A portfolio of currencies from my wallet. I did the bone headed thing and sold all my Chinese currency...the only one in the whole bunch which will appreciate against the USD on an inevitable revaluation. In the meantime...there's always the Reckoning Day Reserve...the Perth Mint coin in the middle, one of which I'll be giving away in Vancouver... 

Back where it all started...from the 12th floor of the Peabody Court. Looking down on the ugly, dirty Baltimore. 

Immorality from Coast to Coast

Immorality from Coast to Coast

***From La Jolla to Baltimore
***Dollar Down, Bonds Up
***Revised Schedule
 
Dear Reader,
 
Woe is the U.S. market. Back in the States now, and again reminded of how the cult of Greenspan has grown to obscene proportions. The market hangs on the Chairman’s lips, like loose spittle at the mouth of a frothing maniac.

What will he say?

I’ll tell you what he’ll say and save you the trouble of waiting. “The Fed has flexibility to remain patient in removing its policy accommodation,” or some such non-committal nonsense. In other words, the Fed will not raise rates before the election. More on why below.
 
But one more personal broadside against the Fed. One of the first things I did when I made it back to America was buy a copy of Pete Peterson’s new book, “Running on Empty.” Peterson chronicles the inept failure of our elected officials to reign in the ruinous and immoral spending habits that bankrupt the country.
 
You’ve probably been hearing some version or other of the impending entitlement bust for years. The difference between ten years ago and today is that today we’re a few years away from the beginning of the boomer retirement wave.

Time has run out on preventing the crisis. The storm is upon us.
 
In dry, economic terms, much of government spending is non-discretionary (locked in). The mandated growth rates in Social Security and Medicare alone are going to consume most of Federal spending in the not too distant future. And that does NOT include the cost of paying interest on the debt.

If you STILL think it’s no big deal that foreigners own our bonds, let me know what you think when you find out that your taxes pay foreign bond holders first…and American taxpayers last…if at all.
 
Peterson’s book is grim reading. And he may again be a bit ahead of his time, although not by much. He gets to the heart of the issue: the immorality of government borrowing and the low-interest rate regime/demon child that Greenspan has midwifed.

You can borrow from the future to pay for your consumptive lifestyle today, as America is doing. But you’re impoverishing the future...gutting the American dream from future unborn children. It’s not just gluttonous. It’s prideful, slothful, and greedy too.
 
Greenspan, for his part in abetting the bankrupting of America and encouraging the moral decline that borrowed money brings, will go down as the John Law of his time—a man whose monetary alchemy destroyed the wealth of a nation and left its people poorer.
 
You look around in America and see that all the pieces of a radical decline are in place. What’s missing is any sense of urgency to prepare for it.

And I suppose from an investment point of view, that means you still have time to profit from it.
 
In any event, I’ve written more about both issues—the preparation and the profit—in the August issue of Strategic Investment—which is due out late this week or early next. Enough of the historical context for today. Let’s move to what’s happening to the dollar and the bond market.

Dollar Down, Bonds Up

“It doesn’t make any sense,” I explained to the audience. “But then again, financial markets aren’t sensible. They’re emotional. And if you’re a trader, that’s not a bad thing.”
 
I was trying to explain to the attendees at the currency and commodity conference in San Diego an apparent paradox in market action. On Friday last, you saw an economic cause that did not produce the expected effect. Instead, it produced precisely the opposite effect of what you would expect, economically speaking.

What am I talking about?
 
On Friday, the Treasury Department reported that foreign purchases U.S. securities were down 32% in May from April. Actually, the report revealed that foreign purchases fell from $81.2 billion in April to $54.8 billion in May, which works out to a one-month decline of 32%.
 
Private foreign investors continue to be net sellers of U.S. equities. In fact, private foreign investors increased their selling of U.S. equities by 680% from $2.4 billion in April to $7.8 billion in May. That begins to explain the lagging stock market, which has depended so much on foreign capital flows to keep it afloat.

It also explains weakness in the dollar…this is early confirmation that the adjustment in the current account deficit is going to come from a decline in the dollar caused by reduced foreign purchases of U.S. assets. Foreigner are going to stop trading the dollars they make selling goods to the U.S. for underperforming U.S. stocks and bonds.
 
Even more interesting, if you’re a data junky like me, is to break down the bond market numbers in terms of private and public purchases. That is, central bank buying and private sector buying. On both counts, and for both stocks and bonds, the news is ominous. But the bond market data is more urgent, as it has a direct impact on interest rates…and what the Fed might say and do in the coming months.
 
Net private purchases of Treasury bonds and notes fell 44%, from $13.2 billion in April to $7.3 billion in May. That was a big decline, in percentage terms. In nominal terms, net government purchases of Treasury bonds fell $7.5 billion, from $22.1 billion in April to $14.6 billion in May, a smaller percentage decline, but a decline nonetheless.
 
Foreigners, both central banks and private buyers, are reducing their dollar exposure by buying fewer U.S. bonds. That’s what the data shows.

In a sensible world, when the demand for a product declines, it indicates the price is too high. Normally, the price falls. In this case, that would mean falling bond prices. The cause (reduced foreign buying) would lead to a specific effect, lower bond prices.
 
Yet we didn’t see that at all last week. But the Newtonian world of causality does not operate in the bond market.  In fact, take a look at the Lehman 20+ U.S. bond index (TLT). TLT is a proxy for the U.S. government bond market. It’s also one of my favorite trading vehicles for my options trading service.
 
If you look at a recent chart for TLT, you’ll see that on Friday, the same day the Treasury Department reported the big declines in foreign bond purchases, bond prices, as measured by TLT, actually went up. Specifically, TLT finally broke out of the glass ceiling it kept bumping into at 84 and moved up as high as 85.50 in intraday trading.
 
This mini bond bull in the midst of bearish data was made even more paradoxical by the fact that the dollar was making, at the same time, four and half month lows against the euro.

The dollar going down while the bond market goes up? What gives?
 
Like I said, it’s not sensible. It’s utterly irrational. You can see the vapors of a strategy in this madness. U.S. investors are still giving U.S. government bonds the “safe haven” bid. When U.S. investors get nervous on stocks, they stay in the market, but change asset classes and move into cash.
 
This is confirmation that in their heart of hearts, investors are still nursing dreams of a new bull market. The psychology of the bull is still in control.
 
The mini bond bull might also be an indication that investors realize the sell off in bonds was overdone, based as it was on Fed rate expectations. The bond market is expecting Fed rate hikes. It’s been selling off bonds.
 
But what if the Fed rate hikes don’t come? That would mean bonds are short-term oversold, and you might see a rally (long term, bonds are in what I believe will be the bear to end all bond bears…climaxing with the immolation of the dollar.) What if, in fact, the Fed is constrained in its policy making by an economic reality that makes short-term rate hikes a virtual death sentence for American consumers?

THAT would mean the Fed isn’t raising rates any time soon, and that there could be some legs to a rally in bond prices.
 
