An article today in the Denver Post reminded me of an article I read last week about tipping points. A tipping point is a specific event that changes the course of history. Most of the time, tipping points are identified after the fact.
A couple of examples might help clarify what a tipping point is. Right before the start of the Civil War, the South announced that they were seceding from the Union. This was in response to large tariffs that were imposed by the government on exports of commodities by the southern states. As most of you know from your history studies, the right of any state to secede was instrumental in convincing the states to ratify the constitution. Lincoln's proclamation of war to prevent the South's secession is seen today as a major tipping point in the balance of power between the federal government and state's rights. (And no, slavery was NOT the primary reason we fought the Civil War, it was just a convenient PR plan to detract the citizens attention away from the secession issue.)
Another more recent tipping point is the events of 9/11. With that event, the rights of innocent Americans was severely undermined in an effort to protect us from terrorists. If you read through the Patriot Act you will be amazed at what the government can do to you or I without a search warrant.
Ok, hopefully you understand what a tipping point is and how these seemingly random events can sway human history. A recent article by Jim Puplava of Financial Sense Online, details what he sees as six tipping points that could cause the economy to fall. To that list I would like to add a couple of non-financial tipping points that could cause the economy to tumble over the edge.
That brings me back to the article in the Denver Post this morning. It was a short article buried in the middle of the paper. I searched the online version of the Post and could not find it. The basic premise of the article is that a scientist has come out with a prediction that the world will reach peak oil production sometime this year or next. I discussed the term “Peak Oil” in an earlier post here. The significance of the article this morning is that what has been discussed in alternative news media outlets is now starting to seep into the mainstream news media. This is significant because this seeping or slow changing of opinions about our current oil situation is the tip of the iceberg. And as this becomes more pervasive, it will begin to weigh on everyone's mind. This is my first tipping point. The point in time when the general population begins to awaken to the fact that we have a limited amount of oil and things are going to get a lot worse before they get better. This awakening could easily send the economy over the cliff.
The second possible tipping point is some type of climactic crisis. We have all been reading the stories from around the world detailing unusual weather. A February article by Michael McCarthy of the Independent reports that the findings of the Cambridge-based, British Antarctic Survey shows that a massive Antarctic ice sheet in disintegrating at an alarming rate. The collapse of this ice sheet could raise sea levels around the world by 16 feet. Imagine what that would do to the coastal areas around the world. Most of the U.S. refineries would be under water as would several cities.
The third possible tipping point has to do with a major terrorist attack on U.S. soil. I believe of all of the possible tipping points, this one is probably the most remote, but it has to be considered. Some type of biological or radiological attack on a major metropolitan area would be devastating to this country and would no doubt plunge us into deep recession or worse.
Now, in addition to these three non-financial tipping points, Jim's article discusses six financial tipping points that I will briefly summarize here. (Go here to read the entire article and study the accompanying charts that help clarify his position.)
Tipping Point 1: Leveraged Carry Trade. Briefly, the carry trade is a practice by speculators and hedge fund operators whereby they borrow money at the current short-term rates and lend it out at the higher long-term rates. As long as the difference between short-term rates and long-term rates remains high enough, these traders make money, and lots of it. What is happening right now is that the rate differential is narrowing and this is putting profit pressure on these speculators forcing many of them to “unwind” their positions. If this unwinding accelerates, liquidity dries up and hedge funds will not be able to liquidate their positions and will suffer catastrophic loss. Imagine an event like the Long Term Capital Management collapse in 1998 magnified by 100 times. The world financial system would lock up.
Tipping Point 2: Growing Trade Deficit. The current trade deficit continues to grow with no signs of slowing. It looks like the deficit this year will exceed 2004's record of $617 billion. While you and I continue to purchase all sorts of items at our local Wal-Mart for great low prices, we are putting our manufacturing sector out of business. In effect, we are shipping our production overseas where labor costs are lower. This has created huge imbalances in our economy that sooner or later will have to be dealt with. Bottom line is that we are going to see price inflation of imported items and a continued reduction in high paying manufacturing jobs.
