Finance Digest for Week of March 22, 2004

ALAN GREENSPAN: CORRUPTED BY POWER OR SCHIZOPHRENIC ALCHEMIST?

Alan Greenspan is a perplexing individual. When he testifies in Congress or delivers a speech, he inevitably leaves people scratching their heads -- due to his torturing of the English language and of logic itself. Even more confusing is Dr. Greenspan’s radical change of heart when it comes to commodity money. At one time, in the 1960s, he was an Ayn Randian and an ardent defender of the gold standard. Yet now, as the Federal Reserve Chairman, he has become an unabashed denigrator of commodity money.

Dr. Greenspan understands, as a servant of the state, that the health of the modern state is inextricably linked to how its fiat currency is managed. However, when it comes to commodity money -- i.e., gold and silver -- Federal Reserve Chairman Alan Greenspan’s words are denigrating and deceitful. For the sake of the state’s power and his own power, it appears that Dr. Greenspan disparages and spreads misinformation about commodity money -- thereby “protecting” the state’s sacred fiat currency. On the other hand, considering that Alan Greenspan was a Randian and a fierce defender of the gold standard, one could argue that his present-day anti-gold mindset reveals that he has simply become schizophrenic. Although the power versus schizophrenia question cannot be definitively answered here, it is interesting to compare and contrast the transcript of a recent Alan Greenspan speech with an essay he wrote in 1966. In all seriousness, one could plausibly assert that Alan Greenspan is an alchemist. For it could be argued that trying to fuse monetary central planning with the free market is a modern-day form of alchemy.

If Dr. Greenspan starts reading books about animal husbandry, is spotted walking an ox, and reveals a secret formula for turning a sow’s ear into a silk purse, you will know that he has lost all touch with reality. In the meantime, it is painfully apparent that he is willing to obfuscate and deceive for the sake of power. Such power, concentrated in the Federal Reserve and its chairman, will most likely end up impoverishing countless people as they bear witness to the inflationary and economically devastating conclusion to the United States’ experiment with a fiat currency. At this point, Americans will come to understand the madness behind trying to manage a spontaneous phenomenon: the wonderful and beneficent free market.

THE FED’S GOT IT BAD, AND THAT AIN’T GOOD

The most unsettling news of the past week is that Treasury Secretary John Snow has apparently requested a meeting with all 12 Fed governors. The Treasury Secretary and all of the Fed governors in the same room ... at the same time. This cannot be good. My prediction: whatever they do will be so horrible that future historians are going to have a field day with it. Trust me on this one.

The part that is so tragic is that everybody knows the end result of this kind of money-madness excess. Nobody even disputes it. Nobody even tries to hide the truth, because the history of the world is littered with the inescapable evidence. You will end up with, and you might want to write this down, because it will soon seem very important to you, high and ruinous price inflation caused by high and ruinous monetary inflation.

Robert Prechter still sees deflation on the cards, and points to the action in the money supply. But not all prices will fall under deflation, just as some prices do not rise during inflation. I can easily see why houses, stocks, bonds, and collectibles, and other such things would go down in price -- because demand will fall. And because they are being supported at these lofty prices by the rampant monetary goosing by the Fed, these prices would seemingly fall a long way if demand faltered.

On the other hand, I can also see inflation on the cards. We are a nation that imports a lot of the stuff it consumes, and a falling dollar equates to the rising price of imports, ceteris paribus. I am thinking specifically of oil, which has gone up dramatically in price, oh and food as well, and since we are talking about it, just about everything else.

“For many people,” Mr. Prechter writes, “the single biggest financial shock and surprise over the next decade will be the revelation that the Fed has never really known what on earth it was doing. Make sure that you avoid the disillusion and financial devastation that will afflict those who harbor a misguided faith in the world’s central bankers and the idea that they can manage our money, our credit or our economy.” Bravo!

THE COMING OIL CRISIS: TEMPORARY SQUEEZE OR LONGTERM INVESTMENT OPPORTUNITY?

At more than $33 a barrel, crude oil is currently trading 17% above its average price last year, instead of prices closer to $20 that the experts expected after the end of the Iraq war. Global demand shows no sign of weakening, as it often does this time of the year, with the northern hemisphere winter fading and with it the need for heating fuels. Oil stocks in the US, the biggest consumer, are at their lowest levels since 1975, while in the advanced nations as a whole they are only enough to meet 28 days’ use. Is the strength in oil prices a temporary phenomenon, or is it signaling a longer-term investment opportunity?

My conclusion? I think there is a persuasive case for a core holding of energy, and in particular hydrocarbons (oil and natural gas), in an equity portfolio. The simplest way to do this is through a collective fund such as the excellent Investec Global Strategy Global Energy -- an offshore open-ended fund registered in Guernsey.

The new reason for pain at the pump.

Everyone knows that the recent rise in the price of oil has had an effect at the pump, but something less well known is also affecting gasoline prices. It is something the federal government could reduce, since the federal government created it in the first place. It is gasoline regulations. Until the mid-1990s, the feds did not micromanage the recipe for gasoline, the only exception being the phaseout of lead in the 1970s. But that changed with the 1990 amendments to the Clean Air Act, which began to take effect a few years later. As a result of these provisions, we now have a bewildering variety of gasoline requirements. Beyond the direct role of the federal government, several states have also come up with their own unique gasoline blends, often in order to obtain the required federal approval for their pollution-fighting plans.

