- Where in the U.S. can you find a pot of oil twice the size of Alaska’s reserves? Is this just a pipe dream? The answer is no. Locked away in North Dakota is just such a place, but it is buried under miles of rock. In fact, it is so large that it stretches across the entire state and actually into Montana and Canada. Why haven’t we gone after it before? Too many technological difficulties. Even if we had the technology, the expense was so great that anyone who drilled for it would lose a lot of money. With the price of oil over $100 per barrel and better technology available, several companies are now expressing interest in trying to drill in that area. It won’t provide any immediate relief, however, because it will take half a decade or more to begin production.
- Over the past couple of years the U.S. Treasury has introduced new bills starting with those most commonly created by counterfeiters, including the $100 bill and the $20 bill. A couple of weeks ago the new Lincoln $5 bill was introduced. It’s a lot more colorful, including having a purple hue which begins in the middle and fades out to the edges. Don’t think you are getting a counterfeit $5 when you receive one of these new and “funny looking” bills.
- A big event occurred in 1957 that totally changed the way education proceeded. Remember the Russian’s sending up Sputnik? That simple act motivated both federal and local governments to commit huge amounts of money to education, especially to math and science. This gave way to a period, over the past 50 years, which has been the most productive and innovative in history. The question becomes what will happen over the next 50 years? In the spring of 2006, President Bush formed the National Mathematics Advisory Panel to look at the math skills of today’s students. While the 24 member panel has made recommendations regarding improvements in the teaching of mathematics, the recommendations were made in light of a report that shows that 23 industrialized countries ranked ahead of the U.S. in math at the 15 year old level. It was noted that those who took the most math classes, and especially those who completed algebra, attended and graduated from college on a more regular basis than some others. We simply cannot allow our history to pass by without trying to rectify this situation. It was ironic that this report came out on the same day that Congress found it better to spend more money on pork barrel projects than to continue the Bush tax cuts. Somehow we might even be able to swallow the expiration of some of those tax cuts if the money were going to be directed toward education, rather than toward “give away” programs at the local level. An educated society is a rich society. We simply need to totally reinvent our educational system. This will take great leadership at the local, state, and federal level and it will need to be a coordinated effort. Many older Baby Boomers won’t see the degradation that will occur in our society without good education, but their children and grandchildren will. Perhaps, somehow, those who were the beneficiaries of the last great push for education in America can be the leaders to make sure it happens again.
- With everything that has occurred during the past nine months since Bear Stearns first announced their concerns about two of their hedge funds that contained sub-prime mortgage exposure, it’s time to reflect on the past to see if there is something we can learn from it in the current environment. First, has something like this ever happened in the past? The answer is yes. The real estate boom of the 2002 through 2006 time period is now viewed as a “bubble”. Surprise! Surprise! It’s just like the bubble that developed in the stock market during the late ‘90s. People refused to believe it was bubble until it actually burst. Let’s go back even further in history. About 100 years ago, before the creation of the Federal Reserve in 1913, there was a huge panic amongst the banks due to insane speculation. Of course, this insanity was not recognized until it began to play out. One of the richest men in the world at the point in time was J. Pierpont Morgan (yes – JP Morgan). It was to Morgan that Wall Street banking, and yes, even politicians in Washington DC turned to stop the panic of 1907. Remember, we didn’t have all of the idiosyncrasies in the financial banking industry as we do today. What was needed to save the banks at that time was cash: what we have referred to for years as the “energy needed to move the economy forward”. Because of his vast wealth and reputation, Morgan was able to singlehandedly provide cash to those banks willing to play by his rules and to starve the ones that refused. By no means are we suggesting that Morgan was a philanthropist. He is without doubt, one of the world’s greatest capitalists. He realized what needed to happen in order to prevent deflation from occurring following the bursting of the bubble. It was an influx of cash, which would result in stability. He also recognized that while the influx of the cash might cause some inflation, in his mind inflation was not nearly as big an issue as deflation. Morgan had a brilliant young associate who did some research and found that much of the speculation was a direct result of the actions of the Nickerbocker Trust. Morgan basically singlehandedly bankrupted this Trust by starving it of cash. He then called all of the other bankers to his home and told them that he needed their cash in order to stem panic. In fact, he gave each of them a piece of paper with their name on it and a dollar amount, and made each of the bankers sign the paper and pledge the cash that would be needed to bail America out of the speculative bubble. Morgan knew that if this did not happen, it would spiral out of control, leading to a deflationary cycle and perhaps even to a depression. For five years following this, JP Morgan was the de facto head of the banking system in America. After he died, the Federal Reserve was created by Congress. Through the years, the Fed has learned from experience and continues to refine policy decisions. For example, today’s initial limit on margin loans against securities is 50%. Back in the 1920s, however, 90% could be borrowed.
