A common mistake that people make when trying to design something completely foolproof is to underestimate the ingenuity of complete fools.

- Douglas Adams, The Hitchhiker’s Guide to the Galaxy

For quite some time in this letter I have been making the case that for the eurozone to survive, the European Central Bank would have to print more money than any of us can now imagine. That the sentiment among European leaders was that they were prepared for such a move was clear � except for Germany, which is haunted by fears of a return to the days of the Weimar Republic and hyperinflation.

When Germany agreed to a fixed monetary union and a European Central Bank, it was with the clear understanding that it would be run along the lines of the German central bank, the Bundesbank. The members of the Bundesbank and the German members of the ECB were most outspoken about the need for a conservative monetary policy that would keep a clamp on inflation.

However, as I have previously noted, the Bundesbank was a toothless tiger. Germany has two votes out of 23 on the ECB, and the loud drumbeat from most of Europe, which is experiencing the difficulty of austerity accompanied by too much debt, is for a far more accommodating ECB.

The simple fact is that Mario Draghi, the Italian president of the ECB, created �1 trillion euros to help fund European banks, which promptly turned around and bought their respective countrys’ sovereign debt. Germany’s Angela Merkel forced the Bundesbank to “play nice” and go along with what was seen as the only way to solve a growing banking crisis in Europe. Everyone breathed a sigh of relief, thinking that this at least bought a year during which things could be sorted out. But it turns out that a trillion euros just doesn’t go as far as it used to. The “relief” lasted about a month. The last few weeks have presented yet another budding crisis, as least as large as the last one. Where to get the next trillion?

This week the German Bundesbank waved the white flag. The die is cast. For good or ill, Europe has embarked on a program that will require multiple trillions of euros of freshly minted money in order to maintain the eurozone. But the alternative, European leaders agree, is even worse. Today we will look at the recent German shift in policy, why it was so predictable, and what it means. This is a Ponzi scheme that makes Madoff look like a small-time street hustler. There is a lot to cover.

At the end of the letter I will mention a few upcoming speaking engagements, in Atlanta, Philadelphia, and a webinar I will be doing next week. Now let’s jump over to Europe.

Waving the White Flag

It is the world’s worst-kept secret: Germany does not want inflation but wants to abandon the European Union even less. And as we will see, the eurozone simply does not have enough money to keep itself together without massive ECB intervention.

“Cry havoc,” wrote Shakespeare in Julius Caesar, “and let slip the dogs of war.” The military order “Havoc!” was a signal given to the English military forces in the Middle Ages to direct the soldiery (in Shakespeare’s parlance “the dogs of war”) to pillage and incite chaos.

The cry is much the same in Europe today, though it is not the dogs of war that will ravage the land but the hounds of inflation. The English edition of Spiegel Online today carries a story with the headline “High Inflation Causes Societies to Disintegrate.”

Spiegel Online explains:

“‘Inflation Alarm!’ reads the front-page headline in Bild, Germany’s biggest selling newspaper. “How quickly will our money be eaten up?” the paper continues on page 2. “Millions of Germany [sic] are worried: Inflation is returning!” Just in case the message wasn’t clear enough, the article is illustrated with a picture of a 1-trillion-mark note from 1923, the high point of German hyperinflation.

“The fact that Bild, arguably Germany’s most influential newspaper, chose to run with the story in its Friday edition shows just how deep-rooted Germans’ fears of inflation are. Nine decades later, the hyperinflation of the early 1920s still haunts the country.

“The panic-mongering was prompted by a statement by a senior official from the Bundesbank, Germany’s central bank, to the finance committee of the German parliament earlier this week. Jens Ulbrich, head of the Bundesbank’s economics department, said that Germany is likely to have inflation rates ‘somewhat above the average within the European monetary union’ in the future and that the country might have to tolerate higher inflation for the sake of rebalancing national economies within the euro zone.

“Ulbrich did not give concrete figures in his statement, saying only that it was important that inflation in the euro zone as a whole continues to remain stable, even if it rises in some countries and falls in others. Observers believe the Bundesbank may be reckoning with an inflation rate of around 2.5 or 2.6 percent.”

If only they could be assured that inflation would be so mild. It is already at 2.1% in Germany. On Thursday, Finance Minister Wolfgang Sch�uble, heretofore an inflation hawk of the old Bundesbank school, told reporters that inflation could go as high as 3 percent. “As long as we are … in a corridor between 2 and 3 percent �we are in an area that is still acceptable,” Sch�uble said.

Bild wrote in the actual editorial:

“For 10 years, the euro was very stable and had lower inflation than the deutsche mark. But now the worst part of the financial and euro crisis is coming: creeping currency devaluation and inflation which could possibly continue for years. That’s how counties want to wash away their debts. But it mainly affects (blue-collar) workers, employees and retirees. They are precisely the people who have borne the burden of solving the crisis and who have kept a cool head. That’s unfair�.

“Inflation gnaws at our trust in money, in our most important institutions, in politicians and in the central banks, which in German are dubbed ‘guardians of the currency’ for a good reason. Because they experienced it so bitterly, Germans know that in the end high inflation causes societies to disintegrate. It robs the individual of trust in the future, without which no country can thrive.”

What brought on such a remarkable display of German forbearance? The threat of a complete eurozone collapse, brought on not just by Spanish banks (the present culprit) but what appears to be the dawining realization that this is about more than just Spain or Greece or Portugal or Ireland.

Viva Los Rescates Financieros de los Bancos

I have been writing for almost two years about the fact that the cajas, or Spanish regional banks, are worse than bankrupt. US banks are shut down when their nonperforming loans are at 5% of their capital. Spanish banks are at 20% and rising rapidly. My coauthor Jonathan Tepper and I spent a whole chapter in Endgame on Spain, at the end of 2010. This week the Spanish government basically nationalized Bankia, the nation’s 4th largest bank, which had been cobbled together from seven failed cajas and given a large government guarantee and a �3 billion public-offering equity infusion. Only roughly half of its real estate loans are generating returns, and that is the number for public consumption.

“Aside from creating a financially unsound bank, the government also demanded an additional 30 billion euros worth of write-downs on loans � valuing 84 billion euros in total, when combined with the original requirement of 54 billion euros in write-downs. The combined write-down program is, however, unlikely to be sufficient to address the close to 180 billion euros in toxic assets held by Spanish banks. Furthermore, many of Spain’s struggling banks will be unable to maintain the core tier-one capital ratio required by EU regulations without the government’s assistance. Spanish banks will require an estimated 100 billion-250 billion euros in recapitalization later this year to reach this capital ratio target � a significant percentage of which will have to be shouldered by Madrid.

“The government takeover of Bankia is a clear policy reversal for the conservative administration of Prime Minister Mariano Rajoy, who for months insisted that no additional public funds were needed for the banks. Intervening on Bankia’s behalf demonstrates the failure of Spain’s banking consolidation strategy.” (Stratfor)

We are talking the need for new Spanish-government debt amounting to roughly 25% of GDP that will be needed just this year, and that’s if things don’t deteriorate beyond present assumptions in their real estate sector. Care to make a wager on how sound those assumptions are? About as sound as Rajoy’s assessment, only a few months ago, that no public money would be needed, perhaps?

Let’s do some basic math. Spanish banks took down some �352 billion in the LTRO (created by the ECB), or over 1/3 of the total amount. They have about �80 billion left after deposit outflows and buying sovereign debt. Which will be needed to buy yet more Spanish government debt, so they can be bailed out.

As near as I can tell, Spain is guaranteeing about $20 billion of the new IMF funds that will be used for a European bailout. Spain already has $332 billion of liabilities to the ECB, $125 billion to the stabilization fund, another $99 billion for something called the Macro Financial Asset Fund, and various guarantees for other bank and European funds, all of which totals over $600 billion, give or take. Their public debt-to-GDP ratio is only 69%, but add in these other guarantees and commitments and you get over 130% debt-to-GDP. And that is before they start bailing out their banks, and before any additional debt from their fiscal deficit, which is running at 8%.

(Yes, I know they say it will be around 5%; but they are in a deepening recession; unemployment is rising at an alarmingly high rate, which lowers revenues and increases government spending; and their bond costs are rising. Care to take the over/under bet on, say, a 7% fiscal deficit? You get to be the under. Hmmm, I don’t see many hands out there.)

Look at this chart of ten-year Spanish bonds:



Notice that rates came down when the LTRO was issued and Spanish banks had the money to buy Spanish government debt. Why would they buy it? Because they got to borrow money from the ECB at 1% for three years and could make a very fat spread. Making a “free” 4% is a tried and true way to garner profits that can be used to offset losses.

Once the LTRO was done, Spanish interest rates began to climb. Note that they only briefly dipped below 5%.

I think I have this straight. Spain wants to guarantee more bank debt that the banks will use to get more money from the ECB, which will in turn be invested in Spanish bonds that will provide the money to run higher deficits, which will�

This is somewhat like a destitute bar patron guaranteeing his friend’s tab so his friend will buy him more drinks. The ECB is the bartender. European taxpayers are the bar owners. We know who pays the tab in the end.

Contagion is Real

It seems quaint that only a few years ago the concern in Europe was that there would be “contagion” risk resulting from a Greek default. So worried were they that we had almost-daily pronouncements that Greece would not be allowed to default, that there was no need for a Greek default, the developed countries no longer defaulted, etc. Now that Greece has defaulted, the line in the sand is “That was just Greece; no other country will need to default.”

But just in case, European leaders created all sorts of funds, guaranteed joint and severally, to help bail out nations in trouble. First Greece, then Ireland and Portugal. Even with all the money that was raised, it was not enough to prevent a Greek default. And the “new” debt is trading at around 10% of what the original was � as I was predicting two years ago.