Some of these measures have helped reduce vehicle emissions and improve air quality, while others have not. But all have succeeded in driving up the cost at the pump. In addition to the compliance costs of each regulation, the fact that we have gone from an efficient, fungible, national market in gasoline to a patchwork of regional, state, and local ones adds to the logistical costs in meeting the nation’s fuel needs. The impact of these regulations, some of which are still being phased in, has become especially noticeable in recent years. The fact that gas in the more expensive cities (mostly in California) currently costs as much as 75 cents per gallon more than in the cheapest cities attests to the fact that there is more going on than an increase in the price of oil, which is the same everywhere. Not coincidentally, the most expensive cities also have the most onerous regulatory requirements. Nonetheless, when gas price spikes occur, the policy debate focuses on the cost of crude while the regulatory burden often gets ignored.

HOW ARGENTINA CAN GET OUT OF ITS PAPER-MONEY MIRE

The ability of governments to borrow enables politicians, bureaucrats and the constituencies that receive succor at the public trough to live beyond the means they seized from taxpayers, knowing full well that the exploited, productive class will also foot the bill due to investors keen on purchasing government bonds. In the case of Argentina, the only means to exorcise the debt demon is to deny government access to credit, namely by repudiating all outstanding obligations to multilateral and private lenders alike.

Governments do not pledge their own assets against “public” debt, but taxpayers’ instead, with creditors cognizant that the principle and interest will be paid through the involuntary confiscation of private property -- taxation. In effect, both sides are complicit in the violation of property rights of a third party in the future, which scarcely deserves to be acknowledged as a contract. Beyond the dodgy status of sovereign borrowing, debt repudiation is beneficial in two respects. Immediately it alleviates the citizenry of onerous repayments on obligations issued by previous governments. More importantly, by denying the Argentine government credit altogether, as lenders will be liable to do, it will be compelled to operate within the constraints of a balanced budget, a novel notion in that country’s history.

Initially, private Argentine firms will likely suffer rebukes from international capital markets due to government debt repudiation. However, when the citizenry is relieved of massive tax-funded repayments on these obligations and no longer saddled with a credit-worthy government, foreign lending will return to invest in promising private enterprises. Likewise, indigenous capital formation can emerge as the profligate public sector is reined in. Fortunately, Argentines are estimated to have stashed close to $100 billion of savings abroad. Hopefully a substantial portion can be repatriated.

HONG KONG ANALYSTS WARNED OVER USE OF INSIDER INFORMATION

In a circular released on Friday which was designed to clarify how analysts can use information supplied to them by the management of listed companies, the Hong Kong Securities and Futures Commission warned that analysts who receive non-public price sensitive information about a particular company, and then write reports recommending the purchase or sale of shares in the firm could face a $10 million fine and a 10 year jail term.

AVOID AUTO STOCKS

The unenticing nature of the cars that the Big Three carmakers (Ford, DaimlerChrysler, General Motors) generally produce there is as nothing compared with their shares. Investors, it seems, are starting to agree. Having fallen by 17% so far this year, the auto sector is one of the worst-performing in the S&P 500, where competition is stiff; Ford’s shares have dropped by a quarter from their peak in January. The sharp rise in carmakers’ shares last year now looks like having been the triumph of hope over reality. Put bluntly, the short-term outlook for the Big Three is dreadful. If anything, the long-term outlook is worse. There are, for a start, huge pension obligations.

That GM and Ford survive at all is thanks mainly to the largesse of their finance arms, General Motors Acceptance Corp (GMAC) and Ford Motor Credit (FMC). Which makes the car firms’ credit ratings hugely important, for without a decent rating, the companies would not only find their debts more expensive but their competitive advantage in finance eroded compared with banks, which as a group are being upgraded. Alas, all of the Big Three have had their ratings slashed in recent years, to within a sniff or two of junk. If Ford were to fall to junk, its financing costs would rise to levels that were probably unsustainable. In 1992, GM was said to be within an hour of going bust, with its bosses waiting by the fax machine for the ratings downgrade that would have tipped it over the edge.

This is not a problem that afflicts Toyota, which carries a rock-solid AAA rating from Standard & Poor’s and spews out more cash than a salaryman on a golfing holiday. Japanese carmakers have, indeed, been rapidly eating into the market share of the Big Three. Toyota has taken over from Ford as the world’s second-biggest car manufacturer behind GM, and on present trends will become the biggest in the not-so-distant future. So far this year, the Japanese have grabbed 32% of the American auto market, up from 28% in 2002. They also have much lower pension and health-care costs than their American competitors and, it seems, a better range of cars, since Japanese firms spend about a third as much as the Big Three on marketing them. Small wonder that Toyota makes $1,500-2,000 on every car it sells in America -- or that Japan’s biggest carmaker has a higher market capitalization than the Big Three combined.

