False Knowledge Is Far More Dangerous Than Ignorance: Dr. Marc Faber Market Commentary October 1, 2010

Dr.
Marc Faber Market Commentary October 1, 2010
False Knowledge is far more Dangerous than Ignorance
"The misapprehension springs from the fact that the

learned jurists, deceiving themselves as well as others,
depict in their books an ideal of government - not as it really
is, an assembly of men who oppress their fellow citizens, but
in accordance with the scientific postulate, as a body of men
who act as the representatives of the rest of the nation. They
have gone on repeating this to others so long that they have
ended by believing it themselves, and they really seem to
think that justice is one of the duties of governments.
History, however, shows us that governments, as seen from
the reign of Caesar to those of the two Napoleons and Prince
Bismarck, are in their very essence a violation of justice; a
man or a body of men having at command an army of
trained soldiers, deluded creatures who are ready for any
violence, and through whose agency they govern the State,
will have no keen sense of the obligation of justice.
Therefore governments will never consent to diminish the
number of those well-trained and submissive servants, who
constitute their power and influence."
Leo Tolstoy (Writings on Civil Disobedience
and Non-Violence)
"The greater the ignorance the greater the dogmatism."
William Osler
"If you do not smile, you are judged lacking in a 'pleasing

personality' - and you need to have a pleasing personality if
you want to sell your services, whether as a waitress, a
salesman, or a physician."
Erich Fromm
www.gloomboomdoom.com Page 2 of 21
© Copyright 2010 by Marc Faber Limited - All rights reserved
Dr. Marc Faber Market Commentary October 1, 2010
"A warm smile is the universal language of kindness."
William Arthur Ward
I am frequently asked, by young readers especially, “what they should do in

