4.1. Oil

Without considering the current market price of oil, I am fully confident in drawing the conclusion that an oil shock did in fact occur during 2004. Simply put, more people are competing for lesser amounts of cheap oil worldwide. Oil is the ultimate diplomatic tool. The controller of the oil is the sculptor of the global economic and political framework.

Any economic or military power needs access to energy. A glance at the map shows that cheap oil was naturally located in the most conflict-prone or remote regions of the world. Additionally, with oil being harvested in remote and unstable regions, can it retain its ability to be cheaply and reliably transported?

The "oil shortage story" has been unfolding since the 1970s, so we should not be surprised at any drama that might occur in coming years. It's highly likely that a crisis will unfold during 2005 or 2006.

During 2004 it was prudent for President Bush to fill the Strategic Petroleum Reserve. It was a wise move regardless of its impact on oil prices. Paradoxically, an oil shortage could be assuaged by a global economic slowdown because, in the United States, personal transportation (not heating) represents the primary use for oil.

Oil in the SPR might be adequate to command oil towards the direction of next immediate crisis, but then again it might not. These reserves cannot address the fact that since the 1970s the US has had no energy vision. A fully stocked reserve provides a next step, not a solution.

In 1977 the much-maligned Jimmy Carter presented an energy action plan "to give our children and grandchildren a world richer in possibilities than we've had." I suggest that the US vision was in that decade at an important inflection or crisis point.

It was a point in time when we could have chosen the harder and more sustainable path. With the Reagan administration strategic focus was placed on the Soviet Union, with the oil crisis left for us to deal with now. The Soviet Union fell, but was a victory over the evil empire really won?

Russia may not have the military might it did, but neither does the United States. The net present value of people to resources within Russia is much greater than in the United States. After a few setbacks, Russia may become more visionary.

4.2. Agriculture

Our food supply and domestic agriculture system stands vulnerable to events of variable and multiple complexity. It's always a great surprise when a system we rely upon for seamless operations breaks in some unexpected way.

I am not quite sure how the failure will manifest itself, or how severe it will be, only that it will occur. The knee jerk reaction to any agricultural dislocation will naturally be price inflation. At what point, however, does inflationary price pressure in this sector constrain people from obtaining a necessity?

The domestic food production system relies heavily on fertilizer. Fertilizer depends upon energy input. In 2004 the dislocations we experienced in energy supply, which drove up prices, must and will transfer to the agricultural sector. It will make no difference if oil supply increases in late 2004 and 2005, because the costs of the initial price change have already occurred.

Investment in land conservation-sustainability and water infrastructure have not occurred because an oligarchy of corporations (some privately held) maximize profits by depleting and depreciating the foundation stock of agriculture -- land. The farm stock of America, land, has been depleted of important trace nutrients. Selenium would be but one example.

A similar dynamic occurred in regards to the failed electric distribution system of the US in 2004, the rail system, the natural gas pipelines, and public transport. How could anyone be so naive as to assume that agriculture can be any different? Depletion means fragility.

Imports will initially compensate for decreased domestic production. Exchange rates will make these imports overly expensive. Additionally, China and other nations will look to build strategic partnerships with countries worldwide, such as Brazil, to secure the agricultural resources they will need.

A system can also be forced to fail to the will of politics. Trade protectionism provides one party with benefits and one with costs. The US corporate oligarchy benefits by having the flow of food from Canada to the US constrained. With increased price, reduced supply and inelastic demand, consumers lose and bottom line profitability goes up.

5.1. Currency controls, Customs, and the Transport of Monetary Instruments

Transiting between the US and Canada as I regularly do, I need to report to you the factual impression that the surreal has been trying to assert itself. Most of the aberrations occur when crossing from Canada to the US side.

This time around, a question was asked of me on the Amtrak train, by the US agent, as to whether or not I was carrying more than $10,000 worth of monetary instruments including checks and cash. The folks on the US side have figured out that terror can be prevented if you keep cash money from landing on US shores. Not being a terrorist, I am not interested in moving money into the US. Instead I have been steadily moving money out!

I don't want all my money sitting in a US brokerage house, even if that account can purchase gold shares and foreign currency denominated bonds. For safety, a portion of my wealth has to be located outside the United States, period. As actionable advice, a portion of your wealth needs to be allocated outside this country as well.

The last time I moved gold to Canada, in my car, I made sure to declare the fact that I was moving more that $10,000 worth of gold so I had Homeland Security and Canadian forms ready. The gold was in the form of .9999 bullion bars and the Homeland Security folks would not take my form.

The guys in blue wanted to see what the gold looked like, and they asked me what each little bar was worth. To them it was not money but a commodity covered by NAFTA. Coins would be another issue entirely. Anything coin shaped could potentially be construed (or not, depending on someone's discretion) as a monetary instrument.

