Clyde Harrison’s Speech: Tomorrow Will Come

Governments and Central Banks are Completely Incapable of Keeping Tomorrow from Coming

by Clyde Harrison, April 2006

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Introduction:  I’ve met Clyde numerous times as a fellow panelist at the Chicago natural resources show.  Clyde sent me his latest draft of his speech, which he continually revises, as he is in very high demand as a speaker.  You will see why, as he has a genius for clarity of vision, as well as presentation. I’ve only edited the text for punctuation, to help make it more readable.  Clyde knows how to turn a phrase to make his market insights humorous and memorable.  This speech comes at a perfect time, as the commodity markets seem to be stumbling with increasing volatility and uncertainty.  But Clyde’s comments from a month ago reassure us that commodities will probably be in an up trend for the next 10 to 15 years, and he gives plenty of reasons why.  This is definitely a “must read”. –Jason Hommel

Clyde Harrison’s Speech
April, 2006

God gave me the ability to recognize the obvious, some common sense and a sense of humor to stand the first two. 

The one trend in place is the overall advance of mankind.  It began when we emerged from the cave.   

The world is going through a dramatic change.  The world has discovered capitalism.  China and India are transforming their economies from poor agrarian economies to industrial powers.  The effect of these changes will be felt for years. 

One of my favorite quotes is, “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for life.”  Today in order to teach a man to fish, you need two fishing licenses, a state boat sticker, OSHA approved life jackets, EPA approved weights and hooks, you pay a park fee, obtain a fire permit to cook the fish and an EPA permit to dispose of the waste.  Thanks to the government, fish you catch costs 8 times as much as the fish you purchase in the supermarket, caught overseas.

When I started in the investment business 38 years ago, the Golden Rule was “Do unto others as you would have them do unto you.”  In a few years it was corrupted to, “He who has the gold makes the rules.”  Today it has been totally corrupted to, “He who makes the rules gets the gold.”

Our educational system is failing the students. US high school graduates do not have the knowledge to pay teachers’ pensions.

In 2005 in the US, 70,000 engineers graduated from college, 30% were foreign students.  India graduated 200,000, China 500,000.  By 2010, 90% of all PHD engineers and scientists will live in Asia.  When US students enter school, they test at #1 in the world for over all knowledge. After 12 years with the NEA, they graduate from high school 24th in the world.

The moral values they are taught are: diversity, tolerance and respect for the environment.  Jefferson said, “without an educated voter, the republic will not stand.”  

What’s the latest suggestion from the national education association? It is to grade papers with purple pencils instead of red because red hurts the students’ feelings and to ban the game of tag at recess, because it is too aggressive. 

Governments in most cases and most places make things worse. George Washington said “Government is not eloquence, it is not justice; it is force. Like fire, it is a dangerous servant and a fearsome master.”

The definition of politics is: “The advance auction of goods that have not yet been stolen.” 

Whenever a government does something for someone, it must do something to someone.  If expanding government were the solution, Russia would have been paradise. 

In the US, we have a two party system and what a party they are giving themselves.  Since 1960 government spending has grown 8 times as fast as the GNP.

Republicrats borrow and spend.  Democins tax and spend. From 2000 to 2005, federal spending increased 38.2%.  Federal debt increased 40.5%. 

The government taxes and regulates success and subsidizes failure.  The Government’s motto, “If it ain’t broke, fix it until it is.”  Whenever you contact the Government, you are met by one of two groups who work for the government.  The first group is just out of college hoping to work in government for three years, learn who to talk to in order to get things done, then get a real job and triple their pay.  

The second group is much older.  They couldn’t get a real job after 3 years.  Government has either no experience or no talent. 

If you believe in government, FEMA has 10,000 trailers in Hope, AR they would like you and your friends to move into.

Today, lawyers run the government.  Seventy-three percent of the cabinet members are lawyers.  Eighty-five percent of the gang of 535, the Congress, are lawyers.  Lawyers train on the principle that when there’s a solution to a problem, they stop making money.  You know the system is corrupt when Congressmen spend $6 million to get a job that pays $162,000 per year. 

