21st Century Economics

~*~ In another essay, I wrote of 2010 and beyond and cited 9 serious financial events that will happen over the next few years – most of those will happen during and beyond 2012 – such as the retirement of the baby boomers.  Some will happen before such as spending all of the ARRA money.  Some time after 2012, the impact of all of those nine inevitable events will take the economy into a 10+  year depression.  Go and read that other essay on 2010 and beyond and see if you do not agree.

~*~ But in this essay, I want to speak of just 2012.  You know, the 2012 from the movie.  The 2012 in which the world is going to literally be torn apart and all but a very few are going to die in multiple worldwide natural disasters.  The 2012 that everyone from the Mayans to Nostradamus to the Oompa Loompas have predicted the end of time.  December 21, 2012 is supposed to be the exact date of a global cataclysm of some kind.  Perhaps war, perhaps collapse of the dollar, perhaps a meteor impact, or something worse.  That 2012.

~*~ If you are one of the space cadets with a tinfoil hat that thinks all this is really going to happen, then perhaps you should not read this essay because I am going to tell you that it is all just a bunch of lies and hype mostly fanned by Hollywood to promote a movie and by various news media because stories of disaster and doom sell better than stories of good news because nothing is going to happen.  First let me tell you about the real 2012:

~*~ There is a very good coverage of the 2012 phenomenon in Wikipedia that covers this subject quite well and points out that it is all a bunch of fictional stories, misunderstandings and deliberate deceptions on the part of numerous self-appointed prophets and profiteers.  I’m not going to repeat those arguments or factual rebuttals except to say that for any reasonably intelligent person, it is clear that the whole 2012 scary scenario is all fake.

~*~ So why am I writing this?  Because this is nearly a carbon copy of the whole Y2K scare of 1999 and it will play out almost exactly the same way.  There will be enough space cadets and gullible people that think that this will happen that it will spook Wall Street into making a lot of “cover your ass” and “just-in-case” investments.  The most common of these will be investment in gold.  As in the Y2K event, gold will rise in price slowly going into 2012 and more dramatically as we approach December 2012.  When the world does not die on that fateful date, people will sell off their gold and the price will drop rapidly in late December and into January 2013.

~*~ In keeping with the theme of this blog – “Event Investing - If you know an event is going to happen, you can profit by it”.  This is a classic case of being able to make a profit from a very predictable event.  Here’s how:

~*~ You must be really confident that the price of gold is going to go up as a result of 2012. If you are then you buy a call option in mid to late October 2012 for 120 days for 1000 or more ounces of gold at the going rate in August, let’s say it is $1,100 per ounce. Now you wait and watch the gold price increase as the 2012 sillyness approachs and there is an increasing degree of panic among investors. This option is not cheap. It might be as much as $2,500.

~*~ By the middle of December, the price of gold will probably go up to $1,350 or more per ounce. You can then decide to exercise your option. You buy 1000 ounces of gold at $1,100 and immediately sell it at $1,350. You keep the difference of $250,000 minus the cost of the option. You pocket a total of $247,500.

~*~ But you are not done yet.

~*~ You should also be very confident that the whole 2012 threat and its related investor panic will subside very quickly after December 2012 with a corresponding decrease in the price of gold. It has to! It is a mathematical certainty called regression to the mean.

~*~ So in late November, you buy another option. This one is a “put” option.  By buying it will the price of gold is higher than you think it will be in January, you can buy a relatively cheap option.  Your option is for 45 days for 1000 ounces or more at the then top gold price which is likely to be over $1,250 per ounce. If you want to be safe, get a 60 day option.  This means that if you exercise your option, the broker will buy your gold at $1,250 per ounce. In this mythical scenario, because the time period is shorter, the cost of the option will be lower, perhaps $1,500.

~*~ Now you wait until the end of 45 days or so when the price of gold has dropped back to probably around $875 per ounce. You buy 1000 ounces at that price and then exercise your option to sell it at $1,250 per ounce. The difference of $375,000 minus the cost of the option, nets you $373,500.

~*~ Combined with your call option, you could have cleared $621,000 in less than 4 months.  At no time did you have at risk more than $2,500 and you could have started with as little as $2,500 in cash.   Of course, every option could have been for more ounces of gold and your real upper limit is much higher.