In 1927 and 1928 the economy was booming, but by late in 1928 and early 1929 it went into a speculative cycle, which eventually led to the stock market crash of October 1929. What did the Federal Reserve do? Rather than injecting cash into the system to replace the dollars that were wiped out by the stock market crash, they reduced the money supply. By doing so, they deprived America of the much needed cash that was required to keep the economy moving forward - albeit after what might have been a pretty severe recession. This starvation of cash led to the closing of factories, home prices spiraling downward at unbelievable levels, and a near evaporation of the stock market. This led to 25% unemployment and what has subsequently been called the Great Depression. All because the Fed did exactly the opposite of what it should have done.
Now, let’s fast forward to 2007. Make no mistake. Our economy is experiencing some very difficult times, and at this point, most economists believe that we will go into a recession, if we are not already in one. The questions now surround severity and duration. The average recession lasts a little over ten months. Bernanke is an inflation fighter, but he is also a zealot about fighting deflation and the best way to fight deflation is to make sure that the economy has plenty of cash. While inflation can be defined as too much money chasing too few goods, deflation is just the opposite. When people don’t have cash, they don’t buy things and prices go down in the hopes of attracting buyers. People still don’t buy, so prices go lower. People still don’t buy and the prices plunge even further. Eventually, people say that they won’t buy it today because they “know” it will be even cheaper tomorrow. That is the death spiral that is such an issue. The best way to combat this type of mentality is to make sure that liquidity exists in the system. Based on a speech that Bernanke once gave and the fact that he is a helicopter pilot, he was dubbed “Helicopter Ben”, because he said that the Federal Reserve should drop bales of money from helicopters in order to prevent deflation and provide liquidity. He is living up to his reputation. First, he lowered interest rates - gradually in the beginning. Then he accelerated, and at the last Federal Reserve meeting, he proved once again his desire to stop deflation and to deal with inflation later by dropping interest rates by 75 basis points. More than that, he developed the idea of the $60 billion in auctions that would occur at $20 billion per month for three months. He accelerated this to $20 billion in auctions every two weeks. Each time, all of the money was scooped up. Then, in a coordinated effort with other world banks, he came up with an agreement for them to provide the cash to the banks that needed it – i.e., the ones holding securities that had no value in the current marketplace. It was not that the securities were totally worthless, but that there were currently no willing buyers. This is deflation. At one point, the sub-prime bonds were worth $1,000 and then they went down to $900 and someone bought them because they thought it was a good deal. Then, they dried up and the bonds were worth $800, then $500, then $300, and in some cases there were some that were virtually unsellable. In essence, what we have seen in the sub-prime and credit areas is a deflationary cycle. The only way to break that cycle is with cash. The cash not only provides the liquidity that is needed to break the cycle, but it replaces the dollars that are “lost” as a result of the values going down, i.e., in this case, real estate prices. Then the Fed moved to provide cash through opening the discount window not only to commercial banks, but to investment banks as well.
