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 Forecasting America's Destiny ... and the World's


Web Log - October, 2008


Dalai Lama hints at significant change of strategy for Tibet vs China

A special strategy meeting for Tibetan exiles will occur in mid-November.

This little-reported story that may have important significance in a few weeks.

The Dalai Lama is changing his position from one of preaching conciliation, compromise and tolerance with China into something that's a lot more confrontational.

The Tibetan spiritual leader shocked observers last weekend for his unusually blunt statement.

On Saturday, the Dalai Lama told a public function in his exile location, Dharmsala, India, that he has "been sincerely pursuing the middle way approach in dealing with China for a long time now but there hasn't been any positive response from the Chinese side." He added: "As far as I'm concerned I have given up."

In an interview on Thursday with the BBC, he made the following bitter statement:

Dalai Lama describes his faith in China's government. <font face=Arial size=-2>(Source: BBC)</font>
Dalai Lama describes his faith in China's government. (Source: BBC)

"My faith in China's government has become tiny, tiny, tiny.

Our main aim has been to improve conditions inside Tibet. That has not happened. Now the suppression is much, much increased - very, very tight control, something like military occupation - like that. Sometimes I feel like the Tibetan people are passing through a death sentence - something like that."

He's called an extraordinary mid-November meeting of Tibetan exile leaders to discuss future strategy. One possible outcome, though far from certain, would be a call for full Tibetan independence.

Ironically, this call for independence would do little to stir up the Tibetans, since the Tibetans are in a generational Unraveling era. The most you could expect from the Tibetans would be a few demonstrations, and perhaps some scattered violence.

But the Chinese have the most nationalistic, paranoid government on earth. It's quite possible that the Chinese Communist Party (CCP) will take this change of strategy as a major threat, and will overreact.

The Chinese DID overreact last March, with an extremely violent crackdown on demonstrating Tibetan monks. Worldwide attitudes towards the Chinese became increasing angry and xenophobic until May, when a massive earthquake in Sichuan province created a period of good will that lasted through the Olympics game in August.

It became clear in March that the fault line between Han Chinese and Tibetans is very deep and full of hatred. This hatred exploded in March, and the Dalai Lama's announced intention to change strategy raises the possibility that it will explode again. (31-Oct-2008) Permanent Link
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Stocks soar worldwide as corporate earnings plummet

Panic buying pushes indexes up 10-11%.

Market summary, 28-Oct-2008
Market summary, 28-Oct-2008

The girls were all giggly today on CNBC and Bloomberg tv, as investors poured money into the market, pushing the Dow Industrials index back above 9,000 that really took off furiously in the last hour of trading.

There was an 11% surge two Mondays ago, and since then there have been several large falls. The volatility and wild swings seem to be growing. I've been expecting these wild swings for some time, as they occurred just prior to the 1929 crash.

There was plenty of bad news around on Tuesday.

According to one report, U.S. consumer confidence has dived to the lowest reading since the survey was started in 1967. According to another report, housing prices fell at the fastest pace on record, as foreclosures continue to climb.

There was one piece of news which some might interpret as very good news: Sales of long-term commercial paper soared to a historic record on Monday, as companies sold 1,511 issues totaling a record $67.1 billion of the debt due in more than 80 days, compared with a daily average of 340 issues valued at $6.7 billion last week,

Commercial paper (CP) is the most common way for a corporation to lend money to another corporation. The corporation issues CP notes, and a purchaser loans money by purchasing the CP. Later, the purchaser sells the CP back for cost plus interest.

Sales of commercial paper have plummeted since the credit crisis began in August, 2007, since no one wanted to buy it. Thus, the Fed began buying CP on Monday, as part of the $700 billion bailout. The program was spectacularly successful, at least for one day, and investors showed their pleasure on Tuesday. It remains to be see whether the credit crisis continues to soften.

Crashing corporate earnings

However, the long-term trend that I've been reporting on for a long time took a nose-dive on Tuesday.

As regular readers know, for the last few quarters I've been posting the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters. These tables have shown sharp falls in corporate earnings estimates from week to week.

Actual earnings have been pouring in since mid-October. For a while, it seemed that third quarter earnings growth estimates were stabilizing around -10% (that is, 10% lower than third quarter earnings for last year).

However, the estimate posted on Tuesday suddenly fell off a cliff:

  Date    3Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Mar  3:              25.0%
  Apr  1:              17.3%   Start of previous (2nd) quarter
  Jul  1:              12.6%   Start of quarter
  Sep  5:               0.8%
  Sep 12:              -1.6%
  Sep 19:              -0.3%
  Sep 26:              -1.7%   End of quarter
  Oct  3:              -4.8%
  Oct 10:              -7.8%
  Oct 15:              -9.8%   Wednesday
  Oct 16:             -10.3%   Thursday
  Oct 17:              -9.1%   Friday
  Oct 20:              -9.6%   Monday
  Oct 21:              -9.9%   Tuesday
  Oct 22:             -10.0%   Wednesday
  Oct 23:             -10.9%   Thursday
  Oct 24:             -11.0%   Friday
  Oct 27:             -11.3%   Monday
  Oct 28:             -23.8%   Tuesday

Investors had been particularly hopeful that the third quarter would be the end of the falling earnings. Third quarter earnings had fallen in 2007, and so there was a lower base to build on this year. Investors had hoped that, because of the lower base, earnings would actually grow 25-50% above last year's depressed earnings.

But no such luck. In fact, earnings growth has been negative for several quarters in a row now, and this quarter is turning out to be among the worst.

As usual, a fall in earnings estimates means an increase of price/earnings ratios estimates.

There's a price/earnings ratio chart at the bottom of this web site's home page, and it gets updated automatically every Friday. Here's last Friday's version of the chart:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 24-Oct-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 24-Oct-2008. (Source: MarketGauge ® by DataView, LLC)

As you can see, the P/E ratio index was at 18 for several years, which is well above the historical average of 14. In fact, the index has been above average for 13 years, since 1995, and by the Law of Mean Reversion, this means it has to be equally below average for roughly the next 13 years.

Starting in March, however, the P/E index is spiked upward again, to astronomical levels in the 20s. This was when first quarter actual earnings were coming in. But investors believed that they should be ignored; the common wisdom was that the credit crisis would be over by the fall (i.e., now), and that earnings would grow in the third and fourth quarter by 25% and 50%, respectively.

Because of that widely held belief, investors pushed the P/E index up into the 20s. Finally,

It's only in the last three weeks that it came back down to 18. This was thanks to the stock market losing 25% of its value in the last three weeks.

Tuesday's events -- a 10.8% increase in the S&P index, and a fall in earnings growth estimates to -23.8% -- will push the P/E index temporarily into the astronomically high 20s again, until a new collapse brings it down again.

The pundits don't see it that way, however. "This may be the sign of a turnaround. Maybe people are coming out of the woodwork again, and buying stocks." Idiots.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (29-Oct-2008) Permanent Link
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What's coming next: Understanding the deflationary spiral

Why are the dollar and the yen getting stronger, while the euro is getting weaker?

Investors and government officials worldwide are breathing easier this weekend, because Wall Street didn't completely melt down on Friday, as had been feared. Friday and Saturday may be the first times they slept through the night for a week.

But they won't be sleeping well on Sunday night, or probably any night this week.

Stock markets around the world have fallen very far from their recent highs, most of which were reached late in 2007. Here's list compiled by the LA Times:

    Iceland              -88.7%
    Russia               -73.9%
    Ireland              -73.4%
    Peru                 -73.2%
    Vietnam              -70.5%
    China                -69.8%
    Poland               -62.6%
    Hong Kong            -60.1%
    Brazil               -57.2%
    Egypt                -56.9%
    Italy                -55.2%
    South Korea          -54.5%
    Turkey               -58.5%
    India                -58.3%
    Singapore            -58.2%
    Japan                -58.1%
    Mexico               -48.3%
    Germany              -47.0%
    Spain                -46.4%
    U.S.-S&P 500         -44.0%
    Australia            -43.3%
    Great Britain        -42.3%

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There are other things going on, besides stock markets crashing all around the world. Commodity prices are falling 50% or more, and the Baltic Dry Index, which measures costs for shipping iron ore, copper, and similar commodities, has fallen almost 90%.

To get a better picture of what's going on in the world, here's an interview with Simon Rose, CEO Dahlman-Rose, who's been to Singapore recently, and has had a view of international shipping trade. This is my transcription from Bloomberg tv.

"Rose: I spent about a week in Singapore, a lot of time in the port, no activity. No activity at all. They've ground to a halt.

I can give you anecdotal information, and I can give you factual information.

Q: Start with anecdotal information

Rose: Anecdotally, I spent two days driving around two of the biggest ports in Asia, and saw very little activity. Very little. Ships loading, unloading - very little activity.

Factually, the BDI [Baltic Dry Index] is down around 90% this year, and it confirms what I saw with my own eyes.

It's really very simple. You can watch the BDI, you can watch commodity prices, you can watch the stock market -- they all depend on the credit market.

You cannot get credit to load a cargo and bring it from point A to point B. Credit does not exist. 60 sovereign countries cannot get a letter of credit to buy oil.

Q: Are we close to hitting bottom?

Rose: I think it's really simple. I take a leading economic indicator from cab drivers. I asked the cab driver in Singapore what the problem is. He said, "You don't lend money to people who don't pay it back."

No one can buy anything, because there's no global trade right now, and so until we unfreeze the credit markets, and people can get a counterparty and help them buy oil, and deliver it from point A to point B, there's not going to be a lot of commerce.

So, watch the credit market. A lot of people are focusing on Libor.

I'm far less focused on Libor. You know why? The banks can borrow from the central bank. They don't need to borrow from one another.

So banks are borrowing from the central bank, but where's the new credit? Banks are struggling to find the capacity to finance the loans they've already promised, let alone new loans.

Q: Should investors be looking for bargains to buy shipping stocks?

Rose: These companies have all been hit by a tsunami that was not of their making. All of a sudden, they cannot get credit to load ships. This is not the ship owners' fault. Our analyst downgraded the group over the summer, based on the price of commodities coming down, which was an indicator for him of ship cargoes going down as well. He did a great job.

How do you figure out what the bottom is? Watch the credit markets. When the credit markets open, there'll be enormous buying opportunities. ... There's been huge wealth destruction, as a result of the credit markets being seized. When the credit markets open, then we'll have an idea of what real value is in the marketplace."

We could point to many more individual national and global trends, in areas like real estate and employment in countries around the world, and generally they're all trending downward. All of them are reinforcing each other, in a very broad picture of a worldwide economy that's plunging downward with incredible momentum.

It's like a hundred-ton rock rolling downhill. There's nothing that can stop it.

Certainly the $700 billion Washington bailout hasn't slowed it down at all, and has had almost no noticeable effect whatsoever.

There's a very easy way to see this: If the bailout were easing the credit crisis in any meaningful way, it would be touted by government leaders around the globe, and it would be worldwide front page news. Instead, all we've heard about is a barely significant fall in the Libor interest rates, and even that's ending, as Libor is now inching back up.

Why didn't the bailout work?

Starting in 1995 with the dot-com bubble, the world began creating more money through the creation of bubbles. It's hard to measure exactly how much money was created, but we can take some reasonable guesses.

The dot-com bubble of the late 1990s probably created around $1 trillion in new money, through stock options, stock appreciation, venture capital, and similar things. However, a lot of that $1 trillion was destroyed with the Nasdaq crash that began in the year 2000.

The dot-com bubble was an almost pure Boomer play. The major bubbles formed when the Generation-Xers were filling middle-management positions throughout the economy, in the early 2000s.

Fraud and deception took place at all levels. At the lowest level, homebuyers lied on loan applications, builders, appraisers and brokers lied about property values, and loan brokers lied about verifying application claims. At upper levels, "financial engineers" took the fraudulently created loans and securitized into collateralized debt obligations (CDOs) and other securities that have turned out to be worthless. They took fat commissions to sell these worthless securities, and they received cooperation from ratings agencies who took fat commissions to give them phony AAA ratings, and from "monoline" insurance agencies who took fat commissions to give them phony insurance.

We can make some reasonable guesses that the real estate bubble created about $5 trillion in new money, through inflated real estate prices. The securitization process created $25 trillion in CDOs and other near-worthless mortgage-backed securities.

Then we have the insurance contracts, the credit default swaps, or CDSs. There are about $60 trillion of those in portfolios around the world.

(For those interested in the math behind the creation of CDOs from CDSs, see "A primer on financial engineering and structured finance." For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

Finally, we have other credit derivatives of various kinds. These add up to about $1 quadrillion (1,000 trillion dollars), according to the Bank of International Settlements (BIS).

And so, depending on what you count, the credit bubble has been bloated with at least tens or hundreds of trillions of dollars in new money, mostly in the form of bad securities.

Pieces of this credit bubble have been leaking. The real estate bubble began deflating in 2005. CDOs and other mortgage-backed securities began to be revalued early in 2007. By late 2007, the stock market bubble began deflating. Early in 2008, there was the Bear Stearns rescue, followed by a number of other financial services bailouts, bankruptcies and mergers. In the last few months, the rate of forced selling by hedge funds, and withdrawals from money market and mutual funds has been increasing.

So we had a period of several years where the credit bubble grew to hundreds of trillions of dollars, probably adding a few trillion dollars per week, at the height of its growth.

Today, I would guess that the same credit bubble is deflating at the rate of $1 trillion or more per week.

So now we have a $700 billion bailout, 7/10 of $1 trillion. That amount of money disappears every three or four days.

So there isn't a snowflake's chance in hell that any bailout can possibly keep up the leaking of the credit bubble. It is literally impossible.

That's why every bailout must fail.

Bernanke will do whatever is necessary

A forum member claimed that there would be no stock market crash because Fed Chairman Ben Bernanke would do whatever is necessary to prevent it. He quoted from a 2002 Ben Bernanke speech to prove his point:

"Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation."

It really depresses me to read this speech, because it exhibits such a shallow understanding of the 1930s Great Depression from a man who is theoretically the world's leading expert on it.

The 1920s stock market bubble was smaller, by several orders of magnitude, than the credit bubble that we have today, and so the deflationary spiral that followed the 1929 crash was not as big as the one we're facing.

Bernanke talks about inflationary measures that were taken in 1933-34. Well, that was 4-5 years after the deflationary spiral had begun. By that time, the deflationary spiral had run its course, and reflation would have begun no matter what FDR had done.

By contrast, Bernanke has opened the liquidity floodgates in this past year, right at the beginning of the deflationary spiral, and it's done almost nothing to stop the deflationary spiral today. Perhaps, if he's lucky, President Obama can find a way to take credit for reflating the currency when its time comes, around 2012-13.

Let Bernanke try anything he wants. It will accomplish nothing.

Why is the dollar more valuable?

A lot of people have been predicting that the current crisis is going to make the dollar become worthless. Some have predicted hyperinflation, along the lines of Germany in the early 1920s, or Zimbabwe today.

But there was no deflating credit bubble in either of those two cases. The reason that the dollar is becoming more valuable is because there's less money in the world every day, and so the dollar is becoming scarcer. As the dollar becomes scarcer, it becomes more valuable.

I hear politicians and financial ideologues (especially from the so-called "Austrian school") that apply 19th century concepts to the current situation and conclude that the dollar will become worthless. That might be true in the absence of a deflating credit bubble, but it is not true today.

Thus, there should be no surprise at all that the dollar continues to strengthen sharply against almost all currencies (except the yen), and also continues to strengthen against "safe havens" like gold.

When I make statements like this, people accuse me of being nationalistic. That has nothing to do with it. The strengthening of the dollar has to do with only one thing: The leaking of the credit bubble, resulting in a deflationary spiral that strengthens the value of the dollar.

Here's a question from the forum:

"If money is scarcer, and on the basic laws of supply and demand why does it not lead to inflation? The less money there is the more expensive it will become leading to inflation."

To understand this, you have to look at the dollar from the point of view of another currency, like the euro or yen.

If you hold euros, and you want to buy dollars, and dollars are getting scarcer and scarcer, then by the law of supply and demand the price of dollars in euros is going to increase, which means that dollars become more valuable relative to the euro.

Therefore, the exchange rate (euros per dollar) will go up, meaning that it's the euro that's inflating relative to the dollar, while the dollar is deflating relative to the euro.

Here's another question from the forum (paraphrased):

"You describe "falling prices" [deflation], but here in the EU the situation is different.

Namely, 6 months ago the oil prices was double what they are today ($140 per barrel, against $70 roughly today). But, at the gas stations this nice reduction of prices - is NOT seen. The reduction is about 20-25% (at most!)"

The deflationary spiral is caused by the deflating of the massive credit bubble, and that was created by securitization of various kinds of flaky investments. Depending on how you count it, the credit bubble created tens or hundreds of trillions of dollars, or even $1 quadrillion.

However, all of these securitizations -- CDOs, CDSs, etc. -- all of them were denominated in dollars. Thus, the deflationary spiral now applies only to the dollar. As the credit bubble collapses, there are fewer and fewer dollars in the world, and dollars become more valuable relative to other currencies.

Thus, as expected, we've seen the dollar strengthen sharply against other currencies (except for the yen). In the case of the euro, the exchange rate was close to $1.60 a few months ago, and is now close to $1.30.

So there are two different things going on. The commodities prices, as denominated in dollars, have been falling sharply. But with other currencies weakening against the dollar, commodities prices denominated in those currencies have been falling far less.

So if we just take some round numbers, the fall in the price of oil in terms of the dollar is (1 - 70/140) = 50%.

In terms of the euro, it's 1 - (70/140 * (1.60/1.30)) = 38%.

That 38% is still a fairly large fall, and so you should have seen reductions at the gas pump, but not as great as at dollar-denominated gas pumps.

Beyond that, most countries charge fairly hefty tax rates for gas, you might want to check whether tax rates have changed in your country in the last few months.

