2-9-09

  A Zero-Sum Game

Money is a zero-sum game. Any time someone receives money, someone else has parted with it- this is the basic law of economics.

A simple example is you buying something from a store; a profit was made at your expense.

If your house drastically went up in value between 2001 and 2006 (who's house didn't?!), then IF, and I repeat IF, you had sold it, you would have realized that value- made a profit- at someone else's expense (the purchaser).

Trouble is, people didn't pay attention to that big "IF" I wrote there. They assumed this value was locked in forever and even rising. So, they borrowed money from banks against the UNREALIZED profit in that property. Mostly, this money was spent at the shopping malls, vacation shops and car dealerships- nothing to show for it. Stupidity, in other words.

Banks did a similar thing. They assumed the value in the mortgages they owned was locked in and would go up forever, so they borrowed against it to invest in risky derivatives. Greed, in other words.

The stupidity and greed outlined above resulted in the perfect storm and here we are now. People don't want to admit to their mistakes and pay the price though- instead, they scream at politicians to save them.

Over to you Mr. President...

Now, the government simply CANNOT and WILL NOT do what perhaps it knows it should do; to let the forces of nature work their stuff. The cure for a recession is a recession!

No, that really won't secure a second term...

So instead, the government must hear the cries of 'its' people and respond. It must DO SOMETHING!

But you see, as I've already pointed out, money is a zero-sum game. The trillions of dollars of losses have already been incurred to real estate and stocks. Where did that money go by the way? Did it just disappear??

No. A zero-sum game means that if there's a loser, there must be a winner. So who was the winner?

The winner was the economy. Property went up in value (on paper). The owners of that property borrowed money against the equity and spent it in the economy. Why do you think all this retail development popped up over the last few years?

The economy was booming because of home equity withdrawals. You want to hear the really stupid part though? Future projections were made on this basis- that's to say, an assumption was made that this trend of growth would go on indefinitely. Malls rose from swamps. Restaurants sprouted up everywhere. It seemed at one point every other store in a strip mall was a Starbucks.

It was a house of cards built on sand.

So the beneficiaries of all that money have spent it on structures that are now effectively redundant- because the boom they were built for has gone.

We now have an economy built for a high level of retail consumption... but we have low consumption.

Anyway, "Save us!" scream the shuffling masses.

But if money is a zero-sum game, what CAN a government do?? It can't force real estate prices back up to restore that core value which was lost. It can't impose laws that make people spend more money! And consider, even if you get banks to lend again, can you force people to borrow?

I write this newsletter on the weekend before the Monday you receive it. By the time you read this issue, the world will have heard what the government intends to do to 'save us'.

You will hear a lot of complicated phrases and new terms like "Aggregate Bank". Popular sound-bites like "Tax-Breaks for property owners". The government will guarantee certain debts (if a debt gets worse it will cover that debt).

But how? Remember: if anyone receives money, someone parts with money. If money is a zero-sum game, how exactly can they achieve this?

With a printing press.

But the law of money still stands; say after me: "MONEY IS A ZERO-SUM GAME."

In other words, there's no such thing as a free lunch. Using a printing press violates this law, it doesn't circumvent it. The government are merely passing the loss on to somebody else.

Who?

Anyone who has dollars and/or dollar-denominated assets!

If you print more dollars and get those dollars out into circulation, you make the dollar worth less- simple supply and demand, right?

And while you, my dear dollar holder, may be horrified to hear this, how do you think the Chinese feel? They hold hundreds of billions of the worthless pieces of paper!

If the Chinese stopped buying American debt, American interest rates would soar and stifle consumer buying of Chinese goods. This stand-off worked well in the boom. The thing is now though, is that Americans have almost stopped buying Chinese goods anyway! So what do they have to lose? Even if the Chinese merely reduced the purchases of American debt, this would be enough to make rates here rise uncontrollably.

Ah, not to worry say the Federal Reserve. They will simply print more money to buy their own debt. By the way, I still can't get my head around the ridiculousness of this. I don't even know which law of economics this nonsense violates- answers on a postcard please...

