Sorry to have been such a lousy correspondent of late. As I'll explain in a moment, over the last couple of weeks I've been on a quest for the truth about the economy. Much of today's missive revolves around what I discovered, though I also have some guest commentaries to share on a couple of seemingly important stories recently in the news.
As my topic is rather large, let's get straight into it.
The Big Question
For pretty much everyone, no matter where they are located in the economic strata, few if any questions are more germane to making plans for the future than whether the US and other major global economies are in recovery.
Getting the answer to that question right is of special importance to investors and businesses.
Stating the obvious, if the broader economy really is in recovery, then investors would be well served by investing in the equities of solid companies positioned to take advantage. Similarly, those very same solid companies would be rewarded by increasing their productive capacity through investments in the plants and people necessary to meeting growing demand.
On the same side of the ledger, bond investors would want to begin shorting up their durations or leaving the bubbly bond market altogether, in anticipation that the flood of funds into fixed income would reverse, sending rates higher (and bond prices lower).
Conversely, if the recovery is a head fake, then an entirely different course of action is called for. For instance, one would want to adopt a cautious attitude about common stocks. And because of the nature of the crisis – crushing levels of sovereign debt – one would want to take advantage of pullbacks in precious metals to buy more, along with other so-called "tangibles." That way they would have some measure of protection against the inflation that fiat-currency powers make all but a certainty.
In addition, reducing personal and business spending in order to conserve rainy-day cash would be advised.
And what about US bonds in the no-recovery scenario? A sound case can be made for including them in a portfolio as that puts you in lockstep with the government's desperate need to keep interest rates down – or, better yet, have them fall further still. Given the highly politicized nature of our economy, that seems reasonable – and anyone who has been long bonds over the last few years has done very well, indeed.
While you'll have to make your own call on bonds, my own enthusiasm is curbed by looking at the charts of the upwards spiking interest rates on the bonds of Spain, Greece, Italy and so forth. When Mr. Market ultimately becomes disenchanted with the fiscal excesses of the sovereign deadbeats, he can express his ire most energetically. When the current bond bubble here in the US ultimately bursts, as it must, it's going to be a bloodbath.
Of course, there is much, much more at stake to coming to the correct answer on the recovery, or lack thereof, than that.
For instance, poor economies make for poor reelection odds for political incumbents. And when it comes to maintaining a civil society, the lack of jobs inherent in poor economies often leads to a breakdown in civility. On that note, overall unemployment in Spain is now running at depression levels of almost 25%, and youth unemployment at close to 50%. How long do you think it will be before the citizens of this prominent member of the PIIGS will refuse being led to the slaughter and start taking out their anger on the swine (governmental and private) seen as bearing some responsibility for the malaise?
Meanwhile, back here in the United States, the commander-in-chief is striding around the deck of the ship of state trying to look like the right man for the job in the upcoming elections, despite the gaping hole of unemployment just under the economic water line. His future prospects are very much entangled with this question of recovery.
So, what's it going to be? Recovery… no recovery… or worse, maybe even a crash?
We all have a lot riding on getting the answer right.
The Quest for Confidence
Ultimately, the purpose of searching for the truth about the recovery isn't about either fear or greed. It's about confidence.
If you really knew what's coming, then the right moves to make become obvious. You could then make those moves with the calmness of spirit that comes from certain knowledge and get on with your life. While others struggle or miss an opportunity by betting on the wrong future, you'd have set up your affairs to survive and prosper.
Of course, given that we are talking about a complex system – the economy – total certainty is never completely possible. But for reasons I'll share, the nature of the current crisis paradoxically allows for more certainty than would normally be the case.
And so, with that characteristically long-winded wind-up, I want to share my conclusion about how I believe things will unfold from here, followed with some support for that conclusion.
While, as readers of any duration are well aware, we here at Casey Research foresaw the current crisis years in advance and have remained firm in our conviction that the recovery is a charade… based on my own readings, and after spending the last two weeks in the company of a couple dozen very plugged-in economists, top-performing money managers and top financial analysts, my conclusion is as thus:
The world's largest economies, including the US, Europe, Japan and China are speeding for the equivalent of a brick wall. In short, I believe that before this crisis is over, we will experience the Greater Depression my dear friend and business partner Doug Casey has long anticipated.