Here's another reader question:

"I have a question about this. The Bretton Woods agreements caused all foreign central banks now hold mostly dollars in reserve. If the dollar becomes twice as valuable, then does that mean that the central banks can issue twice as much foreign currency?"

The easiest way to understand it is as follows: The dollar becomes scarcer, and therefore more valuable. So if another central bank wants its currently to maintain parity with the dollar, it would have to make that currency equally valuable, by withdrawing the currency, and making it scarcer. Of course, that would be politically impossible.

Here's another comment posted by a forum member:

    From: Peter Schiff  
    Sent: Tue, 21 Oct 2008 4:28 pm 
    Subject: RE: Dollar discussion 

I disagree in that the dollar is intrinsically worthless and will approximate that value based on the policies we are perusing.

"This is a response received from Peter Schiff regarding the dollar's eventual decline. At some point the bubble in treasuries will pop and the rest of the world will discontinue financing the USA debt and unfunded liabilities."

This claim makes absolutely no sense at all.

The US owes China, Japan and other countries $5 trillion.

If those countries were to take actions to destroy the value of the dollar, then the US would owe these countries nothing, since the debts are denominated in dollars.

China, Japan and the other countries will look for ways to bail out the US, just as the US bailed out many other countries in the past. They will do this not because they give a sh-t about Americans, but because they'll see it as the only way to save their own economies.

As a final point, you have to separate the fate of the US from the fate of the dollar. The fact that the US is in debt does not mean that the dollar becomes worthless.

If you haven't read the fascinating story of "The bubble that broke the world," then now is a good time to do so. It's the story of what happened in 1930 and 1931, when the world's central bankers got together to save the world from financial collapse.

However, when you read that story, and compare to the situation today, remember that America was a creditor nation in 1931, but a debtor nation today. The debtor nation in 1931 was Germany, and the creditor nation today is China. Thus, we should expect China today to act like America in 1931, and America today to act like Germany in 1931.

Central bankers in Britain, the US and France got together with a plan to prevent the financial collapse of Germany by injecting huge amounts of liquidity into the European banks. It worked for a while, but not for long.

Why is the yen strengthening?

If you look around the world at the major currencies, almost all of them are weakening against the dollar. The major exception is the Japanese yen, which is strengthening against almost every currency, including the dollar. Why is that?

The answer is that the yen is still suffering from Japan's own deflationary spiral. As I wrote recently, there was a huge stock market bubble in Japan in the 1980s, beginning around 1984. There was also a huge real estate bubble and, at its height, the total price of all property in Tokyo was greater than the total price of all property in the entire United States. That's how huge the Japanese bubble was.

Japan's generational stock market panic and crash occurred in 1990s, and the yen went into a deflationary spiral that last 16 years. In some ways, it's still continuing. So the yen is still on a roughly deflationary path, although at the end of that path.

And so the dollar is strong because it's at the beginning of a deflationary spiral, and the yen is strong because it's at the end of a deflationary spiral. This is not true of other currencies, and so other currencies are weakening against the dollar and the yen.

The euro and the Emerging Market Bubble

The main problem with the euro currency is that it's so new.

The euro currency, which only really came into existence in 1999, has not yet had enough time to gain stature as a full-fledged major international currency. In fact, it's always been possible for any individual euroland country to back out of the euro and return to its national currency, as I described in 2004, based on a Morgan Stanley report. (Can you imagine any US state trying to back out of the dollar currency, and print its own money?)

There's really no central control for the euro currency. Each country still has its own central bank and its own policy for printing euros, and some European countries (like Switzerland and Britain) don't even use the euro as an official currency.

Now the euro is approaching an imminent crisis, according to analysis by Ambrose Evans-Pritchard, and there's a very interesting reason why.

The Europeans like to brag that, although they've had problems with investments in near-worthless mortgage-backed securities, they didn't risk nearly as much as the Americans did in the real estate bubble.

Well, it turns out that there's a completely different bubble that they did invest in: The Emerging Market Bubble.

While America invested $5 trillion in a real estate bubble, the Europeans invested $4.7 trillion in bonds from emerging market countries that will never repay the loans. These emerging market countries are in Eastern Europe, Latin America, and Asia.

Now that many of the emerging market stock markets are crashing (see list earlier in this article), the loss in value of these investments is creating tensions within euroland.

Austria's banks, for example, are heavily invested in Hungary, Ukraine, and Serbia -- countries that are close enough to bankruptcy that they're appealing for help from the IMF.

Banks in Switzerland, Sweden, Britain and Spain have invested astronomical amounts in Latin American bonds -- bonds that have little or no chance of repayment, as countries like Argentina and Brazil head for a freefall.

Because different euroland countries have different exposures, and because different euroland countries can set different banking interest rates, the opportunity exists for these interest rate differences to widen significantly, allowing enormous opportunity for exploitation by hedge funds.

Hans Redeker, currency chief at BNP Paribas, says that, "The system is paralysed, and it is starting to look like Black Wednesday in 1992. I’m afraid this is going to have a very deflationary effect on the economy of Western Europe. It is almost guaranteed that euroland money supply is about to implode."

What's coming next

The implosion of the euro is just one part of the massive event that's about to occur. This is the "generational panic and crash," the first since 1929, and now apparently very close.

Here's how I've described it several times in the past:

"A generational crash is an elemental force of nature, like a tsunami.

You'll have millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, not even believing it was possible, and in a state of total mass panic, trying to sell all at once. Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt."

In the article I wrote about this last week, I quoted Nouriel Roubini, who is expecting officials to have to shut down markets for a week or two, and I quoted Art Cashin, who is expecting a "dramatic climax" within the next few days.

Cashin works for UBS AG as a floor manager, one of the old-timers on the New York Stock Exchange floor. He probably talks to hundreds of people a day, and reaches conclusions based on those conversations. What he's sensing is that something very big is coming. I heard him again when he was being interviewed late Friday, and he said that he's expecting "something major, something that will be remembered for generations."

From the point of view of Generational Dynamics, here's what to expect for the near future:

A lot of the discussion going on in Washington these days is on the question of what new regulations to develop in order to prevent this disaster from ever happening again.

From the point of view of generational theory, this is a joke. Nobody today would make try to securitize debt the way it was being done just last year, and if they tried, no one would buy the securities. People today are far more risk-averse, just as the survivors of the Great Depression were.

The survivors of the Great Depression passed new laws and regulations to make sure that nothing like the 1920s bubble would ever occur again. In fact, preventing another stock market bubble was the primary responsibility of the SEC, but nobody even cared when they failed to prevent the dot-com bubble.

So let them pass all the new rules and regulations they want. Those new rules and regulations would be irrelevant now, since no one would dare practice the same credit abuse as before. After enough time has passed, and people have forgotten the consequences of credit abuse, then the new rules and regulations will be repealed or ignored as "old-fashioned old people's laws."

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (27-Oct-2008) Permanent Link
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Wall Street index futures frozen at "Limit Down" at 7 am Friday

Stock markets in Asia and Europe are in free fall this morning, as forced selling is causing investors to liquidate their positions to meet margin calls.

Wall Street index futures frozen at "Limit down," early Friday morning <font face=Arial size=-2>(Source: CNBC)</font>
Wall Street index futures frozen at "Limit down," early Friday morning (Source: CNBC)

By 7:00 am ET, Dow Jones futures had fall 550 points, S&P futures had fallen 60 points, and Nasdaq futures had fallen 85 points. These falls were the maximum allowed before a "limit down" is triggered, making it impossible to continue trading.

The "limit down" will be in effect until the markets open in New York at 9:30 am ET.

When the markets open, it's expected that stocks will continue to fall, driving the index values even lower. According to one pundit, expect the market indexes to fall in the first hour, and then settle down for the rest of the day, possibly recovering the lost amounts.

The counter argument is that these sharp falls are being caused by forced selling, causing a vicious cycle: Forced selling pushes stock prices lower, this causes more margin calls for investors, especially hedge funds, and more margin calls result in more forced selling.

Other stats of note: Gold fell below $700/ounce, to new 13-month low. The dollar continues to strengthen sharply against the euro. Crude oil continues to crash, currently at $63 per barrel.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (24-Oct-2008) Permanent Link
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Roubini: The situation is "sheer panic," as hundreds of hedge funds are going bust

Policy makers may need to close markets for one or two weeks.

I've been sick for the last few days, but that's nothing compared to how sick hedge fund investors must be feeling.

Emmanuel Roman, CEO of GLG, Europe's biggest hedge fund, can't be feeling too well these days. Speaking at a hedge fund conference in London on Thursday, Roman said that 25-30% of the world's 8,000 hedge funds would disappear "in a Darwinian process." He added, "This will go down in the history books as one of the greatest fiascos of banking in 100 years."

Speaking at the same conference, New York University Professor Nouriel Roubini agreed, saying that, "We've reached a situation of sheer panic. There will be massive dumping of assets'' [and] hundreds of hedge funds are going to go bust.

Roubini added, "Systemic risk has become bigger and bigger. We're seeing the beginning of a run on a big chunk of the hedge funds. ... Don't be surprised if policy makers need to close down markets for a week or two in coming days."

This scenario would be the generational panic and crash that Generational Dynamics has been predicting for years. (See "List of major Generational Dynamics predictions" for more information about Generational Dynamics predictions.)

As I've said many, many times, from the point of view of Generational Dynamics, if you go back through history, there are many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

These are called "generational crashes" because they occur every 70-80 years, just as the generation of people who lived through the last one have all disappeared, and the younger generations have resumed the same dangerous credit securitization practices that led to the previous generational crash. After each of these generational crashes, the survivors impose new rules or laws to make sure that it never happens again. As soon as those survivors are dead, the new generations ignore the rules, thinking that they're just for "old people," and a new generational crash occurs.

It's now been 79 years since the last generational panic and crash, so we're probably overdue for the next one.

What would one of these look like today? Here's how I've described it in the past:

"A generational crash is an elemental force of nature, like a tsunami.

You'll have millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, not even believing it was possible, and in a state of total mass panic, trying to sell all at once. Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt."

This sounds a lot like the kind of thing that Roubini is predicting.

A lot of investors don't realize this, but my expectation for a major "panic event" is similar to mainstream predictions of a "capitulation event."

Art Cashin is a very well known (and, I'm told, well beloved) analyst, working on the floor of the stock exchange. He appears frequently on TV, and on Thursday morning he appeared on CNBC before the market opened.

Art Cashin is a major proponent of the "capitulation" theory, and in this interview, he gave details about what he expects:

Art Cashin, on floor of NY Stock exchange. <font face=Arial size=-2>(Source: CNBC)</font>
Art Cashin, on floor of NY Stock exchange. (Source: CNBC)

"Q: We're feeling the bottom again, Art. What's going to happen?

Cashin: I would love for a little bit of an up move today - maybe go up to 8750 or 8800 -- that would be a textbook Elliott Wave move -- and then you'd get that big washout / selloff. I was hoping for it by the end of this week, guess it's going to be pushed into next week. A dramatic climax looks like it's very near at hand here.

Q: Yikes! That could be scary. I guess if it was early November, that's not much different than making a low in October, is it Art?

Cashin: Well, in 1929, you made the low on November 4. I prefer to keep them in October. ...

I'm looking for a climactic bottom, down from here obviously, and that could carry through for several months [i.e., lead to a rally for several months], and then maybe in May, we'll get to know the full effect of the recession, and see how things look then. ...

I don't want to scare anybody. You could get an overtrade, You retest the original lows around 7850, you could go to 7400, you could go to 7000, you could even overtrade that. But it will be quick. Get your basket out, and be ready to catch the bargains when they come your way."

As I've pointed out before, this is a major mainstream view, and to a certain extent, it agrees with what I'm expecting (a generational panic and crash, as described above). This is the kind of thing that happened in 1987, and Cashin is expecting it to happen again.

When you drill down into the "capitulation" concept, you get something that's very strange. There's a large, amorphous group of investors who are slowly selling their stocks, bringing the market down. At some point, this amorphous group will become completely discouraged, they'll panic, sell off everything else, and "capitulate." Once this amorphous group of investors have sold everything off, then they won't push the market down any more, and the market will go up again.

The problem is: Who are the investors in this amorphous group? All the investors listen to these arguments on CNBC, so none of them is going to simply give up and capitulate at any time. So who are the pundits talking about with the capitulation message?

I'm trying to imagine what kind of person would see the market fall, and would say, "I'm not going to take a chance on losing any more money, so I'm going to get out of the market."

Generally speaking, the only person who might say that is someone from the Silent generation (the generation that grew up during the Great Depression). They were running things in 1987, and this is exactly what happened. These Silent top-level managers simply decided to get out of the market, all at one time, at a time when the market was underpriced, and they ended up losing out in the rally.

But you can see where I'm going next -- the Silents are gone. I can't imagine a Boomer or Gen-Xer saying, "I'm not going to take a chance on losing any more money, so I'm going to get out of the market." (The exception, of course, is Boomers and Gen-Xers who read this web site.)

So this explains why there's a capitulation concept at all, why it applied in 1987, and why it doesn't apply at all today.

And so, getting back to what Cashin said, he and I are expecting roughly the same thing, a "panic event," but the differences in our views have to do with the aftermath:

It's interesting that if you take all three people -- Nouriel Roubini, Art Cashin, and myself -- we're all expecting some major, cataclysmic event, but we all differ on the reasons for it, and what will happen afterwards. And although I would be reluctant to name a specific date for this event, it's clear that Roubini thinks it's coming very soon, and Cashin expects it within the next week.

From the point of view of Generational Dynamics, this will be one of the major events in history. From Tulipomania in the 1600s to the 1929 crash, there have been a series of five generational panics and crashes that will never be forgotten. We're now very close to the sixth one.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (24-Oct-2008) Permanent Link
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Pakistan nears bankruptcy, as China refuses aid

Pakistan will forced to seek unpleasant help from the IMF, after failing to get a hoped-for bailout from China.

The country may need as much as $6 billion in foreign-currency reserves, in order to meet scheduled repayments in dollar-denominated bonds before February.

As recently as Thursday, the Financial Times was reporting that China had promised to save Pakistan from default. The promise was expected to become a commitment during Pakistan President Asif Ali Zardari's visit to Beijing at that time. But when he returned Friday night, he had a promise from China to build two nuclear power plants, but no commitment for the badly needed aid.

Next, Zardari will have to turn to the International Monetary Foundation (IMF) for a bailout, but this will be a bitter pill to swallow because the IMF will impose onerous controls on spending and governance in return for the money. These controls will be extremely unpopular, and will be blamed on the U.S. The Taliban, which have been conducting a series of terrorist acts throughout Pakistan, will be emboldened to do more.

China's failing economy

It's quite possible that China is refusing to provide financial aid to Pakistan because it cannot afford to. China's own economy may be failing, now that the massive building bubble from the Beijing Olympics has ended.

You never know in advance what event is going to trigger anxiety, fear and even panic in the markets, but such an event occurred earlier this week, when the CEO of Rio Tinto said that China's economy will "pause for breath" in the next quarter. The remark spooked markets throughout Asia, especially in the energy sector.

Commodity prices <font face=Arial size=-2>(Source:</font>
Commodity prices (Source:

Rio Tinto is a giant multinational firm, one of the largest mining companies in the world. It has seen sharp declines in prices for iron ore, aluminum and copper in recent months, throwing the company into financial distress.

It's attributing the fall in these commodities prices to the cooling of China's economy.

This would not be a surprise to thousands of employees of toy factories in southeast China.

Half of China's toy makers have declared bankruptcy recently, as it became clear that sales to the U.S. and Europe are going to be particularly slow this year. In one of the highest-profile examples, a toy maker that sold to US giants Mattel and Disney announced last week it had gone bust due to the global economic crisis, leaving up to 7,000 people jobless.

Some analysts see dire warning signs in China. Independent Shanghai-based economist Andy Xie says that a property crash is imminent because prices are too high and developers have borrowed heavily and built too much.

In fact, malaise is affecting the entire Chinese economy, and many analysts believe that the trouble goes deeper than just a post-Olympics pause.

Whether it's millions of tonnes of surplus coal stacked up in ports, or Swiss jewellers from Shanghai experiencing total despair, the signs of collapse are growing.

A collapse of China's economy would affect all of Asia. Vietnam, Cambodia, Thailand and other Asian countries supply materials and unfinished goods to the Chinese, who finish them and ship them off to the Americans and the Europeans. The knock-on effects have extended to South Korea, whose currency, the won, crashed earlier this week, and has to be bailed out. So the reluctance of Americans and Europeans to buy as many toys this year is having knock-on effects throughout Asia.

And, of course, it means that Pakistan won't get aid from China.

From Eastern Europe to Latin America

Pakistan is not the only country seeking aid from the IMF to weather the global credit crisis.

In Eastern Europe, Ukraine, Hungary, and Serbia are all in emergency talks with the IMF. The plunge in prices for commodities like grain and steel, their chief exports, along with the drying up of foreign investments, have brought these countries close to default as well.

"This is turning serious," said Hans Redeker, currency chief at BNP Paribas. "Countries in Eastern Europe have been living beyond means for years and now they face a full-blown credit crunch. They are going to have to cut back on imports and that will push the eurozone deeper into recession. We think the next phase will be an attack on the currency pegs in the Baltics and Bulgaria."

He points out that many other countries Argentina, Ecuador, the Baltic States (Estonia, Latvia and Lithuania), Romania, Bulgaria, and Turkey are all flashing warning signs that are much worse than they were a few months ago.

"The global credit crisis is spreading to the most leveraged economies in the world," says an East Europe bank expert. "Iceland was the canary. It was the first to need a helping hand from the IMF, but all countries that have had asset bubbles and rely on foreign funding are vulnerable."


Russia has had a major stock market crash in the last month, requiring frequent suspensions of trading.

This has been caused by the high-flying, big-spending Prime Minister Vladimir Putin, who was counting on high prices for oil exports to fund his projects. With the price of oil now down almost 50%, the country is in serious trouble.

