Outside_The_Box

I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

With grateful thanks to John Mauldin: JohnMauldin@InvestorsInsight.com.

Before we get into today’s Outside the Box I want to clear up a few ideas from this weekend’s letter. There have been posts on various websites equating my piece on deflation with Paul Krugman. They say I am advocating kicking the can down the road and not reducing the deficit.

Wrong. What I have been trying to point out for several years is that we have no good choices. We are down to bad and very bad choices. The very bad choice (leading to disastrous – think Greece) is to continue to run massive deficits. The merely bad choice is to reduce the deficits gradually over time. As I try to point out, reducing the deficits has consequences in the short term. It WILL affect GDP in the short term. Krugman and the neo-Keynesians are right about that. To deny that is to ignore basic arithmetic.

I am not for kicking the can down the road. Not to begin to deal with the deficits, and soon, risks an even worse problem. But – and this is a big but – I don’t want to stomp on the can, either.

Now, let’s get into this week’s Outside the Box. I offer you a very intriguing essay by those friendly guys from Bedlam Asset Management in London. They argue that Belgium’s sovereign debt should be suspect, and is the country that could be a “sleeper” problem. This is a very interesting read, with a lot of history. It is not too long and very interesting. Enjoy. (www.bedlamplc.com)

Your thinking sovereign debt is the biggest bubble of all analyst,

John Mauldin, Editor
Outside the Box

Running through a minefield, backwards
Part II – farewell Flanonia?

The last issue concentrated on sure sovereign default by Greece, Spain and Portugal – partly due to hopeless economic numbers but more because of various ‘soft’ issues. For, just as the numbers in a company’s balance sheet theoretically provide all that is required to understand and value it, the reality is that squishy issues, such as the quality of management, staff morale or even simple luck can make a mockery of these numbers. Part I also emphasised the futility of gnawing at the bone of the de facto bankruptcy of these three countries. Backward looking investment never makes money; better surely to recognise the sovereign default cycle has further to go, and so spend time identifying the next unexpected candidate.

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I’m pleased bring you another “Outside The Box” special edition newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

From my friend George Friedman, founder & CEO of STRATFOR, here’s my newest favorite quote concerning economic recessions: “Like forest fires, they are painful when they occur, yet without them, the forest could not survive. They impose discipline, punishing the reckless, rewarding the cautious.” The thin line of where risky becomes reckless is something I’d like to focus us on today. No matter the risk-level of your portfolio, if you are reading this you are probably smart enough to know that when you play with fire you may get burned. You have to know how to look for smoke, or signs of a potential catastrophe, so you know not to grab the doorknob with both hands.

I’m including George’s discussion of the contributing facets of a recession, its inevitability and the idea of risk. As if the title won’t intrigue you to begin with, take my advice and give “The Global Crisis of Legitimacy” a read. STRATFOR uses its signature analytic approach to decipher today’s issues, applying historical context ranging from Adam Smith to the Lehman Brothers. Also, join their mailing list to receive two weekly intelligence pieces, and find that fire before your next investment opportunity comes along.

John Mauldin

Editor, Outside the Box

The Global Crisis of Legitimacy

By George Friedman

Financial panics are an integral part of capitalism. So are economic recessions. The system generates them and it becomes stronger because of them. Like forest fires, they are painful when they occur, yet without them, the forest could not survive. They impose discipline, punishing the reckless, rewarding the cautious. They do so imperfectly, of course, as at times the reckless are rewarded and the cautious penalized. Political crises – as opposed to normal financial panics – emerge when the reckless appear to be the beneficiaries of the crisis they have caused, while the rest of society bears the burdens of their recklessness. At that point, the crisis ceases to be financial or economic. It becomes political.

The financial and economic systems are subsystems of the broader political system. More precisely, think of nations as consisting of three basic systems: political, economic and military. Each of these systems has elites that manage it. The three systems are constantly interacting – and in a healthy polity, balancing each other, compensating for failures in one as well as taking advantage of success. Every nation has a different configuration within and between these systems. The relative weight of each system differs, as does the importance of its elites. But each nation contains these systems, and no system exists without the other two.

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I’m pleased bring you this week’s “Outside The Box” special edition newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

Let’s have a thought game. What if the Eurozone breaks up? My friend and very serious philosophical thinker Charles Gave (of GaveKal) thinks that would be a positive event. To quote his conclusion:

“But we return to the most simple of questions, namely: Was the end of the USSR a negative event? When Americans stopped wasting capital building empty condos in Florida or Arizona, was that bad news? If, like us, our reader answers “no” to the above questions, then the Greek crisis should be seen as a reason for hope, rather than despair.”