BANKRUPTING COMPLACENCY

Four years into the 21st century, the Great Bear Market Americans are so at ease with themselves and life in general... so deeply asleep to the rigors of life... that they have nearly lost consciousness. Back in the 1970s, the national current account deficit rose to nearly 1% of GDP. Economists were alarmed. The dollar fell. Stocks fell. The nation was so strapped and the dollar so weak that the Carter Administration planned to borrow $10 billion in foreign currency to tide itself over. By the time the period was over, you could have earned 15% interest yield from a U.S. Treasury bond. A typical stock -- which you could have bought at an average of 6 times earnings -- would have paid dividends of more than 5%.

Today, the current account deficit is above 5% and economists see no problem. For the moment, the U.S. government still borrows in a currency it alone controls. Foreign central banks still seem so happy to lend that over the last 3 months, their holdings of U.S. government securities rose at more than 50% annual rate to more than $1 trillion. And on the advice of Alan “Bubbles” Greenspan, the poor lumps go further and further into debt, digging a deeper and deeper grave for their money. They refinance their houses to buy what they cannot afford and do not need, and count on Greenspan to pull the right levers and turn the right knobs so they will never have to pay for their mistakes.

Day by day, the entire Lumpen Nation loses its jobs, its skills, its capital... and risks losing its soul... to E-Z credit. The Feds add $2 billion to the national debt every day. Five hundred billion per year is the net cost of America’s trade deficit. Ben Bernanke at the central bank pledges to keep short-term lending rates as low as necessary, as long as necessary... to make sure the borrowing binge continues. The sooner it is over, the better. The end is coming... we think.

WHAT INVESTORS HEAR ... AND WHAT THEY IGNORE

A few facts about the stock market so far in 2004: 1.) Last Friday (March 19) saw this year’s first weekly back-to-back declines in the S&P 500; 2.) All three major indexes (Dow, S&P, NASDAQ) are in the red for 2004; 3.) The Dow Industrials have ended lower in 6 of the 11 weeks this year, the NASDAQ in 8 of 11; and 4.) Cash is flowing into U.S. stock mutual funds at the fastest rate since early 2000.

Now, most investors would say that the last one of these points seems to stand in contrast with the others; if money is flowing into stocks at a blistering pace, shouldn’t the market go up? They think high inflows must mean higher prices, just like the research director of a mutual fund consulting firm who made this remark about the cash inflow data: “By their actions, fund investors continue to demonstrate a high degree of confidence in the stock market.” Alas, the vast majority of investors (and too many “professionals”) have never understood the emotions that produce extremes in sentiment.

The reason is simple. “Emotion,” not rationality, is precisely what drives the financial decisions that these investors make. The emotion builds on itself, the herd grows, and the time eventually comes when the data shows that “cash is flowing ... at the fastest rate.” That is what people hear and respond to. Somehow the “since early 2000” part of the sentence that follows does not register -- as in, “What else happened in early 2000?”

THE INCREASINGLY CONCENTRATED U.S. BANKING INDUSTRY

With JP Morgan’s acquisition of Bank One, America can claim to be the home of two banks with assets in excess of $1 trillion each (the other being Citigroup). Whereas the top ten banks held only 17% of total U.S. bank assets in 1990, now the top ten hold about 44% of all bank assets. So, we have the increasing size of US banks and a greater concentration of banking assets. Are these trends cause for concern?

The size of individual companies is of no concern in a free market. The size of individual companies is of no concern in a free market. As Rothbard taught, the market naturally puts limits on the size of a firm or company, because there are limits of calculability in a market. Stated simply, the idea means that firms must be able to refer to external markets to rationally allocate their own resources. The more that these external markets are absorbed into one firm, the more difficult it will be to avoid losses and “greater will be the sphere of irrationality”. Essentially, the argument is an extension of the Misesian notion that socialism, which is fundamentally one big cartel, cannot calculate.

But the banking industry is hardly free. What we are witnessing is the culmination of deposit insurance, fractional reserve banking, an undefined currency and a long trail of bailouts and other interventions into the workings of the world of money. The Fed -- and by extension the US taxpayer -- has become the reinsurer of the banking system, willing to bear the risk of catastrophe.

Given the increasing size of financial institutions, including Government Sponsored Enterprises such as Fannie Mae, and also given the concentrations, it may also be time to revisit the concept of too big too fail (“TBTF”). Given the Fed’s history of intervention in financial crises, it would seem reasonable to conclude that if JP Morgan or Citigroup should ever run into financial trouble it seems unlikely that the Fed would stand by and let them become martyrs for the cause of free markets.

The itchy need to rescue failure is really bigger than the Fed itself. It extends to all government attempts to protect people from the consequences of their own actions. Moral hazard is the term thrown about to denote the effect created when people are continually shielded from the consequences of their own errors. What happens is that this factors into their future decision making and they will tend to take greater risks in the future (and make more errors). Herbert Spencer, who wrote “The ultimate result of shielding men from the effects of folly is to people the world with fools,” perhaps penned the most succinct and memorable expression of this phenomenon.

THE GM OF THE BANK FOR INTERNATIONAL SETTLEMENTS TALKS ABOUT THE WORLD ECONOMY

A speech by Malcolm D. Knight, General Manager, Bank for International Settlements, attempts to “outline what I see as the current issues for international financial stability and to touch on the role of the BIS in meeting these challenges.” A long and interesting analysis follows -- one must do one’s own guessing about where he is toning down his assessments in order to avoid spreading alarm.

