A 12-point recommendation list will fix numerous structural problems, create lasting jobs, and reduce the deficit.

Midst of Deflationary Collapse or Brink of Inflationary Disaster? 12 Recommendations

As I've often said, sometimes it is better to just post what someone else has written much more eloquently than I could do so. the following is an article by Mike (Mish) Shedlock. He does an excellent job of not only explaining the state of economic affairs now, but further, he offers concrete ideas on how the U.S. can begin to get our economic house back in order. Additionally, I've often expressed a concern about the foundations of inflation being sown because of the Fed's "crank up the money printing presses" mentality. My thought should always be expressed with a caveat: in order for inflation to get going, it is necessary for banks to lend money. Well, banks aren't to anyone except the BEST of credits.

Credit Cycle Understanding Is Key to Returns

It is very refreshing to see someone else writing about debt deflation and how powerless the Fed is to stop it. Instead, we see article after article by people touting high inflation, even hyperinflation.

Hyperinflation is complete silliness at this point. Were it to come, it would be an act of Congress that would create it, not an act of the Fed, and the Fed would probably have to play along (though I doubt it would). For all its many faults, the Fed does not want to destroy banks. Hyperinflation would do just that.

The Republican-dominated House wants little or nothing to do with more stimulus. Certainly US government debt is going to mount, but it is going to mount in Japan, the eurozone, and the UK as well.

Moreover, eurozone structural issues matter now, while US government debt will matter more in the years to come.

Midst of Deflationary Collapse or Brink of Inflationary Disaster?

Although the Keynesian and Monetarist economists have missed the boat on what is happening and why, Austrian-minded folks who fail to understand the importance of credit and how little the Fed can do to revive it have blown the call as well.

It pains me to see articles like On the Brink of Inflationary Disaster by Austrian economist Robert Murphy.

Clearly we are in the midst of a deflationary collapse as noted in Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists
Wrong Twice Over.

Focus on Money Supply Alone Is Fatally Flawed

Deflation is about credit; it is also about attitudes that govern the demand for credit.

As I have stated many times over the years, and in the Contrary Investor article, there is nothing the Fed can do to force businesses to expand or banks to lend.

That point explains why Austrian economists who focus on money supply alone have failed and will continue to fail.

Until consumer demand returns, businesses would be foolish to expand. Unfortunately, the Fed's misguided easing policies have stimulated commodity speculation, thereby increasing manufacturing costs, while simultaneously clobbering those on fixed incomes and reducing final consumer demand.

I wrote about the plight of those on fixed incomes in Hello Ben Bernanke, Meet "Stephanie" back in January. Please give it a read if you have not yet done so.

The Deflationary Hurricane of Deteriorating Social Mood

One of the best posts recently on social mood and deflation is by Minyanville contributor Peter Atwater.

Please consider The Deflationary Hurricane of Deteriorating Social Mood

This morning, in the aftermath of Fed Chairman Ben Bernanke’s speech on Friday, the editorial page of the Wall Street Journal noted, “Mr. Bernanke also lectured that ‘U.S. fiscal policy must be placed on a sustainable path,’ though not by cutting spending in the short-term. So the Fed chief joins the Keynesian queue of spending St. Augustines – Lord, make us fiscally chaste, but not yet.”

Everything we need to do for long-term economic, if not societal success and stability comes with very severe short-term consequences. And so the response of most policymakers (and not just those responsible for fiscal policy but also regulatory policemen like Mr. Bernanke himself) has been to advocate for short-term expansionary programs and rules, while postponing the real teeth of necessary change until some later date in the future. Basel III, for example, has a phased-in capital-strengthening requirement for the banking system that does not finish until 2019 – again, "chaste, but not yet."

I am sure that what is behind the thinking of policymakers is the notion that if we can just get through this tough “transitory” period, the economy will turn up; and at that point, whether it is fiscal or regulatory policy, our ability to handle constraints will be much, much easier to bear.

After 11 years of declining social mood, the notion that further monetary stimulus has limited use is hardly a surprise. As I have cautioned so many times, when it comes to the consumer it is not the depth of a recession that matters, but rather its length. And while for policymakers and financiers this may feel like a three-year-old recession (and for some even just a three-week-old recession!), for the American consumer this is a decade-old recession that has deteriorated well into a depression. The average American is now financially and emotionally exhausted. And given the news reports out of Washington over the past month, they are also now afraid that they are at risk of losing some or all of their government safety net, too. Like the children of fighting, divorcing parents, they are now fearful of what an increasingly uncertain future holds.

While further fiscal stimulus – particularly job-related initiatives – may slow the pace of deterioration, I am increasingly afraid that further fiscal and monetary policy actions are now impotent agents against our current social mood. Where in 2000, the future was so bright that we’d need shades, in 2011, the future for many Americans is so dark that they can’t see their way forward.

The consequence will be price deflation -- and not just further price deflation across those debt-dependent purchases like homes and automobiles, but across all categories of consumer goods. And for the first time since the 1930s, American businesses will see that lower prices are not always met with greater demand.

Price Deflation on the Way?

My definition of deflation is "a decrease of money supply and credit with credit marked-to-market." Judging by symptoms of deflation and the Fed's efforts at fighting it, the US is back in deflation now by my measure. In my model, falling prices are not a requirement for deflation.

The important point is not definition, but rather the expected conditions. Yet, the conditions I expect -- and indeed the conditions in the US right now (in aggregate) -- match deflationary scenarios, not inflationary ones.

