Gold & Silver, STAFF NEWS & ANALYSIS
David Stockman … Right and Wrong
By Staff News & Analysis - September 19, 2014

Fed and TWTR Overvaluation, Evidence of Looming Market Crash … The Federal Reserve Wednesday reassured investors that it will hold interest rates near zero for a "considerable time" after it ends the bond-buying program known as quantitative easing in October. In response, the Dow Jones Industrial Average (,DJI) closed at a new record high. Former Director of the Office of Management and Budget and author of the book, The Great Deformation, David Stockman, has significant concerns about that very policy. – Yahoo

Dominant Social Theme: Don't worry about the stock market. Relax … and enjoy.

Free-Market Analysis: It's hard to pick stocks these days because what's going on is so wrong. Surely a crash must be looming at any second.

And yet when Yahoo sat down with David Stockman for an interview, the questioner pointed out that since David Stockman had last warned people to leave the insanity of the modern stock market, stocks were up 28 percent!

Stockman answered that the market would eventually conform to his expectations and many people who stayed in were going to end up losing a great deal.

And yet that 28 percent lingered …

That's a lot of money to leave on the table – even if the percentage is manipulated by a few large stocks, etc.

Here's more:

… In an interview with Yahoo Finance, Stockman blamed Fed policy for creating that madness … "We have been shoving zero-cost money into the financial markets for 6-years running," he said. "That's the kerosene that drives speculative trading – the carry trades. That's what the gamblers use to fund their position as they move from one momentum play and trade to another."

And that, he says, is not sustainable. While Stockman believes tech stocks are especially overvalued, he warns that it's not just tech valuations that are inflated. "Everything's massively overvalued, and it's predicated on zero-cost overnight money that continues these carry trades; It can't continue." And he still believes, as he has for some time – so far, incorrectly – that there will be a day of reckoning.

"When the trades begin to unwind because the carry cost has to normalize, you're going to have a dramatic re-pricing dislocation in these financial markets." As Yahoo Finance's Lauren Lyster points out in the associated video, investors who heeded Stockman's advice last year would have missed out on a 28% run-up in stocks. But Stockman remains steadfast in his belief that the current Fed policy and the resultant market behavior cannot continue.

Stockman is correct; but there is a theoretical "reality" and then there is real life as it occurs in real time. Yes, stocks are absurdly puffed up via asset inflation, regulations that concentrate capital flow and even government policies that create plunge protection teams and actively encourage large central banks to intervene to stabilize the market with asset purchases. But that doesn't mean a collapse is imminent.

We understand what's wrong, but we also understand that the powerful upward bias of the marketplace can yield considerable profits to those who approach markets intelligently and keep in mind the balance between risk and reward.

This Wall Street Party may end soon enough, but Stockman's perspective followed theoretical logic and thus he left 28 percent on the table. His analysis was right and reasonable. He's a courageous man in this regard. And yet from an investment standpoint he was "wrong."

An alternative approach, of course, is to deny the wrongness of the current system entirely. That's what The New York Times just did in an article entitled "Monetary Policy: The Fed Is Boring Again. That's a Relief."

For the last six years, Federal Reserve policy has been sexy, or at least as sexy as monetary policy can ever be. Leaders of the central bank have had to improvise answers to tremendously consequential questions. What should the Fed do to combat a severe financial crisis? (Pretty much anything they could think of, and then some, was the answer.)

… But now, the big questions of Fed policy have mostly been answered, all the more so after this week's meeting of the Federal Open Market Committee and the news conference on Wednesday by Janet L. Yellen, its chairwoman. And that is terrific news.

… You may not like the Fed's policy strategy. But the problems with it now are not a lack of clarity or transparency. Yes, something could come along to throw an unexpected wrench into all this, but if the American economy proceeds pretty much the way it has the last couple of years, with steady and gradually improving growth and few inflationary signs, we know what Ms. Yellen's policy will look like.

…That may be less exciting for those of us who make a career out of parsing the words that emanate from the Marriner S. Eccles Building, the Fed's headquarters here. But it's better for everybody else …

Stockman's analysis is rooted in theoretical reality rather than current reality. This sort of analysis is just plain nuts.

There's never been a central bank prognostication – or adjustment for that matter – that really worked out. No one in central banking anticipated the 2008 crash, though later reports tried to pretend that some "good, gray men" did get it right.

But they didn't. They can't. They won't. And this time won't be any different.

The idea that the next years are going to be smoothed by a recovery that will create a kind of Fed-on-autopilot is ludicrous. The Golden Bull remains in force, for instance. From the standpoint of the 1970s, we seem to be located around 1976 or 1977. We never had a gold runup and blowoff that would signal the end of the cycle.