He concludes: “Very accommodative macroeconomic policies and the rise of China have been supporting global growth. These forces will at some point have to be brought onto a sustainable path in a way that avoids abrupt changes in expectations in financial markets. The main risk is high volatility in global bond markets, perhaps with an “overshooting” of bond yields. The chances that financial institutions can absorb higher interest rates are at present good, thanks to improvements in recent years in their identification and management of financial risks. The BIS has played its part in this process. And it will continue to do so. Ensuring monetary and financial stability is a permanent challenge which demands that policymakers keep their eyes open to risks and are prepared to address them.”

THE PEARL OF THE ADRIATIC

Think of a country... bathed in sunshine 300 days of the year... so mild that subtropical vegetation covers the landscape and the aroma of olive, fig, and lemon trees is carried on the breeze. Here is a clue: in the early 20th century, this country was a holiday destination for the European royalty. Italy? Spain? Greece? Try Croatia -- a soon-to-be-discovered paradise with more coastline than any other European country! Most people associate Croatia with the Balkan war. But the war ended nine years ago, and times have changed. Now Croatia has become the gentle, friendly, Mediterranean country that it once was.

40 years of war and socialism made this area a no-go zone for investors and tourists alike. Real-estate values were destroyed, along with everything else... but this all about to change. We believe some properties in Croatia may gain as much as 200% in value over the next five years, and probably much more.

The country offers some of the highest quality property in the Mediterranean, yet prices are the lowest in the region. And even though prices have already started to rise significantly, the general price level is still 50% below 1990 levels...and you will not have to pay €8 for a cappuccino! The current level of tourism is still less than 50% of levels hit at the peak of the 1987 tourism boom... yet the quality of the country’s infrastructure is be far superior... and improving every day.

A CONVIENT WAY TO GET SEE WHAT THE MARKETS ARE DOING

The “marketwatch” page from the Ludwig von Mises Instituted conveniently combines charts for the Dow Industrial and NASDAQ Composite stock indexes, the dollar index, spot gold, the CRB commodities index, and spot oil on one page. Also included are time-series charts for various economic indicators, such as the money supply (M2 and MZM), the CPI, unemployment, the U.S. current account, federal government receipts and surpluses/deficits, and the personal savings rate.

MARKETS SHOULD WORRY ABOUT THE SURGING OIL PRICE

Goldman Sachs now thinks that the world economy will grow by 3.8% this year, not the 4.6% it had originally forecast. The main reason for this sharp reduction is the sustained rise in the price of a commodity long dismissed by most economists as having little impact on mature economies: oil. That the rise in the oil price might be more than a temporary blip is best illustrated by the price of oil for future delivery. When the spot price of crude (that is, oil for immediate delivery) spiked in the past, notably on the eve of both Gulf wars, the forward price rose only slightly, mainly because the market expected the interruption to be short-lived. This time, not only is the oil price rising, but the forward price is going up sharply, too. On March 18th, the recent high, when West Texas crude rose to $37.93 a barrel, the price for delivery a year hence rose to $32.51, its highest ever.

OPEC’s desire to force the oil price up is almost certainly linked to the falling dollar. All crude is priced in dollars, and exports are thus worth a lot less because the dollar has plunged. Many think that this is one reason why OPEC is happy to see the oil price remain higher than its self-imposed band of $22-28. Possibly, too, Arab-dominated OPEC is rather less enthused by America’s war in the Middle East than George Bush. If oil supplies have been tight, demand has been expanding briskly, and in China -- where else? -- it has been growing at a breathtaking pace.

Many argue that the latest jump in oil prices is far more modest than it was in the two oil shocks of the 1970s. In real terms -- that is, adjusted for inflation -- the price is still a lot lower than it was then. Rich countries are, moreover, far less dependent on oil than they were, because they have become more efficient at making things, and anyway make fewer of them. And the rise in the oil price, as measured in anything other than the beleaguered dollar, has been comparatively trifling. All true, but nonetheless many pundits may have cried sheep once too often.

America may be more efficient than it was, but it is far from immune to higher prices. For consumers, the recent sharp rise in petrol price -- which hit an all-time high this week -- is, in effect, an increased tax burden. And it comes just as the effects of Mr. Bush’s (official) tax cuts start to wear off.

Costs are rising for companies as the price of oil and other commodities goes up. In the past, this would have been inflationary: companies simply passed these higher costs on to consumers. But, perhaps because of excess capacity at home, or because China’s increasing presence in world trade pushes the prices of manufactured goods and labour down, wholesale prices have been rising much faster than the price at which companies are able to sell their wares. To stop profits from falling, American companies must keep a tight lid on labour costs. A prolonged rise in the price of oil and other commodities would make this problem still more acute: America’s jobless recovery is likely to stay jobless. This would eventually kill the recovery, since consumers in fear of their jobs are unlikely to carry on splurging.

THE OUTLOOK BRIGHTENS FOR GOVERNMENT BONDS AND DARKENS FOR RISKIER ASSETS

To noone’s surprise, America’s Federal Reserve left short-term interest rates at a 46-year low of 1% on March 16th, again with heavy hints that they would stay there a while. Ultra-low interest rates pose a huge problem for investors and ultimately for the Fed itself. The central ban’qs stance has encouraged punters to take risks on an unprecedented scale. America’s rock-bottom interest rates have unleashed a flood of money into risky assets the world over. Since late 2002 everything from rich-country shares to emerging-market bonds have soared as American investors, who save almost nothing, have sought better returns than the desultory ones available from popping their money in the bank.