their lives and careers” and whether I had any recommendations for particularly
good universities (I am not aware of any university that teaches Austrian
economics). Over the years, I have hired numerous people who worked with me
(for now I do not need to hire anyone) and I am still involved in numerous
business partnerships. I have to say that I was never interested in anybody’s
educational or family background. Whether somebody had a MBA or any other
degree was for me also completely irrelevant. For me, what mattered was
whether someone had the personality that was suitable for a particular job. I
mean, you do not need a marketing genius as your accountant or as a back
office clerk. However in sales, communication skills and the ability to earn
people’s trust and hearts is very important. Equally important for me was that
somebody had integrity (nobody is perfectly honest), reliability, initiative,
creativity, enthusiasm, and that he or she (to be politically correct) was
interested to learn and work very hard. I never ran a company with thousands of
employees. Therefore, the most important factor for me when hiring somebody
was that I liked the person and that I felt comfortable to have him or her around
the office. I know that IBM and Citigroup will have different criteria when
hiring their staff but what I am driving at is your personality is your most
important asset. This is something you have to work on very hard and all your
life. If you are shy and lack communication skills, you can change this by
forcing yourself to be more outgoing. Originally, I felt very uncomfortable
making speeches. I then attended a two-days speaking course in New York, in
1980. Although the teacher told me in front of the entire class that I had
hopeless communication and sales skills (I had to pretend to be a tire salesman)
I learned quite a few things. As time went on and as I forced myself to speak as
often as possible in the early 1980s, I gradually gained confidence whereby I
admit that even today I feel nervous just before delivering a presentation.
Imagine how uncomfortable I was at the time when at one of my speeches three
Nobel Prize winners in economics were sitting in the first row (this would no
longer unsettle me nowadays knowing more about some of these economists’
abstruse theories). One lesson that I remember very vividly in the speaking
course was our teacher’s emphasis that a presenter should speak freely. He told
us that if you needed to read a text you were not intimately familiar with the
subject to start with and that it was difficult for the audience to follow a pre-
written speech (presenters who read their speeches will put the audience
instantly to sleep and lead them to think of their wives, girlfriends etc.). What I
want to say is that if you prepare yourself well for an exam, a speech, an
interview, or any kind of job and sport, you will have far more confidence when
performing your task. Therefore, to the many readers who ask me about career
advice, my suggestion is that it does not matter what you do. However, that you
do what you chose to do with enthusiasm, initiative, devotion, persistence,
determination, discipline, and a big smile – also at yourself when you make bad
mistakes or take bad decisions (see above quotations). Things will not always
work out and we all fail badly from time to time. Real failure is not falling
down but staying down and, as J. Paul Getty observed (and all investors should
never ever forget this), “a man can fail, but he isn’t a failure until he blames
someone else.”
This week I wish to discuss three topics: the symptoms of inflation, the asset
shortage theory, and some of the shortcomings of ETFs.
Recently, a Bloomberg column quoted an American tourist from Phoenix. He
said that, “we were warned that in Switzerland everything is very expensive and
that food and hotel prices were out of this world” (a McDonald’s Big Mac costs
$6.19 in Switzerland, compared with $3.73 in the U.S. and $4.33 in the Euro
area, according to data compiled by The Economist). Another visitor indicated
that in future he might go somewhere else in Europe rather than return to
Switzerland.
So, why is Switzerland so expensive? After all Switzerland, like Japan, had
very low inflation rates for the last ten or twenty years (although higher than
what the government published). The reason is very simple: The Swiss Franc
has appreciated strongly against both the Euro and the US dollar (see Figure 1).
Figure 1: Swiss Franc against US Dollar, 2000 – 2010
Source: www.decisionpoint.com
I need to add that the strength of the Swiss Franc is not a recent phenomenon.
When I was young, in the 1950s (I am now 64, I am afraid to say) one US dollar
still bought around five Swiss Francs (SFR). Now it buys less than one SFR.
Why is one currency strong while another one is weak? Moreover, why does
gold sell around $1,300 when it sold for just $35 until the early seventies?
Imagine yourself in a closed economy with Mr. Bernanke running a gigantic
money-printing machine. Obviously, the more money he prints the more paper
money’s value will diminish against the goods and services the economy
produces and against the assets that are available in this closed economy (see
Figure 2).
Figure 2: Annual Growth Rate of Austrian Money Supply
Source: Michael Pollaro, www.trueslant.com/michaelpollaro
One of the problems of inflating the supply of money with the printing machine
(or of debasing paper money’s value) is that not all prices will increase at
exactly the same rate and at the same time. Obviously, prices of goods and
assets, for which supplies cannot be increased much (or not at all), will
appreciate more in price than of goods and assets for which supplies can easily
be expanded. Also, from time to time asset bubbles will develop in the one or
the other asset class because if some assets went up in price for a long time it
will attract an increasing number of investors and speculators who will bet –
usually with leverage - on further price increases. At the same time, academics
will publish books why stocks, real estate, stamps etc. always goes up in price.
The point, however, is this: if money and credit rapidly expand in a closed
economy (no foreign trade and strictly enforced foreign exchange controls), the
price level of that economy will over time also increase rapidly (but not
necessarily at all times at exactly the same rate as money and credit growth
exceeds output growth).
The situation becomes more complicated when the US economy with Mr.
Bernanke’s giant money printing machine opens up to foreign trade and allows
completely free capital flows. If, at the time of the trade and foreign exchange
liberalization the price level of the money printing US is far above the price
level in other countries, it is almost certain that the dollar will depreciate against
other currencies. This was the case for the US compared to Europe and Japan in
the early 1970s and it is now again the case for the US compared to China and
other Asian countries. In the 1970s, the dollar lost more than 50% of its value
against strong European currencies and the Japanese Yen. Now, the dollar is
again in a downtrend - this time against resource based and Asian currencies.
Even if two countries have a similar price level, the currency of the country
that prints money at a faster rate than the other will likely experience over time
a decline in value of its currency. This especially, if the regulatory and fiscal
environment (burdensome and costly health care reforms, taxes etc.) are less
favorable in the country that prints money at the faster rate (in today’s case the
US). In addition, in a money-printing environment, the excessive liquidity will
produce large speculative flows. So, when a currency appreciates against
another currency, as was recently the case for the Swiss Franc and the Yen
against the dollar and the Euro, investors will through their speculative
purchases drive the appreciating currency even further to the upside (see Figure
3).
The problem for the central bank of the country whose currency appreciates
strongly is now what to do about the currency, which becomes “too” strong.
(According to Brazil’s Finance Minister, Guido Mantega, “we are in the midst
of an international currency war. This threatens us because it takes away our
competitiveness”).
If the central bank does nothing it endangers temporary the competitive
position of some sectors of the economy because of the excessive strength of
the currency. If the central bank prints money, most likely, inflationary
pressures will eventually follow. In other words, by printing money the Fed
can to some extend force other central banks to engage in similar monetary
policies. Michael Pollaro who compiles detailed money supply figures notes
that, “the money supply aggregates based on the Austrian definition of the
money supply (TMS) surged in August, with broad TMS2” (his preferred
money supply metric), “up an annualized 9.5% (see Figure 2). The more
important year over year growth rate on TMS2 was once again sporting a
double digit rate, posting a rate of 10.7% in August, up from July’s 10.3%
rate. This makes the 20th consecutive month that TMS2 has posted double digit
year over year growth, a cumulative increase of 19% over those 20 months. To
put those figures into perspective, the run-up to the now infamous housing
bubble turn credit implosion turn Great Recession saw a string of 36 months of
double digit growth for a cumulative increase of 48%. So yes, today’s

