Investment risks and opportunities

Knowledge: The New Power in Retail

2007-05-02T06:49:00.000-07:00

Knowledge: The New Power in Retail
by Glynn Davis

Everybody knows that knowledge is power so it seems strange that many
retailers seem to have little insight into their customers. But their
interest is growing as they increasingly recognise customer intelligence is
now a key factor in differentiating winners from the losers in the retail
sector. An example of how important it has become (in all parts of the
business world) is the recent Business Week 'Best Performers 2007' survey.
This concluded that the key distinguishing factor of many companies in the
top 50 was a deep understanding of their customers.

This gave them the competitive advantage to sell more goods and services
than their rivals. And nobody would argue that the likes of Google, Goldman
Sachs and Amazon, which finished high in the list, are exemplars in using
customer knowledge to drive sales.

Nowhere is the increased desire for customer insight more evident than in
the ultra-competitive food retailing sector. So much so in fact that even
the mighty Wal-Mart is in the midst of jumping onboard.

As the creator of the long-standing Every Day Low Prices
(EDLP) strategy (that was pretty much adopted by all retailers around the
globe in recent years) it believed that all it needed to attract customers
was low prices.
But it now realises this view was wrong and that its myopic focus has
limited its business development. For a company not keen on showing any
signs of weakness it was pretty open in admitting that it had to become more
customer-focused: "Broad stroke 'Always Low Prices' has not allowed us to
develop some of the businesses to their full potential, because that doesn't
resonate with the customers."

Nowhere has Wal-Mart seen greater proof of how customer intelligence can add
significant value to a retail business than with Tesco. For some years the
Wal-Mart owned Asda has been losing ground to Tesco in the UK as it
increasingly capitalises on its extensive customer knowledge to drive sales
harder and move into new categories.

It's fair to say that Tesco's insight into its customers is regarded as
second to none in the retail world. And what makes this possible is
marketing data specialist Dunnhumby (of which Tesco owns 83%). So successful
is it that the company has also sold its services to Kroger a US-based
supermarket and general store business that operates over 2,500 outlets that
trade under a variety of fascias including Fred Meyer, Kroger and Dillons
and also to leading French supermarket operator Groupe Casino.

It has helped Kroger to stage a recovery against Wal-Mart after a long
period of losing ground. Unsurprisingly, its smaller scale meant it was
unable to fight on an equal footing with Wal-Mart using an EDLP strategy. It
has been using Dunnhumby's expertise with customer data to segment
- or tailor - its stores to their specific local markets.

The Kroger chairman and chief executive David Dillon has described the data
company as his secret weapon in fighting Wal-Mart: "Dunnhumby has helped me
reset my understanding of what the customer is after, and it helps replace
intuition with actual data and actual facts. And it's those facts that are
driving our decision making."

Dunnhumby analyses the sales data from stores to enable it to construct
complex marketing strategies and promotional campaigns. This essential
information on actual buying behaviour has guided most of the key decisions
taken by the management team at Tesco in recent years (such as the launches
of both Tesco.com and its financial services arm, and its entry into
non-food categories such as clothing). It will increasingly have the same
effect on Kroger and will likely do the same for Casino in the future (the
link-up was only announced in October 2006).

What makes is possible to enjoy such customer insight from the data analysis
at these retailers are their loyalty schemes through which they are able to
collect personal details on their customers and to link this with the
purchases that they make in-store. Such loyalty schemes have not been
regarded as particularly good ideas to date and Tesco has received much
criticism about its loyalty programme since its launch in 1995. They were
just seen as a cost on a business since they would reduce margin as
customers collected points to redeem against goods or money off their
shopping bills. David Sainsbury infamously dismissed it as "no better than
electronic Green Shield stamps".

But he was to eat his words many times over because since the first customer
signed up to the scheme it has provided much of the fuel that has powered
Tesco to the top of the UK retailing tree. It is no coincidence that since
Tesco launched the scheme it has overtaken Sainsbury's to become, by a long
way, the UK's largest retailer.

Within only a few months its impact was obvious. Research showed that
customers spent 28% more at Tesco while cutting their spending at
Sainsbury's by 16%. This had a major effect on the market shares of the two
companies with Sainsbury's having a 19.4% share in January 1995 compared
with Tesco on 18.1% but by May of that year the former's share had slipped
to 18.8% while the latter had grabbed a 19.4% share. This trend has
continued to this day and Tesco now commands a 31.3% share against the 16.5%
of Sainsbury's.

From day one Tesco knew that the scheme would provide a whole lot more than
simply allowing people to collect loyalty points to reduce their shopping
bill. In fact this was never the point of the exercise because the
point-accrual mechanism was simply the carrot to customers that would get
them to dig out their loyalty cards whenever they visited a Tesco store,
thereby enabling Tesco to collect data on them.

But as other retailers launched their own loyalty programmes they soon
recognised that collecting data is one thing but making sense of it and
transforming it into customer intelligence is a completely different matter.

It was an inability to overcome this problem that prompted Sainsbury's (yes
it did ultimately launch a loyalty card despite David Sainsbury), Safeway,
Somerfield, Asda and Waitrose to abandon their schemes one-by-one.

Just consider that even when Clubcard had a mere five million cardholders,
during a three-month trial of the scheme, Tesco had to deal with 50 million
shopping trips that comprised 50 billion purchased items. What made the
analysis of this data mountain possible was the decision by Dunnhumby to
only analyse 10% of the data and then apply the findings back to the other
90%. It realised that even a 10% sample could give 90% accuracy whereas the
massively more complex and expensive task of analysing a much larger
percentage of data might only deliver 95% certainty so it came to the
conclusion that crunching any more than 10% of the numbers was simply not
worth the cost or effort.

So powerful were the findings from this trial period that the then Tesco
boss Ian MacLaurin said: "You know more about my customers in three months
than I know in 30 years." The belief at Tesco was that if Dunnhumby could
replicate the success from the trial across the whole business then there
was a chance that it could propel the company to become the UK's number one
food retailer - displacing Sainsbury's. Since this has come to pass
Dunnhumby has played a serious part in customer intelligence creeping up the
agenda of an increasing number of retailers. They have come to realise that
without sufficient knowledge of their customers'
behaviour and buying habits then they are doomed to failure.

A number of years ago I spoke with a former chief executive of Wal-Mart and
asked him whether the company - and its UK arm Asda - would be likely to
introduce a loyalty scheme to learn more about its customers and he gave a
categorical 'no'. Although he was right and neither company has launched
such a scheme this is not to say that they won't in the future. Especially
as Wal-Mart will soon find itself competing directly with Tesco on US soil
as the UK supermarket will shortly be opening a chain of 'Fresh & Easy'
shops on the West Coast.

Ominously for Wal-Mart, the Tesco boss Sir Terry Leahy recently stated that
the company intended to roll out its Clubcard scheme to each of the
countries in which it operates thereby throwing up the scenario where
Wal-Mart could be facing the might of Tesco's customer insight on its own
doorstep.

But even if Wal-Mart resists committing to a scheme there is little doubt
that it is increasingly looking to learn more about its customers having
recognised that price in no longer the be-all-and-end-all for consumers.

To this end last year it appointed a new head of marketing who had
previously spent 19 years at Target - which is recognised as very proficient
in targeting segments of customers through focused marketing made possible
by customer insight. Target has proved itself particularly adept at
extracting more money out of its customers by targeting them more
effectively through knowledge of their behaviour, thereby achieving higher
profits out of its existing stores. Target's business is regarded as the
'upmarket discounter' in the US.

Wal-Mart is now attempting to follow the same path. Its new marketing man
has set up a market research and consumer insights competency that is
intended to help the company adopt a marketing approach that focuses on
specific categories. This will help it to introduce new categories and
better tailor the mix of goods in each of its stores so they are better
suited to their location and customer bases.

There is evidence that retailers are using various methods to boost their
customer knowledge without necessarily running their own loyalty scheme. The
multi- retailer loyalty programme Nectar is one example of how retailers
have been able to increase their customer knowledge without running their
own scheme. In the UK Nectar has signed up some serious retail names
including Sainsbury's, Debenhams and Dollond & Aitchison but although it
provides the mechanism for cardholders to collect and redeem points it is
nowhere near as effective at providing customer insight as Dunnhumby is for
Tesco and Kroger.

To address the increasing demand for such insight Nectar is now working on
creating a data analytics division (a la Dunnhumby) that will enable it to
make much better sense of the mass of data that it collects each day on
behalf of its retail clients. Tesco has successfully used market
intelligence to steal a march on its competitors who are now belatedly
waking up to its potential.

Regards,

Glynn Davis
For the Daily Reckoning

We open the papers this morning and find the same two- headed schizophrenia
we have been watching for so many, many months.

One head proudly announces that not only is everything doing well - it is
doing better than ever in history. The Dow hit a new record yesterday. The
funds are flush with cash. Takeovers...Mergers and Acquisitions...new
IPOs...are all headline news. Rupert Murdoch is bidding for Dow Jones,
Microsoft is working on a major purchase.
Money...money...money! Deals...deals...deals..!

It is glorious to get rich...as Deng Tsaio Ping put it.
And many people, all over the world, think they are bound for glory.

Meanwhile, the other head hangs down in despair. "Actual underlying
conditions of the world economy continue to deteriorate," it mumbles.

Larry Fink, CEO of Black Rock, a trillion-dollar fund management company,
spoke out last week and said that all these mergers and acquisitions were
going to cause "tomorrow's problems." Why? Because they are all funded with
debt. And lending standards for big, commercial deals have gone the same
way as the lending standards for people buying trailers.

"Standards have deteriorated to a level that we never even dreamed we would
see," said Fink.

Almost on the very same day, the Bank of England said almost the same thing.
Loose credit standards have "increased the vulnerability of the [global
financial] system."

The Boston Globe helpfully provides
more detail:

"Private equity firms are raising gigantic new funds, which in turn are
buying companies on an unprecedented scale. The targets are bigger than
ever, and the deals are gushing at fire-hose volume. But that isn't just a
function of all the billions raised from limited partner investors. Borrowed
money is the real fuel driving an overheated market.

"I think of this as a debt bubble, not a private equity bubble," says Kevin
Landry, chief executive of the Boston private equity firm, TA Associates.

