We live in strange times, but now the citizens are baying for blood and politicians are answering the call in spades. The only problem with that is they have no idea what they are doing but conversely they want to be seen to do something.

Last week we were treated to the spectacles of the ultimate bankers’ and politicans’ showdown, at least for the English speaking world. We saw the failed chief executives of HBOS and RBS take a total skewering at a parliamentary select committee on Monday,  and then on Wednesday it was the American version, with top bankers all being summoned to a hearing in Washington. Although their tone wasn’t as contrite as their UK counterparts, and perhaps because they haven’t been nationalized yet by less obvious magic, they realize that public opinion is against the banking industry for the excesses of the past couple of decades.

Within all this extra global spending, consumers are actually paying down debt with any spare cash, in preference, to just going out and spending it. This data comes to us from Australia, which instituted its own spending package and surprise, surprise, the data shows that indebted consumers preferred to pay down debts rather than spend the money.

It could be worse, back home in Japan here, it was noticed in the 90s when the Japanese government made a similar move, a lot of the extra cash ended up in extra savings.

Perhaps the politicians are hoping that by throwing enough cash at the problem that the problem will go away, and they won’t be labeled as the lame ducks they are..

Here in Japan, the hopelessly outclassed premier, Aso, starts trying to rewrite history and mentions that he was against the corporatization of the Post Office, so effectively pushed through by his successful predecessor, Koizumi. The former premier was so flabbergasted that he could only laugh in response.

This is unprecedented in Japan’s postwar economic history; it only shows a total lack of understanding of the situation facing this country right now. Then, his politically appointed Minister of Finance gets a well deserved roasting for falling asleep at an important meeting of politicans. Good on him I say, he showed the true utility of these multilateral ministerial parties.

You may not be aware from the media at least, but the US unemployment rate is probably around 20% already, if one reads shadowstatistics.com. Extrapolates these trends a little, we are already in a depression. For most working people, we all know that, but the media is trying to tell us that we aren’t in the hope that if we don’t realize it we’ll continue spending.

One investment you should make, and this is probably the cheapest, longest lasting effective investment is an investment in your own health. A good friend is about to publish his manuscript on the subject of how capitalism and healthy societies are mutually exclusive forces and the more a society becomes engaged in capitalism, the worse it is for general health levels and later generations to succeed and prosper.

Look at the US, or any OECD nation, health and disease levels are all showing worsening trends. I rest my case.

Such is the outrage as the general population awakes like Rip Van Winkle to the fact that the self proclaimed creators of wealth are nothing more than robber barons. Unfortunately this outrage is now coming too late, as the current global economy could be likened to a hot air balloon with thousands of holes that has been stretched way beyond a natural point of equlibrium. Unfortunately massive pumping of more air into the balloon does not keep it inflated everyone knows that it is slowly deflating. Thus the stock markets are falling, consumer expenditure is falling, and there seems no end to bad economic news.

Frugal producer nations that at first glance hadn’t indulged in excessive credit growth have still built up excess productive capacity to satisfy the excessive consumption in other nations. Japan, Korea, China and to a lesser extent the countries of South East Asia are all afflicted by the slow down as are producers of raw materials. This pretty much sums up the rest of the world. The effect is seen in the price of commodities, none of which is more visible than the precipitous drop in price than oil. For those of us in the west, we are suffering a recession, for countries in Africa, this is a life and death situation for many populations.

In the political arena, the growing popular frustration for something to be done is resulting in ever growing stimulus packages from government. Prudent fiscal discipline to hold back inflation is being thrown out the window of short term expediency as politicians boldly step forward with your money to spend their way out of these problems.

What is the investor to do? Well at the moment cash is king, everyone is hoarding it and not spending it. Precious metals have come back from the highs set just a few months ago as investors that need to raise cash literally sell the kitchen sink. Even good investments are sold to cover the losses of bad investments and it is all going out in one giant garage sale.

Will this continue? While it may seem in the short term that the selling will never end, there will of course be a time when astute investors feel that prices are too low, and will start to buy. The turn around begins when a general realization seeps in, early buyers have picked up the cheapest assets, and others start to pile in from the sidelines with their ready cash. The pattern has been repeated many times in history and no doubt it will be repeated this time around but in the meantime, where will it happen?

We have to step away from stocks in general. There is now an oversupply of money, which despite a slow down in velocity of money in the economy will at some point start to seep out and cause a rise in asset prices.