Meanwhile, hedge funds around the world are collapsing, thanks to the fall in commodities prices, stock prices, and developing nations' currencies. This forced selling creates a vicious cycle, where stock prices fall, leading to more margin calls, leading to more forced selling.

According to one expert, hedge funds "are not the sole culprit" for the selling vortex that's going on. He says mutual funds, pension funds and sovereign wealth funds also have been pulling money out of the market.

It's this kind of forced selling cycle that caused the crash of 1929. Experts today are hoping that the forced selling cycle will burn itself out, and that things will return to "normal" (whatever that is). But after many years to create the credit bubble, worth hundreds of trillions of dollars, it's going to be a long time and a huge deflationary spiral before anyone can talk about "normal" again.

(Comments: For reader comments and response, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (20-Oct-2008) Permanent Link
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A BBC interview with with another clueless economist

The questions were penetrating, but NYU economist Mark Gertler evaded them all.

Mark Gertler, New York University professor of economics
Mark Gertler, New York University professor of economics

This interview with New York University professor of economics Mark Gertler is significant because Gertler has worked closely with Fed chairman Ben Bernanke for many years. Bernanke, of course, is considered the world's leading expert on the Great Depression, so this interview provides insight into Bernanke's theories and thinking.

It was the usual nonsense by an economist, but what was interesting is that the interviewer, Owen Bennett-Jones, asked some very difficult and pointed questions, much more penetrating than you ever hear on CNBC or elsewhere in the mainstream media. The result is that we have one more view into the shallowness of modern macroeconomics. (The interview can be heard for a week by going here, or by clicking here.)

I'd like to quote three excerpts from the half-hour interview:

Owen Bennett-Jones: "Is this where economics crosses with social science, and can we say that in 70, 80 years time this will happen again and people WON'T remember, and people WILL feel overconfident, for precisely the same reasons as they did this time. And that's part of the cycle, actually."

This is a remarkable question in the mainstream media, for several reasons:

Gertler's answer shows how completely oblivious he is to the question being asked:

Mark Gertler: "Well, I guess in some sense you have a point. What's happening now is similar to what happened in the US for example in the late 80s, early 90s. There was deregulation in banking, and we had instead of residential mortgages it was commercial mortgages that got into trouble, we had to go in and bail those out. It's just that at the time the problem was contained in the commercial banks, which the fed directly regulated.

This time, it's happened again, just 20 years later. The problem is much more complex, and hopefully we'll learn from this bigger crisis going forward to avoid the same situation. I guess it's up to us as academics to kind of take the lead on this."

As usual, Gertler has no historical sense of what's going on. He immediately goes back to the 1980s, as if it were relevant to what happened in the 1930s.

Mainstream economics has a flat view of time. In their standard models, every decade is pretty much like every other decade. 60 year olds in one decade are the same as 60 year olds in another decade.

That these assumptions are totally absurd is completely obvious. 60 year olds in the 1980s, that is, people who lived through the Great Depression, are going to have completely different attitudes and behaviors towards money and spending than 60 year olds today. And yet, as incredibly simple as this observation is, mainstream macroeconomics is totally oblivious to it, as is Gertler, who completely evades the question and gives a non-answer.

In the second interview excerpt, Bennett-Jones asks specifically about the 1930s, and got an equally absurd answer:

Bennett-Jones: "How bad was the 30s, and what actually happened? How bad did it get?"

Gertler: "Well, let me say the 30s - the behavior of the real economy was much, much worse than it is now. There was a recession in 1929-30, where output fell about 8-9%. The situation completely deteriorated in 30-31. At this point, the US central bank was frozen, it didn't respond, and the banking system just collapsed."

The answer was so incredible, I could barely believe my ears. He said that what happened was this: There was a recession in 1929-1930, and the Fed didn't move fast enough to prevent bank failures in 1931.

I've heard economists say really dumb things before, and I've quoted many of them on my web site, but this is really the limit.

To Gertler, there was no 1920s stock market and real estate bubble, there was no 1929 crash. It was just an ordinary, run of the mill recession that the Fed mismanaged.

When I was growing up and going to school in the 1950s, everyone "knew" what caused the Great Depression: it was greed, it was everyone buying on margin, and it was the bubble. Today, these economists think that it was just a bad day at the beach. Do you see why I keep calling these people morons?

It really is depressing and frightening that our nation's leaders and experts know absolutely nothing about what's going on and what's coming.

The third excerpt that I want to quote is actually a continuation of the above. Gertler explains why everything is so much better today than in the 1930s, and segues into Japan of the 1990s:

Gertler: "Unlike today, there was no deposit insurance, there was no protection of financial systems, so the banking sector collapsed, choked off the flow of funds to many borrowers. There was a deflation of the price level, prices fell around 10% a year. What this did was raise the real debt burden of borrowers who were borrowing in normal terms. It made it difficult for the borrowers who didn't rely on banks. It made it difficult for them to get credit. so there was a total collapse of the financial system, and at the trough, output fell about 40%, the unemployment raised to 25%.

We are nowhere near that, and I expect us to get nowhere near that. ...

The policy makers today have the tools and they're very attuned to avoid what's now going to be a downturn to turn into a very serious recession.

The fear is not the 1930s. The fear is a situation like Japan where there'll be a prolonged period of stagnation. Japan suffered a financial crisis that began in 1990, and led to slow growth for nearly a decade. So what's going on now is to avoid that situation."

Bennett-Jones: "What's the difference betweeen Japan and America?"

Gertler: "The key difference is that the policymakers were very, very slow to react. Essentially Japan went through a situation where they continually bailed out financial institutions, without forcing them to restructure."

Gertler's answer is always the same: It was just a recession, but the central bankers didn't act fast enough to keep it from getting worse.

Nikkei 225 Index -- Tokyo Stock Exchange -- 1984-2007 and 1914-2007.
Nikkei 225 Index -- Tokyo Stock Exchange -- 1984-2007 and 1914-2007.

Last year I wrote an analysis of Japan's 1990 stock market crash, and the aftermath. If you look at the adjoining graphs, which are from that analysis, you can see why Gertler's response is naïve.

Note that there was a huge stock market bubble in Japan in the 1980s, beginning around 1984. There was also a huge real estate bubble and, at its height, the total price of all property in Tokyo was greater than the total price of all property in the entire United States. That's how huge the Japanese bubble was.

The top graph shows the Tokyo Stock Exchange's (TSE's) most recent stock market crash. The crash began on January 4, 1990. The Nikkei index had been 38915, and fell to a low of 7607 on December 31, 2003. That's an 80% fall over a 13 year period.

However, this wasn't the TSE's first major stock market crash. The TSE's previous major stock market crash occurred in 1919, as shown by the lower graph. Then, 65 years later, the next stock market bubble began in 1984.

Did you get that? Wall Street: Crash in 1929, new bubble in 1995, 66 years later; Tokyo Stock Exchange: Crash in 1919, new bubble in 1984, 65 years later. Once again, you can see Generational Dynamics in action. A new bubble occurs as soon the generation of people who lived through the last crash are gone.

But Gertler is totally oblivious to all of this, and of course Bernanke is as well. Mainstream economists have a switch turned off in their brains, making it impossible to understand the most obvious and trivial things about generational theory. To them, all generations are identical, and they'd believe in Martians before they'd believe anything else.

WSJ discovers deflation

Mainstream financial reporters are generally so oblivious to what's going on in the world that they almost always act like they've never heard of the word "deflation."

In the past few years, there's been an explosive bubble in commodity prices, thanks to surging demand in China's bubble economy. And yet, the CPI (consumer price index) has increased only modestly in that period. It never occurred to them to wonder why those commodity increases didn't send the CPI to over 10%, as happened in the 1970s.

Commodity prices <font face=Arial size=-2>(Source:</font>
Commodity prices (Source:

Now, with China's economy cooling, commodities demand on the margins is crashing, and commodities prices are falling at the same time. And suddenly WSJ is dicovering deflation:

"Falling prices in commodity markets have helped ease inflation.

Fed officials generally consider price stability to be an inflation rate between 1.5% and 2%. Their preferred measure of core inflation, which excludes food and energy, stands above 2% now, and is expected to remain above that mark as price increases from earlier this year advance through the product pipeline.

The economic slowdown and declining commodity prices have eased the nation's consumer inflation rate, which surged to 5.6% over the summer. Annual inflation in the U.S. is likely to turn negative for at least several months next year, on declining energy and food prices.

With the unemployment rate rising rapidly and capital markets in turmoil, "pretty much everything points toward deflation," said Paul Ashworth, chief U.S. economist at Capital Economics. "The only thing you can hope is that the prompt action of policy makers can maybe head this off first."

The Japanese economy in the 1990s and the U.S. during the 1930s illustrate how deflation can choke a weak economy and spiral out of control. A sagging economy exerts downward pressure on prices because of weak demand for labor and goods. Broad-based declines -- particularly in a credit crisis, which can push asset prices down sharply -- can also force down wages, preventing consumers and, therefore, companies from paying their debts. Falling prices also encourage businesses and consumers to save rather than spend, because money would be worth more after prices decline. The restrained spending, in turn, hurts the economy even more.

Federal Reserve Chairman Ben Bernanke, in a speech as a Fed governor in 2002, said deflation in the U.S. is "highly unlikely" but added, "I would be imprudent to rule out the possibility altogether." The reason, he said at the time, was the Fed "has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief."

As usual, there's no historical sense of what's going on. They mention the deflation of the 1930s without wondering whether the inflation of the 1970s and the deflation of today are part of the same cycle.

From the point of view of Generational Dynamics, these excerpts from Mark Gertler and from the Wall Street Journal are important because they demonstrate how oblivious mainstream economists and reporters are to what's going on.

As I've said many times, mainstream economics did not predict and cannot explain almost anything that's happened in the last 15 years -- why the dot-com bubble occurred when it did and why it occurred at all, why the credit and real estate bubbles occurred when they did, and why they occurred at all, and how we got to where we are now.

The stupidity and idiocy of mainstream economists, financial reporters, and Nobel prize winners is an important part of the fabric of today's society that has led, in the past 15 years, to the destruction of the world's financial system.

This weekend, I cleaned out most of my backlog of e-mail messages and questions from web site readers, and most of them, along with my responses, have been posted in the Financial Topics thread of the Generational Dynamics forum. For those wishing further information, that thread will serve as a useful resource.

Readers should also feel free to post their own responses and discussions in any of the forum threads. (19-Oct-2008) Permanent Link
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Warren Buffett joins the kool-aid crowd

In his dotage, he seems determined to bankrupt himself.

Warren Buffett is buying stocks again.

Market summary, 16,17-Oct-2008
Market summary, 16,17-Oct-2008

The news seemed to electrify the market for a few hours on Friday. The markets fell sharply on Friday morning, after a big advance on Thursday, but as knowledge of Buffett's article spread, investors poured into the market, to the point where the Dow was 400 points up.

Somewhere along the line, investors must have actually read Buffett's article, and decided, along with me, that what he wrote was nuts.

Buffett says that those who are holding cash (or cash equivalents, like Treasuries) are making a big mistake. His NY Times op-ed article says the following:

"Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”"

How could he possibly have reached these conclusions? He doesn't have the vaguest idea how the stock market will perform over the next decade.

He gives examples of previous market advances, and they are truly bizarre. They're so absurd that I'm going to list a couple of them:

This is insane.

Once upon a time, Buffett had some sense. Here's what he wrote in Berkshire Hathaway Inc.'s annual report for 2002 at

"We continue to do little in equities. ... Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble.

Unfortunately, the hangover may prove to be proportional to the binge.

The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks – if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pre-tax returns (which translate to 6½-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity."

Now this is odd. He wrote this early in 2003, He says that "short-term money" (i.e., cash equivalents) were paying less than 1%. That's what he's warning people against today, but it was fine with him in 2003.

Well then, where was the Dow in 2003? Well, the above report was posted on the internet on March 6, 2003. On that day, the Dow was at 7674, after having fallen from a high of 11723 in 2000.

Today, the market is at 8852, having fallen from a high of 14164 a year ago.

Furthermore, I doubt that anyone would argue with the claim that after a series of bank failures, the economy today is much worse off than it was in 2003.

How in the world could Buffett possibly conclude that the market is a big buying opportunity today?

Actually, Buffett has been making a lot of bad decisions recently.

In 2006, when Buffett still seemed to have his marbles, he said:

"Speculators are like Cinderella at the ball having a great time, but at midnight everything turns to pumpkins and mice. As midnight approaches the party gets to be more fun, and everyone thinks they'll get out before midnight. The problem for Cinderella is that there are no clocks on the wall."

He changed enormously by May of this year, when he said, "The worst of the crisis in Wall Street is over."

That was before the collapse of AIG, Lehman brothers and various other financial institutions.

But it's much worse.

This is the person who called derivatives "financial weapons of mass destruction." In May 2007, he said this:

"The introduction of derivatives has totally made any regulation of margin requirements a joke. I believe we may not know where exactly the danger begins and at what point it becomes a super danger. We don't know when it will end precisely, but ... at some point some very unpleasant things will happen in markets."

And so, a lot of people (including me) were completely shocked when he announced in May that first quarter profits of Warren Buffett's Berkshire Hathaway fell by 64% because of $2 billion in losses from investments in derivative contracts -- some of the most irresponsible investments possible.

Buffett is saying and doing incredibly stupid things, and there's little doubt in my mind that at age 78 he's really screwing things up.

In his op-ed article on Friday, he writes:

"A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors."

Buffett violated his own rule when he got greedy while others were also greedy, when he lost $2 billion in derivatives contracts that later turned out to be disastrous.

Now he's telling people to get back into the stock market at a time when doing so completely contradicts his own position in 2003.

Buffett is being neither greedy nor fearful. He's simply turned into a whack job.

Actually, his op-ed piece provides a clue to his fantasizing. He says that economic conditions deteriorated until President Roosevelt took office, implying that they got better because of Roosevelt's policies.

Then he says that the economy was in the tank in the early 1980s, when President Reagan was in office.

Buffett is a open supporter and economic adviser of Barack Obama. What I infer from Buffett's op-ed is that he believes that President Obama will be a new FDR who will immediately improve the economy.

I've heard others say similar things, but this is a total fantasy. FDR took office after 3 years of economic cratering after 1929, all of which was blamed on Hoover. Whoever takes office in January will also face 3-4 years of economic cratering, and is going to be presiding over a national disaster.

This shows the danger of anyone getting too deep into the swamp of politics. You start to believe your own lies, and assume that the choice of President will actually make any difference to what's coming.

In fact, shortly after Buffett made his statement that "the worst of the crisis ... is over," a web site reader referred me to an article that had appeared in the New York Herald Tribune on May 1, 1930:

"WASHINGTON: Attributing the Wall Street crash of last fall to the "inexorable consequences of the destructive forces of booms" and paying tribute to the American people for their "unity of action in time of national emergency," President Hoover addressed the United States Chamber of Commerce here tonight [May 1]. "We have been passing through one of those great economic storms which periodically bring hardship and suffering to our people," said Mr. Hoover. "While the stock exchange crash occurred only six months ago, I am convinced that we have now passed the worst, and with continued unity and effort we shall rapidly recover."

A lot of people who compare today's events to those of the Great Depression think that George Bush will be the discredited "Hoover" figure today. But if Obama listens to Buffett (and even if he doesn't), then it's Obama who will be the new "Hoover."

From the point of view of Generational Dynamics, the world is headed for a major financial crisis and then a world war, and no power in the world can stop it, even Warren Buffett.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (18-Oct-2008) Permanent Link
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Stock markets in Iraq and Iran are surging.

Iran's President Mahmoud Ahmadinejad says "it is the end of capitalism."

The Tehran stock market has been unaffected by the credit crisis that's affected other stock markets around the world. This includes stock markets in neighboring Gulf states.

But it doesn't include Iraq's stock market, which soared 40% in September, at a time when other stock markets were crashing.

From the point of view of Generational Dynamics, the reason is simple: Both countries are in generational Awakening eras. The bloody, genocidal Iran/Iraq war of the 1980s, and now a full generation has passed.

The Iran/Iraq war devastated, destroyed and flattened both countries. When the war ended, people in both countries started rebuilding.

Now, 25 years later, both countries' industries are really humming. Instead of living off of credit, both countries are generating goods and services. What a radical idea!

Contrast that with the United States where, in the last ten years, tens of millions of manufacturing jobs have fled to China, and as many service jobs have fled to India, and the principal business of the country has been financial transactions and figuring out more ways to create new debt and credit.

In the 1960s and 1970s, when the United States was in a generational Awakening era, our industries were really humming. The Great Depression had destroyed most existing businesses, and forced the remaining ones to completely renew themselves. By the 1960s, they were mature enough that they were really turning out products that everyone wanted.

Mainstream economic models completely mishandle the birth and death of businesses. The assumption (usually unstated) is that businesses are born and die pretty much at the same rate in every decade. But that isn't true. Almost every business died, in one way or another, in the 1930s, and by the 1940s, almost all businesses were new. Those businesses grew and thrived in the 1960s and 1970s.

Today, those businesses are old and mature. The employees used to focus on producing the best products for the customer, but today the employees focus on doing as little work as possible while maintaining the most pleasant lifestyle. (See "Boomers and Gen-Xers: Dumbing down IT" for how this works in the computer industry.)

That's generally true of all the countries that fought in WW II as a crisis war. Their industries were all destroyed, and their businesses have gone through a similar birth and death cycle as the United States has.

Even China, for all its vaunted industrial strength, is unraveling. Its economy depends on manufacturing goods for sale in the US, and now the credit crisis in the US is also a credit crisis in China.

Of course, that isn't the way officials in Iraq and Iran look at the situation.

Taha Abdul-Salam, the head of Iraq's stock market, says, "I believe we're still far from what's happening in the world in the financial markets. But in the end you must know we are part of this world. I believe somehow we will have some problems."

At least he isn't too arrogant about what's going on. But that description doesn't apply to Iran

Iran's President Mahmoud Ahmadinejad, who is known to believe in the Mahdaviat of Shia Islam, the belief that the Mahdi is coming soon to save mankind.