In 1987 the US signed a treaty allowing Japanese lawyers to practice in the US and US lawyers to practice in Japan.  At the signing there were a total of 14,000 lawyers in Japan and 650,000 in the US.  Two years later, Japan entered a depression.  It is just starting to recover.  Just coincidence? Maybe.

Consider the following:
The Lord’s Prayer: 66 Words; 
The 10 Commandments: 179 Words; 
The Declaration of Independence: 1300 Words; 
U.S. Government Regulations on the Sale of Cabbage: 26,911 Words; and
U.S. Income Tax Code – simplified: 1,607,000 Words.

Last year congress failed to change course on the unsustainable path of Social Security and Medicare.  The financial cliff is still out there.

It would be a great improvement if the government respected individual’s rights as much as they respect the rights of the caribous.  

If the current congress wrote the bill of rights it would be as follows:
 The right to pay taxes.
 The right to adhere to any and all federal regulations.
 The right to be guilty of any and all IRS accusations, until you prove yourself innocent.
 The right to turn your property over to the government if they have a better use for it.

The government is already too large and too expensive.

Bush Sr. simplified taxes.  Now we only tax the living and the dead.  Clinton promised to tax only the rich.  Once in office, he defined rich as, “Those Americans with Indoor Plumbing.” Bush Jr. said he cut taxes but the tremendous increase in spending means W just delayed tax increases. 

God, who created everything, only wants 10%!

The demands of the majority are always greater than taxation alone can provide; that’s where the FED comes in.  

The following will not be in Allen Greenspan’s book:

Between 1800 and 1913, the value of the dollar was more or less constant. 

Since the Feds creation in 1914, the value of the dollar has depreciated 97%. 
Since the maestro, Allen Greenspan took over, the dollar has lost 37% of its value. Consumers have gone deeper and deeper into debt in order to spend freely out of artificial purchasing power extracted from over valued homes.  All that paints a compelling picture of an excess demand driven US economy.  

The 1% Fed funds rate moved the savings rate to between zero and zip, while mortgage debt increased 62%.

The last central banker to get it right was Joseph, in the Bible. Seven good years followed by 7 bad years.  The Fed is like the Post Office giving out money instead of stamps.  Faith in the Fed is based on elaborate mathematical models relying on the breathtakingly faulty assumption that human beings behave rationally. 

The FED’s invisible hand of intervention is trying to keep interest rates as low as the world will allow.  But the world is becoming a bit nervous.  The US has borrowed over $1 trillion from overseas.  Some day it will be repatriated.  The exchange of paper for wealth will go into reverse.  We will get our paper back and have to return real wealth.  Recently, the dollar has been rapidly declining against the Euro and gold but at a much slower rate against the Asian Tigers. Our biggest export under Greenspan’s term was paper – the US Dollar. 

Japan and China have purchased massive amounts of US treasuries to stem their decline.  They loan us money to buy their products because they need the US as a customer.  When will this end? It will end when the Asian Tigers develop a consumer credit system and their three billion plus citizens become the customer.  At that point we will no longer be able to live beyond our means – the dollar decline will accelerate and interest rates will rise dramatically.

The dollar bears the legend on it, “In God We Trust.” Placing your faith in the Fed could be a dangerous plan. Someday, the dollar could fall to its intrinsic value. Denial is not just a river in Egypt.  Currencies do not float, they sink at different rates. Currencies are abstractions not redeemable in any specific amount of anything, they are an “I-owe-you nothing” certificate.  

Foreigners currently own 45% of US treasuries.  The FED can create $30 billion of paper in a week.  They can raise rates, but it won’t create one drop of oil, one pound of copper or one bushel of rice. 

Now we have Bernanke as the new head of the FED.  Bernanke has studied the depression and deflation at great length.  He has stated the FED has many options to avoid deflation including dropping dollars from helicopters if necessary, earning him the nick name “Helicopter Ben.”