Tipping Point 3: U.S. Consumer Debt. We as a nation are in debt up to our eyeballs. Since 2000 consumers have added debt to the tune of $3,246.2 billion. That's a lot of debt. Not only are we borrowing more money, we are spending more than we make at an increasing rate. I believe that the U.S. consumer has, by itself, keep the U.S. economy limping along for the past 5 years. To keep the game going, housing prices have continued to climb allowing consumers to borrow more and more on their houses. Interest rates have been held down by the Federal Reserve, which has helped homeowners to afford more and more debt. And the increase in popularity of adjustable rate mortgages has allowed homeowners to buy bigger homes and take out larger loans that they could ever afford with a conventional loan. The only problem…when, not if, rates start rising, millions of homeowners will not be able to make house payments. Wave bye-bye as the economy disappears into the abyss.
Tipping Point 4: Banking Crisis Ahead. Just two weeks ago, banking regulators issued a warning to U.S. banks to tighten up their lending standards. It seems that bankers are making some of the same mistakes that Savings & Loan companies did back in the 80's. The difference this time is everyone is involved in home mortgages, banks, insurance companies, credit unions, and thrifts. Not only is everyone playing the game, but there is almost no equity in any of these properties. And the equity that a few of the properties have now would completely evaporate if the housing market suffered a 10% price contraction. Lending institutions are in an extremely vulnerable situation right now and as Jim puts it so well in his article, “If we aren't at the edge of the cliff, we are certainly close.”
Tipping Point 5: Reliance on Foreign Investors. Currently, more than 44% of our outstanding government debt is held by foreign governments. In fact, our government has to sell close to $60 billion dollars in bonds every month just for our government to meet its obligations. In other words, these foreign countries, most notably, China, Japan, Korea, and Taiwan are carrying us on their dime. And now we are hammering China to revalue their currency. All that will do is cause our cost of buying foreign goods to increase. All I can say is we better be careful what we ask for. We just might get it.
Jim's final Tipping Point is called the Rogue Wave. If you saw or read The Perfect Storm, you know that rogue waves happen with no advance warning. They are the result of random events and when they hit, they are devastating. Basically, the rogue wave tipping point could come from any sector. There are so many imbalances in our economy right now that any one of them could set events in motion that literally changes the course of history. In addition to financial tipping points there are a lot of political hotspots around the world that could set off a firestorm that would take down our economy.
The goal of bringing to light all of these factors that could play a pivotal role in the direction of our economy in coming months is not to cause a panic or severe depression. It is to alert you to what could happen. Hopefully, by paying attention to these areas, you may have a little notice of impending crisis and take appropriate defensive steps. A little notice is more notice than 99% of the population will get. Most will never see it coming until it hits. Don't allow yourself to be a part of that group.
Tuesday, May 31, 2005
Wednesday, May 18, 2005
Stocks Soar...Why?
China’s currency, that’s why. This morning I read in the Denver Post that the Treasury Department announced yesterday that China’s monetary policy has created an unfair trade environment.
You see, China has pegged their currency, the yaun, to the dollar. To maintain that relationship, China has been buying tons of U.S. Treasuries in an effort to spend he billions of dollars that it is collecting from the U.S. This pegging of the yaun to the dollar is creating a situation where Chinese products are cheaper than everybody else’s in the world. The U.S. consumer is spending money like there is no tomorrow at Wal-Mart and other discount stores. Why is this a bad thing? After all we consumers want the best price for all of the trinkets we buy, right? We are getting exactly what we want…inexpensive stuff from China, but at what cost? We are in effect exporting our jobs to low cost producers like China and India.
Instead of the markets reacting to this latest news by going up, there should be some serious concern about what a revaluation of the Chinese yuan really means. It means that prices are going to go up for all of the products we have been importing from China. In fact, Wal-Mart sees the writing on the wall as they warned about future profits in light of increasing prices. If Wal-Mart sees this coming, why can't our governement, and more importantly, the stock market?
In other news this morning, two economists at the Stanford Institute for Economic Policy Research warn that the current administration is putting way too much emphasis on the coming social security crisis while ignoring a far bigger problem which, in all likelihood, will blow up years before social security. This new impending crisis has to do with the Medicare System. Thanks to recent changes in Medicare, it is a far bigger problem and will consume far more money than even social security. While social security spending is expected to grow from 4 percent to about 6.4 percent of the total U.S. GDP when the baby boomers start retiring in the next three years, the Medicare System will consume up to 14 percent of the GDP and will be spending more than they take in by 2010.