Thus, it's not surprising that Ahmadinejad would see the financial crisis as a divine sign that "the oppressors and the corrupt will be replaced by the pious and believers," and that "an Islamic banking system will help us survive the current economic crisis."

In a recent sermon at Tehran University, Ayatollah Ahmad Jannati said, "We are happy that the U.S. economy has come across difficulty. They are attesting unfavorable consequences of their conducts. They are experiencing divine punishment. We are happy over that. The unhappier they become, the happier we get, as they become happy as we get unhappy."

We can't stop here without mentioning that while Ahmadinejad is waiting around for the Mahdi, he has plenty of troubles of his own. Those who remember America's Awakening era in the 1960s will recall that it was peppered with mass riots and demonstrations, and even violence and bombings.

Well, Ahmadinejad is beginning to have his own share of similar activities, typical of what happens in any country's Awakening era. Ahmadinejad has had student protests, and protests by women who wear loose headscarves.

So both Iran and Iraq are experiencing both the advantages and pains of an Awakening era, as most of the rest of the world, in a generational Crisis era, heads for a new world war. (17-Oct-2008) Permanent Link
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Market selloff resumes savagely, as markets collapse around the world

Commentary on Wednesday has been the most negative I've ever heard, although it's framed in terms of a "severe recession." Still, I believe I've heard the words "1929" and "depression" more often on Wednesday than I ever have (since I was in school in the 1950s).

Market summary, 15-Oct-2008
Market summary, 15-Oct-2008

Wall Street indexes fell sharply at the open, and continued to fall throughout the day. Markets in Asia and Europe also fell sharply, and as I write this on Wednesday evening ET, Tokyo's Nikkei index has fallen another 11% in the last two hours.

The market seems to be reacting to the drunken orgy on Monday, where the market went up 11%, following the incredible worldwide fantasy bailout over the weekend. Now, the market seems to have resumed its path for the preceding three weeks, where the market fell 25%.

A major problem is that interest rates are not falling fast enough. This was apparent yesterday from the quote from Rick Santelli that I posted yesterday.

On Tuesday afternoon, after the Fed auction, CNBC reporter Rick Santelli reported that interest rates causing the credit crisis were not easing, despite Monday's fantasy bailout announcement. He made the point that interest rates for GSE bonds (bonds offered by Freddie Mac and Fannie Mae) continue to be much higher than interest rates for US government Treasury bills. Here are his words:

"Some of us are disappointed in the thaw, and I'll tell you why. If the government is basically underwriting the GSE's, and they've ramped up all of their coverage, like FDIC, tell me why it is that the 3 and 6 month bill for the auction today garnered a yield of .5 and 1.10 respectively?

Yet, when Freddie went to the market with 3 and 6 month bills, their 3 month bill was at 1.95, and their 6 month was at 2.70.

This is living proof that, for whatever reason, we're not seeing this money that's been thrown into the banking system do exactly what it is we want it to do. And somebody at Treasury or Fed, or the banking regulators, have to go pound some heads, because the T-bill rate should be coming up, and the GSE rate should be coming down, and it's NOT HAPPENING."

On Wednesday, the credit crisis still showed little or no sign of easing. The news services tried to put the best face on it. Here's a a news story from Wednesday morning:

"Libor for Dollars Drops as Central Banks Offer Unlimited Cash

By Gavin Finch and Nate Hosoda

Oct. 15 (Bloomberg) -- Dollar money-market rates fell after the European Central Bank, Bank of England and Swiss National Bank offered lenders unlimited U.S. currency for the first time in a coordinated effort to unlock credit markets.

The London interbank offered rate, or Libor, that banks charge each other for three-month dollar loans dropped for a third day, its longest sequence of declines in seven weeks, according to the British Bankers' Association. It slid 9 basis points to 4.55 percent today. The comparable euro rate declined to 5.18 percent. Asian rates also decreased."

That sounds pretty good, until you read several paragraphs later:

"While the cost of three-month dollar loans has dropped in the wake of the measures, it's still 305 basis points more than the Fed's target rate. The difference was a record 332 basis points on Oct. 10. It was 82 basis points on Sept. 15, the day Lehman Brothers Holdings Inc. filed for bankruptcy and 11 basis points on July 31, 2007, just before the start of the credit squeeze."

And so, if you look at interest rate spreads in the past year (where 100 basis points equals 1%):

    Date                   Basis points
    ---------------------  ------------
    July 31, 2007           11
    Sept 15, 2008           82
    Oct 10                 332
    Oct 15                 305

In other words, the Libor spread has fallen a tiny amount, compared to where it was even just a month ago.

This is just one major cause of the huge pessimism among investors that was evident on Wednesday.

This was buttressed by a slew of disastrous data: The U.S. retail sales report revealed big September sales declines, and the U.S. Empire State manufacturing index plunged the greatest amount in its history.

This afternoon, Ben Bernanke gave a speech, in which he attempted to defend Fed policy, adding that the recession is going to last a long time.

The market fell sharply after that speech. Well-known financier Mort Zuckerman commented on Bloomberg television after the speech. Zuckerman is normally a pretty upbeat guy, but on Wednesday afternoon, he was bitter and angry:

Mort Zuckerman <font face=Arial size=-2>(Source: Bloomberg)</font>
Mort Zuckerman (Source: Bloomberg)

"I think that the economy is not only bad now, but it's going to get worse. The fact is the credit crunch is not over, and it's not going to be over.

What they just did for the banks is to make sure that no major financial institution is going to fall down a trap door and disappear in 72 hours, but it is not going to dramatically change the credit crunch.

And so we're in for a very, very weak period in the economy, and who knows how far that will go? Nobody knows, because there are unknown factors in our economy that we've never had to deal with before, one of them being plummeting house prices, which has a good ways to go. They're off about 20% and may go down another 15%.

And another is these toxic securities and credit default swaps, and nobody knows how bad they're going to be."

This is a real statement of despair, but it's realistic. I've been commenting on the issue of real estate prices and mortgage-backed securities (CDOs) for a long time, and I've mocked and ridiculed analysts on CNBC, in WSJ and elsewhere, who said that the real estate crash was near the bottom, or that the mortgage-backed securities was a small, "contained" problem.

My thoughts go back to a year ago, when pundits were talking about a "kitchen sink" quarter. This meant that corporations would take as many writedowns as possible in the third quarter, so that they'd be completely rid of them.

We heard the same thing every quarter since then. Even those who thought that the problem would go on for a while longer were absolutely certain that it would be over by now, near the end of 2008.

But you could hear the bitterness in Zuckerman's voice when he said that falling home prices, toxic securities, and failing credit default swaps will go on for an indefinite time. He expressed no hope whatsoever.

He was asked, "Ben Bernanke, who's studied the Great Depression, says that it won't happen again. Do you agree?"

"Well, we won't have a similar kind of depression. We won't have the Treasury and the Federal Reserve not providing the liquidity to the financial system. We won't have a balanced budget - we're gonna have a huge deficit. We won't have trade dropping because of Smoot Hawley and similar things like that.

But we have different things that may be just as serious. For example, we their $52 trillion in credit default swaps out there -- nobody knows how good they are.

When they came [to rescue] AIG, AIG thought they needed $40 billion to get out of the hole. The government said $85 billion. They're already up to $121 billion. So who knows how bad it would be?"

The AIG bailout is less than a month old, and it appears to be spiraling out of control.

However, his answer is inconsistent. He says that the Fed will continue providing liquidity, but he's already shown that the Fed can't possibly provide enough liquidity to matter. The new Depression will be much worse than the last one.

(For a description of the AIG bailout, see "The Fed will loan American International Group (AIG) an $85 billion bridge loan." For a discussion of credit default swap (CDS) counterparty risk, see "Brilliant Nobel Prize winners in Economics blame credit bubble on 'the news.'")

"With Lehman Brothers, which was THE fundamental mistake the Fed's made -- they now are apparently exposing the financial world to $360 billion of losses on credit default swaps that were guaranteeing Lehman papers.

So I don't know where this ends. Nobody knows where it ends."

This is another fundamental mistake. He talks as if the crisis BEGAN only five weeks ago when Lehman Brothers collapsed, and he implies that if only that one mistake hadn't been made, then we'd all be OK today. This is wishful thinking.

These are dark days, and they're going to get darker very soon.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (16-Oct-2008) Permanent Link
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Corporate earnings continue to plummet

Price/earnings ratio (P/E10 only) falls below average for first time in 13 years.

As regular readers know, for the last few quarters I've been posting the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters. These tables have shown sharp falls in corporate earnings estimates from week to week. Here's table as of the end of last week:

  Date    3Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Mar  3:              25.0%
  Apr  1:              17.3%   Start of previous (2nd) quarter
  Jul  1:              12.6%   Start of quarter
  Sep  5:               0.8%
  Sep 12:              -1.6%
  Sep 19:              -0.3%
  Sep 26:              -1.7%   End of quarter
  Oct  3:              -4.8%
  Oct 10:              -7.8%

We're seeing a very familiar pattern -- the same pattern that we've seen for the last four quarters. At the beginning, analysts expect meteoric increases in earnings growth. The earnings estimates fall as the quarter progresses. Once the quarter ends, and actual earnings begin to be published, the earnings estimates plummet.

A fall in earnings estimates means an increase of price/earnings ratios estimates.

There's a price/earnings ratio chart at the bottom of this web site's home page, and it gets updated automatically every Friday. Here's last Friday's version of the chart:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 10-Oct-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 10-Oct-2008. (Source: MarketGauge ® by DataView, LLC)

As you can see, the P/E ratio index was at 18 for several years, which is well above the historical average of 14. In fact, the index has been above average for 13 years, since 1995, and by the Law of Mean Reversion, this means it has to be equally below average for roughly the next 13 years.

Starting in March, however, the P/E index is spiked upward again, to astronomical levels in the 20s. This was when first quarter actual earnings were coming in. But investors believed that they should be ignored; the common wisdom was that the credit crisis would be over by the fall (i.e., now), and that earnings would grow in the third and fourth quarter by 25% and 50%, respectively.

Because of that widely held belief, investors pushed the P/E index up into the 20s. It's only in the last three weeks that it came back down to 18. This was thanks to the stock market losing 25% of its value in the last three weeks.

However, Monday's drunken orgy, pushing the stock market up 11%, has also pushed the P/E index up above 20 again. Those who claim to believe that the market is going to rally this quarter, in the face of falling corporate earnings and high P/E ratios, are going to be disappointed.

Market Summary

Asian and European markets were sharply higher last night. Wall Street opened sharply higher, with the Dow up 400 points at one time. But by 11 am, the Wall Street indexes turned around, and are now flat or negative.

Market summary, 14-Oct-2008
Market summary, 14-Oct-2008

The pundits, who this morning were still grinning like idiots, as if they'd just gotten laid, were talking about how and why everyone should get back into the market. By the end of the day, the pundits were far more serious, as the Dow fell to a 300 point loss, before partially recovering.

At the very least, what this means is that the panic buying spree that followed the latest worldwide insanity bailout is over, and stoned, drunken investors are beginning to sober up and look at the reality.

One sobering reality is that P/E indexes are still astronomically high, and computer software is telling investors to "Sell! Sell! Sell!"

Another sobering reality is that the market is still 35% down from its high, and there is still a lot of deleveraging and forced selling going on. In fact, investors are withdrawing money from money market funds at record levels, causing a potential chain reaction.

(Correction: A web site reader has pointed out the phrase "money market funds" is incorrect in the above paragraph. The record withdrawals are from stock and bond mutual funds, and those are not money market funds.)

Nouriel Roubini provided another sobering reality. In a Bloomberg interview, he said that the US would have the worst recession in 40 years. "There are significant downside risks still to the market and the economy," he said. "We're going to be surprised by the severity of the recession and the severity of the financial losses."

Nobel prize winning economist Paul Krugman spent the day texting Matt Damon. He did have a hard-hitting statement in his blog, however, saying that, "The policy outlook has improved a lot.... But it’s way too soon to start counting chickens."

P/E10 drops below average for the first time since 1995

According to Robert Shiller, in a WSJ interview, the price/earnings index (P/E10) has fallen below average for the first time since 1995.

Robert Shiller, whose 1999 book "Irrational Exuberance" predicted the Nasdaq crash, and whose 2005 second edition predicted the real estate bubble crash, has a web site that provides the historical data that I and other researchers use.

When I write about the "price/earnings ratio" or P/E ratio, I'm usually referring to P/E1 -- the current price of a share of stock, divided by the company's earnings per share for the previous year. This is the version that's used in the chart that appears on the bottom of this web site's home page.

Robert Shiller prefers to use the measure P/E10 -- the current price of a share of stock, divided by the average of the company's earnings for the previous 10 years.

I believe that P/E10 is a more meaningful measure, but I write about P/E1 because it's easier for people to understand, and it makes the same point: That P/E ratios have been way above average since 1995, and by the Law of Mean Reversion, will have to fall to values way below average for roughly the next 13 years. Either P/E1 or P/E10 can be used, as long as it's used consistently. The historical average for P/E1 is about 14.1, and the historical average for P/E10 is about 16.3.

According to Robert Shiller, last week's bloodbath brought P/E10 down to 15, which is below the historic average of 16.3.

In the Wall Street Journal interview with Shiller, he says he "doesn't make predictions" and he's afraid that "it might go down a lot more." He's being very diplomatic with the Journal, by not quoting the Law of Mean Reversion, which says that it will certainly go down a lot farther, and stay down for a long time.

So add P/E10 to the list of things that have been crashing in the last weeks -- commodities, emerging market currencies, worldwide stock prices, the Baltic Dry Index, various major financial institutions -- and now add one more, P/E10.

This is a huge downward trend with a great deal of momentum. It's like a ten thousand-pound boulder is rolling downhill, and you'd like to stop the boulder, and start pushing it up the hill again. It can't be done.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (15-Oct-2008) Permanent Link
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We're all Icelanders now, as markets rocket 10% around the world

The world is a much more dangerous place today than yesterday.

Unfortunately I used up the phrase "Bailout of the World" to describe the last major bailout announcement -- the one that preceded last week's bloodbath. So what should I call this one? Bailout of the Universe?

Countries around the world have been moving to guarantee all bank deposits of whatever size. What's new this time is that countries around the world are moving to guarantee all bank obligations.

So now every investment by every bank is backed by some country's taxpayers. Essentially, the concepts of "bank" and "country" and "hedge fund" have merged. Last week it was just Iceland. But now, every country is also a bank and a hedge fund. In fact, the world (or at least most Western countries) are one large investment bank / hedge fund. So let's call this bailout plan the World Hedge Fund bailout.

We don't have enough money to bail out all the foreclosed real estate, but somehow we do have enough money to bail out all the securities backed by foreclosed real estate. And any bank failure immediately becomes a country failure.

These CDOs and CDSs that I've been writing about for years are much huger than a government can handle. The US government perhaps has one or two trillion dollars of resources, but the CDOs and CDSs are exposures of tens or perhaps hundreds of trillions of dollars.

It was one thing when those obligations were on the books of banks and other financial institutions, as well as investors. But now, all those obligations are on the books of the US and other nations.

This has got to be the stupidest, most disastrous move in the history of mankind.

You know, Dear Reader, I've been saying for years how astounded and amazed I am at what's going on in the world, and what people are doing, out of sheer stupidity.

But I've completely run out of superlatives. This can't possibly be happening. Surely I'm dreaming this, or perhaps fallen asleep in a very bad movie. This is a fucking disaster.

Market summary, 13-Oct-2008
Market summary, 13-Oct-2008

And just to show what a disaster it is, the European and New York markets surged over 10% today on panic buying. As I'm writing this, on Monday evening, the Nikkei is up 12.5%. I just saw some giddy idiot on CNN, grinning from ear to ear, saying that the worst was over, and people should start buying stocks now.

I actually heard someone describe this as "they've finally managed to restore investor confidence." This emotional outburst of panic buying is supposed to represent "investor confidence"? What superlative can I use to respond to that?

Sure, go ahead folks. It's time to buy. Raid your kids' piggy banks and your parents' retirement funds and get into the market. That's what the "smart money" is doing. Why shouldn't you?

And then to add to the surreal and phantasmagoric quality of the day, Paul Krugman got the Nobel Prize in Economics.

A web site reader wrote this to me today:

"Headline: Nobel prize committee disses John Xenakis on economic prize.

In a surprise announcement the Nobel committee decided NOT to give John Xenakis the Nobel prize for economics. “While we do believe his work has merit, it is far too simplistic and easily understood by 90% of the world population. We prefer intricate and complex analysis using arcane and irrelevant factoids that are overblown and dissected ad nauseum, the covert purpose of which is to seduce 17 year olds to mortgage their future to overpriced universities with the hope that they too can achieve academic stardom."(600,000 to one chance).

We have awarded the prize to Paul Krugman who retread a 19th century principle, which is not the reason he got the prize. The real reason is he hates George Bush and so do we. (ha ha)"

I got a big chuckle out of this. Thank you, Mary.

As I wrote last week, at least Nouriel Roubini has done some brilliant work, and has at least foreseen some of the current crisis before it happened. But Krugman has done nothing. The guy's a macroeconomics idiot.

Ironically, the Nobel committee was too clever by half. They wanted to stick it to President Bush, so they gave the prize to Krugman, saying it was for some obscure work he did years ago. The result is that they've damaged their own credibility, as well as Krugman's (both of which were already pretty low anyway). All of the accounts of the award mention Krugman's war against the Bush administration, and that he's a Barack Obama supporter and adviser, and one article accuses Krugman of having "pandered" to politics in his economics. So even in the remote possibility that the Nobel committee thought they were being politically neutral, nobody believes it.

However, there's a very interesting by-product of the Krugman selection: Krugman fully endorses the World Hedge Fund bailout plan.

