Getting Back to the Roots of Turmoil
Today's comment is by John Pugsley, The Sovereign Society's Chairman, best-selling author and long-time free-market Libertarian. Dear A-Letter Reader,New Year's Eve, 2007 - It's a perfect time for wise investors to reflect on the past year, and the lessons 2007 brought. However, to really understand the turmoil in stocks, bonds and real estate of these past 12 months you must understand the roots of that turmoil.
Those of us who lived through the financial storms of the 1970s remember inflation peaking at 18%, and interest rates tracking them closely. Paul Volcker took over the helm of the Fed in August 1979 as the inflation crisis raged.
Volcker Veers Us Towards Prosperity
Rather than letting the U.S. plunge into hyperinflation, Volcker did the right thing: He put the brakes on money creation. It worked, and inflation subsided. Then, to prevent the recession from turning into a depression, he changed course and began to ease in 1981.
Between January 1981 and 2004 the Federal Funds rate bounced erratically downhill. The Fed Funds eventually fell from its high of 20% to a low of just 1% in 2003. It was a rate not seen since 1954, 50 years earlier.
The Fed's relentless credit expansion over this past quarter century had predictable effects: Price inflation...no, not price inflation of consumer goods. Strangely, this vast money expansion didn't show up it the CPI. Rather, it created a boom in asset prices. Stocks, real estate and even art seemed destined to rise forever, and investors' expectations skyrocketed right along with them. It seemed a new era of endless prosperity had arrived.
In the Age of Alan
As the 21st Century began, now with Alan Greenspan at the helm, credit was flowing, and stocks and real estate boomed.
Using the global supply of dollars as a proxy, The Economist estimated that liquidity had risen by an annual average of 18% in four years. The Economist said it was probably the fastest pace ever. Worldwide, an abundance of easy credit lured investors into riskier assets for higher returns.
Real estate became the investment darling. Now, every American could become a homeowner. If you didn't quality for regular mortgages, you could turn to the new sub-prime lenders.
Starting from a virtual standstill 10 years ago, sub-prime lenders became by far the fastest-growing segment of mortgage lending. They wrote US$540 billion in mortgages by 2004 and US$625 billion at their peak in 2006 - roughly one-quarter of all new mortgages. By late 2005, the battle for market share had pushed rates for borrowers with poor credit down to a little over 7%.
Sub-prime Lending Starts to Unravel the Economy
Fast forward to this past January. As 2007 began, the unintended consequences of the credit surge began to appear. In December a number of mid-sized mortgage firms failed. The first was Ownit Mortgage Solutions, the 17th-largest sub-prime lender. Owners of other sub-prime lenders put their businesses up for sale soon after to flee the business. .
One by one, anyone holding the packaged mortgages have been hit, from Fannie Mae and Freddie Mac, to big banks. We read of queues forming outside Northern Rock, the Britain's fifth-biggest mortgage lender. It was the first bank run in Britain since 1866. The writing was on the wall. And it isn't over yet.
Nor was the credit-induced asset bubble confined to real estate. By early 2007,Wall Street had enjoyed its longest period without a 2% daily fall for more than five decades. Margin debt - the money buyers borrow from brokers - passed its previous peak, recorded during the dotcom bubble.
Mini-Crash - a Warning that No One Heard
Then a sell-off in the Chinese market gave a hint of the weakness.
On February 27th, at around 3:00 PM New York time, the Dow Jones Industrial Average was down by a couple of hundred points. In less than a minute, the Dow plummeted another 200 points. Traders said it was an unprecedented rate of decline. The Fed came to the rescue, and the public's fears, and caution, evaporated.
Real estate and stocks are not the only inflated asset classes, either. Global liquidity is such that money is pouring into any investment with the potential to produce a quick return, even art. But, as one commentator noted, at least a Jackson Pollock looks better hanging on a wall than a share certificate does.
Still Your Average Investor Doesn't Get It
Of course, the public still does not understand the roots of the sub-prime debacle. Nor does your average investor understand that the vast credit excesses of the past quarter century are far from being purged from the system.
In spite of the distortions created by central bank money creation, the public still wants another money injection. More "hair of the dog," please.
As 2007 began, members of The Sovereign Society were already well versed in the story of the credit bubble. We profited handsomely from the turmoil, through wide diversification into classes of assets that offer tangible values, like gold and commodities, and through international diversification among currencies and countries.
The lessons of 2007 were simply repeats of lessons that our cadre of experts here at The Sovereign Society have been teaching for the past 10 years. Trust not in the sovereign state. Trust in your own individual sovereignty - especially over your portfolio.