~*~ Had the price of gold not followed the current predictions, you were at risk for the first $2,500 call option but by early December 2012, you would see that the price of gold is not following the predicted trends and you would decide to not buy the second option.

~*~ In other words, you could have had a $621,000 upside and a $2,500 downside in this investment. That is just about as good as it gets on Wall Street!

~*~ This is one of those highly predictable trends that I base all my investments on.  During the Y2K scare when we were approaching 12/31/1999, turning over to 1/1/2000, the gold did exactly what I have described above – rose and then fell.  Lots of my subscribers made money on that one also.

~*~ Remember, there are other limitations and restrictions on options that I did not go into in this brief article that may affect your profits or the ability to buy the option at all. Don’t make investments based on this article - do your homework and read all the details so you fully understand what you are doing first.  Any investment you make is entirely your own decision and I take no responsibility for how, when or why you make your investments nor do I guarantee any specific result.

Much has been written about how the US is following the classic cycle of historical growth and demise followed by dozens of civilizations in the past.  For most of us, these comparisons can be easily dismissed because we cannot relate the parallels between us and ancient Rome or the Myans to give it much credibility.  There is, however, a trait of a society that most should be able to agree will almost certainly result in the fall of the society from a position of power and influence in the world.  This trait can be described thus:

“When a society allows a class of people to rise to a position of unchallenged power and that class of people have no regard for anyone but themselves, then they will destroy the society from within.”

It is a simple concept and quite logical.  You are, of course saying to yourself, “what has that got to do with the US?”.  Believing, as you do, that there is no such class of powerful people in the US and certainly none that do not have some interest in the success of the US society.  Unfortunately, you are wrong on both counts.  There IS a very small group of people (about 15) that have incredible power and influence over the US economy.  Much more powerful than the Fed, or Congress, or Wall Street or the banks.  These people wield more money and are above the law and reproach from anyone else.  They operate in secret and outside of the law – often in direct violation of the law but they are nearly totally immune to prosecution.  If I named then, you would not recognize any of them – well, perhaps one.  They do things to the economy that are so complex that often the Fed, or Congress, or Wall Street or the banks don’t really know or understand what they are doing.

Here is the true story of our most recent economic collapse.  I have simplified it as much as I can but rest assured that this was performed in such a manner that no one really knew what happened and after they did find out, they were so afraid of the consequences of the information leaking out, that they concocted an elaborate cover story that seemed plausible.

A company we’ll call LB was trading at about $64/share in Feb 2008.  As with all stocks, the share price was, in part, due to the total number of shares that had been released and sold by LB.  As with all stocks, if more shares become available, the price per share goes down.  Simple Supply and Demand.    “Someone” began selling shares of LB.  These were not actually shares but were IOU’s that a share was owed to the buyer.  This is something that is allowed on Wall Street to facilitate sales without the burden of slow administration but it was intended to be used only on rare occasions and in small lots of shares.  But this time, instead of a few hundred or a few thousand shares, millions of shares were being sold over a really short period of time.  The effect on the LB stock price was exceedingly predictable – it went down.

When it went down, someone else made a huge profit on a short position they took out in early Feb on the LB stock.  They were able to sell over a million shares of stock at a $4 per share gain in just 7 days.  What was unusual about this short selling was that the person that took out the “put” “bought” the shares on margin – meaning that they did not actually take position of the LB shares that they later sold at a higher price when the stock price dipped.  This type of transaction is called Naked Short Selling or just naked shorting.  Naked shorting is not legal in the US but it is actually a common practice since it is conducted off-the-books and is very hard to identify by regulators.

Whoever the someone was, they had taken advantage of the drop in LB stock price, almost as if they knew it was going to happen.  Using non-public foreknowledge to make a profit on Wall Street is also illegal but someone did it and made off with millions of dollars.

Were it to end there, the LB stock would have dropped by about $5 or $10 and then recover and no one would think anything else about it.  In fact, the stock did rise some but the sale of unsupported LB shares continued and over the next few months, millions more shares of LB stock were dumped on the exchange by “someone”.  In that time, someone else was taking repeated naked short selling positions on LB.  Each time, the stock went lower, someone got richer until by the end of Sept 2008, the LB stock was selling for 5 cents a share.