Now, that is a truly Outside the Box proposition and one which I found very compelling. His partner, Anatole Kaletsky, elsewhere argues that the ECB will enlarge their mandate to try and save the day by printing enormous sums of money, ultimately making things worse.

The team at GaveKal gave me permission to share this with you, as I think it deserves a wide audience. Warning: the first part is philosophical in nature. You will need to think through it. This is not one for speed reading. But if you grasp what he is saying, I think it will give you a major insight into the plight that is now engulfing Europe. Note. Even though Marc Faber calls the GaveKal team “euro perma-bears” GaveKal is mostly quite bullish on everything else. They always seem to find the bright side of the street to walk on, or at least a few spots in the sun in which to sit.

Read this and learn why the break-up of Europe might be a bullish event. As I said, Outside the Box is for ideas that challenge the status quo, and this, if anything, does just that.

John Mauldin, Editor
Outside the Box

Was the Demise of the USSR a Negative Event?

Everything one reads on Europe these days varies from the seriously gloomy to the downright apocalyptic so let us immediately re-assure our reader: this is not yet another GaveKal paper explaining that the Euro is a doomed currency. GaveKal has done too many of those over the years to the point where our friend Marc Faber started to refer to us as the ‘Euro perma-bears’. I even wrote a book, in French (Des Lions Menés Par Des Anes) in which I explained, as simply as I could, that the Euro would lead to the biggest misallocation of capital since the Soviet Union, leaving us with too many houses in Spain, too many factories in Germany, and too many civil servants in France, everybody specializing in what they were best at.

Amazingly, now that the markets finally seem to be putting an end to a political interference in the free market which, like the Soviet Union, or Fannie and Freddie Mac, could only lead to disaster, most commentators appear to believe that Europe is on the edge of a precipice. And two reasons are typically proposed to defend the notion of sending good money after bad: the first is that without a bailout of Southern Europe, the very existence of the Common Market and the dream of European Unity will collapse.

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I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

Let me start this week’s Outside the Box by venting a little anger. It now looks like almost 30% of the Greek financing will come from the IMF, rather than just a small portion. And since 40% of the IMF is funded by US taxpayers, and that debt will be JUNIOR to current bond holders (if the rumors are true) I can’t tell you how outraged that makes me.

What that means is that US (and Canadian and British, etc.) tax payers will be giving money to Greece who will use a lot of it to roll over old bonds, letting European banks  and funds reduce their exposure to Greece while tax-payers all over the world who fund the IMF assume that risk. And does anyone really think that Greece will pay that debt back? IMF debt should be senior and no bank should be allowed to roll over debt and reduce their exposure to Greek debt on the back of foreign tax-payers.

I don’t think I signed on for that duty. Why should my tax money go to help European banks? This is just wrong on so many levels and there is nothing seemingly we can do. Oh, well. Thanks for listening.

This week we look at an essay by my friend Tony Boeckh, who from 1968 until 2002, was chairman and editor-in-chief of BCA Publications, publisher of The Bank Credit Analyst. He has written a very important book called The Great Reflation. Tony feels that one of the most important things for investor to understand is money flows, whether from debt or monetary easing. The ebb and flow of money can both create and burst bubbles and we are now in what he calls a Great Experiment where governments around the world are trying to again reflate the economy (and are succeeding). What bubbles will this create and how does it end? How should we then invest?

My good friend Marc Faber has this to say about The Great Reflation:

“The Great Reflation is by far the best economic and investment book that I have read in the last ten years. Tony is a seasoned historian, economist, and strategist with a unique ability to explain complex issues in simple, readable terms. These are illustrated with numerous charts on economic and financial trends that put current conditions in a historical context.”

- Marc Faber, Editor, The Gloom, Boom & Doom Report

The book is in most bookstores and you can of course get it by going to www.amazon.com and you save 34% and it is available on Kindle. So, let’s enjoy Tony’s essay.

Your never did like the IMF anyway analyst,

John Mauldin, Editor
Outside the Box

The Great Reflation

The Mother of all Financial Experiments

By Tony Boeckh

Chuck Prince, the former CEO of Citigroup, who presided over the bank’s collapse, famously remarked in July 2007 that “as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Shortly after, the music stopped, the financial system broke, and Citigroup and other financial behemoths went under.

To rescue the economy and financial system from near-total meltdown, the government created an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits. It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity, on a vast scale was unleashed into the financial system, demonstrating, once again, the power of such flows to drive up the prices of stocks, commodities and other risky assets.