The numbers are striking. Between the start of 2003 and its peak on March 9th, Japan’s Topix stockmarket index rose by 35%, all because of foreign buying: domestic investors sold all the way up. At its high point in February America’s S&P 500 was more than 30% up; NASDAQ, driven by hope and hype, climbed more than 60% by late January before taking a breather. Spreads of riskier bonds over riskless government debt collapsed just about everywhere. Junk and emerging-market bonds had their biggest and fastest-ever rally. What began as a legitimate search for higher returns following a collapse in prices in many markets led to valuations that stretched the bounds of credulity and made little or no allowance for error. No matter: even at the start of this year, just about every indicator of risk appetite suggested that investors were, if anything, more gung-ho than ever.

It is a good rule of thumb that if things cannot get any better, they can only get worse. So it has turned out. Some economists, worried that last yea’s sharp pick-up in growth in America and elsewhere might not be sustainable. Having started the year in bullish mood, investors have become more skittish too. In Merrill Lynch’s latest survey only 48% now expect the global economy to strengthen this year, compared with 74% in January. And if it does not? Then government bonds are not as expensive as many had thought, and shares and corporate bonds are rather more expensive -- and the riskier the asset and the loftier its price, the dearer it will look.

Thus the prices of American Treasuries have soared and their yields have dropped. At the start of the year, ten-year Treasuries yielded 4.3%, which most investors thought absurdly low. They must think today’s prices even sillier: recently the yield tumbled below 3.7%. The low yields on Treasuries contain an unpleasant message for investors that have been buying without heed to risk or price -- that there is much uncertainty about future economic growth. That message, and its corollary -- that risk is ill rewarded -- seems to be filtering through at last. From the middle of January, investors started to dump risky, generously valued assets. A storm in a teacup, or a prelude of worse to come?

IT MANAGER’S JOURNAL: WHY DELL STAYS IN THE BLUE CHIPS

Dell, Inc. is the premier name in IT hardware due to its strategic themes of cost and scale leadership, a disciplined focus on industry standards, and incremental growth drivers, such as geographic expansion, product-line expansion, and expansion in margins and market share. Dell is leveraging the industry migration to standards in order to boost market share in both enterprise computing and services. In addition, the company continues to increase share in the consumer businesses. The hardware sector includes a number of second-tier players distracted by mergers or turnarounds. So I believe Dell’s superior operating performance and strong competitive position justify the stock price premium.

Dell is managing its business better than other hardware manufacturers, and its initiatives for growth in its enterprise and printer businesses have helped it bypass, to some extent, the flattening growth of the U.S. PC market. In particular, Dell appears to be the only hardware company that abandoned, some time ago, the notion of an economic recovery as essential to growth -- and that was a smart thing. The company has managed its business effectively in the softer economic climate, staffing and aiming for profitability at the realistic business levels. I continue to believe that Dell’s expanding margin story can unfold, despite the relatively indifferent outlook for IT spending.

The outlook (no pun intended) for Microsoft.

The European Union’s ruling against Microsoft -- a fine of €497 million for antitrust violations -- is a joke. I do not see a major or immediate impact on the MSFT stock price as a result of the EU ruling, but I do think that the stock progressively and gradually will continue to weaken. I see support for the stock in the $23.50 to $24 range. MSFT is in the process of forming a substantial bottom pattern, so I would hold off going long until that bottoming process is more complete. That said, I think the next big move is up, but I would be inclined to hold off starting a long position so long as the broader market continues to soften.

Looking out longer term, say in 12 months’ time, I believe that MSFT will be trading at lower levels than it is currently, even if the market is marginally higher. This view was discussed in this column. It is a rough period for a share price when a company goes from being a growth stock to a value stock and the ownership constituency shifts from growth- to income-oriented. Then you must discount the risk of being declared a monopoly at Microsoft, as well as the threat of a substitute technology such as Linux. In light of this view, MSFT stock trading at nine times sales seems a bit high.

EXXON TAPS TECH TO FUEL GROWTH

Exxon Mobil is the world’s largest publicly traded energy company. And if it hopes to keep growing, it must replace billions of barrels of new oil and gas reserves each year without eroding profits. Technology is key to both challenges, even as oil prices hover near 13-year highs. Exxon spends more than $600 million a year on basic research and development and employs some 1,900 scientists and engineers, more than any other oil company. That is in addition to 20,000 scientists and engineers working in the field. “We probably have the single largest, sustained commitment to proprietary research of all the major oil and gas companies,” Stephen Cassiani, president of Exxo’qs Upstream Research, said in an interview. “We believe it will continue to provide a competitive advantage.”

Contrary to their image as a gritty, old-economy business, oil companies over the decades have always relied on science to help find and develop resources. Today, new technology is critical as producers search the ends of the earth to find oil and gas that was overlooked or once deemed unrecoverable. Producers have used new tools like 3-D seismic exploration to find new resources more accurately. Horizontal drilling and other new methods get more energy out of aging fields. Technology is one reason Exxon has kept its finding and development costs below the average among its peers and consistently locates enough reserves to replace production.

