Agora Financial’s Rude Awakening

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Dubai, UAE

• The case of the October Crash…and the “Crash Baby”
• Tracking “Dow triangles” all the way to boom…or bust,
• A few credit card statistics that will make your eyes water and more…

Joel Bowman, reporting from the United Arab Emirates…

“It’s barely yours on loan,
What you think you own.
The place that you call home,
The ideas in your bones.”

~ “Time Trap,” Built To Spill, 1999.

Leave it to a relatively unknown “indie” band from Boise, Idaho to offer the
most succinct summary of the state of today’s American consumer.

Whether lead singer and songwriter, Doug Martsch, was thinking about sub-
prime mortgages, credit card debt and mind-numbing television shows when he
sat down to pen these lyrics at the turn of the century, we do not know…but
we doubt it. Still, Martschs’s inadvertent fortune telling gives us food for
thought.

There are some 20,000 credit cards available to the American consumer today.
They come in all sorts of “personalized” colors and designs and carry equally
“personalized” terms of use. Whether you are the businessperson on the go or
a needy college student, credit card companies have devised a nifty way to
help you accrue debt with a feeling of independence and empowerment.

Lunch at Smith & Wollensky Steakhouse for the partners of the firm? Throw it
on the Gold Amex. Emergency Euclidian geometry textbook/drinks at happy hour
for you and your study buddies? The Discover Open Road Card For Students has
you covered.

Such a bevy of options has enabled Americans to effortlessly breeze their way
to record levels of personal and national debt.

According to Paul Banister of Bankrate.com, there are around 1.2 billion
credit cards in use in the United States today; roughly four cards for every
man, woman and child in the country. American’s say, “put it on the card,”
for about a quarter of their personal expenditures, helping the average
household to bury themselves under $8,400 of credit card debt.

For the luxury of living this life-on-loan, the average American family pays
around $1,200 dollars annually in interest on their plastic. Including those
pesky fees, that’s about $50 billion in revenue for the credit card
industry…every year.

Ma and Pa’s profligacy with the plastic is not setting a particularly good
example for junior, either. The average college student graduates with no
less than six credit cards. One in seven has even managed to rack up over
$15,000 in library fines/bar tabs.

Disturbing as these statistics are, this final one has to take the cake.
According to Mr. Banister’s study, “9 out of 10 Americans claim credit card
debt has never been a source of worry.”

And we wonder why the state of the nation’s finances is in such shambles…

In today’s Rude, the esteemed Mark Skousen offers his thoughts on market
crashes and the magic national credit card or, as it is more widely known,
the Federal Reserve. Enjoy…

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The Ghosts of October 19
By Mark Skousen

Certain dates stand out in my life. One is October 19, 1987, the day the Dow
Jones Industrial Average suddenly collapsed by 22%. That day is also
significant because it happened to be my 40th birthday. Ever since then, I’ve
been known as the “crash baby.”

Most of my broker friends and investors were in a somber mood that Monday
evening, stunned by the 509 point drop in the Dow. I was ebullient because by
some fortune I sent out a “flash alert” on September 8, 1987, six weeks
before the crash, telling my subscribers: “The coming credit squeeze could
devastate the stock and bond markets; get out now! I advise you to sell all
stocks and long-term growth mutual funds.”

That evening, my wife had arranged a surprise birthday party. I had a lot of
fun, but the party ended early as friends rushed home to check the financial
news overseas.

Was the crash a portend of something more ominous, another Great Depression
perhaps? After all, a similar stock market crash occurred in October, 1929,
followed by the worst economic collapse in world history.

One of my technical trader friends was deeply worried. His trading system was
based on moving averages of stock indexes like the Dow. At the New Orleans
investment conference a month later, he showed a chart of the Dow with a
“triangle” formation. He pointed to the triangle. “If the Dow breaks below
the triangle formation,” he warned, “the Dow could fall another 1,000 points
or worse!”

I thought it was all a joke, but he was dead serious. He staked his
reputation on his prediction. A few days later, the Dow started falling
again, ominously below the point of the triangle. Yet, miraculously, the Dow
never crashed. In fact, it rallied to new highs. My friend soon ended his
newsletter, shamed perhaps by his failure to predict the next Great
Depression.

As a macro-economist, I look at the economic fundamentals before making a
prediction. And, in the case of the October, 1987, crash, the economic
fundamentals looked to me to be largely sound. Business across the nation was
doing well, both before and after the crash. The economy was growing,
inflation was under control, and interest rates were relatively stable. So
while I anticipated short-term trouble, I thought the long-term outlook
looked good, and it wasn’t long before I started recommending stocks again.

So why did the Dow Jones Industrial Average collapse by 22% on October 19,
1987?

Historians point to several factors, such as comments by the Treasury
Secretary about a weak dollar and trade deficit, but I believe the crash can
be blamed in large measure on an impulsive “Mr. Market” and the technical
traders who encouraged mindless trading based on a line on a chart rather
than business fundamentals. Too many investors were listening to my friend
with the charts.

