Start Worrying When The Really Smart Guys Say "Boo!"

They use different measurements of intelligence when they talk about Marc Faber. He is one of the few money-men who ranks as an "Ultra-Genius." Many try to emulate his original thinking, few succeed. Read and absorb the raw smartness, and yes, I'm a fan.

EXTRAORDINARY MONETARY MEASURES
by Dr. Marc Faber
If any longish marriage is an exercise in irritation management, so islistening to the hype by media commentators about the soundness andsuperiority of the US economy and about how well US stocks are performing.I suppose that if Larry Kudlow were living in Zimbabwe, where the economyhas been contracting for eight straight years and has shrunk by 50% since1999, and where hunger is spreading and life expectancy is down to 35years, he would also be enthusiastic about the prospects of Zimbabwe'sstock market, which is currently soaring as inflation is likely to reach5,000% this year. (Michael Lewitt of Harch Capital Management recentlycommented on the Zimbabwe stock market and noted that on March 20, theZimbabwe stock exchange rose in that one single day by as much as in theprevious 40 years to December 2006 combined.)As in the case of the US, but in a more extreme way, while stocks aresoaring in Zimbabwe, the currency is collapsing. (In fact, it is an exactreplica of what happened during the Weimar hyperinflation of 1919-1923, inlocal currency terms, the stock market index soared into the trillions butcollapsed in gold terms.) John Paul Koning, an analyst at Pollitt & Co inToronto and writing for the Mises Institute, has made the followingpertinent observation about the Zimbabwe Stock Exchange:"The ZSE is growing some three times faster than consumer prices. Thisrelative outperformance versus general prices is a result of stocks beinga chief entry point for the flood of newly created money. Keep Zimbabweandollars in your pocket, and they've already lost a chunk of their value bythe next day. Putting money in the bank, where rates are pithy, is notmuch better. Investing in government bonds is the equivalent of financialsuicide."Converting wealth into foreign currency is difficult; hard currency isscarce, and strict rules limit exchangeability. As for capitalimprovements, there is little incentive on the part of companies to investin their already-losing enterprises since economic prospects look sobleak. Very few havens exist for people to hide their wealth from theevils created by Mugabe's policies. Like compressed air looking for anexit, money is pouring into shares of ZSE-listed firms like banker OldMutual, hotel group Meikles Africa, and mobile phone firm Econet Wireless.It is the only place to go. Thus the 12,000% year over year increase inthe Zimbabwe Industrials."Our Zimbabwe example, though extreme, demonstrates how changes in stockprices can be driven by monetary conditions, and not changes in GDP. Newmoney gets spent or invested. In Zimbabwe's case, because there are noalternatives, it is stocks that are benefiting. This sort of thinking canbe applied to the stock markets in the Western world too. Though westerncentral banks have not been printing nearly as fast as their Zimbabwecounterpart, they do have a long history of increasing the money supply.It forces one to ask how much of the growth in Western stock markets overthe preceding twenty-five years has been created by a vastly increasingmoney supply, and how much is due to actual wealth creation."Perhaps stock prices have increased faster than goods prices for the lasttwenty-five years because, as in Zimbabwe, Western stock markets havebecome one of the principal entry points for newly printed currency."Now, I don't anticipate that a Zimbabwe-like scenario will unfold in theUnited States soon, but the phenomenon of investors realizing that cashdeposits don't give them adequate protection from the loss of their papermoney's purchasing power and therefore rushing into any kind of asset isthe same everywhere in the world. Also similar is the increase in assetprices in local currency in Zimbabwe and the United States, and thecollapse of the Zimbabwe dollar and, to a far lesser extent, the declinein value of the US dollar.Still, for now, there is some hope for the US dollar. As explained in lastmonth's report, it is not the Fed that has tightened monetary conditions,but the marketplace through the collapse of the sub-prime lendingindustry. Since the housing market is more likely to deteriorate furtherthan to recover, credit problems could get much worse. In any event,Robert Toll, CEO of Toll Brothers, just sold another US$8.3 million worthof shares. Since his company's shares are down from almost US$60 in 2005to US$27, his selling would indicate that he doesn't see any immediateturnaround in the housing industry. Moreover, there are several reasons why the Fed is unlikely to cutinterest rates in the near future. Food and energy prices as well asimport prices are rising, which could further increase inflationarypressures. The dollar is also in a very precarious position, and bondyields have so far