KURT RICHEBACHER ON “POLICY TRACTION”

“Policy traction” is an expression that lately has come into fashion. In essence, it is about the relationship between the size of the monetary and fiscal stimulus injected into an economy... and their effect on economic growth and employment. In the past three years America has experienced an interest rate collapse, a record fiscal stimulus and the loosest monetary policy imaginable fueling money and credit creation at a scale that has no precedent in history. Has it really worked?

Well, in one way it had fabulous “traction”. It engendered the greatest credit and debt bubble in history. Total outstanding debt, financial and non-financial, in the United States has ballooned by almost $6,500 billion since 2000, as against GDP growth of $1,238 billion. For each dollar added to GDP, there were about six dollars added to indebtedness. And it had fabulous traction in a second way: The runaway money and credit creation went with a vengeance into asset markets -- stocks, bonds and housing. When the equity bubble popped in early 2000, the consumer simply moved on to the housing bubble that had been waiting in the wings, helped by the Fed-inspired bond bubble driving mortgage rates sharply downward. While businesses were slashing the consumer’s income growth, he offset this income loss largely by stepping up his borrowing.

Yet in the course of 2002 it became clear that the lowest short-term interest rates in nearly half a century were failing to create the customary strong economic recovery. Without great discussion, the U.S. economy has been shifting to a growth model that radically differs from past experience. In the old model that has ruled for centuries, monetary easing was conceived to work directly on the real economy, and it could be counted on to promptly do so. But it was a world with low debts and strong employment and income growth. Most importantly, it was a world in which financial systems of very limited size principally served as mere conduits for channeling savings into capital investment, creating national wealth in the form of productive plant and equipment, and commercial and residential buildings. The true name of the new game is bubble-driven growth... and all bubbles end by bursting.

WHAT IS GOLD’S EQUILIBRIUM VALUE TODAY?

The article uses a wide variety of approaches to try and determine what gold should be selling at today. Values range from a bit higher than it is selling for today, to a lot higher.

SELLING THE PAO MO (“PAO MO” = “BUBBLE” IN CHINESE)

They say they don’t ring a bell at the top of the market to let you know when to get out. No, they don’t. Yet to me, there are very real indications that the boom in China-related stocks has peaked. You know we are at the peak when waiters and windsurfers want in and “China Clubs” pop up. And you know it is running out of gas when you see PetroChina soar on huge volume after having done absolutely nothing for many years, followed by a fizzling of both the price of and volume in the shares. I expect China-related shares to fall dramatically. Here is a piece of advice for you: if you own any China-related stocks, sell them now.

Don’t get me wrong. I see what is happening in China. Of course I know that the economy is growing. And of course I know that China has completely changed the landscape in commodities, as its demand for raw materials seems insatiable. So let me be clear -- I am not “voting” against China. I am simply voting against China stocks. They have simply run too far, too fast. Everyone, including waiters and windsurfers, want in. To me, that means it is time to sell.

Just take a look at what has happened in previous “China manias”. We do not have a decent history of stocks in China to draw from, but the next best thing is Hong Kong. Over the last 20 years, every time the P/E ratio of the Hang Seng Index (Hong Kong’s version of the Dow) reached 20, Hong Kong stocks lost between a third and half of their value. It happened in late 1987. It happened in January of 1994. It happened during the dot-com boom in 2000. Can you believe that it has happened again already? Yes, last month, the P/E of the Hong Kong stock market rose above 20. Time to sell.

P.S. Consider this... the following list is all the countries whose stock markets have risen by more than 100% total in U.S. dollar terms over the last five years. There are only six markets, and they are all in “stinky” places... 1.) Russia, 2.) Pakistan, 3.) Czech Republic, 4.) Venezuela, 5.) Hungary, and 6.) Indonesia.

MONOPOLISTS IN CAVES

The War Party’s loudly trumpeted concern for democracy does not evidently extend to serious public examination of cause and effect, aims or finance. The Bush administration’s disgraceful and determined efforts to short circuit any meaningful public enquiry into the events of September 2001 is one manifestation of this. Its refusal to seriously investigate the collapse of accounting and financial control in the government is another. The military budget is out of control, and so is the military. The very people and agencies tasked with protecting the American nation have been rewarded for their failure to do so by using the federal credit to finance a massive arms spending spree and global deployment of forces.

The military and security complex has been ceded de facto the ability to dictate its budgets. The conflict of interest that this implies is profound but simple, and understood by gangsters everywhere. Protection is a racket, and so is the Pentagon. This is one reason why we are doubtful about the ability of the US to alter its course irrespective of the outcome of the presidential election this year. There is simply too powerful and too broad a coalition of interests to do otherwise. With Kerry’s nomination there is no serious reason to expect the basic policies of unrestricted war and unrestricted deficit finance to change.

This still leaves the matter of the nation’s finances unresolved. We have argued for some time that the priority of the Treasury and the Federal Reserve would necessarily be to finance the Federal deficit, which is to say the war. That precludes serious action to deal with the current account deficit for the time being, which in turn means that a meaningful rise in interest rates any time soon to do so is unlikely. By soon we mean this year, and by meaningful rise we mean a rise in the Fed Funds rate to more than 4%. This implies that the Fed is going to rely on prices to do the job of suppressing demand for them.

