut down for two days to fix damage
from a hunter's rounds. Al Qaeda has targeted the global oil industry
for sabotage, as reflected by a recent attempt to attack the world's
largest refinery in Saudi Arabia. Another point on oil: global demand is
escalating, particularly from China, while North America and other areas
outside of the Middle East face a production decline curve. "War
for oil" will probably become an increasingly familiar theme in the
21st century. Check out Jim Puplava's "PowerShift"
series on oil, politics, and war.
As for a possible
financial system meltdown, many bears believe that there are still a lot
of other "Enrons" and "LTCM's" out there waiting to
happen (Long Term Capital Management is the hedge fund that blew up in
1998). A prime suspect is Dow Company JP Morgan Chase, implicated along
with Citigroup in suspect dealings with Enron, and which has over 20 trillion
(twice America's GDP) in derivatives exposure, whose counterparty risk
and deal structure quality is open to question. The LTCM blow up
required a coordinated Fed/bank bailout to avoid a financial meltdown.
The problem is that JP Morgan Chase is on an order of magnitude 100 to
1000 times larger and may not be "containable" if it blows up.
(J.P. Morgan is being sued along with Citigroup for allegedly helping
Enron set up bogus offshore entities, also, as mentioned elsewhere, it
is being sued by Blanchard &. Co. for alleged gold market
manipulation. The company has been experiencing profitability problems
in its retail banking operations, and many critics claim that they can
only guess what is going on in the derivatives area).
...This does not
include American bank exposure to third world countries such as Brazil
and Argentina that are unlikely to ever repay their debts. Pat Buchanan
wrote about the most recent crisis in "Bailing
Out Brazil or Robert Rubin?" (Aug 14, 2002) in which the Bush
Administration stepped in on behalf of the big banks to stave off the
day of reckoning one more time. As Buchanan points out, although the
third world debt problems started with prior administrations, no one
wants to be in the wheelhouse when the ship hits the reef. This is
actually ominous information, because it implies that we have top policy
makers who are in fact desperately trying to "keep up
appearances" at all costs while sweeping major problems under the
rug that only get larger and messier over time and morph and reemerge in
other places. Pat Buchanan wrote on January
27th that he thinks the global economy could be on track to crash.
Financial risk to
American corporations has increased because the high amount of debt they
have absorbed in their capital structure. As an example, according to
Adam Barth in "The
Collapse of the Inverse Pyramids," in regard to the thirty
"blue chip" companies that make up the Dow Jones industrial
average, "The Dow’s net tangible assets are presently leveraged
at a 6/1 ratio- a capital structure bearing far greater resemblance to a
hedge fund than a prudently financed corporation."
on a government, corporate, Wall Street, and national media level
may still be adding fuel to the fire, driving us deeper into crisis.
Symptom suppression and feedback
Critics charge that in
the late 1990s the Fed and U.S. Treasury intervened to artificially
build a strong dollar and suppress the price of gold and silver to mask
underlying economic problems and disguise inflation, and now we are
beginning to experience pent up whip-lash as the smoke-and-mirrors act
begins to unwind. Among other things, an artificially strong dollar
increased demand for the exports of third world countries struggling to
pay their debts to major U.S. banks. As part of this pattern, the U.S.
bailed out Mexico in the mid-1990's following the Peso crisis. An
artificially strong dollar and artificially low inflation rates also
helped fuel the greatest speculative stock market in history and make
money for major Wall Street firms.
Misleading inflation reports.
The topic of inflation can be complicated by the process of netting out
pockets of deflation resulting from cheap imports from China and lower
cost chips from the microcomputer chip revolution with pockets of
inflation elsewhere, such as in basic commodities, consumer durables,
and asset prices (stocks and real estate). But step back and look at the
big picture, and Jim Rogers sees plenty of snake oil in the way
"inflation" is being presented overall to Americans. Go to his
archives at www.jimrogers.com,
click on "articles," scroll down to "22 March 2002 They
Are Lying To Us Again." (This was published in a summer 2002 issue
of Worth Magazine).
How policymakers may have put
the gold and silver barometer of inflation to sleep for a while.
