the 4 pillars of investing fundamentals: module 2 · is called script. and the continental ......

Fundamentals: Module 2THE 4 PILLARS OF INVESTING

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The 4 Pillars of Investing | Fundamentals : Module 2

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In fact, we can kind of see where this is going by looking back in the past. Some people say they repeat itself. Remember policy plus demographic tells us what the future will be like. So let’s see what this policy has done in the past. This right here on the chalkboard is one third of a dollar, this is called script. And the Continental Congress of the United States way way way way back; this is dated February 17th, 1776, the Continental Congress deemed that they could begin to print script. First they started back with money but then couldn’t do it, started printing too quickly. And so they declared independence against Britain, and they fought a Revolutionary War, and they started printing these…and you’ll find in times of war, that’s when they really have to print money to pay for all the supplies for war. That’s often really a big time for printing money, is in war.

And so, sure enough the more of these promises they made without backing it with anything, the less value each and every one of them got. And these poor soldiers that fought with George Washington came back, they were paid in continentals, and the continentals by the time the war was over weren’t worth anything. And so, someone tried to buy something with continental, they’d say “Ah, I’m not gonna take a continental. Do you have some gold?” And so anything that was worthless, they coined a phrase. They said, “Hey, that’s not even worth a continental. That’s how bad it is.” Coincidentally, coinciding with that they got another phrase called “good as gold.” So, one thing that’s worthless, ‘not even worth a continental.’ Number two, ‘good as gold’, it’s got some value. This happened again. Happened in the Civil War of the United States, the South and the North are not getting along, and so the South kinda goes away from the union for a bit, they try to vacate there, and they don’t have enough gold so they started printing confederate dollars out of paper. And of course, the more they printed, the less value they had. And by the end of the conflict there, “You wanna borrow soap? Costs you fifty confederate dollars.” Must have been pretty good soap. Little suit, I’m not talking a nice suit, we’re talking an ordinary suit of clothes, like a suit of clothes like Levis and a denim shirt, $2,700 right there. So not designer anything there. And so, this eventually became worth zero and that’s why they didn’t circulate it anymore.

FUNDAMENTALSMODULE 1 2 3 4

A transcription of

The 4 Pillars of Investing

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That’s happened all around the world. This is Hungarian currency, I don’t speak Hungarian, do you? 400 octillion though, wow, they had to revalue their currency. And if there’s a penny on the ground, you pick it up, right? ‘Cause a penny is worth one hundredth of a dollar. But if it’s only worth 1/400th octillion of a dollar, well you probably just sweep them up like this guy’s doin’, because they’re just not worth picking up. How many of those notes would you have to have to make even a penny? You’d have to have a warehouse full. And why sweep up a whole warehouse and store it if it’s only worth one penny? It’s not worth the space it takes up, so you just sweep it up and revalue the currency. Start all over again, kinda rough times for those people.

This is a Zimbabwe dollar more recently. In 1980, Zimbabwe issued a dollar. The Zimbabwean dollar, you wanted one of those you have to spend $1.47. Wait a minute, I’m spending $1.47 just to get one, that means it’s more valuable than a US dollar by 47 cents? Yep, almost 50% more valuable. And they have a leader, I think his name is Mugabe, I hope I say that right. If I don’t, that’s okay ‘cause I don’t care; he’s not a very nice man anyway. And they owed some money. It wasn’t a time of war; they owed some money to the International Monetary Fund, and so they started printing it. What happens when you print money? It loses its value for the reasons we saw. And by 2009, they started to add zeros to this. You see, if you at-cost 2 billion dollars for a loaf of bread, you can’t carry around that in one, so we have to increase the denomination. And in 2009, they redenominated this the last time. In fact, I got a stack of these. I bought some on Ebay for a souvenir. $100 trillion dollars, that’s right. So I bought a stack of a hundred. That’s one hundred $100 trillion dollar bills for a total of $10,000 trillion; I don’t know how much that is, like a sextillion or something like that. I don’t know what that is, a quadrillion, I don’t know. I think it’s a quadrillion, maybe it’s a hundred quadrillion. I don’t know, it’s a lot of money. It’s actually not a lot of value though, it’s just a lot of paper. And so that’s $100 trillion that’s bust now, it’s not worth anything.