What we had instead was an unprecedented central bank intervention and probably some sort of gold manipulation. And thus, this is a stock market on borrowed time.

It seems to us that this bull may run on for a while, thus making Stockman's predictions more wrong still. On the other hand, the fall is the market's bloodiest time …

And that's why we've pointed out that people should be careful if they are going to participate – that they should hedge and allocate and take profits to put into gold and silver.

This Wall Street Party is a wild ride, and wrong in so many ways. And yet there is no arguing with 28 percent.

After Thoughts

That's why David Stockman is wrong, even though he's very right.

Posted in Gold & Silver, STAFF NEWS & ANALYSIS
  • Bruce C

    The “problem” with Stockman’s analysis is that it counts upon the central banks and governments losing control and investors responding rationally, and those are low probability events.

    To say that ZIRP, for example, is unsustainable may be true in theory but as long as the central banks are willing to buy bonds at any price there is no reason why it has to end. The central banks create the currency they use to buy the bonds so they have unlimited “funds”, no limit to the size of their balance sheet, and no need to profit from those “investments.” Investors who understand that have no basis to judge when enough is enough because it’s all funny money.

    Even government balance sheets have no theoretical limits. The US government is officially in debt for $17.5 trillion and borrows an additional $1 trillion per year that will probably continue indefinitely. Investors don’t seem to care. Will they ever care? Probably, but when is anyone’s guess, because it is already mathematically impossible to repay, so there will have to be some other reason that triggers a change of mind.

    Ditto for Japan, which is 3 times “worse off”, and yet 10-yr JGBs pay less than 1%. Absolutely amazing.

    No one seems to care about the various wars going on. That probably means that people feel like they are under control, and as long as they seem to be then everything will keep muddling along.

    I think that something has to happen that the CBs and governments can’t control for the financial markets to correct. Something like a natural disaster. Solar flareups that knock out communication satellites or a contagious disease that kills millions within a few weeks is what it might take (not just a few thousand).

    • $6618258

      Some good thoughts, thanks!
      More things to consider 🙂

  • $6618258

    I think if unlimited naked short selling of gold & silver were not allowed as well as not permitting governments to directly intervene in the stock market, neither the stock market could have been propped up nor nor the price of precious metals could have been artificially suppressed for so long. But the Central Banksters (who have unlimited power to do naked shorts on gold & silver & who can print up unlimited amounts of cash to intervene directly in the Markets) will not have the power to get away with this nonsense forever. In the end, I think Mr. Stockman (& others who see today’s economic reality) will be proved correct, only wrong on their timing. It’s very difficult to correctly be on the “right” side of the trades in manipulated markets like we have today. But eventually, even the powerful Central Banksters will bow to the forces of economic reality & people will wake up to the reality that fiat currencies are headed towards their true value: zero! (as have virtually all fiat currencies in the past).

  • Bolt Upright

    My “current reality” is investing in hard assets like bung fodder and straights. I’m ready.

  • Chris Hulme

    It’s alright saying take profits; but when?
    Do I take them last year, or now, or next year?
    Stockman has only to be right once, and my money’s on him!
    As Dubya used to say, ‘this suckers going down’!

  • Chris

    The gigantic amount of money printed had not reached the man on the street. The shorting by bombing the commodities markets, which some people claimed is led by Fed, had kept prices in check to reduce inflation. So money had found its way into all kinds of assets and derivatives. Assets and derivatives derived their value from income generated by the other assets and income depends on consumption. If average income of man on the street had not increased and the increase in consumption is based on increased borrowing, then at some point, the limit to borrowing will be reached and consumption will fall, causing assets and other derivatives prices to fall. This whole financial structure is so crazy where there are so many levels of derivatives where the value of one derivative is derived another derivative. Example CDOs derive their values from the borrowings in the mortgage market and CDS is an insurance for the CDOs which are not AAA rated and then the insured CDOs which are not AAA rated can then be sold again as CDO AAA rated called CDO squared. There are most likely some other nonsense going on in the interest rate market which is not revealed yet until the next blow up happens. It can be as simple as banks taking risks in fixed rates vs variable rates and when variable rates increase dramatically, someone will lose his pants. This is not investment, this is gambling. After the crash of 2008, all these financial inventions should have been disallowed especially the still unknown interest rate derivatives worth quadrillions of dollars. The present scenario is that interest rate cannot be raised. US, Japan and Europe sovereign debts are not viable even with a small rate increase. It is like waiting to die. When inflation flare up, nothing can be done to control inflation. I think we are looking at hyperinflation at some point as confidence will snap.