inflationary largesse may be only 40% of that which brought on the Great
Recession, but this one’s still in process.”
Figure 3: Is the Price Level in Japan Deflating or Inflating?
Notes Pollaro: “As has been the case throughout 2010, M2, the mainstream’s
favorite monetary aggregate, continues to show anemic growth, in July posting
a year over year growth of just 2.7%.” In his opinion, “M2 is a grossly
misleading measure of the money supply, meaning the gap between the true and
the perceived rate of monetary inflation is a hefty 8 percentage points (for a
definition and additional explanations concerning Pollaro’s money supply
calculations - see www.trueslant.com/michaelpollaro).
Now, I am not suggesting that differences in the rate of money and credit
growth are the only factors influencing currency fluctuations. What I wanted to
show is that the Fed with its monetary policies is capable to force the US price
level down and other countries’ price level up. The increase in the price level of
other countries will occur through the appreciation of their currency, their
overall price level through inflation, or a combination of the two. So, a visitor
from Mars (or Phoenix) traveling to Switzerland or Japan will think that these
countries are very expensive (he will conclude that they have high inflation)
whereas he will think that the US is inexpensive and, therefore, think that the
US has low inflation. However, the opposite is true. Of course, a Keynesian
economist will point out that in the US there is practically no inflation because
he will just focus on consumer prices (see Figure 4).
Figure 4: Is Inflation in the US Really This Low?
Source: David Rosenberg, Gluskin Sheff
In fact, he should ask himself why he now pays so much more when he travels
to Brazil, Singapore, Australia, Japan, and Switzerland. And why does he have
to pay far higher prices for gold, silver, heating oil, gasoline, coffee, sugar,
cotton, agricultural commodities, etc. (needless to say that US consumer prices
are increasing far more than official statistics show). He should then ask, “why
are emerging economies performing so much better than the US and Europe?’
Yes, the US Fed can print as much money as it likes. However, what the
Fed does not control is where the money will flow. The Fed and Mr.
Krugman (the greatest protagonist of another bubble) also do not control
what kind of other bubbles – economic or financial - they will create (to
their credit they were very successful at co-producing with mentor
Greenspan the NASDAQ bubble in the late 1990s, and the housing bubble
thereafter). So let us not underestimate the power of these assassins of sound
money! What we know is that all the stimulus and money printing has hardly
helped the US economy, which is far worse off today than ten years ago.
However, US monetary policies created another economic and asset boom in
numerous emerging economies and in regions with resources (mostly located in
emerging economies - see Figure 5).
Figure 5: Corporate Earnings in Developed and Emerging Economies
Source: Jonathan Anderson, UBS
As can be seen from Figure 5, developed countries’ earnings are still well below
their pre-crisis peak. However, in emerging economies, corporate earnings are
either, close to their previous peak or, as in the case of Indonesia, they exceed
them significantly. This better economic and corporate profit performance in
emerging economies compared to the developed countries of the West and
Japan has also been rewarded by far better stock market performances. Year-to
date, the Malaysian stock market is up 28% in dollar terms, Thailand up 43%,
the Philippines up 41%, and Indonesia up 45% . This all occurred because of a
combination of currency and stock market strength (see Figure 6).
Figure 6: Emerging Stock Markets Have Outperformed the World!
Source: Jonathan Anderson, UBS
This leads me to the second point I wanted to discuss. In July 2007, I published
a Gloom Boom & Doom report entitled “Is there Indeed a Shortage of Assets?”
(See enclosed GBD report dated July 1, 2007.) In this report I discussed a
theory advanced by Professor Ricardo Caballero, which claimed that the world
“had a shortage of financial assets” (On the Macroeconomics of Asset
Shortages). I should add that, at the time, Stephen Jen of Morgan Stanley
advanced a similar theme in a paper entitled “Proposing an ‘Asset Shortage
Hypothesis’” (Morgan Stanley Research Global, dated March 22, 2007). It was
no coincidence that the authors published these absurd theories just as stock
markets around the world were peaking and dead ahead of a very serious
economic downturn (see Figure 7).
Figure 7: S&P 500, 2003 – 2010
According to Professor Caballero, “The world has a shortage of financial

