(Taipan Publishing Group) – Gold, small caps and the U.S. dollar have had a stable three-way relationship for the better part of the 2009 rally. Now the three could be parting ways.

Dr. Marc Faber is one of the few market wise men whose thoughts are worth pondering. His monthly “Gloom, Boom & Doom Report” is always a good read. He is an active, Asia-based investor with decades of experience, hundreds of millions under management, and many prescient calls under his belt.

Faber has stated firmly and clearly what he thinks of the U.S. dollar. As you might expect, his opinion is not too flattering.

In the long run, Faber assigns the buck a value of “zero.” In the manner of all fiat currencies, America’s scrip is slowly being turned into toilet paper. The present cast of clowns in Washington seems bound and determined to accelerate this process as Wall Street cheers them on.

But that’s the long term, mind you. In the shorter term – i.e. for at least the next quarter or so – Faber is bullish on the buck. So bullish, in fact, that he is now on record as a buyer of $USD.

“As of today, I will be long in dollars,” Faber told Bloomberg last week. (Perhaps he is buying from my colleague Adam Lass, who professed on Thursday his intent to remain short.)

Continue reading Justice Litle on Taipan Daily.

That’s the president talking, not Taipan Daily. Mr. Obama’s remarks came in response to a question from a Canadian journalist, at a North American summit held in Guadalajara, Mexico.

Meanwhile, U.S. Representative John Dingell was shouted down by an angry protester at a town hall meeting in Romulus, Mich., last week. The protester, pushing his wheelchair-bound son to the podium, called Dingell a “fraud” and said that proposed changes would not help his son.

Emotions are heating up all around the country, with strong outbursts on either side of the divide. Some are furious that healthcare reform does not go far enough. Others are furious that it is being foisted upon the country at all.

We touched on this debate two weeks or so ago – see “Throwing Rocks at the Healthcare Hornet’s Nest” – but it seems worth another look.

“Increasingly, the [healthcare reform] battle looks like a presidential contest,” says The New York Times, “with expensive advertising campaigns and Internet-driven efforts to mobilize support.”

Interestingly enough, the debate does not appear centered on how much all this might cost. Instead, it is more focused on quality of care… and whether Americans would be denied access to care, as some say happens routinely in other systems.

The below excerpt (slightly edited for clarity) from Taipan Daily reader Helen M. does a good job, in your humble editor’s point of view, in summing up the strengths and weaknesses of socialized medicine:

Let me tell you a bit about socialized medicine, this coming from someone who lived with it. First 28 yrs of my life I lived in Eastern Europe, in Czechoslovakia. This country strived to reach socialism and eventually communism, after the Russian example. Thank God it never reached any of them. You had a doctor that was assigned to your employer, or in absence of employer to the place where you lived.

Offices were always overcrowded, they did not [push] medicine on you as doctors in our country do, for [they] were in short supply. Medical care was rationed and so were the surgical procedures. When you did not like the doctor assigned to you you couldn’t switch, [most] people of my generation worked very hard even physically (exercise) ate very sensibly (they could not afford more than basic food cooked from scratch at home, thus healthier than the USA supermarket food, most of which is bad for you) and they said keep away from the doctors if you want to live long healthy life. All my ancestors from both parents side lived a very long healthy life and worked till the day they died.

Later my scientist husband and I lived in other European countries for months or a few years. The U.K. had a sort of socialized medicine. It was not any better: overcrowded offices (lonely old ladies [w]ent to see their doc to talk), medications and medical care was rationed.

Germany did not fare much better. Not only for patients but for the doctors as well. Government determine[s] what they are allowed to charge even to private patients and till recent days it did not change. During the month of June German doctors were on strike to object to their low fee scale. Actually in spring of 2008 I did go to Munich, where [a] top oral surgeon placed 7 implants into my mouth and his associated fine American dentist educated in USA… did 3 perfect bridges and both charged me equivalent of $ 20,000 whereas USA dentist and his oral surgeon would not even give me an estimate [beyond] saying could be up to $ 120,000. I chose German team and paid $16,000 or $20,000 including two trips to Munich. And that for the best team in Munich.

But due to their government ran system they are much less paid than their U.S. colleagues. Still they provide very fine care. [German] strike accomplished some fee scale increases but how would American doctors respond when their salaries go 300% and more down? We shall all get equal care regardless [of]our financial status – equally lousy. I would rather pay my last buck for a fine doctor of my choice.

These experiences are not based on speculation… but where I was and what I experience[d]. Lets all pray this sick scheme never passes.

Sincerely, Helen M. AIA, subscriber

Notice the interesting plot twist in regard to excellent German care. Helen’s long experience with socialized medicine was, overall, quite undesirable – “pray this sick scheme never passes” – but that did not stop her from saving $100,000 or so on an expensive dental procedure courtesy of a government-run system.

Does that count as hypocrisy? I would say no – it’s only common sense. Who wouldn’t want to save $100,000 without any noticeable reduction in quality if they could? There is real value in upholding one’s ideals and making decisions based on principle… but there is also real value in hard-nosed pragmatism and doing what makes sense in a world that will by and large remain screwed up anyway.

Saving $100K on a procedure is no small thing, and in many ways it goes to the heart of the healthcare reform debate. Many of those who passionately argued for reform, like Taipan Daily reader Ron E., had experience with financially debilitating healthcare-related events.

What about honest, hardworking Americans who have health care, insurance, good doctors, etc, but still face ruin in the event of a catastrophic health issue? For example, I am a hard working individual who has a fairly decent health policy. I have bulging of damaged vertebra in almost every disc in my back, and a fused neck. On top of that I had to have a valve replacement when my heart was attacked by infectious bacteria while on a trip to Singapore. My wife had brain surgery to clip an aneurism, she also suffers from Hepatitis C, and she has [a] ruptured disc due to an accident – a patient kicked her in the E.R. These health issues have required us to cash in 401Ks, IRAs, savings, and every penny we can get our hands on, and still led to financial ruin.

I don’t expect to have a free ride, nor do I expect the government to pay for all of my costs but it just isn’t right that I live in ruin due to poor health over which I have no control. Don’t tell me our health system is fine. It isn’t. I’m only one of millions in this position. I would say if you would take the anti-govt health plan constituent and give them a good healthy dose of my problems they would be changing camps in a hurry. Something must be done, and fast. There are way too many people with views like yourself. I’m not one to wish bad luck on anyone, but I do wish that all of the people that are “happy” with our health system would suffer (just temporarily) until they get a good taste of the consequences of poor health. They would change their minds in a hurry.
– Ron E.

TANSTAAFL

Ron E.’s situation powerfully underscores the source of strong emotions in this debate. In a free market system, the safety net is thin at best. Catastrophe can be absolutely devastating, no doubt.

This strikes many as a deep and grievous injustice… and who can blame them? Personally I would not wish poor health or capricious tragedy on anyone – there is already enough pain in the world – but given what Ron has gone through, I can understand why he would.

The debate also brings to mind one of the best science fiction novels of all time: The Moon Is a Harsh Mistress by Robert A. Heinlein. Written in 1966, the story is about a lunar colony’s revolt against exploitative Earthbound rule. The novel has been embraced by libertarians as one of the best expressions of libertarian thought to be found anywhere.

An acronym popularized by the Heinlein novel is TANSTAAFL, which stands for “There Ain’t No Such Thing As A Free Lunch.”

No matter how much we would wish it to be otherwise, everything has a cost. Like the moon, Mother Nature is a harsh mistress too. The discipline of economics is all about the allocation of scarce resources – “scarce” denoting the fact that there is not enough for all to have as much as they desire in the quantities they seek.

One might say TANSTAAFL applies to healthcare in terms of a trade-off… the trade-off between astronomically expensive (but rare) medical procedure coverage versus quality and availability of day-to-day care. Consider this from TD reader Joan:

As a Canadian I’m here to tell you our Health CARE(?) sucks. Our government has no problem making [its] citizens wait well over a year in pain for procedures to eliminate that pain. It doesn’t matter how much money you have you wait just like a bum on the streets. I needed a herniated disc operated on and waited 13 1/2 months to see a surgeon, who told me it would be another year to get into surgery. BUT, he wouldn’t operate on me then because 70% of hernias heal. (really?) Well, I had been in pain for a year and a half already and it was getting worse by the day. I was taking morphine and you know how addictive that is! I went to the U.S. and had the surgery in 2 weeks. I’m fine now and pain free. I look around me at all the people in pain and wish they could afford to go somewhere to be fixed. Now mind you, If you have a car accident and need immediate care, you jump to the first of the line. They also take cancer seriously. You only have to wait a month or so for that surgery. Imagine having cancer and waiting at all!!

Just my opinion, but I would take the U.S. health care over ours. Private insurance in the U.S. costs about $4500/year. I pay that here for additional health insurance and still have to wait in line for specialists.

Free ain’t what it’s cracked up to be…

Joan

Yep. That’s TANSTAAFL right there… anything with the appearance of “free” actually has a cost.

Where You Stand Depends on Where You Sit

The healthcare reform debate seems deeply driven by personal experience. “Where you stand depends on where you sit” as the old saying goes.