So here’s a young man who’s got a stack of Zimbabwe money. Looks like he’s got, what, three stacks there, about three stacks; can’t quite see, but I believe those are $200,000 each. So each bill is $200,000, not $100 trillion, just $200,000. Reportedly, you know what this boy’s on his way doing, reportedly? He’s on his way to buy a banana. He’s got three stacks. Now the guy in the other picture on the right, let’s see, he’s got one two three four five six seven; he’s got twelve stacks of those and what’s he doing right here? He’s buying dinner. So he must’ve eaten more than one banana, interesting stuff. Poor Zimbabwe, the value of their currency down to nothing now. Why? Printing money, printing too much money. It’s happened every single fiat currency, eventually this happens to. Don’t believe me? Look at the list.

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Notice ’95, ’91, 1922, 2002, a lot of these have happened in our lifetime. In fact, most of them happened in our lifetime. It’s happened before, it happens again. It’s just a cycle, just how it works. So we gotta be careful with that power we give to taxes and fiscal policy. Gotta be careful with that power we give ‘em to print money. The interesting thing that happens is those who follow the ‘saver rule’ here, a penny saved is a penny earned, yeah, but it doesn’t buy a gallon of gas. And so if we put a dollar in the bank, it stays a dollar and grandma does this because she used to think it was a silver certificate, and it was like saving silver. But it’s not saving silver anymore, it’s just a promise to pay. And that promise is getting diluted. And so, if we have a dollar today and we have a dollar tomorrow, we say “Well I didn’t lose any money, I still have a dollar.” Yes, you lost money. You have the same amount of currency, but you don’t have the same amount of wealth, because your currency can no longer pay. If you kept the same amount of wealth, your dollar would have turned into ten dollars. But that’s not how it works. You put a dollar in the bank, it stays a dollar. There’s not a lot of interest on that.

But yet, check this out. If you borrow a hundred grand, your debt stays at a hundred grand. It doesn’t grow with the currency. So, savers lose, debtors win. Because the same mortgage that would cost a million dollars now, you’ve locked it in at a hundred grand for thirty years. Imagine what happens when currency’s blowing in the street like that. Currency becomes less and less valuable in commerce. For the same good and services you produce, you get accept or have to pay more and more and more of these dollars. The dollars are flooded, they’re everywhere. They’ve been printed. And so imagine this, you have a banana. And you sell the banana, well what’s the banana worth now? It’s worth hundreds of thousands of dollars. And you can take the money that you sold your banana for in today’s dollars, you can pay off your whole mortgage. How unbelievable is that? What if you could pay off your mortgage with the same amount of currency that it costs to buy a banana? Because you locked your mortgage in. So, savers really lose with inflation. Debtors, they win big time with inflation. Amazing stuff. The problem is, what if you don’t have the money to buy the banana? That would be lame. That’d be lame to have to mortgage and sell your whole house, and you have to sell your house so what, so you can buy a banana? So it works both ways. It works both ways.

So, if this causes so many problems, why do we do this? Well, remember if we look down here, the treasury needs that money to cover the deficit. So this all comes out of operating in a deficit, gotta print all this money, gotta loan all of this stuff, gotta loan out all those bonds, which tells us, there’s two markets here we could learn as investors. We have a debt market and we have an equities market. Now debt, the market loans. So if you loan money to a corporation, that’s a corporate bond. What’s your risk? They go out of business, they don’t pay you back. You have a municipal bond. Maybe that’s your city, they want to build a school. They’ll issue bonds. And

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then you have treasury bonds. Well, maybe the United States will pay you back. Standard & Poors is wondering if it’s likely. So think about this from a standpoint of risk. Why would they issue bonds? This is very important because we’re gonna talk a little bit about debt here. The reason a corporation would issue a bond, a corporate bond, is because they want to expand possibly. They don’t want to wait for revenues.

Let’s say that you have a business and you’ve figured out a way to make a great cup of coffee, better than Starbucks, $12 a cup, whatever you’re gonna charge. But it’s your formula that’s gonna get out there, and the biggest fear you have is that you’re just small. You’re selling a few cups, you’re making a few thousand dollars, but how are you gonna take this nationwide by selling it a few cups at a time? You’re limited by how fast you can grow, right? You’re limited by how many cups you can sell, and since you’re small, you can’t sell a lot of cups; what if the big guys comes in with lots and lots of money, and he takes your formula and boom, you can’t sue ‘cause you have no money. So you’ve gotta get big fast. You can’t just wait until you sell your cups of coffee and your earnings to grow, because earnings take time. It’s called the velocity of money.