In case that conclusion fails to communicate my current view sufficiently clearly, I will condense it as follows:
The world's largest economies are screwed.
And I will even set my conclusion to music, in the form of the song "Somebody That I Used to Know" by Gotye, which seems appropriate because the economy that we used to know won't be back again for many years to come.
Trust me, stating an opinion on the direction of the economy in such unequivocal terms troubles me. For starters, I wish my conclusion could be otherwise because no one likes to be a harbinger of doom. Mostly, however, I have long resisted adopting a set-in-cement position on something as wiggly as the future. In my experience, anyone who absolutely, totally buys into a particular future is almost always proven wrong by time.
Yet, as my quest for certainty unfolded, I could come to no other conclusion than that the world as we know it is headed for an economic catastrophe.
Allow me to explain.
The quest started with our Casey Research Recovery Reality Check Summit, April 27-29, in Weston, Florida. We took our mandate of getting to the bottom of this matter of recovery seriously, including faculty members with a variety of perspectives to see if an overarching conclusion about the recovery could be ascertained.
In addition to our own team of Doug Casey, Bud Conrad, Terry Coxon, Louis James, Marin Katusa and Jeff Clark, included in the faculty were… Lacy Hunt, former economist with the Dallas Fed and the world's most successful bond manager; Jim Rickards, money manager and author of Currency Crisis; John Mauldin, best-selling author of Endgame and the just-released The Little Book of Bull's Eye Investing; John Williams of ShadowStats fame; Porter Stansberry, founder of Stansberry Research; Michael Lewitt, editor of The Credit Strategist; Gordon Chang, China analyst; Harry Dent, author of The Great Crash Ahead (who also debated James Rickards on the question of inflation or deflation); Andy Miller on real estate; Greg Weldon of the Weldon Report; John Hathaway of the Tocqueville Funds; resource market guru Rick Rule of Sprott Asset Management; Caesar Bryan, a senior portfolio manager for the Gabelli Fund group; and David Stockman, the head of the Office of Management and Budget during the Reagan administration.
(Plus, on the taking-action front, there was a special panel on international diversification as well as panels where a dozen or so experts on everything from gold stocks to uranium, to rare earths, to graphite, to technology, to energy gave their best picks.)
In other words, a full program.
Then, immediately following the conclusion of our summit, Olivier Garret, Casey Research CEO and partner, and I climbed on a plane for California and John Mauldin's Strategic Investment Conference.
John's event is geared more for hedge fund and very high net worth investors and, as such, includes a more mainstream slate of speakers, but what a slate it was.
For the better part of three days, Olivier and I hunkered down to hear presentations and meet with the likes of David Rosenberg, the star analyst of Gluskin Sheff; H. "Woody Brock," an economist with some of the deepest credentials in the business (you can Google any of these guys for bio info); economic historian and best-selling author Niall Ferguson (great speaker, by the way); Marc Faber of the Gloom, Doom and Boom Report; David McWilliams, the popular and very erudite Irish economist; David Harding of Winton Capital Management; Jeffrey Gundlach of DoubleLine Capital; Lacy Hunt again… and my favorite for this conference, Mohamed El-Erian of PIMCO fame.
In other words, for the better part of two weeks, I was immersed in presentations and one-on-one discussions with truly some of the smartest, best-studied people in the world today on economics and investment markets – with the primary topic being whether the so-called recovery is real, and the consequences if it falters.
While the speakers used a variety of methodologies to approach the topic, when all was said, the only conclusion that could be reached was that the world is headed for a very challenging period.
That conclusion was for the most part derived from three aspects of the many presentations:
[Me] "All of the speakers, you included, point to the current trend of higher debts and deficits and say they are untenable and so the big economies will hit a wall in the not-too-distant future. Yet, hardly anyone actually then defines what hitting the wall will look like."
[Him] "Yes, well, things will likely get a bit messy if the politicians can't pull together to address the structural problems in the economy."
"But wouldn't you agree that, given the nature of our democracy, the odds of the politicians taking action before we hit the wall are almost nil?"
"Not at all. If everyone in this country would read my new book, they would understand the situation and rise up to force their elected representatives to take the right action."