On the Canadian side they took my form but they were not sure if they needed it or not. They wanted to be sure that I made my US declaration before moving the gold. I guess they are obliged by treaty to cooperate with the US when it comes to enforcing US law. Lesser quality gold and US coins would be another issue to Canada Customs, and the transfer or either might be subject to taxes. For this reason I only recommend the purchase of gold bars.

The moral of this story is that the US side of the border has not yet figured out that they need to keep money in the country. Economically, they are looking in the wrong direction.

Money can flow out of the country, and it won't be confiscated as long as you have your paperwork in order. If you were to wire money out of the country, your bank would look the transaction over to assure itself that it complies with homeland security regulations. In the economic crisis, between now and 2006, it's likely that it will become increasingly difficult to move money out of the US.

My experience transiting the border tells me that drama may not be too far off in the future, at which point it will be structurally impossible for your money to find an exit. By that time currency controls may be in place, and hopefully we will have advance notice before they stop the flow of people looking to exit the US as well.

5.2. Command Economy vs. Socialism

If an expanding number of people are unable to afford necessities, they are going to get angry. As an inhabitant and denizen of NAFTA I have perspective from both sides of the US and Canadian border.

I get to enjoy the diametrically opposed but equally frustrating operating philosophies of two styles of governance. In the US we have a republican oligarchy whereby a select group of the familiar and economically privileged exchange leadership positions. In Canada, majority rule can be a cruel dictator to the excellence of private sector initiative. Both systems can be either enabling or oppressive, based on your perspective.

The unworkable universal solution on the Canadian side of the border usually consists of greater amounts of socialization and taxation. When people are hurting, the initial reaction is to throw money at the problem. Over-governance must find a funding source, so the productive parts of the private economy are pummeled.

In the United States the selective solution of choice will be the Halliburton model. The concentration of wealth will occur to the extent it can.

Nobody in the younger generations knows how to protest effectively, and the Vietnam generation is just too tired, strung out and scattered to provide leadership. In 2006 I envision "homies" milling about their destitute middle class neighborhoods in much the same way they were doing when I did some door-to-door campaigning in Pennsylvania.

I cannot envision a time where the US would find a comprehensive socialistic solution to anything. I doubt that the next New Deal could take hold under the present structure of US governance. It's more likely that the economy will be selectively commanded into action, and that the result will be the selective allocation and concentration of wealth. This is what I mean by the Halliburton model. This will occur until the system breaks entirely, at which point someone will take advantage of the situation.

Sarcastically speaking, in the race to be a savior I would not lay odds on Elliott Spitzer, Jeb Bush, Hillary Clinton or Carlos Menem. To assume that democracy remains or even exists as functioning governance should be considered naive. In this respect Canada has much more stability, stability being a cornerstone of investment.

Even if things got so bad in the US that it had a "cultural revolution," a question remains as to whether or not US citizens still have the skills and inclination to work in the dirt building rail systems, or stamping out metal parts in a factory. Does the US have the capital stock or machine tools to do so? Do we have a foundation in the practice and physical economy of true productivity?

The United States might experience a long period of economic stagnation until such time as the natural hand of dislocation has its way, correcting all the structural imbalances that need to be worked out of the system.

5.3. A Canadian Wilderness Guide

Saving money is hard for individual Canadians. It's very hard to accrue a large enough pool of savings-capital in order to participate in ventures that harvest leveraged profits from intrinsic natural resource wealth. Here too the Canadian government has an answer: allow the sale of untapped natural resource deposits to the Chinese in the hope that it will generate jobs.

What a foolish strategy -- giving your wealth away, your real physical wealth! A fire sale of wealth designed to address a transitory social concern like employment.

If the Canadians are foolish enough to tax, socially reallocate their strategic advantages, or just give wealth away, then why not as an international investor take the windfall that has been offered?

Oh Canada, hear the words of Veblin: "Abstention from labour is the convenient evidence of wealth and is therefore the conventional mark of social standing; and this insistence on the meritoriousness of wealth leads to a more strenuous insistence on leisure. Nota notae est nota rei ipsius."

Time will tell if Canada has the midset of governance to prevent it from becoming another Saudi Arabia, a country rich in wealth but filled with poor people. For Canadians to become rich they need to be able to form capital, they need to develop business acumen, have confidence, and say no to social governance. With capital, they could become part of Veblin's leisured class. If you are an international investor, be aware that Canada is running a fire sale on wealth.

5.4. Pandemics and Other Questions

On this issue I have more questions than answers.

Could the bird flu or some other plague force the restructure of global free trade? Could a pandemic be used as an excuse for a failing economic system? How will pandemics affect air travel? Could a pandemic be used as a method for making the world more sustainable through asymmetric theocratic genocide?