"Debt markets that finance private equity transactions have changed in three
important ways. They are charging lower interest rates, reducing the premium
normally charged for greater risk. They are lending more money for the
purchase of an operating company, exceeding normal caps based on the cash
generated by the acquired business. Finally, debt markets are reducing or
virtually eliminating covenants and other rules that now make it almost
impossible for private equity investors to default on loans used to buy
companies.

"Got that? Low rates, more leverage, practically no conditions. How do you
think that story is going to end?
"The reality is the markets are willing to provide extraordinary amounts of
debt, almost indiscriminately,"
says Scott Sperling, co-president of Thomas H. Lee Partners, the big Boston
private equity firm. "It's hard to put these companies into default. I can't
think of the last time we had a real covenant in one of our deals."
In the financial deal business, it is still like the middle of the property
boom, when householders practically couldn't default, because lenders
wouldn't let them. As soon as they got into trouble, the lenders would give
them more money.

Landry explained that in a deal his company made recently, he didn't even
have to make the scheduled payments. If he ran into trouble he could make a
"toggle payment," or "payment in kind," essentially borrowing more to make
the regularly scheduled loan payment.
"How do you default?" asks Landry. "You used to say,
'Can I pay down enough of this debt so if a recession
hits I can get through it?' Now it doesn't matter even if a recession hits
next week."

"Investors stretching for yield are making all kinds of markets do strange
things. Look at the sub-prime mortgage market to see how that practice can
end badly. Private equity's debt bubble could become another story with a
very ugly ending."

The bubble in sub-prime lending ended when the value of its collateral -
housing - stopped rising in price. The bubble in Private Equity financing
will pop too when its collateral - ultimately, the stock market - ceases to
go up.

Then, over-stretched lenders will go broke. A few high- profile hustlers,
prosecuted for financial hanky-panky, will go to jail. And, like soldiers
tripping over the bodies of their dead comrades, the survivors will have to
find some other route to glory.

More news:

*************************

Rob Mackrill pondering some very big numbers:

Accountability. Integrity. Reliability.

- These three words grace the web pages at the US Government Accountability
Office (GAO), formerly the General Accounting Office. They might strike some
of a cynical disposition as a tad ironic, not for the organisation itself,
but for the charges over which they must cast their analytic eye.

- The GAO changed its name almost three years ago. It wanted to clarify
things for the benefit of dim job hunters and journalists, that they weren't
just a bunch of nerdy bean counters poring over the government's books.

- These days they do so much more they say. But when all's said and done, it
remains by its own admission the lead auditor to the US government's
consolidated financial statements.

- If you feel your eyes glazing over at this point, you're not alone but
bear with me. The GAO is not the sex and violence of government. It's the
chronicler of the consequences of sex and violence...or as an old saying
would have it 'an auditor is someone who goes onto the battlefield after the
battle has been fought and shoots the survivors'. Whatever your definition
its recent report makes for some eye-popping reading.

- In February bean-counter in chief, Comptroller General David M. Walker,
amongst other representations, wrote a letter to Congress. We've got a
problem he tells them and we need to change our ways was the general
gist...oh, and by the way, I have prepared a little report that's easy to
read - even for those not good with numbers - and is near enough guaranteed
to ruin your day.

- The title of his report gives us a clue as to its nature:
Fiscal Stewardship: A Critical Challenge Facing Our Nation.

- Here we offer up a few choice excerpts from Mr Walker's assessment:

"We are failing to properly discharge one of our biggest stewardship
responsibilities to our children, grandchildren, and generations of unborn
Americans: fiscal responsibility.

"The federal government's financial condition and fiscal outlook are worse
than many may understand...in fiscal 2006...its costs exceeded its revenues
by $450bn...

"As at 30 September 2006, the US government reported that it owed more than
it owned by almost $9trn.

"In addition, the present value of the federal government's major reported
long-term 'fiscal exposures'
- liabilities (eg debt)... contingencies (eg insurance), and social
insurance and other commitments and promises (eg Social Security, Medicare)
- rose from $20trn to about $50trn in the last six years.

"GAO is responsible for auditing the financial statements included in the
Financial Report [prepared by the US Treasury], but we have been unable to
express an opinion on them for the 10th year in a row because the federal
government could not demonstrate the reliability of significant portions of
the financial statements...

- Not signed off for 10 years on the trot. Wow! Sounds bad, like the US is
just some giant Ponzi scheme waiting to tumble, but then the EU accounts top
that achievement.
They have not been signed off for 11 years. Reasons for which is now
engaging the attentions of a House of Lords Sub-Committee on Economic
Affairs.

- Maybe a nation's, or block of nations', accounts are just too complicated,
convoluted and twisted for even the boldest to dare putting a signature to?
We don't know, but certainly wouldn't relish the task.

- But wait there's more, how about those Social Security and Medicare
promises?

"...one would need approximately $39trn invested today to deliver on the
currently promised benefits for the next
75 years."

- Okay so Uncle Sam is rich. At $13trn it accounts for over a quarter of
global GDP, but even this vast wealth looks pretty puny against the job in
hand. Living beyond your means is ruinous whatever the scale. Time to wheel
out Dickens's timeless advice courtesy of Mr Micawber:

"Annual income twenty pounds, annual expenditure nineteen pounds, nineteen
shillings and sixpence, result happiness. Annual income twenty pounds,
annual expenditure twenty pounds and sixpence, result misery."

- So if the US is looking at misery what's the GAO got in mind? Well its
bitter medicine. To sort out the mess would require either spending cuts or
tax increases equal to 8% of the entire economy for the next 75 years.

- Try selling that to an electorate Messrs Guiliani, McCain, Clinton, Obama!
A critical challenge indeed...

For interested readers the full report can be found via this link:

http://www.gao.gov/fiscalstewardship.html

*** There may be considerable anxiety about the rise of China in many parts
of the world, not least the US, but a note from a reader tells us
Nostradamus - as ever - was on the case and provided a forecast long ago as
to who should be most worried.

'The Complete Prophecies of Nostradamus' by Henry C.
Roberts reportedly predicts that by the year 2025, by ritual, China, having
completed her industrial and economic expansions, will absorb almost the
whole of Northern Russia and Scandinavia.

So now you know...in advance.

*************************

And more views from Bill:

*** How time flies! It is already May...the 5th month of the 7th year of the
21st century. Who'd have thought?

We remember back in the 1950s...we wondered what it would be like in the
year 2,000. Flying cars...regular commutes to the moon...we imagined all
sorts of things that turned out to be farther in the future than we had
thought.

What really changed in the last half century?

Cars...airplanes...skyscrapers...golf...hamburgers...
TV...air-conditioning...antibiotics...nuclear bombs - all the big things
that shaped our lives had already been invented. What has been invented
since then?
Hmmm...the Internet?

We can't think of anything else.

Of course, the Internet is changing the world. It is part of the reason real
estate prices are going up faster in desirable resort locations than
elsewhere - so many more people can live in these places and still continue
working. It is also changing the way we get information and ideas...never
before have so many people had such ready access to so many bad ideas.

In today's headline news is a report from New York, where Rupert Murdoch has
just offered to buy Dow Jones. He's offered a 65% premium over yesterday's
share price. Major shareholders are said to be considering it.

Elsewhere is news that the New York Times has sold its flagship building in
Manhattan to a diamond merchant.

And everywhere traditional news media, in which the lies are printed on the
pulp of trees, is giving way to the new news media, in which the drivel
comes to you electronically.

Through no fault of our own, we have occasionally been the victim of news
stories, in which the 'news' differed dramatically from what we knew to be
true - often to such a degree that the reader would come away with the exact
opposite of the truth. But what would you expect? The fourth estate is no
less self-interested than the other three. And it is dominated by a class of
people who are particularly dull-witted and lazy. Generally, they have 'the
story-line' already in mind - because it has been written hundreds of times
already - before they ever take a single note or look at a single fact.

"But it's really gotten a lot worse in the last few years," explained a
journalist friend. "The newspapers used to spend a lot of money on
investigative journalism...to come up with facts that would keep readers
interested. But now, they don't want to spend any money on research or
investigating. They don't even want the facts, because they might interfere
with the story- line. They spend all their money hiring pundits..."

*** Our old friend Ron Paul is running for President.
Poor Ron. He is much too honest and thoughtful for a career in politics. We
are sure the press will trip over itself in its rush to ignore him. He will
get in the way of their story line.

*** Meanwhile, in London, global warming seems to having a delightful
effect. The trees are green. The wisteria is blooming a month early. The sun
is out all day long. It
is not spring at all; it more like midsummer.

The ocean is so warm, icebergs are melting faster than ever. Dry areas seem
to be getting drier.

Is Global Warming real? We don't know... all we know is that it seems
unusually warm and pleasant here in Europe.

"Winters have been milder than they used to be," said a couple from Nova
Scotia, with whom we lunched on Monday.
We were in Paris. The flowers were out. The smell of blooming things was in
the air. The sidewalks were crowded with tables. People were out...
walking...
sitting... sunning themselves in the parks.

*** And last night, we almost had a chance to sample urban poverty for
ourselves, when we had a brief brush with the life of the homeless.
Economists and investors should always remember to eat at regular intervals.

Otherwise, their blood sugar level is likely to drop to such dangerous
levels that they will do something stupid.
So it was, that upon entering our hotel, we got into an argument with the
desk clerk and at midnight proudly marched out of the hotel in 'high
dudgeon,' as they say...only to find ourselves with nowhere to stay.

We wandered the streets of South London for a while, wondering about the
life of the homeless. How did they support themselves? Where did they eat?
What did they do all day? They were beginning to bed down. A group of young
bums spread out filthy sleeping bags under a bridge An old man lay down on a
piece of cardboard in a doorway, covering himself with newspaper. A mental
defective sat in a dark corner, asleep, but still holding a cup and a
sign: Please Help.

We considered the choices. We could lie down with the young whelps under the
bridge. Or we could grab a piece of cardboard from a dumpster and join the
old dog in the doorway. Or, we could just sit in a corner until daybreak...
perhaps muttering to ourselves in order to look like we belonged there.

Instead, we checked into the Hilton...
The Daily Reckoning PRESENTS: Glynn Davis identifies the secret edge that
helped transform the British supermarket group Tesco, from high street dog
to retail superstar...

Tasty Morsels of Deficit Spending

2007-04-11T09:24:00.000-07:00

Behavioural finance and investment decisions

By Bill Bonner

"The bulk of the money in this world is managed in a cover-your-ass
fashion."