Murphy calls for an "inflationary disaster" while Atwater calls for "price deflation across all categories of consumer goods."

I do not know if we see across-the-board price deflation Atwater calls for given peak oil constraints and an inept US energy policy that also affects food prices.However, I do expect to see falling education costs and medical costs as well as falling prices in a broad array of consumer goods and services, especially if Republicans can get a few sensible deficit measures passed.

Whether that scenario happens or not, the idea "brink of inflationary disaster" is complete silliness unless and until the Fed can revive credit, yet the Fed is powerless to do so.

So, unless Congress goes really haywire, attitudes will change and deleveraging will play out before the US experiences serious inflation. Unfortunately, Fed and Congressional policies have only served to lengthen the deleveraging timeline.

Those looking for hyperinflation or even strong inflation have missed the boat again, and again, and again, and will continue to do so, interrupted by periodic inflation scares until debt-deflation plays out.

Understanding the Deflationary Cycle

To understand what is happening, why businesses are not hiring, why housing is stagnant, and where the economy is headed, one needs a model that takes into consideration five key factors:

1. Mark-to-Market Measures of Bank Credit and Capitalization Ratios
2. Credit Cycle Theory
3. Attitudes of Banks, Businesses, and Consumers
4. Futility and Limits of Keynesian Stimulus
5. Futility of Monetary Stimulus

1. Mark-to-Market Measures of Bank Credit and Capitalization Ratios

Banks cannot and will not lend unless they are not capital-impaired and unless they have credit-worthy customers. Atwater noted Basel III was delayed until 2019. I noted on many occasions banks are still hiding investments off the balance sheets in SIVs, and mark-to-market rules have been suspended several times.

As happened in Europe, delay tactics can only work for so long before the market questions if loans on the balance sheets of banks will ever be repaid. That time is now, not 2019. Thus banks are too capital-impaired to take excessive risks, even if they wanted to. Moreover, too few credit-worthy businesses want to expand in the first place. 2. Credit Cycle Theory

In accordance with long-wave, Kondratieff Cycle (K-Cycle) theory credit expansion and contraction cycles play out over decades. At least 75% of the time, continuously (not on and off), the economy grows in an inflationary manner. When deflation hits, few expect it because all that many have known for their entire lives is inflation.

As long as consumers have ability and willingness to add debt and leverage, the Fed seems to have power to revive the economy via various stimulus efforts. Once a consumer deleveraging cycle starts, the Fed's power ends.

3. Attitudes of Banks, Businesses, and Consumers

The willingness and ability of banks to lend and consumers to borrow and increase leverage is shot. Banks don't want to lend (or are to capital-impaired to lend), and boomers are heading into retirement overleveraged in housing, without enough savings.

Consumers first thought tech stocks would be their retirement, then housing. Both dreams have been shattered. Consumers are now determined to pay down debt (saving), even if by outright default or walking away. Default and walking away impacts banks' willingness and ability to lend.

Think of attitudes like a pendulum. Attitudes can only go so far before they reverse. Housing reversed in 2007 as did the Nasdaq in 2000. Both reversed when the pool of greater fools ran out.

The Nasdaq is still nowhere close to old highs. These cycles last longer than most think. I expect housing will be weak for a decade once it bottoms, and it has not yet bottomed.

Finally, it's not just boomer attitudes that affect credit. Kids see their parents and grandparents arguing over debt, worried about bills, worried about jobs and vow not to repeat their mistakes. This point ties in with K-Cycle theory above.

4. Futility and Limits of Keynesian Stimulus

Keynesian economists always want more, then more, then still more stimulus until the economy heals. Japan with debt-to-GDP ratio over 200% has proven such policies cannot ever work.

Keynesian economists always refuse to discuss the endgame, how the debt can be paid back, and what happens when stimulus stops.

The US has virtually nothing to show for all the make-shift, ready-to-go projects that temporarily put people back to work in 2009 and 2010. Not only did we repave roads that did not need paving, those hired still have debt-overhang and are still underwater on their houses.

All that happened was a delay in the day of reckoning. More Keynesian stimulus will only further delay the day of reckoning while adding to the national debt and interest on the national debt.

Priming-the-pump Keynesian theory will fail every time in a debt-deleveraging cycle. Indeed, it never works; it only appears to work until debt leverage is maxed out.

5. Futility of Monetary Stimulus

As discussed above, monetary stimulus negatively affects the real economy for the temporary benefit of the financial economy and Wall Street. The trade-off was not worth it except through the perverted eyes of Wall Street.

Telling action in bank stocks says the limits of helping Wall Street may have even run out.

Many point to excess reserves as a sign of future inflation. I point to excess reserves as a sign of failed Fed policy. Commentary from Austrian economists shows they fail to understand how credit even works.

The idea that those excess reserves are going to pour into the economy in a 10-1 leveraged fashion is simply wrong. Banks do not lend when they have excess reserves. Banks lend when they have credit-worthy borrowers, provided they are not capital-impaired.

It is time Austrian economists finally wake up to this simple economic truth.

Academic Theory vs. Reality

Economists of all sorts stick to failed models.

• The Monetarist want more monetary stimulus even though it is counterproductive
• The Keynesians simply will not admit end-game constraints
• The Austrians, for the most, part either ignore credit or incorporate failed models of credit expansion into their theories

Each camp points the finger at the others as to why the others are wrong. Ironically, none of the camps seems to understand the combined mechanics of debt deflation, deleveraging, and attitudes.