So what you do is you say, “Hey, I’d like to borrow money.” You issue a bond and now, boom you go huge. Or, maybe you sell part of your company, that’d be the equities market. You sell ownership in your company. Let’s go to municipal bonds. Again, how does your municipality, your city make taxes or get income? How do they make money? They collect taxes. Well, if your municipal taxes, your city tax, right, the amount you have in property taxes on your city, and your home and all this type of stuff. If the tax space isn’t big, and you need a new school today, and you want a new rec center to attract more business, how are you ever gonna grow if no one wants to move to your city? You gotta improve your city so people will move there so you can get more taxes. So maybe the city council says, “Hey, let’s issue some municipal bonds.” For some reason, they even make these tax-free, isn’t that cool? And they say, “We’ll sell you a tax-free municipal bond if you give us the money now.” And they build the school, and they build the rec center, and lots of people move and have to pay more taxes. And they use that taxes to pay off the bond-holders. They can grow faster.

Let’s say the treasury has no money in it. We’re fighting a war, where we want to pay social security, we have no money for it, gotta get a credit card, please buy bonds. Or maybe you sell ownership in your company. That’s what stock is, common stock, preferred stock. All preferred stock means is that you’re gonna get your dividend first. If the company goes out of business, who do they pay off first? Well they pay the bond-holders first, then the preferred stock next. If there’s anything left over, you might get something for your common stock, probably not though. That’s why the debt market is considered, in theory, to be less risky than the equities market, because they have a higher priority if the thing goes to pot. However, you can have private stock,

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my companies, my LLCs, my escort, that’s shares that I own myself. If I want to go public, I share the sells to the public. So we have the debt market which is loans, bonds, debt. And we have the equities market which is stock. And both have a huge effect on sovereign fundamentals.

For example, policy demographics equals the future. Well, the policy of most financial planners is to move their clients from equities to debt as they get closer to retirement. For example, maybe you’re a young person, and you’re twenty years old. They’ll load you up with stock, why? Well, if the stocks fail or they fall through, you got plenty of time before retirement. But let’s say you’re getting closer to retirement; you don’t have time to make those big mistakes. And so they’ll move you from equity to debt. My question is, you got 85 million baby boomers in that demographic, you got a policy of moving from equity to debt as people get older; as these people start moving from equity to debt, if you wanna sell your stock, someone’s gotta buy it. That’s supply and demand. Ooh, interesting stuff, huh? Interesting stuff. That could put pressure on the equities market if we move our money from equities to debt. All types of things happen. Foreign policy matters with debt. Look at these bonds for example.

I’ll tell you a little bond story. You’ve seen Captain America; remember when he sold the war bonds? In World War II, Captain America, if you’ve seen the movie, he’s selling war bonds before they let him fight. And we fought shoulder to shoulder with Britain in that war to kind of get rid of Hitler and all this stuff. And so we sold war bonds and we financed that war. Well, Europe needed some help, especially Britain, and they had something called ‘sterling bonds.’ And so we helped them not only with our tanks and our soldiers fighting next to them; we helped them buy their tanks and we bought their sterling bonds. So here we have a bond, it’s not a sterling bond, it’s 1999, it’s not a war bond, but it’s represented and you see it’s 10,000 pounds, British pounds. So we gave them some money and they gave us this bond. Now, on the bottom, they’re gonna send us some of these notes with the Queen on them, 50 pounds, 20 pounds, whatever to pay off this bond plus interest. So the United States received the bond and then they received the money for the bond. Well, during the war, World War II, we stacked up all these bonds. We had a lot of them. And the war ended and everyone came home, and the United States decided, “Let’s celebrate with our wives and go out to dinner and have a romantic dinner.” And all of a sudden, we started leading to other things and we had a baby boom. And the baby boom got huge.