John Embry, chairman of
investment committee for the Royal Bank of Canada, has accused the Fed
and U.S. Treasury of artificially suppressing the price of gold through
coordinated central bank sales. You can find his internal report that
got leaked to the public by clicking on 'The Embry Report" archived
at Chris Temple's National Investor "Other Experts" web site
In Dec 2002, Blanchard
& Co., the largest retailer of physical gold in America, filed a $2
billion anti-trust law suit against Barrick Gold Corp and J.P. Morgan
Chase for "unlawfully combining to actively manipulate the price of
gold" and making $2 billion in short-selling profits by suppressing
the price of gold at the expense of individual investors.
James Sinclair, lauded
by Forbes magazine as a successful CEO of a precious metals trading
company and gold mining firm, accuses the Fed and Treasury of using an
Exchange Stabilization Fund and other tools to manipulate gold as well
as currencies. He provides a brief history of the ESF, created by
Congress in 1934, and some insight into how it manipulates markets in
his Dec 5, 2002 guest editorial "What is the Difference between
Stabilization and Manipulation?" Go to www.jsmineset.com
and type the title of the article in the search box.
Manipulation of commodities
markets and general stock market.
Jim Puplava describes
how "gearing" may be behind "flag pole" rallies that
have periodically bolstered the markets: http://www.financialsense.com/Market/archive/shortsilver_1.htm
According to Puplava, the gold and silver markets are among the most
heavily "geared" markets of all. He claims there are about
three times as many short positions in derivative contracts on gold and
silver as there is physical gold and silver to cover. Most long
contracts get rolled over rather than delivered on the commodity
exchanges. If the longs all demanded delivery, some financial observers
think that this could possibly cause panic and possibly bring down some
exchanges...and maybe even J.P. Morgan Chase, which some sources believe
is heavily exposed in this area. Bill Murphy, head of the Gold Anti
Trust Action Committee, provides important insights in his interview
with Jim Puplava at: http://www.financialsense.com/transcriptions/Murphy.htm.
...a quick editorial remark...
when the price of gold steadily declined under the pressure of central
bank sales and other influences from 1996 to 1999, it threatened to put
half of the world's gold mining companies out of business. Back in 1996,
many investors responded to Alan Greenspan's comment about
"irrational exuberance" regarding overall stock market
valuation (the Dow then was at 6500) by seeking to diversify into gold
as a safe haven, only to see it collapse underneath them as internet
stocks without earnings kept moving up. "Prudence" was
punished and recklessness was rewarded. This is a theme I will return to
later in my comments in the "grid-lock" section about social
values getting turned on their head. Ironically, back in 1966, during
his more Bohemian days as a member of Ayn Rand's inner circle, Dr. Alan
Greenspan wrote a paper titled "Gold
and Economic Freedom" in which he stated towards the last two
paragraphs: "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...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."
So in other words, if
John Embry is correct, Alan Greenspan's Federal Reserve policy has been
a major adversary of gold, yet in his younger years Dr. Greenspan was an
ardent supporter of gold. Ayn Rand's laissez faire, libertarian
capitalist philosophy is generally against big government and Fed
intervention, yet Dr. Greenspan's Fed has presided over one of the most
proactive Feds in history in terms of money expansion and support for
deficit Federal spending. This dovetails with a theme I reinforce at the
end of this report about the need for the American people and their
policymakers to resolve inconsistencies, establish credibility, and sort
things out. (Jim Rogers thinks Greenspan's policies as Fed Chairman have
been a disaster, as pointed out in his excellent 22 Oct 2002 article
"For Whom the Closing Bell Tolls" archived at www.jimrogers.com).
Could a headstrong guns and
butter policy drive us to double digit inflation?
According to my
introductory economics textbook by MIT professor Paul Samuelson,
societies can afford either guns or butter but not both. Go for both,
and financially beleaguered governments eventually end up running the
printing presses to make ends meet --and one gets serious inflation.
(For example, in the 1970's Vietnam-related spending plus the Great
Society Programs plus oil shocks helped to give us stagnation and double
digit inflation that killed the stock market).