The FED is attempting a neutral interest rate policy.  Neutral for the FED is like pornography to the Supreme Court.  They can’t define it, but they will know it when they see it. 

Stagflation is coming.  Slow GNP growth, inflation increasing, and net disposable income declining.

Currently the FED is raising the rent on money but you can get all you want.  Money is very loose. It just costs more. 

We all work for something.  Our government manufactures with no sweat, no work, and no creativity – just turn on a computer and create more dollars. 

Unless you have the ability to chain-weight, seasonably adjust, and substitute–in your checkbook, then your dollars probably don’t go as far as the government would like to have you believe.

The Bureau of Labor lies are a bit better than the government’s response to Katrina because the footnotes explain why these reports are worthless.

There is a disconnect between the man on the street and how he feels–and how the government tells him he should feel.

The BLS over time has made tiny incremental changes in the way they manipulate the statistics. 

In a bipartisan effort, presidents and the FED chairman have tried to make the news just a little better.  Over time, these tiny changes have begun to add up.

 If we just go back 20 years and remove these changes, then unemployment today would be about 8%, the CPI would be about 7% and the GNP growth would be 0.

On the unemployment front, if you were a discouraged worker, you were counted until the Clinton administration.  During Clinton’s reign, workers who were discouraged for over a year were taken out of the number. That knocked 5 million off the broader unemployment report.  U-3 is now the reported number of 4.7 but if you look in the footnotes, U-6, the old number is over 8% unemployment.  

The real degeneration over time is the CPI.  In the 90’s, Michael Boskin at the council of economic advisors and Greenscam at the FED wanted to fix the CPI simply stating that it was overstating inflation.  They created substitution–assuming that if the price of steak went up, the public would substitute hamburger.  The CPI was originally designed to measure a fixed basket of goods for a constant standard of living.  Today it has changed to a basket of survival. 

The Clinton administration and the BLS changed the weightings method of the CPI. Arithmetic was changed to Geometric weightings which as the benefit that if something goes up in price it automatically gets a lower weight.  If the price goes down, it gets a higher weight.  They also try to adjust for product improvements.  If they determined the product’s price increased but it was improved, the price didn’t go up with hedonic adjustments.

Wall Street economists and bank economists don’t adjust for these changes because like politicians, they tend to have an upbeat view. 

If inflation is understated then reported real growth (the GNP) will be overstated.  Bob Reich, in his memoirs wrote that they found in their polling that if you could overstate economic growth, understate inflation, tell people things were are better than they really are, then it could help you win a tight election.  That was their conclusion, so of course the numbers were adjusted. 

Last year if you didn’t eat, didn’t drive to work, didn’t heat your home, didn’t visit a doctor, didn’t buy a house, didn’t buy insurance of any kind, didn’t have a child in college and didn’t pay state or property taxes, your cost of living agrees with the government’s.

If you’re using government statistics for your investment decisions, you’ll substitute cat food for hamburger when you retire.  

Since the Feds creation there has been deflation – deflation of the currency.  It shrinks, on average 2.5% to 3% per year.  In the US, we have voters who are deep in debt.  Deflation would crush the voter.  Currency deflation will help the debtor.  Expect stagflation – the value of the currency goes down while the economy goes no where; an, “L” shaped recession.

Prices will be lower for every thing that can be manufactured in China or serviced in India.  

Prices will be much higher for what can only be made in the US; medical care, insurance, plumbers, trash collection, raw materials, real estate, and government.

In the next 10 years, the government will lie about the deflation of the currency; so when the baby boomers retire, their social security check will be worth half of what they anticipated in real terms.

When the Fed fine-tunes, the orchestra gets fired.  All soft landings by the FED have resulted in thousands of casualties.  Ever since the earth was cooling the Fed was headed by a banker.  Greenscam was the first economist.  Carl Marx was an economist!

If you believe the Fed guides the economy you must also believe the twelve birds sitting atop the rhinoceros guide him through the jungle. 

Currently the government is trying to boost the economy with one of the largest doses of steroids in history.