The austerity that was forced on Greece has resulted in a backlash from Greek voters. The two ruling parties, basically run by two families, had traded control of the government back and forth for 50 years. Last week they could not even get 33% between them. In fact, no coalition can be cobbled together from any of the splinter parties. There will now be new elections, probably in June. Looking at the early polls, it is probable that a coalition will form that will reject the enforced austerity. Which will of course mean that Greece will not get the European funds it needs to be able to pay for even the austerity programs. Which will make things worse and hasten the departure of Greece from the euro.

Europe and the euro can survive without Greece. They could even make it without Portugal. Ireland will merely default on the debt it incurred from the ECB to bail out its banks, but will want to stay in the eurozone.

But the euro needs Spain, to maintain a credible standing, or so Germany evidently believes.

It Doesn’t End With Spain

The next usual suspect is Italy. And indeed Italy will soon be paying 5-6% of GDP just to cover the interest on its debt. If it were not for interest, they would have an actual government surplus. While they are making progress, a European recession is not going to make it any easier.

Let’s move on from Italy. Let’s consider France. They just had an election, and to no one’s surprise they voted a Socialist into the office of president. And it appears likely he will get a majority in the legislative branch as well, giving Hollande control of the government. What he says he will do is get things under control by raising taxes to cover about 40% of the deficit and cutting spending to cover the other needed 60% � although he has not said what he will actually cut. He has pledged higher taxes on business and top earners (75% taxes on earnings over �1 million), subsidies for companies taking on younger and older workers, a partial reversal of the rise in the retirement age to 62, a promise to hire 60,000 new teachers, and he will take longer to get the budget under control than the current agreement with the EU allows.

Brussels issued a rather stern warning today, asserting that France must comply with the agreed-upon budgetary terms, which will require a lot more taxes and/or cuts than Hollande is willing to do. And whatever he decides, he has no easy task. France’s acknowledged, official debt-to-GDP is 86%; but when you include their various commitments to the ECB, the ESFS, ESM, EIB, etc., the number rises to about 146%. Not all of that requires France to make the interest payments, but just to cover any losses in case of a default. But that 86% number is rising rather rapidly.

And their problems are not a short-term cyclical issue. They have committed to relatively larger entitlements and pensions than even here in the US! And those bills are coming due in the same time frame as in the US. It does not get any easier, and the French are notoriously unwilling to accept cuts in pensions or labor conditions. Want to touch agricultural subsidies? Want to see more tractors and burning tires on the Champs-�lys�es? Just saying.

France has not balanced its budget since 1974. Note that the budget deficits are over 8% for the last few years (but not as bad as US deficits!), and now they have a negative trade balance. (chart from my friends at GaveKal)



Hollande campaigned explicitly on an anti-austerity platform. Angela Merkel campaigned for his opponent, Sarkozy. Not exactly the basis for a lasting friendship. And the rest of Europe is watching closely to see how this all works out. What will Germany do? Louis Gave (living in Hong Kong but still very French) writes: 

“Assuming this program [Hollande's pledges to increase spending, raise taxes, etc.] ends badly, then France will need friends. Fortunately, the head of the IMF happens to be French, though this may be a double-edged sword, as Christine Lagarde cannot be seen giving France a privileged deal. In light of this rhetoric, and his promise of more spending, it is hard to think that Hollande and Angela Merkel will become fast friends. Meanwhile, Hollande’s promise that his first act will be to pull France’s troops out of Afghanistan is unlikely to endear him to the US administration. In short, France will soon need friends, but those may be as rare as an interesting French presidential candidate. Meanwhile, we have to hope that, like Groucho Marx, Hollande is a man who will declare ‘These are my principles and if you don’t like them, I can change them.’”

The Economist recently wrote:

“Although one ratings agency has stripped France of its AAA status, its borrowing costs remain far below Italy’s and Spain’s (though the spread above Germany’s has risen). France has enviable economic strengths: an educated and productive workforce, more big firms in the global Fortune 500 than any other European country, and strength in services and high-end manufacturing.

“However, the fundamentals are much grimmer. France has not balanced its books since 1974. Public debt stands at 90% of GDP and rising. Public spending, at 56% of GDP, gobbles up a bigger chunk of output than in any other euro-zone country � more even than in Sweden. The banks are under-capitalized. Unemployment is higher than at any time since the late 1990s and has not fallen below 7% in nearly 30 years, creating chronic joblessness in the crime-ridden banlieues that ring France’s big cities. Exports are stagnating while they roar ahead in Germany. France now has the euro zone’s largest current-account deficit in nominal terms. Perhaps France could live on credit before the financial crisis, when borrowing was easy. Not anymore. Indeed, a sluggish and unreformed France might even find itself at the center of the next euro crisis.”

The banks of France are over 4 times the size of French GDP. The markets have been punishing the larger banks, with some of them down almost 90%. Look at this graph for Societe Generale:



While French banks are not the problem that Spanish banks are, they are far larger relative to the size of their home country. Even a small problem can be large for the country. And French banks have very large exposure to European peripheral debt. A default by Spain would push them (and a lot of other European banks) over the edge. Which is one reason that Sarkozy was so loudly insistent that any bank problems should be treated as a European problem and not the problem of the host country. (Interesting idea if you are Irish!) France simply cannot afford to deal with any problems in its banks while it is running such large deficits. And not while it is guaranteeing all sorts of European debt, which is at the heart of the problem. Germany needs France to help shoulder the financial burdens of Europe. And as long as France can keep its AAA rating, Germany has a partner. But if France loses that rating, then any European debt it guarantees clearly loses that rating as well.

S&P has already taken France down one notch to AA+ and still has a negative outlook. Moody’s has warned of a possible downgrade to France. Italy now has a BBB+ rating, just below that of Spain. When you look at the actual balance sheet and total debt, France is not all that far from further downgrades, unless it embraces a new budget ethic, which is precisely what Hollande has said he will not do.

That would be a real crisis for the eurozone. German voters might not be willing to shoulder the European burden without a full partner in France. And if France had to guarantee a great deal more pan-European debt, while it continued to run deficits and, God forbid, had a crisis in one or more of its banks, it would be putting its credit rating at risk.

Is there any wonder about the timing of the Bundesbank retreat? They looked at Greek and French elections and then at the ongoing Spanish crisis, which is trending from very bad to awful with a risk of horrific. They glanced at the balance sheets of their own banks and those of French banks vis-�-vis sovereign debt from peripheral Europe, then took a peek at German-voter polls and flipped through their own balance sheet, and decided that the only entity with enough money to stem the crisis was the ECB. And that means a “little” inflation.

I think the vast majority of Germans (and to be fair, the entire world) have no idea how many trillions of euros are going to be needed to keep patching the leaky ship that is the eurozone. It is even possible that most German politicians actually think it might only be 3% inflation.

Spain is too big to save and too big to fail. The only way for Spanish debt to remain at 6% is for the ECB to basically buy it (or lend to Spanish banks so they can buy it, or whatever creative new program Draghi and team can think up). When Spain goes, it is just a matter of time before we lose Italy and then, yes, even France. The line must be drawn with Spain. And the only outfit with a balance sheet big enough that can also do it in a politically acceptable manner is the ECB, and the only way they can do it is with a printing press.

Will it buy time? Yes, but time for what? To fix government deficits? To deal with bank debts? Sovereign debt? To somehow solve the massive trade imbalances between Germany and the European periphery? To force voters to accept a fiscal union? In the midst of a crisis? If there is some conspiratorial cabal that has a secret plan, they have kept it well hidden. Because from here it looks like they are making up the “plan” as they go along.

Their actual intentions are no secret. They will do whatever it takes to keep the European Union and eurozone together. And whatever it takes is a very open-ended plan. But it is going to cost them trillions of euros.

Someone is going to have to pay that bar bill. And there’s going to be one helluva hangover.

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com. 

Disclaimer 
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

It should not be assumed that the methods, techniques, or indicators presented on these websites will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these websites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

The US employment numbers came out this morning, and they were disappointing. But disappointing does not begin to describe the situation I read about today in Europe. I have just finished up with my conference in Carlsbad, California and am getting back to the room late. I have to get up in a few hours (4 AM is rather obscene) to fly to Tulsa to see my daughter graduate from university, but wanted to drop you a note as I normally do on Friday night. But given the time and the need for some sleep, tonight I will draw your attention to the writing of a few friends and some of the more interesting charts I saw at the conference. It will be a shorter letter than usual, but we will uncover a few real nuggets; and next week I will be back to a more normal writing schedule.

April Employment

A few hours after the employment numbers are released, I always get a rather thorough analysis from Philippa Dunne & Doug Henwood of The Liscio Report ( www.theliscioreport.com). Philippa gave me permission to share this with you just this once. While it may be more detail than you are used to, it will help give you a perspective on how much data is actually tracked. I think Philippa and Doug are some of the best at analyzing employment, and their regular reports are a must-read for me. They call the “labor department” in every state and track what is going on at a very deep level, and also follow tax receipts and flows. (Funds and managers who need detailed analysis like this can contact them for a look at their recent work and decide if you should subscribe.) And now to this morning’s report:

Though it’s likely there are lingering weather influences on this month’s disappointing employment report, as there will be in coming months, it appears that the trend is also slowing. That conclusion is bolstered by the decline in our withholding survey, which we believe to be less weather-sensitive than the BLS numbers, and weakness in our survey was not limited to states sensitive to this year’s unusual weather.