Those who have experienced catastrophic health events in their lives tilt strongly toward U.S. reform, of the sort that would have society (i.e. taxpayers by way of government) pay full freight. In contrast, those who have experienced the headaches of a dysfunctional government-run system on a day-to-day level tend to focus more on the general awfulness of that experience.

It isn’t quite that cut and dried, of course. Socialized healthcare systems also have horrible failings on the catastrophic side – think of patients dying on waiting lists – and free-market oriented systems can feel like a blatant rip-off to healthy individuals gouged by frivolous charges left and right.

Simple answers are hard to come by. TANSTAAFL still seems a fair guideline, though, because there will be major costs associated with whatever system America chooses. It’s never a pleasant exercise assigning financial weight to moral decisions – but the alternative is a fiscal road to ruin.

Source:  The Catastrophe Conundrum – Healthcare Revisited

My little brother and his fiancée dropped into Reno/Tahoe for the weekend. They were wending their way west to go apartment hunting in San Francisco, visiting friends and family along the way.

On Saturday we took a two-hour catamaran cruise up at the lake. It was as perfect a day as I’d ever seen it. The water was so clear and blue, you could see 30 feet down through the netting of the boat. The sky was just as blue – not a cloud to be seen – and the day was just hot enough to be perfected by a crisp Tahoe breeze.

At one point in the cruise we sailed past the “Ellison project” – a stretch of lakefront put under construction by Larry Ellison, the billionaire founder of Oracle (ORCL:NASDAQ). The two adjoining $15 million mansions weren’t big enough for Larry, so he had them torn down to build something more to his liking instead.

At another, equally secluded bend in the Tahoe shoreline (the lake is 22 miles long), we passed by the Stack family estate. Robert Stack, the late actor best known for The Untouchables and Unsolved Mysteries, spent his boyhood summers there. Adjacent to this, a 5- or 6-acre parcel of waterfront land was on the market for “only” $19 million – a bargain-basement price by Tahoe standards.

As we noshed on beer and wine and cheese and fruit, I joked with my little brother that we should go in on the property together – get the ball rolling on a new patch of Litle estate.

“Not just yet, big bro,” he replied. “Unless I can make do with, say, a zero-point-five percentage ownership.”

“Couple years,” I chuckled back. We were joking, of course… $19 mil is a bit rich for a piece of undeveloped real estate… but then again, five or 10 years from now, who knows?

Perfect weekends like the one that just unfolded in Tahoe remind me of something Einstein once said – you can live your life as if everything is a miracle, or nothing is. I think that’s true. In hearing the stories of some of the families who built those lakefront estates, I was also reminded of something else I believe.

Of all the traits that separate those who live their dreams from those who don’t, courage and determination seem to be the biggest two factors by far. Smarts, connections, money, and even lucky breaks seem to pale in comparison to those first two. Luck is still an undeniable factor, of course, but in some ways luck is like an ocean wave. It’s not enough just to be standing on the beach… you have to have the gumption to get out there and surf it.

Anyhow, just some quick thoughts from an idyllic weekend…

Cliff Asness, Hero

Back to the slightly more grim (but important) matter at hand. It’s not the custom of Taipan Daily to direct readers to outside essays written by outside writers. But in this case, the piece to which I call your attention now is well worth it.

The piece is called “Health Care Mythology” by Clifford Asness. A friend forwarded it to me, but you can find it on this Web site (the WSJ has been directing readers there too).

As the founder of a multibillion-dollar quantitative strategy hedge fund, Cliff Asness makes for an unlikely hero. Your humble editor calls him a hero, in a tongue-in-cheek but not totally undeserved sense of the term, because Asness is wealthy, outspoken and exposed. The things he says – and he says them quite forcefully – could lead to trouble for his wildly successful fund management business.

In “Health Care Mythology,” Asness eloquently and brutally dismantles certain myths about the healthcare industry. Lest you think this is a boring exercise from a stuffy fund manager, consider some of these excerpts:

…Step one is understanding how and why they are wrong. Step two is kicking their asses back to Cuba where they can get in line with Michael Moore for their free gastric bypasses.

…. if one more person cites soaring health care costs as an indictment of the free market, when it is in fact a staggering achievement of the free market, I’m going to rupture their appendix and send them to a queue in the UK to get it fixed. Last we’ll see of them…

The Seven Myths, Summarized

In case you don’t have time to read Cliff’s more than 6,000-word commonsense manifesto – a good chunk of prose by even your humble editor’s standards! – the seven myths are summarized briefly here. (Keep in mind, though, that the summaries really are no substitute for reading the whole “Health Care Mythology” piece.)

Myth #1: Healthcare Costs Are Soaring

No they’re not, says Cliff Asness. They only appear to be soaring if you compare on price but forget to compare on quality. As Cliff puts it, “you cannot judge the cost of something simply by what you spend.” We may be spending a lot more dough than we did in the 1950s, but we’re also getting a lot more value for our money. As Asness puts it, “nobody in the US really wants 1950’s health care (or even 1990’s health care). They just want to pay 1950 prices for 2009 health care.”

Myth #2: The Canadian Drug Story

Those who cast a skeptical eye on healthcare reform are constantly beaten over the head with the Canadian success story. Our neighbors to the north have a far more humane and effective system, the reformers say. Cliff Asness calls B.S. on this argument by making a non-politically correct point…. the government-run Canadian system only works by leeching off the free-market U.S. one.

Asness’ case in point is the drug market. U.S.-based pharmaceutical companies have to spend ungodly sums of money on the testing, development and marketing of new drugs. Big pharma then has to charge a lot of money for their end product to recoup this massively expensive pipeline cost – otherwise the drug isn’t worth making in the first place.

But Canada, in its capacity to act as a single government-backed customer, puts big pharma over a barrel. After a drug is already developed for the U.S. market, it only makes sense to sell into Canada too, and big pharma needs all the profits it can get to fund further research.

So basically, Asness argues, many of Canada’s benefits come from piggybacking on a functional American system. Take the functioning U.S. market out of the equation and what do you get? No more cheap drugs, eh.

Myth #3: Socialized Medicine Works in Some Places

As Asness sees it, the leech argument further applies to all the government-run healthcare systems in the world that benefit from an influx of U.S.-based medical advances originally developed for a profitable market.

And so, Asness argues, if America tries to go the way of Canada or the U.K. or what have you, there will be no one for America to leech off of in terms of drug development and innovation… and the U.S. centric march of progress towards better medical technology will simply collapse.

So, please [Asness begs], stop pointing to all those “successes” that even while living off the US still kill hard-working people who could afford their own health care while they stand in line for the government’s version (people’s cancers growing while waiting ten weeks for a routine scan, which these people could often afford on their own if allowed, is a human tragedy). Even the successes you gin up for them would not be possible without the last best hope of humankind (the US) on the front lines again making the miracles for the world.

Myth #4: Socialized Medicine Is Better Because Their Cost/GDP for Healthcare Is Lower

Asness argues that this is a failing of logic rather than statistics.

While technically correct in a pure statistical sense, the fact that countries with socialized medicine spend less per capita on healthcare is misleading for a number of reasons. For one, Asness points out, many of these countries are subsidized by U.S. drug development and innovation. Second, differences in overall spending do not account for choices made in the United States that simply aren’t available elsewhere.

There are a number of other arguments Asness uses – basic point being, you can’t always trust an upfront number to tell an accurate story. As Mark Twain liked to say, “there are lies, damn lies, and statistics.”

Myth #5: A Public Option Can Co-Exist With a Private Option

This is the myth that, under the guise of national healthcare reform, those who want to keep access to a private system can do so without seeing significant degradation of their choices.

Asness argues at length that this is basically a ruse. If we go “public,” Asness asserts, we are signing up for socialized medicine whether we like it or not. There are all kinds of technicalities and wavers and ways to artfully dodge this assertion, and Asness tackles many if not most of them in his piece.

Myth #6: We Can Have Health Care Without Rationing

For this myth, Asness points to the elephant in the room, addressing an ugly word – “rationing” – that no one in Washington seems comfortable with.

It’s simple economics, Asness says. No matter how much we might wish it weren’t so, idealism won’t change the fact that a scarce good cannot be provided in unlimited, equal amounts to everyone. As Asness puts it,

If you have a material good or service, like health care, that is ever increasing in quality, and therefore cost, there is no way everyone on Earth can have the best at all times (actually the quality increases are not necessary for rationing to be needed, it just makes the example clearer). It’s going to be rationed by some means. The alternatives come down to the marketplace or the government.

Myth #7: Health Care Is a Right

“Nope, it’s not,” Asness says. “But we are at the nuclear bomb of the discussion. The one guaranteed to get me yelled at or perhaps picketed by a mob waving signs printed up with George Soros’s money.”

Asness makes the case as to why healthcare is not a “right” with a mix of insight and sarcasm. Much of his argument centers around the difference between positive and negative rights – e.g. the right to be left in peace versus the right to some form of entitlement – and also touches on the crazy idea that new technology, a driving force in medical care, should somehow be instantly appropriated for the masses. (At one point Asness asks, “Did you have a right to chemotherapy in 1600 AD?”)

Asness further goes on to point out one of the ironies of “unfair” free market healthcare versus “fair” government provided healthcare.