Right now, it’s hard to see through the thick fog of the “talking heads” on television, many of whom have little knowledge of how money actually works. They mostly know how to be entertaining, and of course, bad news sells a whole lot better than good news. So when will we come out of this cycle? No one knows for sure, but the best guess is that the blow will be softened by the rebate checks coming out in the next few months that will aid the consumer. It doesn’t mean that a blow won’t happen or hasn’t already, it simply means it will be softer. We cannot eliminate economic cycles from occurring. They have always been there and will always be there. What we can hope is that our true leaders will do the right things – and thus far – it appears that Bernanke and the Federal Reserve have done just that. It’s just hard to see it at this point. When we come out at the end of the tunnel, we believe we will see a comeback in the economy. In fact, it could be strong. They say it’s always darkest just before the dawn and it is certainly dark at the moment. We just don’t know when the dawn will come. Patience is the key at this point. Deflation will set into your portfolio only when you take the paper losses and turn them into real losses and don’t participate in the inevitable upturn that will occur in the marketplace. Hopefully, this analysis of the current situation helps provide you with some perspective not only in what has happened and is happening, but also what is possible going forward. We came out of the last recession with five years of an expanding economy and gains in the financial markets. While no one can predict the future, we are confident that better economic times will ultimately return.
- With everything that has occurred in the markets over the past eight to nine months and especially the volatility that has existed since December of 2007, it’s sometimes hard to keep things in perspective. Reflecting back ten years ago to 1998, little did we expect to have the significant stock market bubble that occurred during the last half of 1998 coming off the currency crisis of that year and ending in March of 2000. October 2002 marked the bottom following that bubble and about six months later was the beginning of the Iraq war. On March 20, 2003, the Dow Jones was at 8287 and today it is 12263, or up about 48%. The S&P 500 was trading at 876 and today it is 1323, or up approximately 51%. On the same date, the NASDAQ was at 1403 and it closed today at 2279, or up about 62. Yes, we have come down from the recent highs in October of 2007. When you consider what we have absorbed in the way of news over the past six months, however, it amazes many Bears that the markets have not fallen out completely. Why haven’t they? It speaks to the strength of the U.S. economy and to worldwide growth. No one knows what the future will bring. However, when we step back and look at where we were five years ago, it adds some perspective. When we were near the bottom of a prolonged Bear market, with the 911 terrorist attack still fresh in our minds and with a war starting in Iraq, it was hard for many investors to visualize the growth that ended up occurring over the last five years. While there will certainly be bumps in the road (always have been, always will be), the long-term movement of the market has been in a positive direction. Source: BTN Research and Yahoo Finance
- In what came as no surprise to most, the trustees of both Medicare and Social Security said these programs are in trouble. Surprise! Surprise! According to the report, Medicare’s trust fund will be depleted in 12 years by the end of 2019. Social Security’s reserves will be exhausted by 2041. What was the response of the Republicans and Democrats? As usual, they blamed each other. The Democrats accused the Republicans of wanting to make drastic cuts in both programs, while the Republicans suggested that the Democrats wanted to raise taxes. What are the odds that one party will prevail? In our opinion – zero. The fact is, both of these programs, especially with Baby Boomers moving closer to retirement and Medicare coverage at age 65, are going to have to do something fairly quickly. It will likely be a combination of reducing benefits and increasing taxes. Of course, this is an election year, so who wants to attack this problem right now? Should McCain win the election and the Democrats continue in control of both Houses, then the debate is liable to continue for a long time. On the other hand, should either Obama or Clinton win, we can likely expect them to weigh in on the side of raising taxes versus cutting benefits. There is no easy solution and it will take strong leadership. Frankly, this seems to have been greatly lacking in Washington from the Whitehouse to the Capital for a long time.
As always, we encourage you to give us a call if you would like to discuss anything further. We will visit again soon.
RAY, KIM, ERIC, BRUCE, and LOU
©3/31/08 ProVise Management Group, LLC
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