In the summer of 1987, telephone-switching between no-load mutual funds was
all the rage, based solely on a technical charting system of a 39-week moving
average. Mutual fund investing was extremely popular, to the point where you
couldn’t go through a meal at home in the evening without a broker calling
and telling you about the latest mutual fund. Few investors knew or cared
about the companies the fund managers were buying. Just follow the line on a
chart showing the mutual funds were moving higher. The brokerage business had
become so successful that a book was released that year written by a Merrill
Lynch broker entitled No Experience Necessary: Make $100,000 a Year as a
Stockbroker (Simon & Schuster, 1987). How? By buying and selling mutual
funds.

As a result, the market got way ahead of itself, with everyone following the
same charts. Then when the price of the mutual funds went below their 39-week
moving averaging, on the Friday before the Monday crash, everyone sold at
once. The October 1987 crash was purely a technician’s folly, and with the
business fundamentals sound, the market quickly recovered within a few weeks.

As we celebrate the 20th anniversary of the 1987 crash, the media has
recently asked me repeatedly this question: What factors could cause the
stock market to collapse again? Or are we immune to another financial
disaster?

Here is my answer: There are several potential financial crises out there
that could cause the market to suddenly turn south. At the beginning of this
year, I attended the American Economic Association meetings in Chicago, where
I was fortunate to attend a luncheon with Fed chairman Ben Bernanke. He
wouldn’t take questions about current Fed policy, including interest rates,
but he spoke volumes when he gave his formal talk to us at the luncheon.
Ostensibly, the topic was “Central Banking and Bank Supervision in the United
States,” but reading between the lines, it was clear to see that Bernanke was
worried about a financial storm ahead.

In his speech, he used the terms “crisis,” “risk,” “panic,” “threats,”
“stress,” and similar words at least 36 times. 
 
Bernanke said that the Fed has set up a “crisis center” to handle potential
global financial problems - to anticipate them, and to deal with them if they
occur. What are the possibilities?
 
* A dollar collapse, like the one Paul Volcker suggested would happen in the
next few years. (We’re certainly moving in this direction.)
* A non-dollar currency crisis in Asia, Europe or Latin America (shades of
the 1997 Asian currency crisis).
* A housing crash and foreclosure crisis (we suffered one this summer).
* A major terrorist attack on a financial center, such as New York, London or
Tokyo.
* A sharp unexpected rise in inflation.

Bernanke revealed the various policy measures the Fed might take in response
to a crisis: buying government bonds, providing overdrafts and other short-
term credits to banks, facilitating currency swaps (to boost the dollar), and
“securities lending,” that is, lending money to institutions to buy stocks.
 
In sum, the answer is always the same: inject liquidity into the system to
keep the stock market from collapsing. So far it’s worked like a charm. Alan
Greenspan applied this bailout policy several times during his 19-year tenure
– during the 1987 crash, and 1997 Asian currency crisis, the Y2K computer
threat, and the 2001 terrorist attacks. (His new book “The Age of Turbulence”
addresses all these events in detail.)

Bernanke had his first test this past summer with the mortgage credit crunch. 
The world’s markets were on the verge of collapse on August 18 when the Fed
intervened…by injecting liquidity.

But what if the same old medicine stops working, and the Fed injects
liquidity, but the dollar and the stock markets keep on falling? There’s only
one protection: buy gold! And buy the products gold will buy. And that raises
the specter of hoarding and the collapse of the world monetary system. And
that leads to social unrest and…the institution of new emergency powers by
the Federal government.

[Joel's Note: Mark Skousen is a financial economist, university professor,
and author. He is editor of Forecasts & Strategies, writes his own free
weekly e-letter and produces Freedom Fest, the “King of Worldly Conferences,”
scheduled for July 9-12, 2008, in Las Vegas.

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———————————————————

Rude Endnote: In our effort to provide you with daily Rude columns, we
occasionally make errors. These are errors anyone with the luxury of a weekly
or monthly deadline may not make…at least not as often.

Rude captain, Eric Fry, would like to issue to following correction to his
Wednesday column, Bail-Out Nation:

Dear reader,

Due to a careless typo, we mistakenly referred to CDOs as SIVs in Wednesday’s
column. When we wrote, “The fund will buy AA- or AAA-rated SIVs,” we should
have written, “The fund will buy AA- or AAA-rated CDOs.” We made a similar
error a second time, later in the column. Suffice it to say that we apologize
for confusing SIVs with CDOs, and will endeavor to be more careful in the
future, especially when referring to the initials of securities that almost
no one understands.

We’ll now hand you over to our near-flawless cohorts on our Baltimore desk.
Addison and Ian are knee-deep in today’s data and will have it all sorted,
filed and commented on in today’s 5-Minute Forecast, due in your inbox
shortly after lunch today.

Cheers,

Joel Bowman
Rude Awakening