In an “unfair” system, the initial users of a new medical technology are willing to pay an expensive price – a price the masses could not afford. But the profits generated from this early use lead to innovation and price competition, eventually making the medical technology available to everyone.

Think of it like DVD players. These days you can buy a serviceable DVD player for a whopping 30 bucks. Considering the technology involved, that’s damn cheap… and that’s why DVD players are so popular. But DVD players started out being ridiculously expensive… too expensive for the average family to afford. It was the “early adopters” willing to pay hundreds and hundreds of dollars for experimental technology (the first DVD player prototypes) who enabled profit-driven improvements and the migration to a mass market.

So now imagine what would happen if the government had declared home entertainment equipment to be a “right” from the outset. Under this “rights” based system, the idea of a super-expensive DVD player that only some rich technophile could afford would be considered an outrage. And in the absence of expensive DVD players at the outset, the competition-driven free market would never have figured out how to serve up cheap ones.

The DVD player story is Silicon Valley in microcosm. “First expensive, then cheap” is how innovation spreads. The difference between healthcare technology and home entertainment technology is an emotional one, not a logical one… and so viewing healthcare as a “right” creates the same problems you get when the government is put in charge of most anything at all.

What do you think? Is Cliff Asness on target? Or do views such as these count more as part of the problem than the solution? Let me know: justice@taipandaily.com

Source:  The Seven Myths of U.S. Healthcare Reform

Fenster: They treat me like a criminal. I’ll end up a criminal.
Hockney: You are a criminal.
Fenster: Why you gotta go and do that? I’m trying to make a point.
– The Usual Suspects (1994)

Ah, Goldman Sachs, how we despise thee. Let us count the ways.

First there is the matter of jaw-dropping compensation. As The New York Times reported last week:

Goldman posted the richest quarterly profit in its 140-year history and, to the envy of its rivals, announced that it had earmarked $11.4 billion so far this year to compensate its workers.

At that rate, Goldman employees could, on average, earn roughly $770,000 each this year – or nearly what they did at the height of the boom.

Senior Goldman executives and bankers would be paid considerably more…

The unofficial party line from Goldman is, “Don’t hate us because we’re smart.” (Or in the street vernacular, “Don’t hate the player, hate the game.”)

To get rich in a capitalist system you need three things – hard work, smarts and luck. America, rightly, bears little or no ill will when fortunes are made through the combination of these three. Take the Google guys, for example… or Warren Buffett… or any other number of big winners in our (quasi) free market system.

Heck, America even goes one better than that. In the United States, you can make ridiculous sums of money that no one even remotely thinks you deserve, and most folks won’t begrudge your good fortune.

If a ne’er do well CEO convinces his shareholders to pay him a bonus worth tens of millions for doing diddly-squat, that might be a shame… but it’s the shareholders’ money, free to be wasted as they wish.

Or if an athlete signs on to a professional sports team for tens of millions and then, say, gets into a nightclub shooting, wilts under pressure, or otherwise turns out to be a total flop, well… c’est la vie. A contract is a contract.

Point being, private financial exchanges are akin to what happens in the privacy of a home. The result may be weird or goofy or stupid or obscene, but as long as consenting adults are involved, the public doesn’t really care.

Where Goldman (and others) crossed the line is in the source of their gains…

Taxpayer Largesse

First, an interesting tidbit. Goldman’s take of $770,000 per employee is stunning enough. But as it turns out, Goldman may have actually used a subtle accounting trick to make that number smaller, so as to tone down some of the spotlight glare.

Various Wall Street sources have reported to Dealbook that “in a footnote to its financial results… Goldman said that for the first time it was including consultants and temporary staff in its overall employee figures. This had the result of increasing its official staffing levels by 2,000 jobs or so in both the first and second quarters.”

By spreading the haul over a bigger head count, you see, the gaudy top line number – average profit per employee – is reduced.

So by throwing in consultants and temps and, who knows, maybe even janitors and deli delivery boys, Goldman can practice its own peculiar brand of modesty in at least keeping the profit per head below a million bucks.

Again, the reason for gall is not because Goldman’s traders are “smart.” It is because this pound of flesh was extracted directly from taxpayer’s hides.

On one level the chain of events is simple:

• Goldman Sachs takes huge, multibillion-dollar taxpayer cash infusion from the government.
• Goldman uses these funds to make an absolute killing.
• Goldman says “Gee thanks!” and pays back the money with minimal (i.e. zero) penalty attached.

But actually it’s a lot murkier and uglier than that.

Thanks a Billion, Hank

To really get a bead on how stinky this whole situation is, consider why 2009 has proven so profitable for Goldman Sachs. Two reasons stand out. First, half its competition has been crippled or killed off. Second, AIG (a major Goldman Sachs counterparty) was specifically kept afloat.

If you’ll recall, the previous Treasury Secretary was Hank Paulson, a.k.a. “Hammerin’ Hank,” the ex-CEO of Goldman Sachs. (Paulson was recently back in the news defending his tough-guy leanings in the whole Bank of America/Merrill Lynch fiasco.)

Taipan Daily is not one to promote irresponsible conspiracy theories. But nor do we shy away from putting two and two together. So with that in mind, let’s look back at the dark days of September 2008.

During Paulson’s time at Treasury, there was no question who was top dog (in terms of the relationship between the Treasury and the Federal Reserve). Hammerin’ Hank was everywhere. Bernanke was a shrinking violet in comparison.

Now the uncomfortable questions…

On that fateful weekend in question when Lehman Brothers collapsed, who stood to benefit (in the long run) from the disappearance of a major Wall Street competitor? Goldman Sachs.

Coincidence? Maybe. But then note what happened just a few days later. Within 72 hours of Lehman Brothers’ collapse, Paulson announced that AIG would be saved… at an outrageous opening bid of $85 billion. (The taxpayer tab would eventually run much, much higher – and it’s still running.)

Again, using the old Latin phrase “cui bono” (Who benefits?) as our guide, one has to ask… who was one of the major beneficiaries, if not THE major beneficiary, in seeing AIG survive?

Goldman Sachs.

This is true because AIG played the role of busted bookie, having made tens of billions worth of dumb bets with other investment houses on the street. Normally when a gambling house folds, the gamblers waiting to be made whole are SOL – a technical acronym which means “out of luck.”

But when the gamblers are high rollers it’s a different story. In part, Paulson and Bernanke saved AIG, flooding it with tens of billions in taxpayer cash, so that those very same funds could be kicked right back out to other players on the street. In its death throes AIG served as a “beard”… a convenient one-stop money laundering shop, used by the Treasury and the Fed to avoid the political inconvenience of writing big checks out in the open.

As a result of AIG’s last-minute bailout, and the discreet transfer operation outlined above, Goldman walked away with a cool $13 billion or so… profits on AIG-backed contracts that would not have paid off had Hammerin’ Hank – the ex Goldman CEO – not saved the day.

Rotten Egg Insurance

There is yet another amusing question that must be asked. It would be a small miracle if Congress figures out the importance of this question, but who knows – they may eventually get around to it.

That question has to do with the morality, or even the legality, of buying rotten egg insurance on the very eggs one is selling.

Put it this way… suppose I set myself up in the fly-by-night homebuilding business. You decide to trust me, and soon move your family into a beautiful new 3,000 square foot home built by my construction firm.

In time you discover the home is a disaster. The drywall is rotted and mildewed… the electrical wiring is a fire hazard… the foundation is cracked… the generic insulation is asbestos-prone… a residential nightmare through and through.

Naturally you would want restitution on this disaster of a house. You might get some money back, but nowhere near enough. On top of that, the emotional anguish (and headache and hassle) could never be repaid.

So how would you feel if you later found out that, even as I sold you the house, I had acted with foresight by loading up on a certain type of disaster insurance… insurance that paid off specifically in the event of a construction-related loss? And what if, let’s further say, you found out that I made an absolute killing on the trade – making more from my side bet than I paid in restitution on our deal?

This is a fair summation of what Goldman Sachs did in relation to the whole toxic asset subprime debacle. It sold rotten eggs – or rotten houses if you like – and protected itself by taking out disaster insurance on the very garbage it was selling.

This is murky legal ground, of course. One can hardly blame an investment bank for looking out for itself. And making bearish bets in the market should hardly be illegal.

At the same time, this dramatic separation between “sell side” and “buy side” is very interesting. What to make of it when an organization that is shoveling toxic-related assets out the door as fast as it can – stuffing its clients like geese until their livers explode – is simultaneously making aggressive downside bets on the very same dreck?

It’s no big deal though… they were just being “smart”…

An Age-Old Pattern

There is yet more… plenty more. We could get into the front-running accusations tied to the stolen Goldman code, or the practices of certain players that look tantamount to stealing $15 billion-$25 billion a year directly from investors’ pockets, or the direct manipulation of certain markets… but that would be overkill. By now the point has hopefully been driven home.

The truth of the matter is that nearly all major banks – not just Goldman Sachs – have exploited their privileged position within the system for decades. Goldman is simply the biggest, most brazen example at this point in the cycle – and one of the few “smart” enough not to have blown itself up.

The crux of the problem is “regulatory capture,” in which the players in an industry amass so much power and influence that they successfully “capture” the watchdogs who are supposedly watching them.