But one does not make predictions about changes in the global currency order lightly. As Lance Armstrong says, extraordinary accusations require extraordinary proof. My proof comes via Greg Weldon at Weldon Financial Publishing.
 
For months, Greg has been on a theme that I think is right on. Specifically, Greg has shown that average real hourly earnings in America are disinflating. In June, it happened for the fourth month in a row.
 
Greg reports that real earnings deflated by 1.4% in the last four months. That’s an annualized rate of 4.2%. Odd, isn’t it, to see real earnings deflating when everything else is rising (inflating) in price. And where does that leave us?
 
Let’s summarize, from the perspective of the average American consumer. Gas prices are rising. Long-term interest rates are rising, increasing the cost of debt service, or of financing consumption through borrowing. And average earnings are deflating.

Is this a scenario in which the Fed can tighten rates?
 
I don’t see it. Consumers already have little margin for error with such a low savings rate. Any rate hikes are likely to exacerbate the consumer’s chief problem: debt.
 
Thus the Fed’s choice: raise rates and put the squeeze on consumers or keep rates low and feed the speculative beast. Neither is a good choice.
 
In the meantime, expect more selling in the stock market, more buying in the bond market, and more acid reflux in millions of American esophagi.

Revised Schedule

I’ve been dealt another blow by the capricious gods of government immigration. I’m unable to pick up the proper documentation to enter the U.K. until next week…and I have to do it up in New York. So I’ve decided to make a trip of it and spend a few days up in the City visiting with the New York editor of the Daily Reckoning and his Wall Street friends.
 
From there, back to Baltimore (which you can see below in a shot from my 12th floor hotel room in Mount Vernon. And from THERE, to Colorado to visit hearth and what used to be home for a week, before I see some of you in Vancouver in for the Agora Wealth Symposium.  

By the way, in Vancouver, I’ll be recapping my Asia trip as I did in San Diego. But by then I expect to have finalized the investment strategy, including specific picks that follow from the trip. Stay tuned.
 
From Vancouver, it’s back, finally, I hope, to London in mid August…. and from there…who knows? Perhaps I’ll be coming to a city near you soon…at the very least, I’ll be coming to an email box near you even sooner. Later this week, I’ll take another look at China-U.S. war scenarios…and a short-term strategy on trading the oil price (with credit due to the many talented traders and speakers whom I visited with in San Diego.)
 
Until then,
 
Dan

Exit Strategy: The Adventure Continues

Exit Strategy: The Adventure Continues

Wouldn’t you know it? I make it all the way through Asia with nary a stomach problem and felled, at last, by garlic shrimp in Darling Harbor. The Law of Perverse Outcomes (people get not what they expect, but what they deserve.)

My stay in Sydney was short anyway. Just a few days to pack up my bags one more time. I did, at least, get a chance to talk with a man we’ll call Kevin. Kevin is a trader. He used to work the swaps desk for a major international investment banker. We discussed a financial meltdown over tea.

Kevin came to Australia twenty years ago from England. He’s seen the halcyon days of the bull market. He started off his professional career as an actuary, in the business of scientifically assessing risk for insurance purposes. Trading derivatives (swaps are one subset of the derivatives universe) was probably a natural move.

After all, according to Greenspan and others, the derivatives market allows for more sophisticated risk intermediation. It turns liabilities (debts) into assets by packaging them up and parceling them out, often times with a snazzy credit rating, to investors looking for a higher yield than say, the money market or a U.S. Treasury bond.

“It’s not the GSEs you have to worry about, although there is certainly a problem there in its own right. It’s the CDO and CBO market,” Kevin said. He was talking about the securitization of debts and bonds. A CDO is a collateralized debt obligation…a CBO…collateralized bond obligation. The CDO/CBO market, according to the British Banker’s Association, has a notional value of just under $5 trillion. The business of trading debt is big.

In the great hunt for a few points on a trade…and investment instruments to sell investors…CBOs and CDOs represent a strange new devilry. Packaging up debts in and of itself is not so wicked.

But it IS an occasion for financial sin…and there are three cardinal ones.

First, you can be a hedge fund and make a wrong directional bet in the derivatives market. This is what happened to Long Term Capital Management. They expected global interest rates to converge. They had a position in Russian bonds. Russia defaulted. LTCM was leveraged to the hilt. Once their Russian position fell apart, they were forced to liquidate everything else, which brings me to the second sin, default.

Default is always a risk when you buy risk.

Greenspan has said that the derivatives market allows for the dispersion of risk in the market from a few players to many players, sort of like saying if you cut a big piece of evil up into many little pieces and give those pieces to individuals, you’ve made the world less evil by making evil less big.

It doesn’t work that way, of course. Especially when all the purchasers of the evil count on it for income.

I’m oversimplifying and moralizing. But I should stop, because the problem IS serious, not least because of the last and greatest sin: insuring risk.

There aren’t a lot of firms that guarantee CDOs and CBOs. And that’s exactly the problem. Some insurance firms found a good business in guaranteeing the quality of otherwise non-triple A rated CDOs and CBOs. That is, some institutions are barred from buying emerging market sovereign, corporate, or municipal debt on the open market because ratings agencies like Fitch, S&P, and Moody’s have rated the debt less than triple A. If it ain’t triple A, some institutions are forbidden from buying.

But if an insurance company comes in and slaps a guarantee on the packaged up debt, it’s effectively given the junk a triple A rating, making it safe for the big money to come in and play.

All of this is fine, although difficult to do. The real risk comes from having so few derivatives insurance firms. Insurance firms like MBIA carry enormous risk should any of the derivatives they’ve guaranteed default.

The obvious risk, and the reason Warren Buffett has called derivatives “financial weapons of mass destruction” is that a major derivatives insurer goes under…wiping out all the guarantees that firm has extended to CDO and CBO bond buyers. It’s the vaunted “daisy chain of risk default.”

Such is the modern financial era we live in. There is a gut busting irony to this predicament the West has gotten itself in. The West has a longer history and creating “sophisticated” financial instruments. And yet the East is gobbling them up at a ferocious pace.

Kevin tells me the Japanese are famous rain makers for the investment banking industry, buying up exotic new debt products almost as fast as they buy Luis Vuitton bags and Burberry Scarves. Instead of a handsome handbag, however, they’re getting something far more dangerous: a liability that looks like an asset right up until the moment it doesn’t.

Bondholders of the world beware. Those that have guaranteed your debt (the U.S. government, Fannie Mae, Freddie Mac, derivatives insurers) are running tremendous risks. I say “those” but what I really mean are individual traders now responsible for managing complicated positions AND making a profit. There’s a long history of traders in risk making faulty calculations, and I’m not talking just Orange County and LTCM. It’s a common occurrence in financial markets.

By this time Kevin and I were on our second cup of Earl Grey and moved on to the failure of the Western Welfare State and the urgent question of what will replace the dollar standard. We agree that we’re not witnessing the end of the world, just the end of the world as we know it.

