“Don’t be one of those people who go through life pretending not to know what they know… Don’t waste time wishing the world is different than it is… Don’t expect people to be something they can’t.”

— Richard Russo

Hillary, Mitt, Barack or Mike… Who’s to say?

Americans turned to the Hawkeye State this week for a sign, an answer or at least a gentle reassurance of blue skies ahead.

“Assure us,” they say. “Make us believe. The ominous clouds billowing over the interminable American dream can’t open up, can they? Somebody…anybody…just make the subprime mess go away! Make the hangover stop.

“OK, OK, OK,” they confess. “The party crept a bit too far past midnight.”

It comes as no surprise. From Dutch tulips to dot-coms, people fool themselves into believing it’s “different” this time.

The first sip of wine is always better than the last. The more we drink, the better we feel…and the better we feel, the more we drink. But consumption, like most things, comes at a price. For the fourth glass of wine, you pay with a headache. For spending more than you make, you pay with interest.

Bankers and borrowers alike felt rising asset prices, much like the euphoric sensation that fourth glass magically bestows, would go on forever. They acted as if risk were not a four-letter word. At the very least, they believed others (the government) would pay for their sins.

It serves to reason. More often than not, people write checks with their hearts, instead of their heads. The government, the proverbial king of the jungle, has a heart, doesn’t it? It can write another check, can’t it?

So how did so many people make the same mistake? How did John Q. Public trick himself into believing his 2.5 bedroom house would fetch 20% annual returns forever?

Governments, people and even animals find comfort and solace in knowing lots of other entities, people or species have made the same choices…like votes at the U.N., fans in the stands or, if you prefer, sheep following the flock. The aforementioned naturally gravitate toward the crowd. And crowds cannot think. They can only feel and act. So mob mentality, the fundamental crux behind our cultural infatuation with asset inflation, naturally sets in.

So the sirens (benevolent benefactors of cheap credit) continue their ballroom ballad as the well-dressed children (bankers and borrowers) auspiciously circle the chairs. Each child is convinced he’s sharper than the rest. He, not me, will be the one standing when the music stops playing. Or so he, like me, believes.

But this charade had a twist. The chairs weren’t built to hold jubilant children endlessly jumping to and fro. Eventually, every spoiled child takes the fall.

But like good God-fearing Christians, these children were quick to repent. Their sins, they believed, would simply wash away.

“Just give us a pill, Dr. Ben. We’re truly sorry.”

But Ben hesitated. He’s seen this behavior before.

“Come on already,” they pleaded. “Please, please make this irascible little nuisance stop.”

Ben, for better or worse, has a heart. Reluctantly, he conceded. The Fed stepped in. But even the maximum dose couldn’t completely cure the pain. So the vanquished, true to their nature, demanded more. Fortunately, a few other ears were listening.

That’s where Hillary, Mitt, Barack and Mike come in.

In wanting a pill, they want a promise. They want politicians who push populist economic agendas. They yearn for Washington do-gooders who espouse more government intervention atop more cheap credit. What could be better?

So which well-wisher promises the most? That’s hard to say.

Regardless, any political production worth its salt has three main characters: the hero, the martyr and the villain. Heroes (politicians) need a martyr (America’s middle class) and a villain (foreigners and the rich) — and if they’re lucky, a super villain (rich foreigners).

Unfortunately, superhero crime fighting doesn’t come cheap. So to what do our saviors turn? History says they turn to the Treasury. Their bank, in turn, will reluctantly appropriate more imaginary debt. And let’s be honest. Who wouldn’t like a little more Monopoly money to clean up easy street? Who couldn’t stand a little more debt?

Well, homeowners, for one. The ratio of household debt to disposable income now rests at 130%, up from 80% in the early 1990s. Meaning the collateral cash cow fueling American consumption has most likely come and gone:

Meaning America’s appetite for more “stuff” may be waning. Surging fuel prices in the dead of winter certainly won’t help matters.

Should iPod holders beware? Maybe so, maybe not. We’re not so sure.

The feeble greenback kick started America’s waning export markets. The Economist reports that American export growth, currently 12% of GDP, should be able to offset the drag from weaker construction. Meaning foreigners may find iPods too cheap to pass up? We’ll see.

The only problem here: Exports rely on rich foreigners (Southeast Asian super villains). And heroes and super villains rarely play nice for long.

Eventually, all villains must die. All happy endings require punitive justice. So Hillary, Mitt, Barack or Mike must eventually step up.

They know the barricades (quotas and tariffs). They choose their weapons (taxes and legislation) wisely. But the price of war isn’t cheap. Trade wars precipitate more problems than they solve. More often that not, everything gets more expensive. So discretionary items (iPods) may become just that — discretionary.