Financial history has seen these episodes play out over and over again. One over-the-top example was the 1980s failure of Continental Illinois Bank and Trust Company – at one time the seventh largest bank in the United States.

When “Conti” finally failed, it was only after an extended comedy of errors, in which the bone-headed bankers running the show repeatedly told the Federal Reserve to shove off and mind its own business. Conti’s ship of fools was piloted by buffoonishly confident captains until the very day it ran aground.

And the Fed, far from being the all powerful regulator and stern disciplinarian it was supposed to be when it came to reining in the big money center banks, was instead cowed and stymied by Conti’s political clout and systemic importance. (Just as it is thoroughly cowed by the likes of Goldman Sachs and JPMorgan today…)

A Bonus Too Far

The reason this kind of thing matters is because now, finally, the big banks may have taken their greedy taxpayer rip-off game “a bonus too far.”

And again, it isn’t just Goldman Sachs. It isn’t even just the United States. In a recent piece titled “The devil’s punchbowl,” The Economist reports:

A new hiring frenzy in the City [London's financial district], with bonuses guaranteed for “only” the first year; investment-banking results for the second quarter likely to top those of the first; an innovative securitisation [sic] by Barclays to get bank loans off its balance sheet. The term “business as usual” normally delights tradesmen and their customers. Applied to the banks that plunged Britain into economic crisis, it strikes fear to the heart.

Surprisingly, there has been a steady drumbeat of public outrage over Goldman Sachs’ latest round of eye-popping profits (rather than the usual obliviousness). It is no longer quite “business as usual” for the most connected player on Wall Street.

The American taxpayer is slowly waking up to the true source of such profits, and the free market travesty such ill-gotten gains represent. If anything, these fat cats are more socialist than capitalist in their smoky back-room domination of a secretive, incestuous, oligarch-infested state.

But with that said, your humble editor doubts it will be outrage alone that derails the big bank gravy train. Politicians love a bit of theater in front of the cameras to please the folks back home, but most of the time it winds down to nothing.

No, what would really wreck the gravy train would be another global banking crisis… a sort of “financial supernova 2.0″ with as much destructive power as the first one (if not more).

And we could see it too… more on that to come.

Source: A Bonus Too Far (Bankers on Borrowed Time)

Field Reporter: Are they slow-moving, chief?
Sheriff McClelland: Yeah, they’re dead. They’re all messed up.
– Night of the Living Dead (1968)

In B-grade horror movie lore, Tokyo has to fend off attacks from rampaging monsters like Mothra and Godzilla. If the cinema were more true-to-life, however, Japan would be less worried about overgrown fire-breathing lizards… and more terrified of zombies instead.

In response to a recent Taipan Daily asking what brought us out of the Great Depression, a number of you responded with a good question. “What about Japan?” Or rather, “What about Japan’s extraordinary rate of consumer savings – and why hasn’t it helped?”

The Nikkei chart above shows the extraordinary extent of Japan’s pain.

After putting in a massive blowoff top to cap a truly insane 1980s bull market, Japanese stocks proceeded to head lower… for the next twenty years. The Nikkei is now less than a quarter of its value at the 1990 peak – a 75% decline over two decades in which the rest of the world boomed. Meanwhile Japanese real estate, depending on location, is down anywhere from 50%-80% from the 1990 peak. And depending on how things play out, prices might fall lower still before all is said and done.

(By the way, just as an aside – the next time someone extols the virtue of passive index funds and “stocks for the long run,” consider showing them this chart. As legendary natural resource investor Rick Rule likes to say, “You’re either a contrarian or a victim.” Few markets showcase the brutal truth of this statement like Japan.)

How in the World…?

So how in the world did this happen? How did the second largest economy in the world – and the benchmark index for one of the richest, most prosperous countries in the world – wind up in a two-decade slump?

In a word, “zombies.”

George Romero’s zombies liked to eat brains. Japan’s zombies prefer to eat wealth. In the past 20 years, as the Nikkei outlook went from ugly to bad to worse, Japan proved itself to be a world champion wealth destroyer…

The Rise and Fall of Japan Inc.

Japan first established itself as an economic powerhouse in the aftermath of World War II. Once known for shoddy, low-quality, knock-off type goods, Japan eventually morphed into a juggernaut in high-tech areas like robotics, electronics and automobiles. Today, companies like Toyota and Honda remain the standard for cutting-edge efficiency, quality control and incremental innovation.

In the 1980s, when the country reached the pinnacle of economic might, Americans feared that “Japan Inc.” would soon dominate the West – and perhaps even own the United States outright. Television programs like “Lifestyles of the Rich and Famous” spoke breathlessly of unknown Japanese businessmen worth untold billions (back when “billion” was still a big number). Western minds were concentrated by the spectacle of Japanese buyers snapping up real estate icons like Rockefeller Center. The Japan Inc. juggernaut looked unstoppable.

And what exactly is “Japan Inc.,” you ask? Investopedia defines it as “a nickname for the corporate world that came about during the 1980s boom, when Western business people saw how closely the Japanese government worked with its nation’s business sector.”

On the whole, one could think of Japan like a giant aircraft carrier. In the 1980s, the aircraft carrier was chugging along in exactly the right direction, with MITI (Japan’s Ministry of International Trade and Industry) plotting the course.

The trade-off for running such a concentrated top-down plan, however, is an utter lack of flexibility. An aircraft carrier can’t turn on a dime. It can’t even turn on a football field. It has to go miles and miles out of its way just to make a small adjustment in course.

By the end of the 1980s, the global economic landscape (or seascape rather) had shifted. For the first time in years, flexibility was once again at a premium over relentless focus. Given this sea change, the “Japan Inc.” mindset turned from blessing into curse. The country lost its way.

Mega-Boom and Mega-Bust

In the go-go 1980s, Japan also experienced a fantastically epic stock market and real estate bubble. At the height of this bubble, Japanese companies were trading at 60 or 70 times earnings as the Nikkei climbed towards 40,000. The real estate situation got so out of hand, the patch of land under the Imperial Palace in Tokyo was at one point deemed more valuable than all the real estate in California.

This insane mega-boom led to an equally insane mega-bust. And this is where Japan’s problems really began. When market forces turned against it, the country didn’t know how to handle it.

There is a saying (attributed to various sources) that “capitalism without bankruptcy is like Christianity without hell.” That is to say, it just doesn’t work. Without the threat of punishment, sinners have no reason to repent from their wicked ways. And without the discipline of bankruptcy, a market has no means of cleansing and renewing itself.

One of the major problems Japan has wrestled with these past 20 years is the need to liquidate and start fresh – and the consistent refusal to do so. The Japanese “zombies” mentioned earlier in the piece are zombie banks and zombie corporations… “living dead” type organizations that shamble on aimlessly, gobbling up manpower and resources, kept from their natural graves by routine capital injections from the state.

The Nail That Sticks Up Gets Hammered

Part of the problem, it seems, is the distinctly Japanese preference for unity and harmony over diversity and discord. I am no expert on Japan, but everything I have seen, heard and read seems to emphasize this preference.

There is a phrase that encapsulates Japanese corporate culture: “The nail that sticks up gets hammered.” In other words, it’s better not to make waves… to keep your head down and stay loyal to the organization.

For a long time the unofficial mascot of Japan was the sarariman, or “salaried man” – the white collar Japanese worker who rose through the ranks of a single company and stayed with that company for life.

The deep desire to remain loyal and not make waves influences Japanese corporate culture at the higher levels too. Another distinctly Japanese concept is the keiretsu, which Wikipedia defines as “a set of companies with interlocking business relationships and shareholdings.”

For many decades – from the post-World War II renaissance through the end of the 1980s – the “Japan Inc.” system worked and worked well. The loyal sarariman found lifetime employment with his parent corporation, which in turn strengthened its business ties via the keiretsu. And the Japanese government coordinated the efforts of the keiretsu through MITI (which has since been replaced by METI, the Ministry of Economy, Trade and Industry).

Here Come the Zombies

The “zombies” arose from Japan’s desperate need to preserve not just a way of doing business that had long worked well, but also a culture and a way of life. To let loose the raging forces of creative destruction would be an uncouth, uncivil, unloyal thing to do in the Land of the Rising Sun. It was simply not the Japanese way.

And so Japanese corporations held on to their workers as long as they could. It was not an unheard of thing for a hapless sarariman, no longer with work to do but still supported by his employer, to come in and sit at an empty desk for eight hours, then go home.

The Japanese government kept exactly the same mindset. Banks and corporations were to be rescued, not liquidated. Meanwhile, in the hopes of stimulating the Japanese economy back to growth, staggering sums were plowed into useless construction projects – highways, roads, tunnels, “bridges to nowhere” all over the country. None of it worked.

Paradoxically, Japan’s wealth worked against it in this case. The country was able to afford such expensive measures – in effect, to pour money down a huge rathole for 20 years – because Japan was (and still is) rich.

A Vicious Deflationary Circle

Now we can circle back to the original inquiry, as to why accumulated Japanese consumer savings couldn’t break the two-decade slump.

As best as this observer can tell, the problem was something of a vicious circle that kept Japan’s economy in the dumps. This bogged-down state of affairs was created by wealth-destroying government policy and enabled by a wealth-destroying corporate mindset.