"Seriously? The only way to avoid the next leg down is if everyone in the US reads your book? That's it?"
At which point, I kid you not, he picked up his plate and changed tables. (There's a reason I am only rarely allowed out in public.)
But the fact remains that other than perhaps Doug Casey and a small handful of other presenters at our conference, almost no one even attempted to anticipate just what happens when the crisis swells up to its full height and then comes crashing down.
Or, specifically, what the consequences are likely to be when the world's largest economies all hit the wall at more or less the same time. For the record, I have compiled a list of the ten largest economies in the world, and a reasonable assessment of their current situation follows in descending order by size of GDP:
United States – screwed
China – really screwed
Japan – massively screwed
Germany – pretty screwed, especially in that export economies take a big hit in a crisis
France – le screwed!
Brazil – somewhat screwed
United Kingdom – blimey, screwed, too
Italy – properly screwed
Russia – hardly screwed at all (lots of resources and next to no government debt)
Canada – pretty screwed, eh?
As concerning as it is to see how many of the world's largest economies are in trouble, the biggest problem of all is that the central bank reserves of virtually every country in the world are stuffed with US government IOUs masquerading as tangible assets.
So, what happens when the world's reserve currency enters collapse and the dollar turns into a hot potato? Don't know, but I'm pretty sure we'll find out in the not-so-distant future.
The Crux of the Problem
Sorting though my notes for a few key pieces of support for my stark assessment of what the future holds, I find the following that should help make the point.
The first is from Lacy Hunt, who was voted the most popular speaker at our summit (in addition to being very smart, he's also a very nice guy).
(Click on image to enlarge)
The takeaway from this chart is that the world's largest economy is in unchartered waters in terms of debt. This chart, or one telling much the same story, was used by a number of speakers. They used it for the simple reason that it points to a problem that is truly untenable –unfixable by any other methods than overt default or covert default through inflation.
And the picture is much worse than that, because this doesn't show unfunded liabilities – for example, the trillions that aging Americans expect the government to fork over for Medicare and Social Security benefits. Toss those into the pot, and you are talking a total liability overhang of closer to $65 trillion.
Of course, it's far from just here in the US… Lacy referenced a recent ECB study of the unfunded state-sponsored pension plan liabilities in 19 European Union countries and found that those liabilities came to five times the GDPs of those countries (actually a bit better than the situation here in the US).
The always agreeable John Williams of ShadowStats and I had an on-stage discussion about the work he does to strip away the government's tampering and obfuscations when reporting economic data. The first chart here shows the government's rather encouraging picture of recovery in GDP.
(Click on image to enlarge)
Now, here's the same picture adjusted for actual inflation. Not quite so good.
(Click on image to enlarge)
How about housing starts? Recovery there? You tell me.
(Click on image to enlarge)
The all-important matter of unemployment? Ouch.
(Click on image to enlarge)
Because I am already running way behind on time, let me try to jump to some of my key takeaways from my two-week quest.
In other words, the crisis we face isn't just that there is no mathematically possible way for the debts and obligations of the governments to be met… or that the population at large is struggling under its many debts (thanks in no small part to regular enticements by the government and banking sectors)… it is that the political systems in the larger economies structurally reward ever greater prolificacy in public finances.
Which means this train is speeding up toward the wall and won't stop until the crash.
Earlier on I wrote that, paradoxically, predicting the future is easier than usual these days. That's because the major economies are so highly politicized. Thus, when you see the hard data that says things are broken beyond all politically tenable ways for them to be repaired, you can go one step further and ask, "What would a politician do?"
And asking that question, you can be unusually confident we're headed for a wall.
Some, like Harry Dent, believe that the crash will come in the form of a massive deflation. This would occur if the politicians misgauged their many interventions in the economy and the deflationary pressures from debt deleveraging in the private sector were able to outstrip the inflationary actions of the government.
On the other side of the argument, many analysts including those of us here at Casey Research, believe the grand finale will be highly inflationary in nature because in a fiat system, the waves of money printing can just keep rolling in.
That said, a good case can be made that we will see a period of deflation, followed by the blowout inflation that brings the crisis to its tumultuous end.
The important thing, at least to my way of thinking, is to recognize that we are speeding for a wall. That will put you well ahead of the average person who has literally no idea and so will be caught unawares.