Thus speaks a modern day Zarathustra; a prophet of the school of
'behavioural finance,' Mr Whitney Tilson, fund manager, founder of T2
Partners, and Financial Times columnist.

As an investment theory, behavioural finance turns out to be a full-dress
version of the familiar truism about the fool-and-his-money. What worries
the behaviourists is the way investors make mistakes by following their
impulses...with nary a sign of rational profit- maximizing. If only the poor
suckers would stick with sober investment analysis, complain the
behaviourists, drumming their fingers in a nervous, academic sort of way.

Think about it. Here, an investor holds a stock too long. There, another
buys a fund simply because everyone else is buying it. A third bumbler
investigates so much he gets 'married' to his picks, having put so much time
and effort into them.

We might feel sorry for the poor fools for we realize that we make all those
'mistakes' ourselves...only, we wonder if they really are mistakes.

You see, the problem with the behavioural finance chaps is that they don't
go far enough. They pretend to analyze what people do, and then compare it
to what some fictional, non-existent investor 'ought' to do. So, today, we
ask the question, why should he?

If we investors do not really invest the way a theory says we should, where
is the fault? Where is the error?
In ourselves or in the theory? Why, after all, should investors behave in
any other way than the one they are accustomed to?

The behaviourist professors assume that man is essentially a rational,
profit-maximizing creature who simply makes 'mistakes.' But these 'mistakes'
are no mistakes. If an investor does not invest the way the professors think
he should, it is because he is not the animal they think he is. In other
words, we investors do not invest merely to make money.

If our only goal were to make money, we would go into pornography, illegal
drugs or even worse, hedge funds!
Yes, if men were only money-makers, we would go door-to- door in trailer
parks, offering zero-down, no-interest, negative amortization loans on new
houses. And we'd give a discount for buying two of them. Where we met
resistance, we'd throw in a subscription to one of those nifty Internet porn
sites for free with every purchase.
And maybe some crack cocaine too, just to ease the settlement.

But the 'lumpeninvestor' does not have only money-making as his goal. Making
money is merely a part of a whole complex of desires and prejudices that
drives him to his much-deserved fate. The lump wants not only to make money,
you see, but also to feel both wise and hip, both daring and cautious. He is
certainly willing to try contrarian investments, only so long as everyone
else is too!

And that is why in the hard world of investing, the lumps are losers. For,
in investing, what tends to go up are just those things that have gone down.
But, buying down-and-out investments is not what the average investor wants
to do. Why? Because it makes him feel marginalized, odd, in danger. It makes
him feel like an outsider when he wants to feel anything but, and would as
soon forego his profits to pay for that privilege. In fact, the lump tosses
and turns at night, unless he is firmly and squarely bedded down in the
middle of the vast herd of other slumbering fools.

The lumps may not maximize their investment returns...but they judge being
able to sleep well worth the cost.

Other investors don't care so much about making the right decision as they
do about avoiding the wrong one.
Such men fear losses less than laughter. They dread most of all being in a
position where anyone - especially their wives - might point a finger and
call them a jackass. To tell the truth, they would rather actually be a
jackass, financially speaking, than be accused of being one by an ignoramus.
And, what do you do to avoid your wife's criticism? Why, you do exactly what
Citibank or Lehman Bros does. Or what the Federal Reserve Bank tells you to
- even if it means taking out an adjustable rate housing payment.

Yet another lot of investors exhibit a loyalty we can only admire. They
stick with an investment sector - or even an individual company - through
thick or thin, rich or poor, success or failure...until death do them part.
And death often does. Others tend more to be bad boyfriends, dropping their
poor girls as soon as another bit of skirt wiggles in front of them.

But, of course, if you believe the behaviourist geeks, the cads are only
being rational, profit-maximizers. Not a whisper of spring fever in the
blood at all.

But if investment decisions really were such cold- blooded, binary choices -
one clearly right, the other clearly wrong - computer programs might make
them for us just as well. Only, computers don't get to read tomorrow's
headlines any sooner than we do and even a silicon chip can't tell which
investments intend to go up or down.

Which means that the whole idea of a rational profit- maximizer - a perfect
investor who doesn't make mistakes
- is so lacking in any connection to reality, we can safely classify it as a
bloodless intellectual fraud.

That is why our ingenuous and irrational investor is right, after all.
Knowing that the success or failure of his investments - money-wise - is
mostly beyond him, he goes for the non-monetary rewards - bragging rights,
sound sleep, social cache, derriere-covering, wife-
pleasing...skirt-chasing.

He may be a fool to finance professors. But, in the real world, he is a man.

Bill Bonner, August 23rd 2006

The Daily Reckoning Brings you: Tasty Morsels of Deficit Spending

by The Mogambo Guru

"And this pathetic performance occurs despite the fact that the government
has been buying huge, huge, HUGE amounts of war materiel from the 'defense
industry' and running up enormous, enormous, ENORMOUS deficits to pay for
it!"

Money must be getting tight, as Total Fed Credit is up only $1 billion from
last week, foreign central banks are cutting back on their gluttony (adding
only $4 billion to their holdings at the Fed), and now I am forced to make
the painful choice between paying for the kids' damned dental problems or
getting that expensive new driver that is GUARANTEED to give me another 15
yards off the tee, curing my accursed fade-away slice problems forever. And
this will (in the final analysis) make me a whole lot happier, and will last
a hell of a lot longer than anything that stupid dentist does, too.
("See you again in six months, suckers!")

But it is neither golf nor dentistry that disturbs my already restless
slumber; it is inflation that makes me wake up screaming in the night, with
a spasmatic trigger-finger, and my loud, irritating voice issuing both wails
of fear and sulfurous curses to add to the incessant Mogambo Inflation Alert
System (MIAS) buzzer - which indicates that monetary inflation is raging,
raging, raging around the globe, as all the central banks are busily,
busily, busily creating money and credit at monstrously high rates of
issuance, averaging (as I understand it) about 14% a year. That means that
inflation in prices will continue to get worse and worse
- as will my aforementioned sleeping and trigger-finger problems.

And surely things are going to get heated up pretty soon thanks to inflation
- especially when the middle class starts whining; Congress really comes
alive then. And speaking of that, we have Ty Andross of TraderView.com
newsletter reporting that "the broad middle class has not shared in the
wealth of this expansion except for the bubblicious appreciation of their
home values."

He adds, picturesquely, that they were "robbed at night while their money
was sitting in the bank and the Treasury's printing presses churned out
dollars and credit by the trillions", which made every dollar of that
appreciation in the house worth less! And then the homeowner had to pay
higher property taxes and insurance premiums on the now-expensive house!
Hahaha! I'll bet THAT is not in the stupid little econometric models the
stupid Federal Reserve uses! Hahahaha! What dorks!

And all that price inflation was spawned by the Federal Reserve, since it
created the money and credit to finance a stock market boom, and a bond
market boom, and a derivatives boom, and a financial-services industry boom,
and then a housing boom. All now busted, to one degree or another.

And while the inflation "problems" of the stock and bond markets is one
thing to be officially ignored, the inflation in the effective prices of
houses (taxes, mortgage and insurance) and the subprime mortgages that
spawned it, now has the idiotic Congress frantically looking into it (at
long last), now that the bust is here and it's too late to prevent the boom
that caused the ensuing bust that they are so bent out of shape about.

And why will the government try and bail out these homeowners and investors
who are looking at huge losses in a housing bust? Taxes, I figure! Same as
always!
Congress is surely aghast at the prospect of trillions of dollars of losses
being deducted on tax returns next year, and for years to come, too.

I mean, next year the federal budget balloons to a whopping $2.9 trillion,
up from $2.7 trillion this year, and so the LAST thing they need is less tax
revenue coming in!

But feigned ignorance and subsequently being aghast at the results also
comes naturally to the Federal Reserve, which has an annoying habit of
ignoring (and lying
about) inflation in prices, especially the kind of willful ignorance about
the results of creating inflation in money and credit, as perfectly
illustrated by the essay "Inflation and the Ironic Productivity Tax"
by Richard Benson of Benson's Economic & Market Trends newsletter.

He writes, "It dawned on me that the one thing the government never reports
on is that the dollar in my pocket will buy me more next year. Indeed, my
dollar should buy more because of the relentless increases in productivity,
and I should in reality be better off if I saved money, rather than spend
it."

I leap to my feet and shout, "Bravo! Well said! An increasing standard of
living is the whole promise of productivity!"

Ignoring me completely, he goes on to say, "But, in my lifetime, my world
has only known inflation, so buying goods today that I will need tomorrow,
and stashing them away, has proved to be a better investment than saving
cash in the bank. As a consumer, when I think about the escalating cost of
food today, I realize I really didn't benefit at all from all those
productivity gains!"

So where did the benefits of productivity increases go?
He explains, "With inflation, the government has basically stolen/taxed my
share of productivity away."

He dryly and sarcastically notes, "It's ironic that the best and brightest
at the BLS are employed to figure out how to use fancy statistics to rob
their grandparents of their social security increases". After which, he goes
on to calculate, "If money and credit growth were restrained, I estimate the
dollar could purchase about two percent more each year, and we would be
living in a saver's paradise." And a spender's paradise too, as prices would
go down each year!

He calculates that productivity, as measured by the Consumer Price Index,
deliberately understates inflation, and "Taking productivity out of the
Price Index means that when the CPI shows three percent, in reality it's
more like five percent." 5% inflation! Yow!

We glean a little macroeconomic forecasting lesson when he says, "So, when
looking forward, it is important to remember that whenever productivity
slows down, inflation will suddenly pick up", which I take to mean that if
productivity drops, you should immediately short bonds! Hahaha! This
investing stuff is so easy!

"Now that I clearly understand how this productivity tax works," Mr. Benson
goes on to say, "I am less inclined to buy inflation-indexed bonds and more
inclined to buy gold and silver. I believe precious metals are more likely
to track the real inflation numbers."

"And why is this?" you ask with that cute little innocent, quizzical look on
your adorable, trusting face. Instantly I am on my feet to deliver a
stirring and powerful condemnation of the Federal Reserve for creating all
that money and credit, gradually working the crowd into an absolute
blood-frenzy, see, ending with me being declared King Mogambo by cheering
throngs of adoring people ready to obey my every command, and given
unlimited powers of retribution and vengeance! I cruelly sneer as I laugh
the hollow laugh of the damned, "Hahaha! Let the games begin!"