That said, I side with the Austrians about what to do (essentially, let things play out, while implementing much-needed structural reforms).

Twelve Specific Recommendations

1. Banks and bondholders should take a hit. Banks are not going to lend anyway so bailing them out at the expense of taxpayers is both morally and economically stupid. End the bailouts, all of them, and prosecute fraud -- the higher up, the better.

2. Implement serious bank reform now, not nine years from now. Banks should be banks, not hedge funds. This proposal will necessitate breaking up banks. So be it.

3. Scrap Davis-Bacon and all prevailing wage laws. Such laws drive up costs and have wreaked havoc on many cities and municipalities now bankrupt or on the verge of bankruptcy.

4. Pass national right-to-work laws. Once again, we need to reduce costs on businesses and local governments to spur more hiring and reduce costs.

5. End collective bargaining rights of all public unions. The goal of unions is to provide the least service for the most money. The goal of government should be to provide the most services for the least money.

6. Scrap ethanol policy and end all tariffs.

7. Legalize hemp and tax it. Prison costs will go down, tax revenue will grow, and biofuel and fiber research will expand as hemp produces very soft fibers.

8. Corporate income tax rates should be lower in the US than abroad. Current policy encourages capital flight and jobs flight via lower tax rates on profits overseas than in the United States. This penalizes businesses that work only in the US, especially small businesses that do not have an army of lawyers and lobbyists.

9. Stop the wars and set a plan to bring home all US troops from Iraq, Iran, and 140 or so other countries.The US can no longer afford to be the world's policeman.

10. Implement Paul Ryan's Medicare voucher proposal. It is the only way so far that anyone has proposed that puts much-needed consumer "skin-in-the-game" that will reduce medical costs.

11. Legalize drug imports from Canada.

12. End the Fed and fractional reserve lending. Both have led to boom-bust cycles of ever-increasing amplitude.

Those are the kinds of things we need to do, not throw more money at problems. The latter does nothing but drive up national debt and interest on the nation's debt for short-term gratification.

Notice how counterproductive Fed policy is and how counterproductive Obama's policies are.

The Fed wants positive inflation but businesses have not been able to pass the costs on. Instead, companies outsource to China. Those on fixed incomes get hammered.

Fool's Mission

Obama wants to create jobs via stimulus measures. This is a fool's mission.

Prevailing wages drive up the costs, few are hired, and the cost per job (created or saved) is staggering. Money never goes very far because the US overpays every step of the way.

Stimulus plans that do not fix the structural problems are unproductive. Then when the stimulus dies, which it is guaranteed to do, a mountain of debt remains.

Instead, my 12-point recommendation list will fix numerous structural problems, create lasting jobs, and reduce the deficit.

How Much Insurance Coverage Does The FDIC Provide?

For the inevitable question:

The standard deposit insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

The FDIC insures deposits that a person holds in one insured bank separately from any deposits that the person owns in another separately chartered insured bank. For example, if a person has a certificate of deposit at Bank A and has a certificate of deposit at Bank B, the accounts would each be insured separately up to $250,000. Funds deposited in separate branches of the same insured bank are not separately insured.

The FDIC provides separate insurance coverage for funds depositors may have in different categories of legal ownership. The FDIC refers to these different categories as “ownership categories.” This means that a bank customer who has multiple accounts may qualify for more than $250,000 in insurance coverage if the customer’s funds are deposited in different ownership categories and the requirements for each ownership category are met.

http://www.fdic.gov/deposit/deposits/insured/basics.html

Lot's of Volatility This Week - Is That Good or Bad?

The Stock Market has just had a REALLY volatile week. The S&P closed on 9/2/2011 at 1173.97 and closed on 9/9/2011 at 1154.23 – a loss of 1.68% That doesn’t seem so volatile, though, does it? Well, during the week, we ranged from a low of 1140.13 to a high of 1204.40 – a variance of 5.64%. That is a big range for one week. And we closed on 9/9/2011 much closer to the low point, so does this have any immediate future implications? Maybe. So let’s get a little background in here first:

Let’s start off and define what it means when you hear about “volatility”. Since this topic has been discussed at length by many people smarter than I am, I see no reason not to let Marty Chenard of Stocktiming.com discuss it:

“The Volatility Index (or VIX) is a weighted measure of the implied volatility for real time $SPX put and call options. The puts and calls are weighted according to time remaining and the degree to which they are in or out of the money. From this is created a hypothetical at-the-money option with a 30 day expiration time period. In this way, they are trying to set a value that is equal to the equivalent value of the $SPX's current price. (When a stock's option strike price is "at the money", it is theoretically the same as the price the stock is trading for at that moment.) So what does that mean? It means that the VIX really represents the "implied volatility" for the hypothetical $SPX put/call options on an "at the money" option value.

Let’s use a brief, more understandable explanation:

The VIX is a key measure of market expectations in the near term. For almost 20 years, the VIX has been considered as a valuable barometer of investor sentiment and volatility. Another way to look at it, is that it measures perceived risks of investors. The greater the perceived risks investors have about stocks, the more they buy "protection Put options", which means that the VIX will therefore be moving higher. When the VIX moves higher, the market moves lower because they are inversely related.