The SEC has positively confirmed that these unbacked stock IOUs and the naked shorting was occurring but they have chosen not to investigate.  They could easily identify the culprit but have not.  Why?  It turns out that there are dozens of companies that have experienced this process of naked shorting on stocks that have been artificially manipulated to decline – making the short positions worth millions.  Some of these companies include: VeraSun Energy (VSE), Allied Capital (ALD), Ford, GM, Dendreon Corp., InterMune, Force Protection, to name just a few.

This game can be played as long as investors try to take positions in failing stocks because they have good “fundamentals”.  That is, if the company is basically sound and solid, it is an ideal candidate for this kind of fraud.  The “someone” sells the IOU stocks and the “someone else” does the naked shorting.  Then, because the company is basically sound, investors buy up the lower priced stock – pushing the price back up so the process can be repeated.

OK, so who is doing this.  The someone that is selling the IOU stocks has to have the complicity of a brokerage firm that is licenses to sell stock on the exchange.  They also have to have a huge amount of money in order to repeatedly sell these stocks and buy these short positions.  If they take a short position and the stock goes up, they can be stuck with a huge loss but records show that happens rarely.

This someone has to be so powerful that when the SEC finds out who it is, they take no action, despite the fact that all this is illegal.  Who could be that powerful.  Turns out that the mysterious world of hedge fund managers are the ideal candidates.  Hedge funds do not come up normal regulations so what they do to manipulate the market and/or coordinated assaults on businesses is completely off-the-books.  Every time anyone tries to setup regulations that might cramp the style of these hedge fund managers, they get fired or removed or eliminated or voted out of office or some other method that will stop their efforts.  This has been occurring on a daily basis for the past 40 years but has recently gone global in scale and scope.

The bottom line is that the market is not at all what you think it is.  There are players in the market that regard you as fodder to be bilked and discarded without any regard for your misfortunes.

Digging our Hole
4/15/2010

The laughter from recent talk shows and from comedians about the politics and economy is like the laughter of looking at your scraped knee and bruised arm after an accident that totaled your car.  We all are laughing at our scraped knee while the economy has been totaled and traffic has turned into a suicide ride.  What we don’t see now are the massive internal injuries that will hurt us in the future.

Greenspan, Paulson and Bernaki made some huge mistakes but no one in Washington knew any better or understood more so we all blindly followed these financial “leaders” down a path that ended in a lot of poor, at best, results.  Whether or not the bias of being former Wall Street competitors or seeking political favor skewed their judgment is something we will debate about.  Even they admitted that they just did not know what to do so they did the only thing they could - based their decisions on the actions and mistakes from 1933 - which proved to be mostly the wrong moves.

We are in a DEEP hole!
Most people do not understand how big a hole we are in.  The facts remain that our total national debt is well over $12 trillion and is growing by $3.7 billion per day.    We collected about $1.5 trillion per year in taxes over the past 10 years.  Since the time of having a budget surplus under Carter, we have spent a total of about $27 trillion!  The actual taxes collected in the past 10 years covers only 5 years and 7 months of our spending.  The remaining 4 years and 5 months has been “financed” with debt.  Debt that must eventually be paid back and that has interest payments.  The Congressional Budget Office estimates that total additional national debt will grow by $9.3 trillion over the next decade.  That will put the total national debt at just over $21 trillion by 2020.  That will cost about $865 billion per year in just interest payments on the debt.

STOP Digging!!
The consequences of Greenspan, Paulson, Bernaki,. Bush and Cheney have already created a huge loss of jobs, homes and industries and that is at a time when we are still spending - digging the hole deeper.  We have been digging ourselves into a hole for years.  Amazingly, the proposed solution is to dig further.  When we finally stop digging, the job of filling in the hole, to bring us back to a balanced budget, will be such a huge task, it will take decades of a lot of pain and effort to resolve

Digging Deeper
We know that the retiring baby boomers will boost medical costs and social security costs at a rate faster than we can reasonably increase taxes in a slow economy and too much taxes will actually increase the need for government subsidies.   Any investment in oil-independence will cost billions or more.  The crumbling national infrastructure of roads, bridges and water pipelines will cost billions or more.  The edge that our military has must be maintained and updated and that will cost billions.  We can reasonably expect there to be other unexpected costs and new wars over the next 10-15 years.  The dollar will likely lose value in the international market making foreign goods and raw materials more expensive - especially oil - jacking up the price of almost everything else.  We can only hope that global warming, natural disasters and limited fresh water reserves will not enter the picture until we can afford them - but they are on their own schedules.  The hole we are in will be getting deeper for at least the next 10-12 years.