* April’s headline gain of 115,000 was the weakest initial print since last October’s 80,000 (now revised up to 112,000). It’s considerably below the 146,000 average for the second half of 2011, before the acceleration earlier this year. Looking just at the private sector would make those comparisons a little better, but not much. Manufacturing added 16,000, almost all in durables; retail added 29,000, mostly in general merchandise (largely reversing the losses of the previous two months); professional and business services added 62,000, a third of it from temp firms; education and health added 23,000, well below its recent averages (with health care alone adding just 19,000, at the 20th percentile of gains since 1990); leisure and hospitality, 12,000 (more than accounted for by accommodation and food services, up 27,000). Finance was up just 1,000, and mining and logging were unchanged (low natural gas prices seem to have put an end to the fracking boom).

In the loss column: construction, off 2,000, with nonres leading the way down; transportation and warehousing, off 17,000, mostly from ground transportation; information, off 2,000; and government, off 15,000, almost all of it from local government education (where losses have averaged 8,000 a month for the last year). Almost 70% of job gains came from bars and restaurants, temp firms, and retail, which do not seem the strongest foundations for long-term growth.

* March’s gain was revised up by 34,000, and February’s by 19,000. Revisions have been fairly strongly upward over the last few months, prompting some talk – but they’re actually not as great, in percentage terms, as they were in 1993 and 2005, which were at roughly comparable spots in the recovery/expansion. More than a third of the March revision came from retail, and concentrated in general merchandise; those areas seemed strangely weak last month, so the revisions seem to be righting a wrong rather than uncovering hidden strength.

* With the exception of the six-month measure, diffusion indexes all fell. The general pattern was to reverse the acceleration we saw in the indexes in the first months of the year, suggesting that while the job market is still growing, it’s lost some breadth along with momentum.

* The household survey was weaker than its establishment counterpart.

Total employment fell by 169,000 – or 495,000 when adjusted to match the payroll concept. (The yearly gain in the adjusted household measure, 1.5%, has nearly come back into line with the payroll gain, 1.4%, after three months of strong outperformance. This is a reminder not to take these departures too seriously, unless they’re sustained for more than a few months.) The employment/population ratio fell 0.1 to 58.4%, 1.0 point below where it was when the recession ended, and where it was in September 1983. There was substantial labor force withdrawal in April, with the participation rate falling by 0.2 point, 2.1 points below where it was when the recession ended.

* The longer-term picture of labor force withdrawal is kind of shocking. Total household employment is down by 4.4 million since the Great Recession began in December 2007, and the number of unemployed is up by 4.9 million. The civilian population is up 9.6 million – but the labor force is up just 447,000. The number classed as not in the labor force is up by 9.2 million – and those not in the labor force and wanting a job is up 1.7 million. In other words, just 5% of the increase in the adult population over the last 4 1/3 years has found its way into employment; the other 95% are not in the labor force.

* The unemployment rate fell by 0.1 point to 8.1%, its lowest level in more than three years. The number of unemployed fell by 173,000 – but the labor force shrank by almost the same amount, 169,000.

Without the labor force shrinkage, the unemployment rate probably would have been unchanged. Within the unemployed, the number of job losers fell – but so did the number of re-entrants and voluntary leavers, suggesting that the increased confidence we saw through those indicators in recent months may be dissipating. With the quit rate down, and the long-term unemployed dropping out of the labor force, the mid-ranges of unemployment duration (from 5-26 weeks) saw an increase, as the extreme short- and long-term durations fell.

* Average hourly earnings for all workers were up just a penny, which rounds to unchanged in percentage terms. Over the year, hourly earnings are up just 1.8%. Since the all-worker only begins in 2006, we have to use the production worker series for longer-term comparisons.

Except for two brief periods in 1986 and 2006, recent annual gains in nominal wages are the lowest since the series began in 1964. [JFM note: this growth in earnings is considerably lower than inflation and given the rise in fuel and other ordinary expenses (like food) the wage earner is getting hammered,]

* The workweek was unchanged at 34.5 hours, with an 0.1 hour rise in manufacturing offsetting an 0.1 hour fall in services. Aggregate hours were up just 0.1%. Aggregate payrolls – the product of aggregate hours and average hourly earnings – were up 0.3% for the month, and 4.1% for the year. That yearly gain is the weakest since January 2011.

So, a disappointment, if not a crushing one. But the job market is still in a deep hole. At April’s rate of job gains, it would take well over three years to return to December 2007′s employment level, without adjusting for population growth; at the average rate of the last six months, it would take about two years. Earnings are weak, and the strongest sectors aren’t those of which economic miracles are spun. QE3 looks like more of a possibility than it did a few days ago.

(End of excerpt from The Liscio Report)

A Graphic Review of the Strategic Investment Conference

Now let’s look at a few charts that caught my eye, out of the several hundred we saw (quite the graphic experience) at my conference. This first one is from David Rosenberg, who was in classic form. I get to be with him again Monday morning in Chicago, where we are on a panel together at the International CFA Conference. This puts a 27-year perspective on how poorly wage growth is doing.



Next we have a chart shared with us by Niall Ferguson, showing how the US and Japan (and to some extent Germany) have seen their share of world GDP fall relative to China and India. He argued (as did several speakers) that the relative growth in the world is moving from Europe, Japan, and the US to the emerging markets. This is estimated data through 2016 from the IMF.



The following chart is also from Niall and shows gross government debt-to-GDP. This may be difficult if you are not looking in color, but the US (when all debt is counted) does not look all that much better than some of the problem countries in Europe.



And while I was checking email between speakers, I opened Greg Weldon’s latest note, where he looks at European unemployment. Greg is my favorite slicer and dicer of data. What caught my eye was not just the horrific condition of unemployment among Spanish youth, but the data which followed about unemployment among youth across a wide range of European countries. This is the stuff from which civil unrest springs in hot summers. ( www.weldononlime.com)



“We are monitoring the BROAD rise in Youth Unemployment Rates, across the EU (this March, versus March of last year):

— Bulgaria … 32.8% … up from 26.7%
— Portugal … 36.1% … up from 27.6%
— Denmark … 15.1% … up from 13.7%
— Ireland … 30.3% … up from 28.7%
— Cyprus … 28.8% … up from 18.8%
— Hungary … 28.8% … up from 25.4%
— Netherlands … 9.3% … up from 6.9%
— Poland … 26.7% … up from 25.7%
— Slovenia … 16.5% … up from 16.3%

“The Summer of 2012 could easily become the Summer of Social Dissent in the EU…”

Jeffrey Gundlach of Doubleline spoke Friday morning and really impressed me with the breadth of his presentation. This slide has a LOT of implications.

 

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com. 

Disclaimer 
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

It should not be assumed that the methods, techniques, or indicators presented on these websites will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these websites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

There are times, my friends Michael Lewitt and Dr. Lacy Hunt agreed today at lunch, when the study of economics is best informed by a sound knowledge of history. Indeed, Michael’s son wants to follow his father into the finance world, and Michael is starting him off in history. I have spent hours listening to Lacy stroll through economic history, detailing the path of economic thought from Fisher to Kindleberger to Minsky. The last few days have been one of those times when I realized how much I don’t know and how much more there is to learn. Not only Lacy and Michael are here in Florida, but a long list of bright minds to learn from. James Rickards, who has recently written the tour de force book Currency Wars, Harry Dent, Doug Casey, Porter Stansberry, Greg Weldon, and John Williams of Shadow Stats, with whom I look forward to meeting (do I have questions for him!). And so many more.

And it is because I simply have to stop, listen and learn (and visit with friends) that this week I will kind of take the weekend off and instead send you one of the more remarkable essays I have read in a long time. It is a speech by Jim Grant to the New York Federal Reserve. The always erudite Grant takes us back in time to the very beginnings of the Federal Reserve, to show us how far we have strayed from the original intent. I really think you should read this. I have perused it several times and intend to read it yet again – and then some more.

Grant argued for a return to the gold standard in the very halls of fiat money! It seems the New York Fed is asking some of its critics to come and speak. I have read some of the speeches, but this is the best so far for several reasons, not the least of which is that it contains some very funny lines. If you find yourself invited to the lion’s den, Grant seems to think it is best to make fun of their teeth! You really do have to admire his courage. I think I would be a little concerned that I might be on the menu!

I will make a few comments at the end of his speech and then note some upcoming speaking events in Atlanta and Philadelphia. But let’s jump straight away into today’s main event.

A Piece Of My Mind

By Jim Grant

My friends and neighbors, I thank you for this opportunity. You know, we are friends and neighbors. Grant’s makes its offices on Wall Street, overlooking Broadway, a 10-minute stroll from your imposing headquarters. For a spectacular vantage point on the next ticker-tape parade up Broadway, please drop by. We’ll have the windows washed.

You say you would like to hear my complaints, and, on the one hand, I do have a few, while on the other, I can’t help but feel slightly hypocritical in dressing you down. What passes for sound doctrine in 21st-century central banking—so-called financial repression, interest-rate manipulation, stock-price levitation and money printing under the frosted-glass term “quantitative easing”—presents us at Grant’s with a nearly endless supply of good copy. Our symbiotic relationship with the Fed resembles that of Fox News with the Obama administration, or—in an earlier era—that of the Chicago Tribune with the Purple Gang. Grant’s needs the Fed even if the Fed doesn’t need Grant’s.

In the not quite 100 years since the founding of your institution, America has exchanged central banking for a kind of central planning and the gold standard for what I will call the Ph.D. standard. I regret the changes and will propose reforms, or, I suppose, re-reforms, as my program is very much in accord with that of the founders of this institution. Have you ever read the Federal Reserve Act? The authorizing legislation projected a body “to provide for the establishment of the Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States, and for other purposes.” By now can we identify the operative phrase? Of course: “for other purposes.”