Many talk about the VIX's implied volatility changes ... but, don't get caught up about the term "implied volatility" if you don't understand it. What is important is that the VIX moves up during times of uncertainty or fear, and down during times of greed or confidence. Since the VIX moves in the opposite direction of the market, you can know what to expect for upcoming market movements by observing what is happening to the VIX. If you think about it, the VIX is a good example of "the self fulfilling prophecy". (The definition from Wikipedia is: "A self-fulfilling prophecy is a prediction that directly or indirectly causes itself to become true, by the very terms of the prophecy itself, due to positive feedback between belief and behavior.")

How does it work as a self-fulfilling prophecy? Imagine that an investor has bought a lot of equities over time and now believes that market risks are rising, so he feels that it would be wise for him to buy protective Put options in order to protect his equity. If he believes the market risks are truly rising, he not only buys the Puts, he also stops buying ... otherwise it would be counter-productive. The mere action of enough large investors stopping their buying is often enough for the market to be unable to sustain its up movement. Thus the market pulls back a the self-fulfilling prophecy event occurs.

**NOTE** Since investors have to buy options expiring in the future in order to protect themselves from their perceived beliefs about upcoming changes in the stock market, those actions cause the VIX to move ... and the VIX's movement therefore measures investor expectations of what they believe will happen in the near future. That's it ... this is all you need to know about what the VIX really is.

Since the VIX reflects the actions of investors who buy options as insurance against losses on their current portfolio positions, it would suggests that the VIX's action is predicated on the actions of some very knowledgeable, as well as some very large investors.

So, should you learn more about the VIX and use it ... or not? Here is what you need to ask yourself and decide about: Is the VIX a reliable measure for me to use in determining what will happen to the stock market or not?

If it isn't, then simply disregard it and do NOT use it as an important tool for making investment decisions. HOWEVER, if it is, then you MUST consider using the VIX as a tool when making investment or trading decisions.

I know that you cannot answer this question without also knowing how the VIX tracks with the Stock Market, and how to use the VIX in an effective manner.


How to Use Technical Analysis on the VIX to know when the market will change direction.

Since the VIX moves in the opposite direction of the market, we commented that one could know what to expect for upcoming market movements.

But we also said, ... that is only if the VIX is a reliable tool for determining what could happen next in the stock market. So, what is the correlation between the VIX, the Stock Market, and other indicators? Further, Is there sufficient correlation between the VIX and the Stock Market?

The answer is NO if the VIX is used alone. Most investors are just not cognizant of the fact that when they are investing or trading ... they are trying to compete with Goldman Sachs and other large Wall Street firms. These firms use a multitude of programs and tools to hedge, sell against hedging, and to initiate clean buy's into the market.

There are some critical factors that are involved when the VIX is moving up or down. If anything, they will show you WHY you should not rely on the VIX by itself.
When Wall Street players hedge or play the market, the NYSE Down Volume (Symbol: DVOL) is always a factor with what is going on with the VIX. So, the first thing to do is look at the 4 possible VIX to DVOL combinations that can occur, and what they typically mean for the market movements.

Here they are ... this chart shows the 4 major possibilities for various VIX and DVOL combinations. As you can see, there are really 2 important possibilities for investors, and that is when the VIX and the DVOL are going in the same direction ... whether up or down together. (When they are going in opposite directions at the same time, one is offsetting the other which influences a sideways market move.



Between April to August of 2011, there were 6 times where 1 of the 4 possible conditions occurred. Below is the matrix showing the VIX to Dvol combinations that occurred on the chart above and their resulting market action.


So, what helps to determine how large the SPY move is or isn't? ... or what helps determine how long a move will last? A significant part of the answer has to do with how much Institutional Investor Selling is occurring at the same time.

At the beginning of August, the VIX and the Dvol both peaked. Even though the VIX peaked, many people were not sure if the VIX was going to continue in an uptrend or not. The answer came just after 48 hours had passed because the Institutional Selling shifted to a down trend. Indicator tools like Institutional Selling are important for understanding what is really going on in the market, and why an isolated indicator like the VIX can't tell the whole story by itself.

Tools like these indicators are important parts to the whole equation, but still they don't tell the complete story. It is always better to try to gather as much information as possible in order to see what the Institutional Investors and Wall Street firms are doing.

These days, a good part of investing sensibly is to never go against what the Institutional Investors are doing. The days that a smaller investor can win when going against what the big Institutions are doing are few and far between.”

Sorry for the length of this post, but this is important. All of this volatility is increasing the risk of being in the Market! Are the potential rewards adequate to compensate you for this risk that you’re taking on?

The European situation remains dismal. The U.S. is running huge deficits in a moribund economy and the Fed has essentially used all of their silver bullets to stimulate the economy. In fact, many people are arguing that they have over-stimulated the economy by printing so much new money that we will eventually have to pay the piper through some serious interest rate increases or suffer through inflation. Emerging economies are also over-heating and are dealing with their own economic problems.

My point is that given the global situation, I do not believe that the Markets can adequately reward you for this additional risk. This is why I’m remaining predominantly in cash.

A New Danger Courtesy Of The Government?

Marty Chenard runs an excellent service - StockMarketTiming.com: http://www.stocktiming.com/Stock-Market-Daily-Analysis.htm . His site features FREE Daily Market Updates and his premium site features some of the best Market analysis available, all for a very modest fee. This site is subscribed to by some very large and well-known institutions and tells investors in black and white terms whether it is too risky or not to have exposure in the Stock Market.