Well, during this time after the war, Britain, that old Union Jack we see there, this thing flew around the world. They had all these territories, islands, stuff they would have control over. And they lost control of the Suez Canal, great lesson, lot of people don’t know this story. They lost control of the Suez Canal, and so what they did is they said “We’re gonna get control back.” And so they fought with Egypt and they got France to help them; poor little Egypt no match for Britain

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and France. So Egypt is getting their allies, they’re gonna get the Soviet Union involved and pretty soon, we’re escalating into war again. So they call President Eisenhower and Britain says, “President Eisenhower, would you help us again?” And isn’t that interesting, it’s been a long time since we had a US President that didn’t want to go to war, but since Eisenhower was a General, he said “You know what, we’re tired, we’re here, we’re having a baby boom. We don’t think we want to fight and start another world war over the Suez Canal.” And Britain says, “Please will you help us?” They said, “Nope. In fact, not only that, why don’t you just get out of there? We’ve had enough war.” And they said, “We want this oil that goes through the Suez Canal.” And they said, “Nope, we’re not gonna help you. Get out.” And Britain said “Make us.” We said “Okay. We will.” Britain said “How are we gonna make ya?” And the United States said, “Well we got all these sterling bonds over here, and they represent your debt. The world’s based on supply and demand. What if we sell all your sterling bonds? What if we sell them off cheap? That’ll crash your pound. That’ll ruin your currency. ‘Cause see, your pound’s based on debt.” And holy cow, sure enough, the Ministry of Finance over in Britain says they can do it, and they threaten to, and so they had to leave their tanks, or they took their tanks out of Egypt in a matter of weeks.

And so, this is all about sovereign fundamental analysis. It all starts from that balance sheet; who’s in debt to who? Who owes who what? Fiscal policy, monetary policy, what else shapes it? Foreign policy. And people say, “But Andy, wait a minute. When you take on another country’s debt, you can sell off their bonds and effect their economy?” Yeah. They say, “Well that really happened in the Suez Canal? True story?” Yeah. So people say, “Well, aren’t we doing this in China?” And I say, “Yes we are. In fact, since we can’t pay our bills, we have to issue bonds to the world remember?” And part of the world is China, and so the central ranks in China, they will buy the US bonds. So they buy the bonds, and they go over from the United States, and then we have to pay off the bonds by sending them on the bottom. Why do we have to send them? They’re cash. So they end up with not only the cash they loaned us, but interest on that cash. And people say “Well, what if they sell all of our US bonds? Wouldn’t that crash the dollar and affect the dollar?” Yes, it would. “So why don’t they do that?” Well, they’ve kinda got us right by the neck. You see, we also have a trade deficit with them. And if you can imagine this, they loan us US dollars. They loan us money by buying bonds. We take that money from what we sold the bonds, and we send it back to them, see that, we send dollars back to them, not just to pay off the bonds, but to buy all the stuff that’s made in China. Shoes, clothing, textiles, plastic stuff, all kinds of stuff made in China, because their labor’s cheap.

Well, all this stuff over here, let’s get the marker out, all this stuff over here winds up in the landfill. So, we borrow money from China by selling them a bond, then we send the money that we borrow from them back to China, and they send us their stuff. And so they got us both ways. Yeah,

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absolutely. They got us with the money we send them to pay off the bond, and they got us with the money we send to buy their stuff. So, they’re not gonna crash the US dollar yet. Why? They want a strong dollar. If they’re selling us all the crap, they don’t want a weak dollar. And so a trade deficit, the stronger the dollar is, the better off China is. It actually benefits China because we’re sending our strong dollars over to them for all their cheap shoes and stuff that wind up in the landfill here. So China’s not too happy with us printing money, because it devalues their dollar. It makes their trade advantage less so. Because, how would you like to loan someone money and get paid back in US dollars that are not valuable? And how’d you like selling your stuff to people in US dollars that are not valuable. You sell someone stuff for a dollar, and then that gets devalued over time? Ooh, China wasn’t happy. That’s why when the S&P downgraded us, they said “Hey, we might not just be your credit company anymore. We might not buy all these bonds anymore if you’re gonna act this way.” Interesting stuff.