Japan is unique in that something like 95% of Japanese government bonds are domestically owned by Japanese institutions with ties to the government. Unlike America, which has borrowed staggering sums from the rest of the world, Japan has more or less borrowed staggering sums from itself.

This habit of borrowing huge sums, pouring them into the maw of zombie banks and corporations, and then repeating the process all over again, has managed to keep Japan’s domestic economy in an almost permanent state of funk. No liquidation of zombie companies means no room for vital new growth. An overhang of stagnant bureaucracy means a lousy employment situation, which in turns encourages Japanese consumers and companies to save.

Consumer and company savings then go into JGBs (Japanese Government Bonds), which pay painfully low interest rates, because there are few better places for it to go. Meanwhile, when Ms. Watanabe looks around she sees prices gradually falling, not rising… and so the Japanese economy gets saddled with a deflationary mindset on top of everything else.

A Cautionary Tale

All in all, Japan presents a cautionary tale. Without a vital center of “creative destruction,” capitalism simply cannot work.

In a forest, dead trees eventually fall to the ground and decompose. This natural birth-death process gives nutrients to the soil and opens up the leafy canopy to sunshine and new growth. But without death you don’t get rebirth… you just get stagnation.

Interestingly, too, people forget that 20 years is not the same as forever. Japan has been able to go on for decades as it has precisely because the country is so rich. Via issuance of JGBs and the propping up of unproductive enterprises, the government has been able to squander wealth on an epic scale because Japan had so much stored wealth to squander in the first place.

But there will come a day – perhaps not all that far off – when Japan runs out of capacity to borrow. At some point, no one will lend more money to debt-laden, zombie-prone Japan… not even the citizens and corporations of the country itself.

When that happens, we may well see a “big bang” of supernova-style proportions as the Japanese government is forced to do something drastic. Wouldn’t it be ironic if, after 20 years of fearing inflation and pursuing muddy stagnation-type policies, the Japanese Central Bank were forced to bring about one of the most explosive currency devaluations of all time?

Thankfully, there are reasons why America will not automatically be consigned to Japan’s interminable fate. A taste for creative destruction, a diehard entrepreneurial spirit, and the opportunity to benefit from breakthrough technology are three possible “escape hatches” that come to mind.

The pressing lessons for Western policy makers (currently hoping to circumvent the Japan experience) are ominous: Do not assume that a fat checkbook is the answer. Beware the politics of consensus and the grasping hand of bureaucracy. Short-circuit creative destruction at your peril.

Will they get it right? Guess we’ll see…

Source: The Zombies That Ate Japan’s Recovery

In a role that would later deem him “the man who broke the back of inflation,” Volcker took the helm of a weakened and disillusioned Fed in August 1979. Known for his no B.S. attitude and blunt, conservative style, Volcker’s appointment was only made under significant pressure on the Carter White House to lick the inflation problem.

After years of wishy-washy policy – and a widespread sense that the Fed simply didn’t have the cojonesto deal with inflation once and for all – the intense pain that Volcker was willing to inflict (via high interest rates) led to the inflation-subdued conditions from which the late, great bull market sprang in 1982.

Volcker was also in the mix on August 15, 1971, when President Nixon shut the gold window. As Tricky Dick informed the world that “We are all Keynesians now,” ushering in a decade of runaway prices and platform shoes, Volcker was dispatched on an urgent, two-year globe-trotting mission in his role as Treasury Under Secretary for Monetary Policy and International Affairs.

The goal of Volcker’s mission: To hold together the long-standing currency exchange system that Nixon had blown apart in 1971… and convince the rest of the world America had not gone mad.

No one has more claim to “been there, done that” than Volcker. Perhaps more importantly, Volcker has shown a capacity to act under pressure – and to make incredibly tough decisions when need be. In his role as Fed Chairman, taking on a dragon (inflation) that many thought unslayable at the time, Paul Volcker endured scathing criticisms and sharp reversals of fortune that would have broken lesser men.

So Where Did He Go?

All this counted as good news when, in 2008, it emerged that Volcker was advising the Obama campaign. Many who had misgivings in regard to team Obama’s unknown and untested political agenda were soothed, at least partially, by the thought of a wise and experienced hand like Volcker’s playing a role.

Alas, on examining the policy put forth by Washington thus far, the man’s fingerprints are nowhere to be found. The White House gave Volcker an impressive sounding title – head of the “Economic Recovery Advisory Board” – and then seemed to ignore him completely from that point on.

It’s true that Volcker, now in his 80s, has a heightened taste for fishing these days. But one has to wonder if there wasn’t a bit of bait and switch going on here. Use a man’s stature to lend gravitas to a fresh-faced political campaign, promise to listen closely and heed his wisdom, and then…

A Wall Street Railroad

We here at Taipan Daily have no special dispensation as to why the meatheads in Washington do what they do.

But we do have the ability to make an educated guess or two… and the guess here is that Volcker wound up getting railroaded. It’s a good bet that Volcker made the mistake (if one could call it a mistake) of being too forthright in his views – not willing enough to “play ball” as it were.

You see, the White House finance team is dominated by a Wall Street mentality. So dominated, in fact, that insider culture permeates the place like the smell of trout guts in a fish market.

One can see this (or rather smell this) in observing team Obama’s top financial pitchmen, Tim Geithner and Larry Summers. As president of the New York Fed, Geithner was a creature of Wall Street, bought, sold and paid for, from day one. Even the staid New York Times has called out Turbo Timmy, noting his exceptional “reliance on bankers, hedge fund managers and others.”

And if Obama advisor Larry Summers didn’t start out aspiring to be top shill on the hill, he certainly wound up settling in to the role quite nicely, having raked in a cool $8 million (give or take) in speaking fees and hedge fund consulting fees these past few years.

In addition to the above, add in the fact that Goldman Sachs is not just a mega-powerful investment bank these days, but a weird sort of temp agency with a quasi-official role in filling all high-level government finance posts.

The net result is a sort of noxious self-interest cocktail that proves toxic to anyone not considered a tried-and-true friend of Wall Street. And that would include Paul Volcker.

Glass-Steagall Blasphemy

In the eyes of Wall Street, Volcker’s apparent sins are twofold. First, he openly endorsed “Glass-Steagall-like” restrictions on Wall Street investment houses. Second, he showed warmth to the idea of banks as utility companies.

The Glass-Steagall Act was passed in two parts in 1932 and 1933. The second half of Glass-Steagall, also known as the Banking Act of 1933, required commercial bank activity and investment bank activity to remain separate by law.

For 66 years, Glass-Steagall was the law of the land. Under Glass-Steagall, investment banks could not take customer deposits or make commercial loans. Commercial banks, meanwhile, could not get involved in high-powered investment bank-type activities.

Glass-Steagall was repealed in 1999 (Thanks Phil Gramm!) by Republican majority vote. Thanks to this move, the blind-idiot-behemoth known as Citigroup was born. Before the repeal, Citi had to more or less stick to its boring customer deposit knitting. After the repeal, Citi was free to gorge on the high-powered stuff, with the leverage of customer bank deposits and FDIC insurance as a backstop… resulting in the quivering mass of financial wreckage now splayed out at our feet.

In suggesting that a new “Glass-Steagall-like” reform would be a good idea, Volcker declared himself an enemy of Wall Street. Through the eyes of the bankers, unfettered leverage is good – even if it blows up the entire country every once in a while – because anything that fattens the kitty at bonus time is good. To return to the days of Glass-Steagall would be a step backward in the banksters’ eyes, as would any maneuver that threatened to permanently reduce their power.

The same thought process applies to Volcker’s endorsement of the “banks as utility companies” idea. This is the notion that any business back-stopped by government should be a safe and boring business by law. The logic runs something like this: “You want to do sexy exotic stuff? You want to take big risks with your own investors’ capital? Fine. Just don’t do it with taxpayer funds, don’t do it as a government-backed entity, and don’t expect a bailout if you blow up. If you want to enjoy FDIC insurance, “too big to fail” support, or any other form of government support or largesse, then you need to take the plain-vanilla restrictions that come with that.”

Seems like a fair trade-off, no? In the eyes of Wall Street, that’s exactly the problem.

Keeping the Deal

Right now Wall Street has a very sweet deal, which some have memorably characterized as “socialism for the rich.” One can also think of it as “I take the upside, you take the downside.” As in, when a cockamamie scheme works out, the players reap tens or hundreds of millions… but when it doesn’t work out, the taxpayer gets socked with the bill.

If the White House were to embrace the idea of making banks more like utility companies, as Volcker suggests, then Wall Street’s sweet deal would disappear. The pleasingly asymmetric nature of the equation – heads Wall Street wins, tails someone else loses – would be lost.

And so, most likely, this is why Volcker has been muzzled. Geithner and Summers live in Wall Street’s back pocket. They are shills or, possibly worse still, moles… tasked with making sure the interests of the true master are served. President Obama seems either not to know or not to care. Either way the result is the same… the financial interests of the United States have more or less been hijacked by a quiet oligarchy. Worse still, when the self-interests of this oligarchy run directly counter to the economic interests of the country, it is the country that loses. Every time.

Paul Volcker, on the other hand, is not a shill. Not a mole. Or at least, he hasn’t shown any clear sign of being such. If Volcker had been “compromised,” he would be out there towing the party line – putting his credibility to work in service of the agenda, à la Colin Powell and the Iraq War.