From Marty Chenard's free Daily Market Update:

For months, we had pointed out the very large, two year negative divergence that the Financials had relative to the S&P 500. As discussed, the importance of this was that the Financial Sector represented 14% of the S&P's component structure.

And yet, the S&P went up for two years while the Financials went down for two years. We had commented that when conditions get too far out of sync, equilibrium is always re-established ... it is only a matter of time. See today's chart below ...

So, why are we bringing this topic up today?

It is because Governmental actions may have a self-destruction wish. Let me explain ...

Institutional Investors were starting to panic yesterday. They realize how bad the banking system is and how difficult it is for them to make a profit when interest rates are very low. (The Banking Index's two year drop could be suggesting that a more serious problem is around the corner .. see the chart below.)

So, our government should respect this potentially destructive state of Banking weakness, and NOT inject any new stress elements into the Banking arena. But, instead of that happening, Institutional Investors were starting to panic yesterday because the government appeared ready to do the opposite.

How so? Apparently, the U.S. Federal Housing Finance Agency has been planning to sue the nation's largest banks for approximately 30 Billion Dollars. The idea is to recoup money for Fannie Mae and Freddie Mac. Such a protracted legal event could easily overhang in the banks and markets for two plus years.

If in one's wildest dream, the FHA could find the WORSE timing for such a thing ... this would be it. But, sometimes a personal bias interferes with clear thinking with a disregard for the best long term solution.

Could it be ... that the FHA is looking at this as a possible funding source for the much discussed "underwater mortgage program"? We are referring to the refinancing program being discussed that would help homeowners who owe more on their home than the house is currently worth.

Take a moment to look at today's chart, and you will see the precarious position that the Banking index is still in.

It is possible ... that if the FHA does launch a lawsuit, that the Banking Index will have another leg down and that would have serious repercussions on the stock market. The FHA has until the end of the day on Tuesday to file a lawsuit ... so keep an alert eye out for what happens.

This is exactly what our weak banking institutions don't need and very well trigger a vast number of unintended, very bad consequences. Note Marty's caveat that systems that are out of balance as badly as the Banking Index compared to the overall Stock Market eventually get back in sync. This could very well happen by the Stock Market taking a plunge to the downside.

Am I Still Worried About Europe?

You bet I am.

Frankly, the fact that more people are not concerned about the European banking situation has me... concerned. My stance remains the same - the Stock Market is a risky place right now. Most of my friends and family members are investors, not traders. They cannot pull their money out of stocks in either individual stock accounts or retirement accounts, immediately. And if the European situation continues, let alone deteriorates, the financial markets could see some fast and furious action - to the downside.

I continue to believe that for the average, prudent investor, the best place to be right now is on the sidelines.

The European Situation

Christine Lagarde, the IMF’s new chief, set off tremors at the Jackson Hole summit over the weekend with warnings that the global financial system is on very thin ice and vulnerable to the slightest shock.

“We are in a dangerous new phase. The stakes are clear: we risk seeing the fragile recovery derailed, so we must act now,” she said.

“Banks need urgent recapitalization. If it is not addressed we could easily see the further spread of economic weakness to core countries, even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization,” she said.

Although it’s encouraging that these issues are getting addressed at the highest levels, Europe’s lenders are already reeling from a share price collapse since the debt crisis spread to Italy and Spain, threatening to overwhelm Europe’s bail-out fund and leave banks exposed to sovereign defaults. We are getting perilously close to a crisis and it is questionable if they aren’t already so far along that anything can be done, let alone if all of the necessary parties are even on the same page as far as what needs to be done.

Europe’s inter-bank market is effectively frozen and EMU banks have lost access to America’s $7 trillion money markets. Lenders have parked €126 billion at the European Central Bank for safety rather than risk exposure to peers. When a bank’s peers are afraid of depositing money with a bank, that should mortify corporate and individual account holders. It will not be surprising at all to see large corporations shunning these institutions and then individuals. What’s going to happen to those institutions that are slow to withdraw? I don’t know the answer – I’d just take steps to ensure that I’m not one of those “last” institutions (or individuals!).

The IMF exhorted Europe’s banks over the last two years to beef up their capital base while the rally lasted. Many failed to do so and will now face harsher terms. Some may fall under state control, wiping out shareholders. The Eurozone economy ground to a halt in the second quarter, tightening the noose on EMU’s weaker states and their banks. Julian Callow from Barclays Capital said Europe is already in “industrial recession” and risks tipping into outright economic slump.

“The recent slide is eerily reminiscent of the pattern during the third quarter of 2008,” he said.

Ms. Lagarde issued a thinly-veiled attack on the ECB’s rate rises and Europe’s fiscal austerity drive. “Monetary policy should remain highly accommodative, as the risk of recession outweighs the risk of inflation. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery,” she said. Note: What she is advocating is turning up the money printing presses. But there’s a problem – Germany, the strongest country in Europe isn’t keen on the idea of sacrificing their decent economic situation to help bail out those countries that have shown neither the want nor desire to implement the economic structural changes necessary to rectify the causes of their poor financial condition.

Additionally, Tim Congdon from International Monetary Research said it is folly to force Europe’s banks to raise money too quickly or crystallize losses abruptly. This will cause a monetary implosion and a repeat of the 2008 disaster. He said the ECB’s restrictive policies over the last 18 months and the lack of EMU fiscal union have doomed the euro. to certain break-up.

“It cannot be saved. Banks will suffer large losses,” he said.