The Bush Administration
has proposed a $500 billion deficit, or some huge number like that (it
keeps changing, and the real number, that probably includes government
"slush" accounts, is probably much larger). Our national debt
is officially around $6.5 trillion (again, who knows what it really is,
unless one can somehow uncover and figure out all of the "off
balance sheet" and social security-related obligations) and is now
perhaps somewhere around 65% of America's $10 trillion GDP. As a general
rule of thumb, when a nation's debt gets over 100% of GDP, it runs into
a serious danger of falling into a liquidity trap. In fear of this, in
the late 1990's, Sweden and Canada slammed on the austerity brakes to
bring down their national debt levels just in the nick of time. There is
currently no sign this is happening in America, in fact, quite to the
contrary. Fed Governor Ben S. Bernanke and Chairman Alan Greenspan have
stated publicly that they are willing to err on the side of trying to
inflate our way out of tight spots. As mentioned elsewhere in this
report, Alan Greenspan recently expressed concern about a liquidity trap
in his recent Congressional testimony. In the aforementioned video
interview with Marc Faber and Jim Rogers, the two individuals claim that
the Fed is clearly signaling that inflation is ahead.
Corporations need to rebuild
"Illusory Profits Cloud USA Inc" claims that profit growth may
have been overstated by American S & P 500 companies by about 150%
from 1995 to 2000. http://news.bbc.co.uk/1/hi/business/2075864.stm
Warren Buffet stated in a November 1999 Fortune article that on average
companies in the 1990's actually had below average profits and earnings
growth, particularly compared to the 1950's. In other words, deceit was
practiced far more widely than by just Arthur Anderson.
Major Wall Street firms still
need to show they know what they are doing.
Back in late November
2002, Wall Street firms faced over $1.0 billion in fines over charges
that they misled investors during the boom years. Post bubble
performance has been problematic as well; according to David Futrelle,
in "Rebuilding Credibility on Wall Street" (Business2.com, Feb
8, 2002): "Consider the results of a recent survey by Zack's
Investment Research: For the second year in a row, researchers
discovered that the stocks that were least popular with analysts
ultimately performed the best. Stocks with the highest percentage of
"sell" ratings moved up nearly 60 percent in 2001, while the
stocks with the highest percentage of "buy" ratings (you
guessed it) plunged more than 70 percent." Part of this could be
due to herd instinct that exists in all industries, for example Forbes
Fisher points out how the consensus year ahead forecasts of Wall
Street strategists has tended to be consistently wrong in his studies
that have gone back a decade.
The national media has been a
big part of the problem.
Please note the Washington
Post expose: "The
Media Fueled New Economy and Vice Versa", read about Maria
"Money Honey" Bartiromo and other cheerleaders in "On
CNBC, Boosters for the Boom", and lastly, this article explains
why the media tends to deny the reality of a bearish economy: "Why
James Grant Will Never Be Louis Rukeyser" at Bloomberg.
overall patterns may suggest something more serious
than a relatively short, self-correcting recession
A movie running backwards?
Morgan Stanley economist
Steve Roach has commented that all of the "virtuous circles"
that led to economic and market expansion in the 1990's seem to have now
reversed into vicious circles, and it feels like the 1990's
"movie" is now running backwards.
Worse than Japan?
Contrary to the current
Wall Street consensus that America is different, Doug Noland in "Pondering
Post Bubble America" argues that the U.S. is actually worse off
than Japan and may emulate the tragedy of Argentina. Japan entered its
decade of economic malaise as a net surplus, net creditor country, which
has given it a cushion that the U.S. now lacks as a net debtor country
with record trade deficits.
Are we overly
"grid-locked" when it comes to handling the REAL problems?
(Are policymakers so encumbered with "hidden agendas",
conflicts of interests, "super ordinate goals," and
misperceptions that they are unlikely to adequately address and help
"fix" our economic problems any time soon?)