While we can see that the crisis is not over and is headed into a very dangerous period, other than in general terms, the matter of timing is almost impossible to pin down.
The reason is that while we can see cascading structural problems looming just ahead, we can't anticipate how the governments around the world are going to attempt to deal with these problems.
For example, we can only guess at how the US government will be able to keep funding itself as well as rolling over trillions of government bonds over the next year.
Or how Congress will deal with the triple witching hour of another approaching debt ceiling, along with the mandated sequestering of funds resulting from the political wrangling around the last debt ceiling fiasco, compounded by the scheduled year-end expiration of the Bush tax cuts, all of which together promise to suck trillions out of the economy.
Thus, while the crisis should come to a head before the end of next year, that assessment assumes that some form of "standard" for government action exists. In other words, that the government will stay within predictable boundaries when dealing with economic setbacks. Because it doesn't, it's literally anyone's guess just how far it will be willing to go before finally allowing the free markets to once again operate and things are resolved.
For instance, many people now think that quantitative easing is the final word in the government's economic meddling. In contrast, I take the view that QE may be the last in the category loosely defined as "warm and fuzzy" options used by the government to try and retain power by fixing the unfixable, but it's a far cry from how draconian they can get.
History has shown us the far fuller slate of options available to the state, including exchange controls, confiscation, nationalization, punitive taxation, wage and price controls, war and even assuming dictatorial powers.
Simply, the morally and economically bankrupt super-powers haven't even begun to fight, and so this crisis could drag out for years to come.
Now, as to how to protect yourself.
First and foremost, while it may seem a shameless tout, I would highly recommend you buy the CDs from our just concluded Recovery Realty Check Summit. In addition to everything you need to make your own confident assessment about where things are headed (invaluable), you will also hear a lot of solid, specific ideas on how to position your investment portfolio to preserve your wealth and even profit through the challenging times ahead.
More information and details on the CDs from the recently concluded Casey Research Recovery Reality Check Summit can be found by clicking here.
We will, of course, continue to share our thoughts on the continuing crisis in our various publications so that, together, we will get through this. Before moving on, I would mention, however, that even Lacy Hunt, bond bull that he is, admitted to making regular purchases of gold.
And now, with the clock running down, I will turn to a couple of contributions in our Casey Research constellation of contributors. I'll then be back with some closing thoughts and my latest (actually entertaining) experience with our friends at the TSA.
Our first contribution returns us to the topic of degrading democracies.
By Paul Rosenberg
Politics makes people mean.
We always knew that, but if ever we said it, people passed it off as a trite complaint about one political party or the other. But now, thanks to a couple of researchers at the University of Michigan, we can prove it.
This new study was very cleverly set up so that the researchers could measure the empathy of Republicans and Democrats for each other, without using political questions. Here's how they did it:
In their first experiment, the researchers recruited subjects on a cold winter day (some of them were outside, waiting at a freezing bus stop). They said that the test was on reading comprehension.
In one version of the test, they gave the subject a story to read about a left-wing, pro-gay-rights Democrat. This Democrat was, in the story, hiking through the woods on a cold winter day. In the other version the story was the same, except that it was about a right-wing, anti-gay-rights Republican. Only after the experiment did they ask the political leanings of the subjects.
In the second experiment they did the same thing, but they used thirst instead of cold. They fed the subjects salty foods and gave them no water; then they told a story about a man walking across a parched desert. Again, one version of the story featured a Democrat and the other a Republican.
You'd think that a thirsty guy would feel some level of sympathy for another thirsty guy, right? And normally, that would almost always be true, but it turned out that politics killed that natural sympathy.
Democrats felt sympathy for a Democrat in the story 100% of the time. Republicans felt sympathy for a Republican protagonist 96% of the time.
But when the freezing or thirsty person in the story was from the other party, sympathy died almost completely: The sympathy of Democrats fell to 0% and the sympathy of Republicans fell to 9.5%.
WORSE THAN MEAN... EVEN MONSTROUS
Mean is a non-specific word. Even though it always refers to something negative, it can refer to many different types of negative things: grumpiness, outbursts or malice, for example.