Another Banking Crisis?

We are perversely incentivizing the people who run our key financial institutions to take risks. Lots of risk! Because there is little or no downside for them. And we've already been burned from this just a couple of years ago!

From Barry Ritholtz:
"The banking system was not saved. The massive injections of liquidity temporarily soothed day-to-day operations of banks, but they did not repair the more profound troubles. Indeed, pouring billions into nearly identical management teams that mismanaged risk, overleveraged exposure and drove banks off the cliff in the first place was an invitation for another crisis .. They remain stuffed with declining assets, primarily in housing and derivative holdings. Another leg down in housing could be nearly fatal; Balance sheets are unnecessarily opaque; Capitalization: This remains too thin. Leverage should be mandated back to the pre-2005 rule change of no more than 12 to 1.; Misaligned incentives: Compensation and bonus schemes were not significantly changed after the bailouts, except during loan repayments. Thus, management and traders still have the same upside to roll the dice, but they do not have the downside risks."

The U.S. Debt Situation – Putting It Into Perspective:

The U.S. Debt Situation – Putting It Into Perspective:

- New debt: $ 1,650,000,000,000
- Federal budget: $3,820,000,000,000
- National debt: $14,271,000,000,000
- Budget cut: $ 2,100,000,000,000 ( CBO estimated ) / Annualized over 10 years ($210,000,000,000/ yr)

Looking at the raw numbers, it’s hard to put it into perspective. Most people tend to better grasp numbers and concepts when put into terms that they deal with everyday. So, let’s remove eight zeros from these numbers and pretend this is the household budget for the Spendthrift family:

- Total annual income for the Spendthrift family: $21,700
- Amount of money the Spendthrift family spent: $38,200
- Amount of new debt added to the credit card: $16,500
- Outstanding balance on the credit card: $142,710
- Amount cut from the budget: $2,100

So, in effect last month Congress, or in this example the Spendthrift family, sat down at the kitchen table and agreed to cut $2,100 from its annual budget. What family would “solve” their budget issues by cutting that much from their $38,200 spending; $16,500 more than their income? Right… only the Spendthrift’s! And THIS is what the Spendthrift’s in Congress are trying to sell to us – the American public.

Europe's Banking Situation

Last week, Nicholas Sarkozy and Angela Merkel got together to talk about the European economic issues. Their response was not amazingly political: what is needed is another eurozone governing body overseeing fiscal debt and promises by governments not to run large deficits. They also said that they will harmonize their tax structures within five years. As John Mauldin notes, the problem is not tax structures, it is debt that cannot be repaid.

Lars Frisell is the Swedish Financial Supervisory Authority Chief Economist - the Swedish group that regulates that nation’s banking system. A few days ago he was quoted as saying:
“It won’t take much for the interbank market to collapse. It’s not that serious at the moment, but it feels like it could very easily become that way and that everything will freeze.”

Porter Stansberry wrote the other day:
“In Europe, the problem is a bit different … and slightly more technical. Most of the debt in Europe is held by the big banks, not the sovereigns. Look at just two French banks, for example. Credit Agricole and BNP Paribas have combined deposits of a little more than 1 trillion euro. But they hold assets of 2.5 trillion euro. Those assets equal France's entire GDP. And those are only two of France's banks. Right now, the tangible capital ratios of these banks have fallen to levels that suggest they are probably bankrupt – like UniCredit in Italy and Deutsche Bank in Germany. BNP's tangible equity ratio is 2.85%. Credit Agricole's tangible equity ratio is 1.41%. (UniCredit's is 4.42%, and Deutsche Bank's is 1.92%).
“These banks have long been instruments of state policy in Europe. They've funded all kinds of government projects and favored industries. Making loans is far more popular with politicians than demanding repayment for loans. As a result, these banks are left with nothing in the kitty to repay their depositors. If there's a run on these banks (and there will be), how will they come up with money that's owed?”

Again, from John Mauldin, "If there is a sovereign debt credit crisis in Europe, it is entirely possible that a majority of Europe’s banks will be technically insolvent, depending on the level of the crisis. Frisell could be eerily prescient. We gave them subprime; they may pay us back with their own crisis and in spades. The next real crisis in Europe that is not bought off with yet more debt will push the world into recession. It is that serious. That is why the ECB keeps ignoring its charter and taking on bank debt and buying sovereign debt they know will be marked down."

Does reading any of this from some very educated people sound like the world's banking system is stable? We are talking BIG European banks. And they are all inter-connected through a myriad of swaps, derivatives, etc... with most of the other large banks in the world. Just out today is a great story that tells us that the bank bailout in 2008 wasn't the $500 billion that was advertised - it was $1.2 TRILLION: http://www.americanthinker.com/2011/08/that_federal_bank_bailout_in_2008_was_bigger_than_we_knew_a_lot_bigger.html
What's going to happen when people really start thinking about these events?

Time To Fire Up My Blog

It is time to fire up my blog gain. I am getting the distinct and foreboding feeling that we are entering a very precarious time for the Stock Market and I'd like to use my blog to help as many people as possible. The last time that I felt like this was in October/November 2007. This time period has many of the same characteristics as that time period:
- Many of the major banks in the world have rotten Balance Sheets. One could probably argue that the Balance Sheets were never fixed in the first place.
- Lack of political leadership.
- Downward spiraling consumer confidence.
- A lack of faith in the financial markets.
- The onset of a recession. Again, one could probably argue that we never exited the last recession. Were it not for the massive liquidity inflows from QE and QE2 this would be readily apparent.

