Fred Dupont says:

Harry,

You may be correct in your assessment of Aussie bks, however, please keep in mind that Australian banks are very sophisticated and large players in the derivatives markets… Their disclosure is opaque and their exposure unknown… anticipate the worst!

Aussie miners are also very sophisticated hedgers and derivative players, expect “some” surprises down the road.

Wayne Palmer says:

True Fred,

There are many ways to look at it. In your example of the ghost town, the people who walked away abandoned any value the town had for them, but others came in later and harvested tremendous value from the former mining town. Park City Utah is such a town, as is Telluride, Colorado. Some of the most expensive real estate in the US is located in just such towns. So, was the wealth “wiped out?” Was value totally destroyed?

Your point is well taken when it comes to paper assets. However, even in that case, I still hold that because with every paper transaction that took place as the price went up, wherein someone pocketed a profit or a gain and redeployed that gain, either in another investment or by spending it in the world economy, the value of the higher transaction is still out there, at work. Isn’t that one of Bucky’s fundamental principles… that we are all cosmic Billionaires and that the wealth of the earth is not what we traditionally think it is, but is rather an inescapable endowment, that cannot be destroyed but only underutilized?

I do see how your point is accurate when it comes to say the .com bust. There were all kinds of paper gazillionaires who had very little invested in their stock values. When the stocks plunged, they lost paper profit, paper equity, paper wealth. My question is: “Was that wealth ever real?” Until it is converted to some tangible form of money or wealth, of what was it constituted? I surely do see how there is an increment of market value that is based on a belief that a stock is worth X and that when the market corrects as it is doing now, that increment, that never had a connection to real wealth, evaporates. As you put it, “The bulk of the inventory not being transacted is artificially inflated on the way up and deflated (in price) on the way down.

For instance, in my business, I can prepare a financial statement at any time and say that my real estate is worth X. A year ago, my home may have been worth $425,000. Today is may be worth $375,000. Did I lose $50,000? I don’t think so. I never had the $50,000. It was only a theory, a number on paper. If I would have sold it at that price, the paper equity would have become real wealth to me. If someone had bought it at that price and now it is worth less, he still hasn’t lost anything until he liquidates at the lower price, regardless of what the neighbors are doing. I can’t see how the gain or loss is real until it is “real”-ized.

One of the elements that is raising havoc in the marketplace right now is the new accounting rules that require publicly traded firms to mark their “assets” to market. The price of the mortgages that Bear Stearns had to mark down was temporarily depressed because of fear. The entire investment class, securitized mortgages, has fallen out of favor on Wall Street. I contend that in spite of the current price, the value of the mortgages is still there. J P Morgan stepped in and bought the company at ten cents on the dollar. As time goes on, I believe the Bear Stearns portfolio will prove to be worth as much as ninety cents on the dollar. Was any wealth destroyed? I think not, it was only transfered to the shareholders of J P Morgan, at the expense of the shareholders of Bear Stearns. What I see happening right now is a huge transfer of wealth in the marketplace and very little destruction of wealth.

In my way of thinking, price does not necessarily equal value until a transaction takes place. Once a transaction takes place, the value is “real-ized” for the two parties to the transaction. If I buy into that theory, I have to believe that a new car is worth what the dealer asks for it and that real estate was worth what the last sucker paid for it at the peak. I don’t believe that and I never have. Maybe what we are contrasting in the end is a fundamental difference between price and value. If I use the value I have in my personal purchasing power to pay a price that is too high and the price corrects, I will have lost value in my personal net worth. However, the person to whom I paid the price that is too high has that value in his or her account.

It seems our society and our financial institutions have bought into the idea that market price equals value, whether it be on the high side, with the example of a real estate appraisal, or on the low side with a mortgage that has been marked to market. From that perspective, I could agree that a certain amount of wealth has been lost, but only to the extent it was static and benchmarked to a third party trade, not the direct subject of a first hand transaction. For every actual transaction that took place, I hold that the real wealth, the value, is still out there in the economy somewhere working and circulating.

Isn’t this viewpoint a core element of the Rich Dad philosophy? Robert has been incredibly courageous in saying that the wealth Americans pretend to have in their mutual funds, IRA’s, 401K’’s, etc, will most likely prove to be an illusion and hold no “value” to them at the moment they are expecting to use it (retirement) for the very reasons you state, Fred… mass liquidation and few buyers to support price. As we said last night on the call, he is willing to change at the drop of a hat, to have his “wealth” in assets that maintain value in spite of price. Gold is down right now from its highs. I wonder if Robert is nervous about the “loss” he has taken in his portfolio or if he still sees the “value” of his holdings over the long term. That brings up another weakness in the American perspective in my opinion. We are way too focused on the short term, next quarter, instead of next year or next generation with our money.