Here's what he wrote on his blog last night, before learning of his award:

"Worthwhile British initiative

Ask, and you shall receive. I asked plaintively for policy makers, at least once, to exceed expectations in this crisis instead of falling short — and it seems that the eurozone governments have delivered, more or less adopting the British plan.

And I should have given props to the British government, which vastly exceeded expectations last week — and has effectively shown the world the way forward."

What he means to imply by this is the following: Led by the UK, the Europeans have taken steps that "exceed expectations," steps that the US didn't take. On a BBC interview today, he indicated that the reason that the US didn't take these steps earlier is because of "ideology." He loves the fact that these governments are all going to become banks (and hedge funds), and thinks that will save the world.

On the BBC interview, he compared today to 1931, saying that things could easily slide into another Great Depression if the markets were left to themselves, but now the governments have done exactly what they need to do to prevent that.

He apparently doesn't have any idea that today is more comparable to the time just before the 1929 crash.

Actually, Dear Reader, I suppose we have a little contest here. Krugman and other economists think that this new plan will save the world from the worst, leading to at most a recession.

I say that World Hedge Fund plan is a total, utter, fucking disaster, and will make things much worse than they would have been otherwise. I guess we'll have to see who's right. Actually, I'd be only too happy if Krugman were right. But Generational Dynamics and generational theory haven't been wrong yet, and I don't expect them to be wrong this time.

And I haven't said this recently, but receiving Mary's message, quoted earlier, has reminded me.

I don't get paid to write for this web site. I do it because (*) it's an obsession; (*) I want to prove that Generational Dynamics is a viable scholarly subject; (*) I'm saving people's lives.

When people write to me and I respond, or when I post something in the new Generational Dynamics forum, which I usually do several times a day, I never forget the fact that I have an enormous obligation to my readers. Something that I write could literally mean life or death in some cases. People who have been long-time web site readers have prepared themselves for what's coming, and many of them will survive because of me. I never forget this obligation for a second.

As usual, you can write to me using the "Comment" link at the top of every page. Or you can write to me by using the "Forum" link at the top of every page, and taking part in the forum discussion. I can't always respond quickly, but I have still been keeping up with the e-mail messages, and usually get back within a couple of weeks. (14-Oct-2008) Permanent Link
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European leaders race the clock, while G-7 leaders make reassuring pronouncements

Once again, officials are attempting to take action before Asian markets open on Monday morning (Sunday evening ET). This follows a familiar pattern that's been going on for several weeks now, even though these weekend meetings never seem to prevent the markets from getting worse.

On Friday and Saturday, we had meetings of leaders of the G7 nations, "united in their resolve to avert a global financial meltdown." They didn't come up with any solutions, but they did issue statements designed to project the image that they were accomplishing something.

(The Group of Seven (G7) includes the United States, Japan, Germany, France, Italy, the United Kingdom and Canada. The European Union is also a participant. The G20 includes those eight and adds China, Brazil, Russia, India, Mexico, South Korea, Saudi Arabia, Argentina, Australia, Indonesia, South Africa and Turkey. Together, the G20 account for about 90% of global gross domestic product.)

President Bush made the following remarks on Saturday:

"[O]ur government will continue using all the tools at our disposal to resolve this crisis. At our meeting, Secretary Paulson and I described the bold actions the United States has taken over the past few weeks. ...

I'm pleased that other G7 countries are making strong -- are taking strong measures. Finance ministers and central bankers have acted to provide new liquidity to markets, strengthen financial institutions, protect citizens' savings, and ensure fairness and integrity in the financial markets. ...

As our nations carry out this plan, we must ensure the actions of one country do not contradict or undermine the actions of another. In our interconnected world, no nation will gain by driving down the fortunes of another. We're in this together. We will come through it together."

I think it's really interesting that the emphasis is not on finding a solution (there is none, anyway), but on avoiding the "every country for itself" trend that has been increasing, especially in Europe.

Exactly the same sentiments were expressed at a Sunday meeting in Paris of leaders of 15 euroland countries. French President Nicolas Sarkozy said, "I expect Europe to speak with a single voice."

And German Chancellor Angela Merkel said:

"The goal is to define a coordinated common procedure for the euro zone that enables us in the next few days to take national steps to stabilize the financial market, but measures that do not discriminate against individual member states. ...

I think that the meeting today will send a very important signal to the markets."

Germany is planning its own €400 billion bailout of its banking system. The UK is expected to announce on Monday a bailout of its banking system.

The Paris meeting of euroland countries did tentatively agree to guarantee interbank loans, in order to end the worldwide credit freeze caused by banks' fear of loaning money to one another.

However, the agreement is not certain, and is likely to falter on parochial grounds; for example, will an eastern European country be required to help bail out a German or French bank? The question will be decided at another meeting, scheduled for Wednesday.

The meetings of G-7 leaders and European leaders, in the end, didn't accomplish anything except provide an opportunity for photo ops and self-serving statements, just as is happening in the US political campaign.

Listening to the Sunday morning news shows today gave me a headache. I don't believe I heard anyone make any sense whatsoever. Pretty much everyone took an ideological position, with the Republicans on the defensive. Several people blamed Ronald Reagan and George Bush for the current situation, but no one blamed Bill Clinton for the dot-com bubble.

Of those who said things that weren't purely ideological, they all followed the Nouriel Roubini formula: "Do exactly what I tell you to do, or we'll have a major worldwide crisis." That way, even though they have absolutely no idea what's going on, they've covered their asses no matter what happens, and if there's a crisis, they can blame it on the fact that no one listened to them.

What's really sickening is that no one gives a f--k what happens to anyone else, as long as they're protected. "It's everyone's fault but mine."

As always, there were the usual soothing words that people were saying in 1929: "The fundamentals are sound." "This will pass soon." "We've had recessions before."

The most amazing time in my life, and also the most sickening.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (12-Oct-2008) Permanent Link
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There's never before been a day like this on Wall Street.

Possible exception: One of the days just before or after the 1929 crash.

Market summary, 10-Oct-2008
Market summary, 10-Oct-2008

The Dow index fell 621 points within moments after the market opened on Friday. In the next few minutes, it rallied by 688 points. Several times, the Dow went up or down over 100 points within a few minutes. In the last hour of trading alone, the Dow changed direction 16 times. During just one commercial break on CNBC around 3:45 pm, the Dow went from +300 to -100. Never before in history has the intraday high been more than 1000 points above the intraday low. The Dow ended down 128 points.

The Dow has fallen 25% in the last three weeks alone. This would cause huge amounts of forced selling anyway, even if we didn't know that many hedge funds are liquidating.

And yet, I was shocked that one person after another called this good news. CNN's Ali Velshi said that it meant that the market would start going up again.

In the Financial Topics thread of the Generational Dynamics forum, one person wrote, "today was the most bullish day we've had so far during the decline." Another wrote, "My best guess is that ... stocks will rally for a few days, or maybe even a few weeks or months. " My best guess is that you are correct this time and stocks will rally for a few days, or maybe even a few weeks or months."

At a time when P/E ratios are at astronomical highs, and corporate earnings keep falling, it's really hard for me to understand how anyone could hold that belief.

And yet, analysts and pundits seem to have no idea what's going on.

International superstar Professor Nouriel Roubini says that Dow 7,000 is likely "sometime next year," though apparently not before then. Actually, he said that on Tuesday, when the Dow was just beginning to fall through 10,000. I wonder what he thinks on Friday, with the Dow near 8,000?

I'm getting increasingly bemused by Roubini. He's become the the Paris Hilton of economics: He always knows exactly how much leg to show in order to keep himself in the headlines.

His 12 steps to financial disaster was actually quite brilliant, but when it comes to saying what's going to happen, he seems to change his mind every day. Will there be a recession, or not? Will it be V shaped or U shaped or L shaped? If you don't like his answer, then wait a minute.

However, whatever Roubini says on any particular day, the formula is always the same: "Unless the Administration does exactly what I say, then the world is going to suffer systemic financial crisis." He's got it both ways. If there's no crisis, then he can slide by; if there is a crisis, he can claim that he predicted it, because they didn't listen to him.

Paul Krugman is another Paris Hilton-like figure. In his latest column, entitled "The Moment of Truth," he says the following:

"They’d better do something soon — in fact, they’d better announce a coordinated rescue plan this weekend — or the world economy may well experience its worst slump since the Great Depression."

Whew! I'm shaking from what a hard-hitting statement this is. They'd better DO something or something MAY happen. Wow, you can take that to the bank.

Actually, I heard Krugman being interviewed on Bloomberg tv on Friday, and I really had to laugh when he was asked what's different today from 1929? Here's what he said:

"Two things are different. We know the Great Depression happened, and this actually gives us some urgency in policy. And I think we do understand economics better than we did 75 years ago. I think we know something about what needs to be done."

Boy, you could fool me. These economists have no idea why the dot-com bubble occurred, why the real estate bubble occurred, why the credit bubble occurred, why they all occurred at the time they did, and how we got to where we are today. They have no idea whatsoever. Mainstream economists know little more than they did in 1929.

(For further information on the failure of mainstream economics, see "System Dynamics and the Failure of Macroeconomics Theory.")

I have to mention the latest column by Michael "Mish" Shedlock. He applies Elliott Wave analysis to the current situation, and evidently fails to find any pattern that predicts what's going to happen.

Things like K-cycles and Elliott Wave analysis actually are valid, but researchers always make the same mistake: they try to use them to analyze generational crashes, and they're not valid for that purpose. Generational cycles are completely independent of K-cycles and Elliott wave cycles, and the fact that researchers don't take that into account is why these tools never seem to work.

I mention this today because I want to make this point: That tools and policies that work fine in "ordinary" times do not work at times of generational crisis. In a generational Crisis era, the financial crisis or war crisis is caused by massive generational behaviorial changes that can't be stopped by any policy that would have worked fine just a few years earlier.

This is something that the survivors of the Great Depression and World War II understood, because they learned that lesson in the 1930s. But those people are all gone now, and today's Boomers and Gen-Xers, including people like Roubini, Krugman, and Shedlock, have to learn all over again.

I had to chuckle when I was listening to a radio talk show on Friday with Krugman as a guest. A lady called into the show and asked, "Why do you give all the air time to people who have been wrong over and over again in the past few years? Why don't you find someone whose predictions have been correct?"

Being right or wrong is completely irrelevant in today's society. If people like Roubini, Krugman and Shedlock are wrong time after time, they're still listened to because they're skillful at saying what people want to hear, rather than what's true.

That's certainly not my skill, as I get shunned by the media, even though every major Generational Dynamics prediction has been correct for the past six years. The media are interested only in supporting their own political biases; they're not interested in the truth.

So I will now once again state the truth, as I have so many times before, about what's coming.

The Wall Street stock markets are now down 60% from their peak a year ago. We're following the same cascading pattern as happened in the 1929 crash. But does that mean that the market is going to keep falling, as it did in the 1930s, and reach below Dow 3000? Or will it bottom out where it is now, around Dow 8000?

Certainly the "experts" don't expect it to go much lower, and neither do the pundits that I hear on tv and read in the papers.

As I'm writing this, I just received an e-mail message informing me that John Mauldin's new column is now available. I've criticized Mauldin for being "muddled" in the past, and this column is no exception. Here's what he says:

"This is not the end of the world. There are a lot of very positive things happening in the US and the world. Companies are creating new inventions. Much of the economy, including health care, is moving along fine. I have lived through two serious recessions (1973-74 and 1980-82), and the point is that a free-market economy will find a way to eventually get back to solid growth. Recessions are simply part of the business cycle. Congress cannot repeal the business cycle. This will not be the last recession of my life. I hope to live long enough to go through 4 or 5 more.

Depressions are caused by governments making major policy mistakes. And we have made some in the areas of not regulating mortgage lending, allowing the five large investment banks to increase their leverage to 30 or 40 to one in 2004 (what was the SEC thinking?), and failing to oversee the rating agencies. That is behind us. It will make a normal recession deeper and the recovery longer, as I have been forecasting for some time.

But as I argue below, immediate actions must be taken by the government to avoid a much deeper problem. To not take actions to stem the credit crisis would be that major policy mistake which would compound all the other mistakes. I think everyone knows the seriousness of the problem and will act. Let's pray they do."

I have nothing against John Mauldin, and I wouldn't be picking on him if I hadn't just received this e-mail message. But this is typical of the nonsense that all the pundits and analysts are using. He's lived through the 1973-74 and 1980-82 recessions? That's nice, but what could that possibly have to do with the deflationary spiral that's going on today?

He criticizes government "policy mistakes," allowing investment banks to increase their leverage. Well, did he say anything about that when it was happening? Mauldin is an investment expert who boasts that his clients all have at least $2 million in assets. He claims to be able to be giving these people expert advice on where to invest. Well, did he ever give these people expert advice about avoiding investing in financial firms that have been over-leveraged? I doubt it very much. He had no idea what was coming, just as he has no idea today what's coming. (As I said, I have nothing against Mauldin in particular; he's just like all the others.)

Of all of these experts I've quoted today, only Roubini has at least foreseen some things before they happened, although he was late to the game, and he's still playing his Paris Hilton act.

But in general, these experts and pundits and politicians and journalists and analysts and college professors have no idea what's going on, and when their so-called "predictions" are wrong, as they are time after time after time, they simply blame someone else. "The regulators should have stopped this." "The Administration should have stopped it." "Congress should have stopped it." Pick your favorite target. If you're an "expert" or even worse, a politician, who's been wrong time after time after time, it's never the fault of your own stupidity and short-sightedness. It's the fault of everyone BUT yourself.

I listened to Fox News Channel's Bill O'Reilly on Friday night. Just three days ago, I heard him advise everyone to take a deep breath and not panic, essentially advising his millions of viewers not to sell, because "The bottom will soon be reached." Now he's claiming that he doesn't give investment advice, and that everyone is at fault but him for not seeing this. Well, why didn't he see it? He's always running various exposés of all kinds of political and financial scams. Why didn't he ever run an exposé of this one? Like all the other "experts," he never blames his own stupidity and short-sightedness. It's the fault of everyone BUT himself.

So let's get back to the truth that none of these "experts" ever talks about:

The S&P 500 price/earnings ratio index is in the 20s, and corporate earnings continue to fall, so the market is nowhere near a bottom.

Furthermore, the P/E ratio has been at historically high levels for 13 years -- since 1995 -- and so by the Law of Mean Reversion, the P/E ratio will be at historically low levels for roughly the next 13 years.

That's what I've been saying for six years, and I've been right every time, and it's really all the proof you need.

Now, I don't expect someone like Bill O'Reilly or CNBC anchor Maria Bartiromo to understand something as mathematically deep, sophisticated and complex as the computations for the price/earnings ratio (i.e., you divide the price per share by the earnings per share), since these people would have trouble figuring out how to add two numbers together.

But Nouriel Roubini is a Professor of Economics at New York University. Paul Krugman was a Professor of Economics at Princeton University, the same place where Fed Chairman Ben Bernanke was head of the Economics Department.

Now, do they even teach calculus in the economics departments of these schools? Judging from what I hear from these "experts," I wonder if you have to know any math at all to be a Professor of Economics at Princeton University or New York University. It seems that all you have to really study is sociology, because these "experts" never seem to say much beyond sociological statements.

I've been analyzing this situation since 2002, which is when I first noticed that we had to be headed for a new 1930s style Great Depression. I've been posting all of these analyses on this web site over the years, and I summarized them last year in the article, "How to compute the 'real value' of the stock market."

As I've noted before, the timeline for the past year has been different from 1929, as you can see from my Dow Jones historical page. The timeline in 1929 was as follows:

The timeline so far today is as follows:

Now, first off, it's incredible and baffling to me that any experts could now predict that the trend described in the above list could suddenly be reversed, and the market will start going up. Obviously this is trending toward an accelerating crash, and only an idiot (which apparently includes most "experts") can miss it.

But the question I want to address is this: Have we somehow managed to avoid the generational panic and crash that I keep talking about?

I've described many times what I expect to see happen; here's a summary: An elemental force of nature, where millions or even tens of millions of Boomers and Generation-Xers in countries around the world, never having seen anything like this before, and not having believed it was even possible, suddenly try to sell everything in a mass panic. This will bring down computer systems for hours, perhaps even for a day or two, as people watch tv in glazed horror as their life savings disappear.

That's the kind of generational panic that occurred in 1929, and is remembered as "the crash of 1929," and it was a year after the generational panic that the market was 40% below its peak. But that hasn't happened this time, even though the market has already fallen 40% from its peak value in the last year. So have we managed to avoid it?

Generational theory says "absolutely not." This generational panic MUST occur, if only to teach a lesson to the generations of "experts" who keep saying stupid things. Generational panics are nature's way of educating "experts" to what is really going on.

However, remarkably enough, this is actually a point of commonality between me and mainstream pundits. Most of them are expecting some sort of "panic event," like the panic of 1987, that will cause a "capitulation," and the market will bottom out and start going up again.

So in fact, most pundits and I are in agreement that some kind of major panic is going to be occurring shortly. The pundits that I hear are expecting it very soon, perhaps as early as next week.

However, this is in the "be careful what you wish for" category, because my expectation is that it will proceed far differently than the mainstream "experts" expect. Actually, this shouldn't surprise anyone, since what happened on Friday didn't happen in 1987, and hasn't happened at any time since 1929. My expectation is that the market will continue its downward path, just as happened in 1930-1932.

There's no way to predict with certainty what's going to happen next week, but I feel pretty safe making the following prediction: One way or another, next week is going to be very rocky.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (11-Oct-2008) Permanent Link
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Stock market is in free fall, as forced selling accelerates

A worldwide full scale panic may be in progress.

The last hour of trading on Wall Street on Thursday was close to a full scale panic.

Market summary, 9-Oct-2008
Market summary, 9-Oct-2008

Note that the market closed at 4 pm, but the post-closing final settlements brought the Dow down another hundred points in 7 just minutes on huge volume.

According to CNBC, the final rush was caused by forced selling by hedge funds and money market funds, because people are pulling their money out of these funds, and also forced selling by people required to meet margin calls (when they had acquired their stocks on credit).