The first thing that is going to happen will be a repeat of the famous spike in precious metals of the seventies. I believe that what you have seen so far is nothing compared to what will happen. I’ve mentioned it before so I won’t go into it again, but we are now seeing forecasts for gold to hit US$ 2,000 per ounce sometime this year. Recently we have been seeing the price of precious metals react to this phenomenal growth in money supply. Mass media financial commentators, the people who have been telling us there is a recovery on its way, dismiss worries about the resurgence of inflation, which is exactly why you should be worried.

The financial system while creaky still works. It will stop working when politicians decide that it is showing the wrong results and try to change the rules of the game; it won’t be because the market breaks down of its own accord.

I don’t want to sound like a cracked record, but, there are plenty of cheap assets around that should be more expensive, time will tell, and you can still choose them with a bit of common sense.

It is the Tokyo MadHatter back from last time, I hope we didn’t put you off following financial matters too much. A lot of financial commentators are told to make things sound good, especially the paid ones, well I prefer to tell it as it is.

So, to cap off the last blog, I will admit it, I did recommend Gold and Silver. Everyone knows, or at least everyone knows that during a crisis, people sell other “risky” assets, and try to buy less risky assets, ie the famous “flight-to-quality”. Now, as we non-North Americans also know, US Treasury bonds used to be considered the best “less risky asset” and were always the beneficiary of any flight to quality movement.

For the US investor, that is still true. But, for the Rest Of The World (ROTW) that has all finished. The ROTW can all see that the US government can’t be trusted anymore and they want real assets, not worthless IOUs, which in effect anything denominated in US dollars should be viewed as these days. The ROTW have decided that Gold is the asset of choice and to a lesser extent Silver too.

Now, let’s take a brief break here while I explain why buying gold is not so easy. Obviously the price is known, hey, it is quoted every day. Equally obviously, there is a limited quantity, so the amount you can sell is also limited. Thus, the incentive to sell it is limited. As it happens, there is very little money to be made in selling gold. Now compare that to say selling shares in a company, or selling units of a fund. A company can issue unlimited numbers of shares, equally a fund can raise unlimited amounts of money by issuing unlimited number of units.

What is the difference?

One is paper, one is real. The real one is not a liability. If you own gold it has intrinsic value that does not rely on anyone paying you back. So, since the early 70’s when the Nixon government finally broke the link between the US dollar and gold by refusing to exchange dollars for gold, the financial industry has gradually done a fantastic job of convincing us that paper has more value. And to a great extent it did. This spurred a lot of technological innovation, but as empires go, and the US dollar and US empire has followed, bad money chases out good, so, what began as a positive influence in global finance, ultimately ended up corrupting it, and unfortunately we are now seeing the cumulative effect of all this coming together in one major crisis.

Now, so the price of gold has actually fallen while the crisis got worse. How can this be? Well, what price are we talking about? We are only referring here to the price of paper gold, because the financial innovators long ago created a paper gold that could be traded along with all the other paper assets.

How can you believe this?

Go down to the local gold merchants, yes they even exist in Japan and find out how much gold you can buy. Good luck, there is hardly any physical gold available to be purchased at the moment.

What has happened? Well, if the price of gold is a market signal, there is a lot more demand for physical gold that there is physical supply. Ok, thanks MadHatter, anyone who has done economics 101 knows that in cases like this the supply will increase to meet demand, particularly if the price has gone up a lot recently. Well, yes and no, and no particularly because of the laws of physics. There isn’t enough gold for sale because global gold production actually fell last year, and some of the more popular places to buy gold, like the PerthMint have actually has to suspend deliveries because of supply.

Ah, I hear you say, the price should go up. Yes, it should and it does. Again, if you are familiar, there is a little thing called a premium. So, if you walk into a gold shop anywhere in the western world, you’ll actually pay $200-300 dollars more for the physical gold that the “paper” gold price that is quoted as the “official” gold price.

How long is this going to go for? That is a good question. I don’t have an answer, but, I would say that there is an old Wall Street theory. Everything is a theory if someone wants to argue with it, but maybe over time this will be renamed as the old Wall Street truism. The theory states that a price of an ounce of gold can and sometimes is greater than the price of the Dow Jones Index. Let’s see, the Dow is around $8,500, gold is $768. Can it happen again? It happened in the thirties, gold was $32 or so, the Dow went below that level. I leave this one up to your judgement

However, as this recession has started to affect the citizens of Japan, and you our dear readers that reside here, we felt it was necessary to come out of retirement and give you the heads up on what is really happening in global markets, with an obvious focus on the stock market. You have to have a knack of reading between the lines, but don’t worry, the Mad Dog team is here to decipher the decipherable and give you the gist so that you can plan how best to get through the next few years.