I must say Fred, that I am heavily persuaded by your perspective and I can see what you are saying. I am not 100% sure that I am seeing this accurately. I may be groping the proverbial elephant while wearing a blindfold. I feel the tail and think it is a snake or the leg and think it is a tree, etc. I surely see that there is more than one way of looking at this and both may be accurate because of the disconnect between price and value. It would seem that price only equals value in the middle of the curve, before an asset class is overbought or oversold.

Also, Fred, I want to compliment you for your language skills. I can’t imagine trying to carry on this conversation in any language other than my mother tongue. The strength of your intellect continues to impress me.

I look forward to seeing you soon,

wlp

Wayne Palmer says:

Hi Fred,

I agree with you. I am surely not suggesting that we should pretend assets are worth more than they are. My concern, which I surely see as an exception, is that most of the mortgages in the sub prime blended pools will prove to be viable and valuable, so the mandatory mark down unnecessarily causes a crisis that could be averted with greater restraint and wisdom, as opposed to the knee jerk reaction to an accounting rule that proposes to be “One size fits all.”

I surely don’t propose to turn the entire financial world into one big Enron. I agree that if assets are permanently impaired, they should be marked to market, or even below, if justified. I just don’t think the across the board markdown of mortgage pools was justified. I also see that Bernaki is taking many steps to isolate the assets, long enough to give the pools time to assert their core value, thereby calming the crisis. There is no question that certain of those mortgages will go bad and that the default rate will perhaps be higher than historical product types. Still, I am betting that 90% or so pay as agreed. There is no long-term crisis in 90% pay rates and no need to mark down an entire barrel of apples, because of a few bad ones.

I also completely agree that if they start doing “Make Believe” evaluations of their assets and pretend they are worth whatever they want them to be, as you suggest, they will cause an even greater crisis of confidence. That is a Financial Fraud Free For All.

And finally, I agree that the weak must be naturally weeded out of the capitalistic system to maintain the integrity and efficiency of the system. The bad apples must be removed from the barrel, to avoid spoiling the whole barrel.

Thanks for the dialogue Fred. Travel safely and I will see you in Phoenix in a couple of weeks.

Cheers,

wlp

Wayne Palmer says:

Hello everyone,

The link below leads to an article that addresses the topic Fred and I have been discussing over the past week.

Hope you find it interesting.

wlp

Where has all the money gone?

Fred Dupont says:

Hi Wayne,

Thank you for the article, it reads:

‘…economists and “banksters” would have us believe in normal times…’

as opposed to abnormal times for the banking industry I suppose? Nassim Nicholas Taleb has a different opinion; he is merely saying that it is normal for bankers to go bust!

From Nassim Nicholas Taleb – “The Black Swan”:

‘…(talking about lending bankers) There is no way to gauge the effectiveness of their lending activity by observing it over a day, a week, a month, or… even a century! In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking – everything…’

(see attached scan previously sent to the group on Dec 9th 2007)
This scan is visible in the archives of The Bucky Call.

Wayne Palmer says:

[Fred] Dear Wayne, As promised, please find a more elaborate answer hereunder.

In your example of the ghost town, the people who walked away abandoned any value the town had for them, but others came in later and harvested tremendous value from the former mining town (…) Was value totally destroyed?
[Fred] The extremely illiquid (total absence of demand) market conditions made the prices collapse to zero for 3 generations… This market valuation remained until pot smoking hippies in 1968 decided to live off the land and raise a few goats – this activity resuscitated some demand and prices rose slowly at first but then violently as dollar rich boomers (maybe the same, now ex-hippies!) bade the price up.
The rise and fall of activity explains the extreme variations in valuation (as does the availability of dollars and demographics). Was value totally destroyed? …I don’t know, it seems that the definition of value has dimensions that than are not easily accounted for – in Kelly’s terms, it would be TIME, SPACE, MATTER and ENERGY, with a particular emphasis on the relationships.

[Wayne] I agree that property didn’t have current visible market value during those three generations, but that value of some kind still existed, however latent. As I read in Grunch of Giants:

“Livingry industry had to wait until capitalism graduated from its for-centuries-held assumption that physical land property constituted capitalism itself, to the startling realization that the strictly metaphysical, technological “know how” had become the most profitable property…”

The silver and gold under the ground may have been played out, but those who came later saw something more in the ghosts of mining towns. They saw the beauty of the surrounding mountains, the slope of the hills that lent itself to downhill skiing, the freshness of the mountain air and the peace that it afforded, as depicted in John Denver’s legendary song, “Rocky Mountain High.”