However, I was not prepared for Mr. Benson apparently being so appalled at
the prospect of a King Mogambo, and he quickly preempted my plan for a
speech leading to world domination by pithily summing it up by saying, "The
U.S. is inflating like crazy, and it's only going to get worse."

Already angry at being thwarted in my attempt to deliver the Speech Of A
Lifetime (SOAL) that would have lead to my being crowned King, the news that
inflation is "only going to get worse" makes me angrier and angrier, until I
race home to fire off flaming emails and faxes to my Congresspersons ("Dear
Butthead, I hate you for allowing the Federal Reserve to create all that
money and
credit!") and the Federal Reserve ("Dear Buttheads, I hate you, too!").

But while stocks, bonds and houses may not be going up in price (and may be
going down in price!), the kinds of things you and I have to buy to satisfy
our insatiable wants and needs for tasty morsels and various kinds of fun,
ARE going up in price...every one of them! That is the horror of it all!

And speaking of raging price inflation, Doug Noland of the Credit Bubble
Bulletin says that last week "M2
(narrow) 'money' rose $9.1bn to a record $7.164 tn (week of 3/19). Copper
gained 2.5%. May crude surged $3.59 to $65.87. May Gasoline jumped 5.7% and
May Natural Gas 4.4%. For the week, the CRB index gained 1.9% (up 3.1%
y-t-d), and the Goldman Sachs Commodities Index (GSCI) surged 4.2% (up 7.9%
y-t-d)."

And now Bloomberg.com reports that we have entered a portal to what I think
may be characterized as the Worst Of All Worlds (WOAW): The economy is going
down and prices are going up. More specifically, "Manufacturing growth in
the U.S. slowed more than forecast last month"
as "The Institute for Supply Management said its factory index fell to 50.9,
from 52.3 in February."

And what's worse, "raw-materials costs jumped, reinforcing concerns that a
cooling economy isn't reducing inflation" as "A sub-index of prices rose the
most in seven months."

But worst of all, "measures of employment and new orders declined."

All of this is provided as more proof of the eerie accuracy of the economic
indicators, like the leading indicator has been right in forecasting future
economic activity, in that it has been going nowhere for quite a while and
thus has been predicting today's lower economic activity.

Specifically, we now find that in February, durable goods orders fell by
0.1% when you exclude aircraft orders - which was huge - but including
aircraft, durable goods orders, it would have risen by 2.5%!
Making an economy out of airplanes! Hahaha!

And this pathetic performance occurs despite the fact that the government
has been buying huge, huge, HUGE amounts of war materiel from the "defense
industry" and running up enormous, enormous, ENORMOUS deficits to pay for
it!

How much defense industry spending? Well, Mark Skousen of Forecasts and
Strategies newsletter says, "the U.S.
government's share of GDP spent on defense has gone from 3% to 3.7% since
September 11, 2001", adding, "while other nations collectively have declined
from 2% to 1%."

Well, as uncannily correct as the leading economic indicator has been in
forecasting this slowdown, the lagging economic indicator (which can be
characterized as measuring burdens and future inflation) has been on a
relative tear, and has been absolutely prescient in predicting the inflation
that we are seeing.

And the coincident indicator has always been right about current conditions
all along, too. It looks like three out of three!

On the site bbj.hu, which apparently got the news from somebody else, there
was the headline "Central Bank gold holdings fall to lowest since 1948" and,
"Gold holdings by central banks and other government organizations declined
for the eighth straight year in 2006, to the lowest in almost 60 years,
figures from the International Monetary Fund show. Bullion holdings were
867.6 million ounces last year, down 1.2% from 2005."

So where is all of this gold? Well, it turns out, "Of the 4.98 billion
ounces of gold in inventories at the end of 2005, 52% was in the form of
jewelry, 18% was in central bank vaults and 16% was investor owned."

As to why this may be important, we turn to the famous and handsome John
Embry of Sprott Asset Management, writing in the March 30 issue of
Investor's Digest under the title "The Time For Gold 'To Go Ballistic'
Approaches". He starts off by explaining, "In reality, it isn't the price of
gold that changes, but the value of the paper currency in which it is
denominated. I have made the case many times that paper money is being
seriously debased, and I think my position is strongly supported by the
recent spate of money-supply growth numbers that have emerged from around
the world."

He then ticks off the annualized growth of some broad money supplies, namely
Eurozone M3 up 9.0%, UK M4 up 13%, China M2 up 15.9%, South Korea up 10.6%,
Australia
M3 up 13%, United States M3 up 10%, Russia M2 up a staggering 48%.

And if you are wondering how the dollar is faring right now, after this kind
of debasement, Yahoo.Reuters.com reports, "The dollar fell around 3 percent
against a basket of major currencies in the final quarter of 2006." This is
a huge move! Huge!

I know what you are thinking: "That Mogambo Idiot (TMI) has gotten off the
subject again, which was supposed to be about the world's gold. And so why
in the hell is he is yammering about money supplies? Who needs this crap?
Screw this! What's on TV? We got any beer left?"

If you were not so rude, impatient or thirsty, you would have soon learned
that Mr. Embry feels, "we are very, very close to that key moment when there
could be insufficient central-bank gold to meet mounting demand.
As I have said before, that is when the gold is price is going to go
ballistic."

This assessment agrees perfectly with that of Richard Russell, of the Dow
Theory Letter, who says that he thinks "the dollar will die a slow, probably
a very slow death. It will be death by inflation. In other words, the dollar
will, over the years, lose an increasing amount of its purchasing power."

And as for gold, he says, "Another irony is this - essentially, holding gold
is a rich man's escape. The reason is that gold doesn't pay interest, and it
doesn't pay dividends. The rich man can hold a large amount of gold, and it
doesn't affect his life style. The poor man, the middle class man, can't
afford to hold a significant portion of his assets in gold. No, the average
American remains at the mercy of his government and the Fed. He's doomed to
see his savings (assuming he has any savings) taxed away or inflated away",
as will his increasingly meager earnings, I might add.

To tell you the truth, I disagree with the idea that only the rich can buy
gold. When I see the enormous amounts of money the middleclass and the poor
spend on pure trash every year, I say, "And you want me to believe that out
of all that money, they can't manage to buy a stinking half-ounce of gold a
year? Or some silver? Hahaha! Don't hand me that crap!"

I think that the important point is that gold is a "rich man's escape",
which, by definition, means that rich people will be buying gold to effect
their escape! And given the staggeringly huge amounts of money now in the
world (mostly owned by the rich!), versus the pitifully small amount of gold
in the world, this could be Really Big Time Stuff (RBTS) indeed, because 1.)
History has shown that rich people always take their money and rush to the
safety of gold at the inflationary ends of booms (like this one), 2.) Gold
is essentially (like all
markets) an auction market, and 3.) Rich people bidding against other rich
people for a finite supply of gold, with unimaginable amounts of money, is
the stuff of which auction history, and newspaper headlines, is made!

And the good news, the better news, the best possible news, is that gold is
still selling at only about $660 a lousy ounce! What a screaming bargain
when viewed against what is surely coming, just like it has always come!
Unbelievable! But, "Whee!"

To a suspicious little creep like me, I naturally connect Mr. Embry's point
that there may not be enough central-bank gold to satisfy demand, to Bill
Murphy of Le Metropole Café citing a Dow Jones report that "The
International Monetary Fund has proposed to increase transparency in the
gold market by publishing statistics that reveal the amount of gold loaned
and swapped into the market by central banks."

What? This surprises the hell out of me! Then I remember (and make some
rude, disparaging noises) that the IMF has mismanaged itself, which comes
mostly from the fact that no country needs to borrow any money from the IMF
these days, as the entire world has long since gone completely freaking
insane with creating all this excess money and credit in which the world is
currently sloshing greedily around.

Now, with the slowdown in the "bail-out-and-meddle-in-
your-sovereign-affairs" business, the IMF desperately needs more money with
which to overpay themselves and maintain their expensive little lifestyles,
empires and power, to which end they recently actually proposed to sell the
gold (their capital) that the United States loaned them to fund the damned
IMF in the first place!
What thieving arrogance!

Rebuffed, I guess, this proposed new disclosure rule by the IMF to reveal
the actual gold holdings of central banks is, I figure, just the usual slimy
blackmail.
"Give us more money, or we will tell what you did!"
(Which is sort of how I ended up getting married, but that's another ugly
story, which I don't want to get into because I will cry like a baby and get
all embarrassed. And then angry. Very angry. And nobody wants that!)

Exactly what the central banks did (but not how much) is hinted at by the
news that "Although they provide regular reports of their gold purchases and
sales, central banks don't currently reveal how much gold is loaned and
swapped."

But there are just too many tremors, and tremors in central bankers
everywhere, not to think about predicting earthquakes in the gold market,
and getting long gold.

And speaking of central bankers, from Bloomberg we read, "Federal Reserve
Chairman Ben S. Bernanke said monetary policy is still aimed at combating
inflation even though risks to economic growth are multiplying. 'Our policy
is still oriented towards control of inflation, which we consider to be at
this time to be the greater risk,' he told the Joint Economic Committee of
Congress in Washington."

Bernanke is reported to have said, with no hint of embarrassment,
"uncertainties have risen, and therefore a little more flexibility might be
desirable." The Mogambo is also reported to have said "Hahaha!" in snarling
disdain, and if you didn't read or hear about it, it obviously means that
this highly-illuminating Mogambo Editorial Comment (MEC) was censored by
government goons, which that proves they're all out to get me. And it also
proves that snooping government agents and spies are prowling around in my
bushes, probably right now, and thus I am fully justified in ruthlessly
hosing down the shrubbery with withering machinegun fire until I feel safe
again (or until I run out of bullets, whichever comes first).

Okay, well, maybe it doesn't actually mean all that, but it DOES mean that
the Fed wants to ignore inflation, although preventing inflation and
attendant boom/bust cycles is the reason that power over America's money was
given to the Fed in the first damned place! They obviously haven't done
their damned jobs - I mean, look at the record! They've failed miserably!
And now, they still don't want to do their damned job; they want "more
flexibility" to give us more of the same! This is insane! And yet Congress
does nothing! Nothing! I am incensed!

