[Mb-civic] Interesting financial overview

[Peter Fleming]

Friends,
I send this to you because, whether you agree with
the information or not, it is so widely based, so all
encompassing, which, to me, makes it very interesting
reading and the only financial piece I have re-sent out 
in a long time. This fellow has a broadly interesting view.

My bottom line literary agent analysis: it's a "good read".

 Best regards,    Peter F

------------------------------------------------------------
from Gary North's, The Daily Reckoning

Santa Fe, New Mexico
Wednesday, August 04, 2004

The Daily Reckoning PRESENTS: Porter Stansberry smells 
inflation, and last month, Porter glimpsed two items that 
bolster this conclusion. 

THE BIG BAD WOLF      by Porter Stansberry

The title of this essay comes from one of my favorite 
WARREN BUFFETT quotes. This one is taken from his 1988 
annual report. It was written just after the great 
leveraged buyout and junk bond boom. Said Buffett, about 
volatile markets and people doing foolish things with OPM 
(other people's money), "But we do know that the less the 
prudence with which others conduct their affairs, the 
greater the prudence with which we should conduct our own 
affairs."
 
What would BUFFETT say about the Federal Reserve today as 
they do foolish things with everyone's money? I'll show you 
what I mean. But before we get to the facts about the Fed's 
currency debasing, consider that WARREN BUFFETT is now 
holding $34 BILLION IN CASH !!!!! - with most of it in 
foreign currencies. In his previous 50 years as an investor, 
he'd never bought foreign stocks or currencies. Now he owns 
billions of both.
 
He didn't suddenly see the advantages of global asset 
allocation. He's just doing his best to protect his assets 
from the confiscatory policies of the Fed.

Other notable money managers - the best in the business - 
have allocated heavily into cash and foreign securities 
too. Mason Hawkins of Longleaf Partners is the best mutual 
fund manager in the United States. He's holding 25% of his 
fund's assets in cash now, and his largest equity holding 
is Vivendi, a French media conglomerate.

Bill Gross, the "bond king," who manages $400 billion in 
bonds for PIMCO, says he'd own more foreign bonds if he 
could, but his funds' charter prevents him. Meanwhile, he 
personally sold his own flagship bond fund and is buying 
commodities and, more recently, tax-free municipal bonds, 
another way of holding a cash-like asset.

Ironically, as the world's best investors get out of 
stocks, move out of U.S. bonds, and move heavily into cash 
and foreign securities, Mr. and Mrs. Mutual Fund are still 
piling in. But that's par for the course. Mutual fund 
buyers tend to have all their money in stocks and bonds at 
the market top and all their money in cash at the market 
bottom. 
They're right on track once again.

In 1981, after a 15-year grinding bear market, Mr. and Mrs. 
Mutual Fund held 77.1% of their investable assets in money 
market funds (cash). Said another way, at the bottom of the 
market, Mr. and Mrs. Mutual Fund only held 22.9% of their 
investable assets in stocks and bonds.

Today the average mutual fund buyer holds 72.3% of his 
investable assets in stocks and bonds. Only 27.7% of his 
mutual fund assets are in cash.

This bullish level of asset allocation was only slightly 
exceeded at the last market top, in 1999, when money market 
fund assets, as a percentage of all mutual fund holdings, 
hit a cycle low of 23.7% (76.3% in stocks and bonds).

In their own ways, the world's best investors and the 
world's patsies are telling us it's time to be cautious in 
stocks and bonds. Why?

I began this year with a warning about the stock market and 
I've returned to the theme frequently over the last several 
months. I think it's very important: Expensive stocks and 
inflation don't mix.

INFLATION    INFLATION    INFLATION
And last month, I saw two things that make me think 
inflation is going to continue to grow and be a much bigger 
factor this year and next than most people realize.

SUPER MONEY       SUPER MONEY
The first thing I saw was research by Ed Yardeni on 
something he calls "Super Money." Super Money is a measure 
of global money supply. It's the sum of the U.S. monetary 
base PLUS DOLLARS HELD BY FOREIGN CENTRAL BANKS. You can 
think of this as a good measure of the world's supply of 
dollars.

It's important to measure foreign dollar holdings as well 
as the U.S. monetary base because many of those foreign 
dollars are invested here, influencing our economy and our 
bond market. Specifically, 

  ...foreigners now own 40% of all U.S. Treasury debt.....

 Over the last 12 months, foreign 
central banks bought $198 billion of U.S. Treasury 
securities, financing 49% of the U.S. deficit last year 
(the largest annual deficit on record). Additionally, 
foreigners bought enormous amounts of U.S. agency debt 
(Fannie Mae and Freddie Mac) - a total of $170 billion in 
agency purchases in the last 12 months. 

Federal credit creation (deficit spending) and foreign 
investment increases the money supply in the United States, 
which leads to faster rates of economic growth and 
inflation.

What's worrisome to me is that "Super Money" is now growing 
at a faster rate than at anytime in the last 30 years.