My question is, wasn’t that value there all along? If anyone would have had the vision of what could be and ultimately was created on the land, wouldn’t an investment in the dirt, abandoned by miners, have proven brilliant over the course of a few decades? I am quite sure it would have. So, once again, the price may have fallen, but value was still present. However, just like the miners had to have the proper technology to get the minerals out of the ground, so must we have adequate metaphysical technology to harvest less visible opportunities lying latent in such situations. CREATIVITY is the thing that makes the huge difference. VISION and FORESIGHT to see how to rearrange the existing elements into a new form. As Bucky often says:

“Jointly, we humans have always had adequate physical resources to take care of all humanity but lacked the metaphysical know how resources with which to employ effectively the Earth’s physical wealth.”

Violently ripping minerals out of the earth produced only a modest profit as compared to the more harmonious cooperation and partnership with nature that has become a hallmark of most high dollar ski communities. The “lag” for 3 generations was necessary as a “gestation period” for higher thought forms that could better conceive of the optimal use of the land known as ghost towns. Again, quoting Bucky:

“It is only due to humans’ born state if ignorance and the 99.99 percent invisibility of technological capabilities that they do not recognize the vast abundance of resources available to support all humanity at an omni-high standard of living.”

I see price as a fickle thing that rises and falls, largely on the basis of supply and demand, amplified by human emotions that swing from fear to greed. Value on the other hand is the real underlying wealth, properly positioned by enlightened thought… or as Bucky might say, using the mind instead of the brain.

Your point is well taken when it comes to paper assets. However, even in that case, I still hold that because with every paper transaction that took place as the price went up, wherein someone pocketed a profit or a gain and redeployed that gain, either in another investment or by spending it in the world economy, the value of the higher transaction is still out there, at work(…)
[Fred] For the sake of simplification, let’s define a market where “the margin” is 10% of the inventory of stock held by say day traders (that trade 50% or more of their stock every day and their number is constant) and the bulk that never transact is held by your pension fund. The pension fund and day traders positions were established at $100 directly from an IPO where the entrepreneur sold his stock (did not create new stock), so all the money went into his pocket. There are also no dividend payouts, no new issues, no buybacks, no shorting, no taxes, no government intervention and all transactions are fully settled in cash, no margin (attention, not the same margin as above); the number of players and the size of the market are large enough so we need not worry about liquidity or market manipulation, there is also no change in the value of money (inflation or deflation) so we need not account for that, there are no news agency and no communications from the company.
In such a market, the price is determined by the transactions that happen every day for 50% or more of the stock of all the day traders; every day, a day trader has to chose to either buy or sell his stock – if more traders buy, the price will go up, and the reverse, if more traders sell, the price will go down. The pension funds sit on the stock and do absolutely nothing outside producing a quarterly report of the price action and the “value” of the fund (that is merely a report on the activity of the day traders).
It is easy to account for the following:
1- The day traders determine 100% of the price – any variation in stock value can be fully explained solely by the variation of cash flows from the day traders; if they are bullish in aggregate, they need to inject more cash to purchase more stock and bid the price up, the reverse is also true. (day traders can go bust, but there are enough of them to ignore the losers)
2- The variation of cash flows happen on 10% or less of the stock.
3- The accounting of an “change in value” is done on 100% of the stock; the day traders ledger and the pension funds quarterly report.
10 years have passed, the stock price is now $1000, up 900 from the original 100; Funds hold $900 (up 810 from the 90 invested), day traders hold 100 (up 90 from 10 invested). The day traders wealth increase of 90 is explained by the cash injections they made by being bullish in aggregate over the course of 10 years – the value of the higher transactions is still “out there” at work – however, when valuations were derived from other transactions, there are no ways to explain let alone realize the increase of “value” in the pension fund.

[Wayne] I understood what you wrote in the foregoing paragraph, Fred, but I am not entirely clear on what point you intend to make. It seems you are saying in the last sentence that the dollars in the pension fund, no matter how inflated, have not been realized and (I presume) that if the market falls, there is a real loss. Is that right? If so, I acknowledge that there has been a paper loss, but no pre-existing wealth, or real money, as defined in the article that I sent to you earlier this morning, has been lost. It is all on paper. I surely see how horrible I would feel if that were my paper equity and I lost 40% of it as some did so far this year. I’m sure I would feel it was more real than fiction and probably would beat myself up a bit for not “taking a profit,” i.e. “realizing the gain,” i.e. converting it to something tangible while I had the chance.