Filling in the Hole
So what does the future hold?   Our medical care will have to be partly nationalized in order to be able to cut it back to some level that might be able to be funded.  They will, of course, begin with the civil service and military retirees since they are already under the government’s control.  Social Security will be cut back by using a “means test” that will reduce SS if you have other income - like military retirement or a company pension.  COLA adjustments to SS, pensions, retired pay and other government payments will consistently be just a little behind the actual cost of living increases putting millions on a slow downward slope toward poverty.  Taxes will increase on a massive scale but our politicians, and especially Obama, will work overtime trying to hide that fact or disguise it or to make it sound “fair”.  The rich will pay more.  The caps on salary that pay SS will be lifted.  Taxes will be put on all sorts of transactions that were not there before - road taxes, bridge taxes, fuel taxes, etc.  They will hide taxes as “fees” or “co-pays” to make it sound nicer.  We can reasonably expect to get the national debt paid off and get back to a normal and stable economy around the middle of this century - about the time our most recent high school graduates begin thinking of retiring.

…..but of course, I am an optimist and the reality could be much worse….

     The economy is in the can but our politicians keep telling us that we have bottomed out and are on the upward swing.  They point to rising prices in home sales and in a stock market that has been volatile but generally upward for several months.  All true.  But the mega-trend that is behind all that improvement is the $100 billion that the government is investing in the economy each quarter as a function of the ARRA.  Actually, it is more than $100 billion because there is still funds left over in the TARP funding that is being spent and there are other funds, like the $33 billion for the war effort, extension of unemployment funding, jobs creation programs, state subsidies, etc., that are being invested in the economy.  In the worst of times, the economy will show some improvement if you dump that much money into the markets.     

Unfortunately there are some huge problems with this plan.  Here’s why.     

The ARRA - American Recovery and Reinvestment Act - of 2009 is supposed to invest $767 billion into the economy within a 2 yr period.  That works out to be about $100 billion per quarter.  It’s working.  The economy is making a slow recovery.  Jobs are returning slowly.  Banks are lending again, a little.  Cars are selling again, sort of.  Inflation has not jump too much.  The dollar has not been devalued by much, yet.  The fact that we are spending $100 billion per quarter into the economy has a lot to do with this “recovery” but there is a huge problem with this tactic.      Virtually all of the ARRA money is deficit money - money over and above what we have collected in taxes.  In January 2010 alone, we added $680 billion in deficit spending.  The national debt is well over $12 trillion today and will climb to over $14 trillion within the period of time that the ARRA is active.  Even the CBO predicts we will conservatively add $9.1 trillion by the end of this decade (2010-2019).  That will put the national debt at over $21 trillion.       

This is a huge problem that is not getting the attention it deserves because it is something that has a slow development and a slow impact but like the lava in a volcano or the water in a flood, it moves slow but has devastating effects.  This debt is real and it has its consequences.  The debt represents borrowed money on which the government pays interest.  In 2009, we paid $383.7 billion of interest payments on the national debt - that is just over 3% on the total amount.  That is also 12.79% of the approx. total $3 trillion collected in taxes for 2009.  That payment on the debt rises to $671.5 billion by 2019 or about 16.65% of the total taxes expected to be collected in that year.       

Two problems with these estimates:  One is that the expected taxes to be collected in 2019 is based on a fixed rte improvement of about 3% per year between now and then.  Because of reasons you will see below, that is probably not a true estimation.  2009 taxes collected were 12.9% lower than 2008 - not 3% higher.  A more realistic estimate is that tax income will rise thru 2010 and then decline for several years before rising again.  The net gain between 2009 and 2019 might be closer to 1.5% - if it is positive at all.     

The second problem is that, as we will see below, interest payments on the debt paid out might be higher because of inflation.  It is very likely that all this deficit spending will devalue the dollar and increase inflation making the payments cost more.  Rather than an average of about 3% interest payments, it is much more likely to be about 5% or more.       