Lew Rockwell argues
that America's policy makers are too steeped in inappropriate Keynesian
economic ideology to adequately diagnose and cure our economic ills
(c.f. "George W. Keynes" and "Keynes
Rules From the Grave" in his archives) Rockwell's
"Austrian" school of economics (www.mises.org),
whose proponent Friedrich von Hayek has been idolized by Forbes
magazine, emphasizes saving, prudent investment, cost control, and free
markets as the true path for viable economic growth. Keynesian economics
emphasizes utilizing credit expansion and deficit government spending to
stimulate overall demand. This can be great for pork barrel politicians
and big money center bankers looking to boost loan volume, but tough on
Joe Average American when he finds out that he is tapped out on
unsecured debt while overextended business owners have to cut back on
jobs. Lets rewind the tape here for a moment and recollect that
"Deficit spending is simply a scheme for the confiscation of
wealth" according to Dr. Alan Greenspan (as mentioned elsewhere in
this report) performed by people who might hold the "shabby secret
of the welfare statist's tirade against gold."
writer and CBS Market Watch commentator Peter Brimelow argue that most
Americans are ideologically blind to trends that are permanently
altering the country's social fabric, undermining core values,
increasing welfare and other "drag" costs to the economy while
decreasing its overall level of social and economic efficiency (cf.
reviews of his book "Alien
Nation" at his site www.vdare.com)
From the left, Gore
Vidal claims that policy makers are showing some serious inconsistencies
in terms of their obligation to support and defend the U.S.
Enemy Within" and "The
Last Defender of the American Republic?". (Somewhat
paradoxically, there are commentators on the right such as Pat Buchanan
and Ron Paul who have been making similar observations as Gore Vidal).
Since 1998, the U.S.
has lost 13% of its manufacturing jobs, and NAFTA has exacerbated our
trade deficits. Go to www.aflcio.org,
click on "manufacturing," scroll down and click on "IUC
Report: The Crisis in Manufacturing." Complete with narrative,
charts, and graphs, this paper talks about the results of policymakers
who may be so steeped in internationalist, free trade ideology (or just
plain short-sighted greed) that they have forgotten that charity begins
at home while they proceed to export manufacturing infrastructure, trade
secrets, and skilled, tax-paying jobs overseas to countries that engage
in dumping, gross worker exploitation, vicious human rights violations,
and use of our technology for hostile purposes. Some "free
trade" partners even threaten to become our military enemies, such
as China, which makes angry noises at the U.S. over Taiwan and
influences North Korea behind the scenes. Much of Saddam Hussein's
chemical warfare arsenal (which he freely used in the Iran-Iraq War and
is probably hiding right now), was supplied to him by American
companies. As another paradox, it was a Democratic President and
supposedly ardent friend of organized labor in America, Bill Clinton,
who helped push through the North American Free Trade Agreement that
organized labor decries as a major policy blunder.
Let me summarize here...
There are dozens of sources I could
point to in this area, but what they all have in common is the following
theme: sure, there have been manias and market booms and busts before;
there were stock market booms surrounding canals, telegraphs, railroads,
and electrification in the 1800s and the automobile and radio and
aviation in the early twentieth century. In their day, these innovations
seemed every bit as exciting and revolutionary to prior generations as
the microchip and internet revolutions have been to our generation.
However, the mania from 1995-2000 has dwarfed all prior manias hands
down. The accounting scandals have dwarfed all previous periods of mass
dishonesty. Because of the sheer scale and magnitude, a lot of social
critics are wondering if there is something much deeper going on, that
is, a society that has become too cacophonous in terms of its core
values, and where it does show commonality in values, it appears to be
deeply infected with immediate gratification and a socially
irresponsible "devil take the hind most" and a "wise
guy" approach to life. (Even among some of the sources I like, such
as Jim Rogers and Peter Brimelow, they are at loggerheads on whether an
open borders policy is an economic and social blessing or an economic
and social disaster). Many bears believe America is: a) economically,
ideologically, and ethically too deeply distorted to get back on the
road to true prosperity any time soon and b) there is probably a lot
more negative news and "settling of accounts" left ahead
before things get sorted out and get put back on track.
No evidence yet that we AREN'T
headed towards costly boondoggles and "imperial overstretch."