The meanness uncovered in this experiment was of a specific type: the killing of empathy. And that is a very dangerous thing.
Empathy is the root of morality and cooperation. People without empathy are called sociopaths, and they are by far the most dangerous people on the planet. Every genocide features sociopaths; every mass atrocity and every continued abuse requires them. So, when a study shows empathy being almost entirely crushed, it should be jarring. To put it clearly and simply, this study showed something very scary, which is this:
When people are under the influence of politics, they turn into sociopaths.
That is not hyperbole. Go back and re-read the explanation above. If you think I might be over-stating things, read through the study for yourself.
Such people do not become permanent sociopaths, of course – they are able to experience empathy in other situations. But when politics comes to their minds, they lose all empathy for someone of the opposite party. And that is a very dangerous thing – especially considering that politics is the obsession of the age, the mass addiction of our age.
This is no longer a subject of debate; it is fact.
We always knew that politics made people mean. This study showed us how completely politics crushes empathy... and shows us how toxic the political obsession really is.
The crack addict needs to walk away from his pipe; the alcoholic from his bottle; it's time for us to start walking away from politics.
Paul Rosenberg, a periodic contributor on cyber-security to InternationalMan.com, writes the Freeman's Perspective newsletter. He is also the author of many books, including the highly regarded A Lodging of Wayfaring Men. When not reading or writing on history, philosophy or science, Paul is the CEO of Cryptohippie USA, a company that provides the crucial link in online security: protecting your Internet traffic. What's the point of protecting your computer with a firewall if you send all of that data, unprotected, through the thieves' paradise that is the modern Internet?
By Adam Crawford, Casey Research
Earlier this week, it was announced with no small amount of pride by the government that the US budget had returned to surplus for the first time since 2008. Here's our own Adam Crawford's notes on that announcement.
(Click on image to enlarge)
The US government reported a $59 billion surplus for the month of April. For those who are counting, that's the first surplus in 42 months (I guess 1 out of 42 ain't bad). This is seemingly positive news for an ailing economy. However, a quick glance at the fine print in the CBO report reveals the news isn't so great after all.
The bottom line is, an April surplus is rather common, and this particular April surplus is rather inflated. The fact remains the US will likely run another trillion-dollar-plus deficit this year, which will add to the multi-trillion-dollar total debt. This means a month in the black will be soon be overshadowed by another year in the red.
By Michael Lewitt, The Credit Strategist
Michael Lewitt, a first-time faculty member at our Florida Summit, does exhaustive analysis of credit markets and the derivatives that have become such a large gorilla in those markets. When the news broke last night about JPMorgan losing $2 billion and still being trapped in a trade gone wrong, I reached out to Michael for some quick comments. Those comments follow.
When you are sitting on $71 trillion of derivatives, it is probably best not to argue for the relaxation of regulatory oversight over your business. Yet that is precisely what JPMorgan's Jamie Dimon has been doing in recent months. What occurred yesterday, however, may cause him to think twice the next time the subject of bank regulation is raised in polite conversation. It will also certainly cause investors to think twice about investing in the shares of any of the large US banks, which by traditional-value investing principles appear to be cheap.
Yesterday, after the market close, JPMorgan announced that a series of synthetic credit trades done by its Chief Investment Office had gone terribly wrong and caused a $2 billion loss.
A "synthetic" trade is another name for a derivative trade, most likely some type of credit default swap. The bank claims that this Chief Investment Office's job is to hedge the bank's overall credit exposures, but that can't be all that it was doing. This office had to be making huge bets on the market in what is nothing more or less than a form of proprietary trading.
This is exactly the type of activity that the Volcker Rule is supposed to ban, but apparently Mr. Dimon didn't get the memo. Investors who have been bidding up the bank's shares since last November have gotten another lesson in the risks that can be created virtually overnight on the balance sheets of large financial institutions. And it would be surprising if the losses stopped at $2 billion. Counterpart use will now be piling on.
In recent weeks, a JPMorgan trader in London, Bruno Michel Iksil, was reported to be making massive credit trades. Mr. Iksil (why is it always a Frenchman?) had gained the moniker of the "London Whale," and it appears that at least part of the losses are related to his activities.