When you recalculate the total interest paid in 2019 using these projections, we will pay out 30.2% of the total taxes collected. 

But wait there’s more…..     

The national debt number that everyone works with is the debt owed by the General Fund.  That is the working capital of operations within the government.  Any deficit to that amount represents funds spent over and above taxes collected.  That is exactly the definition of the various Trust Funds within the government.  We have $800 billion in the Federal Pension Trust Fund (FPTF) for the retirement payments to the military and civil service.  This Trust Fund is money that was collected and set aside for the federal employee pensions but then the actual money was spent by the government - leaving essentially an IOU in the FPTF.  There is no bucket of money anywhere containing that $800 billion and set aside for the federal employee pensions.  It is simply a certificate that says that at one time the total excess collected and not paid out in pensions was $800 billion but Congress paid it out in other expenses.  So this is an amount that also must be paid back and because of COLA adjustments, has an ongoing increase to it. 

But Wait There’s More….     

There is, in fact no money in any of the “trust funds” that are “managed” by congress.  The $280 billion in the Medicare Trust is also gone.  The $3.1 Trillion in the highway trust fund is also gone.  The $1.7 trillion of the Social security trust fund is also empty as it every other trust fund in our government.     

The demand for payments OUT of these trust funds is growing at a rate much faster than inflation or in the growth of the economy.  For instance, the needed major infrastructure projects that would otherwise be paid for by the highway trust fund far exceeds the current trust fund balance.  In fact, the repair or replacement of just the bridges in the US that need immediate attention exceeds the amount in the trust fund now.       

The payout from the Federal Pension Trust Fund, the Medicare and Social security Trust fund all are expected to rise very rapidly over the next 10 years as the 74 million baby boomers retire.  For instance, the $1.7 trillion trust fund money plus all the money collected in SS taxes between now and just 5 years from now will be entirely gone by 2018 unless SS benefits are significantly cut.  The average 9% rise in medical costs plus the 280 billion Medicare trust fund money plus all the money collected in Medicare taxes between now and just 5 years from now will be entirely gone by 2016 unless there is a significant cut in Medicare benefits.     

A realistic view of the actual debt and an honest estimate of the rise in cost and the expected tax income would show that in less than a decade, we will likely accumulate in excess of $25 trillion in national debt and will be paying out more than $1.25 trillion in annual interest payments or better than 1/3 of the total annual taxes collected.  That means that rather than the usually 2% or 3% reduction in the annual increase in spending, our government would have to reduce actual spending by more than 30%.  That is something that they have never even considered and certainly have nave done.  In fact, basic economics says that our economy could not survive such a major decrease in funding for entitlement and military spending programs.     

But wait, there’s more. 

As bad as this is, it is unfortunately, not the worst of it.   First you have to appreciate the really really bad timing of the ARRA.  The following is a list of the confluence of events that will all take place over the next 15 years:     

1.Since 2005, it is not just the government but the US population has spent more than they made in income.  A net negative savings rate.  It has continued every year since at increasing amounts of negative savings.  The economists refer to it as wealth spending and it comes primarily from credit cards and home mortgages.  People borrowing to pay bills for items over and above their income.  The ones most affected are the baby boomers.  This latest economic crisis may change the attitudes back to a positive savings but it also may be too late.  Retiring boomers don’t have time to save enough to cover retirement so they will rely on the equity in their homes and investments ….precisely the two assets most impacted by the current economic crisis.     

2.    74 million baby boomers are retiring right now at a rate of 10,000 per day.  That will increase to over 20,000 per day by 2015.  All of them want social security; many will need it because they have no savings.   Applications for SS benefits are up 23% in 2009 over 2008 and the rate of increase is growing.  This increase is remarkable because the oldest boomers (those born in 1946) do not reach full retirement age until 2011.  What this reflects is the massive numbers that are taking their retirement money at age 62 because they either need the money or they have retired early.  If all or even a significant part of the boomers do this, then all of the timetables you see below will have to be moved back by several years.     