But I'm not going to dwell on the reasons for the problems that we're in right now. I'd rather just advise people right now to start taking defensive actions to protect themselves from what promises to be a nasty time in the financial markets.

Barring some currently unforeseen miraculous event, I think it is advisable for people to significantly lighten up their exposures to the Stock Market. We are setting up for what could be a really big drop. I'm not talking about just the U.S. Stock Market, either. I have been and am exiting almost all positive equity exposures. Safe places to put your money would include in cash, U.S. Treasury bonds, money market mutual funds as long as you stay below the FDIC insured limits, and I think that one could also allocate 5 - 10% of their portfolio to precious metals - for the time being. If you need specific instruments to invest in, drop me a line and I can provide some.

I, of course, cannot be certain that I am right. Also, my "call" may also be early, but if the Market tanks like I think it might, I'd rather be early than late. The Market may very well finish off a potential "up" move of several hundred points to complete a "W Pattern", but this will not change the underlying economic problems that we are facing. And I don't feel that staying in the Market is worth the risk right now.

I will post more on the causes and other topics later, but I wanted to get this out tonight. Feel free to make any comments or ask questions in this blog. Chances are that if you have questions that other people have the same questions.

The Zurich Axioms

The First Major Axiom:
ON RISK
Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough.

Minor Axiom I
Always play for meaningful stakes.

Minor Axiom II
Resist the allure of diversification. Diversification has three major flaws:

1. It forces you to violate the precept of Minor Axiom I: that you should always play for meaningful stakes. If your entire starting capital is itself not very meaningful, diversifying is only going to make things worse. The more you diversify, the smaller your speculations get. Carry it to extremes and you can end with amounts that are really quite trivial.

2. By diversifying, you create a situation in which gains and losses are likely to cancel each other out, leaving you exactly where you began -- at Point Zero.

3. By diversifying, you become a juggler trying to keep too many balls in the air all at once.

The Second Major Axiom
ON GREED
Always take your profit too soon.

Minor Axiom III
Decide in advance what gain you want from a venture, and when you get it, get out.

The Third Major Axiom
ON HOPE
When the ship starts to sink, don't pray. Jump.

Minor Axiom IV
Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.

The Fourth Major Axiom
ON FORECAST
Human behavior cannot be predicted. Distrust anyone who claims to know the future, however dimly.

The Fifth Major Axiom
ON PATTERNS
Chaos is not dangerous until it begins to look orderly.

Minor Axiom V
Beware the Historian's Trap. The Historian's Trap is a particular kind of orderly illusion. It is based on the age old but entirely unwarranted belief that history repeats itself. People who hold this belief -- which is to say perhaps ninety-nine out of every hundred people on earth -- believe as a corollary proposition that the orderly repetition of history allows for accurate forecasting in certain situations.

Minor Axiom VI
Beware the Chartist's Illusion. Representing numbers by lines on graph paper can be useful or dangerous. It is useful when it helps you visualize something with greater clarity than you could achieve with numbers alone. It is dangerous when it makes the thing represented look more solid and portentous than it really is.

Minor Axiom VII
Beware the Correlation and Causality Delusions. It is characteristic of even the most rational minds to perceive links of cause and effect where none exist. When we have to, we invent them.

The human mind is an order-seeking organ. It is uncomfortable with chaos and will retreat from reality into fantasy if that is the only way it can sort things out to its satisfaction. Thus, when two or more events occur in close proximity, we insist on constructing elaborate causal links between them because that makes us comfortable.

Minor Axiom VIII
Beware the Gambler's Fallacy. The Gambler's Fallacy is a peculiar variety of orderly illusion. In this case the perceived order is not in the chaotic world all around, but inside, in the self. When you say you are "hot," or you get the feeling that today is your lucky day, what you mean is that you are temporarily in a state in which random events will be influenced in your favor.

The Sixth Major Axiom
ON MOBILITY
Avoid putting down roots. They impede motion. In the lexicon of modern mental-health theory, rootlessness is in the same category as worry. Both are felt to be bad for you.

Minor Axiom IX
Do not become trapped in a souring venture because of sentiments like loyalty and nostalgia.

Minor Axiom X
Never hesitate to abandon a venture if something more attractive comes into view. There are many ways in which you can get rooted in a speculative medium, to the detriment of your overriding goal of making money. One of the most common -- it sneaks up and takes people by surprise -- is to get into a situation in which you aren't sure whether you are conducting a speculation or a hobby.

The Seventh Major Axiom
ON INTUITION
A hunch can be trusted if it can be explained. A hunch is a piece of feeling-stuff. It is a mysterious little clump of notquiteknowledge:
a mental event that feels something like knowledge but doesn't feel perfectly trustworthy. As a speculator you are likely to be hit by hunches frequently. Some will be strong and insistent. What should you do about them? Learn to use them, if you can.

Minor Axiom XI
Never confuse a hunch with a hope. When you want something very much, you can all too easily talk yourself into believing it will happen. This fact of human psychology confounds little children dreaming of what they want for Christmas, and it confounds speculators dreaming of all the money they're going to make.

The Eighth Major Axiom
ON RELIGION AND THE OCCULT
It is unlikely that God's plan for the universe includes making you rich.

Minor Axiom XII
If astrology worked, all astrologers would be rich.