As Americans we have become accustomed to our government taking care of us when we lose our job, or when we get hurt, or when we get old and sick. The founding fathers never intended for our government to take on the role of caregiver, but we now expect it and will be really mad when it doesn’t happen.
And guess what, by the time most of us reach retirement age, it isn’t going to happen.
You see, China has pegged their currency, the yaun, to the dollar. To maintain that relationship, China has been buying tons of U.S. Treasuries in an effort to spend he billions of dollars that it is collecting from the U.S. This pegging of the yaun to the dollar is creating a situation where Chinese products are cheaper than everybody else’s in the world. The U.S. consumer is spending money like there is no tomorrow at Wal-Mart and other discount stores. Why is this a bad thing? After all we consumers want the best price for all of the trinkets we buy, right? We are getting exactly what we want…inexpensive stuff from China, but at what cost? We are in effect exporting our jobs to low cost producers like China and India.
Instead of the markets reacting to this latest news by going up, there should be some serious concern about what a revaluation of the Chinese yuan really means. It means that prices are going to go up for all of the products we have been importing from China. In fact, Wal-Mart sees the writing on the wall as they warned about future profits in light of increasing prices. If Wal-Mart sees this coming, why can't our governement, and more importantly, the stock market?
In other news this morning, two economists at the Stanford Institute for Economic Policy Research warn that the current administration is putting way too much emphasis on the coming social security crisis while ignoring a far bigger problem which, in all likelihood, will blow up years before social security. This new impending crisis has to do with the Medicare System. Thanks to recent changes in Medicare, it is a far bigger problem and will consume far more money than even social security. While social security spending is expected to grow from 4 percent to about 6.4 percent of the total U.S. GDP when the baby boomers start retiring in the next three years, the Medicare System will consume up to 14 percent of the GDP and will be spending more than they take in by 2010.
As Americans we have become accustomed to our government taking care of us when we lose our job, or when we get hurt, or when we get old and sick. The founding fathers never intended for our government to take on the role of caregiver, but we now expect it and will be really mad when it doesn’t happen.
And guess what, by the time most of us reach retirement age, it isn’t going to happen.
Monday, May 16, 2005
Pension Bust
For those of you who have read my previous postings, you will no doubt recall my warning about the future of social security, or lack thereof. Let me be perfectly clear here; this crisis that awaits social security is bearing down on defined benefit pension plans as well.
A case is point is last week’s court decision allowing United to dump their pension fund, which is under funded to the tune of $6.6 billion, in the lap of the Pension Benefit Guaranty Corporation. This is just the latest in a continuing series of pension fund defaults. Next up, General Motors, whose bonds were downgraded to junk status because of the company’s huge pension funding deficit.
Lest you think that you are safe because you do not pay into social security but a private retirement fund, take note of the latest news and plan accordingly. I know what your thinking…my pension plan is insured by the Pension Benefit Guaranty Corp. Even before the United pension mess, PBGC is facing a shortfall of $23 billion from a string of corporations who have gone under in recent years. Even if your particular plan is solvent and looking good 20 years into the future you need to understand that one of the governments fallback plans is to absorb those private plans into social security in the event that a crisis develops.
When that happens your benefits will be severely reduced, just like in United’s case. This brings me back to my original post. No one cares more about your money than you. You need to take control of your finances, boost savings, and prepare for the worst.
A case is point is last week’s court decision allowing United to dump their pension fund, which is under funded to the tune of $6.6 billion, in the lap of the Pension Benefit Guaranty Corporation. This is just the latest in a continuing series of pension fund defaults. Next up, General Motors, whose bonds were downgraded to junk status because of the company’s huge pension funding deficit.
Lest you think that you are safe because you do not pay into social security but a private retirement fund, take note of the latest news and plan accordingly. I know what your thinking…my pension plan is insured by the Pension Benefit Guaranty Corp. Even before the United pension mess, PBGC is facing a shortfall of $23 billion from a string of corporations who have gone under in recent years. Even if your particular plan is solvent and looking good 20 years into the future you need to understand that one of the governments fallback plans is to absorb those private plans into social security in the event that a crisis develops.
When that happens your benefits will be severely reduced, just like in United’s case. This brings me back to my original post. No one cares more about your money than you. You need to take control of your finances, boost savings, and prepare for the worst.
Tuesday, May 10, 2005
Buy Low...Sell High
The above phrase represents one of the great truths about investing that has survived every type of market; both bulls and bears. Today, I want to look at this investing truth from a slightly different angle. Yes, we will still buy low and sell high, but we are going to talk about something other than price.