We also agreed that the silver lining to this dark storm cloud is your ability as an individual investor to do something about it. You don’t have to sit idly by as the major institutions to which you’ve entrusted you financial future run enormous risks. You can have an exit strategy that keeps you out of harm’s way, and liquid in times of crisis…more on that later this week.

Gotta Go,

Dan

P.S. By the way, my return to the Continental United States doesn’t mean my trip is over. In the next six weeks I’m due to hit San Diego, Baltimore, London, Paris, New York City, and Vancouver, British Columbia. I’ll be reporting from several conferences, too. Stay tuned.

Eureka Rebellion

Eureka Rebellion

“How you sparkle. How you shine. How you rise above the sky.”
-Rubyhorse

The Super Pit in Kalgoorlie, Western Australia used to be called “The Richest Mile on Earth.” Today it’s just Kalgoorlie, a real live twenty first century mining town. The work is hard, but prostitution’s legal, beer’s cheap, and when the gold price goes up, life’s good. I can attest to most of the above, because I was there on Tuesday.

Life is getting better everyday for the folks in Kalgoorlie. But if you’re not willing to work in a gold mine, how else can you profit from the rising gold price?

Long-suffering readers know that I’ve been tracking the debut of a gold related exchange traded fund in the United States. The idea is simple: securitize gold and make the security redeemable for the real thing. What’s the benefit?

Not everyone wants to own bullion…to find a safe place to store it, or to pay a bank to store it for you. Not everyone wants to collect gold coins, although there is a growing market for it. In fact the folks at the Perth Mint told me that a Russian bank recently bought the entire issue of a coin that commemorated the Eureka Stockade Rebellion here in Australia.

In 1854, hundreds of gold diggers rebelled in the town of Ballarat against official rule. They ran a flag up the pole at the stockade and swore the oath, “We swear by the Southern Cross to stand truly by each other and fight to defend our rights and liberties.”

Why would a Russian bank take down a whole coin issue celebrating gold and independence from the authority of the State? Hmm. Interesting question. Maybe the only real defense of freedom is sound money and a loaded gun. But we’ll leave that for another day.

Investors not interested in rebellion against the monetary system crave a way to buy and sell a paper form of gold. The market wants it. So why don’t we have one in the States yet?

One possible answer is that the SEC or CFTC is holding up a launch. That’s possible. But from what I’ve been able to gather from primary sources in Perth, it’s a lot more about infighting in the gold industry…and a series of blunders and court cases that have kept a usable product from hitting the market.

The answer is shrouded in tangle of court cases about who really developed the concept of securitizing gold. I won’t go into all the gory details. Suffice it to say there are two basic problems.

The first problem is that the actual structure of the investment vehicle that was eventually launched by the World Gold Council in London (following the launch of the Australian issue) was flawed.

The original structure constituted indirect ownership of gold through a security, something apparently not allowed by U.K. security law. The WGC had to reengineer the instrument and has since done so to clear up the problem.

In the meantime, there is a legal problem revolving around a WGC-backed gold ETF in the United States. All the court records are public so you can look it up if you’re interested. What we have here, though, is a simple case if intellectual property dispute.

The plaintiff in the case in front of the New York Supreme Court claims he broached the idea of securitized gold redeemable for bullion with affiliates of the WGC…and that those affiliates eventually advanced the idea in violation of a confidentiality agreement. The saga goes on, with the WGC in the middle of the mayhem and retail investors no better off.

Of course, nothing is holding back anyone else on Wall Street from launching a securitized gold product.

With the slump in the gold price, though, maybe Wall Street thinks main street isn’t interested in buying paper gold. That, of course, is a real problem.

The spot gold price isn’t volatile enough, right now, to make owning a security that tracks it attractive to speculators. If the underlying asset doesn’t move, why would there be a market for a security that tracks it? And if the underlying asset doesn’t move much, what’s the chance that the security would trade at a premium to the net asset value of the fund?

Funny enough, gold-based securities DO trade at a premium to net asset value. The Central Fund of Canada (CEF) which I’ve recommended in SI currently trades at a 15% premium to NAV.

Is that insane? Not if you believe the gold price is going up, and soon. By owning the fund, you own a non-expiring call on the spot gold price. If and when gold makes a $100 move up, the net asset value will also go up.

As the value of the fund’s gold goes up, the market for the shares heats up. It becomes more attractive to own a paper asset that derives its value from an asset in the middle of big bull market (as opposed, say, to a paper asset like a mortgage backed bond whose value is based on the mortgage payments of overleveraged home buyers.)

Why doesn’t Wall Street get with it and provide more securitized gold products?

One big reason may be lack of institutional demand. Pension funds, hedge funds, and other big market players don’t want to own bullion. If they want exposure to gold, they’ll get it in the futures market, or, in some cases, through gold equities.

In both cases, they get leverage. And in both cases, they get liquidity, the chance to pare several hundred million dollars in one place and get a quick return. Why give that up for a gold ETF that doesn’t move?

For those and more reasons, you don’t see big money managers lining up to trade cash and shares for actual gold bullion. But that doesn’t mean there isn’t real retail demand.

I’ve said for a year that the public is ahead of Wall Street on this way. There is a trillion dollars sitting in money market funds. The owners of this money obviously don’t care about yield since, in real terms, money market yields are practically negative.

If you’re going to get zero yield on your cash and run the risk of owning a depreciating currency, wouldn’t you seriously consider getting zero yield on gold bullion, but owning a commodity that acts like money and goes up in dollar terms the weaker the dollar gets?

I think it’s a no brainer. And we may see Barclay’s jump in with a gold iShare later this year.

But it’s a bit of a paradox anyway isn’t it? Real gold bugs aren’t interested in securitized gold or in a way to introduce mega liquidity to the gold sector. They buy and own gold because it’s real money and can’t be printed, not because they can buy today and sell it tomorrow at a higher price.

Still, it would be great for everyone if there were a liquid, U.S. listed security that’s redeemable for gold.

But I’m beginning to think it’s less and less likely to happen.

And I’m also beginning to think that the idea of owning “paper gold” has a short half-life. If the decline of the dollar is “disorderly” it will bode ill for all paper assets and you’ll better off owning some of the real stuff.

Of course if the deleveraging of the American economy takes another five or ten painful years…trading paper gold might become an easy way to cash in on the appreciation of the gold price. We’ll just have to wait and see.

Okay…it’s late here in Sydney, where I’ve just flown in and the beer is just as cold but the prostitution is less legal. Time for dinner.

Until Next Week,

Dan

P.S. When I was in Thailand I wrote about complimentary currencies, as described to me by a man on holiday there (who ironically lives in Boulder, Colorado…about 30 miles from where I grew up.) After getting a few reader e-mails about that article on currencies I went back and looked at my notes and wanted to add two new points.

• First, the basic idea behind a complimentary currency is to meet unmet needs with unused resources. Easier said than done, of course. But I thought I’d clarify that point.
  
  
• Second, Steven (the gentleman I spoke with) made a point that a reader who wrote also made. Namely, services are a better medium of exchange than commodities.
  