At this writing, on Thursday evening ET, the Asian markets are falling sharply, as much as 5-12%.

Believe it or not, I still heard analysts today say that this is a GOOD thing. "The stock market is oversold by ABSOLUTELY HISTORIC proportions," said one. "You could see a thousand point pop any day now!" Another said, "This must finally be capitulation, and the market has reached a bottom."

These people use the word "confidence" at least once every ten seconds. "The bailout hasn't restored confidence. We have to restore confidence. What can the Fed do next to restore confidence?"

This market crash has never been about confidence. Corporate earnings have been in a bubble for years, and now corporate earnings have been falling, as I've been demonstrating for the last four quarters. This has forced price/earnings ratios (also called "valuations") up to astronomical levels, so that investors' computer models began to say "Sell!" We'll get another earnings report on Friday, so we'll see what comes next.

October 9, 2007, exactly one year ago, was the day on which the Dow index reached its peak. Since then, the market has been falling because of falling corporate earnings.

But now, especially in the last few days, something else is happening.

It's increasingly clear that a lot of forced selling has been going on since the beginning of the credit crunch a year ago. A year ago, the forced selling was just a trickle. Since then it's accelerated, and today it appears to be an avalanche. At some point, and it can't be too much longer now, the avalanche will accelerate further into a full scale "panic event" that will be remembered for decades.

It's important to understand this, because the 1929 crash was not caused by "loss of confidence," even though Fed Chairman Ben Bernanke has spent his entire career believing that. It was caused by exactly this kind of forced selling. It was a lot simpler then. Individual investors buying stocks on margin were forced to sell to meet margin calls. Forced selling lowers stock prices, which causes more margin calls which causes more forced selling.

But this time, it's not just individual investors meeting margin calls. You've got $60 trillion of interlocked credit default swaps that will have to unwind, and there are other credit derivatives totalling $1 quadrillion.

Thus, the generational panic and crash, when it comes, will be far larger than anything that happened in 1929.

The puzzle, as I've mentioned before, is that the timeline is a little different than it was in 1929. In 1929, there was a huge panic that dropped the market 40%, and after that it kept falling to 10% of its peak value.

Today, a year after the credit crunch began, the market has already fallen 40%, so a generational panic and crash might push the market down another 10-20% pretty quickly. Despite the differing timelines, in the end, though, it's reasonable to expect that the market will do as it did in 1929, ending up at 10% of its peak value, or around Dow 1400, sometime around 2012.

As I'm writing this late Thursday evening ET, Asian markets are still falling sharply, and Wall Street market futures for Friday morning are indicating a sharp fall at the open. That doesn't mean that the market will fall on Friday -- we could certainly have a big one-day rally, as happened more than once after the crash of 1929.

But the most important news is the increase in forced selling. It's creating a vicious cycle (forced selling depresses stock prices, causing more margin calls, causing more forced selling) that has to lead to full scale panic at some point, and that point can't be very far off now.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (10-Oct-2008) Permanent Link
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Desperate international intervention fails to calm markets.

The remaining hope: The news is so bad that it must be over.

Interest rate changes, Oct 8, 2008 <font face=Arial size=-2>(Source: AFP)</font>
Interest rate changes, Oct 8, 2008 (Source: AFP)

Six central banks launched a coordinated effort to provide a psychological boost to investors by lowering short-term rates by a half-percentage point in unison.

A year ago this would have been a historic effort, but now it's just another day, and investors weren't particularly impressed.

Market summary, 8-Oct-2008
Market summary, 8-Oct-2008

I had actually expected the markets to rally upward today, just based on the wild oscillations that occurred in 1929. Panic buying is not much different than panic selling.

However, the coordinated announcement must have seemed like such an act of desperation, that an early rally didn't last long. After another rocky day, major indexes fell 1-2%, with the Dow index now at 65% of its peak value, exactly one year ago on October 9, 2007.

Around the world, things were bad. The Nikkei fell 9%, the greatest plunge since 1987. In India, stocks fell sharply, below the key 11000 level. Iceland's currency continues to crash. Stocks fell sharply in Brazil. And worldwide interbank lending rates continue at historic highs.

If we count the "crash" as starting in August, 2007, which is when the credit crunch started, then we're actually following the 1929 crash pretty closely.

With one big exception.

We haven't seen a major generational panic yet, where millions of Boomers and Gen-Xers panic and try to sell everything.

Must such a panic occur? I believe it must. Generational theory says so.

But this time it won't be just a stock market panic. It will stretch much farther, into hedge funds, credit default swaps ($60 trillion) and other credit derivatives ($1 quadrillion).

All the Fed interventions of the last years -- the TAFs and TARPs and other stuff -- have been very successful it targeting specific points of weakness.

If you imagine the global economy as a huge ballooon, then the Fed interventions have targeted specific large holes in the balloon.

But there are thousands, perhaps millions, of tiny pinholes in the balloon that have escaped the Fed's interventions, and so the balloon as a whole has still be deflating. Even worse, as the balloon contracts, the pinholes actually get larger -- the physical analogy breaks down here, but the hedge funds that represent the pinholes become more and more exposed as the market falls.

Pundits that I heard on Wednesday seemed to me to be stunned, stupefied and exhausted. They've been parroting the same super-optimistic words for over a year now, and those words have proven wrong every time.

A lot of what I heard was downright mushy.

On the Calculated Risk blog, we read,

"When I started this blog (Jan 2005), I was concerned about excessive speculation in housing and extremely loose lending practices. It appeared that housing starts and new home sales would fall significantly. I forecast record foreclosures and significant declines in home prices. Many of us wondered who the eventual bagholders would be for all the bad loans. I was also concerned about the extent of equity extraction from homes (the home ATM), and I believed that the coming housing bust would lead the economy into a recession.

This blog was a daily dose of doom and gloom! ...

I'm frequently asked if I'm more concerned today than I was in 2005. There are reasons for concern: the credit markets have seized up, many financial institutions are insolvent, consumer spending and investment in commercial real estate is starting to decline, export growth appears to be slowing, the unemployment rate is rising ... and the economy is clearly in a recession.

There are huge and scary downside risks today, but I'm actually more sanguine now than I was in 2005. ...

It's easy to get caught up in the day to day financial crisis and recession news - and this blog will continue to bring you the doom and gloom of the worsening recession. But it's important to remember that even though the adjustment process is painful, progress is being made. ...

The financial crisis is worse today than in 1990, and there are many problems ahead (like less consumer spending and business investment), but I believe progress is being made."

With the news worse than ever, Calculated Risk apparently believes that the worst is over.

Analyst Kevin Depew, quoted by blogger Michael "Mish" Shedlock, was equally mushy:

"Here is where we stand with the point and figure bullish percent indicators for equities, based on Investors Intelligence data.

  • NYSE Bullish Percent: Os (Negative) 9% - lowest since 1987
  • S&P 500 Bullish Percent: Os (Negative) 7.9% - exceeds 2002 and 1998 lows
  • Nasdaq Composite Bullish Percent: Os (Negative) 13.4% - lowest since 1987
  • Nasdaq-100 Bullish Percent: Os (Negative) 4% - in 2001, this indicator actually reached 0
  • Russell 2000 Bullish Percent: Os (Negative) 14.1% - equals January low
  • NYSE High-Low Index: Os (Negative) 2.5%
  • Nasdaq High-Low: Os (Negative) 2.8%

It is easy to be bearish given the circumstances, but the fact of the matter is these indicators are so washed out and so low that the probabilities increasingly favor a sustainable rally. Given the macro headwinds combined with approaching earnings season, it is doubtful this is THE bottom, but we are nearing, or at, a low. Keep in mind, these are probabilities. The market may simply continue lower. Yesterday's action was not capitulation in the traditional sense."

The message is the same: The news is sooooooooooo bad, that there's nowhere to go but up.

This is the kind of nonsense I've been complaining about for years. When the bubble was growing, good data meant that the stock market was going up, while bad data meant that the Fed would lower interest rates, so the stock market would go up.

Now Depew can't identify even one tiny piece of good news, and yet he still concludes that the stock market is going up.

What's interesting is that data is irrelevant to these people. If the data is bad then the stock market is going up, and if the data is good then the stock market is going up. Therefore, data is irrelevant.

These people are stunned, stupefied and exhausted, and have no idea what's going on. And they seem incapable of learning. They've been wrong almost every day for a year, and yet they continue to make the same stupid mistake every day.

So, if I can summarize the things I've written about the last few days, it's that investors and pundits are waiting for something to happen. Some of them believe that the downward drift of the stock market will just end, and the market will go up again. Others believe that there's going to be a "crash event," and the market will go up again. Either way, it'll be "capitulation," and the market will go up again.

Generational Dynamics predicts something a little different: Yes, there'll be a "crash event," but it will stun the world, just like the one in 1929 did, and will be remembered throughout future history. The only thing we can't predict is the date, but it can't be too far off now.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (9-Oct-2008) Permanent Link
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More convulsions on Wall street, as financial crisis spreads around the world

The country of Iceland is bankrupt (or almost bankrupt) according to Prime Minister Geir Haarde.

With the króna ("krona" or "crown") currency crashing, Iceland apparently went begging from country to country for a bailout, and Russia is looking favorably on a €4 billion loan to Iceland. According to an Iceland official, "We have been calling for aid from neighboring countries and have been turned down. This is looking like the beginning of relations between Russia and Iceland."

There's an irony to that because Russia itself is in a downward spiral.

Or, as the Telegraph's Ambrose Evans-Pritchard says:

"Russia and Brazil crumble as commodity prices crash

The entire complex of commodities and emerging market stocks, bonds, and currencies is now in free-fall as the economic crisis spreads like brushfire, threatening to draw every corner of the globe into the vortex of recession. ...

The euro’s dramatic slide over the past two weeks has for the first time exposed the instability of the twin-pillar system holding up global finance. ...

There are fears that Russia could slip into a downward spiral if oil drops to $50 a barrel, which is now the lower end of Merrill Lynch’s forecast.

Moscow has become addicted to the oil bonanza, ratcheting up spending so quickly that it may now need prices to stay above $90 to fund spending plans. Veteran analysts say they have seen this movie before."

Evans-Pritchard appears to be the only mainstream journalist in the world who appears to have any idea what's going on.

Market summary, 7-Oct-2008
Market summary, 7-Oct-2008

Wall Street was convulsed on Tuesday, as the market

However, you'd barely even know there's a problem if you listen to the pundits on tv.

As I'm typing this on Tuesday evening, I'm listening to two clowns on tv listening to questions and delivering carefully scripted responses that say less than nothing. Both of these guys are totally oblivious to what's going on.

But that's OK. Fed Chairman gave a speech on Tuesday afternoon that also said less than nothing.

But that's nothing compared to what I heard this afternoon.

Keep in mind that nobody has any idea what's going on. They either can't or won't face the fact that the market has been in a bubble for many years, and is now going to plummet for many years, by the Law of Mean Reversion. You'd think that Ben Bernanke, at least, would understand that, but I don't get the impression he has any idea what's going on.

So here's what I heard on Bloomberg TV on Tuesday afternoon:

 Top: Scott Minerd of Guggenheim Partners. Bottom: John O'Donoghue, Cowen and Company, LLC <font face=Arial size=-2>(Source: Bloomberg)</font>
Top: Scott Minerd of Guggenheim Partners. Bottom: John O'Donoghue, Cowen and Company, LLC (Source: Bloomberg)

Scott Minerd of Guggenheim Partners: On a tactical basis, I think the market's getting close to a bottom. Now it may be 800 on the S&P in the next week or two, but tehre's a lot of seasonal pressure here. We're getting deeply oversold, so I would look to put some money to work in equities. I might not dive into financials aggressively, but I would certainly dabble in financials.

And I think that in the longer term, maybe we get a rally off of the bottom here in the order of 25% or so, and then we rethink what the long term looks like.

I would like to see the market have a wholesale panic in the next week or so. We keep having these days when we go down, then we trade up, then we go down, then we trade up. I'd like to see us close down 1000 Dow points, and then set a bottom.

Q: Man, I would not like to see that. John do you want to see a wholesale panic?

John O'Donoghue, Cowen and Company, LLC: No, I've through a lot of these and I don't like those too much. It's worse than going to the dentist. But I will tell you this: The amount of money that has been taken out of this marketplace prior to the third quarter -- now here we are into the second full week of the third quarter -- as opposed to the 25% drop that we had in 1987 -- this is more like Chinese water torture.

I think you'll probably come to the end of this probably in the next week or so. It's just a matter of the selling becoming exhausted, as opposed to - you're going to see this one big swoop-down day. It's becoming quite disconcerting with the false positives that you're seeing.

Q: There's so much cash on the sidelines.

Minerd: And that's why I think you'll get a pretty good lift here - 20-25%. If you're a trader, and even a long-term investor, you've got to start to consider putting your money to work.

There's a really interesting bit of research done -- there's an old saying, "Sell in May, go away, come again on Arbor Day." Well, statistically, it's actually sell on Memorial Day, and buy at the first game of the World Series. So I'm waiting for the World Series.

There's been a lot of bottom-fishing, and I think we've got to get those people discouraged.

Q: If you see us drop to 800 on the S&P in the next couple of weeks, where to you see us at the end of the year?

Minerd: I think maybe at the end of the year we're up to 1000, maybe 1100."

You know, Dear Reader, there are many times when I've expressed astonishment at what was going on. This was true throughout the growth of the bubble, when I always expressed amazement that the investors could possibly be making an enormous bubble even larger.

But I don't know how to express in words what I'm seeing and hearing now. The conversation I quoted above is almost beyond belief in any way possible.

What could these guys possibly be thinking? There is no possible way that they could have the vaguest idea what they're talking about. One is calling for a 1000 point fall in the Dow, after which (he claims) the market will spring back with a 25% rally. The other one says almost the same thing, but with a slower selloff in the next two weeks.

They're just making this stuff up. It's pure fabrication. They have absolutely no idea what's going to happen, so they pass themselves off as experts and say stuff like that. Didn't it even occur to them that on a day when a country like Iceland goes bankrupt, it might mean something on Wall Street?

"Insanity in individuals is something rare - but in groups, parties, nations and epochs, it is the rule." -- Friedrich Nietzsche

When I started talking about the Principle of Maximum Ruin several years ago, I knew it was coming by analysis of previous generational crashes, but I didn't know the exact mechanism.

Now that I see it happening, it's more like a cartoon than anything else. These guys literally have no idea what they're talking about, and they're making stuff up.

How can this be? How could we have come to this.

It's one thing for analysts to make these things up and talk about them on a financial channel like Bloomberg TV.

It's another thing for a mainstream commentator to do the same thing:

Bill O'Reilly <font face=Arial size=-2>(Source: Fox News Channel)</font>
Bill O'Reilly (Source: Fox News Channel)

"More bad news today - Dow down more than 500 points. Just hang in there. Work hard, tough it out, don't panic. The bottom will soon be reached."

There's a HUGE irony here. Last week, O'Reilly got into a huge shouting match with Massachusetts congressman Barney Frank. The tongue-lashing that Frank got was well-deserved, as he's one of the worst hypocrites around. O'Reilly criticized Frank for saying everything was OK, and allowing ordinary homeowners to be hurt.

But now look at what O'Reilly is doing. He's giving investment advice to millions of viewers. He's telling them not to sell, and he's telling them the market will reach bottom soon.

How could he possibly know that? Does he have a crystal ball? Perhaps he prayed to God, and God gave him the information. (Though I have to wonder if even God can predict chaotic events.)

Or, O'Reilly made it up. Having no idea what's going to happen, he simply made up what he wants to happen.

So now when millions of people listen to him and take his advice, they're going to lose their money. And O'Reilly will be to blame.

O'Reilly keeps saying how furious he is about what's going on. That fury will now be directed at him. I hope he has his bunker picked out.

These are truly incredible days, certainly the most incredible days of my life. It's almost too much to believe what's going on.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (8-Oct-2008) Permanent Link
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Markets plummet deeply around the world.

But Wall Street investors are giggling with glee.

The European banking crisis continued on Monday as the country of Iceland faced a financial meltdown, and suspended all trading in financial shares.

Last March, I wrote that the country of Iceland was close to financial default, because for several years, Iceland has been acting like a hedge fund, instead of a country, and the króna ("krona" or "crown") currency was crashing.

The problems in Iceland set the stage for the day.

Overnight inter bank lending rates rose sharply, demonstrating that the $700 billion bailout bill, which just became law, is not having the desired effect of motivating banks to trust one another and lend money to one another.

Tokyo had already suffered its worst day in years. Russia shut down its stock markets 3 times, and finally ended 20% down, its worst day in history. Throughout Latin America, stock markets had big losses of as much as 17%.

World stock market indexes, Sept 1 to Oct 6, 2008 <font size=-2>(Source: AP/</font>
World stock market indexes, Sept 1 to Oct 6, 2008 (Source: AP/

In European markets, there was a stampede to sell. Britain's FTSE lost 7%, the worst since the Panic of 1987. Markets in Germany, Italy, France and Spain were down 4-5%.

Appearing on the NBC Today show on Monday morning, CNBC's Jim Cramer said he expected as much as a 20% further decline in the stock market and, "Whatever money you need for the next 5 years, take it out of the stock market."

With regard to corporate earnings, he said, "The previous quarter, the second quarter, was a bad quarter, but it will look good compared to the coming quarter."

Market summary, 6-Oct-2008
Market summary, 6-Oct-2008

So on Wall Street, there was a lot of anxiety, but there was also a fair amount of glee, because pundits and investors felt that their fantasy "capitulation event" might finally be occurring, meaning (in this fantasy) that the market would now start going up again, and the bubble would grow again.

The Dow Industrials index fell 800 points in the morning, to well below 10,000 for the first time in years.

We interrupt this narrative for a brief commercial interruption from 1999. I'm sure you'll enjoy it:

Now, back to our show.