So, without further ado, let me recap on some recent news and what it means to all of us.

As we head towards the end of the year, the Tokyo stock market has been falling for some time, around 48% since January. Classic economists will say “supply is greater than demand” so stock prices will fall. Ok, great comment from the new kid on the trading desk. Why?

“Foreigners are selling”, a common refrain from domestic investors. Again less than useful to understand what is truly going on.

“Forced selling, liquidations, loss cutting…” now heading in the right direction, gritty words, but starting to give a glimmer of reality to our conversation with the newbie.

That is about the level of sophistication that the market pros speak in as well though, not much of a pertinent indicator for how the Nikkei falling and the snowballing effect of this economic hardship are affecting everyday folks like you and me. But worse is to come, and you are likely to get some arcane details or discussions that normal people wouldn’t hear in the course of normal life. By this I mean when it comes to explaining how they have managed your money, the excuses really start to roll. “Unprecedented” credit market shocks, “black swans”, “once in a hundred year event” as if they can regain your trust for destroying their wealth with a few platitudes.

The fact that major manufacturers like Toyota cutting back on jobs on the front page of the Nikkei as has been pointed out by many commentators is grim reading. But dear readers, you have to keep all this in perspective, and we posit to you that in the big cycles, the following is happening.

Japan had a credit bust in the nineties. To allieviate the ultimate painful repricing of assets and slowly let the lid down, rather than suddenly as used to happen in historical bubbles bursting, the BoJ flooded cash markets with cash, reducing yen interest rates to record lows. None of that helped reflate the domestic bubble, and in fact, a lot of that flowed overseas in the now infamous “carry trade”.

In fact, we believe that this is what underpinned the extraordinary credit growth in financial securities and aided Greenspan in his inept mis- management of US monetary policy for those long 18 years he was blowing credit bubbles all around the US economy, and in effect the global economy.

Now from the new century, the Japanese asset prices which had been in free fall were starting to bottom out and starting to be worth something on a real basis, ie a real yield. Suddenly before you could say “private equity” the foreign investment banks were snapping up all sorts of assets on the cheap, generally by leveraging them up and in a cheeky way showing domestic investors that it was time to come out of their trenches where they had hunkered down for too long. Now, where did all this money come from, well, if it hadn’t been for the extraordinarily cheap BoJ money slushing around the economy, we wouldn’t have had the mini bubble in Japan, or more precisely Tokyo, especially Minato-ku property, and the Nikkei definitely wouldn’t have reached the lofty levels on 18,000 it was trading at last year.

So, the assets change hands, there are the real assets like property and there are the paper assets like stocks or bonds. First, the foreigners buy the assets as they had the “liquidity preference for risk assets”, while domestic investors were hunkering down in deposit type investments hoping they wouldn’t lose any more money. This is what was happening around 1999/2000/2001. Now in 2008 and more in 2009, the foreign money is fleeing but it is really too late to get a good price on that and the buyers of last resort are now the domestic investors.

That is the great thing about a lot of these assets, you can’t take them away with you so you have to dump them for whatever the locals are willing to pay for them. In this case not a lot, because the Japanese investors unfortunately have a lot of dross of worthless assets they purchased overseas and in a mirror image are repatriating their capital back to Japan.

So, right now, we are in the start of a big liquidation period, where cash will return or at least part of it will return to its owners and those who leveraged up to buy assets will be in trouble because suddenly, there is no other investor out there to pick up the stock / building / investment property at the same price that might have seemed reasonable 12-18 months ago.

I am sorry to say, but the news is bad, and it only gets worse, for most people. Bubbles are fun, everyone seems to be making money. As the famous Paul Volcker who ran the US Federal Reserve Bank in the 1980s was famously quoted, the job of a good central banker is to take the punchbowl away at the party. It is never a popular role, and that is why his tenure wasn’t extended for another 6 years compared to his successor who made himself famous for filling up the punchbowl during the middle of the party, and in effect letting the party run on all night.

Right now, stocks and bonds are only for the brave, cash is good and precious metals are best.