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What The Marxists Know But The Capitalists Don’t

But first, a few quick comments on this most interesting week. If you are a bull, you may take comfort in the fact that, with all the bad news swirling about, markets held up very well and that it has “discounted” all this news. Of course, the curmudgeons such as myself would remind you that the market can only discount what it knows, not what it has never seen (such as the disintegration of the EU)

That being said, here are some quick thoughts on the three impending disasters du jour for you to think about

We start with China.We all know the banks lent more money last month than in the prior three months.This was in spite of the regulators halting the practice to cool down the real estate bubble.Yet, counter-intuitively, consumer price inflation moderated, although factory gate prices rose (how does that happen?)

So, the net is that the authorities have ordered slower credit growth, set aside higer reserves, tighten home lending, all WITHOUT raising interest rates.

Now there have been increasing calls that a crash will occur at some time, led by Jim Chanos, one of the smartest and least idealogical players in the business.(Marc Faber has made so many predictions that it’s hard for me to know where he stands.)But the important point for deflationists like myself is the following

The main reason the bubble will deflate differently in China is that the Communist Party controls everything….when real estate values collapse, the government will support prices of other things to keep the economy from buckling under deflationary forces. Strict capital controls will prevent money from leaving the mainland.

It can (and will) force banks to make loans in this attempt to ward off deflation.

Now the LAST thing Beijing wants is to be held responsible for any bubbles bursting.So, the way out is to open the spigots on exports and try to grow their way out of the deflation., which is EXACTLY what it did during the global meltdown.And this is where the US and the EU need to worry.An ever-more export -driven China  would mean ever cheaper goods flowing into the US and EU. This is the ingredient which is so highly deflationary

Which brings me to EUROPE. Before Greece, just think about how Germany has been exporting deflation to the rest of the world for the last few decades. How else could they be the biggest engine of growth in the EU while maintaining such a high domestic savings rate? The answer is cheap wages. So you have a scenario where the biggest industrial engine in the world, and in Europe are both exporting deflation to the rest of the world. This will not change anytime soon.

As far as GREECE,clearly no one knows what the outcome will be. But this WILL happen. They will crush the man in the street.The measures that will be taken will be draconian.Why is a 4% deficit cut demand being made? NO ONE knows why that number was picked. But to quibble is not the point. Greece, as an individual entity, is not important. Germany will provide the backstop, as their bank exposure is massive (as are the Swiss banks). But what this represents is even more important.

This kind of deficit-bashing insanity is spreading across the world (although not the US) A budget deficit is just a number, but the cretins of the NON-ELECTED council somehow think that it is the magical elixer to solve all problems. It is like blaming the thermometerwhen you have the flu.Any doctor would have his license revoked if he suggested putting the thermometer in a bucket of ice water until the patient’s temperature returned to normal.

Yet this is precisely what poor Greece has been blackmailed into doing. And you can be sure this insanity will not stop there. Keep in mind, even FRANCE budget deficit to GDP is almost 9%. What will they do then? What else does this imply? Well, it begins with d and ends in flation.

And talking about further disasters waiting to happen, a note about the US.

You may not have noticed (or cared) but the long-awaited Treasury sell-off started last week.The game has now shifted from not if, but when yields will rise, has started in earnest.The sell-off in the $25 billion 10.year auction was a clear indication of the volatile mood of investors. The US will issue a net $1.7 trillion in paper this year. Without going into the boring details of bond auctions, bid-to-cover, etc, the experts said this auction was a “failure” There will be more


Essentially, they have uncovered the dirty little secret of the US economy. Briefly, between 1980 and 2000, financial industry profits rose from $32.4 billion to $195.8 billion, and the financial sector’s share of all domestically produced profits went from 19% to 29%

It fell to one Paul Sweezy,a Marxist, to point out the ugly truth.To a free market economist (may they rest in piece) the rise of Wall Street was a natural outgrowth of the US economy’s competitve advantage in the sector. But Sweezy pointed out that, instead, it reflected a an increasingly desperate attempt to head off economic stagnation. With wages growing slowly, if at all, and with investment opportunities insufficient to soak up all the profits corporations were generating, the issuance of debt and the incessant creation of new objects of financial speculation were necessary to keep spending growing.

AND HE WROTE THIS IN 1987!!!. And today, nothing has changed. If you ex out an explosive growth in the military budget, the ONLY growth has come from financial engineering.. This is what is happening NOW. Jobs have been disappearing from the US for over a decade.No wonder this is a “jobless recovery”

AND A FINAL THOUGHT on investing for these turbulent times which takes me back to Keynes for some thoughts to live by.

Investing, and most other economic activities are carried out on the basis of information that is limited and unreliable.. A state of near-ignorance is the normal course of events.

Thus, in such an envirnment, investors seek to reassure themselves the current situation will continue, all while knowing intuitively the situation could change at any minute. “A conventional valuation which is established  as the outcome of the mass psychology of a large number of ignorant (not you) individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield”, said Keynes.” since there will be no strong roots of conviction to hold it steady.”He went on:”the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet, in a sense, legitimate where no solid basis exists for reasonable calculation”

And, in a further blow to the efficient market advocates who are still alive, Keynes goes on about trading. The Chicago school (birthplace of the EMH) advocated that professional traders would automatically arbitrage away and price discrepancies that resulted in mispricing of securities. But Keynes had it right when he said (particularly in this day of high frequency trading, dark pools, hedgies, etc) that rather than putting money to work on the basis of what they perceive  as the fundamentals, many professional investors concentrate on ” foreseeing changes in the conventional basis of valuation a short time ahead of the general public” in order to make a quick profit, Keynes wrote. “They are concerned, not with what the the investment is worth to a man who “buys for keeps”, but for what the market will value it at, under the influence of mass psychology, three months or a year hence”(had he written this today, he might well add 3 minutes or 3 hours)

Anyway, keep your paws crossed. The best opportunities are yet to come.
Chuck Karasick

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