In the afternoon, the market regained about 400 points, leaving a lot of people scratching their heads, since there was no special news in the afternoon.

There was a lively discussion on Monday in the Financial Topics thread of the Generational Dynamics forum. One person wrote,

"I could not be more pleased with what I saw today from a traders perspective. We got a beautiful key reversal on massive volume."

Another wrote:

"I had lunch with my co-workers today. Some of them said waiting for some points to jump in the market and pick up some bargains. I think some of these guys may regret not jump into the market this afternoon by seeing the come back."

After the market closed, an analyst on the BBC was asked why the market came back after such a disastrous fall. He said,

"That's a terrific question - we're trying to figure that out ourselves. The pundits are saying that someone with deep pockets came in and started buying, but we don't know who. The stocks that are considered recession-proof -- McDonald's, Pepsi, Coca-Cola -- led the comeback."

What's clear is that the Principle of Maximum Ruin is alive and well. These people are going to lose a lot more money.

The Fed has expanded its liquidity program this morning. European central banks are doing the same. They've already done so much, I didn't think that was possible. But it's not helping. Investors have finally caught on to the fact that the psychological boost of a liquidity injection doesn't last more than a day or two.

It's been amazing to watch this, since I set up the Generational Dynamics web site in 2002. I couldn't foresee the details of what was going to happen, but I applied generational theory to the situation, as well as well-established laws:

I didn't make up these laws, but I've been applying them ruthlessly for years, to predict what's happening now. And, not surprisingly, the predictions derived from these laws have all turned out to be brutally true.

And the fall has much farther to go. Here's Friday's version of the graphic that appears on the bottom of the home page of this web site:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 3-Oct-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 3-Oct-2008. (Source: MarketGauge ® by DataView, LLC)

As you can see, P/E ratios (also called "valuations") are still at really astronomical heights.

Incredibly, the P/E index hasn't even gotten as low as it was back prior to March. It's been at astronomical levels since 1995, and now appears to be the time when the Law of Mean Reversion is applying itself. That means that it's going to be falling well below 10.

All this is lost on the pundits, however. Many of them see this selloff as good news, because it's a "capitulation" event that will cause the market to "snap back" quickly. There's just no limit to the stupidity of these people.

One snap back that we are seeing is the snap back of the dollar, especially against the euro. Those of you who have told me that the dollar would become worthless can now begin to see why you were wrong. The dollar is in a deflationary spiral, which makes it increasingly valuable, while other currencies, including the euro, are collapsing.

I've received a lot of questions about this issue. It's true that America is deeply in debt, inasmuch as we owe China, Japan and other foreign countries far more money than we can ever pay back.

But that's not the issue. The dollar has been the reserve currency since at least the 1930s, and there are huge amounts of dollars in countries around the world.

In the case of Germany's Weimar Republic, which suffered hyper-inflation in the 1920s, few people outside of Germany owned marks. In the case of Zimbabwe today, no one outside of Zimbabwe owns Zimbabwe dollars.

But there are huge amounts of dollars outside of America -- Europe, China, the Mideast -- and all of those holders are as committed to the value and integrity of the dollar as America is.

Forget about the dollar as an American currency. Think of the dollar as a world currency. Even if America no longer had any dollars whatsoever, the dollar would still be valuable on international markets as a world currency.

People have accused me of being "nationalistic" when I write this about the dollar, but that has absolutely nothing to do with it. It's not nationalistic to say that the dollar has become an international world currency, whose value no longer even depends on how many dollars America has. America is just one holder of dollars, among hundreds of other countries, and the value of the dollar is determined by the collective value assigned to it by all those hundreds of countries.

For that reason, the dollar will continue to strengthen against other currencies, as the deflationary spiral continues.

The only other currency I'd be willing to bet on is the yen. Why? Because Japan has already gone through a generational crash in 1990, and they're a nation of survivors of that crash. I'd bet that if there were a way to take a survey of Japanese mattresses, a lot of them would be found to be stuffed with cash.

That means that cash is king. And you should take Jim Cramer's advice: If you're going to need any money in the next five years, then take it out of the stock market, and keep it in cash.

According to my Dow Jones historical page, the Dow Industrials index is now at 70% of its high on October 9 of last year. That's putting an enormous strain on money market funds, hedge funds, endowments, and everything else, and because of high leveraging in the past, it may take just a few more straws to break the camel's back.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (7-Oct-2008) Permanent Link
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European integration is collapsing as banking crisis spreads rapidly

In the so-called "European Union," it's every country for itself now.

The good news is that if you're rich, you can now shift your money into a European bank, and be fully insured -- even for deposits in the millions of euros.

The bad news is that Europe is in the midst of a rapidly spreading bank crisis, and you can't be sure that the bank where you deposit your money will be around much longer.

The crisis was heightened on Sunday when a bailout plan for Germany's Hypo Real Estate collapsed.

Ireland was heavily criticized earlier this week when its Parliament voted to provide a $600 billion guarantee to all deposits, of whatever size, in all Irish banks. The reason given was that the Irish feared a run on Irish banks by panicky depositors afraid of losing their money.

European leaders, led by German Chancellor Angela Merkel, accused Ireland of a "going it alone" approach that ignored the needs of the entire European Union. Some leaders accused Ireland of trying to seduce depositors in other countries to move their funds to Irish banks, risking a run on OTHER European banks. But by Thursday, Greece had joined Ireland, by guaranteeing all bank deposits in Greek banks.

At a meeting of European leaders in Paris on Saturday to deal with the banking crisis, many leaders wanted to take a hard-line position that the banks must deal with their own problems. Hypo bank, in particular, already had a rescue plan in place, with $50 billion to be provided by other banks.

The European leaders particularly rejected a US-like bank bailout, mostly because it would be almost impossible to achieve. All American banks are regulated in the same way, but euroland banks in different countries operate under wildly different sets of regulations. So any attempt at a uniform European response to the banking crisis would immediately get bogged down in different details in every different country.

So the European leaders on Saturday agreed that they didn't know what they would do, but that they would do it together, en famille.

But it took only one day for the entire non-agreement to collapse completely. The other banks backed out of the rescue plan for Hypo bank, and on Sunday a panicked German government, still led by the same Angela Merkel, has guaranteed the savings in all German banks,

As of Sunday evening, officials in Berlin are having frantic meetings to rescue Hypo Bank before the European markets open, around 3 am ET.

However, the bigger picture is the weakness and continuing disintegration of the European Union.

It seems like years ago, but actually it was only four months ago, in June, when Europe was in chaos because Ireland rejected the Lisbon treaty, which had been meant to centralize the EU government. The Europeans would be nostalgic for that kind of chaos right now.

The euro currency, which only really came into existence in 1999, has never been considered entirely trustworthy. In fact, it's always been possible for any individual euroland country to back out of the euro and return to its national currency, as I described in 2004, based on a Morgan Stanley report.

Ireland rejected the Lisbon Treaty, putting Europe into a state of chaos as its hopes for a centralized government were dashed. And now, Ireland has led the way to destroy any common European strategy to deal with the world financial crisis.

Basically, the European Union exists only when everything is going OK; the European Union starts to disintegrate whenever there are any problems.

The events of the last week mean two things, both of which are extremely bad news:

The deflationary spiral continues and accelerates.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (6-Oct-2008) Permanent Link
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The origins of the hare-brained "capitulation" fallacy

It's based on a complete misreading of what happened in 1987.

As I described a few days ago, pundits, analysts and investors are actually all smiles these days because they like what's happening on Wall Street.

They're hoping for "capitulation," where the markets sell off wildly, and then the market starts going up again. This is exactly the mistake that investors made in 1929, and it leads to what I've been calling the "Principle of Maximum Ruin," where everyone gets back into the market, only to lose money again -- the maximum number of people are ruined to the maximum extent possible. In 1929, the markets fell for four years - to 10% of their peak value, by 1933.

In this article, we're going to explain why investors have the fantasy that a "capitulation event" will cause the market to rise again.

The "capitulation" concept is a complete misreading of what happened in 1987, in what I call the "False Panic of 1987."

To understand it, begin by looking closely at the following table, with data from my Dow Jones historical page, which shows the lead-in to the Panic of 1987:

Date              DJIA (Change)    (% of 1987 high)
----------------- --------------  ----------------
Tue 1987-08-25   2722.42( +0.94%) (100% of 87-08-25)
Wed 1987-08-26   2701.85( -0.76%) ( 99% of 87-08-25)
Thu 1987-08-27   2675.06( -0.99%) ( 98% of 87-08-25)
Fri 1987-08-28   2639.35( -1.33%) ( 96% of 87-08-25)
Mon 1987-08-31   2662.95( +0.89%) ( 97% of 87-08-25)
Tue 1987-09-01   2610.97( -1.95%) ( 95% of 87-08-25)
Wed 1987-09-02   2602.04( -0.34%) ( 95% of 87-08-25)
Thu 1987-09-03   2599.49( -0.10%) ( 95% of 87-08-25)
Fri 1987-09-04   2561.38( -1.47%) ( 94% of 87-08-25)
Tue 1987-09-08   2545.12( -0.63%) ( 93% of 87-08-25)
Wed 1987-09-09   2549.27( +0.16%) ( 93% of 87-08-25)
Thu 1987-09-10   2576.05( +1.05%) ( 94% of 87-08-25)
Fri 1987-09-11   2608.74( +1.27%) ( 95% of 87-08-25)
Mon 1987-09-14   2613.04( +0.16%) ( 95% of 87-08-25)
Tue 1987-09-15   2566.58( -1.78%) ( 94% of 87-08-25)
Wed 1987-09-16   2530.19( -1.42%) ( 92% of 87-08-25)
Thu 1987-09-17   2527.90( -0.09%) ( 92% of 87-08-25)
Fri 1987-09-18   2524.64( -0.13%) ( 92% of 87-08-25)
Mon 1987-09-21   2492.82( -1.26%) ( 91% of 87-08-25)
Tue 1987-09-22   2568.05( +3.02%) ( 94% of 87-08-25)
Wed 1987-09-23   2585.67( +0.69%) ( 94% of 87-08-25)
Thu 1987-09-24   2566.42( -0.74%) ( 94% of 87-08-25)
Fri 1987-09-25   2570.17( +0.15%) ( 94% of 87-08-25)
Mon 1987-09-28   2601.50( +1.22%) ( 95% of 87-08-25)
Tue 1987-09-29   2590.57( -0.42%) ( 95% of 87-08-25)
Wed 1987-09-30   2596.28( +0.22%) ( 95% of 87-08-25)
Thu 1987-10-01   2639.20( +1.65%) ( 96% of 87-08-25)
Fri 1987-10-02   2640.99( +0.07%) ( 97% of 87-08-25)
Mon 1987-10-05   2640.18( -0.03%) ( 96% of 87-08-25)
Tue 1987-10-06   2548.63( -3.47%) ( 93% of 87-08-25)
Wed 1987-10-07   2551.08( +0.10%) ( 93% of 87-08-25)
Thu 1987-10-08   2516.64( -1.35%) ( 92% of 87-08-25)
Fri 1987-10-09   2482.21( -1.37%) ( 91% of 87-08-25)
Mon 1987-10-12   2471.44( -0.43%) ( 90% of 87-08-25)
Tue 1987-10-13   2508.16( +1.49%) ( 92% of 87-08-25)
Wed 1987-10-14   2412.70( -3.81%) ( 88% of 87-08-25)
Thu 1987-10-15   2355.09( -2.39%) ( 86% of 87-08-25)
Fri 1987-10-16   2246.73( -4.60%) ( 82% of 87-08-25)

As you can see, on August 25, 1987, the Dow was at 2722, the high for the year. At that point it started falling at the rate of a point or two every day, and then on Friday, Oct 16, it fell 4.6%.

I actually have a personal memory of that weekend. The market had fallen roughly from 2500 on Tuesday to 2200 on Friday, and it was being discussed on television. My memory is of an old guy (who I now realize must have been around 5-10 years old in 1929) saying the following: "The market may fall a little more, but the next 300 point move will be in an upward direction."

Then on Monday, October 19, the market fell 500 points, or 22.6%, all in one day, to around 1700.

Now you can imagine the psychology at the time. The people in charge were survivors of the 1929 crash. As I've described in conjunction with the "58-year hypothesis," these are people 63+ years old who realize that (1) the pattern from 25-Aug to to 19-Oct-1987 was almost identical to the pattern 3-Sept to 28-Oct-1929. These people would recognize the similarity, but younger people would be almost entirely oblivious to it.

(I discussed the 58-year hypothesis in these articles: "The Iraq war may be related to the bombing of Hiroshima and Nagasaki," and "Investors commemorate the false panic of Monday, October 19, 1987.")

The 1987 panic must have been pretty humiliating for the Silent Generation senior managers who had led the panic. They had told the younger people -- the Boomers and Generation-Xers -- that a crash was coming, and no crash came.

Today, the Silent Generation is gone, and the Boomers and Generation-Xers are running things. They learned completely different lessons from what happened in 1987:

The "capitulation" theory comes entirely from that event, and a couple of similar but much smaller "capitulations" that have occurred since then. In other words, the pundits and investors believe that when we have another day like October 28, 1987, a "capitulation," then the market will have truly reached bottom, and will start going up again.

Those who believe in capitulation are missing some very big points:

So it's good to understand that even people who disagree with me about a coming stock market crash still agree that "something" is going to happen -- something like the 22% plunge that happened on 28-Oct-1987. And this is important -- mainstream analysts agree with me that this is what's going to happen.

So mainstream investors agree with me that some kind of panic event is going to occur. Where we differ is what happens afterwards:

I realize that I just quoted the following a few days ago, but you can't possibly read it too many times. It's from John Kenneth Galbraith's 1954 book The Great Crash - 1929. It describes how the "Principle of Maximum Ruin" played out in 1929:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune.

The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. ... The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. ... The ruthlessness of [the stock market was] remarkable." (p. 108)

This is what's about to happen again.

In fact, anyone with any sense at all can see that the market can't start going up again, since corporate earnings are still falling.

As regular readers know, for the last few quarters I've been posting the table of S&P 500 average corporate earnings estimates, based on figures from CNBC Earnings Central supplied by Thomson Reuters. These tables have shown sharp falls in corporate earnings estimates from week to week.

I haven't posted such a table for a while, because there's been so much going on with the various bailouts. However, the third quarter ended last week, so this is a good time to catch up:

  Date    3Q Earnings growth estimate as of that date
  ------- -------------------------------------------
  Mar  3:              25.0%
  Apr  1:              17.3%   Start of previous (2nd) quarter
  Jul  1:              12.6%   Start of quarter
  Sep  5:               0.8%
  Sep 12:              -1.6%
  Sep 19:              -0.3%
  Sep 26:              -1.7%   End of quarter
  Oct  3:              -4.8%

As you can see, the third quarter is proceeding just like the last few quarters -- high hopes and high estimates of rising corporate earnings are dashed as actual earnings come out.

The significance of this to the current article is that with the fall of earnings, price/earnings ratios (valuations) are rising. They've been at very high levels since March, and they continue to be at the astronomic levels of 24-25.

What this means is that the market can't possibly start going up again. The computerized trading programs target a valuation level of around 18 (as I've explained many times, and even that level is way above the historical average. The P/E ratios have nowhere to go now but down, so the hare-brained "capitulation" fantasy can not and will not have anything like the effect that people are dreaming of.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (5-Oct-2008) Permanent Link
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The $700 billion bailout bill becomes law. Now what happens?

We can learn some lessons from China.

The political pressure to pass the Emergency Economic Stabilization Act, which I call the Bailout of the World (BOTW), was enormous, even though nobody could clearly state what the BOTW would do.

However, the tone of the statements from pundits and politicians has changed a bit since a week ago. A week ago, they were always saying something like, "The bailout will prevent the entire financial system from melting down."

Now what they're saying is, "The bailout will make the recession less bad."

And the recession is getting real. There's bad news every day, such as plummeting manufacturing numbers and plummeting employment numbers in just the last couple of days.

We have some good indicators of how much the world economy is slowing down.

Baltic Dry Index and price of oil for 2004 to 3-Oct-2008 <font size=-2>(Source:</font>
Baltic Dry Index and price of oil for 2004 to 3-Oct-2008 (Source:

We hear talk about the real estate bubble and the credit bubble collapsing, but this graph shows that lots of other bubbles are collapsing as well.

Collapse of Chinese economy bubble

What it probably shows most clearly is that the Chinese economic bubble is collapsing.

China's economy has been growing at over 10% a year since the early 1980s, and by the 2000s decade it's been clear that China's entire economy was in a bubble. As I began discussing in 2004 ( here, and in "China approaches Civil War"), China itself agreed that the economy was overheating and had to be slowed down.

Starting in 2003, the Chinese tried to slow their economy down from 10% growth to 7% growth. They failed to do so in 2003, 2004, 2005, 2006 or 2007. I and a lot of other people speculated that the continuing bubble was being caused by the frenzy leading up to the Beijing Olympics, and that the Chinese economy would finally begin to slow down once the Olympics games ended.

Actually, the slowdown began occurring earlier this year, and I discussed it in June, in "Shanghai China stock market and Baltic Dry Index are crashing sharply."

I've frequently stated my belief that a major cause of the huge spike in commodities prices in the last four years -- wheat, iron ore, oil, and many others -- was caused by the accelerating bubble in the Chinese economy. The prices of many of these "dry" goods is reflected by the Baltic Dry Index.

Now the commodities bubble is leaking rapidly, and the graph above shows that the BDI and the price of oil have fallen sharply, and in unison. What I actually believe is that, with the excitement of the Olympics over, the entire Chinese economy is in free fall. We'll see in the next few weeks whether this last turns out to be true.

But now let's get back to the Bailout of the World plan.

The point I want to make is that the Chinese have totally failed, over a period of many years, to slow down their overheated economy.

