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COSMOS: What's Important

by R.E. McMaster, Jr.


Over first quarter this year, I have read reams of analytical material. What follows are the key points that I have gleaned in helping us understand how to make better business and investment decisions throughout the remainder of this year. We will move from philosophy to facts to statistics in establishing this base of understanding The hands down winner regarding the key philosophical economic insight I have gleaned so far this year came from the pen of Dr. Kurt Richebacher in the January 2000 Richebacher Letter. His comments are as follows:

"Dogmatic socialism is dead. Welcome dogmatic Anglo-American capitalism. The more we have thought about this new capitalism, the more we have effectively realized that it really puts everything on its head that historic capitalism stood for. The essence of that capitalism was capital accumulation out of savings. What is the essence of this new Anglo-American capitalism: deal-making for quick profit and inherent neglect of new investment, a dissaving public and unfettered credit creation for consumption and speculation. The old capitalism had a sense of high responsibility for future generations. The rising responsibility of corporate managers under the new Anglo-American capitalism begins and ends with today's stock prices.

"Capitalism has always been about profit; this 'late' capitalism is about greed. Yet, the decisive reason for our aversion lies in the fact that this capitalism, with its manic search for quick profits, essentially undercuts capital accumulation for the future. The effective result of this Anglo-American capitalism is that the present generation raises its living standard at the expense of future generations. In the last analysis, there are two ways one generation can betray and burden future generations: by bequeathing them: (1) a mountain of foreign debts and (2) a depleted capital stock.

"It is the great, negative peculiarity of this capitalism that the entrepreneur and the corporate manager is discouraged from building new factories because it tends to depress profits in the short run. In a desperate search for quick profits, imposed by the imperative to raise shareholder value, cost-cutting, mergers and acquisitions are going to excess in Corporate America with negative effects. Readily, the stratospheric rise of stock prices is regarded as the direct outgrowth of this new corporate strategy, although every child meanwhile knows that this surge of valuations is chiefly courtesy of the most generous monetary accommodation by Mr. Greenspan.

"In reality, this is not new capitalism but late, degenerate capitalism dominated by the most narrow-minded financial interests.

"It is late, degenerate capitalism because it propels asset trading at the expense of asset creation with inherent negative effects on economic growth and overall profitability."

What Dr. Richebacher is telling us, is that our economic system is no longer capitalism in any traditional sense of the word. Today's capitalism is not based upon savings and investment. Rather it is a warped perversion of traditional capitalism. It is debt capitalism, multinational debt capitalism, and elitist at that, power and money driven, a far cry from the classic American Christian free enterprise capitalistic system. It is not long-term oriented, which free enterprise and capitalism have heretofore been. It is not based upon producing worthwhile goods and services demanded by the marketplace. Instead, it is based upon selfish corporate management gratification and stock market speculation. It is short-term oriented, ruthless, and greedy. It is irresponsible. It is debt (death) based.

Profit used to be a byproduct, a result, of producing a desired good or service for people-at-large, for the marketplace. Yet today, greed, the root of all evil, is what is at the forefront of what Richebacher calls "dogmatic Anglo-American capitalism." Far from providing a base for the future, too, this present warped Anglo- American capitalism steals from the future and raises its living standard at the expense of our children and our children's children. This is totally opposite from what has produced a successful free market society longterm ­ savings, a long-term view, investing for the future. Those who have done such historically are those who have risen to the top, have led, become the elite, and provided a heritage for the future. This does not exist today. Richebacher properly calls this new capitalism "degenerate capitalism dominated by the most narrow-minded financial interests." This means we need to be very, very careful, cautious, even protective, in defending our assets against a rapacious and elitist political and economic system.

Next, we need to recognize that we are at the peak of the sunspot cycle, and that economic activity and inflation (this time in the stock market) tops with an 80% probability consistent with the peak of the sunspot cycle. But this is no ordinary sunspot cycle. And this is no ordinary bubble/mania in stock prices. This Sunspot Cycle 23 is a megacycle, which may be the greatest sunspot cycle peak we have seen in recorded modern history. The M-class flares have been awesome. And just as gold peaked when commodity inflation peaked in 1980 at the peak of that sunspot cycle, so too are stocks peaking at this mega-peak in the sunspot cycle, another peak in inflation, this time in paper assets (stocks). We are at the ideal peak right now, in April/ May 2000.

A chart/market/spread perspective is critical, too. The Bridge CRB Index bottomed against the S&P 500 in early 1999. A higher bottom has been made on the spread in first quarter 2000. In other words, commodities bottomed in terms of stocks nearly a year and a half ago. This means hard assets are being favored over paper assets. Also the Bridge CRB Index bottomed in terms of T-bonds in fourth quarter 1998. This spread has generally moved higher since then. This means that commodities have bottomed in terms of T-bonds (debt securities) for already a year and a half. What this tells us overall as investors is that hard assets -- commodities -- bottomed in terms of paper assets -- stocks and bonds -- nearly a year and a half ago.