Price is relative. How do we determine “high” or “low?” High for me might be $10.00. For you it might be $100.00. A high or low price is a very personal observation and is a very accurate observation for any given individual. Our personal observations are what create the market. If we all thought that stock “A” was high, there would be no buyers. The markets would come to a grinding halt. So if determining whether a particular price is high or low is difficult, if not down right impossible, what attribute can we measure to help us make our investing decisions?
The lowly Price/Earning Ratio seems to fit the bill. I just finished reading two different articles written by two people in different countries that come to the same conclusion regarding P/E ratios. Both authors, by doing extensive research, have determined that the opportunity to make a decent return on your investment increases dramatically when the P/E ratio is below historic averages.
When looking at individual stock issues there are, I believe, a few more criteria to research. For example, debt to equity ratio, price to book ratio, price to cash flow, and price to sales ratio. These additional items will help you to weed out the dogs.
I prefer to use the P/E ratio of the overall market as a gauge of how high the market is and as the authors above noted, most of their research involved looking at the market as a whole and then comparing market returns over a period of years. The research is astounding. If you invest in stocks when the market P/E ratio is 10 or below, you will probably enjoy double-digit returns on your investments over the next 10-20 years. However, if the market P/E is 19 or above, chances are your investments will go nowhere or even down over the next 10-20 years. Now, in 1982, which is considered to be the end of the last secular bear market, the average P/E ratio for the S&P 500 was less than 10. From 1982 through 2000, earnings increased by 120% and the market increased by six times. (On an inflation-adjusted basis.)
Where are we at today? Well, depending on whose market P/E numbers you use, the S&P 500 P/E ratio is north of 20 as we speak. That would indicate that we are in for several years of below average market returns. (This could explain why Warren Buffet is holding a lot of cash right now.)
I hope you are not counting on 10-20% returns over the next 10 years to pad your retirement nest egg because it looks like those types of returns are history for the foreseeable future. If you would like more information about market P/E ratios and secular bear markets, grab a copy of Unexpected Returns
Monday, May 09, 2005
Jobs...What Jobs?
I read an interesting little known fact today about how our government, and the Department of Labor in particular, estimates the increase or decrease in employment. As you know, a decrease in unemployment indicates an improvement in the overall economy. Since 2000, the economy has been in the doldrums with layoffs and business closings making the headlines every week.
It seems that in 2003, the Department of Labor started using a business birth/death model to adjust employment numbers. You can read all about it here. As with all government data, these numbers are derived through statistical analysis and are subject to statistical error. This business birth/death adjustment is really of questionable accuracy as the only numbers collected involve business closings. This is from their website, they “use business deaths to impute employment for business births.” In other words, they have no idea how many new businesses are started each month or how many people these new businesses hire, but they are using business deaths in some way to estimate these numbers. This adjustment over the last several months has helped the government to show a substantial increase in employment.
If you back out the birth/death adjustment, you can get a better idea of just how many jobs are being created by this weak economic recovery. For example, during the March-April timeframe, the government reported an increase of 420,000 jobs. If you back out the birth/death adjustment of 436,000 jobs, it becomes apparent that there were no new jobs created and in fact, we actually lost jobs.
This is just another example of how by manipulating numbers; the government tries to put a rosy spin on the current state of the economy. Why do this? So that you and I will continue to go into debt and spend every penny we can on cars, clothes, houses, and food to keep the economy moving forward.
It seems that in 2003, the Department of Labor started using a business birth/death model to adjust employment numbers. You can read all about it here. As with all government data, these numbers are derived through statistical analysis and are subject to statistical error. This business birth/death adjustment is really of questionable accuracy as the only numbers collected involve business closings. This is from their website, they “use business deaths to impute employment for business births.” In other words, they have no idea how many new businesses are started each month or how many people these new businesses hire, but they are using business deaths in some way to estimate these numbers. This adjustment over the last several months has helped the government to show a substantial increase in employment.
If you back out the birth/death adjustment, you can get a better idea of just how many jobs are being created by this weak economic recovery. For example, during the March-April timeframe, the government reported an increase of 420,000 jobs. If you back out the birth/death adjustment of 436,000 jobs, it becomes apparent that there were no new jobs created and in fact, we actually lost jobs.