You are lucky, if I may say so, that I’m the one who’s standing here and not the ghost of Sen. Carter Glass. One hesitates to speak for the dead, but I am reasonably sure that the Virginia Democrat, who regarded himself as the father of the Fed, would skewer you. He had an abhorrence of paper money and government debt. He didn’t like Wall Street, either, and I’m going to guess that he wouldn’t much care for the Fed raising up stock prices under the theory of the “portfolio balance channel.”

It enflamed him that during congressional debate over the Federal Reserve Act, Elihu Root, Republican senator from New York, impugned the anticipated Federal Reserve notes as “fiat” currency. Fiat, indeed! Glass snorted. The nation was on the gold standard. It would remain on the gold standard, Glass had no reason to doubt. The projected notes of the Federal Reserve would—of course—be convertible into gold on demand at the fixed statutory rate of $20.67 per ounce. But more stood behind the notes than gold. They would be collateralized, as well, by sound commercial assets, by the issuing member bank and—a point to which I will return— by the so-called double liability of the issuing bank’s stockholders.

If Glass had the stronger argument, Root had the clearer vision. One can think of the original Federal Reserve note as a kind of derivative. It derived its value chiefly from gold, into which it was lawfully exchangeable. Now that the Federal Reserve note is exchangeable into nothing except small change, it is a derivative without an underlier. Or, at a stretch, one might say it is a derivative that secures its value from the wisdom of Congress and the foresight and judgment of the monetary scholars at the Federal Reserve. Either way, we would seem to be in dangerous, uncharted waters.

As you prepare to mark the Fed’s centenary, may I urge you to reflect on just how far you have wandered from the intentions of the founders? The institution they envisioned would operate passively, through the discount window. It would not create credit but rather liquefy the existing stock of credit by turning good-quality commercial bills into cash— temporarily. This it would do according to the demands of the seasons and the cycle. The Fed would respond to the community, not try to anticipate or lead it. It would not override the price mechanism— as today’s Fed seems to do at every available opportunity—but yield to it.

My favorite exposition of the sound, original doctrines is a book entitled, “The Theory and Practice of Central Banking,” by H. Parker Willis, first secretary of the Federal Reserve Board and Glass’s right-hand man in the House of Representatives.

Writing in the mid-1930s, Willis pointed out that the Fed fell into sin almost immediately after it opened for business in 1914. In 1917, after the United States entered the Great War, the Fed set about monetizing the Treasury’s debt and suppressing the Treasury’s borrowing costs. In the 1920s, after the recovery from the short but ugly depression of 1920-21, the Fed started to implement open-market operations to sterilize gold flows and steer a desired macroeconomic course.

“Central banks,” wrote Willis, glaring at the innovators, “…will do wisely to lay aside their inexpert ventures in half-baked monetary theory, meretricious statistical measures of trade, and hasty grinding of the axes of speculative interests with their suggestion that by doing so they are achieving some sort of vague ‘stabilization’ that will, in the long run, be for the greater good.”

Willis, who died in 1937, perhaps of a broken heart, would be no happier with you today than Glass would be—or I am. The search for “some sort of vague stabilization” in the 1930s has become a Federal Reserve obsession at the millennium.

Ladies and gentlemen, such stability as might be imposed on a dynamic capitalist economy is the kind that eventually comes around to bite the stabilizer.

“Price stability” is a case in point. It is your mandate, or half of your mandate, I realize, but it does grievous harm, as defined. For reasons you never exactly spell out, you pledge to resist “deflation.” You won’t put up with it, you keep on saying—something about Japan’s lost decade or the Great Depression. But you never say what deflation really is. Let me attempt a definition. Deflation is a derangement of debt, a symptom of which is falling prices. In a credit crisis, when inventories become unfinanceable, merchandise is thrown on the market and prices fall. That’s deflation.

What deflation is not is a drop in prices caused by a technology-enhanced decline in the costs of production. That’s called progress. Between 1875 and 1896, according to Milton Friedman and Anna Schwartz, the American price level subsided at the average rate of 1.7% a year. And why not? As technology was advancing, costs were tumbling. Long before Joseph Schumpeter coined the phrase “creative destruction,” the American economist David A. Wells, writing in 1889, was explaining the consequences of disruptive innovation.

“In the last analysis,” Wells proposes, “it will appear that there is no such thing as fixed capital; there is nothing useful that is very old except the precious metals, and life consists in the conversion of forces. The only capital which is of permanent value is immaterial—the experience of generations and the development of science.”

Much the same sentiments, and much the same circumstances, apply today, but with a difference. Digital technology and a globalized labor force have brought down production costs. But, the central bankers declare, prices must not fall. On the contrary, they must rise by 2% a year. To engineer this up-creep, the Bernankes, the Kings, the Draghis—and yes, sadly, even the Dudleys—of the world monetize assets and push down interest rates. They do this to conquer deflation.

But note, please, that the suppression of interest rates and the conjuring of liquidity set in motion waves of speculative lending and borrowing. This artificially induced activity serves to lift the prices of a favored class of asset—houses, for instance, or Mitt Romney’s portfolio of leveraged companies. And when the central bank-financed bubble bursts, credit contracts, leveraged businesses teeter, inventories are liquidated and prices weaken. In short, a process is set in motion resembling a real deflation, which then calls forth a new bout of monetary intervention. By trying to forestall an imagined deflation, the Federal Reserve comes perilously close to instigating the real thing.

The economist Hyman Minsky laid down the paradox that stability is itself destabilizing. I say that the pledge of a stable funds rate through the fourth quarter of 2014 is hugely destabilizing. Interest rates are prices. They convey information, or ought to. But the only information conveyed in a manipulated yield curve is what the Fed wants. Opportunists don’t have to be told twice how to respond. They buy oil or gold or foreign exchange, not incidentally pushing the price of a gallon of gasoline at the pump to $4 and beyond. Another set of opportunists borrow short and lend long in the credit markets. Not especially caring about the risk of inflation over the long run, this speculative cohort will fund mortgages, junk bonds, Treasurys, what-have-you at zero percent in the short run. The opportunists, a.k.a. the 1 percent, will do fine. But what about the uncomprehending others?

I commend to the Federal Reserve Bank of New York Financial History Book Club (if it doesn’t exist, please organize it at once) a volume by the British scholar and central banker, Charles Goodhart. Its title is “The New York Money Market and the Finance of Trade, 1900-1913.” In the pre-Fed days with which the history deals, the call money rate dove and soared. There was no stability—and a good thing, Goodhart reasons. In a society predisposed to speculate, as America was and is, he writes, unpredictable spikes in borrowing rates kept the players more or less honest. “On the basis of its record,” he writes of the Second Federal Reserve District before there was a Federal Reserve, “the financial system as constituted in the years 1900-1913 must be considered successful to an extent rarely equaled in the United States.” And that not withstanding the Panic of 1907.

My reading of history accords with Goodhart’s, though not with that of the Fed’s front office. If Chairman Bernanke were in the room, I would respectfully ask him why this persistent harking back to the Great Depression? It is one cyclical episode, but there are many others. I myself draw more instruction from the depression of 1920-21, a slump as ugly and steep in its way as that of 1929-33, but with the simple and interesting difference that it ended. Top to bottom, spring 1920 to summer 1921, nominal GDP fell by 23.9%, wholesale prices by 40.8% and the CPI by 8.3%. Unemployment, as it was inexactly measured, topped out at about 14% from a pre-bust low of as little as 2%. And how did the administration of Warren G. Harding meet this macroeconomic calamity? Why, it balanced the budget, the president declaring in 1921, as the economy seemed to be falling apart, “There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures.” And the fledgling Fed, face to face with its first big slump, what did it do? Why, it tightened, pushing up short rates in mid-depression to as high as 8.13% from a business cycle peak of 6%. It was the one and only time in the history of this institution that money rates at the trough of a cycle were higher than rates at the peak, according to Allan Meltzer.

But then something wonderful happened: Markets cleared, and a vibrant recovery began. There were plenty of bankruptcies and no few brickbats launched in the direction of the governor of the New York Fed, Benjamin Strong, for the deflation that cut an especially wide and devastating swath through the American farm economy. But in 1922, the first full year of recovery, the Fed’s index of industrial production leapt by 27.3%. By 1923, the unemployment rate was back to 3.2%. The 1920s began to roar.

And do you know that the biggest nationally chartered bank to fail during this deflationary collapse was the First National Bank of Cleburne, Texas, with not quite $2.8 million of deposits? Even the forerunner to today’s Citigroup remained solvent (though for Citi, even then it was a close-run thing, on account of an oversize exposure to deflating Cuban sugar values). No TARP, no starving the savers with zero-percent interest rates, no QE, no jimmying up the stock market, no federal “stimulus” of any kind. Yet—I repeat—the depression ended. To those today who demand ever more intervention to cure what ails us, I ask: Why did the depression of 1920-21 ever end? Given the policies with which the authorities treated it, why are we still not ensnared?

If you object to using the template of 1920-21 as a guide to 21st-century policy because, well, 1920 was a long time ago, I reply that 1929 was a long time ago, too. And if you persist in objecting because the lessons to be derived from the Harding depression are unthinkably at odds with the lessons so familiarly mined from the Hoover and Roosevelt depression, I reply that Harding’s approach worked. The price mechanism is truer and enterprise hardier than the promoters of radical 21st-century intervention seem prepared to acknowledge.