But wait! I may be too hasty! With a sudden, powerful insight, I realize
that I could use this unusual stalling technique to my own advantage: Since
my Annual Employee Evaluation is coming up soon, I evilly twirl my mustache
as I scheme to myself, "This 'more flexibility'
thing could come in very, very handy indeed!"

Goals not met? I cry out "I need more flexibility!"
Losses mounting? I wail, "I need more flexibility!"
Employees and customers in open revolt at my arrogance and incompetence?
With a tone of voice that speaks volumes about what I am going to do to my
boss's car if this Evaluation thing doesn't work out for me the way I want,
I say, through clenched teeth, "I need more flexibility!"

Another way of looking at it was provided by Bloomberg:
"Bernanke said the central bank last week dropped its stated tilt toward
higher borrowing costs because policy makers wanted more room to maneuver."
Thanks! Now I realize I need more room to maneuver, too! I need room to
maneuver! For God's sake, give me room to maneuver!

The message is clear; my boss now hates and fears me more than ever, and the
Fed is clearly signaling that lots of inflation is in our future, as it is
the price we must pay to bail out the blinding, incandescent incompetence of
the Federal Reserve under Alan Greenspan, who created the housing bubble,
which was created to bail out the busted stock market bubble, and the bond
market bubble, and the size-of-government bubble that he also created.
Grrrr!

And how bad is inflation in consumer prices? Bloomberg itself provides an
answer with "The Fed's preferred inflation benchmark, the personal
consumption expenditures price index, minus food and energy, has been at or
above the two percent comfort zone of at least six Fed officials for 34
months. The price measure rose 2.3 percent for the twelve months ending
January."

Three years! Three long, long years of inflation above zero, which is de
facto evidence of their incompetence, and even more so when you realize
that, in reality, even that unacceptable recent 2.3% measure of inflation
actually understates inflation by about four to seven huge percentage points
or so! Gaaaaah! We're freaking doomed!

Even worse, "An index of 18 industrial materials tracked by the JOC-ECRI
Index is up 2.5 percent year-to-date, and 12 percent over the past year. Oil
prices are climbing."

John Stepek, of MoneyMorning at Money Week.com, must have overheard us
talking about oil prices climbing, and says that in Britain, "The rising oil
price was one of the major factors driving official inflation figures higher
across the globe in the past few years. It's also served as a convenient
excuse for politicians to point to - 'rising inflation isn't our fault, we
can't do anything about the oil price' - as Tony Blair effectively said last
year."

He says that he was reading an interesting report from Donald Coxe of BMO
Financial Group, who says, "he's also not expecting the Fed to cut interest
rates. And the reason is that the world is very short on food, at a time
when demand has never been stronger."

As to what this means, he correctly notes that I am an American, I am
stupid, and thus, carefully tailors his answer with, "This means that U.S.
consumers are about to find that their burgers, their buns, their daily pint
of milk, and everything else they eat are going to tick up in price over the
coming year."

By this time I am actually gagging on Mogambo Vomit Of Fear (MVOF), and
since I was so preoccupied with making the crucial decision of whose lap I
was gonna barf in, I almost missed him saying, "The latest U.S. producer
price index data from February showed that food prices rose 6.8% on the
previous year. It's little wonder - data from the U.S. Department of
Agriculture suggests that the amount of coarse grains left over this year to
carry over to the next 'could be the lowest - in relation to consumption -
in decades.'" Gaaaaah! MVOF!

And this is at a time when there have been, "16 straight years of favourable
growing conditions in the Midwest - the world's leading producing region.
This is an historic winning streak."

So, to recap, we ended up with nothing in savings, at the end of remarkably
long booms in stock markets, bond markets, houses, size of governments, and
now even in commodities, too? Hahaha! I laugh in derision because, I mean,
isn't this supposedly an overwhelmingly Christian nation, and thus shouldn't
we, as a people, overwhelmingly know about the Biblical admonition to save
during the fat years in preparation for the cyclically-inevitable lean
years? Hahaha! We're religious idiots, too!

As further evidence of that, I point to the Economist magazine article about
Lynn Westmoreland, "a Republican from Georgia", who appeared on the Comedy
Channel's hit show, the Colbert Report, and who "co-sponsored a bill to have
the Ten Commandments displayed in the Capitol."
Mr. Colbert reportedly asked him to name the Ten Commandments. He could
name, in all, seven.

It is not just The Mogambo and a few of you other gold- bug, whack-job,
paranoid lunatics out there ("Hi, Lucy!"
"Go to hell, Mogambo!"), who are buying gold, as MoneyandMarkets.com
breathlessly reports, "Dubai's Gold Souk, an open-air market that contains
some 500 gold shops, is the largest retail gold market in the world.
An estimated 500 metric tonnes of gold, or nearly 18 million ounces, are
bought and sold each year. In the gold souks of Dubai, both the ultra-rich
and regular citizens are buying gold. I watched wealthy businessmen,
construction workers, and imams all snatching up the yellow metal."

And speaking of prices and gold, Junior Mogambo Ranger
(JMR) Richard D writes "I got this from Sinclair newsletter. 1941 prices.

Gallon of Milk $0.34

Loaf of Bread $0.08

New Auto $925.00

Gallon of Gas $0.15

New Home $6,954.00

Average Income $1,231.00 pa

Dow Jones 110

Gold $34.60"

I note with a certain satisfaction that, since 1941, gold has pretty much
held its own against the rest of the items on the list, which are all up
about 20 times (except milk - which is government-subsidized, so who knows -
and the Dow Jones, which is up by over 100 times
- which is now also government-subsidized by the Plunge Protection Team, so,
again, who knows.

So, is the stock market overpriced in relative comparison to everything
else, or is everything else under-priced in relation to stock prices? A lot
will depend on your answer, but it is bad news either way.
Ugh.

**** Mogambo sez: If GATA is right, and the gold market is being manipulated
with the collusion of the central banks (and I have absolutely no doubt that
it is, and would be stunned, absolutely stunned, to learn that it wasn't), I
again think of John Embry and his phrase, "the gold price is going to go
ballistic" when central banks can't meet demand.

My Mogambo Profit-Sensing Gland (MPSG) recognizes the screamingly obvious
profit that will come when this kind of manipulation ends (as it must), and
it squirts a jolt of "greed hormone" into my bloodstream. In response, I
look at my pitiful stash of gold and silver, and I compare that to how
freaking much wealth I want to have when the inevitable explosion in gold
finally happens, and I wonder "Do I have enough?" which is Polite And
Genteel Mogambo-Speak (PAGMS) for "Has my embarrassing, gluttonous greed and
unspeakable depths of avarice been satisfied with this pathetic little pile
of gold and silver?" Upon reflection, I find the answer is, of course, "no".

Then I wonder, "Should I get a job, to earn some money with which to buy
more gold and silver?" Again, upon reflection, the answer is, of course,
"no".

Then I wonder, "Should I make the wife and kids drop out of school, get
second jobs so that they can buy their own food and clothes (saving me a
bundle!), and maybe pay a little room and board around here (the little
worthless, parasite freeloaders!), and then use the money to buy more gold
and silver?" At last, I arrive at a solution I can live with. Even optimal,
in its own way!

So while I don't know how it works out for you, and you'll do what you do,
but whatever you do, you'll find that you are usually better off if you do
what you know you should do, as this gold and silver thing is "do it or it's
doo-doo!"

The End Of The World As We Know It

2007-03-29T22:41:00.001-07:00

"IT'S THE END OF THE WORLD AS WE KNOW IT"
by Doug Casey

.."And I feel fine."

That's not just the title of an R.E.M. song. It's how today's gold and
silver investors feel every time they get a reminder from a newspaper or
news program.

They see what you see, and anyone paying even a little attention can't help
but notice the stunning array of problems that are menacing the global
economy and threatening traditional investments. In fact, I can't say I've
experienced the like of it before. And that's saying something, considering
I've made crisis (and how to profit from it) the focus of my life's work.

This time around, the unfolding crisis carries several especially dangerous
features - and a locked-in profit
opportunity available to anyone even moderately fleet
of foot.

First, the intractability of the situation. That's the word Paul Volcker,
former Chairman of the Fed, used to describe things, and it's a perfectly
good word meaning, simply, that the underlying problems can't be fixed.
In the Middle East, for example, even if we pull all our troops out today,
the situation won't settle down for years... or maybe even decades. And each
day of turmoil will cost the U.S. more tens of millions in direct and
indirect costs - and keep the global economy in a state of chronic worry
over energy supplies. Then there's the collapsing housing bubble. For years
a galloping real estate market was the primary driver of our economy. Now
real estate is hobbling on three legs and has become the primary driver of
personal and corporate bankruptcies.

Even more serious is the 6 trillion or so U.S. dollars in increasingly
twitchy foreign hands. Hardly a day goes by without some government or
another announcing plans to diversify out of the dollar. And no wonder,
given the record levels of personal and government debt in the U.S.
And even more debt is baked in the cake. We have a freshly-elected slate of
Democrat law makers looking to "do something"... from universal health care,
to global warming, to confronting the "unfair" trade practices of China and
Japan (the very people who own much of the above mentioned $6 trillion).
Those projects are just for starters, of course. Congress's "must-do" list
goes on and on, and for politicians, "do something" never means "do
something cheaply."

So far, so bad.

But it gets worse. Much worse. Over 20% of the U.S.
population - the baby boomers - are now beginning to retire, and most of
them have nowhere near enough savings to enjoy their senior years. So
they'll be absolutely dependent on the Social Security and Medicare promises
they've been hearing all their lives. Politically, those promises are
impossible to renege on. Financially, they're impossible to pay. And along
with the government's other unfunded entitlement programs, they add up to
$50 trillion of off-the-books debt.
Mr.Volker spoke well. Intractable is the word.

There's more, but that's enough. We're in a box canyon with a floor of
quicksand, and the only exit is blocked by a landslide. Investors who take a
business-as-usual attitude are not going to have a nice day.

In case that litany of problems isn't enough to get the sweat beading on
your forehead, ponder derivatives. While these hybrids have been around for
decades, the rocket- shot rise of hedge funds and the advances in financial
modeling techniques have spawned something of a competition among the
so-called best and brightest to find ever-more-complex ways of skimming
pennies from very large piles of money.