Fiscal policy, monetary policy, foreign policy, all parts weaved in of sovereign fundamental analysis. Very cool stuff. So there’s a lot going on here isn’t there? We’ve got the trade deficit, we got foreign deficit, we’re printing currency, we got the deficit, we got quantitative easing, we got the off-balance sheet promise; what is all this stuff? This is called systemic risk. What is systemic risk? Well, I’ll tell you what it is. If you have one company that goes down in value, like this, you’ve just lost money in the company. But what if this is the whole S&P 500? Well, that’s trouble because that’s what your 401(k) is invested in most likely, diversified across the entire system. And so if a person is investing in mutual funds for the next ten to twenty years, they need to ask themselves, “Does this present this sovereign fundamentals?” These dire sovereign fundamentals right here increase the systemic risk. In other words, could the markets have more trouble if the value of our currency goes down? Could we have trouble with these trade deficits and with our foreign debt? I say yeah, yeah it really does. This increases systemic risk.

One of the reasons I wrote the book 401(k)aos is to call to people’s attention that when they invest in mutual funds that are diversified throughout the Dow Jones or the S&P 500, they’re taking what’s called a systemic risk. What if the whole system goes down? Most people buy stocks and they say, “Look, I’m going to buy a whole bunch of stocks, ‘cause I don’t wanna put all my eggs in one basket in case one of the stocks has a problem.” Well, that’s fine but it does not alleviate if the whole system has a problem. So, it’s an interesting time, and you oughta share this with your friends. Say, “Hey, there’s a lot of systemic risk out there right now. It’s a pretty big deal.”

One of the most important numbers that we can look at in a sovereign fundamental analysis is called the ‘debt to GDP ratio.’ And you know, when I was in school, I hated ratios, fractions; this is hard to understand. I hated it. So what I learned is we’re gonna do a lot of ratios. Ratios

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are everywhere in fundamental analysis. And I figured out a way to make them easy. And so I’m gonna share that with you. Just simply use the word ‘relationship.’ Whenever it says PE ratio, price earnings ratio, debt to GDP ratio, all we need to do is take what they’re talking about and say, “What is the relationship?” In other words, what’s the relationship to a country’s debt; how does that relate to their gross domestic product? Well, the way this relates is this; does this country, it’s asking a question, does this country have a strong enough GDP, they’re earning enough money as a country that they can collect enough taxes that they can pay their debts, that they can pay their bills? And so we have debt, how much do they owe? GDP, what’s the engine that helps make the money? Is their engine growing strong enough that they can pay their debt? It’s not for Japan.

Here’s the poster child for debt to GDP ratio that’s out of wack. Their debt to GDP is 234%; what does that mean in English? It means that when you look at their debt, it’s over twice as big as their GDP. Their engine that they produce money with and that they collect taxes from is pretty small and their GDP is pretty big. Actually, it’s not even that small. They’re the third largest economy in the world. But even though they’re the third largest economy in the world, that’s not impressive, because their debt is like massive massive debt in the world. They’re the poster child. So we ask this question; does Japan have a strong enough GDP that they can collect enough taxes to pay off this debt? To pay their bills? I say no, not if it’s 234%. So often you’ll hear, the reason this vocabulary is important, is you’ll hear people say “Well, we’ll grow our way out of the problem. Our economy will grow enough where we’ll produce more taxes. We’ll grow our way out of the problem.” Boy, Japan, I don’t think you’ve grown out of that problem. You’d have to really rock and roll to do it. In fact, if we look at this, this is an interesting thing; this is called the Nikkei Index. Now, in the US, you got something called the S&P 500. And the S&P 500 is 500 US companies, and we put those in an index together to see how things go. And over in Japan, they have something called the Nikkei 225. So, over here in the US where I live, we have GM and we have Microsoft and stuff like that. But over here in Japan, they have Sony and they have Toyota as part of the Nikkei. So they’re pretty much measuring the same type of stuff; how well are the companies in this country doing, the big ones? And so this is the Nikkei 225.

Well, when you have a 401(k) or a mutual fund or an IRA and you diversify for the long-term, what does long-term mean? Well long-term generally means twenty to thirty years, I would say. Twenty to thirty years because you have to harvest that in twenty to thirty. Think about it, if you’re fifty and you wait twenty years, you’re seventy. If you’re forty and you wait thirty years, you’re seventy. And so most people want to harvest that within ten to twenty thirty years. What I think’s so telling about this chart is policy plus demographics equals the future right? Apply the policy to the demographic, you get the future. Well, what was interesting is in the 1980s right here, Japan had huge growth. Look at this, from 10,000 clear up to 40,000, huge growth in their market.