In The Great Reflation we focus on how the authorities pumped air back into the balloon, and got the music playing again.  Investors and banks, including Citigroup, are back out on the dance floor. However, just because the system was saved, doesn’t mean it has been fixed.

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I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here.

I’m also a huge fan of Martin Wolf, and, having read both of these columns last week, and I concur completely with John’s remarks below. Enjoy!

Long time readers know that I am a huge fan of Martin Wolf, economist and columnist for the Financial Times. His writing is the reason to get the Pink Lady (as the Financial Times is known) as far as I am concerned.

This week’s Outside the Box has two columns back to back from last week from Wolf, talking about the problems in Britain which look like the same problem all over the developed world. Wolf argues (rather cogently) that the answer is to increase exports and for a further weakening of the pound. Quoting:

“Weak sterling, far from being the problem, is a big part of the solution. But it will not be enough. Attention must also be paid to nurturing a more dynamic manufacturing sector. With the decline in energy production under way, this is now surely inescapable.”

Can I envision the pound at parity with the dollar? Yes, I can. But look at what that implies. It makes it tougher on US exporters just when we need a strong export base. Can every country devalue its currency (or allow it to fall?) as a way to become prosperous? And against whom? Will Europe sit by? What will that do to the US earnings of multi-national corporations? Will Senator Schumer accuse Britain of currency manipulation and want a 25% tariff?

I have made the point many times that not every nation can export their way to prosperity. Someone has to buy! While Wolf has the right prescription for Britain, it is the same prescription that every nation wants to pursue. But we can’t all do it at once. Read these columns in that light.

Have a great week.

John Mauldin, Editor
Outside the Box

UK Economy must perform a rebalancing act

How ill is the UK economy? What are the challenges for economic policy? These questions seem to me to be far more urgent than before any general election since 1979, when Margaret Thatcher came to power.

The one point on which everybody agrees is over the depth of the fiscal hole: the government is borrowing a pound for every four it spends. But nobody wants to discuss what might need to be done. This is not surprising: today’s fiscal deficits exceed those of any previous period in peacetime. Yet even if one accepts that these deficits must be tackled, huge questions remain over the timing and content of such action.

In the UK at least, the fiscal deficits are mirror images of private sector surpluses. Moreover, the direction of causality is from the latter to the former. The necessary conditions for a return to fiscal (and economic) health are a recovery in private spending, a huge increase in net exports or, ideally, both. The big question is whether the essential recovery in private spending and net exports will occur before, or after, it becomes difficult for the government to borrow on reasonable terms. If it comes before, a smooth fiscal exit is feasible. If it comes after, a crisis would intervene. I am optimistic on this, but am not blind to the risks.

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I’m pleased bring you this week’s “Outside The Box” special edition newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

The United States’ southern neighbors have always held a special interest for explorers. In particular Sir Walter Raleigh and his ill-fated quest for El Dorado comes to mind (I’m sure we can all relate). Modern day explorers, also known as investors, are still looking for the best place to stake their resources in search of riches. Thankfully, we have considerably more information at our disposal than a treasure map. But how do we know when X marks the spot, or if it’s just another faulty lead?

Intelligence, not just mass-produced information, is the key. For my global intelligence, I turn to the experts at STRATFOR. In this edition of “Outside the Box”, I’ve included a STRATFOR analysis on the situation in Mexico. It evaluates the drug wars in terms of the U.S. and Mexican economies. Give it a read and sign up for their free reports. You’ll soon understand the value in intelligence, not just news.

John Mauldin
Editor, Outside the Box

Mexico and the Failed State Revisited
By George Friedman
STRATFOR argued March 13, 2008, that Mexico was nearing the status of a failed state. A failed state is one in which the central government has lost control over significant areas of the country and the state is unable to function. In revisiting this issue, it seems to us that the Mexican government has lost control of the northern tier of Mexico to drug-smuggling organizations, which have significantly greater power in that region than government forces. Moreover, the ability of the central government to assert its will against these organizations has weakened to the point that decisions made by the state against the cartels are not being implemented or are being implemented in a way that would guarantee failure.

Despite these facts, it is not clear to STRATFOR that Mexico is becoming a failed state. Instead, it appears the Mexican state has accommodated itself to the situation. Rather than failing, it has developed strategies designed both to ride out the storm and to maximize the benefits of that storm for Mexico.

