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Why Hasn't "IT" Happened Yet?

December 27, 2005

To listen to the Bears over the past few years, you would have thought we would all be in breadlines and soup kitchens by now. So far, all of the ranting about doom and gloom sounds more like the boy who cried wolf than accurate forecasting. But I do believe that when IT happens, things are going to get much worse than anyone can imagine. Even though the markets, at their lows in March of 2003 had lost over $6 trillion of value, IT still hasn't happened yet.

What is IT? Why hasn't IT happened and When will it happen?

IT is a major financial contraction. IT is an irreversible downward spiral that takes everything down with it. IT will be started by a catalyst, a spark that will get everybody's attention. But IT is already built into the system, like a bunch of oily rags, all in a pile waiting for internal combustion or a match or a spark to ignite. Some of the candidates for the catalyst include the following:

1 ) Crash of the Dollar 2) Stock Market Crash 3) Derivative meltdown at a major bank 4 ) Nuclear War 5) Major terrorist attack on the US (Nuke, Bio or Chemical) 6 ) Major Corporate Debt Default 7) Major Municipal or State Default 8 ) Foreign Dumping or perhaps simply a refusal to continue buying US Treasuries

These are the matches. By themselves, most can be weathered. But when combined with the poor fundamentals of the economy and stock market, and $800Billion Trade and $500 Billion budget deficits, they can turn into an inferno.

Below are some of the oily rags, waiting to ignite.

  • Massive amounts of derivatives ($85 + Trillion)
  • Over valuation of the Dollar
  • Overvalued stock market ( 30+ times last 12 months earnings)
  • Massive build up of corporate debt
  • Record Low cash levels in mutual funds
  • Massive build up of personal debt
  • Under-funded pensions (Gov. & Private)
  • Housing bubble ? I ) Deflation or Inflation ü Municipal and State deficits

But one thing for sure, IT will not happen as every body expects. Some are waiting to see the writing on the wall, Most want to see the fire before they will believe there is danger. Things haven't really changed that much over the past 3 years. Investor attitudes are much too complacent. They see nothing to worry about. Yet Liabilities have been outpacing income for several years. Since Year 2000, income growth has slowed while expenses have continued to accelerate.

So why hasn't IT happened yet? Because the Fed has played Fire Chief and kept liquidity flowing. But the Fed can NOT keep the spigots wide open indefinitely. All they are doing is delaying the inevitable, not curing it. Adding liquidity is only making our future economic problems worse. It's the same as adding tons of kindling. Excessive liquidity was the main cause of the 90's Bubble in the first place and for that matter, every other bubble throughout history. The Crash in 1987 came as a shocker: But Fire Chief Greenspan and his liquidity hose was on the phone to the banks and brokers offering liquidity to anyone that needed it. He saved a melt down with five minuets to spare. The downturn in 1997 was again saved by Allan and his liquidity hose. In 1998, the Long Term Capital Management debacle caught almost everyone flat-footed. And once again along came the Fed to the rescue and voila, problem solved. Then came Y2K and the Fed just automatically turned on the printing presses to prevent any problems. All of these problems had similar characteristics - they were sudden and solved by the Fed with increased liquidity.

This chart shows that the fabled liquidity that Wall Street crows about doesn't exist. This chart is a comparison of M2 (liquid money) to the NYSE capitalization. (If the Nasdaq's capitalization were included the chart would look even worse.) Liquidity bottomed out in the 1st quarter of Year 2000. It is only slightly higher today, but not enough to make a case for a long lasting bull run based on liquidity.

In fact, the Fed's solutions have once again driven stock prices to levels of irrational exeuberance, exceeding even that of 2000.. Too much liquidity has made interest rates so low, corporations and individuals have taken on unmanageable debt loads. Too much liquidity is driving the housing bubble. Too much liquidity must eventually devalue the Dollar. Adding more liquidity doesn't solve any of these problems, it just exacerbates them and delays the inevitable, and quite possibly will make matters worse, when IT does happens.

When will IT happen? It already is. IT is happening all around us. The "oily rags" are there for everybody to see. Debt continues to pile up. The market is still over valued. The Dollar is sagging. No, these aren't things that have "always been going on" as some pyromaniacs on Wall Street would have you believe. No, they haven't happened yet, but we are getting close. The potential for a stock market crash is always there with a market so overextended. Derivatives are only getting worse, now totaling more than $85 trillion, according to the Comptroller of Currency. The total of derivatives is 7 times bigger than the entire US GDP. How risky is that?

What are the odds of any one of the catalysts happening? I don't know It varies. I put the odds of a nuclear war very, very low. I hope (I imagine the North Koreans or Iran, might think differently). The odds of a derivative meltdown taking down a major bank are much higher. Barings Bank's failure and Long Term Capital's failure have shown us that derivatives can cause a financial disaster over night. The top banks are playing with matches, big matches, and there is almost no Federal regulation on derivatives. Warren Buffett referred to derivatives as financial time bombs. The odds are that the catalyst will come from the credit markets. Maybe one foreign bank will start to dump US bonds. Which would cause US long term interest rates to spike up and the Dollar to crash Could this happen? Could this have a domino effect? Japan with its 40% savings rate, has been the biggest buyer of our bonds both public and private, now looks like its finally starting to come out of its 14 year recession: If it hasn't, it will, sooner rather than later, and then they will need most or all of their savings to invest in their own country. Will they also start selling its massive holdings of Treasuries?

Anyone of which in turn could lead to a market decline/crash. long term rates look like they may have begun climbing ever since Greemspan's last 1/4 pt. cut. And the stock market has been in a parabolic mode for almost two months now.. The big question is how high and how far can the market to continue to climb?


If there is any doubt that the world's investment community is suffering from irrational exuberance, just look at the German and French Stock Markets; in the face of 12% unemployment rates and less than 1% growth rates to look forward to unemployment rates can only get worse and yet their Markets are making new five year highs just as Paris is burning after two solid week of Muslim rioting.

There is certainly enough smoke to know there are still problems with stock and bond markets all over the world. Anyone who is tired of hearing about all of the dire predictions from the bears should be doubly careful since some of the most die hard Bears have finally tossed in the towel and turned bullish: When the last Bear turns bullish or neutral, watch out below. Anyone that is waiting for IT to arrive before they act is playing a dangerous game. Now is the time to act to protect your assets. If you wait for IT to be obvious, it will be too late as you get trampled in the mad rush for the exits.


For those of you who do not know how to handle the coming bear markets and insist on always being fully invested rest easy. There is still one ongoing bull market that is still in its infancy. GOLD. After getting into cash by liquidating all of your long term stock and bond holding, begin a program of dollar cost averaging and start buying Gold Bullion and gold stocks or what might be even better is to purchase any one of the well known Precious Metals Funds that are out there and stop worrying. You will more than double your money at a minimum somewhere over the next five years.



Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]


27 December 2005

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