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And they did this by lowering interest rates. Remember the two powers monetary policy has? Monetary policy, you can lower the discount rate in which you can get some Yen, right, some big time Yen, gotta borrow Yen with little interest. Well think about that, if you reduce interest rates like the Federal Reserve can and the Central Bank of Japan can; if you drop your interest rates, what are people gonna do if they don’t have to pay interest? They’re gonna borrow money. And if you can get loans easy, people are gonna get a lot of loans ‘cause they’re easy to get. The supply of loans gets easier, it’s easier to supply loans to people. Well if people have got loans, what are they gonna do? They’re gonna buy houses which increases the demand for houses. So if you decrease the difficulty of getting a loan, in other words if you increase the ability to get a loan, you’re gonna increase the peoples’ ability to buy houses. And when you give them the ability to buy houses, they’re going to, and that increases the demand for houses.

Well, when the demand for houses increases, you got everyone getting loans but only so many houses, boom, we got a real estate boom in Japan, just like we did in the United States a few years ago. And it was a huge real estate boom, it was ridiculous. The price per square foot was through the roof. Well, the problem is is this can only go for so long. These prices go up and up and up and up and up and pretty soon, people aren’t gonna pay those types of prices. People gotta refinance these and they can’t do it, so now they gotta sell the house. Remember the ARM? The adjustable rate mortgage, right? The one where you have the teaser rate, where it was easy to get a loan because you only had to pay a little bit, maybe interest only for the first five years. But bam, five years later, right, 1985-1990, five years later, “Oh you got ARMS.” And all of a sudden the ability to pay that goes down, and so the ability to own a house goes down, and so what do you do when you can’t afford a house and your payment goes up? You gotta sell it. And so as fast as you had demand of people wanting to buy a house, now you’ve got supply, people wanting to sell the house and bam, goes all the way down from 10,000…look at that, this is an exponential chart so we didn’t show it as well, look at this, up to 40,000 bam, down to 15,000 and they meander.

So what did they do to try to fix it? Oh, they started printing Yen. They started printing quantitative easy. They’re the poster childs for quantitative easy…you think we do it, you should see Japan doing it. The problem is, it’s supposed to put all that money into the economy; remember, you buy those bonds, and you put all that money into the economy, it’s supposed to jump start it but it really didn’t. It’s kinda like the defibrillator. Someone has a heart attack and they go in and they shoot you full of drugs. That’s like lowering the interest rate; when you die, they shock you. And the reason they don’t lead with that is because shocking people kills people. Imagine that, that’d be pretty funny; you walk into the emergency room, “Hey, I’m not feeling well.” Bam, hit you with the defibrillator, bam defrib, bam, feel any better? Bam, how ‘bout now? And so, you’ll kill a guy if you keep doing it. It’s for very short-term stuff and it’s an act of desperation. So whenever you

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see QE come out, it’s because lowering interest rates isn’t working anymore, and they gotta try to shock it by injecting electricity or money into the system. Well, this didn’t work out well for Japan, a few rounds of QE and then all of a sudden they got all that technology, bam dotcom bust of 2000, sovereign fundamentals of the United States leak over into sovereign systemic risk, big systemic risk. That was corporate stuff, big systemic risk. Bam, and so they tried to battle back because everyone’s thinking, “Oh let’s buy everything. It’s cheap now so it buys back.” But then bam, what’s this? This is the subprime US housing market, and it’s so big it leaked over there too because debt; Lehman Brothers goes out of business, you can’t get credit, you can’t get debt, and when you can’t get credit, you can’t get debt, you can’t go buy houses. And the demand goes down again and boom, the market plunges again. It’s sitting there at $10,000 a day 2011.

So my question is this, what if you were a guy in Japan in 1985 and your financial planner sits down and says “Okay, 1985 George, you know what you’re fifty years old. Let’s see, fifty, see ’95 you’ll be sixty, 2005, you’ll be seventy, in 2010 you’ll be seventy five and you want to retire. So let’s sit you down, let’s plan out a well diversified portfolio over the next thirty years. And let’s tie it to the market here, let’s tie it to the stocks.” No thank you, not if I can see it’s going down. This is called a downtrend, we’ll learn about that when we do technical analysis next class. So I think it’s fair for you and I, this is why I wrote the book 401(k)aos, I think it’s fair for you and I to go to a financial planner and say, “Look, our policy is just like Japan. We got a housing boom, we got a housing bust, our economy fell to pieces. We’re trying to fix it with QE, it’s not working. We did QE 1, we did QE 2, we might have to do QE 3. Why should I expect a 401(k) to work? Why should I expect this to grow and not disintegrate just like Japan?” Policy’s the same, demographics are similar. Policy and demographics tell you the future. This is called what? Fundamental analysis. Is this interesting; it helps me make decisions as an investor to see what risks are, see where value is, very cool stuff.

