The Rude Awakening
Wall Street, New York
Tuesday, August 23, 2005
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By Justice Litle [Ed. Note: Justice is the editor, along with resource
giant, Kevin Kerr, of the Outstanding Investments
newsletter. Check out what all the fuss has been about
lately right here: Outstanding Investments There are few places on earth as beautiful as Lake Tahoe in
late summer. Those who only come for the skiing don't know
what they're missing. At 6200 feet above sea level, a refreshing breeze takes the
edge off summer's heat. (So much so, in fact, that the
locals have no need for air conditioning.) The mountain
air, thin and clear, makes the crystalline water of the
lake seem bluer than the sky. Against a backdrop of rich
green pines and the majestic peaks of the Sierras, Tahoe is
truly breathtaking. If you choose to stay a while, you'll soon be introduced to
the concept of 'Tahoe time.' Recreation is taken seriously,
hustle and bustle much less so. Business lunches are
conducted in short-sleeve shirts and sandals. Cool,
mosquito-free evenings are meant to be spent outdoors-
preferably with beverage in hand. But as you become acquainted with summer life at the lake,
winding your way through the towns and communities that dot
Tahoe's 72 miles of shoreline, you will notice something
quietly disconcerting. There is one thing, or rather the
looming prospect of one thing, that challenges the
tranquility of this scene. Fire. It doesn't take long to notice the wooden signs posted by
the Forest Service at various points around the lake.
These color-coded advisories alert campers, hikers and
assorted recreationalists to the estimated fire danger for
any given day. Cool and calm after a rare sprinkling of
rain? "FIRE DANGER TODAY: LOW." Three straight weeks of
sunshine and unabated dry heat? "FIRE DANGER TODAY: HIGH." And then there is the advisory least pleasant to see,
presented in glaring, ominous red. "FIRE DANGER TODAY:
EXTREME." What does 'extreme' mean in this instance? The Forest
Service offers a description: Fires start quickly, spread furiously, and burn intensely.
All fires are potentially serious. Development into high
intensity burning will usually be faster and occur from
smaller fires than in the very high fire danger class…
Under these conditions the only effective and safe control
action is on the flanks until the weather changes or the
fuel supply lessens. Tahoe is surrounded by approximately 200,000 acres of
forest. Nearly a third of this vast acreage is in a
"serious state of decline," according to the US Department
of Agriculture, due to "drought, overstocked forest stands,
and the suppression of fire since the Comstock logging
area." Fire, as it turns out, plays a critical role in maintaining
the health of the forest. The occasional blaze is Mother
Nature's version of creative destruction. When a low-
intensity wildfire moves through, dead and diseased trees
succumb to the flames; the heartier, healthier trees remain
intact. Excess underbrush is burned away, clearing the
forest floor. Sturdy old growth survives, even as the
fire's consumption makes way for new growth. A rough
balance is maintained. But the picture is very different today, thanks to
persistent human intervention. For roughly a century-from
1890 onward-the US Forest Service maintained a policy of
"zero tolerance" towards any and all forest fires. Mother
Nature's cleansing efforts were thus thwarted by human
hands. As a result of this policy - and the zealous fire
suppression efforts that followed - dead and diseased trees
were no longer being culled. Density of trees per acre
increased dramatically. With cycles of new growth crowded
out, the forests grew brittle with age. Underbrush and
debris on the forest floor, no longer burned off at regular
intervals, slowly built up to dangerous levels. Over the
course of many decades, the nation's forests shifted away
from their healthy and balanced state, resembling a giant
tinderbox instead. Misguided human intention - the desire
to rein in fire - laid the groundwork for the mother of all
fires to occur. And occur it did: The great Yellowstone fire of 1988 awoke
the rangers to what "zero tolerance" had wrought. A small,
nondescript fire in June of that year, started by a
lightning bolt from a summer thunderstorm, inexplicably
grew to become a raging inferno. The destruction was
multiple orders of magnitude worse than anything ever seen
before. Prior to that year, the worst park fire on record
had consumed a mere 25,000 acres in 1886. This time, more
than 1.5 million acres burned. The Forest Service has learned from the error of its ways,
and is now working feverishly to correct the problem.
