QE2 is out and everything will be down

May 4, 2011

Baltimore, Maryland

Monday was a no-action day on Wall Street. Tuesday was dead too. Except that gold: dropped $16.----------------------------- Don't Miss! Best of The Daily Reckoning... -----------------------------

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The killing of Osama bin Laden was supposed to raise prices. Especially the price of the dollar. The buck has been going down for 3 years. It's now within a few cents of its all time low, registered back in the '70s.

We were prepared to advocate more killing, maybe even mass murder, if it would lower the unemployment rate...but the 'killing lift' was short lived. It lasted only a few hours. Then, things returned to normal.

But normal is very strange. No matter what happens, investors take it as good news.

Investors' sentiment is overwhelmingly bullish. Stock prices are unquestionably high. Dividend yields are low.

It is almost enough to make you think we weren't really in a Great Correction after all. But as near as we can tell, the Great Correction continues.


If we're right, most investors are wrong.

If we're right, stock prices will come down - hard.

If we're right, real bond yields will go up sharply.

If we're right, commodities are over-priced.

If we're right, gold should correct.

But wait. There's more.

If we're right...the Great Correction is only part of the story. The other part is the feds' reaction to it.

That's why all of these Great Correction phenomena could soon give way to another phenomenon - inflation.

If we're right, the feds are just waiting to see what happens next. They know that there's something very wrong with their 'recovery.' But they don't know what. They're just hoping that it picks up enough steam to continue on its own, without the need for more towing.

Because they're watching prices rise too. Bernanke says this inflation is 'temporary.' He's probably right....to a point. Inflation is rising because of the feds. When the feds stop force-feeding liquidity into the system, prices should fall again.

Asked what would go up after the Fed announced its QE 2 program, a shrewd analyst replied - 'everything.' Now, everything is up - except real estate. And now the Fed says its program of QE 2 will come to an end in June.

So we ask. What will come down when QE 2 ends? The answer comes as quickly as a pizza: everything.

If we're right, the feds have not really laid the ground work for a genuine economic recovery. Instead, they've pumped up government spending...and re-inflated the financial sector. This has put more money in voters' pockets. Usually, about 12% of personal incomes come from the governments programs - such as Social Security, unemployment comp, food-stamps and the like. Today, the figure is 18%.

In 1949, 70% of national income came from wages. Now, the figure is barely 50%...with the other 50% from finance and government giveaways. The trouble with income from speculation and government handouts is that it reflects no real increase in wealth. It is 'funny money.' For every speculative gain, there is a speculative loss. And for every dollar given in government payments, there is a dollar taken away somewhere else.

QE 2 was the funniest kind of money. It was created - by a computer - in order to 'pay' Wall Street for US bonds. If we're right, it was this funny money - combined with other comic acts, including zero interest lending and trillion-dollar deficits - that caused 'everything' to go up. And if we're right, everything will go down when it is taken away.

*** Compound Effort Over Time

In a previous Daily Reckoning, we offered dear readers a look at one of our principles of financial success. "Financial Escape Velocity" we called it.

Today, we give you one of principles of success in life: "Compound Effort Over Time." You've heard of the 'miracle of compound interest.' Well, there's a similar miracle at work in the rest of life...

"I'm about ready to give up," said Jules (23) over the telephone.

The young man graduated from college two years ago. He could have easily entered the family business. Instead, he decided to try to make his career in one of the world's most difficult métiers - as a singer, musician, songwriter.

He moved to Brooklyn, which seems to attract young musicians like London attracts fund managers. He took courses at Julliard conservatory. He wrote songs. He put them on the internet. He sang on 'open mike' nights in clubs and bars.

But after 6 months, it didn't seem to be going anywhere.

Meanwhile, his sister, Maria, voices similar disappointment and impatience.

She too has chosen a difficult career; she trained as an actress, moved to LA, and had - like her brother - approached her career in a disciplined, organized way.

But these are not careers where discipline and organization come easily or pay off readily. There are no fixed hours. And no fixed route to professional advancement. Half the work you do, at least it seems to us, is just figuring out what work to do.

Maria has had some success on TV and the movies. But she hasn't gotten the major roles she hopes for.

"I've been in LA for two years already. I'm going to keep at it for another 3 years, according to my plan. But if it still isn't working, I'm going to have to find something else to do."