In notable contrast to the Harding method, today’s policies seem not to be working. We legislate and regulate and intervene, but still the patient languishes. It’s a worldwide failure of the institutions of money and credit. I see in the papers that Banca Monte dei Paschi di Siena is in the toils of a debt crisis. For the first time in over 500 years, the foundation that controls this ancient Italian institution may be forced to sell shares. We’ve all heard of hundred-year floods. We seem to be in a kind of 500-year debt flood.

Many now call for more regulation—more such institutions as the Treasury’s brand-new Office of Financial Research, for instance. In the March 8 Financial Times, the columnist Gillian Tett appealed for more resources for the overwhelmed regulators. Inundated with information, she lamented, they can’t keep up with the institutions they are supposed to be safeguarding. To me, the trouble is not that the regulators are ignorant. It’s rather that the owners and managers are unaccountable.

Once upon a time—specifically, between the National Banking Act of 1863 and the Banking Act of 1935—the impairment or bankruptcy of a nationally chartered bank triggered a capital call. Not on the taxpayers, but on the stockholders. It was their bank, after all. Individual accountability in banking was the rule in the advanced economies. Hartley Withers, the editor of The Economist in the early 20th century, shook his head at the micromanagement of American banks by the Office of the Comptroller of the Currency—25% of their deposits had to be kept in cash, i.e., gold or money lawfully convertible into gold. The rules held. Yet New York had panics, London had none. Adjured Withers: “Good banking is produced not by good laws but by good bankers.”

Well said, Withers! And what makes a good banker is more than skill. It is also the fear of God, or, more specifically, accountability for the solvency of the institution that he or she owns or manages. To stay out of trouble, the general partners of Brown Brothers Harriman, Wall Street’s oldest surviving general partnership, need no regulatory pep talk. Each partner is liable for the debts of the firm to the full extent of his or her net worth. My colleague Paul Isaac, who is with me today—he doubles as my food and beverage taster— has an intriguing suggestion for instilling the credit culture more deeply in our semi-socialized banking institutions.

We can’t turn limited liability corporations into general partnerships. Nor could we easily reinstate the so-called double liability law on bank stockholders. But what we could and should do, Paul urges, is to claw back that portion of the compensation paid out by a failed bank in excess of 10 times the average wage in manufacturing for the seven full calendar years before the ruined bank hit the wall. Such a clawback would not be subject to averaging or offset one year to the next. And it would be payable in cash.

The idea, Paul explains, is twofold. First, to remove the government from the business of determining what is, or is not, risky—really, the government doesn’t know. Second, to increase the personal risk of failure for senior management, but stopping short of the sword of Damocles of unlimited personal liability. If bankers are venal, why not harness that venality in the public interest? For the better part of 100 years, and especially in the past five, we have socialized the risks of high finance. All too often, the bankers who take risks don’t themselves bear them. By all means, let the capitalists keep the upside. But let them bear their full share of the downside.

In March 2009, the Financial Times published a letter to the editor concerning the then novel subject of QE. “I can now understand the term ‘quantitative easing,’ wrote Gerald B. Hill of Stourbridge, West Midlands, “but . . . realize I can no longer understand the meaning of the word ‘money.’”

There isn’t time, in these brief remarks, to persuade you of the necessity of a return to the classical gold standard. I would need another 10 minutes, at least. But I anticipate some skepticism. Very well then, consider this fact: On March 27, 1973, not quite 39 years ago, the forerunner to today’s G-20 solemnly agreed that the special drawing right, a.k.a. SDR, “will become the principal reserve asset and the role of gold and reserve currencies will be reduced.” That was the establishment— i.e., you—talking. If a worldwide accord on the efficacy of the SDR is possible, all things are possible, including a return to the least imperfect international monetary standard that has ever worked.

Notice, I do not say the perfect monetary system or best monetary system ever dreamt up by a theoretical economist. The classical gold standard, 1879-1914, “with all its anomalies and exceptions . . . ‘worked.’” The quoted words I draw from a book entitled, “The Rules of the Game: Reform and Evolution in the International Monetary System,” by Kenneth W. Dam, a law professor and former provost of the University of Chicago. Dam’s was a grudging admiration, a little like that of the New York Fed’s own Arthur Bloomfield, whose 1959 monograph, “Monetary Policy under the International Gold Standard,” was published by yourselves. No, Bloomfield points out, as does Dam, the classical gold standard was not quite automatic. But it was synchronous, it was self-correcting and it did deliver both national solvency and, over the long run, uncanny price stability. The banks were solvent, too, even the central banks, which, as Bloomfield noted, monetized no government debt.

The visible hallmark of the classical gold standard was, of course, gold—to every currency holder was given the option of exchanging metal for paper, or paper for metal, at a fixed, statutory rate. Exchange rates were fixed, and I mean fixed. “It is quite remarkable,” Dam writes, “that from 1879 to 1914, in a period considerably longer than from 1945 to the demise of Bretton Woods in 1971, there were no changes of parities between the United States, Britain, France, Germany—not to speak of a number of smaller European countries.” The fruits of this fixedness were many and sweet. Among them, again to quote Dam, “a flow of private foreign investment on a scale the world had never seen, and, relative to other economic aggregates, was never to see again.”

Incidentally, the source of my purchased copy of “Rules of the Game” was the library of the Federal Reserve Bank of Atlanta. Apparently, President Lockhart isn’t preparing, as I am—as, may I suggest, as you should be—for the coming of classical gold standard, Part II. By way of preparation, I commend to you a new book by my friend Lew Lehrman, “The True Gold Standard: A Monetary Reform Plan without Official Reserve Currencies: How We Get from Here to There.”

It’s a little rich, my extolling gold to an institution that sits on 216 million troy ounces of the stuff. Valued at $42.222 per ounce, the hoard in your basement is worth $9.1 billion. Incidentally, the official price was quoted in SDRs, $35 to the ounce—now there’s a quixotic choice for you. In 2008, when your in-house publication, “The Key to the Gold Vault,” was published, the market value was $194 billion. Today, the market value is $359 billion, which is encouraging only if you personally happen to be long gold bullion. Otherwise, it strikes me as a pretty severe condemnation of modern central banking.

And what would I do if, following the inauguration of Ron Paul, I were sitting in the chairman’s office? I would do what I could to begin the normalization of interest rates. I would invite the Wall Street Journal’s Jon Hilsenrath to lunch to let him know that the Fed is now well over its deflation phobia and has put aside its Atlas complex. “It’s capitalism for us, Jon,” I would say. Next I would call President Dudley. “Bill,” I would say, pleasantly, “we’re not exactly leading from the front in the regulatory drive to reduce the ratio of assets to equity at the big American financial institutions. Do you have to be leveraged 89:1?” Finally, I would redirect the efforts of the brainiacs at the Federal Reserve Board research division. “Ladies and gentlemen,” I would say, “enough with ‘Bayesian Analysis of Stochastic Volatility Models with Levy Jumps: Application to Risk Analysis.’ How much better it would please me if you wrote to the subject, ‘Command and Control No More: A Gold Standard for the 21st Century.’” Finally, my pièce de résistance, I would commission, staff and ceremonially open the Fed’s first Office of Unintended Consequences.

Let me thank you once more for the honor that your invitation does me. Concerning little Grant’s and the big Fed, I will quote in parting the opening sentences of an editorial that appeared in a provincial Irish newspaper in the fateful year 1914. It read: “We give this solemn warning to Kaiser Wilhelm: The Skibbereen Eagle has its eye on you.”

A Gold Standard?

The Casey Research Conference I am speaking at this weekend is a hotbed of gold bugs who, like Jim Grant, argue forcefully for a return to the gold standard. And given the chaos and insistent inflation over time that the Federal Reserve and fiat currency have produced, it is hard to argue that the current system is one that should be encouraged. And I don’t!

But neither do I have a starry-eyed yearning for the chaos of the gold-standard period. There was a reason that hard-money men like Glass helped formed the Federal Reserve. But the Federal Reserve did not do all that well in the aftermath of 1929, and I think we shall look back in 20 years and not be all that pleased with our own current version.

I think I tend to agree more with Irving Fisher, arguably the greatest economist of the last century, who, writing in the late ’30s, after observing the Great Depression and the actions of the Federal Reserve, noted that the best and only way to deal with a credit bubble was to prevent it from happening. Once they develop, there is no easy, painless way back. “Good banking is produced not by good laws but by good bankers.”

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com. 

Disclaimer 
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

It should not be assumed that the methods, techniques, or indicators presented on these websites will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these websites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

Bull’s Eye Investing was the book that really helped establish this letter. It dealt with a host of investing ideas, secular market cycles, value investing, alternative investing, and more. It is still in print some nine years later and has had a very positive response. Today I can share that I have taken that material, updated it, and written a new book, part of the Little Book series done by Wiley, called The Little Book of Bull’s Eye Investing – Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets.

An Introduction to Bull’s Eye Investing

Every hunter knows you don’t shoot where the duck is; you shoot where the duck is going to be. You’ve got to lead the duck. Bull’s Eye Investing simply attempts to apply the same principle to the markets. In this book, I hope to give you an idea of the broad trends that I believe are at work now and will persist for the remainder of this decade. Then I’ll help you target your investments to take advantage of those trends.

Through the Looking Glass

“You’re sure to get somewhere if you only walk long enough…”

—The Cheshire Cat (Lewis Carrol)

When I was invited to do this Little Book of Bull’s Eye Investing, I wondered whether the original Bull’s Eye Investing (written nine years ago and dense in data and research and not little at all) could be shortened and still deliver what put the book on the best-seller lists, made it a choice for the New York Times best summer reading list, and earned it the top spot on Forbes publisher Rich Karlgaard’s roll call of the decade’s most important books on investing. It’s since been published in several foreign languages and is still in print.