The further we go in this discussion, the more I think we are simply differentiating between different forms of wealth. Is it ice, is it steam or is it all just water in its various forms. I appreciate the conversation because it is clear to me that ice cannot accomplish what steam can do, property applied (it cannot drive pistons for example) and steam cannot support heavy equipment to transport it across open water to be deployed on distant land like ice can do in its season. Returning to my theme above, it is, in my opinion, key to know which form of money technology to deploy in which circumstance or segment of the cycle. They all have value, properly deployed, but I don’t see them as being equal and so, going back to the original media broadcasts that got me on this tirade, I don’t agree that $7 Trillion in “wealth” has been lost or destroyed. That doesn’t mean that I think nothing has been lost. I see that certain types of fragile equities have evaporated, as you so eloquently describe above.
(…)
In my way of thinking, price does not necessarily equal value until a transaction takes place. Once a transaction takes place, the value is “real-ized” for the two parties to the transaction. If I buy into that theory, I have to believe that a new car is worth what the dealer asks for it and that real estate was worth what the last sucker paid for it at the peak. I don’t believe that and I never have. Maybe what we are contrasting in the end is a fundamental difference between price and value. If I use the value I have in my personal purchasing power to pay a price that is too high and the price corrects, I will have lost value in my personal net worth. However, the person to whom I paid the price that is too high has that value in his or her account.
[Fred] I agree, I am not opposed to challenging efficient markets and their Nobel Prices – The Long Term Management fiasco in 1998 did that already. price does not necessarily equal value until a transaction takes place – and even after a transaction took place! We are back to a multi dimensional definition of value.

[Wayne] That definition does seem to be indigenous to this conversation, doesn’t it.

It seems our society and our financial institutions have bought into the idea that market price equals value, whether it be on the high side, with the example of a real estate appraisal, or on the low side with a mortgage that has been marked to market. From that perspective, I could agree that a certain amount of wealth has been lost, but only to the extent it was static and benchmarked to a third party trade, not the direct subject of a first hand transaction. For every actual transaction that took place, I hold that the real wealth, the value, is still out there in the economy somewhere working and circulating.
[Fred] The $90 from the “day traders are – “some” of the 810 from the pension funds might, but I can’t explain it in a bordered market.

[Wayne] What do you reference when you say “Bordered Market?”

Isn’t this viewpoint a core element of the Rich Dad philosophy? Robert has been incredibly courageous in saying that the wealth Americans pretend to have in their mutual funds, IRA’s, 401K’’s, etc, will most likely prove to be an illusion and hold no “value” to them at the moment they are expecting to use it (retirement) for the very reasons you state, Fred… mass liquidation and few buyers to support price. As we said last night on the call, he is willing to change at the drop of a hat, to have his “wealth” in assets that maintain value in spite of price. Gold is down right now from its highs. I wonder if Robert is nervous about the “loss” he has taken in his portfolio or if he still sees the “value” of his holdings over the long term. That brings up another weakness in the American perspective in my opinion. We are way too focused on the short term, next quarter, instead of next year or next generation with our money.
[Fred] One of the main causes of the derivative crisis (read CDS, not subprime) is the short term focus on booking unrealized “profits” and bonuses.

[Wayne] Absolutely! I couldn’t agree more. That is exactly my point about the unrealized equities at higher prices, no matter where they are held. It is also interesting to see that many of the clever Wall Street types, with their short term vision, cashed in on those prices and converted them to some other form of value that was thereby removed from the system and presumably somewhat insulated from the risks of their own game. Those sly dogs!

I must say Fred, that I am heavily persuaded by your perspective and I can see what you are saying. I am not 100% sure that I am seeing this accurately. I may be groping the proverbial elephant while wearing a blindfold. I feel the tail and think it is a snake or the leg and think it is a tree, etc. I surely see that there is more than one way of looking at this and both may be accurate because of the disconnect between price and value. It would seem that price only equals value in the middle of the curve, before an asset class is overbought or oversold.
[Fred] From an investment perspective, there are “balance points” that maximize yields and minimize risk based on sets of assumptions, this is what I was modeling in an earlier life. At that time, models worked very well when goods were exchanged (computer power allowed to model barter in spite of the number of relationships that grows fast; in barter each “product value” is defined by its exchange against every single other) and crashed whenever we introduced money!
We are living through a brutal paradigm shift: investments that used to be defined by asset inflation and moderate monetary inflation has changed to asset deflation (in terms of constant value of money) and high monetary inflation – most strategies don’t work when properly accounting for tax and devaluation.