It's a rough life. Maria lives in a tiny studio apartment and works from dawn to dusk trying to get acting jobs. She supports herself, barely, by doing modeling work on the side. Jules, meanwhile, is literally a starving artist, working one day a week as a handyman to help pay the bills.

We don't know how others do it, but our children couldn't afford to be starving artists without family support. Rents are too high. Health care...transportation -- if they were forced to pay 100% of their living costs, they'd have to give up on their artistic careers and find other lines of work.

The point we are making is that success doesn't always come immediately. And it's not easy to sustain a career that doesn't provide quick, positive feedback. But in our experience, it pays to stay the course.

Starting out in life, young people are practically interchangeable parts. They leave school not knowing much of anything. If they can read and write clearly, they have an advantage over most college graduates. But school doesn't prepare them very well for real life. School problems are bounded, controlled, and simplified. Usually, they are idealized, with the confusing parts taken out. In history, for example, they are taught broad themes...and specific 'facts.' But the sequence of events in real life doesn't follow simple scripts. Instead, it is endlessly complex.

Historical characters are like stick figures, heroes or villains according to the storyline. In real life, they are like the people we know personally - they have their positive qualities and their negative ones; they perform well in some circumstances and poorly in others. They are neither good nor bad...but subject to influence.

That's why you cannot make a good history out of recent events; you know it too well!

In every discipline, the phenomenon is the same - in school, the complexities of real life are removed so that students can be tested on set groups of memorable, learnable, understandable bits of stripped down, sanitized 'knowledge.'

That is why more education does not always lead to more success in the real world. In fact, it could go in the opposite direction. The better you get at handling the artificial world of academia, the worse you may do at solving the real world's infinitely nuanced challenges.

Problem solving in the academic world typically involves a part of the brain - but only a part of the brain. It is the 'rational' part...the part that remembers facts, reads, writes, and connects the dots. That is the skill measured by the SAT tests, for example. They are tests of "scholastic aptitude.' And they are pretty good at it. If you able to do the kind of tricks the tests require, you'll be able to handle the kind of work they give you in school.

But life sends very different tests your way. Life's tests involve many, many more variables - so many that your 'rational' mind is frequently overwhelmed. The human face, for example, is capable of hundreds...or thousands...of different expressions. Some people seem better able to read these messages than others.

In the world of textbooks, other people scarcely matter. You read. You write. You check the boxes. But once you get into a workplace, you are faced with an entirely new test. How well can you get along with others, motivate them, lead them?

In school, tests are anticipated. In real life, you never know when you will be tested. You never know what you will be tested on. And even when you are in the middle of an important test, you often don't know it.

In some careers you are able to apply the body of knowledge you picked up in school, but not many. In most careers, you have to learn on the job -- a new body of knowledge, often additional, sometimes completely new and different. And unless your job is to throw the switch on a toll bridge, or to collect tolls on a toll road, your new knowledge is likely to involve a great many things that are uncertain...unknowable...and variable.

Even in 'routine' careers there is still plenty of room for career advancement and money-making. But it requires you to step beyond the routine. If you are a school teacher, for example, you might have to write a book on education...or start a school of your own. Or, if you are a carpenter, you could set up a carpentry business...or use your skills to build something rare and interesting enough that it could be sold at high margin...or mass produced.

Generally, the more formulaic the work, the less scope for making money at it. The more limited, that is to say, the more like school any job is, the less likely you are to turn it into a source of wealth, power, or outsize success.

But assuming you are doing something that is not routine, not formulaic, and not limited (an assembly-line worker, for example, may be able to earn a good living...but it is not a way to build a fortune), what is the secret to making a success of it? Ah, glad you asked. At least part of the secret is sticking to it. Here's why...

If your work is not simple and not formulaic, you need to use a fair amount of creative thinking, innovation and entrepreneurship to get ahead. Sometimes your work can be reduced to simple, school-like thinking. More often, it is more complex...involving subtle judgments about people...guesses about how others will react...mastering new technology and leadership skills needed to get others to follow your plan, and so forth. It may involve raising money...'selling' your ideas...taking a chance on a new career or a new business...convincing clients to leave their habitual sources...or convincing employees to work harder...or better.

You may have to develop a new product. Or, maybe you have an insight that tells you how to invest your firm's resources more productively.

Whatever it is, it is likely to require more than your 'school brain' to make it happen. It is likely to involve wisdom...intuition...and 'people skills.' It is likely to require more of you -- your brain...your personality...your heart. And maybe soul too.