Thinking about doing the Little Book made me go back and carefully read the original, and I was pleased to find how much of it is still useful today. Much of the research that it reports is timeless and still will be valuable a generation from now. Many of the predictions, whether by luck or skill, were spot on. We are still on the path I mapped out but are much further along it. The task for the Little Book is to collect the parts that have held up well and then bring things up to date, to introduce new readers to the concept of Bull’s Eye Investing.

As I write this introduction (the final element), I’ve just come from Hong Kong, where the original Bull’s Eye Investing still has something of a serious following. Publishers are eager to do a Chinese-language version for distribution in Hong Kong and the mainland. The principles of the long-term ebb and flow of markets really do work wherever human beings are involved in investing, which is to say, everywhere.

Successful investing for the remainder of this decade will mean doing things differently from what people did so profitably in the 1980s and 1990s and from what Wall Street is still telling people to do. We started the last bull market, in 1980, with high interest rates, very high inflation, and low stock market valuations. All the elements were in place to launch the greatest bull market in history.

The environment now is just the opposite. Stock market valuations are still relatively high (though well down from the stratosphere where they were flying at the beginning of the decade), and interest rates will eventually have to go up. In addition, gold is volatile, as is the dollar against other currencies, and the twin deficits of trade and government debt stare us in the face.

Everything Is Not Relative

So which way is the stock market going? And how about bonds? Gold? Real estate? Where should you invest?

Wall Street and the mutual fund industry say, “The market is going up, you should buy stocks, and now is the time to do it. You can’t time the markets, so you should buy and hold for the long term. Don’t worry about the short-term drops. And my best advice is to buy my fund.”

Wall Street is like the carpenter who only has a hammer: everything looks like a nail. Those brokers are in the business of selling stocks because that is how they make their real money. Whether they are sold one by one or packaged in mutual funds or as IPOs or in wrap accounts or in variable annuities or in derivatives, what the brokers want to sell you is some type of equity (stock), and preferably today. They have rigged the rules against investors who would prefer more and safer choices, so that most investors are unaware of the options.

Their advice for you to buy what they’re selling has been their same advice every year for a century. And it has been wrong about half the time. There are long periods when stock markets go up, but there also are long periods when markets go down or sideways. And by “long,” I mean longer than almost anyone is prepared to wait.

These cycles are termed secular bull and bear markets. (Secular as used in this sense is from the Latin saeculum, which means a long period of time.) Each cycle has its own good investment opportunities. When I wrote the introduction to Bulls Eye Investing in 2003, I said we were in a secular bear. Now, nine years later, we are in what I think is the latter part of that same trend.

The problem with Wall Street is that most of what it sells does poorly in secular bear markets, so most traditional portfolios have suffered since 2000. But they still tell you that things will get better, so buy and keep buying. “Just look at this chart prepared by our independent economists that proves the market will go back up. Just have patience, and please give us more of your money.”

In secular bull markets, an investor should search for assets that offer relative returns—stocks and funds that will perform better than the market averages. If you beat the market, you’re doing well. Even though there will be losing years, the strategy of staying invested in quality stocks during a secular bull market will be a long-term winner.

In a secular bear market, however, that strategy is a prescription for disaster. If the market goes down 20 percent, and you just go down 15 percent, you’d be doing relatively well, and Wall Street would call you a winner. Your broker would expect a pat on the back. But you are still down 15 percent.

In markets like those we face today, the essence of Bull’s Eye Investing is to focus on absolute returns. Your benchmark is a money market fund. Success is measured by how much you make above Treasury bills.

Some will say, as they say each year, that the bear market is over and that the book you are reading is about ancient history. But experience says otherwise. A secular bear market can see drops much bigger than we have already been through, and it can last as long as 20 years. The shortest has been 8 years. None has ended with valuations as high as they were at the bottom in 2009. And that touches on one of the novel ideas in this book: bull and bear cycles should be seen in terms of valuations, not price.

Investors who continue to listen to the music from Wall Street will be sorely disappointed, in my opinion, as the facts I will present show that this bear market has years to go. For buy-and-hold investors planning to retire within a decade and live on their stocks, the results could be particularly devastating.

Walking “Long Enough”

Bull’s Eye Investing is not, however, about doom and gloom. Despite what Wall Street wants you to believe, there is no reliable connection between how the economy does and how the stock market performs. As we’ll see, the economy should muddle through, with just the usual kind of recessions sandwiched between periods of growth. The world as we know it is not coming to an end. It is merely changing, as it is always doing. There are numerous possibilities for investment growth while the secular bear market proceeds. You just won’t find them on any standard Wall Street menu.

What I hope to do is give you a road map to the future by looking at how and why markets have behaved in the past. We will debunk many of the myths and so-called scientific studies used by Wall Street to entice investors into putting their money into buy-and-hold, relative return investments. As should be no surprise, they use “facts,” theories, and statistics that are carefully selected and in many cases plain wrong. And when the market goes down, they just shrug their shoulders like a Chicago Cubs (or my own Texas Rangers) fan and say, “Wait till next year. And buy some more, please.”

[And now a part of Chapter One]

It’s Good to Be King – But Beware of Tailors Using Invisible Cloth

The traditional wisdom of Wall Street is to buy low and sell high. While it sounds simple enough, the philosophy has fostered an entire industry of financial advisors, prognosticators, and experts. When you reflect on the carnage on Wall Street in the last few years, it is easy to place stock market experts in the same category as TV weathermen. Television shows parade a seemingly endless lineup of financial, economic, and stock market experts who freely give this stock tip or suggest that investment strategy. Yes, they say, the economic outlook may seem gloomy, but happy days are right around the corner. This is the time to buy.

Every talking head seems to have an opinion. (Note: I am frequently be one of those talking heads!) Often a show’s producer will recruit talking heads with conflicting views and let them battle it out. It can make for interesting viewing for some and confusion for others. How can a few sound bites really give you the information you need to confidently invest in today’s volatile markets?

Timing Is Everything

There’s a Wall Street legend that Joseph P. Kennedy, the scion of the Kennedy clan, survived the 1929 crash because he had divested all of his holdings in the summer of 1929. He said that he knew it was time to get out when he started receiving stock tips from the shoeshine boy. If you were one of the smart or prescient investors who got out of the U.S. stock market before October 11, 2007, consider yourself lucky. Between 1929 and 1932, the stock market declined 89 percent, which contributed to the Great Depression. From October 2007 until March 2009, the market lost about 55 percent of its value; the second biggest decline in our nation’s history.

The U.S. economy began shrinking in December of 2007. The recession, by the technical definition of the term, ended in June of 2009, because that’s when the economy began growing again.

A nontechnical definition of a recession’s end has to do with consumer confidence and a general sense of optimism about the financial future of the country. We are now in the first quarter of 2012, and people are still looking for solid proof that the worst is behind us. Consumer confidence is at a level typical of a recession and that is anomalous two years into a recovery. Instead of signs of fiscal hope, we are faced with daily reports of persistent high unemployment, declining home prices, increasing rates of foreclosures and bankruptcies, persistent federal deficits, high gas prices, and hints of coming inflation.

In the face of all the negative news, it would be easy to conclude that investing in the stock market with the hope of making any profit at all would be a fool’s errand. You might even believe that the safest course is to stick your money under your mattress and hope your house doesn’t burn down. You could do that, but you would be absolutely wrong.

Where Were We, Again?

A secular bear market is loosely defined as a period of years or even decades when stock prices are either flat or falling (think Japan since 1990 or the United States from 1966 to 1982). Historically and classically defined, secular bear markets are as short as 8 years or as long as 17. By a broader definition that I prefer and will explain, the range is 13 years to as long as 20 years.

For the last century in the United States, the length has been remarkably consistent—about 17 years from the beginning of a secular bear to the beginning of the next true secular bull. My friend Art Cashin, head of UBS Floor Operations and dean and sheriff of the New York Stock Exchange, recently sent me a note he wrote at the beginning of the last decade.

“Floor brokers have lots of theories of cycles and such. There’s even a fat and lean cycle theory. Just as in the Bible there were seven fat years followed by seven lean years . . . brokers claim to see a similar thing in Wall Street. Ours is much longer . . . 17.6 years.

“You may think what I am about to tell you is negative. I suggest to you it is not. It raises your opportunity by eliminating mindless competition. It just means you have to work at it—seeking advice and information—and not leaving your investment policy on autopilot. That was what folks did in the fat cycle. That doesn’t work any more.

“In the fat cycle, which ended with the bubble, the Dow went from 900 to 11,700. You could throw a dart and pick a winner . . . lots of folks did. Those days are gone. Getting a decent return will be hard work for the next decade. You will need good judgment and good advice. Put the dartboard away. Just so you understand better, let me walk you through this concept.

“The tech bubble or the bull market topped in about February 2000. Just so it works on your calculator—let’s call that 2000.2. The Dow is around 11500. Subtract 17.6 years and you are in the middle of 1982. The Dow is around 900. It will soon embark on the greatest bull market in history. Subtract another 17.6 years from June of 1982 and you are back to the beginning of 1965. The Dow is around 900.

“Yes . . . that’s the same area you will find it in 17 years later. This clearly is the lean cycle. The Dow will go above and below 900 many times. Money will be made and new industries flourish, but it will require skill and hard work to find them.

“Subtract another 17.6 years from 1965 and you are back around the middle of 1947. The war has ended. Smokestack prosperity is in the offing. The Dow is around 220. This was to be a fat cycle.

“Subtract another 17.6 years and you are back in early fall 1929. The Dow is around 380 – but not for long. This . . . clearly . . . will be a lean cycle.