[Wayne] I find your foregoing paragraph fascinating and mostly over my head. I would love to visit with you in more detail about your former life and what you learned. I would also like to drill down into the concepts of asset inflation and deflation you mention above. Maybe in Phoenix?

Also, Fred, I want to compliment you for your language skills. I can’t imagine trying to carry on this conversation in any language other than my mother tongue. The strength of your intellect continues to impress me.
[Fred] Thank you Wayne, it worked, you put a smile on my face! Who does not like a little ego flattering? I do enjoy our discussion, especially that it seems to generate more questions than answers… as for language skills, I wish I’d be able to carry this conversation in… French!

[Wayne] I wish I could carry it on in French, too. Then I would be due the sincere compliment I am giving to you, but I have not paid the price to earn such a compliment and you have!

See you soon,

wlp

Wayne Palmer says:

Hey Fred,

I think we agree more than you may think we do (sounds like a disagreement doesn’t it?):-)

My core point is that if the rules create temporary anomalies that cause the demise of companies, that would be fine under a scenario of greater patience and long term holding of the asset, there are damaging elements to the accounting rules.

Truly, how do we contrast that against the need for transparency and truthfulness in booking asset values?

I may be somewhat biased, because I deal in impaired assets, purchased at discounts and then repair them to realize higher values. The repair is sometimes almost immediate and sometimes takes time. However, in the 16 year history of our company, our losses have been about 1.5%. If someone would have forced me to mark to market (whatever that means in my business), there would probably have been times where my balance sheet would have been out of whack. However, given time and patience, I am able to rectify most deficiencies and restore value, through an adept application of financial and people “technologies” if you will, that balance the economic equations inherent in the instruments, thereby making them collectable.

I don’t see the publicly traded firms nowadays having a chance to do that. Do you? I’m not sure they should be given that chance. What do you think? It seems to be in everyone’s best interest to harvest the maximum value from every transaction. However, if we agree in wealth transfer and that one firm’s loss is another firm’s gain, it does balance in the end. It just doesn’t balance in all accounts.

Thanks again for the dialogue. You are definitely stretching my brain!

I appreciate that.

wlp

Fred Dupont says:

You are right, instability as in Tsunami or as in… Glaciations! It is what I meant, thank you for this important distinction.

Funny these terms refer to water but so do liquidity and other money terms. The physical states we used earlier reappear here and we could observe them in the light of single, double or triple bonds and compression/contraction that Bucky describes.
I agree that imbalances are at the core of the capitalistic system and the root cause of an exchange in a sense that a need to fulfill is in itself an imbalance to resolve… The “exchange” being Nature’s way to self resolve and/or regulate imbalances. A capitalistic system needs to be convex (possess imbalances) to operate (generate exchanges) as does a healthy self regenerating, sustainable ecologic system…

Where is the ephemeralization if the exchange is the goal?

And here I pause and think: did we compare the economic cycles studied with Brent last June to the seasons and the weather? Have we not used the example of a seed of barley? What would happen if the government had the power to enforce a law against bad weather (It sounds absurd to go against the “laws of nature”, right?
…Well, in genetics Lysenko, under Stalin in USSR and in agriculture, Mao in China tried it!

I wonder what next year’s crops will look like?

Is it what is happening now in the world of finance where failure is no more permitted and “dissidents” are silenced?

Jason Kiyosaki says:

Hey Fred,

If its alright with you i’d like to tell you my theory:

there is a reason the “bail out” didnt pass the first time. its so the market would crash so that certain companies can buy out all the crashed companies. so when the bail out happens, their investment will go up.

another part is that i heard the federal reserves banks want to make a one world federal reserve. they’re going to do that by creating currencies for certain chunks of the world. the US, canada, and mexico will have the amero instead of their current currencies.
i thought how were they going to make people accept such a change? they’re going to do that with a 700 billion dollar bail out or i hear it might go to 700 trillion. they are going to destroy the american dollar so that we have to accept the amero. plus i hear the euro is doing well.

take care,
jason

Wayne Palmer says:

My thanks to you, too, Fred.

I have greatly enjoyed our exchange and have received full value for my time spent.

You have a great mind that continues to fascinate me with its veracity.

Have a great week. I will see you soon, I hope?