Serious bottlenecks in strategic commodities are upon us, and the shipping industry cannot keep up with demand. Bottlenecks are bad enough, but the real crunch is coming in energy prices. As the charts accompanying this essay show, the price of every tradable form of fuel is skyrocketing. And the downstream impact of this is already being felt not just in the obvious forms of higher electricity prices, higher gasoline prices, and higher heating bills, but also in higher food prices. Food in the late industrial age is, after all, just reprocessed petroleum.

Evildoers in caves did not do this. Given that the world monetary system is a dollar monopoly, and that control of that monopoly has been ceded to a handful of financial institutions, given further that those institutions are the biggest financial contributors to the US political process, it is hard to avoid the obvious conclusion. One of the problems with having a monopoly on power is that when something goes wrong with that power, it is not very credible to blame it on someone else. It is going to be a long war, if for no other reason than that we have been led into it by those who indeed are operating beyond the bounds of reason.

GRADING BUSH ON THE ECONOMY

President Bush’s critics accuse him of presiding over a weak economy. They claim that job creation has been anemic and that growth has been uneven. Sure, partisan politics color these charges, but that does not necessarily mean they are untrue. What do the numbers actually say? The Joint Economic Committee (JEC) of Congress has just published a comprehensive report analyzing economic performance among the world’s major economies. The report finds that the United States economy has significantly out-performed other developed economies. This does not necessarily mean that President Bush has done a great job, but it unambiguously means that his economic policies have performed better than those of our major foreign competitors.

While the White House can take comfort in the relative strength of the American economy, this does not mean that the administration should be satisfied. Economic growth could be much higher, especially if there are improvements in economic policy. Putting a lid on federal spending would be a big step in the right direction. The Bush administration has not done a good job in this area, while Sen. Kerry has endorsed programs that would add hundreds of billions of dollars in new spending during the campaign.

America has the world’;s most powerful economy, but our advantage will not last if Republicans and Democrats waste money on ineffective government programs. We do not want France’s stagnant economy and high unemployment, so our lawmakers should not behave like French politicians. That means they should compete to make government smaller, not bigger. They can be sure the numbers will vindicate them if they do.

THE LOW PRICE OF SCARCITY

Imagine that you are a shoemaker, and you wanted to know how many shoes to manufacture this month at your plant. To simplify matters, let’s assume that you are not manufacturing on contract. There are two ways you might try to figure out how many shoes to make. One way would be to conduct a series of polls and focus groups to determine consumer demand for footwear at this particular moment in time. It will be guesswork, it will be time-consuming, but you could do that. Of course, you would have to do it again next month. Or you could just do a quick survey of what shoes are selling for, vs. what they used to sell for, which ought to give you an idea of the supply and demand.

This is, in a nutshell, the problem with all those scare stories you hear and read about how the world is about to run out of oil, minerals, water, etc. Usually, these feverish predictions are not accompanied by any price data suggesting a trend towards scarcity. Unless human beings as a whole are entirely irrational creatures -- plenty of individuals can be irrational for my point to remain correct -- prices of goods in high demand will rise as their availability drops. These prices are bits of communication between potential buyers and sellers. They are a 24-7 consumer-demand survey, conducted not by some central planner with a bank of phones but by people engaged in spending their own money and selling their own services in a market economy.

The recent run-up in world oil prices, and thus the price of gasoline at the pump here in the United States, might be offered to rebut me. Doesn’t this price increase suggest that our finite supply of fossil fuels is about to run dry? Hardly. As Ronald Bailey noted in a recent Reason article, these kinds of dire predictions have been issued many times in the past without being anywhere close to reality. In fact, there are many sources of oil left to explore on the Earth, some remaining uneconomical at current prices but likely to be pursued if the price level rises further.

Another problem with the oil-dearth thesis, however, is that inflation-adjusted prices for oil, and for refined and formulated gasoline, are not really high in the first place. When you adjust for inflation, gas prices today are far lower than they were 20 or 30 years ago, when the effective price for a gallon of gas was over $3. Today’s prices are evidence of abundance and innovation, not scarcity and stasis.

THE MONEY FOR BUBBLE 2.0

The money keeps on flowing into venture capital funds, and since few VCs were doing many deals over the past few years, it has been adding up to quite a lot. That “overhang” is now helping to fuel what some believe will be Bubble (and Bust) 2.0. Too much money chasing too few good ideas (with too few good people running too few good companies).

WHEN THE CEO IS THE BRAND BUT FALLS FROM GRACE

Company founders have long believed that placing their name on their company signals their willingness to stake their personal reputation and stand behind their products. That is fine when things are going well and the company and the CEO whose name it bears are held in high regard. But what if the CEO falls from grace? What happens to a company if the CEO’s name is in effect its brand -- and then that name is tarnished?

Rarely has that question come up more sharply than in the case of Martha Stewart, America’s long-reigning diva of decor, who was recently convicted on conspiracy and other charges. Though Stewart had resigned as the CEO of her company, Martha Stewart Living Omnimedia, last summer after her indictment for insider trading in ImClone stock, her name is almost indistinguishable from the company’s brand. Does the fallout from this case mean that companies should rethink the notion of personal branding in which the company leader herself (or himself) is the brand?