assets. Asset supply is having a hard time keeping up with the global demand
for store of value and collateral by households, corporations, governments,
insurance companies, and financial intermediaries more broadly. The
equilibrium response of asset prices and valuations to these shortages has
played a central role in global economic developments over the last twenty
years. The socalled ‘global imbalances,’ the recurrent emergence of speculative
bubbles (which recently have transited from emerging markets, to the dotcoms,
to real estate, to gold...), the historically low real interest rates and associated
‘interest-rate conundrum,’ and even the widespread low inflation environment
and deflationary episodes in parts of the world, all fall into place once one
adopts this asset shortage perspective...
In equilibrium, the value of the (relatively) few existing assets must rise,
which has important global macroeconomic implications” (emphasis added).
It is interesting to note that whereas the good professor felt then that there
was a genuine shortage of financial assets he thought that gold was a “bubble”
(gold was selling at the time for less than $700 - see Figure 8).
Figure 8: Gold and the Asset Shortage Theory
The professor then went on to suggest that “since speculative bubbles are a
necessary evil in this environment, it is important to learn to manage their
risks rather than to obsess over choking them” and that “low interest rates and
inflation rates, as well as high (speculative) valuations, are all market-based
mechanism to rebuild asset supply. Caballero warned “on the deflationary
consequences of chasing bubbles”, and proposed instead “to focus on the risk
management of high valuation equilibria” (emphasis added).
To make a long story short (and I suggest you read the enclosed report),
temporary shortages can occasionally occur but more commonly, and over
longer periods of time, asset prices increase not because of shortages. They do
increase because of excessive money creation (also, please note that a surplus of
cash has invariably always led to a shortage of sense).
Therefore, given what I said earlier about money flowing outside the US, it is
conceivable, that some “big bubbles” could develop in emerging markets (see
Figure 9).
Figure 9: Global Emerging Market Equity Fund Flows, 2003 - 2010
Source: Markus Rosgen, Citi Investment Research
My regular readers will know that I like to buy distressed assets and never chase
assets that enter a bubble phase. My readers will also know that since April I
have been lighting up on equity positions. But I just want to alert my readers to
the possibility (however, not very likely for now) of some major upside moves
in selected stocks (Apple, Amazon, Netflix, etc.), in emerging markets, and in
other asset prices, not because of any shortages but because of excessive money
creation. Above, I discussed Indonesia. I am at present not interested in the
Indonesian stock market but a further sharp upward move is possible before it
turns down (see Figure 10).
Figure 10: Indonesia: Is it Gaining too much Popularity among Investors?
As I said above, I am not playing these possibly “terminal” moves and I would
use further strength to lighten up positions.
The July report concluded that, “the reason I am less confident for the S&P 500
to break below support around 1040 is that I am increasingly convinced that,
should the economy weaken again, the Fed will implement much more
monetization.” Moreover, in last month’s report, I mentioned that, “after having
been in this business for forty years, I can say that if stock markets crashed right
now it would be the best advertised bear market in modern history. A crash
would also be most unusual because bullish sentiment among individual
investors is at the lowest level since March 2009” and that “since everybody
knows about the Hindenburg
Omen and about “weakness in September”, stock markets may first fool the
bearish crowd by rallying for the next few weeks – perhaps to around 1150 for
the S&P 500 (see Figure 16). Thereafter, I would still consider the S&P to drop
to between 870 and 950, as the most likely scenario” (see Figure 11). I have to
say that I am now less certain that we shall drop to these levels. However, this
does not mean that it could not happen!
Figure 11: S&P 500, 2009 - 2010
Source: Ron Griess, www.thechartstore.com
The reason for this slightly more optimistic view is that on renewed asset
market weakness quantitative easing is almost a certainty. Near-term the US
stock market is overbought, but longer-term it is in neutral territory (see Figures
12 and 13).
Figure 12: S&P 500: Near-Term Overbought!
Figure 13: S&P 500: Long-Term in Neutral Territory!
Still, what concerns me is the following. At the late August low (S&P 500: 1039)
investors’ sentiment was extremely negative. This has since changed radically.
The asset inflation trade is back in full swing with investors chasing precious
metals, selected high tech stocks (Amazon, Apple, Netflix etc.), and emerging
and developed stock markets around the world. Moreover, whereas in June
investors were hyper-negative about the Euro (and positive about the US dollar),
now, investors are extremely negative about the dollar and positive about any
other currency (see Figure 14).
Figure 14: Euro Index, 2009 - 2010
Source: Stockcharts.com
As can be seen from Figure 14, back in June, only 2% of market participants
were positive about the Euro. Now, 96% are bullish! I have explained in the
past that whenever the US dollar weakens it is asset price friendly (certainly for
stocks and commodities), but that periods of US dollar strength bring about
asset market declines (like in 2008). Therefore, as a contrarian I would have to
consider the possibility that we are nearing inflection points. A US dollar
rebound and corrections in commodities, precious metals, and stocks!
However, I would use a correction in asset markets as a buying opportunity for
equities, as more quantitative easing (money printing) would almost certainly
follow (I should add that dollar strength would be favorable for Japanese shares).
In the back of my mind, I am naturally concerned that it has become consensus
that commodity and stock markets cannot fall significantly (for stocks say 30%
or toward the March 2009 lows) because the Fed will print money. It is for this
reason that I am currently extremely cautious and that I continue to reduce
my equity positions.
A reader asked me if I was still positive about agricultural commodities. Yes,