Meanwhile, emerging markets (Asia, in particular) keep getting richer. They now account for more than 50% of the world’s GDP (using purchasing power parity), churn out 45% of the world’s exports and hold 75% of the world’s foreign exchange reserves.

And while real wages in the developed West are either flat or falling, wages among the up-and-coming nations of Southeast Asia continue growing.

But many in the West want to go through life pretending we’re still the greatest story never told.

If it makes you feel better, keep pretending.

Until next time,

Christopher Hancock
January 4, 2008

Heroes and Super Villains Rarely Play Nice for Long was originally featured in the Penny Sleuth.

The blazer is fashion that’s never quite in fashion, but never truly out of fashion.

It’s also been your editor’s experience that many often associate fashion with style, and in turn, style with elegance. So by default many often equate fashion with elegance.

Nothing could be further from the truth.

“The words ‘stylish’ and ‘elegant’ are often used interchangeably. And yet, one can be dressed in a completely ‘stylish’ manner and not be in the least bit ‘elegant’ while one who is ‘elegant’ is always ‘stylish’ whatever the clothes they happen to wear. In a similar way, the words ‘beautiful’ and ‘elegant’ are often confused despite the fact that ‘beautiful’ is not always ‘elegant’ but elegance is always beautiful,” said Michael Alden of the London Lounge.

Consequently, fashion is often stylish, but seldom elegant.

Alden continues: “Fashion is what is created in marketing departments driven by managers with fierce intensity to ensnare the unwitting and add significant value to shareholder equity.”

Ask yourself… Would you buy the classic Louis Vuitton carry-all if the parent company decided to adjust their particular sense of tact by removing the endless “LV” adorned on every inch of that brown canvas parading as genuine leather?

Would you accept the virtue that some “suit” working his way up the corporate ladder figured out that the best way to paint a $500 price tag on your average pair of Levi’s was to change the name, slightly alter the cut, and pay the current Hollywood “face” a prince’s sum to reap his boss a king’s ransom?

But the debt-ridden American consumers keep spending the money they’ve yet to earn, all in the name of fashion…keeping up with the proverbial Joneses, if you will. But as Coco Chanel once said, “Fashion is what goes out of fashion.”

And right now, the dollar is certainly “out of fashion.” The dollar has tumbled 23% since 2002, according to JPMorgan’s trade-weighted exchange rates. And that’s a significant fall considering Asian central banks keep buying most everything we print.

They kept the greenback “in fashion” to suppress the value of their respective currencies effectively supporting their export driven economies.

But it won’t be long before the export-driven countries of Southeast Asia start actually consuming what they produce…and when that happens, their appetite for our fiat paper will naturally begin to wane.

And those days look to be sooner rather than later. The “emerging economies” aren’t really emerging any longer.

Last year alone, these economies accounted for more than half of world GDP. They now churn out 43% of the world’s exports and hold 70% of the world’s foreign exchange reserves.

And while real wages in the developed West are either flat or even falling, wages among the up and coming continue growing.

Let’s take a look at China’s current dollar exposure. China’s foreign currency reserves recently topped the $1 trillion mark… And it’s estimated that 70% of those reserves are conveniently tucked away in U.S. treasuries.

But the Chinese currency will not remain “pegged” to the dollar forever. The “dollar peg” has given China financial stability, but excess reserves are creating liquidity levels that could ultimately undermine that coveted stability through inflation, excessive asset appreciation, and the persistent practice of banks funding non-performing loans.

But more importantly, the longer China continues to accumulate dollar reserves, the more they stand to lose when the yuan eventually appreciates against the greenback.

A mere 20% increase in the value of the yuan against the dollar would reduce the value of China’s estimated $700 billion in U.S. Treasuries by more than $140 billion — or roughly 6.3% of China’s 2005 GDP. And many estimate the yuan to the undervalued by upwards of 40%. That would equate to a value reduction in China’s treasuries $280 billion — or roughly 12.6% of 2005 GDP.

The same can be said with other Asian central banks. The longer they pile up dollars, the greater the eventual losses. I don’t believe they’ll support our green ink much longer.

What’s the answer for you the investor?

One solution would be to search for value-oriented foreign stocks that derive a majority of their revenues in currencies other than the U.S. dollar.

I also recommend picking up a copy of The Demise of the Dollar by Addison Wiggin. It was actually this book, along with Wiggin’s other work, Empire of Debt, that led me to Agora Financial.

Both works offer a much more comprehensive and enjoyable explanation of the current and future state of the American currency than presented here. And more importantly, they offer a more thorough guide on what actions you, the investor, are encouraged to take.

And now, you can you can learn savvy ways to turn the roller coaster ride of the U.S. dollar into one of the most important investing decisions of your life.

Sincerely,

Christopher Hancock
December 8, 2006

Small-Cap Fashion Stocks was originally featured in the Penny Sleuth.