THE PLAYING FIELD GETS LEVELER EVERY DAY

By this stage of a “recovery”, say economists who keep an eye on this sort of thing, the U.S. economy should have created 2-3 million more jobs than we have today. Bu the missing jobs did not disappear. They just turned up in Bangalore, India rather than Boston where they were supposed to be. This does not worry Republican economists. Like used clothing and old school buses, yesterday’s jobs get exported to poor countries... while shiny new ones are created in America.

“This time may be different...” said colleague Dan Denning last week. “Never before, since the beginning of the industrial revolution 300 years ago, have there been so many people outside the Western world ready, willing, and able to compete with us. Never before have they had so much money. While Americans spend all their money -- and then some... the average Chinese worker saves more than 20% of everything he earns.” There are more engineers in Bangalore, India, than there are in California, U.S.A. They work well... and cheaply, taking home an average annual pay of about $6,000. And they seem to be just as innovative as their American counterparts.

For many, many years Americans have had the easy ground in the international labor market. The playing field was tilted in their favor by the skills, capital, infrastructure, institutions and habits built up over many generations. They will still have an advantage for many years... but the playing field gets leveler every day.

TOYOTA’S SCOOP AND THE COMING OIL SHORTAGE

An interview with Fujio Cho, the President of Toyota, gives Toyota’s current thinking about the prospect for the world’s automobile industry. It will have been passed around in the Board papers of every major automobile company in the world. Toyota is not in the habit of revealing its private forecasts to visiting journalists. The story is packed with interest.

For European central banks, the important news in this interview may have been the shift of policy on the euro. But Toyota’s eyes are on China and on new technology. Toyota has signed a series of major partnership deals with Chinese companies, including an engine plant with Guangzhou Auto in the South of China. It is the logic of Toyota’s position which is most revealing. Toyota sees China as a rapidly expanding economy, which will continue to expand. That will produce a huge increase in demand for automobiles.

The motorization of China is already pushing up the price of oil, now at $37.50 a barrel. It is likely to go further and create a world oil shortage. In turn that will create a demand for “green” cars. Here Toyota is already in the lead of world development, so much so that Ford has recently agreed to buy hybrid technology direct from Toyota. The Toyota technology is said to be about three years ahead of Detroit.

China changes everything. It changes the outlook for the world oil price, and therefore the forecasts for inflation. It changes the future of technology; it could eventually mean the end of the hundred-year reign of the internal combustion engine, and its replacement by fuel-cell technology. Mr. Cho said that this was not just a matter of image, but of corporate survival. Everything happens faster than one expects. The motorization of China is following the pattern of automobile sales in Europe or the United States. That is already creating a shortage of oil, let alone atmospheric pollution. Green cars will be needed and Toyota will make them. The world is being changed before our eyes.

WHAT MARKETS WERE DOING THEN; WHAT IT CAN TELL YOU NOW...

If you look at what stock and commodity prices were doing during the first half of the 19th century, you would discover, among other things, three important facts: 1.) As stock prices neared a top in the late 1830s, commodity prices made a double-bottom; 2.) When stocks peaked in 1836 and turned down, commodity prices took off running; and 3.) By the time stocks had temporarily recovered from the decline a year later, commodity prices were at multi-year highs. Stocks resumed their decline in earnest, and commodities tanked along with them. The facts above represent the three stages of a tremendous economic shift that was unfolding at the time -- from disinflation, to a great reflation, to across-the-board deflation, respectively.

As stock prices neared a top in the late 1990s, commodity prices made a double-bottom. When stocks peaked in 2000 and turned down, commodity prices took off running. By the time stocks had recovered from the decline four years later, commodity prices were at multi-year highs. And finally, in both the past and present instances, the multi-year commodity highs were still below previous highs recorded during inflationary times.

Is history ready to repeat??

BRAINS VS. THINGS

I have always been reluctant to buy stocks in the natural-resource, precious-metals or materials sectors. In fact, my 2002 book, The Secret Code of the Superior Investor, includes a chapter titled “Don’t Invest in Things. Invest in Brains.” And yet. ... There is one reason to invest in things that I can recommend without reservation. Things -- let’s call them “commodities” -- have very little correlation with stocks or bonds.

Just last week, I received one of those rare items: a promotional brochure from an investment firm that focused on a truly compelling idea. The brochure, from Morgan Stanley, was mainly a large, color-coded chart that showed graphically how six asset classes had performed in the 23 calendar years from 1980 to 2002. None of the six classes -- Nasdaq stocks, European stocks, large-cap U.S. stocks, corporate bonds, Treasury bills and managed futures -- “has consistently outperformed all other types of investments,” wrote Morgan Stanley. “By prudently distributing funds among several asset classes, an investor can potentially reduce overall portfolio risk and increase the chances of achieving greater returns.”

I am not sure about the “greater returns” part, but I am convinced that, by spreading your assets across several categories that do not move up and down together, you will modulate the severity of the ups and downs of your portfolio’s value. In other words, you will get a smoother ride. Bet on brains. But, in an era of stock volatility, terrorism, a falling dollar and a rising China, it is not unreasonable to make at least a small bet on things as well.