For thousands of years
Central Asia has been a graveyard for overconfident empires much like
Russia was for Hitler and Napoleon. Empires that wage costly, prolonged
military ventures without keeping their manufacturing and general
economic base healthy have eventually imploded, such as the Spanish and
British Empires. Larry Lindsay, President Bush's former economic
advisor, lowballed an estimate of $200 billion to go to war with Iraq.
The longer term tab for "nation rebuilding" and prolonged
occupation for more than five years could exceed a trillion dollars. And
of course we still have troops in Germany and the Balkans and South
Korea other exotic places around the globe.
Just as in the case of
buying a risky stock or mutual fund, when it comes to foreign policy, it
can be a good idea to mentally model in advance the possible outcomes
and envision double up, stop loss, or exit strategy points. As the Bush
administration and media talk about going into Iraq and taking a hard
line towards other countries such as Iran and North Korea, the report
cards coming out of Afghanistan are hardly "straight A". (For
example, numerous accidental bombings of civilians --to include a
wedding, U.S. troops abandoning posts along the Pakistani border,
increasing tempo of insurgent operations; (c.f. See SFGate.com
of U.S. Victory are a Little Premature")
Are we up against a hydra?
Let me share a joke that
circulated in Germany in the early 1980's when Israel invaded southern
Lebanon with massive tank and aerial support. The attack was commanded
by Ariel Sharon, Israel's current Prime Minister, nicknamed "the
Bulldozer." The joke was that Adolf Hitler came back to earth from
Hell to look around a bit. When he saw that is now the Germans who are
making money and the Jews who were waging Blitzkrieg warfare, he
couldn't deal with it and decided to go back down to Hell.
As you may recall, the
Israeli blitzkrieg failed miserably in its principal objective to root
out the PLO; ironically, the PLO is politically stronger and its
headquarters is now physically located closer to Jerusalem. Hezbollah,
which is funded by Iran and is considered by some to be as dangerous as
Al Qaeda, developed the insurgent infrastructure to help eject the
Israelis out of Lebanon, and Ariel Sharon has been tainted in the
international community by associations with the Shatilla massacre. To
make a reference from Greek mythology, the Israelis tried to slice off
one hydra head and got three coming back at them.
America's quick victory
against Iraqi troops in the Kuwaiti desert in the Persian Gulf War was a
poster boy of blitzkrieg warfare, complete with massive air support and
a huge left hook envelopment of Iraqi forces by massed tank formations.
But will the same cookie cutter approach work in other situations? Will
"blitzkrieging" and "bulldozing" our way through the
urban areas of Islamic countries solve our problems, or will we end up
creating more hydra heads like the Israelis did in southern Lebanon?
Imagine hearing this from a
Congressman Ron Paul, thinks the Bush Administration has become an
overly adventuristic bull in an international diplomatic china shop and
its policy is creating more problems than it is solving; c.f. "The
Heroic Ron Paul".
Before we try complex
"nation-building" in Iraq, could our military first try to get
it right in preparing for chemical warfare?
One of America's most
heavily decorated veterans and well-regarded military authors, Col David
Hackworth, U.S. Army (Ret) thinks the U.S. military has not adequately
thought through likely chemical warfare scenarios in preparation for
invading Iraq: c.f. http://www.sftt.org/dwa/2003/2/12/da.html.
For starters, up until an outsider recently sent in an e-mail, the
Pentagon was apparently unaware that the water inside its mobile water
tanks ("water buffalos") used by troops to refill their
canteens could be easily contaminated by chemical agents. Everything
might have been fine until our troops had to start refilling their
canteens in the desert. Hackworth claims that the military has failed to
conduct prolonged large unit training exercises in a nonlethal chemical
environment to adequately test its gear and chemical battlefield
doctrine. He also claims that nearly 200,000 Gulf War veterans continue
to complain of ailments that may be linked to indirect chemical
contamination during the Persian Gulf War. (Please remember elsewhere in
this report I mentioned that American companies once
"free-traded" chemical agents to the Iraqis).