In that line of thinking, the service you provide IS the currency, the medium of exchange…. where you exchange your service for someone else’s service.

The idea makes sense to me, and probably works as a concept.

The baker trades his bread for shoes. The shoemaker trades shoes for beef. And on and on.

The problem with this model, as I see it, is that it’s not scalable. How is a microbiologist going to trade his services with a pastry chef? I’ll trade you my yeast culture for your pain chocolate?

Though I’m not a scholar on it, I suspect that money was commodified because it made it far easier for people in diverse lines of work to trade gold for what they needed instead of trading labor. The commodification of money probably enhanced the division of labor.

Instead of getting paid in a service, you can be paid in a commodity, which can be exchanged for other services or goods with anyone else you choose to do business with.

This isn’t to say that trading services as a form of payment is a bad idea. It works really well for certain types of exchange.

But the more complicated the exchange is, and the more value added that goes into the good or service, the harder it is to make a clean exchange of services of values where both sides agree on the value of services rendered.

In some services, like prostitution in Kalgoorlie, the whole process is a lot less complicated.

Free wisdom from one of the merchants in Boulder, Western Australia. Western Australia is about three times the size of Texas. It's also rich in minerals, natural gas, and gold. The "Golden Mile" where the Super Pit is now has produced 50 million ounces since Paddy Hannan, Dan Shea, and Tom Flanagan stumbled on to some gold. Three miles south, Same Pearce and Will Brookman made the big find....and pegged the ground for the Great Boulder and Ivanhoe mines...two of the most profitable mines of all time. 

The little town of Boulder, outside the Super Pit and on the other side of Kalgoorlie. Boulder lives and dies with the mine...and the morning we were there...it looked pretty dead. But as a real estate play proxy on the price of gold, it's intriguing. The thinking, my friend Andre explained, is that as the spot price of gold goes up...real estate in and around big mining towns inflates. It's a sound theory. What we found in practice is that this town, at least, was too illiquid to come in and find good value and yield. If you can wait fifteen years...who knows. By then, the mine will be over 6km long, 500 meters deep and 1.2km wide.  

The little "doorways" in the side of the slope are evidence of the time when the mine was not an open pit mine, but an underground one. Underground mining in the area near Kalgoorlie, "The Golden Mile" as it came to be called, started in 1893.  

The mine is owned jointly by Newmont Australia and Barrick Gold Australia. It's also one of the big reasons why Australia now produces about 300 tonnes of gold a year.  

The Super Pit produces about 850,000 ounces of gold a year....the ore grade averages 2 grams per tonne....which means one truckload of ore contains about 16 ounces of gold, or enough to make a solid golf golf ball. 

A 793C Caterpillar dump truck toils in the distance. The bed of the truck is seven meters wide and six meters high. The engine is a 2400hp V-16 and uses about 4,000 liters of fuel per day. The mine's literature compares driving a truck to driving a two-storey house from an upstairs window. If you want to get a street legal one, it'll cost you about $3 million. Come to think of it, if Fed Governor Bob McTeer thinks buying an SUV on credit will get the economy going...what about putting a few thousand of these bad boys on the lot? 

Here's a picture of a truck on the far side of the pit, rolling up the slope. About 245,000 tonnes of 'dirt' gets moved each day.  

The mine runs continuously...trucks go up...trucks go down into the pit... 

And now with five times zoom...it gives you an idea of the scale. By the way, the tires on the trucks are solid, not inflated. It would be pretty trick to try and fix a flat with tons of ore in the bed. The big shovels that load up the trucks can load up 60 to 70 tonnes of ore in about two and half minutes.  

Little pink houses. Kalgoorlie can be a rough place. But it's also a free one. It was a bit early in the day to uh...see anything along Hay street...where the ladies of the night were fast alseep. We did stop by later...on the way out of town... 

Monetary Independence Day

Monetary Independence Day

Dear Reader,

Don’t let the beach pictures fool you. Your editor was not idle over the weekend, or on American Independence day. The pictures I sent along yesterday are bucolic. Lots of white sand, green trees, and blue skies. Lest you think your editor came to Perth to get a tan and work on his surfing, let me explain.

I came here to Asia looking for a path out of a dollar-based U.S. centric world and into a something-else based non-U.S. centric world. If possible, I wanted to find Asian stocks that provide direct exposure to the growth story taking place here, without taking on too much risk. Easier said than done.

Asia has all the tools to get out of the dollar…high savings rates, domestic demand, raw materials, and cheap labor. Yet it’s still wedded at the head to the greenback. And Asian stock markets are dominated by foreign money—which as we’ve seen in the past few weeks, is skittish. More on Asian stocks when my trip wraps up and I can put all the pieces together.

But I’ll now confess one of the other reasons I came to Asia, and specifically to Australia. I’m looking to become Sovereign. What do I mean by that? Let me put it in the form of a question….

What can you do today to make sure that your financial future is not dependent on things beyond your control?

I’m asking because most people’s eyes glaze over when you tell them the dollar could lose all of its purchasing power in the next ten years.

Most people, and maybe you’re one of them, find it unrealistic that the world’s entire financial system is so overleveraged that it threatens to topple and radically affect living standards.

These aren’t pleasant things to think about. But neither is Hell. And if you choose to ignore them, you do so are your own peril. Why not make Pascal’s gamble instead…hoping you’re wrong but hedging your bets in case you’re right? And if you haven’t done anything yet, the markets have given you a reprieve.

The dollar hasn’t crashed, yet. The bond market hasn’t imploded, yet. And the stock market hasn’t set a new standard for wealth destruction, yet. There is still time to reduce your risk.

Part of reducing your exposure to the biggest financial risk of your lifetime is to think about more than just your stock portfolio. You have to think about all your assets. If you take seriously the proposition that no currency regimes last longer than seventy five years, than you have to put some real thought into what changes you’re going to make to your personal balance sheet to adjust for a radical decline in the dollar.

It’s not simply a matter of reducing your equity allocation from 75% to 50% and adding cash and bullion. You can start with simple, principled goals. Stay debt free. You’re your assets liquid. Have enough cash to survive in a crunch. Live in a place that’s not going to go up in a ball of flame if there’s a great deal of social “disruption” in an American financial crisis.

That’s why I like Western Australia so much. It’s not densely populated. The climate, from what I hear, is a lot like San Diego. And it’s in close proximity to the major investment story of the next one hundred year.

It would be even sweeter, I thought, if it turned out you could get some real Indian Ocean real estate on top of all the other benefits, and get a cheap, with a currency upside. But there’s a slight problem.

Australia, like the U.S. and the U.K. is in the grip of a housing hysteria. A real estate broker I talked to yesterday says the average new homebuyer borrows around 95% of the cost of the purchase price. She all said the margin of error for a first time homebuyer is incredibly thin. If incomes don’t rise faster than inflation or interest rates…the marginal buyer falls off the margin, and is doing so at the rate of 50%.

