The crackdowns are well under way.
Regulators are all over Wall Street's mess.
Here's the story. Not long after
the US government cracked down on Microsoft's business practices,
the FBI began its own crackdown of stock promoter rings by late
2000. Hollywood even produced a movie called "Boiler Room." It was
a depiction of the street level activities of these rings.
This larcenous industry was the by-product
of the biggest bull market ever. Who started it? How much of it
was real? That's for us to all find out eventually.
Then the failure of major west coast
Utilities resulting from the oil crunch during the fall of 2000
produced the largest corporate bankruptcy on record when energy
giant Enron finally came clean. The shockwaves reverberated throughout
the continent and culminated in severe emotional outbursts from
both sides (government and private sector). As the events unfolded,
the failure was found to be more than just the simple case of a
company using too much leverage in a recently deregulated market
As the web spread to complex off
balance sheet deals whose illegitimacy were widely known by key
bankers, members of the government, auditors, and management, it
became an increasingly clear case of fraud. So far the case has
only barely brushed up against the banking and government elite,
but has wiped out one of the world's foremost accounting titans,
That in addition to reports of further
accounting abuses resulted in a SEC crackdown on accounting shams,
which resulted in a Congressional crackdown on the analyst community
that has produced a long list of suspects recently drawn out in
front of the firing squad.
The consequence is new SEC regulation
for analyst disclosures, and new accounting standards by the nation's
auditors as well as its rating agencies.
A break down in relations between
the Israeli-US alliance and the Arab world, which became manifestly
clear on September 11th, was likely responsible in igniting Bush's
passion in the broadening crackdown on terror. The President's charm
in matters of foreign policy extended into matters of trade, where
industry complaints about the strong dollar policy and unfair competition
produced a crackdown on steel importers, which has spread to other
industries now, and threatens to include technology also (see Microsoft
The Congress is cracking down on
energy market manipulation it says is the product of record industry
consolidation, thereby excusing anything the government may be doing.
The Fed is cracking down on the way
stock options are accounted for by corporations in their public
filings. The US department of justice is busy cracking down on private
monopolies like Microsoft. God knows I've missed some.
One crackdown after another. But
boiler rooms didn't pop up simply because there were too many bad
apple baby boomer offspring.
The industry thrived in an environment
where valuations were distorted to promote equity investment and
enterprise above almost all else. There is a direct connection between
the process of inflation and the deterioration of participants'
moral codes, or integrity, at least in theory. Inflation has been
shown to be an unjust redistribution of wealth long ago. Of course
those who manage it are corrupt. Or if not, they are idiots because
such a system has been found to be corrupt as well as breed corruption.
The aforementioned crackdowns might as well be Exhibit A.
If the growth of the financial services
sector, for instance, came about as one of the products of the inflation,
it wasn't real, but rather, it was artificial growth. Austrians
would call it malinvestment. Some writers refer to the concept as
overinvestment or even worse, overproduction.
In other words, if people valued
equities above other assets as a consequence of the Fed's
activities, the structure of the entire system of production
would have to shift to accommodate demand that wasn't sustainable.
In the process, the system would (unwittingly maybe) accrue a share
in the future liabilities arising from the inevitable correction
of market imbalances, which arise from the inability of the Fed
to sterilize its policies. If a central bank's activities can shift
the risk premium away from equities, why wouldn't we expect the
result to be a set of incentives for the promoter classes in the
To the extent that the Fed can be
accountable for financing the bull market euphoria, it has indirectly
subsidized the promotion business. The plain fact is that "boiler
rooms" could not survive in a market that isn't subsidized by a
sustainable inflation, at least not on such a large scale. The reason
is the market conditions necessary for their existence could never
exist for long enough to keep them out of trouble.
Similarly, an oil crisis didn't arrive
because the oil industry is ripe with manipulators. What has happened
to our collective literacy today? We've known for years that the
government's regulatory thrust has created bottlenecks within the
energy sectors, as well as the fact that declining production rates
in the U.S. over the past thirty years are tied to physical constraints
defined by Hubbert long ago.
We could easily blame the Fed for
inflation policies that created excess consumption of this commodity
as well as the way in which they've affected the value of the dollar
in the eyes of major US oil suppliers receiving it in lieu of payment
over the years.
How the Fed inflation affects the
government price indexes is of no consequence to the way it affects
oil. In fact, we've known for years that inflation affects each
price in the economy differently and at different times.
Inflation manifests in many ways
but it affects (distorts) the valuation process along the way. When
the price of something rises relative to another thing it is because
the participants in an economic system value that item (good or
service) increasingly higher. If that change in valuation is induced
by real changes in consumer tastes or preferences the structure
of the economy will change in a way as to accommodate the change
in tastes. In this way the free market system knows what to produce.
But when it is fooled into thinking
it knows what it wants by forces that aren't all that sustainable,
the new economic structure turns out to be wrong. If inflation is
the source of the moral hazard, its ultimate manifestation is likely
to be in the debasement of the currency.
Of course, investors' eyes are way
off the ball. Inflation has been accepted over the past 2 decades
to mean the rate of growth in certain government price indexes.
This way, inflation is only a problem when the government reports
that the various price indexes are growing rapidly.