but obviously like precious metals and other commodities they are also
vulnerable to a correction. Longer-term they still look attractive and they remain
in real terms extremely depressed (see Figure 15).
Figure 15: Soybeans, Adjusted For Inflation, 1914 – 2010
The last point I need to address briefly is why certain ETFs are from a longer-
term perspective unattractive. My regular readers will know that I doubt that we
shall break below the December 2008 lows on Ten-Year US Treasury Note
yields (at the time 2.08% - see Figure 16).
Figure 16: Ten-Year US Treasury Note Yield, 2007 - 2010
Now, even after the recent drop in yields Ten-Year Treasuries still yield 2.50%.
In other words, almost 20% more than at the December 2008 low. Therefore,
one would assume that a short Treasuries ETF – if bought at the December 18,
2008 low when yields touched 2.08% - would have made some money. Wrong!
Because of the high rollover costs, you would have lost money (see Figure 17).
The ProShare Ultra Short Lehman 20+ Year Treasury Bond touched a low of
$35.38 at the yield low in December 2008. Now, with yields up almost 20%,
this “brilliant” instrument sells for just a tad above $31.
Figure 17: Beware of “Short Stock and Bond” ETFs
I have repeatedly argued that these types of ETFs are only suitable as trading
vehicles and not as longer-term investments. The same applies to all
commodities ETFs! The rollover costs are in the long-term the killer.
One last observation: I have seen in the last 40 years many strong months of
September. Often sharp declines followed in October/November. This is just a
word of caution!
Please find enclosed the Gloom Boom & Doom report on the asset shortage
theory.
Also for readers interested in Japanese equities a report by Yaser Anwar about
Japanese stocks.
Finally, remember the words of William Arthur Ward that, “to make mistakes is
human; to stumble is commonplace; to be able to laugh at yourself is maturity.”

