The Daily Reckoning Australia

Melbourne, Australia Thursday, 15 October 2009

From Dan Denning in Melbourne: --Everyone and everything is getting higher and higher. Led by the investment banks, U.S. stocks are reporting earnings that "beat analyst's expectations." The Dow is over 10,000 again. Even oil is trading at $75. --Keep in mind most of the earnings news is garbage.

Earnings are whatever an accountant wants them to be. Compared to last year - which was a shocker - this year's earnings are bound to be better. And when analyst's expectations are subjective, are you surprised to learn that the people who sell you stocks think that earnings are "surprisingly" good? --That said, the official unemployment figures in Australia appear to be going down.

Consumer confidence numbers are back near all-time highs. At least here in Australia, the stock market and the economy are reading from the same prayer book. Both are singing the praises of the recovery (second coming of the Goldilocks Economy). --Amen. --In the States, it's a little harder to figure out why stocks are singing such a different tune than the American economy. But it's not impossible.

Take oil. --While the higher price is good for oil companies and investors, you know it's going to take money out of the pockets of consumers. Lower oil prices were a windfall for drivers all over the world in the last year, putting more discretionary income into the family budget. A higher oil price, as always, is a tax on consumer spending. --But we come here neither to praise nor bury the recovery. In fact, we come here to point out that the recovery is an imposter. It's a financially-fuelled bear-market rally dressed in respectable clothing.

The underlying problems in the economy are still there, dishevelled, dirty, and unwelcome in polite company . And the main problem is simple: too much debt (public, household, and corporate). --Or as Michael Hudson said in a previous interview, "The economy has reached its debt limit and is entering its insolvency phase. We are not in a cycle but the end of an era.

The old world of debt pyramiding to a fraudulent degree cannot be restored." --It cannot be restored, but the rate of its collapse can be arrested so that the members of the financial oligarchy can sell their stocks to a gullible public. And that's what you're seeing now. It makes for an incredibly tradable market. But it does make it harder to value corporate assets when balance sheets remain so badly skewed by a) bad assets b) unrealistic expectations of future consumer demand based on credit. --Advantage speculators. Disadvantage investors. And speaking of speculators... --Here's a prediction about the U.S. dollar. It will find a floor. But that floor could be much lower.

The greenback's collapse is driving more countries to hold Euros, yen and gold in their foreign currency and monetary reserves. This could have a funny effect, though. It will put the spotlight on the fiscal conditions of Europe and Japan. And what do you think could happen then? --The Euro and the Yen may be better off, relatively speaking, than the dollar at the moment. But only relatively. In absolute terms, they are "deeply flawed" currencies as well, to use a Jim Rogers phrase. In the long run, most paper currencies fail. In the short run, there's going to be a lot of volatility until a new monetary regime replaces the old one. --All of this bodes well for precious metals investors...in the long run. But don't be surprised if governments get hostile to gold, at least for every day investors.

Central banks will own it. But it might get harder for everyone else. --We began the week wondering about the cycles of history and markets. We wondered whether Australia is following the Anglo-American cycle into a long-winter...where people lose confidence in each other, in government, and in the institutions they relied on in the past for law and order, employment, and prosperity. --We're not much closer to answering that question, and there's only one day in the week left! Perhaps it will take more time.

In the meantime, if you are interested in the idea of cycles and history, there's a great article by Nick Paumgarten in the October 12th edition of The New Yorker. There are a few quotes from it below. --"Cycle theory is a kind of Gnostic offshoot of technical analysis. The nothing that things generally happen in cycles goes back thousands of years - Joseph's seven-year-fat-lean cycle - but in the West the formal inquiry into economic cyclicality too hold in the mid-nineteenth century.

The British economist William Stanley Jevons correlated economic cycles to the sun, proposing the fluctuations in sunspot activity might affect crop outputs. --"Around the same time, a Frenchman named Clement Juglar identified an economic cycle of seven to eleven years. In the nineteen-twenties, Nikolai Kondratiev, a Soviet economist, concluded that capitalism was inclined to half-century cycles of boom and bust and boom again, rather than, as Marx believed, a single inexorable collapse..." --"It was the Austrian economist Joseph Schumpeter, he of 'creative destruction,' who called these cycles Kondratiev waves and popularised them in the West.

In the Kondratiev waves and other commonly cited cycles - the Kitchin (three to five years), the Kuznets (fifteen to twenty-five years)-the time span is flexible. --"They are suggestions, not rules. Hardcore cyclists, on the other hand, often seek and find instances of periodicity as rigid and fixed as the laws of physics, which is why hardcore cyclists are often dismissed as mystics and freaks. --"It is easy to scoff at cycle theory. Its whiff of predestination chafes the scientific mind.

Our culture's fundamental belief in causation and consequence, to say nothing of free will, does not easily accept the suggestion of helplessness, or of some kind of as yet unidentified exogenous force. God may decide the outcome of football games and debilitating illnesses, but he does not intervene in matters of investing and finance. --"And yet patterns exist, and we slowly discover them.

Seasons, migrations, moons: the template is there. Consciously or unconsciously, most people accept certain components of cycle theory. We seek and see patterns in things. It is the way our minds work, presumably, for the purpose of survival."

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