The collective result is that our financial system has been wired up to $370
trillion dollars of privately negotiated investment contracts. They're
usually written to shift risk from one bank, pension fund, insurance company
or brokerage firm to another. And many are linked together in long chains,
with each contract providing collateral for the next.

It's all very clever, but layering the enormous size- $370 trillion dollars,
far more than the net worth of all the financial institutions in the world -
on top of all that complexity is downright scary. In simpler times, a home
loan going bad would affect only the particular lender. Enough defaults
would put the lender out of business. And that would be the end of it. But
today a wave of defaults can send a shock through the portfolios of
financial institutions around the globe, including hedge funds, banks and
pension funds far removed from the troubled borrowers.

Imagine an electrical circuit with thousands of connections. No one designed
it. No one tested it. No one has a diagram for it. It just grew. Now,
because of its size and power and pervasiveness, everything depends upon it.
So what happens when one of those thousands of connections burns out? No one
really knows, but I say it's a circuit you should disconnect from before the
world learns the answer.

If you are relying on traditional investments to pad your nest for the
future, the problems stalking the world economy should be a matter of
serious concern.
Especially given that as bad as we think things are about to get, there
remains the potential for things to spin entirely and un-recoverably out of
control. That's because so many wildcards are now in play. A war in Iran?
New York hit by a freelance nuke? A worldwide panic exodus out of the
dollar? Traditional investments would be the first casualty.

The $2 trillion or so loss in stock market valuations during the recent
correction is a precursor of what's to
come... in a best case. The worse case is... much,
much worse.

Working apart from the investment multitudes, a very small minority of
investors over the past few years have been building portfolios of precious
metals and Canadian precious metals stocks. It's a minority I'm happy to be
a part of, as it allows me peace of mind and the
considerable advantage of viewing these crises
somewhat dispassionately.

That doesn't mean I'll enjoy standing on the sidelines and watching the
impact of a monetary crisis on the lives of the unprepared. Of course not.
Yet I would be a fool, having recognised a crisis shaping up, not to take
the fairly obvious steps to profit.

Which brings me to the opportunity that the crisis is carrying on its back.

For any number of reasons, but first and foremost its use as money in all
the world's cultures, throughout all recorded history, gold has begun to
find renewed favour with in-the-know investors as the currency of last
resort.

Make no mistake, despite gold's rise from its $255 low in April of 2001 to
over $650 as I write, so far, only the thinnest of trickles, a minor
fraction of global capital, has made it into gold. When the flight to safety
really heats up, the real fun will begin, and the price of gold won't just
add dollars, it will add digits.

If that sounds like hyperbole, remember that, unlike the U.S. dollar, which
can be created at the speed of light, the available supply of gold is finite
and is painfully slow to change.

You can't print gold the way you print paper money. And you can't just build
a gold mine the same way you might build a Starbucks almost anywhere and on
short notice.
Instead, you first have to find a promising ore body - which is, without
exaggeration, like finding a needle in a haystack... a haystack buried
"somewhere" in the earth's crust.

Then you need to go through the immensely complex and expensive exercise of
confirming that the ore body is economically viable. Then, years after you
started exploring, you can start the even more time consuming and expensive
process of actually building your mine. That entails finding a labour force,
bringing in power, roads, mills, etc., etc... with every step hindered by
environmentalists waving court injunctions.

The long and short is that there are hardly any gold mines of size scheduled
to come on stream... and we are not talking about just over the next year or
two, but ever. Most people in the know see annual gold production falling
from here on.

For proof, there was news recently out of South Africa,
the most world's prolific gold producer. Despite the
loud incentive of higher gold prices, South African
gold production in 2006 dropped to the lowest level
since 1922.

And, above ground, there just isn't much gold to go around either. The U.S.
government, for example, possesses the world's largest gold reserves...and
those reserves amount to only about $170 billion at today's prices...not
even a rounding error on the trillions of dollars in debt the government has
guaranteed.

Put simply, the amount of gold available to investors and central banks is
like the number of beachfront home sites at Malibu - it's not going to
change much. As a result, when the rush for the lifeboats begins in earnest,
the upward pressure on gold will be unimaginable. As will be the profits for
anyone who acts now, ahead of the crowd.
If you haven't yet started accumulating precious metals, you still have
time. Start by picking up some bullion coins from a reputable dealer (silver
should do as well as gold).

Then build a portfolio of the better small companies exploring for new
deposits - the ones with the best management teams, working on the best
projects, in the best geology. These stocks are the true profit gems - in
part because of an accident of recent history.

During the long bear market that ended in 2001, the large mining companies
all but eliminated their exploration departments. Now they urgently need new
deposits to restock their declining ore reserves. But rather then scouring
the world themselves, the majors let the more agile and entrepreneurial
junior explorers - often Canadian firms, due to the resource orientation of
that country's economy - invest the capital and sweat needed to find a new
deposit. Then, when a junior company's project seems ripe, the majors
compete to buy the deposit or to acquire the junior explorer itself - and
they pay up in a most serious way.

Pick your companies right, and you can pay pennies today for shares in a
junior exploration company that history has shown again and again will sell,
with a little success, for $10, $20 or more when the market gets rocking and
investors at large rush into all things gold.
While there's no such thing as a sure thing, there are times - like now -
when the deck is heavily, massively, stacked in your favour.

You are, therefore, left with a relatively simple choice.
Do nothing and hope that all the world's troubles just drift away-and risk
personal financial disaster if they don't. Or take action, if even with a
modest share of your portfolio, and position yourself for extreme profits.

Regards,

Doug Casey

Prime slips...and slides into sub-prime.

Problems in sub-prime mortgage loans could be spreading into sub-prime
auto-loans...and sub-prime commercial loans...

As to the sub-prime auto and truck loans alone, there are some $34 billion
outstanding. As to the rest of the loans that were made to shaky borrowers,
without proper credit standards, the total may reach into the hundreds of
billions...

And what about politics? Isn't the US government operating at sub-prime
levels? And aren't the candidates for next year's presidential election also
less than prime?

Oh where...oh where...dear reader...shall we begin?

No big breaks in the financial markets yesterday. But the millwheels keep
grinding...turning the pretensions of the smart...the conceits of the
powerful...the assets of the rich – all to dust.

When standards go out the window, they just don't go out of windows in
trailer parks and ghettos. They go out of windows in gated communities in
Florida...and in Washington...and they would go out of windows of
skyscrapers in Manhattan and London, if you could only open the windows.

Even in education and art...standards slip...

We were looking at Henry's report card last night. Ai yi yi...

"Needs to work harder..." said his science teacher.

"Performing below his capacity..." said his math teacher.

"Work okay...but could be much better..." said his Latin teacher.

The half-empty part of that glass was obvious. But there was a half full
part too.

Henry does his homework until midnight every night...and works on it at
least 8 hours each weekend. And still, his teachers aren't satisfied.

We checked his grades and class ranking (in France, every student knows
exactly where he stands) and found that Henry is above the average in what
must be one of the toughest schools in France. Ah ha! A school with
STANDARDS...

From what we've heard, in most of the schools in France – and America -
students get passing grades, even without really knowing anything.

Meanwhile, yesterday, Elizabeth came back from an exhibit of Greek
statues...attributed to Praxiteles or his imitators.

"It was unbelievable," she remarked. "The sculptures had such dignity. It
is incredible that they were done more than 2,000 years ago..."

A thought crossed our mind. How many of today's artists could create a
beautiful statue out of a block of marble?

But blocks of marble are not our beat, here at the Daily Reckoning, so let
us get back to money.

What is endangering America's money is the same thing that is undermining
its position in the world – slipping standards.

And slipping standards is what had brought about the fifth of our Big E's.

We began to review our Five Big E trends yesterday:
Energy, Experimental Money (the faith-backed dollar), and the Exodus of
power and wealth from West to East. Today, we look at our fifth – the
Empire.

When we say that America is an Empire, it is neither a matter of desire or
reproach. It is simply an observation.

Some readers think it is unpatriotic or un-American to notice. But while a
good husband doesn't notice when his wife gets fat, perhaps, a citizen with
his wits about him might do well to keep a close eye on his government. And
if he looks carefully at America circa 2007 he will see it resembles an
empire more than a modest republic. Its troops...its culture...its
commerce... impose themselves over almost the entire planet.

Empires must be empires and follow the imperial path...from humbug, to
farce, to disaster. They must believe what isn't true (that they have some
intrinsic, inalienable advantage)...and they must relax their standards...as
they stretch...and then overstretch...until they have stretched too far.

Nine trillion in federal debt...a 'fiscal gap' 50 trillion dollars wide...
an $800 billion trade deficit...an everlasting War on Terror...

And in today's news comes word that the US is "no longer technology king."

The BBC reports:

"The US has lost its position as the world's primary engine of technology
innovation, according to a report by the World Economic Forum.
"The US is now ranked seventh in the body's league table measuring the
impact of technology on the development of nations.
"A deterioration of the political and regulatory environment in the US
prompted the fall, the report said.

NETWORKED READINESS
INDEX RANKINGS 2006
(2005)
1: Denmark (3)
2: Sweden (8)
3: Singapore (2)
4: Finland (5)
5: Switzerland (9)
6: Netherlands (12)
7: US (1)
8: Iceland (4)
9: UK (10)
10: Norway (13)
Source: WEF

And more bad news. Alan Blinder writes in the Wall Street Journal that
globalised competition could cost the US as many as 40 million jobs over the
next two decades. Fifty years ago, America was the world's most competitive
economy. Now, Asians have an edge when it comes to low cost production. And
Europeans have an edge when it comes to innovation and high quality
production. The Empire is peaking out...

What will it do when it can't pay its bills? We're going to find out...

More news...

*** "What did the economic boom ever do for us?"

The world is booming...the economy's growing...and yet.
And yet somehow we feel poorer. Somehow we are poorer too, according to a
report in today's FT. Disposable household income fell by 1.7% in the last
quarter of 2006 and managed a miserable 1.3% for the year as a whole.
With inflation nearer 3% than 2%, this for happy campers does not make.

And that doesn't help Britain's Chancellor Gordon Brown either regardless of
the quality of his recent dental work. In the run up to the push (or is it a
shoo-in?) for No 10 a disgruntled swathe of Middle England totters a step
nearer the financial edge as higher taxes, rising interest rates and rising
inflation put a squeeze on take home pay.