One can only speculate as to the thoughts in Paul Volcker’s head. Your humble editor’s guess, though, is that the man feels snookered. He may well have been caught up in the bright shining spirit of the 2008 presidential campaign… the thought of a new day, a new broom sweeping clean, and helping America out of a serious jam (as he once did all those years before).

But one can only do so much, and good intentions only stretch so far. On realizing the truth, the 81-year-old Volcker may well have shrugged and gone fishing.

Source:  The Unconscionable Muzzling of Paul Volcker

The President’s man at the Treasury, Tim Geithner, is also towing the party line. On Friday Turbo Timmy spoke of “substantial improvements” in trying to beat back the “worst recession globally we’ve seen in generations.”

Why the defensive posturing? Because the White House is feeling touchy and irritable as the polling numbers sink. The rotten jobs market, it seems, has cut into Mr. Obama’s popularity. A poll of Ohio voters showed approval numbers falling from 62% to 49% in a mere two-month span.

If the stimulus is “working,” then, heaven forbid how things might look had there been no stimulus at all.

Or hold on, wait a minute. How might things have looked really and truly with no stimulus? What would have been different?

Heads I Win, Tails You Lose

This is one of the challenges in dealing with a very sick patient (i.e. the U.S. economy). Sometimes the patient gets better all by himself. Other times, the medicine that is supposed to be helping actually makes things worse. Without the proper diagnostic tools, though, there’s often no way to tell.

And not all deeply ill patients die, of course. Some really do make a self-powered comeback. Shamans and faith healers often rely on this simple binary outcome to set up a “heads I win/tails you lose” type deal for themselves.

That is to say, if the sick patient gets better, then clearly it was the shaman’s powerful medicine that made it happen.

But there are other alternatives, each tailored to the situation at hand. If the patient fails to get better but still lives, then the shaman can take credit for keeping him from death’s door. And if the patient up and dies, well… then the shaman was called in too late. Or the family members did not have enough faith. Or there was a hidden mortal sin, or some other exculpatory thing.

That’s the trouble with big decisions and messy historical turning points. There’s no way to rewind the tape, so we can’t always be sure what helped or what hurt – or even which actions were justified in the first place.

The weight of history does suggest at least one thing. When it comes to intervention, the government’s track record isn’t so hot. In fact, not to put too fine a point on it, it stinks. And when you think about it, the logic as to why is fairly straightforward.

Take the whiz-bang idea of creating jobs, for example. Creating jobs – real, sustainable productive jobs – is no easy task. Just ask any hard-working entrepreneur. So why should the government be any good at it?

And if the government possessed half a clue when it comes to creating jobs, why wouldn’t that capability be rolled out in good times as well as bad? If the jobs genie is all he’s cracked up to be, why wait for history’s darkest hour to rub the magic lamp?

Quantitative Wheezing

And then there is quantitative easing, or QE for short. What does the historical record say about quantitative easing? Basically two things. “Japan tried it… didn’t work.”

Hugh Hendry, co-founder of London-based Electica Asset Management, had this to say about QE in a recent Financial Times interview:

…There is no precedent, no precedent, that says quantitative easing succeeds. None. I’ll give you one actually, there is one, because there was some quantitative easing exercised by the Federal Reserve in 1933-34, and it did initiate a dramatic economic recovery without inflation. But I hesitate to say that was actually a success of quantitative easing, because it was preceded by a 46% collapse in nominal GDP.

So perhaps if you’re telling me that nominal GDP will collapse by 46% next year, then I would believe, and I would come back to you and I’d say then quantitative easing might have a chance in succeeding.

For the record, U.S. GDP (gross domestic product) was an estimated $14 trillion to $15 trillion in 2008. A nominal 46% collapse would nearly cut that in half, taking us back to 1996 levels. The Dow was around 5,000 back then.

So What’s Worked Before?

This leads to an important question. What can history teach us about getting out of jams? The last economic jam we faced of comparable size and scope was the Great Depression. How did we beat it once and for all?

There are many different theories as to how America finally beat the Great Depression. Some give credit for the comeback to FDR (Franklin Delano Roosevelt) and his far-reaching policies. Others say no, FDR really didn’t help much at all (or even made things worse) – it was World War II that finally pulled us out. And still others say, simply, that “time heals all wounds,” even economic ones, and we simply had to slog our way through.

History rarely obliges historians by providing neat, packaged answers. Most sea-change type events have many factors involved, not just one. But still, your humble editor suggests there is one very powerful, yet generally overlooked element that brought us out of the Great Depression. That element was consumer savings.

Here is a statistic that will make you blink. According to journalist-historian William Greider, personal savings levels hit a whopping 25 percent of income in 1943 and 1944.

World War II played a clear role. As Greider writes, “with so many millions conscripted for war, unemployment vanished and scarcity became the problem.” Those who were not drawn into the WWII effort saw their income levels rise. Women saw as much demand as men, a new development for the times. And because the country was on a war footing, a sort of forced saving effort was in place. Families had to make do on an “austerity budget,” and wound up banking much of what they earned.

This huge build-up of savings – 25 cents out of every dollar earned – set the stage for an explosion of consumption in the years to follow. After the war, an era of new products came rushing in. And consumers had both the pent-up savings and pent-up desire to spend, spend, spend.

A Long, Long Road

So what does history have to say about our current predicament? Mainly that, when it comes to getting an economy back on track, there is little that the government can do (case in point Japan).

And secondly that, short of starting a new World War and railroading the nation into a forced austerity program, the country’s best hope probably resides in the U.S. consumer getting his fiscal house in order.

As Tom Petty once sang about love, “it’s a long long road.” That lone dip on the chart above shows where consumer savings rates actually went below zero at the height of the bubble. The impressively tall bar on the far right – representing one of the fastest savings upswings in more than a decade – tops out at just 4%.

U.S. consumers will probably never again save twenty-five cents out of every earnings dollar. There is too much financial innovation and benign leverage built into the system to dial back the clock that far. (And a little bit of leverage, like the kind that lets a young couple make affordable car payments, is a good thing.)

But could the consumer once again save at double-digit savings rates, as we saw not 20 years ago? Could the savings rate more than double from here, even as a hefty chunk of income goes towards paying off a serious overhang of debt? Absolutely.

And that’s why the U.S. economy is never, ever going back to “the way it was” – if by “the way it was” one means the gross runaway excesses of the past two decades. There will be new mistakes, new insanity, new bubbles… but for now and the foreseeable future, we’ve got a hell of a lot of saving to do.

Source: Guess What Really Brought Us out of the Great Depression?

Mr. Litle,

I find your opinions on the world and U.S. economies very fascinating, to say the least. What I will like to read more of, if you can, is your opinions on some potential solution to these problems, or are you just good at highlighting problem but no solutions?

Thanks for your time in advance.

– TD Reader “Chuck”

Thanks, Chuck! (I think…)

If you want all the solutions you can stomach, here’s what I suggest. First, subscribe to Forbes and The Economist (two highly respected financial rags). Then make sure to catch Steve Forbes’ opening column in each issue of Forbes, and furthermore scan the final paragraphs in the lead article section of The Economist each week.

It’s a tongue-in-cheek suggestion (as you might have guessed). But you really will find a smorgasbord of “solutions” that way. Steve Forbes seems to have a forcefully simplistic opinion on how to fix every single economic problem on the planet. In similar vein, The Economist never tires of ending pieces with a schoolmarmish finger wag that always boils down to, “It would simply be best if world leaders did X.”

I subscribe to both of those venerable publications (plus at least a dozen others, if not more), and I take in absurd quantities of market-related information every single day. The challenge of this process requires me to read at different speeds, ranging from “leisurely” to “lightning bolt.” When it comes to the hand-waving solutions, I zip right past ‘em as if they weren’t even there. (When I come across a Thomas Friedman column, it’s like a blank page.)

The reason why is because most “solutions” of the forcefully delivered type fall into what I call the perfect world trap. The trap applies if whatever solution being offered deserves a “perfect world” qualifier. For example, “in a perfect world, Americans would have a more rational attitude towards healthcare.” Or, “in a perfect world, politicians would have a long-term rather than short-term focus.” And so on.

Many answers to the world’s problems are obvious in terms of what “should” be done. The more interesting question, in my view, is why what “should” be done in a perfect world so rarely plays out in the real one. Power corrupts. Self interest corrodes. Human nature throws a monkey wrench into the works yet again. And so it goes…

As a result of the many slips twixt cup and lip, the gap between clean theory and messy reality is more often than not Grand-Canyon sized. And thus I find myself with zero patience for goobers like Steve Forbes who, in their constant righteous claims of what “should” be done, act as if such a gap does not exist.

I wasn’t always so “anti-solution.” There was a time when I, too, thought fixing the world was merely a matter of getting the right multi-step instruction guide into the right hands. Over time, though, I soaked up more of the zen-like wisdom embedded in the old saying, “The wise man thinks what is easy is hard.”

Pragmatism and Profit

So why talk about this stuff then? Why bring up the world’s troubles in these pages, and dissect them as we do, if sweeping solutions are not the main point of interest?