“Now—on the slim chance that this is any more than an oddity—what does it mean to you?

“It means you have to get off autopilot. In a fat cycle people can almost throw darts and hit a winner. In a lean cycle they need to pay attention and seek advice from someone with skill and brains.”

My contention, and I think the clear lesson of history, is that we are still (as of 2012) in the secular bear market that began in 2000. If the recent pattern holds, the bear market will continue for another five to six years in terms of valuations, if not in price. The key to successful investing will be to hold the types of stocks, funds, and other investments that do well in a secular bear market (when valuations are contracting), while avoiding the types that history has shown have less chance for success in such an environment.

Understanding the environment and investing accordingly are critical to your success. But before I can tell you how to invest in a secular bear market, you need to understand for yourself what these cycles are and why and how they happen.

When Past Is Not Prelude

We are looking for clues as to what the stock market is likely to do in the future. If reviewing the past gives us some idea of what the future will be, we will be way ahead of the crowd.

We can find some clues in a groundbreaking book by Michael Alexander called Stock Cycles. What he wrote early in 2000 accurately anticipated the behavior of the markets since then, and I recommend the book as important reading. (You can order it from Amazon.com.)

Let’s jump to the conclusion: Alexander’s work shows that using past market cycles to predict the performance of stocks over the coming 12 months isn’t much better than flipping a coin (and so does Ed Easterling’s later work!). Statistically, from almost any starting point, you have about a 50–50 chance of the market going up or down, using past price movements alone to make your prediction. Even in a secular bear market, the market goes up in 50 percent of the years, and often quite substantially.

But there are certain long-term cycles that are not random, and the probability of those repeating is higher than 50 percent. As you would expect, the patterns and techniques of successful investing change somewhat dramatically from phase to phase. The trick, of course, is to figure out where you are in the cycle.

I have long been suspicious of stock market cycle theory, especially Long Wave theory. Long Wave (or Kondratieff Wave) theory says the economy and markets repeat every 56 or 60 years. Granted, there seem to be patterns that recur, but there are not enough data points to provide statistical confidence. It is an interesting theory that tells you where you have been and where you are going, but it does not tell you reliably where you are or when you will arrive somewhere else.

I remember, as will many of my (ahem – somewhat older) readers, how Long Wave theory predicted the end of the economic world in the late 1980s. How many of you remember the flood of direct mail promotions, not to mention the books, screaming gloom and doom? Obviously, they were wrong.

The reason is that analysts try to make Long Wave theory a precise predictive model. They do not look at the fundamentals that drive the cycles.

It is like watching two men seemingly walking in the same direction in a large city. Maybe they are friends and are walking together. They could be total strangers going to the same location, or they may part ways in the next block. Until you know who the men are and where they are going, using their past travels to predict their movements is simply guessing.

It is one thing to use the stars, as the ancients did, to construct a calendar to predict seasons, planting times, and weather patterns. It is another to use the stars to predict personal fortunes. One methodology has a basis in fundamentals, the other (astrology) simply notices patterns that have no causal connection to anything else.

Alexander provides, at least for me, the needed link between the patterns in long-wave stock cycles and the underlying economic fundamentals. He shows, as it were, a causal connection between the position of the stars and the seasons.

Alexander doesn’t claim these cycles are as precisely predictable as the spring equinox. Rather, he suggests that when certain fundamental conditions occur, we can look for spring-like events. Just as you plant certain types of food and plants in spring and certain types in winter, there are some investments that do better in their respective parts of the stock cycle. Carrying the analogy further, it is easier to grow your portfolio in economic spring than in economic winter. In spring, you have a much wider variety of “plants” from which to choose.

You can plant spring crops during the winter, but you’re going to have to wait until spring to see them come up. In the meantime, it can be a long, cold season.

It is time to close but I will not leave you totally hanging. The connection between long-wave economic cycles and markets is actually highly attributable to the introduction of technology revolutions (steam, railroads, electricity, telecommunications, etc.) As an aside, as major technological innovations are being introduced at a faster pace than in the previous 500 years, it is highly likely that the long-wave cycle will completely break down, although I am sure that will spark a lot of disagreement among some readers. Which, by the way, does not make Long Wave analysis useless. On the contrary, it shows us something new and entirely different. I find it all very intriguing.

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com. 

Disclaimer 
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

It should not be assumed that the methods, techniques, or indicators presented on these websites will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these websites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

I fully intended to ignore Spain this week. Really, truly I did. I had my letter all planned, but then a few notes drew my attention, and the more I reflected on them, the more I realized that the inflection point that I thought the ECB had pushed down the road for at least a year with their recent €1 trillion LTRO is now rushing toward us much faster than ECB President Draghi had in mind when he launched his massive funding operation.So, we simply must pay attention to what Spain has done this week – which, to my surprise, seems to have escaped the attention of the major media. What we will find may be considered a tipping point when the crisis is analyzed by some future historian. And then we’ll get back to some additional details on the US employment situation, starting with a few rather shocking data points. What we’ll see is that for most people in the US the employment level has not risen, even as overall employment is up by 2 million jobs since the end of the recession in 2009. And there are a few other interesting items. Are we really going to see 2 billion jobs disappear in the next 30 years?

The War for Spain

In my book Endgame, co-author Jonathan Tepper and I wrote a chapter detailing the problems that Spain was facing. It was obvious to us as we wrote in late 2010 that there really was no easy exit for Spain. The end would come in a torrent of misery and tears. Tepper actually grew up in a drug rehab center in Madrid – as a kid, his best friends were recovering junkies. (For the record, he has written a fascinating story of his early life and is looking for a publisher.) His Spanish is thus impeccable, and he used to get asked to be on Spanish programs all the time. Until the day came when the government created a list of five people, including our Jonathan, who were basically named “Enemies of Spain,” and pointedly suggested they not be quoted or invited onto any more programs.

As it turns out, the real enemy was the past government. We knew (and wrote) that the situation was worse than the public data revealed, but until the new government came to power and started to disclose the true condition of the country, we had no real idea. The prior government had cooked the books. So far, it seems it even managed to do so without the help of Goldman Sachs (!)

In about ten days I will be sending you a detailed analysis of all this, courtesy of some friends, but let’s tease out some of the highlights. True Spanish debt-to-GDP is not 60% but closer to 90%, and perhaps more when you count the various and sundry local-government debts guaranteed by the federal government, most of which will simply not be paid. Spanish banks are miserably underwater, and that is with write-offs and mark to market on debts that totals not even half of what it should be. If Spanish housing drops as much relative to its own bubble as US housing has so far (and it will, if not more), then valuations will drop 50%. The level of overbuilding was stupendous, with one home built for every new every person as the population grew. We know that unemployment is 23%, with youth unemployment over 50%. Etc, etc. We could spend 50 pages (which is what I will get you access to) detailing the dire distress that is Spain.

Which brings us to this week. It was only a few weeks ago that most everyone, including your humble analyst, thought that the ECB had bought a little time with its “shock and awe” €1-trillion LTRO. Lots of analysis said there would now be at least a year to put programs in place to deal with the coming crisis.

Yet we may now be fast approaching the Bang! moment when the markets simply refuse to believe in the firepower that whatever governmental entities can muster. It happened with Greece, as it has in all past debt crises. Things go along more or less swimmingly until, as Ken Rogoff and Carmen Reinhart so articulately detail in This Time is Different, we wake up one morning to find that Mr. Market has seemingly lost all interest in funding a country at a level of interest rates that is credibly sustainable. When interest rates ran to 15% for Greece, even arithmetically challenged European politicians could understand that Greece had no hope of ever paying off its debt.

When rates rose last year to almost 7% for Italy and 6% for Spain, before the ECB let loose the hounds of monetization, they were approaching the limits of sustainability. Rates came back down as the ECB either bought directly or engineered the purchase of the bonds of the two countries. But now the LTRO effect appears to have worn off, and yesterday interest rates for Spanish ten-year bonds climbed again to 5.99%. There is a large auction for ten-year Spanish bonds next week, which the market is clearly anticipating with a bit of concern. Meanwhile, Italian interest rates are not rising in lock step, which shows that the anxiety is now clearly directed at Spain. Ho-hum, move along folks, nothing to see here in Rome.

(What follows now is a mix of the facts as I read them and speculation on my part. I admit I may be reading more into the information, as I squint at it at 3 AM, than is justified. But then again, there is a substantial amount of history that suggests I am not totally off base…)

Spain Goes “All In”

I came across this tidbit from typicallyspanish.com, and my antennae started to twitch (hat tip Joan McCullough). The key is the second paragraph. (Hacienda is the common name of the Spanish tax ministry, otherwise known as the Agencia Estatal de Administración Tributaria.)

“Spain led the loss in the number of self-employed workers in Europe in 2011. One in two of the self-employed to lose their jobs in the EU over the year was Spanish. Seven out of ten self-employed in Spain do not employ anyone else. Over 2011 Europe lost a total of 203,200 self-employed workers, 0.6% fewer than in 2010.

“Following the news that cash business transactions over 2500 € are to be banned, Hacienda has said they will not fine anyone who admits that they have been making payments of more than 2,500 € over the previous three months. The cash limit is part of the Governments anti-fraud plans which have been approved today, Friday. Those Spaniards who have a bank account outside the country now face the legal obligation of having to inform Hacienda about the account. The Government hopes its anti-fraud measures will bring in 8.171 billion €.”

My fellow US citizens will be saying to themselves, “So what? We have to report our foreign bank accounts, and any large cash transactions are flagged.” But gentle reader, this is much different. This is new law for Spain, basically currency control writ large, and bells have to be going off all over Europe.

