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To us, the most important number that comes out regarding the economy, is the approval rating of the President. There will always be some people that hate the current president, and there will always be some that love him. The rest of the American population, having no real knowledge of economics or history, tend to judge him by our own financial positions. President Bush’s rating has now dropped to an all time low, which speaks volumes about the average person’s balance sheet. Politicians then, to save face, must blame other people or events to avoid getting slaughtered by the press and by other politicians who don’t want to be associated with such negative feelings. President Bush, of course, will blame Katrina and now Rita, once things start going badly here. Even if there is absolutely no substance to this argument, it makes sense to the feeble American mind. Let’s take September 11,2001 which supposedly “caused” the greatest recession since 1929. Everyone seems to have forgotten that prior to September 11, the Dow had already dropped almost 20%. Not only that, but by the end of the year, the Dow was actually UP over 5% from where it was on September 11, 2001!! Yet somehow, Bush successful explained that the economy tanked because of Muslim fundamentalism. And since we have to blame something, these people became not only terrorists, but also economic destroyers. And when someone destroys our economy, we attack. Throughout history, this is how war has always started. Personally, I am very grateful that the politicians will soon be able to blame hurricanes instead of other people for our economic woes. It might
save a few hundred thousand young soldiers. As an investor, it is important to realize that catastrophic events have never affected markets – not the Indonesian tsunami, nor hurricane Katrina (nor earthquakes in California, nor planes flying into buildings). Markets in both Indonesia and America are UP since these events. True economics is the only thing that moves the marketplace. Forget what the politicians say – they’re only trying to save their behinds. Having said this, I do believe that politicians are getting smarter. They know how much trouble the US is in right now. If they can engineer a recession soon, they can blame everything on Mother Nature and maybe escape office with their heads still attached to their bodies. This is precisely why Greenspan raised rates again, and will continue to do so until the market implodes. I pray that this actually happens, so we don’t end up bombing anyone – which typically happens when things go really badly. Money Creates Money Everyone has heard the phrase, “money creates money.” This is exactly what happens in a fractional reserve banking system, which is what we currently have. Let me explain how this works. Let’s assume there are 2 banks. SonaBANK, which has current assets of $100,000, and JordanBANK which has current assets of $0. Jony wants to borrow $100,000 from SonaBANK to build a house. SonaBANK, not knowing Jony’s poor credit history or currently salary (which, by the way, is now considered OPTIONAL information) gives Jony the money. Jony then pays the builder and gets his house. The builder places his paycheck of $100,000 into JordanBANK. As per federal regulations, JordanBANK has to lock up 10% of the money, but can loan out the rest 90% or in this case $90,000. Jony decides to buy a 2nd house and borrow $90,000 from JordanBANK. He pays his 2nd builder, who then deposits this money into SonaBANK. Again, they lock up 10%, and loan out the rest 90% (now $81,000) to whoever comes in. Jony now buys a 3rd house from SonaBANK. I think you see the picture. Remember, we started with only $100,000 – but yet, with ONLY that money, Jony was able to purchase 3 houses already, with assets of almost $300,000! This goes on until the last cent has been squeezed out. So basically, that $100,000 can purchase up to $900,000 worth of assets! This is called credit expansion – meaning that every time we borrow money, we increase the supply of money in circulation. This number can be found by researching the M1 money supply, which as you will see – has skyrocketed in the past 10 years. This also explains why borrowing leads to an increase in asset prices, which leads to an increase in borrowing and an even bigger increase in asset prices. And Voila – all of a sudden – you got an asset bubble (in this case, a real estate bubble). How does the bubble burst? Well…..here’s the rest of the story: Step 1 - Jony loses his job. SonaBANK is no longer receiving payments from Jony, which decreases the amount of money they have to lend out. This leads to less money being borrowed, and comparatively less increase in the M1 money supply, and a slowdown in asset prices. Step 2- Now, all of a sudden, all those people who made a living day-trading houses, can no longer afford their mortgages. This means that SonaBank is screwed, because no one can pay back their loans. We have just reached Step 1 in the housing market. Since April, the median home price has fallen 14%
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