I see two powerful reasons to do so – pragmatism and knowledge.

First, on the pragmatic side, let me share a crass aside with you. I intend to retire rich. Actually, I’ll probably never retire… I love what I do so much that it hardly feels like work. I can just as easily write to you, or make adjustments to my trading portfolio, from a luxury lodge in New Zealand or an old world villa in Spain as from my comfortable home office here in Reno/Tahoe.

But anyhow, point being, it is my direct and deliberate intent to accumulate a vast sum of wealth before riding off into the sunset. I don’t really give a damn about the money… but I love freedom and I love the great game that is markets. Trading is my passion.

And so, when something of import happens or some new political development bursts on the scene, the natural approach for yours truly is not, “Hmm… how can I find the ideal solution to this issue so that I can share it with the world in hopes that they will listen?”

Instead, my internal response runs more along the lines of, “Okay, what kind of curveball are these goofballs going to throw at us next… and how can we hit it out of the park?”

Or, more simply put, “How might this development impact markets, in either the short run or the long run (or both)? How can we profit from this (or just as importantly, avoid loss)?”

You see, pragmatically speaking, you and I can’t do a thing about the decisions being made in Washington, Brussels or Beijing. (They’re not listening to muckety-mucks like Steve Forbes or The Economist, so why in the world would they listen to us?)

Nor can we repeal human nature, or cure short-sightedness, or otherwise turn water into wine. But what we can do is accept the world as it is… interpret reality as it stands… and seek to create prosperity for ourselves from the swirling nexus of forces that drives current events.

One of the ironies in all this, I believe, is that the righteous souls hell-bent on saving the world often find themselves neglecting their own little corner of it. So much time and energy is spent banging on about impossibly idealistic solutions that real steps in the direction of real goals and dreams are left untaken.

That’s the general trouble, as I see it, with the popular focus on “making a difference.” All too often, the key question “Making a difference to whom?” is never properly considered.

Why the World Wags and What Wags It

“But hold on just a second,” I hear some of you say. “Taipan Daily isn’t all pragmatism, all the time, as you seem to be suggesting here. On occasion you talk about civil liberties and historic world events and other such things. And sometimes you guys take the odd turn that seems to have little to do with trading and investing at all. So what gives?”

To which I say, yep, absolutely true. It’s not all “show me the money” around here, if you’ll pardon the phrase.

And there are reasons for that too… the first one being that a real body of knowledge (as related to trading and investing) is broad and diverse and takes time to build – sometimes taking one to unexpected places. I have always seen that as a good thing, not a bad thing.

When I first got excited about markets (back in my wet-behind-the-ears college days), it was in part because trading and investing seemed such a grand excuse to learn a little bit about everything, yet still put that knowledge to work in a pragmatic way.

In other words, to be a trading and investing virtuoso requires some level of comfort and familiarity not just in the realms of finance and economics, but history, psychology, sociology, philosophy, game theory… even biology and physics to some degree… the list goes on and on. Above all, in your humble editor’s view, success in markets is tied to an intimate knowledge of the human condition (including one’s self) and the ongoing state of the world at large.

Again, what a great excuse to dig in and learn new things! There’s a lot happening on this silly old ball, as Bill Bonner sometimes likes to call it – and I, for one, often feel like a little kid turning over rocks in the woods, bursting with curiosity at the next potential find.

So in that respect, too, Taipan Daily is less focused on packaged solutions because there’s only so much time and energy to spare. Telling the world what should be done leaves less room for understanding the world as it is… and figuring out what might happen next… and learning how to profit from it.

I’ll leave you with one of my all-time favorite quotes, from T.H. White in The Once and Future King. Merlyn said it better than I ever could:

“The best thing for being sad,” replied Merlyn, “…is to learn to something. That is the only thing that never fails. You may grow old and trembling in your anatomies, you may lie awake at night listening to the disorder of your veins, you may miss your only love, you may see the world about you devastated by evil lunatics, or know your honor trampled in the sewers of baser minds. There is only one thing for it then – to learn. Learn why the world wags and what wags it. That is the only thing which the mind can never exhaust, never alienate, never be tortured by, never fear or distrust, and never dream of regretting.”

Source: Why I Don’t Care About Fixing the World (and Neither Should You)

As Grant’s Interest Rate Observer has been known to say, “We wrote it. Did you read it?”

My slim hope is that the Chinese really and truly know what they are doing, because, in fueling investor optimism with such flair, they are playing a high stakes game. My worry is that they drop the ball, somehow, and the result shows up as a violent wake-up call for “high beta” assets… emerging market equities, energy, commodities and the like.

What happens next is far from clear. The huge [commodity] stockpiles could continue to grow at a breathtaking pace – after all, Beijing has plenty of greenbacks to work through – and the dragon’s data points could continue to impress, or at least not frighten.

But with that said, a stumble from the dragon… and the shock of a sharp, swift deflationary contraction immediately following… does not feel like a far-fetched scenario at this point. It would certainly have profit potential as a surprise event, given how far the notion seems to be from Mr. Market’s mind.

– Taipan Daily, June 12, 2009, “The Fate of This Rally May Rest in China’s Hands”

On Monday, the violent wake-up call arrived. You could say the week started off with a bloodbath… a “decoupling” bloodbath that took many investors by complete surprise. (But none who are readers of Taipan Daily we hope.)

The brutal sell-off was more or less led by emerging markets and hard assets. It was as if the World Bank had rung a bell. Out of the blue the race was on to sell anything and everything with any sort of connection to the grand “decoupling” theme.

Speaking of the World Bank, they are the ones to whom the financial media assigned blame. It was an awfully gloomy World Bank forecast, the wires suggested, that led to the carnage on an otherwise light news day.

But as Bespoke Investment Group astutely asked, since when have traders ever paid attention to the World Bank?

The need to match up trading action with a particular news item of the moment shows an amusing failing of the financial press. Many journalists approach the market like a television sitcom… as if every day were its very own episode, with no continuity or chronological buildup of events.

China Weighs Heavy

In reality, the market had been inching ever closer towards a sell-off for some time. Volume was steadily shrinking rather than rising – a sign that the bull move was running out of steam. Public companies were coming out of the woodwork to issue record amounts of stock. Unconventional measures of sentiment, like the bull-bear ratio of money flowing into Rydex funds, showed worrisome levels of optimism. Ill winds were blowing on multiple fronts, as we noted in these pages.

And, perhaps most importantly, the magic pixie dust sprinkled by China had finally begun to wear off.

The bulls happily embraced the China story and ran with it as fast and far as they could, taking oil and copper and the like to eight-month highs.

But, as it turns out, much of China’s stockpiling drive looks to have been pure speculation. And not even official speculation sanctioned and planned out by the mandarins in Beijing… but instead a fast and loose misallocation of funds.

As part of China’s economic stimulus plan, Chinese banks were ordered to lend massive sums to steelmakers, iron ore importers and other industrial players. A large portion of these funds was plowed directly into big commodity price bets.

The iron ore debacle, for example, was almost certainly a result of speculative excess at the local level. Many traders scratched their heads on hearing the news of 90 large iron ore freighters idling in the water for two weeks or more, waiting to unload at overflowing Chinese ports.

Who would plan such a thing? Nobody would. The backlog came about due to a communication snafu. Stockpiling decisions were made by cash-flush managers at the ground level, as a wave of stimulus funds encouraged them to gamble. Beijing lost control of how those funds (handed out as cheap loans) were being used.

This kind of thing is bad news on multiple fronts.

For one, it highlights how little control Beijing actually has over how China’s stimulus funds are being spent. For another thing, it puts many ground-level Chinese industrial producers at risk of insolvency if the price of, say, iron ore falls too far.

“Last year people who stockpiled went out of business,” notes Shanghai-based economist Andy Xie. “I know one distributor who stockpiled six million tonnes of steel and went bust when it dropped by more than half.”

Making Sense of the Story

There are at least two important lessons here. The first one is, try to make sense of the story. In my trading service, for example, I have been wary of the “China leads the world” theme for months, mainly because the basic story line (as touted by the bulls) never quite made sense.

Meaning, how was China ever set to lead the world into recovery when China itself is still so dependent on exports to a weak global economy? How can Chinese business activity truly be picking up with electricity usage falling, rather than rising?

And how could a stimulus plan slapped together by Beijing bureaucrats really solve the issue of internal domestic demand – China’s biggest hurdle and a challenge that simply will not succumb to short-term fixes?

There is a big bullish story in China. But as with other emerging markets, it is a longer-term story, hinging on the day when these countries truly make strides towards weaning themselves from the economic crutch of exports to the West. We are closing in on that point, but are not quite there yet.

Trader or Investor?

Another important lesson is recognizing the difference between trading and investing, and not getting caught in the no man’s land between the two.

A good working concept here is “the Mountain and the Valley.” Here’s what I mean:

Imagine a great, vast mountain off in the distance. You don’t know exactly how far away it is, but you know it’s there, waiting to be scaled. Meanwhile, in between you and the mountain is a fog-covered valley. You don’t know what kind of ups and downs will be in that valley, but you know the trip across won’t exactly be smooth.