So, if we compare this, there’s Japan at 234, now Greece is in an interesting situation. Check Greece out. Greece has their own fiscal policy set by their own Congress or their own political parties and their own sovereign government. But monetary policy’s set by the UK, isn’t that interesting? Those central banks that are owned by, especially the fed that’s owned individually, those guys really get with everything. It’s kinda like Rothschild said, the great Rothschild from Germany that financed World War I on both sides; they said, “Look give me control of a company’s money and I care not who runs it. I got control.” So that’s kind of interesting that Greece has fiscal policy by Greece, but the European Union decides whether to do quantitative easing or tighten it. And all Greece can do now is fiscal policy, either raise taxes on their people or what, cut spending. That’s called austerity. Well if you cut spending, people don’t get their promises. That’s why we’re rioting in Greece.

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Well, it’s a ball in motion tends to stay in motion unless policy changes, unless something changes. So you got the United States at 99%. Hey wait a minute, we’re bigger than Japan; we’re the biggest economy in the world. Greece, heck, they’re smaller than California, who cares, right? I care; I like my people from Greece. Great food over there. But here’s the thing, it’s not where you are, it’s where you’re going, right? Remember that, policy plus demographic tell you where you’re going. So, if we’re at 99% debt to GDP, I guess the question is, our debt is almost the size of the engine that pays it off, so if our engine, even though it’s the biggest in the world, if our debt’s also the biggest in the world, can we pay this debt off by collecting taxes with our GDP? We’re not like Greece, we got a central bank.

Let’s talk about this for just a minute over there. How can I tell credit default swaps? This is an interesting chart. Here, your credit default swaps are debt insurance. So let’s say I buy a car, I’m scared it will wreck, I buy insurance. Let’s say I go out and I buy a house, I’m scared it will burn down, I buy insurance. Let’s say I loan money to Germany, I’m scared that they won’t pay it back, I buy insurance. And the name of that insurance is called credit default swaps. Now Germany right here, the blue, is their credit default swap; that’s how much it costs you to ensure German debt. German debt, going in debt, see Germany, they got pretty good stuff over there like BMWs and Porsche’s and so they sell cool stuff. They got a good strong GDP. And apparently people feel like Germany will pay its bills because they’re not charging much for insurance. You can tell how confident people are in the risk by how much it costs to insure it.

Let’s say your daughter gets five speed tickets. The numbers say she’s now a higher risk so what goes up? The insurance premium goes up. Well look at Greece, look at Portugal, look at the trend. It’s not where you are, it’s where you’re going. And the trend of the insurance, I think, don’t hold me to this, but I think it costs to insure $10 million of Grecian debt for ten years, costs you $5 million, 50 cents on the dollar. Why are people paying it? Better to get back 50 cents than not. I’d rather pay 50 cents to get back a dollar than sit there and lose the whole dollar and get nothing. At least you get dollar back with a 50 cent payment.

So it’s brutal. Look at the trend of the debt, right, look at the trends of the debt on all…look at Ireland, they’re just in a freefall. In fact, they’re in worse trouble maybe than Greece because look at the rate at which they’re falling at. So it’s not where you are, it’s where you’re headed. It’s not where the United States is at 99%, it’s where they’re headed. Look where they’re headed. This is from the Peter G. Peterson Foundation; I want to give a shout-out to them. You oughta know who ran that thing for a while. In fact, let’s even go back further, there’s a man, you oughta get to know his name, it’s David Walker. He was the Comptroller General of the United States, that’s the head of this thing down here. This is called the Government Accountability Office, it was headed

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by David Walker. And he served under some democrats and under some Republicans, you know, Clinton, Bush, the whole thing.