As goes the U.S. stock market, so goes consumer confidence/borrowing/spending. As goes the U.S. consumer, so goes the U.S. economy and the global economy. The U.S. consumer has been 87.5% of the U.S. economy over the past couple of years, up from the normal 66%-70%. The U.S. economy has been as much as a third of the global economy over the past couple of years, too, up from the normal 20%. So, it is very significant that American households have 56% of their financial assets now linked to the stock market, compared with only 28% in 1989. American households, too, now have mortgage debt that equals 43% of the value of owner-occupied housing, compared to only 30% in 1985. It is likewise noteworthy that both investor and consumer confidence have peaked. This means less debt assumption in the future. In a balance sheet in excess of $30 billion, liquid assets in the form of bank deposits amount to less than $4 billion. This means cash, savings, and liquidity are nil in the U.S. financial and economic system. Everything is leveraged. The U.S. dollar has been super strong as it has rallied with the U.S. stock market and higher U.S. interest rates, creating demand for dollars. But the dollar's strength has not been inherent, it has been conditioned and triggered by aggressive American borrowing, not by foreign investing. And with the U.S. trade deficit now approaching $400 billion a year, the U.S. must bring in over $1 billion a day to finance its borrowing and spending habit. The U.S. presently has a net foreign indebtedness in excess of $1.5 trillion. Federal debt exceeds $5.5 trillion. Then there are the derivatives globally, which are placed somewhere in excess of $142 trillion. The big U.S. banks are vulnerable here. We have high energy prices, too, still up 150% from late 1998. Meanwhile, U.S. crude oil stocks have been hovering near a 25-year low, with gasoline reserves the lowest they've been in 15 years. Thus, any type of disruption among major OPEC or non-OPEC producing nations, such as war, could lead to an oil spike which would be devastating for the economy.

The bubble has burst in the NASDAQ high-tech stocks. Microsoft, which has been the flagship of the U.S. stock market, fell 16% on Monday, April 24, in anticipation of much lower third quarter earnings, and on reports that the Justice Department is going to bust up Microsoft into two companies. On April 24, the NASDAQ accordingly plunged 6%. This adds psychological pressure to the $2.3 trillion of losses suffered by the Wilshire 5000 Index, money that evaporated out of the U.S. economy, on the April 14, 2000 meltdown. Technology stocks, which used to comprise 10% of the U.S. stock market capitalization, at their peak accounted for more than one-third. The stock market bubble and mania is aggravated by the fact that margin debt was in first quarter 2000 at an all-time high, with the U.S. stock market seeing its highest volatility since 1932-33. Moreover, day traders account for nearly 20% of daily NASDAQ volume. This is a clear indication that the U.S. stock market has turned into a speculative leveraged gambling casino.

I'm amazed in conversations that I have had with professionals in Austin at how many of them have told me that their friends have given up their jobs to become day traders. This is a sign of the times, of a bubble, a mania, and a sign of an approaching end. Day trading is a non-productive economic activity. It adds no new goods or services to the economy.

Back in 1929, total capitalization of all listed stocks was about 100% of GDP. Presently, it's almost 200% of GDP. The slowing of M3 growth, and the Fed's war against the stock market by way of raising U.S. interest rates, means the stock market bubble cannot long be sustained. This is bad news for the debt-to-equity ratio that has increased from 84 to 116 over the last decade. In the banking system, FDIC insurance is all but depleted at a time total financial and non-financial credit has swelled to $2.29 trillion in 1999 compared to only $500 billion in GDP growth in 1999. Yes, the Titanic sinks slowly at first, but then toward the end, very, very quickly. The U.S. markets and financial and economic system are taking on water.


by R.E. McMaster, Jr.
May 19, 2000

The Reaper is intended solely for the use of its subscribers, knowledgeable, sophisticated and well-informed investors and speculators, who are aware of the inevitable mistakes, errors in judgment, fallibility, and risks inherent in forecasting and investing. Information contained herein is gathered from sources believed to be reliable, but cannot be guaranteed as to its accuracy or completeness. Past performance is no guarantee of future performance, future success or profitability. Readers must invest solely at their own risk. Principals and/or employees, associates, agents and friends of The Reaper may have positions in commodities, futures, options, and any and all other investments referred to herein. Due to the inherent volatility of the futures markets, opinions and recommendations are made subject to change without notice. This newsletter is not intended to be either legal or accounting advice. Consult your own attorney or accountant in this regard. This newsletter does not offer personalized investment advice. Reproduction or copying of The Reaper is not permitted without written consent of the editor.


from The Reaper / R.E. McMaster, Jr., Editor
As originally published in The Reaper Vol. 24, No. 29 & 30, May 10, 2000
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Reprinted by USAGOLD with permission of R.E. McMaster, Jr. No further reproduction without permission.

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