  • Jim Johnson

    Bush shrugged and said “The economy will take care of its’ self.” The former leader of our nation. Gold and silver are the panic index. Keep it down and panic stays down. The days of you and me having our money work for us are over. As Carlin quipped- ‘It’s a big club, and you ain’t in it.’ Go ahead and lose your shirt playing in their sandbox. One little problem with all this is our Constitution must be violated for it all to prosper. And then there is this damned Internet… The old folks learned to keep back 5% in precious metals, if only for a sense of security and a basis for keeping a clear head. Avoid that at your peril. The up side is there has been plenty of time to prepare.

  • MOLON LABE

    Fascism As an economic system, fascism is socialism with a capitalist veneer. The word derives from fasces, the Roman symbol of collectivism and power: a tied bundle of rods with a protruding ax. In its day (the 1920s and 1930s), fascism was seen as the happy medium between boom-and-bust-prone liberal capitalism, with its alleged class conflict, wasteful competition, and profit-oriented egoism, and revolutionary Marxism, with its violent and socially divisive persecution of the bourgeoisie. Fascism substituted the particularity of nationalism and racialism—“blood and soil”—for the internationalism of both classical liberalism and Marxism.

    http://www.econlib.org/library/Enc/Fascism.html

    • Gil G

      And no true Christian can do wrong so those who did wrong were just false Christians.

      • That’s a meaningless comment and irrelevant to the molon labe comment and to the content of the link.

  • PlasticMoney888

    No one in central banking anticipated the 2008 crash,
    No one in central banking anticipated what it is they caused.
    Now it’s The Wealth-Effect Part 3.

  • Friend of John Galt

    Stockman may be right on the theory, but if he’s wrong on the timing, then his advice is not particularly helpful.

    The strategy of the individual investor is, by necessity, tied into the effect of tax rates. Starting last fall, it seemed like the market was long overdue for a “correction” of at least 10% (if not more). This correction is not the expected “crash” that’s been discussed on this forum for some time.

    With that prospect in mind, I began gradually closing long positions where the stocks appeared to be fully valued. (Morningstar’s analysis is helpful, as they give a “consider buy at xx” price, value price, and “consider sell at yy” price for each individual stock that they follow. Other services give similar analysis reports.) I’ve found it helpful to use Morningstar as a starting point in my decision process.

    But the tax haircut (up to 20% on capital gains, before “high income” penalties kick in) is also must be included into the formulation. I calculated the approximate sum of capital gains and dividends I could receive without triggering some of the worst aspects of the current tax policy, and kept my total investment and other income below the trigger point. This limits how quickly I can liquidate investments. However, I did liquidate stocks in 2013 up to my limit (mostly between October and December). I have finished further liquidation within my limit for 2014. At this point my portfolio is roughly 1/3 cash. About 10% in gold and gold equivalents (foreign sourced). Foreign stocks are about 20% and US stocks/ETFs/mutual funds are still near 50%.

    The stocks are focused on investments with hard assets, though the mutual funds/ETFs are more broadly focused.

    With any luck, I should be able t liquidate another 10% or more of my holdings early next year (should conditions permit).

    The market STILL has not had the (now long expected) “correction.” And the “crash” remains a possibility with just the wrong sort of event that sets off a panic.

    It is frustrating that the gold market has been so heavily manipulated, but it does offer a “buying opportunity” for the metal.

    As Bruce C says, Stockman’s analysis “counts upon … investors responding rationally…” I fully agree that such an outcome is highly unlikely.

  • Harry Skip Robinson

    What I can understand, is what is making the USD so strong. Is there anyone that can explain this.

    • A race to the bottom – and everything else is worse?

    • Bruce C

      Fundamentally it’s due to a demand for US dollars.

      Investors who want to buy US bonds or stocks must first convert their foreign currency to US dollars – which means they have to buy them, which adds to US dollar demand.

      Individuals like those in Argentina or Japan (and probably Europe soon too) who want to preserve their purchasing power will eagerly exchange their crappy currency for US dollars, believing dollars to be more stable – again, creating demand for US dollars.

      The “USD” is actually the US dollar index, which is a weighted average of six other currencies relative to the dollar: consistently of roughly 57% euro, 14% yen, 12% Pound sterling, 9% Canadian dollar, 4% Swedish krona, and 4% Swiss franc. Abenomics is abusing the yen, the BOE continues to pound the sterling, and now that the ECB is itching to devalue the euro so the “dollar index” has been rising to reflect foreign currency weakness.

      Oil and most other commodities must be – or traditionally are – transacted in US dollars so foreign consumers must buy dollars to buy those things – thus creating a demand for US dollars.

      When investments in foreign countries (e.g., emerging and developing markets) are sold the proceeds are in the foreign currency so the conversion of those foreign currency profits back into US dollars creates a demand for dollars. (As the Fed’s QE tapers off less low-interest rate dollar loan supply is available to speculate in foreign markets, so profits are taken.)