It is likely to require trusted contacts, seasoned hunches, educated guesses,

Where do these things come from?

Malcolm Gladwell's book, "Outliers', makes the point that there is no secret to success. Successful people just put in more hours than other people. Our point today is similar. Success is usually the product of compound effort over time. It takes time to develop contacts. It takes time to develop trust - both of your own team and outside clients/customers/associates. It takes time and experience to develop the hunches and instincts that are useful in real life. It takes time too to understand other people and learn how to work with them. It also takes time to build a foundation of human and financial capital that allows you to take advantage of the insights and opportunities that experience bring you.

Time does not work in a linear, mathematical way. As with compound interest, time pays off geometrically. As contacts, experiences, wisdom, innovations and intuition are added one to another, your opportunities multiply. A $100,000 deal that you might have done when you were 25 grows into a $1 million deal 5 years later. And instead of doing two deals a year...you might do 10 a year.

This is also why it is so important to put in lots of time. Gladwell refers to the Beatles, major league athletes and people such a Bill Gates. In every case, he found that the leading figures in their industries put in thousands of hours - usually far more than their competitors. They may appear to be 'gifted.' Their achievements may seem effortless. But they are almost always the product of time.

Not only that, but the time spent at the end is much more powerful than the time at the beginning. You can see this by looking at charts of compound interest. Starting from a low base, the first series of compound interest produce little difference. But at the end, the results are spectacular.

Start with a penny. Double it every day. At the end of a week you are still only adding 32 cents per day. By the end of the third week, however, you're adding more than $10,000 per day. So you see, the last increments of time are much more important than the first.

It doesn't exactly work that way in real life, of course. Hang around too long and you get tired...and the lessons you've learned might not be applicable to the new realities. Suppose, for example, that you had learned to make the perfect buggy whip, at age 55, in 1910! Or imagine that you were the leading expert on silent movies...just before the 'talkies' started. Or maybe you were cornering the classified advertising market...just as Craigslist and e-Bay made their appearance.

But aside from that kind of a setback, time compounds your advantages. At age 20, you may know less than everyone in your business. But then, you work 10 hours a day, while others only work 8 hours. In 20 years, you may know more than just about anyone. Then, who gets the new contracts? Who finds the new opportunities? Who has pricing power?

Who makes money?

Compound interest works because each addition is then put in service to earn another increment of gain. Compound effort works the same way. Every insight, innovation and useful contact helps bring on another, bigger and better one.

Remember, success is competitive. While you are adding to your business capital, your competitors tend to wear out...move on...or retire. Sticking to it is not easy. People tend to get distracted. They often want easier, simpler, faster opportunities. They give up their accumulated capital...and take up something new. That leaves you in a commanding position.

Stick to it.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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4 Responses to "QE2 is out and everything will be down"

Suman Bhandari

May 5, 2011

"qe2 is out and everything will be down" Thia article was really a thought provoking one. I understand the power of compounding. Everywhere whether it is in life, money and relationship or meditation or in becoming genius one has to give infinite time to gain the fruit.One has to go through all the cycles and seasons to withstand all sorts of blows.I appreciate the author of this article.



May 4, 2011

I had given up on reading 'the Daily Reckoning'`- it is generally boring, or dull ramblings of the frustration kind. But today was different! The write up on compounding was interesting and angelic. I hope Bill starts dwelling more on life rather than only money & gold and possibly keep it short. This would make his writing far more engaging! Best wishes



May 4, 2011

I remember in many of your last issues, stating that gold is rising due to underlying economy being weak. And since there are no signs of recovery either, the gold will keep on rising.
To my surprise, today's issue states that 'Gold Should Correct', leaving my confused. Does 'correct' here mean Gold will go up further, or does it mean it would come down. And if it means it would come down, what is the reason for a change in trend. Environment is still bad, inflation is still high, fed is still printing the currency and all of those factors are still there which got Gold to new highs.



May 4, 2011


That was a peach from the top draw. Much more valuable than all the gold that can purchased.

It's true. I have realised that the sucessful people are much more hardwoking. But I do not understand one thing here.

Why is everybody always tax successful people instead of rewarding them.

You work hard to be successful and find that the lazy guy next to you also manages to get his food free whereas you have to pay taxes and for the lazy man' food too!

What does a sucessful person ultimately get apart from the success itself

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