Today we have over $1 trillion in fiscal stimulus from the budget and trade deficits and the monetary stimulus of tremendous liquidity and some of the lowest interest rates in over 40 years.

The pedal is definitely to the metal.  The economy’s improvement is sluggish considering the massive size of the stimulus because of the size of the debt we’re dragging behind us.

The ocean of liquidity has created a lot of jobs.  There just not in this country.

What investments will benefit from this major change?  Where should you invest your SEC rebate check, or your own hard earned money?

Long term interest rates are low. The FED is proposing dropping cash from helicopters if necessary.  History suggests this might be a good time to be a borrower or at least have a short duration to your interest bearing investments.

The equity market now has 84 million individual investors.  Over 50% of these investors’ liquid assets are in the equities—but the historical average is 25%.  Using the rules outlined by Graham and Dodd such as dividend yield, P/E Ratio, price ratio, price to sales ratio and price to assets, stocks are very expensive.  They are over owned and over priced – a dangerous combination. 

Who’s recommending increasing equity exposure?  Kudlow and Cramer – CN”BS” – which is a marketing program.  It should be listed in the TV guide as paid programming like George Forman’s cooker.

Who’s recommending caution and much lower returns from stocks going forward?  John Templeton, Carl Icahn, Allen Abelson, Mark Faber, Bill Gross and Warren Buffett: just to name a few.  Buffett currently holds $47 billion in equities and $45 billion in cash.  He must be having a tough time finding those bargains from Omaha.

There has never been a ten year period in history when valuations have been as high as they are now and where the broad stock market indexes out performed money market funds – never!

I expect a moose market, not a bull or a bear but a moose, rhyming with the period of  ’66 to ’82 where the market went nowhere.

I believe the paper bill market has ended and the stuff bull market has begun.

Between 1966 and 1982, equities gained nothing while the GNP gained 330%.  The DOW went from 1000 to 875.  From 1982 to 2000, the GNP gained 170% and the DOW rallied from 875 to 11,700.  Currently the DOW is trading over 11,000, about a 25 P/E ratio.  Between now and 2015 if the GNP gains 100% and earnings gain 100%, then the DOW could be at 10,000, trading at 10 times earnings.  During the past 5 years the S&P is up 5%.  And at that rate of compounding, you will have to work till you die. 

During the last stuff cycle equity mutual funds were in a dead zone while stuff; raw materials, art and real estate had super returns. 

In 1966 oil was $2.90/barrel and rallied to $28/barrel.  Gold was at $35/oz and rallied to $850/oz.  The average price of a home increased 180%.

In 1982 the stuff cycle ended and the great paper cycle began.  In 1982, the public had 14% of their liquid assets in equities.  The Business Week Magazine cover reported “The Death of Equities”.  The P/E ratio was 7.  Stocks were dirt-cheap and stuff was very expensive.  Brokerage firms were selling real estate and oil and gas partnerships.  1982 was the beginning of a great bull market in paper.

By 2000, the DOW was up over 10 fold.  The cost of one dollar’s worth of earnings (the P/E ratio) has risen from 7 to 44, and the public had 57% of their liquid assets in equities.  The Time Magazine cover featured “The Committee To Save The World: Greenscam, Summers and Ruben”.  Brokerage firms were selling tech and dot coms with no earnings.  The paper bull market was ending.  Paper was very overpriced and over owned.  The Dow could be in a trading range of 7,000-11,000 for years.

Stuff, from 1982 to 2000, was in the dead zone.  Oil went from $28/barrel to $26/barrel. Gold went from $850/oz to $280/oz.  The average price of a house had increased 1.2% per year by ‘2000.  Stuff was a bargain.

In the next 10 years paper could be a trading market while stuff is in a bull or buy and hold market.

Change is a way of life. You either accept changes or make changes.

Capitalism is sweeping the world.

Capitalism is easy to understand. It’s nature with a balance sheet.  If you’re wrong, you go broke instead of being eaten.

Three basic things make up an economy; labor, natural resources, and capital.  There is a surplus of well educated labor.

30 years of restrained and neglected natural resource supply is being overwhelmed by demand.