      Foreign exporters are choosing to keep the dollars they receive for their products rather than converting them to their local currency, thus creating demand for US dollars.

      Financial restrictions on Iran and Russia have drawn money out of those currencies and into US dollars.

      The various wars in the world are all because of US interests and investors are betting that the country with the biggest and strongest military will ultimately bully its way, so they don’t want to be holding the currency of the oppressed countries, thus US dollar demand.

      • Harry Skip Robinson

        Thank you, that was helpful. When is the rest of the world going to catch on as to how weak our economy really is. 1/3 living at or near the poverty line, 1 in 6.5 living on food stamps and gov. spending like it grows on tree, pun invented. I think I saw a 0.2% growth rate for July or Aug and that’s probably made up or will be adjusted downward later.
        Anthony, a friend likes to say about currency trading, it is like standing on the top of the empire state building with all the paper currencies in your hand, dropping them all at once and seeing which one is going to hit the ground first.
        Do you think a portion of the higher stock prices here in the US is due to the stronger dollar and to much cash chasing reasonable returns. How about higher housing prices of the last 2 to 3 years? What I am asking, is that since we are experiences higher process in these two investment areas, could that be partially a result of currency debasement. Many of the lower prices homes being sold down here in Florida are for cash and are being purchased by pure investors. Prices are already getting out of the affordability zone for many folks and what’s left of the inventory in the market is in really poor condition.
        I thought it interesting that Hong Kong turned down the Alibaba IPO and the NY Exchange took it, despite it being a Holding Corp. in Grand Cayman or at least that is what CNBC said.

        • Bruce C

          A big reason why foreigners are buying US real estate and other assets is to convert their local currencies to something tangible. When the dollar was relatively lower during the last few years it also gave them some relative leverage. They think the US is still the best currency and country to invest in because of its laws, etc.

          However, as the dollar “strengthens” new investors face a head wind not only in RE but also stocks. One reason corporate profits have risen is because of the lower dollar, but now profits will be worse. The only “hope” is that US consumption increases because of their greater buying power to compensate.

          In any case, this may be the last hurrah, becasue when (not if) the dollar goes south again it’s going to take all the rest with it. Globalization works both ways.

          • Interesting, thanks.

          • Harry Skip Robinson

            Agreed. The large number of investors in the So. Florida residential RE market is causing higher prices, excluding many 1st time home buyers and those in the lower socio-economic spectrum. Their redistribution of wealth and regulatory policies are back firing on them and they can’t just all of a sudden tell the world that what they have been saying for 80 years is BS and isn’t working. That we need to go back to the free market. Stagflation is here and there is only one way out, at least civilly.

  • Joelg

    That 28% gain in the stock market is really a statistical mirage applying mostly to big cap stocks (big multinationals). Smaller cap stocks (small companies) are DOWN as much as 40%, and may be a buying opportunity (and will be a better value if they crash further). Warren Buffett has lived through many crashes without liquidating his holdings, and prospered (just good luck and monetary policy?). Stockman’s graphs and arguments all make sense, which is no doubt why Soros’ hedge fund has hedged the S&P index as a market proxy. Time will tell…

    There are reasons other than theoretical rightness or wrongness to consider. Given the tax rates, the capital gains investment system is a tilted playing field favoring government pension funds and hedge funds (who may invest on behalf of pension funds) over individuals. Government pension funds are tax-exempt (0% tax rate). Hedge funds (not sure if Stockman is still in that business) have a special 15% tax rate (crony capitalism). Individuals get whipped with the stick. In high tax locales like NYC: Federal, state, city and Obamacare tax surcharges on individuals can mean handing over 50% of your gains to tax collection agencies. If you feel a strong patriotic duty to maximize funding for the 134 USA.gov wars…

    Since pension funds are the big stock market players and many by law have to stay invested, even if hedged, it will likely take government manipulation (ala 2008’s engineered credit crunch) to trigger a crash and bailout Stockman’s prediction. Even a brief crash followed by an immediate rebound to a new high could make Soros much richer. Perhaps the fix is in, and watching from the sidelines makes sense. But like with China under Mao learning not to fear a USA nuclear attack, a stock market crash is an event longtime individual investors must learn to live with (and need to be able to weather). If your debt is low and you have expenses covered for a long downturn, then a crash will be an opportunity to buy good businesses for a bargain (ala Buffet).

  • Gil G

    What kind of perfect storm would it take for gold and silver to have their day in the sun? If the economy doesn’t fall far enough then life goes on as per usual. If the economy totally tanks then those with precious metals risked being robbed.

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