3.    As many as 70% of the boomers are expected to sell their MacMansions (homes over 2,000 sq ft) and second homes (1 in every 4 boomers owns a second home) over the 2012 thru 2025 period - putting more than 650,000 homes on the market per year over and above the amount that is historical normal roll-over.  This means that home prices will plunge and stay down until we burn off this excess which is estimated to take 10 to 15 years.  During that time, new home construction will be reduced, wood sales will drop, furniture, rugs, construction jobs, etc. everything related to that industry will also trend downward for a decade or more.  In the meantime, the demand for low cost housing ($600/mo including utilities and taxes) will skyrocket but are nearly non-existent today and currently there are no plans to provide them.  These homes have the lowest profit margins and there are very few investors that are willing to build “projects” like this.  Only the government would be motivated to invest in such massive low-income housing projects and they may not have the money to do so.     

4.    The social security fund will collect $10 billion LESS than it pays out in 2010 and $9 billion less in 2011.  This is the first time that such deficit spending has occurred and it is happening far sooner than anyone has ever projected.   According to the CBO, it will go positive from 2012 thru 2015 but that is based on the CBO projections that the economy will make a continuous recovery over all of that period.  And then it will go negative permanently - in fact, it may be as much as 75 years, if ever, before it will go positive again.  The reason for it going negative for so long is that there will be so many retired people receiving SS and Medicare than there are working people.  When the SS started, there were more than 25 workers for every person receiving benefits.  In 2018, that will fall to less than 2 people.  The taxes that two people pay will not cover the benefits for one person.  However, the average boomer will get $1100 per month in SS - not enough to live on for most.       

5.    The boomers put more that $7 trillion into the stock market over the past 25 years.  As much as 30% of that was lost as a result of the current economic crisis.  This loss means that boomers will be withdrawing money sooner, faster and will run out quicker than they had planned.  What was not lost will be used to fund their retirement.  This means that the stock market will stop receiving the huge inputs of funds and will begin paying out huge amounts in dividends and cashed out stocks.  To be able to fund these withdrawals, companies will have to completely alter their financial priorities - cutting R&D (always the first to be cut out), cutting any new growth or expansions, cutting back on all non-essential expenses, and reducing their work force.  Jobs lost during this crisis will not come back for a lot of industries.  Those jobs that do come back may not last long as they will be cut as soon as the effects of no more TARP, ARRA or other government investments and as lowered consumer spending is felt.      

6.    The national debt will cause two major problems that are economic inevitabilities: (1) the value of the dollar against foreign currencies will drop and (2) inflation will skyrocket to all time highs.  This will mean that all foreign goods will increase in cost with the most effect being felt in the price of fuel - gasoline, heating fuels, airline fuel, etc.  Rising transportation costs will cause almost everything else to rise.  A really serious consequence that could happen is that OPEC decides to change from using the dollar as their base currency to using the EURO.  Right now, all oil, worldwide is purchased and sold using the value of the dollar as the currency.  If OPEC decides that the dollar is too inflated or to over-extended, then they might very well switch over to the EURO.  This has been a threat for the past 10 years and has been stopped only because of the threat of Iraq, Iran and other Middle East unrest.  We have bought the allegiance of Saudi Arabia by giving them sweetheart deals on military aircraft and other weapons and protected them with our Navy and Air Force.  If they decide they are now strong enough, their enemies are weak enough or that we cannot provide any real benefits, then they will switch to the EURO or to gold.  Either way, the devaluation of the dollar against other currencies will make the price of oil climb to over $10/gal. or more.     

7.  All 74 million boomers will want Medicare and a drug program.  The current health care reform will add to that cost by adding those 15 million lower income people that did not contribute as much to their taxes as the middle and upper class.  This is expected to add at least $1 trillion to the total bill that is already projected to vastly exceed income to cover the costs.     

8.    Because of the economic crisis, negative savings, loss of equity, stock market drop and rising costs - many boomers will try to remain in the work force but they will mostly compete with younger workers for service industry jobs at the bottom of the salary range.  When many businesses will not be expanding, the job market will be saturated - forcing many to draw welfare, food stamps, fuel, training, housing, unemployment and other subsidies - adding to the costs of both state and federal government entitlement programs.  This is over and above the payouts to entitlement programs like social security, Medicare, seniors prescription drug programs and other national subsidies.  The sheer volume of old people (mostly baby boomers) will strain every social service program in every town, city, state and nationally to beyond their ability to respond.  Projections that you will never see from the government include an estimated 20 million people might be homeless by 2020 - up from 3.5 million in 2005.       

