Wolf Waves

From a collective financial standpoint the US is now deeply into an increasingly violent and potentially terminal process. This process is best described as a wolf wave pattern, which demonstrates an accelerating and increasingly violent instability. A wolf wave is a series of waves where the amplification of each wave both up and down is expanding. The chart of a wolf wave looks like a megaphone, small on one end amplifying out over time.

The best way to describe this is to show it. The two charts below not only show a clear wolf wave pattern, but they just happen to be two of perhaps the most important long term charts in finance.

 

Crestmont Research

 

The chart above reflects the earnings growth rate of the S&P 500 Index. Please notice that the narrow end of the wolf wave starts around the time that Nixon abandoned the gold standard, and the US and the rest of the world switched to a Fiat money system, or paper money issued by government without any direct link to any tangible asset.

 

As important as this chart is, the next chart is probably the most important chart in finance.

 

Chart Source: www sharelynx.com

 

This chart is simply the Dow Jones priced in terms of gold. Once again please notice that this wolf wave started around the time of the introduction of the Federal Reserve in 1913.

 

The “Pretence of Knowledge”

The charts leave little doubt that, from a long term economic perspective, we are on an unsustainable and increasingly violent path, and they also very accurately point the finger at the source of this instability.

Tragically, this is nothing new from a historical perspective. Indeed the US Constitution attempted to make illegal both Fiat money, as well as the control of money by the banking system. Most of the founding fathers were convinced that these principles were crucial both from a moral as well as financial standpoint. Unfortunately, it seems that each new generation needs to relearn these lessons themselves.

Briefly, massive expansions of government spending, whether from newly printed money or increased government debt, does provide a short term term economic boost. However, it is highly inefficient and increases inequality. When this is combined with a deeply flawed banking system, disaster is sure to follow. It is just a matter of time. The wolf waves show us that an inefficient policy has to be used more aggressively at each successive cycle, which continues to reinforce longer term economic instability and damage.

This does not mean that there is no vigorous defense of these policies. The current banking system is dependent on government support over time, and many other constituencies also benefit from direct government support. However, the rest of us, the vast majority, simply end up having our wealth diluted consistently relative to these other groups.

Rather than delve deeply into the economic arguments, many of which I have previously discussed, I will simply provide a link to Hayek’s acceptance speech of his Nobel award for economics in 1974. 

 http://www.mises.org/story/3229

Hayek’s speech entitled the “Pretence of Knowledge” was deeply critical of the entire economics profession. Hayek simply pointed out that the foundation for so much economic theory was at best highly questionable. Economics is not a hard exact science and yet so much theory ends up with the claim of precise causation, which, in addition, often ignores untold damage through unintended consequences.

Collective Insanity

This is how we have now reached our current state of collective insanity, where, as a group, we have come to accept absurd ideas, even though the dogma continues to damage us at an accelerating rate.

Even though the irresponsible practices and behavior of our banks have thrown the world economy into its worst recession in decades, there is apparently no limit to the support we are nevertheless supposed to provide them.

Just in the US, several trillions of dollars have been pledged to the banks and the check book is apparently still wide open. In return there has been no genuine reform, and the receiving institutions are still debating their yearend bonuses while the rest of the country suffers a depression with almost no support.  The scale of the vast bailouts to financial institutions is simply breathtaking. It already adds up, in inflation adjusted terms, to more than the amounts provided for the 1930s depression, World War II, and the Korean and Vietnam wars combined. So what has it produced? No jobs and barely any investment. It has simply disappeared into the black holes that still lie in the unfathomable balance sheets of the banks.

This amounts to perhaps the biggest misallocation of capital in human history. You do not need to be a trained economist to realize that this is simply abuse. It is like not being invited to a party that then destroys your neighborhood due to wild and irresponsible behavior, and then being forced to hand over part of your life savings to repair the damage.

Finding Health

It has become increasingly difficult to find health within the current environment. So much that surrounds us has been corroded by an increasingly failing macroeconomic system. More and more we have to seek out people and entities that nurture their own self reliance, integrity, and honesty. Only from this basis can we improve our chances of productive engagements, whether we are talking about our investments or other aspects of our lives.

 

In the end flawed systems sow the seeds of their own destruction, and new natural processes begin anew, hopefully with more positive cyclical developments. Unfortunately, this can take a very long time. However long it is, individually we can always start today seeking out and aligning ourselves with enduring natural values and principles.

Summary

From a financial perspective, the first objective is to survive the current period, which alone will not be easy as many problems remain and have yet to be engaged, much less resolved. In a flawed system with so much uncertainty, and so many impaired assets, this is a time for clarity and simplicity.

 

The unique asset for this time is an asset that is the least impaired from the current financial crisis, has enduring timeless purchasing power, is highly liquid and is universally accepted for its value. Gold has held up remarkably well this year, and has sustained its long term uptrend against both US dollars, as well as equities.

 

Government bonds have outperformed in 2008, but currently I would limit exposure to very short maturities, and “inflation protected” government bonds, which are currently attractively priced and are amongst the most resilient assets for safely enduring economic extremes.

 

Equities have become extremely volatile and most likely this volatility will continue. While extreme care needs to be taken with this allocation there are enormous opportunities available at historically highly attractive valuations. To endure the volatility a high level of conviction and commitment is necessary for long term success. Confidence can only be sustained in companies with little or no debt, positive operating cash flows, and fortress balance sheets. The survivors are currently remarkably cheap and will gain market share as we move through the current crisis.

 

 

 

 

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