The difference between trading and investing is, investors tend to focus on the mountain and more or less ignore the valley. They keep their financial and emotional risk low enough to handle the ups and downs without losing their cool. Deliberate staying power and long-term conviction are the operative phrases here. With those two things, many hard asset and emerging market investors will be able to look past the volatility of recent days and ultimately do just fine.

In contrast, the trader is very aware of the ups and downs of the valley. Rather than ignoring that volatility, the trader focuses on it. The trader’s advantage is thus speed and flexibility – an ability to buy and sell a position repeatedly as need be, get a sense of how the terrain is going, and move quickly and fluidly when the timing calls for it.

So which one are you? Steadfast and true, or flexible and fluid? The two temperaments are rather different. Some versatile folks are traders and investors at the same time, but even then, not often with the same positions (or even the same brokerage accounts).

In closing, do emerging market equities and hard assets still offer excellent long-term investing opportunity? Absolutely, without question.

In the eyes of the investor, this week is just another dip in the valley. But in the eyes of the trader, China’s stumble – and the demise of the bear market rally – have created a shift in the near-term landscape worth exploiting.

Source: Commodity Bulls Snared by China Stimulus Snafu

“The Mafia isn’t part of the past, it’s part of the future.”

– Roberto Scarpinato, Sicilian prosecutor

Just how heavy is a million dollars cash?

If you’re trying to smuggle that kind of dough in old-school $100 bills, you’ll be lugging a little over 22 pounds. But if you’re rolling with banded, manicured bundles of the highest denomination euro notes (a cool €500), then the same amount only weighs you down by 3.5 pounds – and takes up a lot less space.

This is the kind of thing it’s good to know when you’re in the most profitable business in the world.

Ask a Wall Streeter to name a line of business that produces endless gushers of cash, and big oil probably comes to mind. The oil majors have certainly been known for record-busting profits these past few years. But the mafia’s profits are far bigger.

The mighty Exxon Mobil, for example, booked a profit of a little over $45 billion last year. That’s a whopping $10 billion per quarter or more. And yet, in comparison, the top three organized crime outfits in Italy – just the top three, mind you – more than doubled Exxon’s profit for the same calendar year.

And of course, where Exxon has to pay taxes, the mafia mostly avoids such hassles. So when you take the tax-free aspect into account, the mafia leaves big oil in the dust. And of course, the “big three” in Italy are just the tip of the iceberg. The powerful tentacles of organized crime extend all over the world…

Meet the Octopus

During my time at Oxford University in the mid-1990s, one of the best things about the experience was the speakers who came and talked to us. The Oxford Student Union (which has nothing to do with unions as Americans know them) would regularly bring in fascinating people to come and speak.

One of the speakers who made a real impression on me was a man named Brian Freemantle. An organized crime expert who has worked in more than 30 countries, Freemantle is the author of a book called The Octopus: Europe in the Grip of Organized Crime.

The book is nearly 15 years old now, and so many of the statistics are way out of date. But the basic outlines of the organized crime “octopus” Freemantle describes still hold true. And if Freemantle were to update his book with numbers for the new millennium, they would no doubt be mind-boggling.

As Freemantle writes in the opening pages of The Octopus,

Crime pays. It always has done. Not, of course, for the street people or the amateurs. They are swept up, like the disposable dross they are, as much victims as those upon whom they prey. The people for whom crime pays are the professionals, the men and women who operate it as a business, conducted through structures closely resembling legitimate multi-national corporations and conglomerates, their boardroom-like hierarchies serviced by accountants and financial advisors.

Freemantle then goes on to describe the eight tentacles (i.e. money-making activities) of the octopus: “the illegal arms trade, the illegal drugs trade, money-laundering, computer crime, prostitution and pornography, illegal immigration, terrorism, and fine art.”

One might think the octopus, too, has been hit hard by the global financial crisis (just like everyone else). One would be wrong though… instead, the crash of 2008 may turn out to be the biggest coup in decades for organized crime.

Cash in Hand

So why is the mafia set to wax, even as the whole world wanes? In a word, cash. We have all heard many times by now, in various guises and forms, that when times get hard, cash is king. And nobody keeps more cash on hand than the kings of crime…

Banks everywhere are afraid to lend their precious reserves. Fears of a fresh downturn, combined with the heightened credit risk of battered borrowers and toxic assets still weighing down bank balance sheets, have all but turned off the credit taps.

Many businesses, including well-run, profitable businesses that simply need access to capital in the normal course of operations, are suffering. At the same time, the most sophisticated players in the criminal underworld are sitting on tens of billions – no, make that hundreds of billions – and have a pressing need to launder those funds.

One of the most important tasks for any self-respecting crime boss is white washing the ill-gotten gains… turning “dirty” money into “clean.” This money laundering process is often handled by channeling funds through legitimate businesses. (I experienced this firsthand during my time in Olomouc, a charming little town in the Czech Republic, where the puzzling proliferation of clubs, restaurants and jewelry stores served mostly as mafia fronts.)

So now, with banks more or less out of the lending picture and businesses facing a dire need, the mafia has a once-in-a-generation opportunity to go “legit” on a bigger scale than ever.

As Giorgio Napolitano, the president of Italy – not to be confused with flashy Prime Minister Silvio Berlusconi – observed in May: “There’s a risk that Mafia organizations can profit from the current crisis by buying control of struggling businesses, infiltrating all regions of the country.”

A “risk?” More like a guarantee…

“The Mafia is ramping up its investing,” prosecutor Antonino Di Matteo tells Bloomberg. “The Mafia’s financial managers are trying to invest now, while the time is right, so that they can launder their fortunes once and for all.”

The Tony Soprano Full Employment Act

It isn’t just Europe where crime pays. In the United States, scores of less than savory characters are salivating at the new opportunities created by Washington.

We already know that the alphabet soup of acronyms dreamed up by Turbo Timmy Geithner and Helicopter Ben Bernanke are borderline criminal – TARP, TALF, PPIP and so on – but I’m talking straight-up Goodfellas type stuff here. For instance…

Two weeks or so ago, I sat next to a paving contractor in a local poker tournament. (Just as in Las Vegas, in Reno/Tahoe you can find a tourney on any given weekend.)

“Business is very good,” my fellow poker player reported. “Amazingly good actually. That stimulus cash is really starting to flow.” Apparently he was doing some heavy construction work on a nearby Indian reservation. Big road upgrades, courtesy of a check from Uncle Sam – and the backlog of work was piling up.

Now, I imagine this paving contractor’s business is probably 100% aboveboard and legit (even though he wears enough heavy gold to fall somewhere between Liberace and Mr. T). But if he wanted to cut a few corners, how hard could it be?

Or, heck, maybe he’s the victim in all this. Plenty of aboveboard businessmen in the construction trade wind up greasing a palm or two on their way to a finished project… sometimes it’s just what you gotta do…

The scale of opportunity, er, corruption, is bigger than one might think.

According to fraud consultant David Williams of the Deloitte Financial Services advisory, a whopping $50 billion worth of stimulus cash could be siphoned off the top for fraud (above and beyond the legally fraudulent activities of a venal and corrupt Congress).

“The rule of thumb typically,” Williams reports, “is that of the about $500 billion worth of money that’s going to run through the procurement process, somewhere between 5% and 10% of that usually finds it way into potential problems.”

The FBI is aware of the danger. As FBI Director Robert Mueller recently warned, “These [economic stimulus] funds are inherently vulnerable to bribery, fraud, conflicts of interest, and collusion. There is an old adage, that where there is money to be made, fraud is not far behind, like bees to honey.”

Of course, being aware of the danger and being able to do something about it are two different things…

Call it the Tony Soprano full employment act. With the government anxious to throw bales of taxpayer cash at “shovel ready” projects, the organized crime element will be standing by with a “shovel” too… “ready” to haul away veritable garbage trucks of loot.

Eyes Wide Open

So what can you and I do about this? Realistically, not very much. (Okay, let’s be honest… not a damn thing.)

But at the same time, I would rather go about my business with eyes wide open than eyes wide shut. The strong and growing presence of organized crime is something that ordinary citizens don’t have much day to day contact with (most of us anyway). But it is a reality we all pay for… like an extra form of goods and sales tax, paid to a de facto shadow government operating behind (and sometimes in direct cahoots with) the official one.

Think about the difference between undertaking a new business or investment venture in a low-corruption Western country, like the United States, versus a high-corruption “frontier market” country, where the rule of law is still only vaguely formed.

In the more advanced Western country, you can rest in peace knowing that the laws will be upheld and everything is completely above board. Right?

Not quite. That bit about the United States being “low-corruption” was a touch of sarcasm. As the global financial crisis continues to unfold, one of the side effects could be the gradual disappearance of the brightly drawn dividing line between high-corruption and low-corruption nation states.

This reality will make following conventional, business as usual, “eyes wide shut” investment advice all the more dangerous in the years ahead… just as it would be dangerous to open an import-export business in some far-flung outpost without having a clear handle on the risks present.

I’m curious too, given my own handful of experiences: Have you had any personal brushes with organized crime? Any local color unique to your town (or country) of origin? Better yet, any ties to “the business” yourself that you’d care to anonymously discuss? If we get some good stories, maybe we can recount them here (with names changed to protect the innocent… or the guilty): justice@taipandaily.com

Source: A Raging Bull Market in Organized Crime