Minor Axiom XIII
A superstition need not be exorcised. It can be enjoyed, provided it is kept in its place.

The Ninth Major Axiom
ON OPTIMISM AND PESSIMISM
Optimism means expecting the best, but confidence means knowing how to handle the worst. Never make a move if you are merely optimistic.

The Tenth Major Axiom
ON CONSENSUS
Disregard the majority opinion as it is probably wrong.

Minor Axiom XIV
Never follow speculative fads. Often, the best time to buy something is when nobody else wants it. The pressure of majority opinion is especially troublesome when it comes to the questions of what to invest in and when to invest. This is when many an otherwise clever speculator lets himself or herself be pushed around, with unprofitable results.

The Eleventh Major Axiom
ON STUBBORNNESS
If it doesn't pay off the first time, forget it.

Minor Axiom XV
Never try to save a bad investment by "averaging down." The technique known as "averaging down" or "averaging losses" is one of the investment world's most alluring traps. It is like those fail-safe, surefire, double guaranteed systems for beating a roulette wheel, which are hawked in the streets and bars of Las Vegas and Atlantic City. When you first examine such a system it seems unassailably logical. "Why, yes, this really would work, wouldn't it?" you say, wide-eyed with wonder. The loss-averaging technique is like the roulette systems, too, in that it will work sometimes -- when the player is lucky. That, of course, adds to its allure. But you must be careful not to let it beguile you. It is a rose with poisonous thorns.

The Twelfth Major Axiom
ON PLANNING
Long-range plans engender the dangerous belief that the future is under control. It is important never to take your own or other people's long-range plans seriously. The Twelfth Axiom says there is only one long-range financial plan you need, and that is the intention to get rich. The how is not knowable or plannable. All you need to know is that you will do it somehow.

Minor Axiom XVI
Shun long-term investments.

What does the "Big Money" think about Quantitative Easing?

Bill Gross, one of the most prolific money managers of our time and Managing Director at PIMCO, provides his investment outlook: http://www.pimco.com/Pages/RunTurkeyRun.aspx . Why is he reluctantly supportive of QE-II? His firm and their clients own billions of dollars worth of Treasuries. He doesn't have any choice. But realize this, he knows a Ponzi scheme when he sees one and he also thinks that PIMCO won't be the last entity holding bonds when it all comes crashing down. Be very sad for people who are in Fixed Income investments at that time (lots of retirees will be in this number).

More Stimulus?? Why?

Well, the brain trust in Congress thinks that the first round of stimulus is not enough (how they have determined this since hardly anything has actually been spent yet is beyond me) and they are floating talk that a second round will be needed. The only thing I can think of, since this defies everything that has actually worked in the past, is that they are going to try to inflate away the consumer debt problem. And this is the least crazy answer I can come up with and it's still crazy. It looks like the $10 loaf of bread is actually going to end up being $20 - provided there is a bakery that can fund ongoing operations in that type of environment.

Bank Failures - How to Avoid Exposure

With the failure of IndyMac over the weekend, concern about the safety of your savings is of paramount importance in many people's minds today. I will try to help answer any questions that any reader may have to help you make a decision on what actions, if any, one should take.

Remember, your deposits are insured up to $100,000, but there is no standard process on how one can get access to their money, even that less than $100,000 in the event of a failure. But at least you know that you'll be getting it all back! Here is a quick and dirty check-up that you can perform on your bank:

Go to http://www.bankrate.com/brm/safesound/ss_home.asp and plug in the bank(s) you are considering. Check the rating and then read memorandum for the particular bank. There is almost certainly a 4 or 5 star local bank within driving distance and probably within a few miles.

To give you an example of what to AVOID, look at IndyMac Bank. Prior to them going bankrupt, they had been given the worst possible rating and they had a negative ROI! The average for the whole industry the first quarter this year was .7%. Typically, 1% is considered "good." IndyMac was -7.0%. Not -0.7% but -7.0%! This was a big red flag.

Then go to http://www.bauerfinancial.com and check the rating they gave the bank as well. Sometimes the ratings will differ. But my thinking is if the bank in question has a high rating from both then that is a good sign while if it has a low rating from both then that is a bad sign.

Been a Long Time......

I know it's been a long time. What's someone to do when there's only so many ways that I can continue to tell investors to conserve cash and stay on the sidelines? So why am I writing now? Well, something has changed. I'm detecting panic and desperation and investors actually throwing in the towel and leaving the market in disgust. This is an important tell because at market extremes - the crowd is usually wrong (the crowd is actually usually right at most other times). So what am I looking for? I don't know. We could get a wash-out where the market washes out the last holders-on. But there are lots of investors just like me (on the sidelines waiting for this event) which decreases the likelihood of this happening. Probably, a little more likely is that the market's volume just dries up though and the market then starts rallying. Nothing spectacular, mind you. Just some days where the market slowly starts ambling up. What sectors should do well? Historically, coming out of a bear market, the sectors that do well are the ones that are already doing well - energy, commodities, agriculture AND the sectors that have been doing the worst - financials, real estate and homebuilders. From the best performing sectors, you can pick names out of Investors Business Daily, or just invest in the ETF's to avoid the exposure of a single company getting hit with bad news. I'd go the ETF route. If you have not already noticed my comprehensive ETF Locator, take this opportunity to familiarize yourself with it. Posted on March 14, 2008 at 5:04 PM on this blog. Good Luck.