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The Problems Spread

By John Browne

Senior Market Strategist, Euro Pacific Capital

April 15, 2008

Last week, General Electric one of the finest companies in the world and an American icon, announced a major fall in earnings. Amazingly, the bad news surprised Wall Street, and GE shares fell 13 percent in a single day. Some surprise!

GE is one of the best-diversified and well managed companies on earth, and is seen as a barometer of both the US and the world economies. Its latest earnings report was impacted by the expected fall in financial services and a continued strength in overseas earnings. However, it also showed a largely unexpected fall in the sales of US medical devises as public and not-for-profit hospitals, suffering massive increases in their borrowing costs, cut back on spending.

In other words, the fall in GE's earnings suggests that recession in America is taking hold across a wider spectrum and is not restricted to sub-prime real estate. As this idea reality finally began to dawn on Wall Street, the Dow Jones Industrials and other broad market indices lost some 2 percent on the day.

As investors lick their wounds, they should also realize that nominal losses in U.S. stocks are really just half the story. So far this year, the American dollar has lost some 7 percent against the Euro and some 10 percent against the Japanese Yen. As more GE-like earnings reports loom on the horizon, and as the dollar continues to slip, holding even blue chip American stocks will remain a risky proposition.

Not long ago, before the sub-prime debacle (of which Peter Schiff and I had warned of repeatedly) really began to take its toll, the majority of economists foresaw little widespread difficulties in the American economy. However, when Bear Stearns became completely unraveled almost overnight, most of these formerly optimistic observers now belatedly recognized real problems. However, their fears have been largely assuaged by the magnitude of the Government's response.

Using methods that the legendary former Fed Chairman, Paul Volcker, said, "stretched the very limits of its legal powers," the Fed dramatically rescued Bear Stearns on March 17th. Such was the sanguine sense of relief that investors felt our national economic problem had been largely cured, at a single stroke, by the Fed.

In the four weeks since March 17th, stock markets appeared to rally, on the back of what can best be described as the 'euphoria of blindness' to the realty of the systemic economic problem we face in the 'real' world.

Renowned Yale Professor Robert Shiller has shown that from 1995 to 2006 the value of U.S. real estate rose some 30 percent above its century-long value line. Today, the U.S. residential housing stock is valued at some $20.145 trillion, of which more than half is debt! Admittedly, not all this debt is sub-prime. But the sub-prime problem is, as we have long forecast, spreading both upwards and across the real estate field and the credit markets.

As the average consumers' single most important asset is their homes, the fall in house values is now adversely affecting American consumer confidence. This bodes ill for both the American and the world economy, in general.

The Fed Chairmen, Ben Bernanke, now has an historic opportunity staring him in the face. Should he continue to back the government in disguising the natural economic recession, by debasing the U.S. dollar and so continue to rob every single American citizen of his or her hard-earned wealth? Or, on the other hand, should he, at long last, stand up for American citizens and their money by using his 'independence' to force our government to adopt sound economic and financial policies?

Recent pronouncements indicate that he has decided to ignore his legal 'independence', and instead submit to political pressures and allow the government to silently tax current and future citizens in order to bail out financial and real property. Characteristically, Wall Street appears to applaud the decision, accepting both more inflation and further debasement of our dollar to save themselves, for a time, at least.

The Fed balance sheet amounts to some $800 billion. This sounds like a lot of money and it is. But it is dwarfed by the county's debt exposure, which includes not just the $10 trillion of residential property debt, but also trillions more in commercial property, auto loans, and credit cards and increasingly vulnerable business loans!

The key question is; has the government got enough money to finance a bailout of several trillion dollars? The answer, of course, is no. But, although national savings are at an all time low, both the American taxpayer and many ordinary citizens still have some net worth that can be both taxed and eroded by inflation and currency debasement!

Recent pronouncements to extend the regulatory powers (read funding ability) of the Fed to the really big gamblers, namely investment banks, derivative traders, insurance companies and even to hedge funds (the speculative vehicles of the super rich) and the increasing political talk of 'help', indicate that both the government and Congress are now set on a path of higher taxation, inflation and dollar erosion.

For alert Americans, investment attitudes must undergo a sea change. Instead of thinking in terms of return 'on' capital, investors will be well advised to think about return 'of' capital! Greed should give way to extreme prudence.

It is becoming increasingly clear that any investors, who wish to protect their wealth, should invest in non-dollar denominated financial assets and, where possible, hold them (legally, including paying tax) offshore, in order to avoid any risk of the future imposition of American exchange controls.

As the old song goes, 'the times, they are a changing'. Soon unfortunately, that refrain will bring smiles only to those who have taken wise protective action with their investments.

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with." A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military, John has a significant background, spanning some 37 years, in finance and business. After graduating from the Harvard Business School, John joined the New York firm of Morgan Stanley & Co as an investment banker. He has also worked with such firms as Barclays Bank and Citigroup. During his career he has served on the boards of numerous banks and international corporations, with a special interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co. and the former editor of NewsMax Media's Financial Intelligence Report and Moneynews.com. He holds FINRA series 7 & 63 licenses.

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