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2 Bulls, bankers blind to inevitable
bust By Doug Wakefield
(with Ben Hill)
While observing current
events through the lens of history over the past
few years, there have been times in which the only
conclusion I could draw was that we were beginning
a bear market that would prove much more severe
than the one from 2000 to 2002.
As fiat
currency and money supplies have exploded the
world over, we have seen a proliferation of
products, with varying acronyms, as the financial
world tries to distance itself from the
risky loans it originated. My
experiences, as a researcher and investment
advisor, suggest that the root of the problem is
in investors' thinking. Between the autumn of 2002
and the spring of 2003, multiple markets began
bull runs. As 2007 comes to a close, the only
lesson most investors learned from the US$7
trillion loss of those years is to "hang on" when
the market declines.
But while the past
five years have produced substantial bull markets
in a range of equity classes, they have also
produced investors who have failed to read the
historic accounts of how rapid credit creation
ultimately ends in collapse. The need to slow down
and prepare for contracting credit is lost in the
fast-paced, unforgiving world of momentum trading.
But those who have been reading the headlines
since the first of August can plainly see that the
world is rapidly shifting from one that embraces
risk to one that shuns it. And as historical
precedent suggests, since the credit bubble
started breaking down just four months ago, our
government, as well as those of the Europeans and
Asians, have sought to intervene.
With
several equity markets set to finish 2007 at or
near historic highs, you may be thinking that
things are not nearly that gloomy. Two years ago,
we released a research paper on short selling,
aptly titled "Riders on the Storm: Short Selling
in Contrary Winds". Some thought it foolish to
attempt to thwart the gods of modern capitalism,
and I must admit it's been a rough ride. Most who
hold to my line of thinking have been unheard by
family, friends, and associates.
But, once
again I write to encourage some and to implore
others to suspend judgement for a few minutes
until they have critically appraised the evidence.
If you come to the conclusion that I am wrong,
what has it cost you but a few minutes of your
time? But if I am right, it will not matter who
wrote what when, but only that, as crowd behavior
shifted from greed to fear, you heard an idea that
later proved to be extremely valuable.
Heard it all before? If we see
something one time, and extrapolate that the
conclusion will always be the same, we stand a
high chance of failure. But if we watch multiple
occurrences of similar patterns unfolding over
months, quarters, and years - sometimes fast,
sometimes slow - with different degrees of force
and destruction, across different nationalities,
cultures, and time periods, then those who ignore
such data, do so at their own peril. So as you
read and try to gain your bearings in this
unfolding market, let me share with you two
hindrances, in the form of words we think or say,
that are barriers to accurate assessments.
Statement 1: "Hey, if you're so smart, how
much did you make in the last 12 months?" With the
Dow substantially higher than it was when I
released our short selling paper in January of
2006, you know I've heard this statement before.
But this statement reveals a fallacious
understanding of how the market, and life itself,
works.
First, financial history is
littered with the corpses of advisors and
investors who thought that things wouldn't or
couldn't change. Taking comfort in yesterday's
successes, we become less and less inclined to ask
the question, "But why were the last 12 months
good to my investment strategies?" Without asking
this question, those being told they are smart and
successful have no idea about how to hold on to
that success should the reason for their success
change course.
This is a fact that I have
learned the hard way. In 1999, with no real
knowledge of the history of money and credit, and
with no real understanding on technical analysis
and crowd psychology, I was convinced that my
success was because of my two financial planning
degrees and all of the reading I had done.
Attending financial planning conferences and
sharing success stories with other advisors
advanced this belief even more. But, when prices
declined rapidly in the bear market of 2000 to
2002, I saw how rare experts really are and how
quickly praise can turn to criticism.
And
while many continue to look in the rearview mirror
as they seek to build their wealth, this practice
is foolish and extremely dangerous. While some
things are random, certain tendencies prove to be
so strong that we call them rules. Though we don't
know exactly how something will turn out, or the
extremes to which a reaction will reach, we do
know that if we mix certain elements together, we
will get a specific reaction.
Imagine
walking up to a young soldier about to be deployed
to Iraq or someone who has recently lost a love
one, and saying, "It will be like it was last
year." No. Life does not offer any of us a promise
that last year's journey, however pleasant or
painful, will be duplicated in the next. When the
yellow dash light is flashing "low fuel", who
expects to stay in their warm car and not stop for
gas because the last 160 kilometers have allowed
them this luxury?
Suggestion 1: If your
financial strategies have presented you with very
positive returns and higher asset values over the
past few years, right now ask yourself: "Why did
my numbers go up in the last few years, and what
will need to happen in the next few years to keep
these numbers rising?" If you're unwilling to
address these questions initially, you will likely
be forced to do so in the future.
Statement 2: "Our capital markets are
huge. We have so many government and private
sector experts; they will fix any foundational
problems that threaten my plans and financial
well-being. The next year or two may be a little
rough, but the experts will make sure the markets
unwind slowly."
This statement is born out
of a lack of understanding of complex societies
and their attendant problems. We grow to depend on
more and more experts and a bigger and bigger
socialistic state to intervene to make certain
that our god-given rights, to a college education
for the kids and a comfortable retirement, are
taken care of.
Any serious student of the
Great Depression will see hundreds of parallels
with the men and women of today. They watched a
new era of credit explode - giving the public the
illusion that they were "wealthy". This massive
amount of credit showed up in a new instrument
called a car loan, and for the first time an
entire generation of American farmers took out
farm loans.
Few ever stopped to ask: "How
did we come into all of this newfound wealth?" No
one was being told that, while our federal debt
remained flat from the final days of the Civil War
until Woodrow Wilson's first year in office,
between 1913 and 1920, it had exploded from $2.9
billion to $25 billion. Was this "random"? Should
we really be surprised at how exploding debt
changes a society's perspectives? The record
speaks for itself. People liked the feeling of
success that debt and credit produced. Most
financial leaders of the 1920s enjoyed this easier
lifestyle and watching their balance sheets grow.
The government "experts" enjoyed the praise they
received. All of this new wealth was "justly due".
We all know what happened. The fundamental
problems went unaddressed. In an effort to keep
market prices (the core of the wealth illusion) up
in and after 1929, the Federal Reserve tried
desperately to flood the money supply, cutting
interest rates repeatedly and increasing their
holding of government securities from $485 million
to $2.432 million in just four years.
Ignoring the fact that it was their
policies of the previous two decades that had
produced our nation's pain, the government
presented numerous "solutions" to declining assets
values. The public didn't question their newfound
wealth on the way up; in the same way, they looked
to government and finance leaders' promises as a
means to get their prosperity back.
Ultimately a new monetary scheme, built on
a less stable foundation, was presented to the
public as a "rescue". And the same basic thing
occurred in August of 1971, when, for the
first
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