While it would not be surprising if the London Whale had been harpooned, it is troubling that JPMorgan has been so reckless with its capital. This is "only" a $0.30/share loss but shows that even a manager as highly regarded as Mr. Dimon can't reasonably have a handle on all of such a massive bank's activities. That is why a $71 trillion derivatives book should worry everyone.
Mr. Dimon said that the Chief Investment Office's losses were "self-inflicted" and "egregious." Those may sound like harsh words, but coming four years after 2008, they fail to capture just how inexcusable this type of risk-taking is by an institution of such systemic importance as JPMorgan. Investors have learned once again that leaving banking to the bankers is very dangerous.
This episode will no doubt renew calls for a stronger Volcker Rule. But the real lesson here is that nothing can replace humility and competence, and both were sorely missing at JPMorgan. Everyone should remember that the next time the banks come hat in hand to the government for a bailout.
(Click on image to enlarge)
Okay, I'm back. As I have related in a past edition of these musings, I am an unrepentant diarist, constantly scribbling notes and observations in the full expectation that most of them will go unread by anyone, ever.
The following, however, is worth sharing because it touches on a couple of issues related to the intrusive (and mostly unnecessary and ineffective) security protocols the public is now forced to endure… at least if they want to take advantage of the modern convenience of air flight…
While waiting sheepfully in line for my turn through security screening precedent to boarding the first of two flights to get me from Florida to California, I had time to read the sign advising me that the Ft. Lauderdale airport was in possession of "Back Scatter X-Rays," the better to see through my clothing for any suspicious items.
Now, I don't know much, but I do know that X-rays are not a highly recommended source of daily nutrition. In fact, most people would go one bridge further to say that excessive dosing with X-rays is actually pretty bad for you, especially if you are a frequent traveler. And so, having arrived early for the flight, I decided to try my luck with my first ever "Opt Out" of the X-ray machine, an action that most people consider anti-social and even unpatriotic.
On notifying the closest TSA operative that I wished not to be irradiated, he notified another TSA colleague standing idly nearby (a description that fits most of them) who in turn opened a small door to the side of the machine and asked me to step through. After ensuring that my feet were planted just so on a mat provided for that specific purpose (I know because it was helpfully imprinted with the outline of feet so I'd know just where to stand), he used his radio to hail another TSA operative with the code words, "Opt out, opt out."
A minute or so later, a surprisingly presentable young man arrived and, after gathering up my gear from the conveyor belt, led me to a semi-private area for my pat-down during which the following exchange took place.
"I travel a fair amount, so I came to the conclusion that regular X-rays might not be the best idea," I said in a pleasant voice.
"I don't blame you," he answered in an equally congenial tone.
"Is it true that your union is concerned about the X-ray machines?"
"Absolutely. We're trying to get them removed. I mean, can you imagine what's going to happen to the guys who have to stand around those machines all day?"
"Nope, but I guess we'll find out in another ten years or so."
Since at this point he and I had become intimate, in the literal sense that he had been groping me throughout our exchange, I felt secure in asking him a question I had been yearning to ask a TSA agent for some time, but previously hadn't found the right opportunity.
"So, what did you do before you took this job?"
"I was a bartender."
"Really? That seems quite the change?"
"I guess, though there are some similarities between the two jobs. You talk to a lot of people, for example."
"Ah, but as a bartender people actually want to talk to you, while in the airport, they are forced to."
"So true, so true."
I then gave him my elevator pitch for how he could escape his current job, namely by studying something he loves one hour a day in his spare time, a suggestion he warmly thanked me for before we parted company.
On the way back from California, I once again opted out and had a nice chat with a former computer salesman who expressed exactly the same sentiments about the risks of the X-rays, and a similar level of what seemed to be genuine appreciation for my sharing the secret to successfully finding a more satisfying line of work.
All of which once again reaffirmed to me the importance of stepping off the beaten track now and again, or in this case out of the line, to experience new facets of life and to meet new people.
In this case, the reward was that I got a different perspective on the X-ray machines and finally got to ask the burning question I had wanted to ask since this nonsense began... which is where did they find all these people to paw through people's underwear and grope grannies and toddlers. And now I know – they are regular folks, "just doing their job."
And with that, I will hastily sign off for the week by thanking you for reading and for being a Casey Research subscriber!