It's hard for me to believe that foreign central banks will 
continue to be such large holders of U.S. currency, 
especially considering that China is now the world's 
largest buyer of U.S. government paper (debts). 

***********************************************************
China buys tons of U.S. paper in order to maintain its 
currency peg to the dollar. Eventually, the Chinese 
government will have to stop buying so many dollars and let 
the yuan rise in value in order to afford the raw materials 
China needs - oil in particular. When this happens, foreign 
central banks could begin selling their Treasurys. The 
result would be a financial catastrophe for the United 
States - a run on the dollar. That would cause drastically 
higher interest rates for U.S. consumers and businesses.

I'm not predicting this will happen tomorrow...  but it 
should be clear to anyone with a brain that foreigners will 
not continue to subsidize our economy's massive deficits 
forever. The most likely trigger for a reversal in foreign 
investment is the falling purchasing power of the dollar, 
especially in the market for oil.
**********************************************************

These facts, combined with the skyrocketing, over 20% 
annual growth in "Super Money," mean investors must be on 
the lookout for rising commodity prices and higher interest 
rates. 
************************************************************
We've already seen examples of both. Oil soared to over $44 
yesterday. And U.S. Treasury bonds have just experienced 
their worst quarterly performance since 1980.

Looking at these facts, you might expect the Federal 
Reserve to make cautionary statements regarding money 
supply. It's not. And that leads to the second scary thing 
I saw last month... 

A report issued in June by the St. Louis Federal Reserve 
proclaims the supply of money is irrelevant to monetary 
policy. We found these views on the cover of the St. Louis 
Fed's monthly publication Monetary Trends. 

"Most central banks that were targeting money growth have 
stopped doing so," writes William Gavin from the Fed. "We 
no longer ask which measure of money is the 'correct' 
indicator for monetary policy. Instead, we directly examine 
measures of inflation and output for guidance about setting 
the stance of monetary policy."

"Since 1982, however, measures of the quantity of money 
have provided little useful information about the near-term 
outlook for spending or inflation," continues Gavin. "Our 
models and our discussions focus not on the quantity of 
money but on the purchasing power of the dollar."

Gavin concludes, "We do not have to pay attention to the 
quantity of money today because policymakers are paying 
attention to its price, by focusing on inflation and 
inflation expectations."

This is especially frightening because the Fed's measures 
of inflation (primarily CPI) ignore many of inflation's 
most important effects - such as asset price inflation.

The Fed took its overnight borrowing rate to a level unseen 
in the last 40 years (1%). And, thanks to the war on 
terrorism and Congress' pork-barrel politics, deficit 
spending has soared. Meanwhile, GREENSPAN CONTINUES TO 
INSIST that there's little to no inflation in our economy. 
Apparently, he doesn't consider soaring housing prices, a 
wildly expensive stock market and rocketing raw materials 
prices to represent inflation. And now the Fed is 
attempting to argue that the supply of money isn't even a 
factor in the creation of inflation. THEY'RE NUTS !!!!!!

I can't imagine a worse outlook for the future value of our 
dollar. Read the last paragraph of William Gavin's report 
one more time: "We do not have to pay attention to the 
quantity of money today because policymakers are paying 
attention to its price, by focusing on inflation and 
inflation expectations." 

Inflation, even measured by the Fed's cross-eyed CPI 
measure, is running at about 3.5% right now. The Fed's 
overnight interest rate is 1.25% annualized - nowhere near 
the rate of inflation. How can the Fed argue it is paying 
attention to inflation? 

Gavin's other comments are even more bizarre. How could 
anyone with more than a 10th-grade understanding of 
economics argue that the supply of money is irrelevant as 
an indicator of future inflation?

I'm not bearish by nature or philosophy. I'm sure things 
will be better in 10 years than they are now. Stocks could 
even be higher. But I can't imagine a worse scenario for 
investors than the one I see developing right now.

Inflation is moving higher. But interest rates are still at 
near record lows. Prices for financial assets, real estate, 
stocks, and now commodities are at record levels. Yields on 
fixed income investments are not attractive, given the rate 
of inflation and the likelihood of it increasing. There's 
almost nothing safe to do with your money...  or anything to 
buy that's likely to garner a good return.

There will be a time to speculate in stocks again - but it 
hasn't arrived yet. Please, be cautious with your equity 
portfolio and don't try to buy the dips... 

We could still be a long way from the bottom.

Regards,


Porter Stansberry
for The Daily Reckoning 

Editor's note: Porter Stansberry is the founder of Pirate 
Investor LLC, a financial publishing group dedicated to 
providing high-quality research for high net-worth 
investors. The former editor of several well-known 
financial letters, including Latin American Index, China 
Business and Investment and the U.S. edition of The Fleet 
Street Letter, Mr. Stansberry is regularly quoted in 
leading financial journals, such as Barron's and World 
Money Analyst.