And what happens when standards of living are under siege? Pull in our belts
and save a little harder in case things get worse? Sounds a sensible idea
but that's not the way it works in practice explains Jonathan Loynes of
Capital Economics.

People do what they want rather than what they need.
Given the choice between foregoing the annual cash ISA allowance and the
holiday in Florida, it's the ISA that gets the bullet. To keep up the
spending, something's got to give and what's giving is the rate of saving.
At 3.7%, the UK household savings rate is at its lowest level since 2004.

So as the queen bee of globalisation coins it in the average drone is
getting squeezed...and these are the good times.

And as money gets tighter the risks considered to get more of it become
wilder and hopes more delusional. A gambler's mentality can develop...

Looking at a chart published in The Times this has already happened in the
virtual world of the internet. It publishes a chart plotting the growth in
UK online gambling revenues since 2000. Were this a stock chart and had I
bet the house on it, I would not be straining away at my keyboard today. UK
revenues have ballooned from around £300m in 2000 to £2,750m in 2005. And
that was 2005! Then there's other temptations for a 'flutter'...spread
betting, the National Lottery, gaming machines, super casinos... Oh there
are many ways for the financially squeezed to throw the dice one last time.

And while Middle England struggles to keep up appearances we hear a
confession from a senior civil servant:

'I'm an alcoholic and do very little for my £737,000 a year'.

Bob Kiley, formerly London mayor Ken Livingstone's transport czar charged
amongst other things with making the London Underground less of a hell hole,
has gone public with his personal problems. We can admire the candour but
despair at the waste. More taxes, more wasted spending - twas ever thus.

Finally, good news. Bao Xishun, at 7ft 9 inches the world's tallest man has,
after a global search for a partner, found a wife says The Times. He's
managed to stumble on a bride living in his home town of Chifeng, 5ft 6 inch
Xia Shujuan. Given the lousy demographic odds of finding a wife in China,
achievement indeed.

--------------------------

And more views:

*** Et tu, Dear Reader?

The Daily Reckoning is too long. That's what readers tell us. We're sorry.
But we don't have time to write something short.

*** And we promised to explain our Theory of Modern Politics...

The question before is how come all governments – including the supposedly
freedom-loving U.S. of A – have edged towards collectivism?

We begin with a conversation we had with our bus driver.
The last two days were spent at the Chateau de Courtomer, where we were
attending a conference with Addison and Eric and many others on the Daily
Reckoning team. The days were bright and sunny. The conversation quick and
agreeable. The wine soft and smooth.

Coming back, we sat up next to the bus driver, where we could get a good
view of the rolling Normandy hills.

"I worry about what will happen to our kids and grandchildren...about what
kind of world they're going to live in," he said.

He was a very-French looking man of about 50, with a full head of dark hair
with gray streaks in it, and an ironic smile. He wore a tie and might have
passed for a waiter in a good restaurant.

"I started my career as a chauffeur 30 years ago," he went on. "Back then,
you had no trouble getting a job.
And they didn't ask you a million questions or tell you what to do. You just
had to drive the bus.

"But now, everything is regulated. Everything. I can't drive more than 4
hours without stopping for a 45 minute break. That's why I couldn't move the
bus out of the parking lot when we got to the chateau. I had to stay there
and do nothing for 45 minutes. The 45-minute break is supposed to be a
safety measure. But, the effect of it was that I was driving at night...and
I was tired.

"Back when I started, I could decide for myself But now everything is
decided for us."

He is onto something. Just look at the current issue of Fortune Magazine for
proof. It is supposedly the voice of conservative, capitalistic freedom
lovers – people who treasure the liberty of the individual to decide for
himself when to drive his bus...or how organize his work...or how to spend
his money.

"Fix the health care system: Raise taxes," says the headline. "Sometimes
raising taxes makes sense, even to conservatives."

The writer, Matt Miller, goes on to explain that there is an "opening of the
capitalist mind," going on, allowing the old robber barons to appreciate the
benefits of taxation.

We almost fell out of our chair when we realised what he was proposing; we
were laughing so hard.

The story is this: employers are finding it hard to keep up with the cost of
health care benefits. For example, another article explains that a
65-year-old couple, not covered by a private health care plan, should plan
on spending $215,000 on health care through the end of their lives – an
amount up 7% from the year before.

But far as we have observed, there is no direct relationship between
spending money and enjoying good health. Many of the most expensive health
problems are simply a result of bad habits. We suspect that 90% of
heath-care expenditures is unnecessary or inefficient, or both. But if
people want to spend their money on health care, well...it's their money.

Already, company-sponsored health care is collectivised.
But it is collectivised privately...and honestly. For the most part,
employers and employees can decide for themselves what they want to do about
their health and how much they want to spend on it. But employees want
health care benefits...and many employers have health care plans with
crushing legacy costs. So what do they want to do? Own up to the fact that
they their costs are out of control? Raise the standards...and cut the
costs?
Figure out how to fix their own health care system problems? No, they want
to shove the costs of their health care obligations onto the general
taxpayer!
They want a program of forced collectivisation – where their employees spend
someone else's money on their health...and where the government will be
ultimately responsible for the health care of everyone in the country.

Most likely, the pseudo-conservatives at FORTUNE will get their wish.
George W. Bush went a long way towards forced collectivisation of health
care costs with his big drug bill. The next president is likely to go even
further.

And so...the whole world goes in Marx's direction...in Bismarck's
direction...away from Liberte and towards Egalite...away from the Theory of
the Individual and towards the Theory of the Collective.

Private equity is the hottest thing on Wall Street

2007-03-28T10:56:00.001-07:00

Private equity is the hottest thing on Wall Street.

Here's why. Profits in 2006 reached $2.27 billion, more than double that of
the previous year.

"That means," says the FT, "each of its 770 workers produced an average of
$2.95 million in net income. By comparison, employees at Goldman Sachs Group
Inc. - the largest U.S. investment bank - each averaged about $360,000 for
the company in 2006."

And now, more news of a fabulous offer by the same Blackstone Group. We say
'fabulous' because it is the stuff of fable…a morality tale telling itself.

Blackstone, this fabulously sucessful firm of private equity investors, now
will offer 10% of its shares to the public for $4 billion. We asked 'Why?'
earlier in the week.

We will endeavour to answer today.

The facts: The Blackstone Group is the largest private
equity firm in the world. According to the report in the
Financial Times, Blackstone's assets have grown from $14 billion to $78
billion in less than 6 years. That is, it has multiplied its assets under
management more than 5 times in 6 years.

Even more remarkable has been the incredible profitability of the firm. Its
annual rate of return is better than Warren Buffett's. Since 1987 it has
averaged 23% a year, while Buffett's rate of return has been 22% -- though
over a much longer time. Blackstone's real estate holdings have done even
better – up 29% per year since 1991.

But now cometh these uber money shufflers with an offer to shuffle some
money to the public.

Or from it?

How does it make so much money? We turned for an explanation to our
colleague, Eric Fry, who is sitting next to us:

"Private equity can mean a number of things. But what a company like
Blackstone does, typically, is to buy a company from the public, reorganize
it and sell it back to the public. Or, sometimes it will buy a private
company and sell it to the public. The paper almost always ends up with the
public."

Today, we stop to marvel at the chutzpah of it.

Associated Press describes the deal:

"Consider this: Blackstone is a great firm. Going public will bring even
greater riches to those at the top. That said, great riches have already
been captured by those up and down the management hierarchy. This is not the
case of a go-go high-technology firm that generates little free cash flow
and requires an IPO or a sale to crystallise value for its shareholders.
Blackstone has been and will continue to be a cash machine that can
distribute substantial sums to its minions every year. Therefore, either an
IPO or a leveraging of the balance sheet is simply a means of extracting
even more cash from the business. Given the friendly nature of today's
equity markets, going public offers the best risk/reward decision for
Blackstone's existing shareholders. This is an opportunistic step driven by
the state of today's equity markets and other considerations such as the
state of the private equity market."

Yes, but what does that mean?

The Financial Times comments:

"These self-motivated, intelligent individuals are trying to tell us
something important. The question is: do we have the ability to look beyond
their words and actions and intuit motivation? Greed, uncertainty and fear.
What are the implications? That the equity markets are in trouble?
That the credit markets are on the verge of a sharp sell- off? That we are
at the dangerous stage of a private equity bubble?"

There is no magic to the Blackstone Group or other private equity firms.
The genius of private equity prime capital is no different from the genius
of subprime credit. When liquidity rises…both ride high.

But money and credit are no different from bananas or lovers; the more you
have, the more will go bad on you.
This is what economists call the Law of Marginal Utility.
Each additional increment, of whatever it is, is less
valuable than the one that came before.

We find in the Fed statistics that the total credit market debt has been
increasing five times as fast as GDP for the entire 21st century, or at
least, what we have seen of it so far. Subprime lenders had so much money
to lend that they gave it away to people who couldn't possibly pay it back.
There are only so many good borrowers. And there are only so many good
private equity deals. And a credit bubble lasts only so long.

AP again:

"What will happen when the debt markets grow less friendly and additional
equity is required to get deals done?
Returns will fall. What will happen to those who have invested in private
equity funds? They will not be happy.
And those who have invested in common shares of the private equity
management company? Unhappier still.

More news:
--------------------------------

Adrian Ash, just trying to make the repayments in Tunbridge Wells:

- Hands up for a housing crash! What's not to love about falling property
prices?

- Bill Gross at Pimco, for instance. He forecasts "an ongoing bond bull
market of still undefined proportions"
to follow the subprime collapse in the US.

- Manager of the world's biggest bond fund, Gross thinks lower house prices
will force the Fed to cut Dollar interest rates. His model puts US interest
rates back at 4%, down from the current 5.25%, if the Fed's going to keep
home prices stable.

- And if the Fed doesn't cut? Average home prices may fall by one fifth,
says Gross.

- "Investigate the Fed's own study," he advises, "written in September of
2005 [and] covering housing cycles in aggregate and individually for 18
countries over the past
35 years. This study's important conclusion...is that if home prices in the
US have peaked, and are expected to stay below that peak on a real price
basis for the next three years, then the Fed will cut rates and cut them
significantly over the next few years in order to revigorate an anemic US
economy."

- Here in the UK, cheaper housing would save the Bank of England from having
to raise Sterling interest rates, too. Which explains why the Old Ladies
keep wishing away their own property bubble, too. Mervyn King told a
Treasury Committee on Tuesday "there are now some signs that the housing
market is beginning to slow."