And a little story about this; Bush, George Bush, he wins the election on Al Gore by almost a tie in Florida. The Supreme Court gives him the tiebreaker and he’s President. Well think about it, four years later, you gonna risk Florida? Who lives in Florida? Seniors. You don’t wanna go down there with John Kerry. John Kerry, he’s gonna take care of all those seniors. He’s gonna make them promises. Well Bush, he’s not gonna be outdone, so what does he do? Right before the election, he says “Let’s change fiscal policy.” What’s fiscal policy? Taxes and spending. And part of spending is Medicaid and Medicare. And he says, “Hey, let’s include prescription drugs in Medicare.” And David Walker, the Comptroller General from the GAO, the Government Accountability Office, he says “Wait. If you include prescription drugs as part of the spending here, aren’t you gonna have to raise taxes?” He says, “Well my father said, ‘Read my lips, no new taxes.’” And he says, “Do you realize we don’t have any money in our asset column? We got zero money in the treasury to cover this. Our expenses will be $17 trillion. You’re gonna spend $17 trillion if you put prescription drugs in Medicare for these people. You have no money. You’re going to have to borrow it. You’re gonna have to go into debt another $17 trillion if you do this.” And Dick Cheney and George Bush said, “Now now now Mr. Walker. We know you’re the head of the Government Accountability Office and you need to make us accountable. We know you’re the Senior Comptroller General of the United States. You’re the number one guy, but let’s not worry about these numbers because there’s a lot of seniors in Florida, and we need those votes.” Interesting how things work, interesting. Oh, Democrats and Republicans are all the same. Those politicians are all the same.

So anyway, that’s policy. Well, right here, this is the trajectory. You can tell the future by policy plus demographics equals the future. When you look at the rate or the direction of the ball, where it’s rolling for the United States out of sovereign fundamentals, the amount of money we’re gonna have to borrow is gonna go up huge and our GDP is not poised to go up as fast as the debt. We cannot grow our way out of these problems. And so, notice in the history right here, Civil War, boom, printing money. Okay, comes back down, boom, printing money. Huge amount of money, World War II is expensive. But you gotta realize something, there’s a difference here. See, up until 1971, we had gold backing our money. We had silver backing our money. Now it’s just a promise to pay.

The other thing is, these were war, war, war; this isn’t war, this is Medicare and this is Social Security. Yeah, both important, gotta take care of the people. This is the baby boom right here. So, pretty interesting stuff. Demographics plus policy equals the future. Very cool stuff. Or added to or times policy equals the future would probably be closer. So good job David Walker; he ran

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the Peter G. Peterson Foundation for a long long time, and now he’s moved on to start his own foundation. He left, he quit the GAO in frustration, and his new job is to help people understand policy, economic policy and sovereign fundamentals. So we’re hearing you, David, at least I am. I’m trying to help you, trying to spread the word, buddy. Interesting stuff.

So, why do I tell you this? Well, now we’re gonna talk about corporate fundamentals, how to buy stock. We’re also gonna help you with your personal fundamentals, how to improve your own situation. But I want you to know that every corporate financial statement in the world, not just the US, in the world and every personal financial statement in the world is in the shadow of US sovereign fundamentals. Why? Well, we had this thing called the Bretton Woods System. And there was a hotel in Bretton Woods, New Jersey and the world came to that hotel and they had a conference. They said, “Since the United States backs their currency with gold, let’s make them the reserve currency.” That was called the Bretton Woods Agreement. So, all the commodities, wheat, barley, oats, frozen concentrated orange juice, gold, silver, and oil, which is a huge one, oil is always purchased in US dollars. It’s the world’s reserve currency. Everything is about the US dollar now because of the Bretton Woods Agreement in Bretton Woods, New Jersey. Is this interesting? They should probably teach this in school but they don’t. That’s why you get it here. So, no matter where you are in the world, all of this stuff occurs in the shadow of the most dire $1.6 trillion deficit, the most dire sovereign fundamental analysis. So there’s a little bit on sovereign fundamental analysis, gives you a taste. Boy, did we cover a lot? I said we were gonna cover a lot, inflation, currency, debt, deficits, debt to GDP ratio, cool vocabulary right? Let’s talk more about fundamental analysis. Let’s move on to the corporate level. Let’s do corporate fundamental analysis.

END OF FUNDAMENTALS – MODULE 2

the 4 pillars of investing fundamentals: module 2 · is called script. and the continental ......

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