So dear reader, back to the thread. Money is a zero-sum game. The government answers the masses' call to save them, but the Gov effectively pass the cost of saving them back to the masses in the form of their dollars being worth less through the printing press.

So now a new loss has been added to the equation- the dollar's purchasing power has eroded and the losers are dollar holders. But again, money is a zero-sum game. If there's a loser (dollar holders), there must be a winner.

So who's the winner?

Gold. Silver. Oil. Wheat, basically, anything that was priced in dollars will have to rise in price to account for the erosion in the dollar's value, gold particularly because the dollar is the world reserve currency (for now). Make sense?
 
Remember, there's never a loss in the world of money, merely a TRANSFER from those who don't understand money, to those who DO.

Money has a homing instinct; it gravitates back to its master.

I say these words to you I hope, as a fellow master, not one of the shuffling zombies occupying Main St. By the way, if any of the shuffling zombies want to 'convert' at any time (by educating themselves instead of reading 'People' magazine), I welcome them with open arms; this isn't about being elitist.

It's not too late for you to understand this you see. This thing has really only just begun. History has shown that the only thing worse than an economic crisis is meddling governments trying to 'save us' from an economic crisis. And the 'saving' is just getting warmed up. I touched on protectionism last week as a sample.

Moreover, the dollar is actually holding up exceptionally well against other (paper) currencies because America is still the world's superpower and largest economy, so you haven't missed the boat. But, this flight to 'safety' by currency is a knee-jerk to the crisis. Soon the reality of printing presses will set in and the world will look for something solid to cling on to, as it always has done. No paper currency has ever stood the test of time. It's dishonest. The Constitution even says so.

Long-time readers may be forgiven for thinking I have a hard time talking about anything but gold (and mining companies), but the fact is, I tell it like I see it. As and when I see gold as not making sense (perhaps when inflation eventually gets so bad they re-introduce the gold standard), I will endorse dumping the yellow stuff. Meanwhile, it's never made so much sense, and all of the analysts I respect most are now in unison over this. I now hear fund managers capitulating even, amazed because they never envisaged themselves buying gold or gold mining stocks. Big fund buying is the key to any major rise in anything and it's now started it seems.

The price of gold is now at a crossroads though gold miners stock prices may march to a (higher) different drum. In the short term, the actual gold metal price is about to make a big break either up or down. Longer term, the trend is up, at least until the government stops trying to 'save' us and let things run their course.

Reality is a far more profitable strategy than denial you'll find. What most people are doing now is clinging on to their stocks and property hoping the values will bounce back. Hope is not a strategy either.

Question: "A while back you mentioned a rebound rally possibility. Where is it?"

As the government dithers with it's 'save us' stimulus package, so does the stock market which is why it's been trading sideways lately. What's been encouraging is on the technical (chart) front. The Dow has refused to dip below the November low of 7570 despite all the terrible economic news.

The market really still is in no-man's land. But you want a definite answer don't you?

My best guess (and it really is a guess) is that this week the government announces the stimulus package and the market finally starts to pick up on the news. If it can get past 9400 it really will mean something and perhaps head back into the 11,000 range. This combined with a property buyers tax-break and perhaps interest rates nudging up again may even put a floor under property prices and encourage buying.

But this would be your last chance to sell I feel. Barring any new developments, the market will go down again over Summer, possibly to even lower than now. What's scary is that stocks are still overvalued.

How?

A stock's value is a function of stock price and earnings from each share of stock (forming a ratio known as P/E or Price Earnings Ratio). You may look at some stocks now and see them as cheap, but this is only relative to what the earnings (the 'E' in P/E) were in an unprecedented boom. So while stock prices (P) have come down, so have earnings (E) only by more. If earnings don't pick up this quarter and prices stay the same, believe it or not, the market would be EXTREMELY overvalued on the (accepted) P/E valuation method.

Well, do you want the truth or some milk and cookies?!

Until next time,

Mark Patricks.

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