- Ha! You should be so lucky, Dr. 'Blin' King! Perhaps the chief pooh-bah is
reading different data from everyone else. Because average national asking
prices have risen 12% from this time last year, according to Rightmove. That
estate agency website covers half of all properties for sale. In March
alone, it shows, average asking prices rose £3,381 ($6,626).

- You call that beginning to slow?

- And while Mervyn King shuts his eyes, sticks his fingers in his ears and
cries "I can't see you! I can't hear you!", would-be buyers are starting to
demand home- ownership as part of their human rights. No, really.

- "Everyone has the right to own property alone as well as in association
with others," says Article 17 of the UN human rights declaration. It's
quoted by a regular blogger at PricedOut.org, the website where first-time
home buyers yet to enjoy their first time gather to bewail their lack of
mortgage debt.

- "No one shall be arbitrarily deprived of his property,"
the UN goes on. "Everyone has the right to a standard of living adequate for
the health and well-being of himself and of his family, including food,
clothing [and] housing..."

- The UN doesn't mention mortgage indemnity insurance or stripped pine
flooring from Ikea. But never mind. That lower house prices will soon prove
obligatory, we have no doubt. The first-time buyers will get what they want,
just in time to dive into negative equity.

- "Legislation must be bought into place to control the market," says Carron
Miller, a young mother and teacher.
She's now threatening a BBC chatroom that she'll emigrate if she can't buy a
house soon. "People need to be put before profit."

- Over in Tokyo, meantime, it's the Bank of Japan praying for slower
real-estate inflation. Incredibly, after 17 years of depression, land prices
in Tokyo finally turned higher in 2006 according to official data last week.

Trouble is, rather than just picking up, land prices in some parts of Tokyo
leapt 46% higher. How the gods must be howling with laughter!

- "We aren't yet in a situation in which land-price gains warrant concern of
excessiveness," said Toshihiko Fukui, governor of the BoJ to the Japanese
parliament Tuesday.
"But we'd like to keep a close watch on them."

- Commercial land prices in Japan's three biggest cities rose 8.9% in 2006.
With interest rates still next to zero, why not? The fastest property gains
came in the Omotesando Hills of central Tokyo, a retail and residential
development that opened in Feb. last year.
Amid the developers' scramble, the city's tallest building is now due to
open on Friday. A 42-storey skyscraper will open in front of Tokyo Station
next month.

- Still, there's a long way to go before Tokyo, Osaka and Yokohama catch up
with Glasgow, Baltimore, Derry, San Diego, Pula, Beijing, Buenos Aires,
Reykjavik, Jo'berg, Auckland and the rest of the planet. Japanese land
values for commercial and residential property now trade for half the price
of their 1989 peak.

- But what a peak! And what a mess Japan's had to endure trying to unwind it
ever since. Gearing up to speculate on the wasting asset called real estate
cost Japan more than a decade of recession, depression, banking defaults and
deflation.

- "The buy to let market," says the young British teacher who can't get a
mortgage, "is responsible for a lot of misery." We don't doubt she's right.
But it's not created half as much misery yet as it will when house prices
really do start slowing down.

- Beware what you wish for, Dr. King...
--------------------------------

And more views?

*** Well, at least we know the fire alarm works.
We were sleeping soundly last night. Then, all of a sudden, at about 3AM, we
became a victim of modern technology. A fire alarm interrupted our dreams.
Was the place on fire?
It didn't seem likely. But we couldn't sleep with the screeching alarm
going off…so we dressed and went downstairs.

It is one thing to turn on an alarm. It is another to turn it off.

Pierre was already at the control panel when we got downstairs. He was
pushing buttons. But the noise continued for another 10 minutes – until
everyone was wide awake.

What could we do, but open another bottle of wine?

*** We know we left you on the edge of your chair, last week, with our
theory of modern politics.

Why has collectivism triumphed everywhere, we asked.
But for today, we have to cease with our views. We're attending a conference
and we need to pay attention; maybe we'll learn something. More tomorrow,
dear reader…

FOLLOW THE SILICON TRAIL TO GLIMPSE THE FUTURE OF MEDICINE

Michael Orme

Set your sights on medical diagnostics as the next big thing. The bloated
$3-$4 trillion global healthcare industry shows itself overripe for radical
disruption and the alchemists of Silicon Valley have set their sights firmly
on it.

When they home in on an industry, the game changes and wealth creation
amounting to hundreds of billions or even trillions of dollar can result.
And sometimes be destroyed, it should be added, when a bubble bursts, like
the Internet 1.0 bubble in 2000, only to bubble up again as Web 2.0.

Here, though, we're in at the creation. So let me give you a sense of what's
being spawned. Today, doctors are overwhelmed by administration and
forceably moved far beyond their main function of old of the laying on of
hands and offering a comforting bedside manner. In prospect, is a medical
world where they will be superseded by medical knowledge and expertise
captured in silicon, software and algorithms and delivered cheaper every
year.

It's been called 'rebooting your doctor.'

In prospect are diagnostic tools that will detect early signs of plaque in
arteries or tiny clusters of cancer cells to enable preventive therapies—all
without the need for hospitals, prima donna specialists or blockbuster drug
treatments. We don't have to speculate about weird nanobots cruising through
our gizzards and blitzing incipient cancer cells en route to get the picture
and see that radical change is afoot.

If you want to glimpse where medicine's going, best to talk to those silicon
alchemists rather than medicos, biotech scientists or government policy
makers. Better still, perhaps, to a truly switched on venture capitalist
with a technology background. I sat next to Don Valentine, the doyen of
Silicon Valley venture capitalists a few years ago at a dinner in Menlo
Park, California.

Formerly, a top executive at National Semiconductor, he is worth over a
billion dollars and put seed corn into CISCO and Google when each was little
more than a couple of bright sparks from Stanford with a business plan. I
asked Valentine his secret. "Follow the silicon'' was his brusque reply as
he turned to his other neighbour.

The one thing I learned in 20 years tracking the technology business, first
as a journalist and then as a consultant, is that once silicon focuses on
something you only have to wait for the big markets to be created from
almost nothing - witness PCs, mobile phones, digital cameras and iPODs.

The master mantra is 'better, faster, cheaper, smaller.' Silicon gets
cheaper by 30% every two years and halves in price roughly every two years.
If you find something that works today, more or less, but is too expensive,
then wait a bit and the fireworks start. Look at PCs, routers, mobile
phones, iPODs, search engines, GPS systems for cars, digital cameras. Under
the lash of this relentless mantra, silicon integrated circuits get better,
faster, cheaper, and smaller with every shortening product cycle.

The same cycle of innovation is about to hit medicine, which contrary to
everything in information technology, gets more expensive, more muscle bound
and less satisfying to its customers every year. This is why medicine meets
the criteria laid out by Professor Clay Christensen of the Harvard Business
School, author of best seller, The Innovator's Dilemma, and the chief
theorist of disruptive forces in business, for being 'ripe for disruption'
from the bottom-up.

This is why Andy Grove, the legendary ex-chief honcho at microprocessor
giant Intel, talks of the need for medicine to move "from the mainframe to
the PC era''.
He is talking metaphorically. He means that technology must now be deployed
to undermine the current medical establishments and their ways of doing
things, not least to evaporate the crippling fiscal burden of healthcare on
governments across the world.

In his recent book, End of Medicine, a sprightly but profound study of the
scene, Wall Street veteran and ex-hedge fund manager Andy Kessler points to
what he calls "the cholesterol cancer conspiracy'' as the main culprit. He
argues that hospitals, specialists, and insurance and drug companies have
combined to put the medical focus on costly 'cut and drug' treatments for
chronic conditions, mostly around 'the Big Three', heart disease, stroke and
cancer. But this 'conspiracy' and this focus on costly late stage treatments
is on the point of being subverted by new breeds of diagnostic tools - real
time 3D scanners, biomarker chips to scan for cancer cells, neural networks
to read mammograms, portable ultrasound kits and expert system GPs etc - all
built around silicon.

Rather as the mainframe and minicomputer cultures were subverted by silicon
dominated and defined PCs, and by employees smuggling them into their places
of work twenty years ago, so these diagnostic tools will surround, squeeze
and suffocate medicine's old ways of operating. And they will keep on
improving in lockstep, just like mobile phones or digital cameras do now,
with the remorseless power of siliconomics.
Let's quickly look at what's happening with CT Scanners (Computerised
tomography scanners: a diagnostic medical imaging technology) to round all
this out and make it tangible.

You're a baby boomer and you may have a heart attack, but then again you may
not.
How about having a look in your arteries to see if there's a blockage?
The test is doable with the current generation of 64 slice CT scanners but
is still too expensive and perhaps still not a good enough test.
Coming next is the new generation of 256 slice scanner making its way to
market. They can scan your heart in 4/10ths of a second or less and create a
colour 3D image of it of sufficient quality that you and a medical
professional, not necessarily a heart specialist, can look at to identify
any clogged arteries. Following that, in two to three years time, will come
new and improved volume produced scanners costing less than $200. They will
become a mainstream product and heart attacks will be a lot less common.

Same for strokes.

With cancer, the development of 'molecular imaging' will be able to detect
tumours 3-5 years earlier when they are easier to treat. Antibody chips
costing 10 cents or less will scan your blood or urine for unique proteins
of circulating cancer cells. The current medical establishments hold on late
stage treatment will be increasingly undermined by technology driving
medical practice to the front end, to early detection and preventive
therapy.

As Grove, looking back on over 40 years in the tech business, remarks:
"technology always wins''. Nobody is forecasting root and branch change
overnight in medicine.
But as Kessler puts it: "even if the things budge slightly from chronic to
early detection, waves of change like a Cat 5 hurricane will rip through
medicine.'' And they will.

Regards

Michael Orme

for The Daily Reckoning

Michael Orme is a financial journalist and former stockbroker.

Editor's Note: A Cambridge philosophy graduate, Michael Orme has worked in
the UK Treasury and in stockbroking, the latter under the legendary fund
manager Nils Taube. He was Mr Bearbull on the Investors Chronicle in the
1970s, then a tech journalist covering Silicon Valley for various journals
in the 1980s, including Management Today, Computing and the Mail on Sunday.
He is currently an Associate at Westhall Capital, a investment house
specialising in Asia.