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I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

This week we look at two brief essays for your Outside the Box. The first is my friend Barry Habib talking to us about where mortgage rates are headed. Barry gives us a very simple, but logical analysis on why rates are headed up. Then we jump to Spencer Jakab writing in the Financial Times about the problems in the municipal markets. Seems we may be under funded on our public pensions by about $3.5 trillion. As a tease to his column:

“Taking a page out of Greece’s playbook, the peeved treasurer of America’s largest state fired off letters this week to the chiefs of Goldman Sachs and other banks questioning their marketing of credit default swaps on California’s debt . The instruments, he complained, “wrongly brand our bonds as a greater risk than those issued by such nations as Kazakhstan.”

“Insulting indeed, but who exactly should be insulted?”

It helps if you have seen Borat, or at least a trailer, but the message is the same.

I am off to Phoenix and San Diego, the NYC next week, so I will be writing on the road. Have a great week.

John Mauldin, Editor
Outside the Box

Where are Rates Headed, and Why?
By: Barry Habib, Chairman, Mortgage Success Source

So the Fed stopped buying Mortgage Backed Securities, and people are wondering if this will affect mortgage rates. There’s been plenty of whistling past the graveyard, guesswork and denial, where so-called experts have been trying to tell us that there will be minimal – if any – change to rates.

That pipe dream is just nonsense.

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I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

It has been some time since we have looked at stock market valuations and expected future returns. I made a large point in Bull’s Eye Investing that long term returns are closely correlated with the valuation of the stock market upon entry. In fact, I argue that secular bull and bear markets should be viewed in terms of valuation and not prices. The market clearly goes from high valuations to low and back to high again over very long periods of time. The average length of a secular bull or bear cycle is 17 years.

Based on valuations, we are still in a secular bear market. But clearly we are in a bull phase, which within long term secular bear cycles are quite normal. They make for good trading opportunities. But should you invest now with a view to holding for 10-20 years?

This week’s Outside the Box from my friend Prieur du Plessis of Plexus Asset Managment looks at what long term return expectations might be from today’s stock market valuations. He offers us a range of expectations which I think should help you in your investment decision making process.

Dr Prieur du Plessis is chairman of Cape Town-based Plexus Asset Management and author of the Investment Postcards from Cape Town blog: http://www.investmentpostcards.com (Subscribe to e-mail updates of new articles by clicking on “Subscribe to Updates” in the top right-hand corner of the blog site and providing an e-mail address.)

I am on my way back to Dallas from a quick trip to Washington DC. The cherry blossoms are beautiful, even if the weather is gray.

John Mauldin, Editor
Outside the Box

US stock market returns – what is in store?

By Dr. Prieur du Plessis

Surging stock markets since the lows of March 2009 have caught most investors by surprise, especially as new pieces of the economics puzzle are not always rosy and do not quite seem to support an overly bullish case. In short, investors are increasingly struggling to make sense of the most likely direction of stock prices.

Are we perhaps nearing the end of a cyclical bull phase in a structural bull market? Or will strong earnings growth ensure the longevity of the bull? Or is a “muddle-through” trading range in store? It seems to be a case of so many pundits, so many views.

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I’m pleased bring you this week’s “Outside The Box” newsletter from John Mauldin. For newcomers and regular readers alike, please read John’s introduction, bio, and subscription information here

While the US was focused on the health care drama over the weekend, over across the pond events are rapidly deteriorating in euro land. For this week’s Outside the Box I offer two columns, one from the Financial Times and another from the London Telegraph. Both describe the problems that the eurozone faces. It is not pretty.

I was sent this note from a Steve Stough who translated this from a German TV news show. It is a nice set-up for the two short columns.

I was reading an interview with Germany’s most-quoted economist and then, all of a sudden, his face pops up on a TV show (a panel discussion on Germany’s version of Fox Business News) at the same time, so I paid close attention. Hans-Werner Sinn’s remarks are apparently listened to as closely as are the Federal Reserve Chairman’s remarks in the US. He said:

The Greek drama will have a ‘frightful’ (‘schreklich’) ending no matter which course of action is taken. The objective is to avoid having a Greek default trigger another banking crisis across the EU.

The EU member states are too financially fragile to take on any flaky Greek debt. The actual Greek deficit is running at 16% of GDP, not 12% as previously reported. Greece is in a deepening retraction, not a recovery, as previously claimed. [Germany's social security, welfare, unemployment, and health care entitlement programs are all running cash-negative or soon will be, but that is another subject entirely. Angela Merkel has a committee established to work on tax reform, meaning tax rate reductions - Steve].

There are three bad alternatives. He recommends #3 (effectively, default):

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