failed to decline despite evidence of an economicslowdown.Finally, I suppose Mr. Bernanke understands very well the difficultposition he finds himself in as the chairman of the Fed. Should inflationunder his chairmanship at the Fed become a problem, he knows that he willbe blamed for it. Conversely, he is also well aware that if some sort ofrecession occurred due to a currently somewhat more hawkish monetarystance, financial observers will be quick to blame Mr. Greenspan for it,since the former Fed chairman addressed any financial crisis or anypotential problem (Y2K, for example) by printing money and can thus beconsidered directly responsible for the housing bubble.So, from a career and reputation risk point of view, Mr. Bernanke willlikely move very slowly in cutting rates and rather take the risk of somemild form of recession occurring. He could then blame a recession, whichwould have come from the housing sector, on Mr. Greenspan. After that, hecould take some "extraordinary monetary measures" in order to engineer aneconomic recovery for which he would take credit. And should at that timeinflationary pressures have failed to abate or have even increased - as Iwould expect them to do - he could always argue that the Fed's policypriorities have temporary shifted to emphasize "economic growth" over"targeting inflation", and that the Fed will deal with inflation once theeconomy has fully recovered. The stance of emphasizing "economic growth"over "inflation targeting" would by then also be perfectly acceptablepolitically and thus would be welcomed by the "establishment",which would have taken advantage of a bear market in housing and hardshipamong sub-prime borrowers to acquire some assets at bargain prices...I am mentioning this because as my friend Bill King, author of The KingReport reported, Ben Bernanke recently gave a speech at Stanford in whichhe said that "increased trade with China has reduced U.S. inflation, nowrunning at about 2%, by only about 0.1 percentage point". He also notedthat while emerging economies have added to the global supply ofmanufactured goods, they are also adding to the demand for oil and othercommodities. And according to Mr. Bernanke, "There seems to be littlebasis for concluding that globalization overall has significantly reducedinflation in theU.S. in recent years; indeed, the opposite may be true."And this is where I think the Goldilocks prophets with tunnel vision, whoargue for continuous economic growth amid low inflation, will be as wrongas they have been for the past few years. The super-bulls on the US havesimply overlooked the fact that if economic growth in China, India,Vietnam, and other emerging regions of the world remains strong and the USeconomy continues to expand, this synchronised global boom will besupportive of commodity prices whose price gains have significantlyoutstripped the performance of US financial asset prices since 2001. So,in the event, as the entire Goldilocks sect argues, that the globaleconomy remains strong, inflationary pressures should increase. Commodityprices, especially for agricultural products, are in real terms stillextremely depressed and, contrary to expectations, could rise far morethan many would think possible.However, illiquidity among the US household sector, along with thereluctance of the Fed to cut rates right away, combined with therequirements for enormous capital investments for infrastructure inemerging and developed economies, could lead to some tightening ofliquidity around the world.Therefore, I expect a more meaningful setback in asset prices and wouldcertainly defer the purchase of financial assets. In particular, I amconcerned by the inability of financial stocks to rally convincingly fromtheir March 2007 lows, since financials are usuallyleading the market up and down. In my opinion, there is an ongoingdeterioration in the US stock market. In the summer of 2005, thehomebuilders peaked out. Last year, it was the turn of the sub-primelenders to top out. And early this year, financial shares, includingbrokers, made their highs. The economy is likely to follow this slow stockmarket erosion and gradually deteriorate, with disappointing corporateprofits to follow.Investors who must own US shares may find some relative outperformanceamong pharmaceutical companies, and oil and coal stocks. For the reasonsoutlined above (a relative tightening of liquidity in the world), I don'texpect the US dollar to collapse immediately. However, it should be clearthat in the long run the purchasing power of the US dollar will continueto decline against sound currencies such as precious metals. Therefore, Icontinue recommending the accumulation of gold and silver.But it is increasingly likely that something will give soon: either assetprices will decline in a tighter liquidity environment, or the US dollarwill fall sharply if the Fed continues to pursue expansionary monetarypolicies. For the US financial market, this means either weak equities anda strong dollar or strong equities and a weak dollar.Not a particularly appealing scenario!