9.     Unemployment will hit over 10% in 2010 and is expected to lower in 2011 and beyond - according to the government.  But of course, that is what you’d expect them to say.  After the ARRA and TARP and other government investments stop, job creation will stop and job losses will begin again.  But what we hear about as unemployed is not at all accurate.  They only count those that are unemployed and actively seeking employment and are doing so with the help of the government.  Those that have taken jobs only to hold them over until they can get a better job, those that have stopped looking because they have exhausted all possibilities, those that are seeking jobs outside of the government programs and those that are doing handyman, maid or other private work because they cannot find other work are all no counted.  In the future, the massive number of old people that will have to work because their social security does not cover basic living costs - will not be counted in the unemployment figures.  Real unemployment in 2010 is probably closer to 14% or 15% of the working population and despite investments and other efforts; unemployment is likely to grow to over 20% by the peak of the boomer retirement era - in 2020.      

Now - why is all this not apparent right now?  Because we are pumping $100 billion into the economy every 4 months.  The ARRA money is hiding the fact that tax receipts in every state in the union are not covering expenses.  It is hiding the fact that the SS fund is running a deficit right now.  It is hiding the fact that the housing market is already saturated with “toxic assets” even before the boomers start selling in mass.  All that plus we are recoiling from a huge financial loss and we are still ONE year away from the first boomers (born in 1946) reaching full retirement at age 65.       

What will happen in 2012, when they have spent all the ARRA money?  How fast will the impact of all of the above inevitable events take to bring the economy into a 10+ year depression?  Ask Chris Dodd and Byron Dorgan - they can see that the Ship of State is being held afloat by band-aids and threads and is leaking badly.  They are abandoning the Ship of State before they are grouped among those that will be either blamed for causing this problem or held accountable for fixing it.   It going to be a helluva mess.     

At the beginning, I said that 2010 is your last chance.  During 2010, when ARRA and TARP and other government investments are still being paid out - while the inflation has not yet taken hold - while most of the boomers are still working and while we have not yet experienced a major devaluation of the dollar - the economy will grow.  The market will climb and you can make some money in the market.  It will be volatile and it almost certainly will not last for all of 2010 but this is your last chance to make an investment in which the objective is more than preservation of the principle.       

Probably in the early part of the 4th quarter, the speculators that will try to jump the gun on inflation and reduced government spending will begin bailing out of the market and into gold or other cash equivalents.  Gold in late 2010 and for the next several years will be rising massively.  As long as the basic economy does not completely collapse, gold will be the safe haven for several years to come.  I for one will be moving into gold in the third quarter or perhaps even sooner.  I will also be carefully picking stocks and commodities that I will be selling short and buying long on to take advantage of this inevitable set of events.  When I did this coming into the Y2K event in 1999, I made a fortune.  This will be the same kind of opportunity but much bigger and it won’t be over in a few weeks.  That means that there are dozens of opportunities to make tons of money if you simply are willing to open your eyes and see the mega-trends that are really driving what is happening.  

It has begun!

It has begun!

The January Effect is a well known and fairly consistent trend in stock market swings. In the 4th quarter, each year, large institutional investors dump losing stocks to take losses that will offset their wins over the previous year. This puts a lot of supply of poor stocks on the market and puts a lot of cash into the hands of the investors. The fact that these are stocks that normally are not swept up by others and the holiday spending spree of the consumers, usually absorbs most of this sell-off so we normally do not see a large drop in the market nor a rush to sell off winners. However, after the New Year starts, these same investors, now flush with cash, want to invest and most do so in January.

With all this pressure to increase the market, in fact, quite the opposite is happening. It is taking a dive. This means that the market drop is actually much worse than it appears. It is diving despite all this upward pressure - or more precisely, investors have lots of reasons to buy but instead they are selling in large numbers.This is not a new trend. The NASDAQ and Dow hit highs in October and have mostly been going down since. This has a lot to do with the Bush administration’s policies of trade, tax and politics but it also has to do with the normal cycles of regression to the mean of normal and typical stock performance. We have been due for a recession for some time.