False Knowledge Is Far More Dangerous Than Ignorance: Dr. Marc Faber Market Commentary October 1, 2010

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False Knowledge Is Far More Dangerous Than Ignorance: Dr. Marc Faber Market Commentary October 1, 2010

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Dr.

Marc Faber Market Commentary October 1, 2010

False Knowledge is far more Dangerous than Ignorance

"The misapprehension springs from the fact that the

"The greater the ignorance the greater the dogmatism."

"If you do not smile, you are judged lacking in a 'pleasing

"A warm smile is the universal language of kindness."

William Arthur Ward

I am frequently asked, by young readers especially, “what they should do in

Figure 1: Swiss Franc against US Dollar, 2000 – 2010

Figure 2: Annual Growth Rate of Austrian Money Supply

Source: Michael Pollaro, www.trueslant.com/michaelpollaro

double digit growth for a cumulative increase of 48%. So yes, today’s

Figure 3: Is the Price Level in Japan Deflating or Inflating?

Figure 4: Is Inflation in the US Really This Low?

Source: David Rosenberg, Gluskin Sheff

Figure 5: Corporate Earnings in Developed and Emerging Economies

Source: Jonathan Anderson, UBS

Figure 6: Emerging Stock Markets Have Outperformed the World!

Source: Jonathan Anderson, UBS

Figure 7: S&P 500, 2003 – 2010

According to Professor Caballero, “The world has a shortage of financial

Figure 8: Gold and the Asset Shortage Theory

Figure 9: Global Emerging Market Equity Fund Flows, 2003 - 2010

Source: Markus Rosgen, Citi Investment Research

Figure 10: Indonesia: Is it Gaining too much Popularity among Investors?

Figure 11: S&P 500, 2009 - 2010

Source: Ron Griess, www.thechartstore.com

Figure 12: S&P 500: Near-Term Overbought!

Source: Ron Griess, www.thechartstore.com

Figure 13: S&P 500: Long-Term in Neutral Territory!

Source: Ron Griess, www.thechartstore.com

Figure 14: Euro Index, 2009 - 2010

A reader asked me if I was still positive about agricultural commodities. Yes,

Figure 15: Soybeans, Adjusted For Inflation, 1914 – 2010

Source: Ron Griess, www.thechartstore.com

Figure 16: Ten-Year US Treasury Note Yield, 2007 - 2010

Figure 17: Beware of “Short Stock and Bond” ETFs

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