That’s why the central bank here has already started hiking rates. And just a modest hike has been enough to put a crunch on new housing demand in the hot markets of Sydney and Melbourne.

But you’re hard pressed to find bargains anywhere, especially here in Perth. The market favors renters. It IS true that in some places of the world, this being one of them, people will always want to live. The Napa Valley, the Rockies, Paris, anything near a beach with a breeze…there are pockets of real estate that survive cyclical downturns quite well. At the worst, you may see real estate values and home prices grow less fast in these regions, but not fall in real terms.

However, in those places where home values have risen strictly as a function of low interest rates making a home affordable to new buyers, watch out. In those places, the housing stock itself is of lower quality. And the appreciation in prices is dedicated on a steady stream of low-rate powered demand coming on line.

The real systemic risk is not in the housing market anyway. It’s in the mortgage lending market, and the fact that personal liabilities (mortgages) have been securitized and turned into assets. The mortgage lending bubble has put trillions of dollars of mortgage-backed securities into the portfolios of pensioners, retirees, and otherwise hapless investors…whose retirements may now depend on the ability of their neighbors to make the monthly mortgage payment.

It’s too bad that the housing angle here hasn’t worked out here in Perth. You’ll have to look in more exotic, less well-lighted places, where the sanitation is dodgy and the value is still obscure to your average comfort loving business traveler. That’s where today’s real estate bargains are.

But the hard asset/real asset strategy is still very much alive. And Western Australia is going to play a big part in it. Which brings me to Independence Day.

On Monday my hosts Andre and his mother went with me to the Perth Mint. You may know the mint through my colleague and friend Michael Checkan. Michael works with the folks here in Perth to sell gold-backed certificates to American investors looking for gold bullion exposure and some currency diversification.

I went to the Mint in a pensive mood, pondering the fate of the dollar. You’ve probably heard about the death of the dollar in a dozen articles by now. Maybe you believe it. Maybe you don’t.

For my part, I believe the Federal Reserve and the Federal Government have betrayed the American people. They’ve robbed savers by destroying yields in the money market. They’ve issued debt that will either destroy America’s credit rating when the government defaults, or take Americans generations to pay back.

The government has sold America’s financial future to foreign investors. Some people think the foreigners are patsies for owning American debt and that there’s no risk to America if foreigners buy our bonds. I couldn’t disagree more.

Instead of directing their savings into new, wealth-creating investments, Americans are going to spend years paying higher taxes so the government can make interest payments to foreign borrowers. Not money well spent.

And with over $400 billion annually going to the defense establishment, we’ve managed to garner the enmity and distrust of nearly the entire civilized world (and all of the uncivilized world), while accepting and now passively enduring routine encroachments on our right to move freely in our own country.

The so-called guardians of our money have destroyed it. Interest rates are about incentives and rewarding risk. A market determined rate of interest would fund good entrepreneurial risks and punish bad risk takers by limiting their ability to borrow through high rates.

Failure would be punished. Risks that create new products and services for consumers that improve standards of living would be rewarded.

Instead, we have a Fed that’s changed the incentives to encourage financial speculation. Why borrow to spend on your business when you can borrow at one percent and buy a mortgage-backed bond yielding four percent? It’s risk free return right? Why worry about the future when you can consume today?

The Fed has engaged in what Richard Russell calls immoral behavior. Russell is right. Free markets break down when people start behaving immorally and taking bad risks simply because they can afford to. As my friend Andre says, it’s going to end up being return free risk by the time the whole affair ends. But when, you might ask, will the whole thing end? And why?

The when is anyone’s guess. The whole world is bound to the dollar’s fate. No one is eager to abandon the devil they know for the devil they don’t. So foreigners keep on selling their own currency and buying the American one. Asia lacks the self-confidence to get off the dollar standard.

Of course there’s got to be a real limit to how many yen Japan’s government can sell or how many dollars it can buy. And as Andre pointed out, the fact that China is now running a trade deficit may have a serious impact on its dollar consumption. When you have no surplus with which to buy dollars or U.S. bonds, you buy a lot less of them.

Heck, you might even sell a few of those bonds to raise the money you need for your raw material and energy needs, or the money you need to feed and provide medical care for the 600 million peasants who live in the countryside and have not enjoyed the prosperity of coastal capitalism.

But just what is the limit? Well…I suppose it’s possible you could see a current account deficit that’s 10% of GDP before the imbalances become so radical that an involuntary adjustment (crash) occurs.

Ten percent is just a number out of a hat though.

The truth is that the world’s financial system is now so intertwined and complex that it’s getting harder and harder for different financial players, from the biggest to the small, to make simultaneous adjustments for interest rates, currency fluctuations, and geopolitical risk.

That leads me to believe that when the adjustment comes, it will be because something has broken…a bullion bank goes bankrupt, a sovereign, corporate, or GSE bond default…an oil terminal terrorist attack that drives crude to $100.

Of course, these are all events, which are out of your control. You can’t do anything to prevent them. But you can acknowledge that any or all of them could happen today…in five weeks, or five years.

That means you still have time to make the big decisions about where you want your money invested and what mix of assets you want in your personal balance sheet. As I said, I’m leaning ever more to fewer equities, more bullion, and when you are in the equities market, being in with leverage in options bets that hedge your risk on your open long positions.

And then there’s gold. The other day at the mint Andre’s mom suggested I have a coin stamped in honor of American Independence Day. But I did her one better. Andre and I were unable to describe what the world will look like when the dollar-standard levee breaks and the great pool of liquidity pumped by the Fed over the last four years sloshes at last down the drainpipe of history.

But a little bullion in your pocket never hurts.

Accordingly, I had three coins stamped at the Mint. Mind you, I’ve not violated the U.S. constitution by minting my own currency. It’s not legal tender and it’s not transferable. Still, I have three collectable coins as a start to a new monetary regime.

On one side of the two silver coins and one gold-plated coin is the Black Swan, a symbol for Perth and the mint. It says, “The Perth Mint, est. 1899.”

On the other I had the following inscribed: One Bill Bonner, Reckoning Day Reserve, DDGU, July 4, 2004.

I know Bill is probably not keen to have a currency named after him. He’s pretty modest. But the Reckoning Day Reserve sounded right to me. DDGU is short for the trade of the decade, “dollar down, and gold up.” And I backdated the date by one day to commemorate this new declaration of monetary independence.

But the date doesn’t really matter. The question for you is, when are YOU going to declare your monetary independence from the fate of the currency your government has done so much to endanger? It’s not too late.

And who knows…maybe the Reckoning Day Reserve will catch on. I’m here in Perth for two more days. Maybe if I crank up the printing presses I can give the Fed Chairman a run for his money.

If not, I plan on giving the coins away as door prizes, one at the commodity and resource conference I’m speaking at in San Diego next week and the other at the annual Agora Wealth Symposium in Vancouver in August. I’ve posted pictures of my monetary experiment below (and the image that inspired them), although they’re kind of fuzzy.