First of all, note that Greece never tried to require its citizens to report cash transactions or to list foreign deposits. This is the new Spanish government revealing serious desperation. The government’s back is to the wall. They have to know they will not collect the taxes they need to generate, but are going to try anyway to demonstrate to the rest of Europe (read Germany) that they are doing everything they can.

In a side note, on Wednesday, Spain’s interior minister introduced new measures to thwart plots using “urban guerrilla” warfare methods to incite protests. And the local papers are printing op-eds by economists talking about how the effort to comply with German austerity demands will just make the economy worse, and that the government is not taking into account the resolve of labor unions to oppose them. “Germany is the problem.” It pains me to say this (truly it does), but this is what we were writing about Greece, not all that long ago. We are seeing footage of demonstrations, verging on riots. It is a familiar pattern.

Second, let’s review what I wrote a month ago. I noted that the LTRO money was being used by Spanish banks to buy Spanish government debt (and Italian banks were buying Italian government debt, etc.). The intention was to help the two countries specifically and Europe in general to finance their debts and allow banks to shore up their capital as part of that effort. But what that does is yield the unintended consequence of making a breakup of the eurozone easier, as it helps get Spanish and Italian debt off the books of German and French banks.

The only reason Germany and France, et al., cared about Greece is that their banks had so much Greek debt on their balance sheets, in many cases more than enough to render them insolvent. Bailing out the banks directly would have been costly, so better (thought the European leaders) to do it with bailouts from funds created with guarantees from the various governments (which is a backdoor way to get it from taxpayers) and the European Central Bank. A crisis was avoided and there was a more or less orderly Greek default – which anybody who bothered to look at the math saw coming well in advance.

A further side note: Spanish-bank borrowing from the European Central Bank doubled last month, “revealing a dangerous dependence on emergency funding that on Friday triggered renewed turmoil in financial markets.” (The Telegraph) And the Spanish stock market is down some 30% over the past year.)

So, in the effort to make sure that everyone pays their taxes and to stop tax fraud, the Spanish government is going to find out which of its citizens have moved their money out of Spain. And let’s be clear, money has been flying out of the banks of Spain and Portugal (and to some extent Italy) as it did, and still is, in Greece.

And it will be easier to track that offshore money than you think. Some people, I am sure, moved their money into cash and then out of the country. But others simply wired the money, thus leaving a trail. Spanish banking regulators can easily require they be given that information, and what bank will say no to the regulators? Spain does not collect taxes from its citizens if they are residents of a foreign country (as the US does), but it can tax everyone who lives in Spain. And if you live in Spain and decide to diversify your risk among a few other countries? I am not sure of Spanish tax law, but I reasonably assume you are supposed to report all your income from whatever source. (Otherwise there would be no one investing with Spanish banks, brokerages, and investment advisors –if it were legal not to report foreign investments, then everyone would invest outside of the country.)

Let me hazard a modest prediction: We will see a rather sudden and substantial need for physical cash in certain other “peripheral” countries, as now their citizens may not want to leave trails as they go about opening foreign bank accounts. What is to keep Italy from doing as Spain has done? Or Portugal? Or France? Or Germany?

Let me be clear about something. I am not suggesting that people should not pay their taxes. If you choose to live in a country, you should pay the taxes that are required. What Spain is trying to do is simply make sure that all their citizens pay the proper amount of taxes. If there was already 100% compliance, there would be no need for new regulations like Spain’s. And the same goes for the US. Our penalties are rather stiff for not paying taxes, more so, I’m guessing, than in most of Europe. I have on more than one occasion noted that the national sport of Italy is tax avoidance.

My friends in Spain tell me a lot of business is done in cash. But that is the case in the US and almost everywhere I go. There are a lot of (ahem) “independent” taxi drivers, services, etc. that do not take anything but cash. Maybe they report everything, but I do not bother to ask. (When I was a waiter in college, did I report all of my tips? I was required to report a minimum amount of income for each hour worked, but did I report everything? Since it has been 40 years and the statute of limitations has run out by now, I might admit to missing a few dollars here and there.)

I imagine there are quite a few Spanish citizens who are not sleeping well this weekend. And more than a few people tossing and turning in other countries as well. If the next month comes and goes without any sign of unusual cash movement in Europe, then I will owe the peoples of peripheral Europe a big apology for doubting their willingness to pay their taxes. Or maybe it will turn out that they were better at “avoidance” than your average American, and planned their movements far in advance…

Let’s get back to the central point. Spain is too big to fail and too big to save. The bond markets are clearly getting nervous, much sooner than was planned. Spain is clearly attempting to demonstrate that it will do everything in its power to comply with the new European austerity rules. Yet Prime Minister Mariano Rajoy has warned that the situation has created “a vicious circle that strangles Spain.”

Rajoy delivered a strongly worded speech to parliament, insisting that it was “as clear as day” that Spain would not need a Greek-style bailout. But in recognition that the country is losing market confidence, he appealed to other European leaders to be “careful with their comments” and remember that “what is good for Spain is good for the eurozone.” (The London Telegraph)

One can look at the amount of money Spain will need to refinance in the coming year and look at their financial ability, then look at how much can possibly be raised by the European community, even under the proposed new structures, and readily come to the conclusion that there is simply not enough money to save Spain if the market goes Bang!

The only possible solution I see is for the European Central Bank to step in with some new program. ECB President Mario Draghi has demonstrated a marked ability to come up with new, creative ways to kick the can down the road. Finding the money to bail out Spain is hopefully in his book of tricks. As fellow central banker Ben Bernanke has noted, Mario has a printing press. And the LTRO showed he knows where it is and how to use it.

“We Are Not Greece”

The German Bundesbank is saying as loudly as it can, “QE? Nein!!” But I count only two German votes among the 23 that compose the board of the ECB. Spain is demonstrating to its European brothers and sisters that it is doing all it can. “We are not Greece” is the clear statement. And “We need and deserve your help.” Yesterday, Rajoy pointedly noted again that “What is good for Spain is good for the eurozone.”

One should not underestimate the willingness of politicians who are viscerally committed to a certain action (in this case European unity) to spend someone else’s money in the pursuit of that action. Especially if that money is a hidden tax in the form of debt monetization.

The markets are moving up the time table on the next large monetization of Spanish (and eventually Italian?) debt. Germans will shout that this is inflationary, and for them it probably will be. But much of the rest of Europe is in the grip of deflation. Spain is clearly in a classic Keynesian liquidity trap. This is what can happen when you have very different economies operating under one monetary roof. This is not simply a banking or sovereign-debt crisis, it is about a massive trade imbalance and huge differences in the productivity of labor. The trade imbalance between the south – Portugal, Spain, Italy, and Greece – and the north (mostly Germany) must be solved before there can be any resolution of the economic crisis. This is Economics 101, which European politicians seem to have slept through.

There will be the attempt to create some sort of fund to buy Spanish debt, but it will prove to not be enough. And given recent market movements, it may not be able to happen fast enough. It will not surprise me if the ECB uses the promise of such a fund as a pretext for acting sooner.

And yes, this will lower the value of the euro. We will have to see how far Europe is willing to push the process. Greece will soon default again (they are in a depression and have a national election in early May), Portugal is still moving toward being bailed out, and the Irish are growing tired of having to repay the British, French, and Germans for bailing out their failed banks. Think bailout fatigue isn’t growing among European voters? Stay tuned…

The New Labor Force

I will end this letter with the beginning of what I intended to write originally and hope to finish next week. Work and employment is changing before our eyes in the US and much of the developed world. As the Baby Boomer generation reaches retirement age and finds out that either it cannot afford to retire or does not want to retire, the “trickle-down” effect to younger workers is starting to become apparent in the data.

Let’s look at three charts (hat tip to John Hussman, who called this to our attention and got me looking at the details). The first shows the employment level in the US for the last five years. The gray area is the official period of recession. Employment growth since the end of the recession has been only a few hundred thousand jobs a month; but since employment is a lagging indicator, you can claim that we have recovered 4 million jobs since the employment bottom in late 2009 or about 2 million jobs since the 3rd quarter of 2009. It all depends on where you want to start your count. But we are still down roughly 4.5 million jobs since the beginning of the recession. This has been the slowest “recovery” since the end of WWII.



Now let’s look at the next chart. This is the employment level for those over the age of 55. Notice that it kept rising all through the recession and especially after. People over 55 have seen their total employment level rise by about 4 million jobs since the beginning of the recession, and over 3 million jobs since the 3rd quarter of 2009. Almost any way you look at it, those over 55 have seen their jobs level improve over those who are younger. If you take the end of the 3rd quarter as your marker, the Boomer generation has seen its jobs level rise by 3 million, while overall jobs rose by just 2 million! Those who are younger are actually falling behind!



And once last chart before we go. Last week we looked at how the civilian participation rate (the percentage of the population who have a job or want a job) for the US has been falling for a decade and especially since the end of the recession. You can attribute a high percentage of the apparent decrease in unemployment to the fall in the participation rate.

Except for one group or cohort. This next chart is the participation rate of those over 65. Their participation rate is rising. The graph is “noisy,” but the trend is clear. Whether willingly or out of necessity, older workers are staying longer in the work force. And given the rather lackluster employment growth, they are taking jobs that would normally go to younger workers, which is why we are seeing higher rates of unemployment among the latter. We will go into the why of that next week, but a great deal of it has to do with work skills.

 

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com. 

Disclaimer 
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

It should not be assumed that the methods, techniques, or indicators presented on these websites will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these websites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, Tiger Shark Publishing LLC, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.