Today's comment is by John Pugsley, The Sovereign Society's Chairman, best-selling author and long-time free-market Libertarian. Dear A-Letter Reader,New Year's Eve, 2007 - It's a perfect time for wise investors to reflect on the past year, and the lessons 2007 brought. However, to really understand the turmoil in stocks, bonds and real estate of these past 12 months you must understand the roots of that turmoil.
Those of us who lived through the financial storms of the 1970s remember inflation peaking at 18%, and interest rates tracking them closely. Paul Volcker took over the helm of the Fed in August 1979 as the inflation crisis raged.
Volcker Veers Us Towards Prosperity
Rather than letting the U.S. plunge into hyperinflation, Volcker did the right thing: He put the brakes on money creation. It worked, and inflation subsided. Then, to prevent the recession from turning into a depression, he changed course and began to ease in 1981.
Between January 1981 and 2004 the Federal Funds rate bounced erratically downhill. The Fed Funds eventually fell from its high of 20% to a low of just 1% in 2003. It was a rate not seen since 1954, 50 years earlier.
The Fed's relentless credit expansion over this past quarter century had predictable effects: Price inflation...no, not price inflation of consumer goods. Strangely, this vast money expansion didn't show up it the CPI. Rather, it created a boom in asset prices. Stocks, real estate and even art seemed destined to rise forever, and investors' expectations skyrocketed right along with them. It seemed a new era of endless prosperity had arrived.
In the Age of Alan
As the 21st Century began, now with Alan Greenspan at the helm, credit was flowing, and stocks and real estate boomed.
Using the global supply of dollars as a proxy, The Economist estimated that liquidity had risen by an annual average of 18% in four years. The Economist said it was probably the fastest pace ever. Worldwide, an abundance of easy credit lured investors into riskier assets for higher returns.
Real estate became the investment darling. Now, every American could become a homeowner. If you didn't quality for regular mortgages, you could turn to the new sub-prime lenders.
Starting from a virtual standstill 10 years ago, sub-prime lenders became by far the fastest-growing segment of mortgage lending. They wrote US$540 billion in mortgages by 2004 and US$625 billion at their peak in 2006 - roughly one-quarter of all new mortgages. By late 2005, the battle for market share had pushed rates for borrowers with poor credit down to a little over 7%.
Sub-prime Lending Starts to Unravel the Economy
Fast forward to this past January. As 2007 began, the unintended consequences of the credit surge began to appear. In December a number of mid-sized mortgage firms failed. The first was Ownit Mortgage Solutions, the 17th-largest sub-prime lender. Owners of other sub-prime lenders put their businesses up for sale soon after to flee the business. .
One by one, anyone holding the packaged mortgages have been hit, from Fannie Mae and Freddie Mac, to big banks. We read of queues forming outside Northern Rock, the Britain's fifth-biggest mortgage lender. It was the first bank run in Britain since 1866. The writing was on the wall. And it isn't over yet.
Nor was the credit-induced asset bubble confined to real estate. By early 2007,Wall Street had enjoyed its longest period without a 2% daily fall for more than five decades. Margin debt - the money buyers borrow from brokers - passed its previous peak, recorded during the dotcom bubble.
Mini-Crash - a Warning that No One Heard
Then a sell-off in the Chinese market gave a hint of the weakness.
On February 27th, at around 3:00 PM New York time, the Dow Jones Industrial Average was down by a couple of hundred points. In less than a minute, the Dow plummeted another 200 points. Traders said it was an unprecedented rate of decline. The Fed came to the rescue, and the public's fears, and caution, evaporated.
Real estate and stocks are not the only inflated asset classes, either. Global liquidity is such that money is pouring into any investment with the potential to produce a quick return, even art. But, as one commentator noted, at least a Jackson Pollock looks better hanging on a wall than a share certificate does.
Still Your Average Investor Doesn't Get It
Of course, the public still does not understand the roots of the sub-prime debacle. Nor does your average investor understand that the vast credit excesses of the past quarter century are far from being purged from the system.
In spite of the distortions created by central bank money creation, the public still wants another money injection. More "hair of the dog," please.
As 2007 began, members of The Sovereign Society were already well versed in the story of the credit bubble. We profited handsomely from the turmoil, through wide diversification into classes of assets that offer tangible values, like gold and commodities, and through international diversification among currencies and countries.
The lessons of 2007 were simply repeats of lessons that our cadre of experts here at The Sovereign Society have been teaching for the past 10 years. Trust not in the sovereign state. Trust in your own individual sovereignty - especially over your portfolio.
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