It’s ironic that the hotel I’m typing from formerly housed the Australian Tax Office. Some things, like buildings and land, can be reclaimed and put to their proper, life-affirming, profit-making use. Other things, like fiat money, are irredeemable.

Human beings, for their part, are always redeemable.

It is our great virtue, or gift from God, as you choose to believe. And while our government may have betrayed us and behaved in a grossly immoral fashion by running up debts it can’t pay and selling out ownership of our future, there is always personal redemption to be found, and the financial kind can even be secured in this lifetime.

That redemption begins without debt, proceeds with cash in hand, and endures with real assets that you can make liquid if and when you need them. You may never need them. But it’s better to be sovereign than sorry.

Tomorrow, the much-anticipated truth about why there is no exchange traded gold fund, redeemable for bullion, in America. Plus, the Golden Mile, the Super Pit, and the brothels of Kalgoorlie.

Until Then,
Dan

Currency Decade: Most analysts believe we have not even reached the halfway point in the "Commodities Decade" that began in early 2001. One great way to take advantage of this opportunity in commodities is to own precious metals. And, one of the safest, most flexible, and easy ways to own precious metals is through the Perth Mint Certificate Program (PMCP), a cost-effective, government guaranteed precious metals program. I have just visited the Perth Mint, and I can attest to the fact that they are "for real." To find out more about this unique precious metals program, please fill out the short form to request detailed information.

The "Reckoning Day Reserve," coming soon to a sovereign individual near you. 

Your editor strikes it rich at the Perth Mint. 

The Black Swan of Perth meets the Red Icon of America...and gives birth to a new sovereign currency? Details above... 

Surf crashing white sand. 

Looking West on the Indian ocean near susnet. 

I'll tell you about the pot of gold tomorrow. 

Another beach view...to cold to swim, plus, I dont' swim anyway. 

I took this to be a good omen as well...looking over to Freemantle. 

The Swan river and the city skyline from King's Park. I spent Saturday with my host Dr. Andre Homberg and his mother. They said the weather was awful by Perth standards. It felt an awful lot like a Colorado fall to me...and so was quite nice. 

Egg Butcher to the World

Egg Butcher to the World

Perth is the first city I’ve arrived in in the last two months that didn’t greet me with a big traffic jam. Paris, London, Washington, Dallas, Hong Kong, Shanghai, Nanjing, Beijing, Tokyo, Bombay, Bangkok, all of them, massive traffic.

But Perth is small, only 1.4 million people (it’s also the second windiest city in the world, from what I gathered last night). In fact the entire population of Australia (20 million) is barely larger than the population of Shanghai. Geographically, though, Australia is as large as the continental United States. And it’s got a LOT of natural resources….

Wheat, wool, beef, lamb, lobster, prawns, pearls…wood, oil, wine, natural gas, iron ore, eggs…it’s a veritable company store for East Asia. Of course that’s why I’m here. Who’s selling what to whom and how much, per share, are they making?

What Australia doesn’t have is a lot of labor. As my unofficial host Andre (Strategic Investment reader, Daily Reckoning reader, and money manager) pointed out to me last night, you don’t see a lot of finished goods or even manufacturing. The cost is too high. What you get is mostly wholesale…an enormous open-air market for raw materials that get exported.

Andre is a German émigré who’s been in Australia long enough to sound South African. He dragged me out of a minor jet lag stupor early yesterday evening to pay a visit to a local club (not THAT kind of club). It was more like an English Gentleman’s club. Unlike an English club, there were women, and younger people, Cuban cigars, and Bon Jovi playing on the CD changer (Livin’ on a Prayer).

We had a chance to discuss the itinerary for the next few days…some vineyards, the Perth Mint, a day trip to the Kalgoorlie mine (one of the largest open pit mines in the world) and much, much more. You’ll be reading about it next week, and seeing some pictures too.

For today, my notes are short as I have a pile of deadlines to work through before my Baltimore-based publisher sends out a bounty hunter. Just two short, somewhat macroeconomic notes about the Money Migration and the end of the dollar standard and the U.S. centric global economy

Asia has a self-esteem problem. By the way, this is a bit ironic. You know the old saw about Americans being the most self-centered and arrogant people in the world? Turns out its true of just about everywhere I’ve been. France, England, China, Japan, India…everyone seems to think they’ve got the best culture in the world.

And they expect you—as a burger chomping, coke swilling, blue jeans wearing, non-football understanding American—to respect their exalted place in the world. Kind of refreshing actually. Everyone’s proud of where they come from. But enough of this chiding Americans for being arrogant. It’s a pretty common nationalistic fancy.

Still, Asia, with its long history lacks the economic confidence of young upstart America. Economically, Asia is the total package. It’s got the internal domestic demand to sustain GDP growth. It’s got the resources, labor, and technology, to trade amongst itself and with the rest of the world as an equal partner.

What it doesn’t have is that basic naïve American faith in a better economic future. In many of the places I’ve been, there’s a reluctance to shift away from U.S. centric growth. It’s almost like a belief that America still has some ineffable quality of success that outweighs the mountains of debt piled up from sea to shining sea.

And so the simple post World War two era economic model hasn’t changed yet, neither in practice nor in belief: keep your currency competitively low relative to the dollar and export. Generate a trade surplus and hold on to the dollars for a rainy day in the currency markets.

The variables in the formula that make it work are a U.S. consumer with a wallet full of credit cards and a U.S. dollar that remains relatively strong. But now both those variables ARE changing and the model is starting to break down. The U.S. consumer has reached a cyclical peak in his ability to consume. And the dollar is fixing for another decline as the current account deficit forces a dollar adjustment.

Still, Asia buys dollars and seems to lack confidence in its own future. It still believes, at least in currency terms, that there is strength in weakness. And of course there is a measure of truth to this. Currencies can only get to strong before their strength starts to hurt exporters. A stronger currency makes your goods more expensive to foreign buyers. When a good portion of your economy is based on selling to foreign buyers, a currency that’s too strong prices your goods out of the market.

The obvious answer is to weaken the currency by lowering interest rates. Print more money, inflate, and the problem becomes less acute. This is a double-edged sword, though. You can’t just make the cost of borrowing cheap and hope to solve the strong currency problem without unintended consequences.

As central banks all over the world are finding, a little monetary goosing goes a long psychological way. That is, central banks love to see the growth in GDP and consumer spending that comes from borrowed money. For a few quarters the stimulus looks benevolent.

But you can’t use monetary policy as if it were a chemistry set. When you change the cost of borrowing and encourage consumers to spend, you also change attitudes about risk. Generally, cheaper money for all leads to more bad risk taking.

What starts out as an attempt to keep the currency competitive and the economy growing morphs into a spending free for all based on credit, with its own set of stock bubbles, equity bubbles, and huge personal and corporate debt loads. Thus Asia’s ingrained fear of bad loans and bad debt in the banking sector.

That’s one “big picture” issue. The other, and I’ll be briefer this time, is experience. You can have the heart of a capitalist. But without the experience of one, you’re to going to make a lot of mistakes. All over Asia you see the signs of growing wealth.