The longer things remain stable, the more likely they become unstable.  

Peace put 2 ½ billion people in the world labor market. India and China alone contain over 2 billion consumers. Suppose each of the 2 billion people consumes a mere quart of gasoline per week as their economy booms; that’s an additional 1.7 million barrels a day, new demand that is sure to increase price. Today, China is booming. They have declared the national bird to be the construction crane. Last year China’s factory floor produced 50% of the world’s cameras, 35% of the TV’s and 30% of the refrigerators sold worldwide. In the last five years china went from exporting oil to the second largest importer in the world.  The Chinese will go from walking, to bikes, to motorcycles, and to autos. They will need oil and gas, chemicals, forest products and metals.  At 80 cents per hour they are deflating manufacturing costs, but as they become more successful, they will throw away their bicycles and buy motorcycles and eat better, increasing the demand for raw materials.

China and India are transforming their economies from poor agrarian nations to the newest industrial powers, replete with heavy industries, mass transportation and higher education.  Rising from these giant new economies will come millions of new consumers, the very people who are already straining the natural resources of the earth.  

In 1900, the US started to industrialize.  We were using one barrel of oil per person per year.  By 1970, we were using 27 barrels per person.  In 1950, Japan started to industrialize, they were using 1 barrel per person. By 1970, they were using 17.  In 1965, South Korea started to industrialize.  They were using one barrel per person per year.  By 2000 they were using 17.  Today, China uses 1.3 barrel per person per year and India uses .7. 

In 1950, Japan per capita income was 18% of the US, today it’s 96%. In 1965, South Korea’s per capita income was 16% of the US, today it’s 56%.  India and China have 2.5 billion consumers, 9 times the US.  The US uses 25% of the world’s energy, China and India use 2%.  India and China have 280 people per car.  The US has 2 people per car. 

Real incomes are just beginning to rise to levels that create large demands for consumer goods.  Between 1950 and 1970, Japan’s urban population increased 70%.  Personal consumption increased 600%. 

China currently is 40% urban, 60% rural.  The US is 97% urban and 3% rural.

China has 20% of the world’s population and 7% of the world’s land. China’s grain imports will grow from 14 million tons today to 57 million tons in 2020.

Today, 1 billion people consume two thirds of the world’s raw materials. 5.6 billion people consume the other third and they are becoming more successful.

There is no need to connect the dots, they over lap.

Lead times to create raw materials are measured in years.  In Canada $80 billion in infrastructure has been committed to production of the tar sands.  The goal is to produce 3 million barrels a day by 2015.  At $60, oil is a bargain liquid.  It costs 10% less than bottled water; it’s one-third the cost of milk, one-fifth the cost of beer, and only 2% of the cost of Jack Daniels.  Phelps Dodge is planning to open a new copper mine in 2007.  It took 12 years of paper work to receive federal approval.  Currently oil companies who search for oil at great risk earn 9 cents per gallon.  Government, at no risk, makes 51 cents per gallon. 

In the US, half of our energy problem is government regulations.  The only place oil companies are allowed to drill for oil is next to a dry hole.  The only place you can build a refinery is nowhere.

Demand for raw materials has increased. In many cases, the capacity to produce raw materials has declined dramatically in the last 20 years. Tops and bottoms are creatures of extreme.    Markets rise above all expectation and then go higher and then fall further than common sense suggests.  The most desirable investments for the future might not be in cyber space but back to the basics. 

By the end of this bull market in commodities, there will be a bounty on caribou, you will be able to see an oil rig from every beach and they will be digging a copper mine in Barbra Streisand’s yard. 

As you climb the ladder of financial success, check to make sure it’s leaning on the right wall.  I believe raw materials will be one of the best investments for the next 10 to 15 years.

Long-term, the future is very bright because man has been succeeding in bringing about change for the better since he or she first emerged from the cave.  Big problems usually disguise big opportunities. 

Governments and central banks are completely incapable of keeping tomorrow from coming. 

In the next 12 months, let the winds of change fill your sails. Thank you.