I may have been wrong about that date. It might have already started. This is not that unusual since it is common for investors to buy on rumor and sell on history (news) – making them always over reactive to even the hint of good or bad news. In this case, they are perhaps acting sooner than I had expected or maybe just reacting to a shorter term crisis that will coincidentally run into the large crisis looming just ahead.As one of the more informed generations of investors, they may well be aware of the coming problems created by the boomers and may well be also reacting to that crisis a few years in advance. This can happen if the institutional fund managers are of the mind to be cautious about what they know will happen eventually.

Bottom line is that a major financial downturn has started and will continue for the next two decades or it will take a short spurt upward for a year or two before taking the plunge for two more decades. Either way, prepare now or suffer later. 

High Risk Speculation

Hidden High Risk Speculation
Losses

The bottom line is that getting rich slower is a much safer bet. 

Stock Predictions Using Beta

Using Beta to Predict

Now suppose they cut a deal with a major oil company for a long term commitment to buy fuel at some negotiated predictable price. This would remove their dependence on the commodity market shifts and reduce their need to adjust prices and expenses (earnings per share). Their beta would go down. Typically their stock value will go up. The beta would be a predictor of that rise. 

Stock Volatility

Stock Investing
Volatility
Officially, volatility of an investment is the characteristic to rise or fall sharply in value within a short period of time. This means that for a number of reasons, the price of the investment changes more frequently than can be accounted for by normal market fluctuations. How volatile it is depends on how often and to what extremes the price changes in a given period.

Today’s technology stocks are typically a high beta and a high alpha. They are very volatile but typically are expected to grow faster than the S&P 500.  

Inflation - The Master Economic Control

Inflation
The Misunderstood Master of Economic Control
Why Is it Important?
Inflation is a word that drives Wall Street to madness. At even the hint of a small amount of inflation, there is a massive over-reaction by investors to migrate rapidly to bonds or money market funds. This is such a predictable response that even the old pros that know that a little inflation is not bad are forced to follow the masses or their investments will suffer. This tends to snowball down from the top investment houses on Wall Street to the small investor on the street that thinks he should take his cash out before “inflation eats up his profits”. The result is usually a recession or, at best, a major “correction” in the market.
The influx of masses of novice investors and the inexpensive access to trading in recent years has increased this knee-jerk response to inflation making it the one economic event that has one of the most exaggerated and dramatic impacts on the US economy.

If we take Paarlgerg’s theory to heart, and try to compare the M1 money supply with our primary inflation indicator, the CPI, we see they do NOT agree. We see that there is a difference between the rate of increase in the CPI (which has remained nearly flat for 10 years) versus the rate of increase in the M1 and M2, especially in the last decade or so. If Paarlgerg is right, there should be closer correlation. The answers why they aren’t are complex.

Where is that extra money going.

The first place it is going is into the coffers of the government in the form of taxes. Federal taxes on personal and corporate income and changes in other taxes like social security, excise taxes and trade levies have risen rapidly in the past few decades. In 1970, total federal receipts from all sources was $187 billion. By 1997, that had risen to $1.5 trillion - more than a 700% rise in 20 years. That takes a lot out of an economy but it is not reflected in the CPI because taxes are not shown in any of the 200 categories of consumer expenditures.

CPI Doesn’t Really Work

M1 and M2 Don’t Really Work Either

…but the one money supply indicator that we have does not reflect where a LOT of money has gone in the past few years. If the M1 and M2 do not reflect that lots of people have put money into the stock market and lots more have paid large amounts into taxes, then what do they indicate?

Conclusion

CPI is not inflation and is giving us a figure lower than it should be. M1 and M2 are not complete because they do not reflect stocks and taxes but if they did they would be considerably higher than they are now. In other words, based on:
historical analysis by Don Paarlberg and

then the gap between CPI and M1 is really very much larger than we think it is. Inflation, as a function of money supply is much larger than the current 3.6% figure predicted by the CPI. In fact the numbers would indicate that true inflation might be closer to twice what the CPI indicates.  

Precursor of Inflation

Consumer Price Index
CPI - The Precursor of Inflation
The Consumer Price Index or CPI is a measure of the prices at a consumer level for a fixed basket of goods and services. It compares these prices to a based period of the average prices that existed between 1982 and 1984 which has been arbitrarily set to equal 100. For instance, the level in July of 1990 was 130.5 which means that this fixed basket of goods and services, in July of 1990 costs 30.5% more than they did during the base period in 1982-84.

There is no other indicator that has so consistently predicted bear markets.