Jim Puplava (www.financialsense.com)
points out how "things" (commodities and precious metals)
rather than paper claims (stocks in general) have been in a
"stealth" bull market for the last two years, signaling
current rising prices and inflation concerns. If we head towards a
stagflatonary scenario similar to the late 1970's, these areas should
continue to do well while the overall market may experience a steady
slide until it ultimately reaches a historically low P/E and high
dividend yield. In 1982 the average P/E was around 7 and the dividend
yield on many "blue chip" stocks was around 6%.
The Wall Street
consensus for the year ahead has been mildly bullish, and I think the
odds are that it will be wrong again. The bear arguments I have outlined
have not yet been openly absorbed by Wall Street strategists or the
general public. My guess is that that full absorption will not be
achieved until about two to three years from now. In the 1970's about
25% of American households were into stocks, at the bull market peak by
2000 it got up to 75%. Mutual fund withdrawals have remained relatively
subdued despite the market drop. One hellish scenario I haven't even
addressed yet is if the public starts to panic and pull their money out
of mutual funds all at once. In the aforementioned video interview with
Jim Rogers and Marc Faber, Faber claims that Japan's malaise for over a
decade has cost Japanese mutual fund companies over 90% of their assets.
A couple of years from
now, if the public mood starts to really get ugly, paradoxically the
market may form its first major bottom and then it may time to start
increasing ones exposure to on the long side to general equities. Until
then, I would look at sitting on the side lines or leaning towards
certain foreign bond funds, short funds, precious metals, commodities or
"hard assets"-related funds.
America still has ample
natural resources and in terms of demographics the equivalent of
Germany, Britain, France, and Scandinavia inside its borders, so I do
not see us necessarily turning into Argentina or Brazil within the next
five to ten years. Once the bad debts get liquidated and the middle
class gets unconfused (perhaps after a period of crisis and cynicism to
finally figure it out how badly they have been misled), I think we will
finally have the basis for a viable rebound. I am reminded of the
observation of Friedrich Nietzsche that in order for civilizations to
function, they start promoting "white lies" in their public
discourse to avoid social conflict. The problem is that generation after
generation, the white lies get built on top of each other (and the new
generations take too much at face value) to the point that the value
systems (and even religious theologies) become inverted and
dysfunctional and removed from basic realities of life. Anyone who has
watched the movie Gangs of New York knows that American leaders
have been making extra efforts to "spin" and smooth over messy
problems ever since the War Between the States. But sometimes the smooth
talk gets too rich, and "putting your best foot forward" for
corporations becomes outright fraud. "Free trade", carried to
excess (depending on what kinds of concessions are made), can bleed away
a country's competitive advantages and wealth and turn into outright
"treason." A lot of this still needs to be uncovered and
sorted out. Among other things, we need to motivate American business
leaders to get a bit more interested in generating business income to
benefit American workers rather than sweat shop operations run by active
duty military officers of the Red Chinese Army.
Noting the jagged saw
tooth downward chart pattern of the S& P 500 index (on a five year
chart), some of my more adventuresome clients have tried to play the
cyclic bull rallies within the context of the longer term secular bear
market. Just remember if you want to be a trader to get out a few months
after the market makes its most recent deep dip to avoid getting swept
along in the next possible leg down.
Two outstanding sources
for an in-depth explanation of the bear arguments, complete with charts,
graphs, supporting data, and easy to read narrative are:
Jim Puplava's "Perfect
Storm" and "Storm Watch" series. Although
written from 2000-2002, the Perfect Storm Series has been on target so
far in predicting the course of the market. It provides good background
on how we got into our present state of woes: http://www.financialsense.com/series2/perspectives2.htm
His Storm Watch updates
bring you up to date and are also very good. Archived at: http://www.financialsense.com/stormwatch/oldupdates/main.htm
David Tice's series of articles
for "On Wall Street" magazine archived
David Tice is manager of the Prudent Bear fund whose home page is
www.prudentbear.com. As mentioned earlier, it is well worth scrolling
through his PowerPoint presentations at: http://www.prudentbear.com/bc_library_bear_case_home.html.
© 2003 Bill Fox
Bill Fox, VP
America First Trust Financial Services
P.O. Box 820669
Vancouver, WA 98682
Toll Free: 866-945-5369 (866-WILL FOX)
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