Vigorous policies of deadwood culling, underbrush clearing
and 'controlled burns' are now under way. Yet the task is
akin to sweeping the Augean stables, and rangers admit
their efforts may prove too little, too late. The Forest
Service website offers this grim assessment: "Today's forests, dense with green vegetation, may seem to
be beautiful, but in fact are deadly. Many forests are
choked with brush and dead trees that make catastrophic
fires a certainty." What does this have to do with markets and finance, the
normal purview of this space? As it turns out, plenty.
There is another long-standing agency, established 1913,
that is dangerously addicted to "zero tolerance." It is
frighteningly easy to recast the rangers' warning in a
manner fit for the Federal Reserve: Today's economy, flush with green liquidity, may seem to be
beautiful, but in fact is deadly. Many consumers / banks /
hedge funds are choked with leverage and debt burdens that
make catastrophic downturn a certainty. As noted earlier, occasional low-intensity fires are Mother
Nature's cleansing agent-her way of maintaining a healthy
forest ecosystem. In an unmanipulated business cycle, the
same can be said of low-intensity recessions. A modest
downturn induces belt-tightening without stirring up panic.
Overextended consumers and businesses rein in their horns;
credit lines are reduced, optimism is scaled back, and
sobriety returns to the fore. A few businesses fail at the
margins, but the healthy enterprises survive. Risk is
reduced, capital is recycled, and new growth takes place. Unfortunately, Greenspan has emulated the bad old ways of
the Forest Service prior to their Yellowstone awakening.
The Fed's zealous suppression of downturns over the years
has created a build-up of potentially catastrophic
proportions. Thanks to massive liquidity stimulus, business
operations that should have folded linger on. Credit lines
that should have been cut back are extended. Speculators
who should have tempered their bets are encouraged to
become more aggressive. Excessive reliance on easy credit
is mistaken for economic strength, and even bigger bets are
made.
The chart does not tell the whole story. According to
statistics from mortgage behemoth Freddie Mac, the total
volume of home equity cash-outs, including second mortgages
and home equity lines of credit, has gone from
approximately $22 billion in 1995 to an estimated $200
billion this year… a better than 800% increase. Behind
the scenes, the amount of credit derivatives traded amongst
banks and hedge fund players has gone well into the
trillions, with no one certain how these exotic new
products will perform under stress. A catastrophic fire needs more than ample fuel to get
underway. It also needs the hot, dry conditions necessary
for flames to spread rapidly. If debt is the primary
kindling, then savings are the dampening agent that keeps
the fire from getting out of hand. Alas, The Economist
opines that the 'global savings glut' is actually a 'global
liquidity glut;' thickets of cash have grown so dense that
bonds are merely catching the runoff. Worse still, US
consumer savings have recently hit zero, as homeowners
double down on property gains at the very worst time. The
well doesn't get much dryer than that. The last question, then, is what might kick things off. How
and when will the next fire start… and will it be the big
one. We have no more of a crystal ball than the rangers in
this regard. Are we in the midst of our summer
thunderstorm, lightning waiting to strike? Or will we be
spared for another season? Time will tell. [Ed. Note: When faced with such a critical situation, as
Justice has explained, many of the world's top investors
and finance minds turn to the insights of Dr. Kurt
Richebacher. Find out what one of the greatest living
economists has to say about the current state of affairs
here: The Richebacher Letter --- Advertisement --- ------------------------- And the Markets… | Monday | Friday | This week | Year-to-Date | DOW | 10,570 | 10,559 | 11 | -2.0% | S&P | 1,222 | 1,220 | 2 | 0.8% | NASDAQ | 2,141 | 2,136 | 6 | -1.6% | 10-year Treasury | 421.00% | 4.21% | 416.79 | 416.78 | 30-year Treasury | 443.00% | 4.42% | 438.58 | 438.18 | Russell 2000 | 657 | 653 | 5 | 0.9% | Gold | $438.20 | $437.10 | $1.10 | 0.1% | Silver | $7.06 | $7.01 | $0.05 | 3.6% | CRB | 317.12 | 315.18 | 1.94 | 11.7% | WTI NYMEX CRUDE | $65.45 | $65.35 | $0.10 | 50.6% | Yen (YEN/USD) | JPY 109.70 | JPY 110.44 | 0.74 | -7.0% | Dollar (USD/EUR) | $1.2228 | $1.2163 | -65 | 9.8% | Dollar (USD/GBP) | $1.8004 | $1.7961 | -43 | 6.1% |
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