This is just another example of how by manipulating numbers; the government tries to put a rosy spin on the current state of the economy. Why do this? So that you and I will continue to go into debt and spend every penny we can on cars, clothes, houses, and food to keep the economy moving forward.
Friday, May 06, 2005
What’s Wrong With Bush’s Social Security Plan?
It’s a hoax. A giant hoax. If we were looking at a true privatization plan, it would be great. You and I could send our hard earned money and that of our employers to a retirement account similar to an IRA and we could invest that money as we see fit. Some in stocks, some in bonds, some in real estate, some in precious metals, and maybe some in an inverse mutual fund. (See my previous post “Review and Rebalance.”
The sad news is that any plan put forth by the government is not going to be a truly private plan. The government will still collect your money and they will tell you which funds to invest in…and you can bet that none of the approved funds will cover such asset classes as real estate, precious metals, or inverse funds. They will be either stock funds, bond funds, or some combination thereof. After all, this new plan requires that the stock and bond markets remain strong. Think what a boost all of this new investment would do to the stock market. It would literally soar…for a while, and then it would drop and it would continue to drop, but by then, the politicians that brought you this wonderful plan would be long gone. Retired with a guaranteed pension by the way.
Like I’ve said from the get-go. You have to take control of your own destiny. Do not count on the government to take care of you in your old age because it just isn’t going to happen.
The sad news is that any plan put forth by the government is not going to be a truly private plan. The government will still collect your money and they will tell you which funds to invest in…and you can bet that none of the approved funds will cover such asset classes as real estate, precious metals, or inverse funds. They will be either stock funds, bond funds, or some combination thereof. After all, this new plan requires that the stock and bond markets remain strong. Think what a boost all of this new investment would do to the stock market. It would literally soar…for a while, and then it would drop and it would continue to drop, but by then, the politicians that brought you this wonderful plan would be long gone. Retired with a guaranteed pension by the way.
Like I’ve said from the get-go. You have to take control of your own destiny. Do not count on the government to take care of you in your old age because it just isn’t going to happen.
Thursday, May 05, 2005
Stress Cracks Appear In Economy
According to an article entitled "Japan Urges China to Manage Reserves Responsibly," Japan is asking China to be very careful as they look at currency reserves and the large concentration of dollars in those reserves. Why would Japan, a country that is not all that friendly with China, care how their currency reserves are handled? Well, it's like this. The two countries are currently holding in the neighborhood of $2 trillion dollars of currency reserves in foreign assets. A majority of those reserves are in U.S. dollars.
So what happens if China begins to rebalance their currency reserves in attempt to lighten up their holdings of U.S. dollars? The obvious result would be a drop in the value of the dollar. If Japan is left holding the bag (of dollars) it would result in huge loses. It might also start a stampede for the door by other countries and the fragile house of cards, or dollars, would come tumbling down.
Now, to be sure, it is not in China's best interest to cause a collapse in the value of the dollar. After all, the U.S. consumer is the buyer of first choice for all of the bangles and baubles that China is cranking out right now. A collapse of the dollar would in turn cause a collapse of China's export economy. That would not be a pretty sight.
All of this points to a real problem that the U.S. is facing. We have financed our economy with debt and most of that debt has been purchased by foreign investors. When, not if, these foreign investors stop buying our debt, the fun will really start. For all of the posturing by the Fed, our economic future is now in the hands of foreign countries and that is not a very comforting position to be in.
So what happens if China begins to rebalance their currency reserves in attempt to lighten up their holdings of U.S. dollars? The obvious result would be a drop in the value of the dollar. If Japan is left holding the bag (of dollars) it would result in huge loses. It might also start a stampede for the door by other countries and the fragile house of cards, or dollars, would come tumbling down.
Now, to be sure, it is not in China's best interest to cause a collapse in the value of the dollar. After all, the U.S. consumer is the buyer of first choice for all of the bangles and baubles that China is cranking out right now. A collapse of the dollar would in turn cause a collapse of China's export economy. That would not be a pretty sight.
All of this points to a real problem that the U.S. is facing. We have financed our economy with debt and most of that debt has been purchased by foreign investors. When, not if, these foreign investors stop buying our debt, the fun will really start. For all of the posturing by the Fed, our economic future is now in the hands of foreign countries and that is not a very comforting position to be in.
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