But to go Platonic on you, the signs aren’t the wealth. The wealth, as Stephen in Samui pointed out, comes from people and their ideas and their hard work. It also comes from a certain kind of economic thinking…based on competition. Can you provide a better service at a lower price? Can you provide a product that consumers are willing to pay for?

These are different questions that whether or not something can be manufactured at a lower price in a different country. Asia has many advantages when it comes to labor costs. That’s pretty well known.

But where Asia may be at a genuine disadvantage to the West is experience in competing in a free market economy. The good news is that graft and corruption or simply old ways of doing things don’t stand a chance at surviving the more competitive the world begins.

Americans have been unpleasantly surprised that one of the unexpected side effects of globalization is that you may have to compete for your job with billions of people on the other side of the world.

On this side of the world, I suspect Asia is going to be unpleasantly surprised too. The institutions of free markets take years to develop. Banks, stock markets, property markets, and the insurance industry…the West has a big head start in how to provide financial services in a competitive marketplace. It’s one industry that we may do very well in, even in the Asian Century.

Until this weekend,

Dan

P.S. The great thing about a trip like this is the number of ideas you can generate when you come into contact with new people and new places. Most of them are investment or economic ideas. But not all of them.

For example, before I went to Thailand I didn’t know the Thais had a royal family, and that the current royal family is well educated and quite scientific. It got me to thinking of the differences between royal families…which lead to the idea of a new reality T.V. show. Put all the Royal families on a desert island and see which one survives. Think Royal Family Feud meets Survivor.

Since I’ve had so many cab drivers in the last three months, I’d also like to organize a pay per view contest called “World’s Best Cab Driver.” You hold competitions in big cities like London, Tokyo, New York, Bangkok, and Shanghai in order to find the best local driver. Then that driver brings his car and all the cab drivers compete on a busy downtown street to see who wins. Haven’t picked the location for the competition or the route yet. Suggestions are welcome.

I’m also considering writing a book about “Fine Airport Bars of the World, or “Secrets of Eating Deep Fried Food in South East Asia.” That’s if this whole Money Migration investment business doesn’t work out

It’s also occurred to me that many people may never make it to the parts of the world I’ve been fortunate enough to visit in the last year. That’s why I’d like to take several thousand acres in Las Vegas and create a “Museum of Museums.” The idea is to create scale replicas of the major tourist and museum sights of the world…. the Louvre, the British Museum, the Uffizi Gallery, Angkor Wat…and others. Vegas already has a Paris and a New York and a Venice.

With the world getting more dangerous and it getting harder for Americans to travel abroad safely, why bother with it? Instead, let’s simply recreate the best places in the world, but make them air conditioned and less dirty. If you’re a developer who has several hundred million dollars and some real estate in Las Vegas please contact me via email and we can talk further.

Here's what cheap interest rates can do for a hot foreign market...drive stocks up until the cheap money cycle ends. You'll notice the downturn in EWA (a basket of Australian stocks that trades like a single stock) began at about the same time as talk of higher interest rates in the United States began. Also, the rally in the Aussie dollar began to run out of steam about about $0.80 Australian to $US. The Aussie dollar has since corrected (weakend) down to $0.70...so traders looking for another round of dollar weakness could see a move, albeit smaller than the last one, here.  

Ahh yes...a little different type of picture this morning to go along with the commentary above. This is the U.S. dollar versus the Aussie dollar over the last three years. The falling line means a weaker U.S. dollar and an appreciating currency. You can see the recent move up in the dollar. It was caused by two events. First, the threat of rising interest rates in America caused investors in emerging markets to take profits and exit. The "carry trade," where you borrow cheap in America and invest the borrowed money in higher yielding stock and bond markets abroad began to unwind in December. The second event is that a currency can only gain so much before its strength starts to hurt domestic firms. While Aussie consumers may have benefitted from more purchasing power at home, Aussie exporters saw the price of their goods abroad (at least in the States...and in China because it's linked) rise relative to the competition. There comes a point when a strong currency can be TOO strong for your exporters to be competitive. 

In the Sovereign I Trust

In the Sovereign I Trust

“Many of you are well enough off that... the tax cuts may have helped you. We're saying that for America to get back on track, we're probably going to cut that short and not give it to you. We're going to take things away from you on behalf of the common good.”
Hillary Rodham Clinton,
Former First Lady and Future Candidate for
Vice President or President of the United States

I’m writing today from Perth, Australia after traveling all day yesterday. My publisher (and you) may be glad to know I did not disappear in Thailand or Samui. It was tempting to give up Fed watching for water buffalo watching. I was even going to look for that beach in the Leo Dicaprio movie and start up my own experiment in deserted island economics.

Instead I got a plane to Perth, where the air is colder but cleaner. And from Perth I’m going to make two final observations about Thailand before launching into my Australia schedule.

First, the economy and the people are still vulnerable. The Thais who lived through the baht crash in ’87 are slow to believe in turn around stories. They saw first hand how your stand of living can disappear over night.

You still see signs of it all over Bangkok, giant concrete pillars supporting roads that were never built. Rebar cages sticking out of the ground waiting for cement that was never poured. And those are just the visible reminders.

The biggest scar that comes from a crash in financial markets isn’t physical. It’s psychological. It’s the giant gash in your brain where trust and confidence in the future used to be. That kind of damage isn’t easily repaired, which explains why the Thais I spoke with are deeply suspicious of another bad loan crisis in the banking system, or worse, another crisis in the currency.

And truth be told, there are plenty of reasons to be suspicious. There are the geopolitical risks of a growing and organized Muslim rebellion in the South. And yes, $60 oil would put a hurt on the country’s currency reserves, risking another baht crash. And absolutely, rising interest rates would cut off some of the easy credit that’s fueled GDP growth.

But the biggest risk in Thailand is that trust never fully recovers. It’s an interesting subject because it’s part of the reason why so many Westerners say they want to live in Thailand, to live in communities and around people that they trust. To replace that sense of distrust and isolation they have in their own lives, wherever they came from.

That’s trust in an uh…sociological context. And it’s not my usual beat. So I’ll say no more about it. But let’s talk trust in a monetary context.

Right now I have six different currencies in my wallet: dollars, yen, remnimbi, rupees, baths, and Aussie dollars. Except for the Aussie currency (which is some kind of rubber…meant to keep it from getting wet at the beach perhaps?) it’s all just paper… colorful, pretty paper.

The reason I can take it out of my wallet and exchange it for something real (food, shoes, a tax ride) is that the other party to the exchange trusts that he’ll be able to trade it for something he needs as well. Such is the basis of all fiat currency. Belief.

One of the men I was introduced to in Samui is Stephen Belgin. Belgin is working with a man named Bernard Lietaer on a book called "Of Human Wealth: Beyond Greed and Scarcity." Belgin says Litaer is one of the architects of the Euro currency and a thinker on the future of money.