The Chinese Communist Party (CCP) had the power to do anything they wanted. They could manipulate any macroeconomy variable they wanted. They could manipulate interest rates, manipulate regulations, manipulate import or export controls, manipulate business laws, manipulate many import and export prices, and so forth. The CCP has all the powers that the American government has, and many more. And they don't have to go through Congress to get something changed; they just do it.

And yet, they've totally lost control of their economy. They couldn't slow it down when it was overheated, and now they can't prevent it from slowing down much faster than they want.

So here's the question I want to ask:

The answer is that, as usual, the people in Washington are dreaming. The BOTW plan will not have the desired consequences. In fact, the American and Chinese economies are closely interlocked, and I believe that both are plummeting quickly now.

Incidentally, a lot of people are making a mistake when they say, "China is going to do well, because the Chinese people are savers, while Americans are borrowers, and are deeply in debt."

Actually, the collapse of the Chinese economy's bubble is just as disastrous as the collapse of America's real estate and credit bubbles. The easiest way to see that is that the 1930s Great Depression was disastrous to Americans, even though Americans had been savers in the 1920s. Read "The bubble that broke the world" to understand how that happened.

The world waits

The bailout bill vote in the House of Representatives has been worldwide news. People around the world have been following the vote with rapt attention, as their economies run down. The concept is: "The Americans did this to us with their worthless mortgage-based securities, so now we expect American money to help us out."

That's going to be a good trick. The Fed and other central banks have already injected a trillion dollars of liquidity, and things have continually gotten worse, so it's hard to see how a few hundred billion more is going to turn things around.

I hear comments from pundits and politicians like, "I feel people have a positive view of the future," and "The economy is biased toward growth." That's sort of true, but when they give examples, the examples are always from the 1990s (the dot-com bubble) or 2003 (the credit and real estate bubbles).

What they refuse to understand is how drastically people have changed. The massive fraud and deception that was commonplace up till the beginning of 2007 -- thanks to the lethal combination of the stupidity of the Boomers and nihilism of the Generation-Xers -- has now been reversed. Mutual trust has been replaced by mutual suspicion. Mutual tolerance has been replaced by mutual condemnation.

These are massive attitude and behavioral changes of generational behavior. Everyone seems to expect that the Bailout of the World bill will cause these massive attitude and behavioral changes to reverse. Why would they believe that? Because they're thinking of the Unraveling era, the 1990s, when the motto still was, "Whatever feels good, do it."

Buy on the rumor, sell on the news

Market summary, 3-Oct-2008
Market summary, 3-Oct-2008

I've heard this phrase, "Buy on the rumor, sell on the news," but I've never been entirely sure what it means. It's something like this: If there's a big event coming, then everyone buys. Then, when the event actually occurs, the day traders sell, taking a profit, leaving behind the poor schmucks who thought that buying was actually a good idea.

Anyway, that's what happened on Friday.

The Dow went up 300 points as the House of Representatives vote approached. Once the vote was completed, around 1:30 pm, the Dow fell 300 points quickly, and continued to fall.

Friday's stock market fall was a disaster all by itself. The Dow index is now 28% below its peak last year in October, and is at the lowest point since October, 2005.

Pundits and analysts had very long faces on Friday afternoon. I heard words like "disappointing" and "disconcerting." The given causes included Friday's disastrous employment report, and other poor economic indicators.

The pundits have a new hope: A Fed interest rate cut on Monday or Tuesday.

It seems that the only thing preventing a big plunge is for the Fed to keep throwing things at the market. If $700 billion doesn't do the trick, then it's hard for me, at least, to see how an interest rate reduction is going to help much.

The deflationary spiral continues to accelerate. The amount of money in the world is decreasing rapidly, fast enough so that the $700 billion can't keep up with it. Credit is becoming tighter, and commercial interest rates continue to be at historically high levels. It'll be interesting to see whether the $700 billion has even a TEMPORARY effect.

The next that the pundits will be watching for is the reaction of the Asian markets, as they open at around around 7 pm ET on Sunday evening.

Comments from web site readers

I strongly urge everyone who wants more frequent commentary and discussion to visit the new Generational Dynamics forum, especially the Financial Topics thread. I've been posting frequent commentary in that thread, and others have been posting their own comments.

In fact, if you're wondering what to do with your money, I recommend reading the entire thread, for lots of good ideas.

Here are some recent comments from visitors to the forum:

"I read your blog about the reader who can only choose 1 money market for his 401K. [See: "Are your 401K funds safe?"]

First of all, he has been informed of what is in it. These companies are required to send a prospectus periodically stating what is in each money market fund and they do. If he threw it away, that is his problem. I read mine and pulled my money out of the fund in 2005 when there was still plenty of time to do it.

Ignorance is no excuse. If someone is too stupid to understand the prospectus or too lazy to read it, then that person deserves to lose their money, and frankly, I don't feel sorry for any of these people."

This is a very hard opinion, but it's typical of how the attitudes of the great mass of Americans are changing. As we've said, mutual trust has been replaced by mutual suspicion, and mutual tolerance has been replaced by mutual condemnation. This change will accelerate.

Another person had an idea for the person who can't get money out of his 401K:

"There is one way out of the 401K debacle if you think you are about to get screwed. 401Ks typically have a loan option. You can take out perhaps up to 50% (the amount equal to the IRS penalty) and hide that somewhere else. Of course you will have to repay that loan... I wonder what the IRS will do if people all of a sudden lost their entire 401K yet still had a loan out (and then lost their job, too). Gives me a headache... Oh well, if the crash happens I will find out. I took out a loan to provide a downpayment on a house (saved me from mortgage insurance, heh heh).

Actually, when I tried to find out about my money market fund it was over a year ago, before all of this stuff started headlining the news. They had no answers then and I'm sure if anything is wrong they will certainly stonewall me now."

I honestly don't know if this idea will work for most people. If you borrow money against your 401K, and then your 401K loses value, then you still have to repay the loan, and your 401K has still lost its value. But the situation may be different for each individual, so check with your lawyer or financial adviser.

I've frequently mentioned the Principle of Maximum Ruin -- the principle that, as in 1929, the coming crash will ruin the maximum number of people to the maximum extent possible. Here's one person's posting on this subject:

"I have to laugh when I think about recent developments. The Principle of Maximum Ruin has to happen because people will believe what they want to... because they have to believe in it. They are so invested (emotionally and financially) in their Pollyannaish outlook that they can't admit that a freight train is about to hit them. I never thought in my wildest dreams that I would witness such collective insanity. It's REALLY mind-boggling."

The "panic crash" or "capitulation event" that we're headed for will only accelerate the Principle of Maximum Ruin. Don't expect the pundits, politicians, analysts and bloggers to start saying, "Ohmigod! I've been wrong all these years, and I now realize that we're the in the midst of a big crash."

Instead they'll say, "It's everybody's fault but mine, because the Congress and Administration didn't take my advice. But now the worst is over, and the market will go up again, especially if they take my advice now."

So ordinary people will listen to this crap, will invest further in the market, and will get further screwed, since the market is going to continue to fall for several years. As the months go by, the maximum number of people will be ruined to the maximum extent possible -- the Principle of Maximum Ruin.

Incidentally, if you'd like to post something on the Generational Dynamics forum, but you don't want to do it yourself, then send it to me as a comment, and I'll post it for you.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (4-Oct-2008) Permanent Link
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Are your 401K funds safe?

I received the following question from a web site reader. I've carefully edited the text to hide identities, and protect the guilty:

"Not trying to create a panic, but just don't like being held hostage by dumb rules that could effect your nest egg.

If you are in the [company 401K plan], you can not remain an employee and move your account balance to a roll-over IRA plan outside the [company-sponsored plan]. If you currently believe your retirement funds should now be protected in a money market fund and not in a stock or bond fund during these times of financial market stress, you have only one choice under the company plan, one specific money market fund.

The problem here is the fund's makeup is only 12% of Government backed treasuries. The other 88% of the holdings are potentially high risk instruments if the financial market turns ugly. They have a security blanket to back up the fund but it is not backed up by the US Government. I spoke to a rep at [the investment firm managing the fund] and he confirmed the fund holds NO guarantee that your money will be safe from loss and could face a situation where it can not maintain the $1.00 par value. The only way an employee can roll their nest egg out to a safer plan is to leave the company by separation (voluntarily or involuntarily) or retirement."

I wrote back to him: You're going to be screwed. I strongly urge you to find a loophole. Perhaps claim a medical emergency in your family and withdraw the funds and take the tax penalty.

There are two things in your message that really raise red flags:

Based on these two major red flags, I believe that your funds are already frozen, meaning that even if you separated from the company, they would make it difficult or impossible to withdraw or transfer your funds.

Read the following articles from earlier this year for examples of this practice: "Wealthy investors in auction rate securities can't get their money out"; "Your money market funds may be frozen without you knowing it"; and "Investment bank UBS is now 'writing down' clients' auction rate securities."

If you have a lot of money in your retirement fund, all I can suggest again is that you try to find a loophole.

If my suspicion is true, then both the investment bank and the company are scared to death of panic withdrawals. If employees discovered that their 401K savings are nearly worthless, there would be a riot.

For that reason, you have some leverage. Get together with a couple of other people, hire a lawyer, and make some demands, with the threat of spreading the word that the money market funds are frozen.

Whatever you decide to do, you have little time. (3-Oct-2008) Permanent Link
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The nutty bailout bill discussion

As I listen to politicians on both sides of the $700 billion Bailout of the World (BOTW) plan, I enjoy seeing how much they're sweating.

If you ask them whether $700 billion is the right amount, they say they don't know. If you ask them whether the bill is going to work, they say that they hope so, but they don't know.

The reason that they're sweating is not because they're necessarily concerned whether the bailout plan will work, but only whether they'll be blamed for whatever happens. You can almost hear the gears in their minds grinding: "Which way should I vote to get reelected in November?"

The result is that we're hearing some pretty nutty arguments.

One is the "mark to market" debate.

Under this proposal, the reason that we're in so much trouble is because financial firms are required to provide "mark to market" valuations of the securities that they manage. If only that nasty requirement could be repealed, then banks could return to claiming high values for mortgage-backed securities, and the crisis would end.

There are several problems with this proposal:

Market summary, 2-Oct-2008
Market summary, 2-Oct-2008

So when a politician talks about repealing the mark to market rules, it's not because doing so would actually change anything, but it might get him votes.

A web site wrote to me today, recommending that I listen to an interview with Nouriel Roubini. She wrote, "I really enjoyed this interview. This clarifies a lot of the questions I am hearing and discussions with friends about why this Paulson bailout plan is a joke. It's more entertaining and informative than most Bloomberg financial interviews because Dr. Nouriel Roubini appeals to basic common sense. The fact that our government hasn't enlisted the majority of economists who agree with Roubini for an alternative plan to Paulson's plan, is a complete failure of leadership."

But all of these people -- journalists, pundits, college professors -- are just screwing around. They're just saying things to cover their asses when everything goes wrong.

These people are arguing about a plan that will have no effect at all. It's as if there were a one-mile-high tsunami heading toward land, and the bailout plan was to line the beaches with buckets, so that people could scoop up the water and toss it back out into the ocean. Bickering and arguing over the number of buckets on the beach is irrelevant, since the tsunami is going to wash all the buckets away anyway. The above graphic shows that investors are not impressed with what's going on in Congress. The Senate has approved the bailout bill, and the House of Representatives will vote tomorrow.

The supporters of the bill say things like, "We have to supply some liquidity to restart the banks, so that they can get back to normal and start lending to each other again."

I can't imagine what these people are thinking. They must think that the world financial system is like a motor on a lawn mower -- all you have to do to get it going is give it a spin.

Well, what made the motor stop spinning in the first place?

The last few weeks have shown a steady downtrend in the stock market indexes. The downward trend is the most similar to the time just prior to the 1929 crash than I've seen so far.

But the real crash is the continuing in the credit markets.

Here's a graph that a blogger posted, courtesy of Barclay's bank:

Credit market summary, 2004 to 2-Oct-2008
Credit market summary, 2004 to 2-Oct-2008

The Libor/OIS and TED spread graphs show that interest rates get worse and worse every day. This is the lawn mower engine that the politicians want to restart with a gimmick. But the credit markets are getting more and more locked up every day.

The reason is the same that I've given before: As the massive real estate and credit bubbles deflate, the world's deflationary spiral is getting deeper and deeper. Each day, there's far less money (US dollars) in the world than the day before because of asset writedowns, deleveraging, and so forth.

The real estate bubble increased the total price of real estate from about $15 trillion to $22 trillion, so the leaking real estate bubble will take back $7 trillion from the world.

Last week, I quoted the Financial Times as saying that a partial deleveraging of investment banks would $6 trillion in asset sales, and since those investments were made on credit, that means $6 trillion less money in the world. Extrapolating those figures, full deleveraging of investment banks would come to $20-30 trillion.

And then we have the matter of credit default swaps. There are $60 trillion of those in portfolios around the world (including a lot of overlap with the $20-30 trillion figure of the last paragraph), and these are all going to unwind at some point, losing more tens of trillions of dollars in the world. And I don't even want to think about that one quadrillion dollars in credit derivatives that are around.

The point I'm making is that we're talking about numbers that are so huge, $700 billion is tiny compared to it. That's what I meant above, comparing the size of a few buckets to the size of a one-mile-high tsunami.

If you're one of those who haven't prepared for what's coming, I honestly doubt that you have much time left. (3-Oct-2008) Permanent Link
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Pundits are all smiles, as they await a "panic crash" or "retail capitulation"

Panic selling on Monday became panic buying on Tuesday, as Wall Street recovered about half of what it had lost on Monday.

I received the following from a web site reader today:

Market summary, 30-Sep-2008
Market summary, 30-Sep-2008

"So how are you doing? I am sitting here watching CNBC and the talk about fear in the markets, I do not see the real fear I have been waiting for, fear where the people exit the markets and the banks. The “follow the herd” has not happen yet, I don’t know if we will be able to see the tipping point or there will be a general panic from Main Street. There may be a couple of days over the next couple months but the downturn now has turned into severe downward spiral, I think October will be brutal. I have been checking your site and blog, the only comment I have is that the great depression will not happen again -- this time it will be the Greater Depression!"

You're absolutely right. The "generational panic and crash" has not yet happened, but it could happen any day now.

The people in Washington have no idea what's going on. They think that the market is going down for psychological reasons, and that all they have to do is "restore confidence."

But the evidence from 1929 refutes that. What is clear is that the 1929 crash was caused by forced selling -- people who had invested on margin had to sell everything to meet margin calls, and selling everything pushed prices down even farther. Investor psychology had absolutely nothing to do with it. It boggles my mind that Ben Bernanke, who is considered the world's greatest expert on the Great Depression, doesn't understand that, and has said some unbelievably dumb things over recent years.

I had previous written about Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, and the Calculated Risk blog (with Tanta), thinking that these people had begun to catch on to what's going on.

These and other blogs have turned into nattering jokes. Shedlock is on some weird crusade to stop the bailout, CalculatedRisk can't decide whether or not there'll be a recession, and Roubini, who's become an international television superstar, constantly flip-flops on whether such-and-such a detail in the bailout plan is will PREVENT systemic failure or CAUSE systemic failure. These people must be getting along on their good looks, because it's certainly not their brains.

What is it that makes these people, as well as Ben Bernanke and other so-called "experts," such airheads? It must be Generation-X perversion (even though they're not all Gen-Xers). All you have to do is look at a couple of the graphs in "How to compute the 'real value' of the stock market," and you can see it right off. This isn't rocket science; it's perfectly obvious to anyone who understands calculus. Don't any of these bloggers know calculus?

There are actually lots of signs that a lot of forced selling is already going on. The Lehman bankruptcy two weeks ago is apparently having major chain reaction effects, according to a Wall Street Journal analysis. Pundits have been saying that hedge funds are deleveraging like mad. And of course, banks have been falling like dominoes, here and in Europe.

Furthermore, the credit markets were worse on Tuesday than Monday, with interest rates at fresh historically high levels.

One day soon there will be a generational panic and crash because there MUST be.

Ironically -- and this is perhaps the craziest thing of all -- the pundits are smiling today, because they believe that the end is in sight. As incredible as it seems, they're all disappointed that we haven't seen a "panic crash" or "retail capitulation" yet.

No, there's no sign of real fear on CNBC. They're waiting gleefully for a "panic crash" and "retail capitulation."

That's where the markets sell off wildly, and then the bubble can start again. They're hoping for that, so that the champagne parties can come back.

Why would they ever think that? Why would they think that if a "panic crash" occurs, then it will mean that the markets had reached bottom and were going up again? Where did they ever get such an idea?

They got it because that's what happened in 1987. The market fell 23% on on one day, October 19, 1987. That's the pattern they've been studying and remembering, and that's the pattern that they expect to repeat.

There are several major reasons why the 1987 pattern doesn't apply today:

But for some reason that totally escapes me, these pundits and bloggers are totally blind to what's going on.

It's really eerie to see what happened in 1929 being repeated, almost as if everyone were reading from a script.

I've quoted the following paragraph from John Kenneth Galbraith's 1954 book The Great Crash - 1929, many times before, but it's a like a mystical song that appears to be more and more meaningful, each time you hear it:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune.

The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. ... The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. ... The ruthlessness of [the stock market was] remarkable." (p. 108)

That's why the comparison of today to 1987 is the same mistake that investors in 1929 made, making a comparison to the panic of 1907. Investors are making exactly the same mistake today, totally oblivious to the generational changes that make everything different.

This is what leads to what I've been calling the "Principle of Maximum Ruin," where everyone gets back into the market, only to lose money again -- the maximum number of people are ruined to the maximum extent possible. In 1929, the markets fell for four years - to 10% of their peak value, by 1933.

So those hoping for a "panic crash" or "retail capitulation" are going to get their wish. As usual, be careful what you wish for.

I had lunch recently with my boss and his boss. They were discussing the stock market, and I said, "It's going to crash. Everyone will lose everything." They both laughed. I guess I was lucky they didn't call security.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (1-Oct-2008) Permanent Link
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