"The Bush Administration is spending millions of dollars on abstinence-only programs that mislead people at risk of HIV/AIDS about the effectiveness of condoms," said Rebecca Schleifer, another Human Rights Watch researcher. "Exporting these programs to countries facing even more serious epidemics will only make the situation worse."...

To me this issue supports the contention that the world will become less global and more regional.

5.5 Blockbuster Drugs and Bad Movies

Corporate executives don't feather their wallets by hitting singles, they need to constantly hit home runs. The rest of us, and society at large, would be much better off if the spectacular was replaced by consistency and conscience.

Big pharmacy has been playing the same irresponsible tune as Enron, airlines, energy, mortgage lending, and everyone else. The difference between movies and drugs being that when corporations try for the blockbuster movie, nobody dies.

5.6 The real estate bubble that ate the stock market (reprint)

Real estate's contribution to the over-inflation of the Dow may prove to be the greatest of all present economic dangers to the US economy. The current price-to-earnings (P/E) ratios of financial service companies are very low. This means the lack of profitability elsewhere has been artificially masked.

But what do the forward ratios look like? I contend that, on a forward basis, aggregate P/E ratios are back at historic highs. Current market P/E ratios are high by historic standards. But they are low according to media opinion, and this has led to complacency and misplaced optimism. Highly profitable financial companies have low current P/E ratios but their earnings have clearly peaked.

We know that demand for new mortgage originations is slowing. "Industry-wide, residential mortgage originations were approximately $800 billion during the second quarter of 2004, down from approximately $1,075 billion in the second quarter of 2003." (Source: Inside Mortgage Finance.)

The present danger resides in the point that most of the easy money in the mortgage industry is made through mortgage resale and loan origination activities. This is why there is no shortage of lending companies and salespeople. Low-hanging fruit tends to be the most profitable.

To retain forward earnings, financial companies must continually write more and more business. At the current point of saturated demand, this cannot occur. Yet, while some companies are already laying off, others are hiring aggressively, and all of them are adopting risky business strategies.

The companies which are laying off workers are doing so in order to retain bottom-line earnings. As a leading indicator of stock market over-valuation, consider this fresh report from the Bureau of Labor Statistics: "Employment in financial activities fell by 23,000 in July. The credit intermediation industry, which includes mortgage banking, shed 16,000 jobs over the month. Securities, commodity contracts, and investments lost 4,000 jobs."

Other mortgage lenders are trying to hire mortgage originators as fast as they can. This too may be a sign of failure. The managements of these companies don't yet realize they cannot market pencils to paupers.

Some companies are bloating their balance sheets with assets (loans) so they retain earnings in a downturn. We know these assets are increasingly risky because the companies themselves report that they are selling sub-prime and exotic products.

I just finished reading the latest 10Q of a large financial institution. It suggests that net yield on asset base has also been declining. To these banks, changing interest rates means that non-hedged portfolio yield has declined year over year. Portfolio size and risk will rise concurrently.

A masking factor exists in that bottom-line corporate profits are sticky, because they can be managed. However -- and this is not for the faint hearted -- the danger can be seen lurking in the footnotes of financial statements everywhere. The next accounting scandal resides in the depths of financed real estate. Perhaps well intentioned CPAs will be summarily executed.

A contraction in new loan originations will have a dramatic effect, and not just on the health of mortgage companies. Lower earnings for this important sector will raise the consolidated price-to-earnings ratios of the major stock indexes. In a real estate contraction, the stock market and employment will adjust long before the main event, which is the collapse of real estate properties and valuations.

5.7 Using Sarbanes-Oxley as a Crucifix

As the economy cascades, the Sarbanes Oxley act will be used in a selective fashion, to criminally prosecute as many corporate fiduciaries as it takes to placate the mob.

Presently, legitimate corporations are chasing their tails, with multiple auditors in tow, in hopes that they will generate enough paper trail to claim that they are complying with the nebulous or the impossible.

Fraudulently structured corporations are signing off on compliance documents because they have no choice other than to do so. Guys like Franklin Raines, the now departed CEO of Fannie Mae, have been willfully certifying financial statements that cannot be fairly presented because their companies would have failed under their tenure thereby collapsing the US economy. Unless he wins on the merits of ignorance, insanity, or admitted incompetence, he will be crucified.

"This situation with Fannie Mae raises big, red flags by former Wall Street financial wizards like Harvey Gordin, President of El Dorado Gold "There are great concerns about mutual funds that have invested in debt and mortgage-backed securities issued by Freddie Mac, Fannie Mae and the Federal Home Loan Banks (FHLB). Thirty percent of the loans being carried by these entities are substandard. Even though these investments must be disclosed in any fund's registration statement, too many investors incorrectly assume that such securities are backed by the full faith and credit of the U.S. Government. They are not. While these operations are chartered or sponsored by Congress, they are not funded by Congressional appropriations. This means that those debt and mortgage back securities are not guaranteed or insured by the U.S. government."

6.0. Reading

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