The problem with the current monetary order, Stephen explained, is that it doesn’t help meet development needs in the many poor places of the world. Most of the world’s communities can’t raise money for infrastructure through a bond offering or a mill levy. There isn’t enough wealth extant to use as collateral for borrowing capital.

So how do you create wealth and opportunity in places that are not rich in capital or natural resources? Stephen is working on an idea called complimentary currencies. Notice that’s it’s complimentary not alternative. He has in mind mediums of exchange that work along side fiat money and are backed, not by the full faith and credit of a government or future tax revenues, or gold, or land, but human capital.

“Hmm,” I frowned. I asked Stephen what he thought of Hernando de Soto. I met De Soto in Paris last year and listened to his speech about the developing world. His main point is that land is the greatest form of unused capital in the world. By creating clear title to land and extending it to individuals—private ownership—you unlock the natural resources of both human beings and an economy.

It’s a pretty compelling argument, I thought. I like it because of the idea of stewardship…that an owner is likely to be the best caretaker of his most valuable asset, his property. Owners make the desert bloom. It’s only on publicly owned land, with no ownership and therefore no accountability, that you see huge mismanagement of natural resources.

Steven nodded but said I had put the question to him the way most of the world would. This didn’t offend my pride. But it did make me wonder. How can any economic transaction be based on anything other than a medium of exchange whose value is agreed upon by both parties? Granted, that medium could be arbitrary…a seashell, oxen, or an ounce of gold. But doesn’t it have to be a real thing that has the attributes of a good medium of exchange?

Steven nodded again, but less amused I think. He asked what the real source of all wealth is. “People,” I said. To use Thomas Sowell’s phrase, people are the ultimate resource.

Stephen agreed with that and asked me to imagine a world where the basis of the currency is the faith we have in each other as human beings, as wealth producers. What kind of great societies could we produce if we abandoned the mental trap of scarcity thinking and unleashed human capital on the world?

Hmm. It’s a provocative question. And what I like about it is that Stephen and his colleagues are trying to solve a real problem…how to create currencies that work at the local level. He said he believes in currencies that work alongside fiat money.

But I think that someday, and perhaps soon, it won’t be an academic question. It will be a practical one with some urgency.

How do communities create a medium of exchange when government paper becomes worthless? THAT’s why it’s a question worth asking.

The skeptic in me says you can’t have a currency based on belief in basic human potential.

Some human beings are bad loan risks, whether you look at it in banking terms or moral terms. It’s prudent not to trust all people because not all people are trustworthy. A man’s word may be his bond in some places, but in other places, I’d much rather have his land as collateral than his handshake.

It’s a matter of trust. And it’s also a matter of memory. You can get burned in a deal, at the micro level. And the macro level, crashes can happen. They happen all the time, in fact.

The other day a colleague sent me a note saying that a crash in the U.S. housing market was impossible because there was no such thing as the U.S. housing market. His point was a variation of a point I’ve made before. Don’t confuse the real estate market with the mortgage lending market.

Real estate prices are affected by interest rates. But they are also affected by local factors as well. Demand for housing, location, taxes…these are just some of the factors that account for the differences between real estate prices in different parts of the country. And in truth, regardless of what’s happened in the housing market, in some parts of the country real estate is still cheap.

But that doesn’t meant there won’t be a housing crash. Home prices in some parts of the country are up primarily because the Federal Reserve kept interest rates so low for so long before finally reversing course yesterday. In other words, the rising value of homes was as much a function of low interest rates as it was of sustainable demand for new housing.

And in any event, the Government sponsored enterprises aren’t exactly poster boys for full disclosure and transparency. We find out just this morning that Freddie Mac (FRE) posted a 52% decline in profit in 2003 from 2002. I don’t care what business you’re in, a 52% decline is pretty severe.

Freddie told investors it won’t report 2004 results until March of 2005. The company says it’s grappling with antiquated accounting systems. That’s a comforting for an entity that manages trillions in risk, and apparently isn’t managing it too well.

To what did the GSE attribute its losses, you ask? Rising interest rates and their affect on Freddie’s derivative positions. The company said, “To the extent changes in interest rates continue to be significant, our overall net income will remain volatile.”

Warning. Warning. Eject. Eject.

We’ve been assured that the GSEs are wizards at managing interest rate risk. And Alan Greenspan has told us that existence of the derivatives market has allowed for the dispersion of risk throughout the system…and that it’s been a GOOD thing.

But there’s another way of looking at it. That way is that you can’t package up dozens of other people’s liabilities and sell them as assets and pretend there is no risk. You can’t expect profits when you’re borrowing costs go up faster than the profits you make lending money at low rates.

These are all pretty well worn financial points by now. Patient readers are familiar with them and are either convinced or asleep. For now, the entire housing market rests on that oh so precarious of assets, trust.

Whether it’s a housing market, a currency, or an investment phenomena, once the trust is gone, it’s amazing how quickly the asset values follow. Americans who doubt this only need look all over the world to see that it’s true.

But if you can’t trust the dollar, a good old savings bond, or the government as we know it, who can you trust?

Sovereign in Samui

This is the other point I wanted to bring up with respect to Thailand. I met a lot people living their own lives here. Sure, they live with government hassles like anyone else. But anyone who decides to pick up and leave home and start over has a pretty strong sense that they’re being over-governed.

What I saw in Thailand was an attempt by people to reclaim some sense of their own individual liberty. Not political liberty. Simply the liberty to live your life unmolested by your neighbors or your government.

It’s a common mistake to attribute the quote “L’etat c’est moi” to Louis XIV. But the Sun King, that famous fan of absolutism, never said any such thing.

It was actually, at least according to my Google sources, Louis XI who said “I am the State.”

Today, let us reclaim the power of government and all say to ourselves, “I am the State.” Let’s secede from the common goodness of Hillary Clinton and become sovereign in our own right. One of the definitions of the word sovereign as an adjective is “self-governing, independent.”

Samui, like a lot of small islands, holds the alluring of a place where you might govern yourself, become a state unto yourself, a sovereign in your own right. Of course it turns out not to be that way. You are never really independent of your obligations to other people, whether you recognize them or not. That’s probably a good thing. People aren’t meant to be emotionally and spiritually sovereign, everyone running around in his or her own head ruling his own little realm.

I mean sovereign in the physical and financial sense, when you are not at the mercy of your government’s jails or its tax collectors.

Whether you can accomplish that kind of independence by moving out of America (whether, indeed, you have to move out of America to find it) or whether it can be achieved in other ways…by the accumulation and preservation of wealth…and by finding like-minded individuals…this is the question that I often try and answer through my work on Strategic Investment.

True, it’s a lot more grandiose that trying to forecast where interest rates are headed. But it’s also a lot more important.

Breakfast for two at the twilight of the nation state. 

More empty beachfront...there isn't a lot of quality beachfront left in Samui that's been left undeveloped. A few of the five star hotel chains are rumored to be looking for places to set up shop...but the space is already crowded. This is in Lamai, where I stayed.