Consequently, we can no longer blame
the government for the affects of inflation on anything but prices
because we don't measure inflation any other way. So long as prices
are "under control" we can't pin the blame for widespread corruption,
financial sector volatility, malinvestment, over regulation, accumulating
economic imbalances, rising unemployment rates, failing global relations,
worsening national default rates, or even select price distortions
on inflation; for price distortions only exist in the first place
when the prices that the government reports all rise at the same
We can't even properly allocate the
blame for the government's deteriorating budget if our eye is on
the wrong ball.
Certainly, the government's expenditure
outlays anticipate the success of inflation in ultimately increasing
its tax revenues. But if in our minds we've redefined the term inflation
to apply only to specific price indexes, we'll see the government's
expected outlays as confidence in a revival of the economy.
There is a difference between anticipating
the revival of an economic expansion and the revival of an inflation
cycle in far-reaching implications.
Not surprisingly, investors seem
to be confused about where to pin the blame today.
The sideshows and witch-hunts have
been drawing fanfare. They were predictable. In fact, so much so
that they're largely boring and old news to us. For instance, the
proper accounting for stock options is important in the right context,
but otherwise irrelevant in determining appropriate valuations today.
Perhaps "redundant" would be the better word.
The question is why doesn't any of
this ever happen on the way up? Could we point to these belated
trends (backlashes) as proof of the extent of the malinvestment
and equity overvaluation? If yes, the blame can be easily identified
by asking the simple question, which has more influence on valuation
in the stock market, the accounting for options or the inflation
policies of the Fed?
Why is it that while stock prices
are appreciating we can look at the poor practices of Wall Street
firms, and know nothing will be done about them until we're on our
way down? The answer is simple. Delusion. But nobody admits to being
part of it even well after the factů in many cases not even to themselves.
It's a matter of mass psychology.
In a bull market, investors treat news like we are seeing today
with skepticism, doubt, and contempt, if they don't ignore it altogether.
Is somebody going to try and tell us that the issue of the proper
accounting for stock options wasn't discussed during the bull market
years of the late nineties?
In fact, I remember discussing the
impact on employment costs and wage prices that would arise under
both conditions - a bull & bear market - as a consequence of the
growing use of this form of remuneration with my own clients way
For those whom these crackdowns are
news, the stock market is probably not seen as overvalued in the
first place. But then we know that a bear market can't endure if
everyone has already discounted the bad news like the lead bears
have. The bears need to eat something.
I'd like to invoke an analogy that
was written once by one of the stock market's legends (either Ben
Graham or Gerald Loeb) where he likened the market to a still pond.
As a stone, representing the information I presume, was thrown into
the water, the impact from the stone would cause waves, or circles,
which grew from the center outward. Each one of these circles represents
information being passed to the next group, and the next, resulting
in larger circles, or waves. This is a bull market.
Academia, mostly, argues that this
can't really be since market values presume that all information
is already discounted. Many technical analysts concur.
I don't. Not at all is the market
efficient in my own experience, for whatever that bit of anecdotal
evidence is worth. The controversy over stock options and other
overly ambitious accounting tactics has been in the public domain
for years. If the market is only discounting it now, how can it
Another example of the market's general
inefficiency could be the leverage the Fed enjoyed while gold prices
fell. The declining price of gold could very well be the chief motivator
helping many investors to delude themselves into seeing inflation
as under control. I know that sounds arrogant, but it's not really.
Ask any layperson what inflation
is? The answer will be straight out of the Fed's own handbook on
how to perceive the world their way; that is, if the person questioned
even knows the answer in the first place.
And while few journalists have the
gall to accuse the government's banking cartels of gold price suppression,
many professional traders in private know very well what the motives
would be, even if they stay in the closet on those views.
Back in 1999 analysts were well aware
of how the gold industry's hedging programs would ultimately reverse
because they were broadly overdone. Today's unwinding of many hedge
books is news to many, but only a milestone to us.
As the bull market in gold grows,
investors could become more confident about what they already know,
and closet gold bulls should feel safer coming out of the closet.
What investors believe and take for granted today they might not
believe tomorrow, and vice versa.
If they believe the government's
definition of inflation, and gold prices rise such that the bullion
banks lose money and investors get it in their pocket books the
credibility of the Fed will decline, and the circles in the golden
pond will simultaneously grow ever larger.
One day far off into the future,
when this discussion is no longer seen as contrarian, the public
will crackdown on the FRB, one way or another. When that day arrives
the majority of people will treat the event as news. The primary
bull market in gold will be in full swing and questioned only by
perma-contrarians looking to call a top. We cannot tell how many
circles will be left to grow in the bull market at that point. But
we can predict the market to be discounting what we already know
What do we know today? We know that
US asset market valuations are distorted, largely as the consequence
of runaway and unsustainable (money & credit) inflation, which is
in the process of breaking down now. We think we know the dollar
is losing its position as the premier global common medium of exchange,
and that its position was also the result of unsustainable forces.
We know that inflation is not under "control," and we are confident
that runaway price spirals and commodity shortages are inevitable
in the not so distant future.
We know that it is only a matter
of time before the public cracks down on the enemy from within.
We are confident that the major banks will see more scrutiny for
their gold hedging as well as other derivative activities, and that
more extraordinary write downs will occur as these markets move
against their off balance sheet positions.
I know - who are we to know anything?
We don't really. But we've been right so far without knowing much
about anything. I think that if you came back to this page in 2
years time, you'd find that the market is still discounting the
2 paragraphs before this one. After all, it is a big rock that's
landed in this pond.