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					Market Notes by Chris Belchamber Investment Management LLC
          2/10/06 (www.ChrisBelchamber.com)

      Who’s the Patsy?
      "If you've been playing poker for half an hour and you still don't know who the
patsy is, you're the patsy." --Warren Buffett

       "There is no means of avoiding the final collapse of a boom brought about by credit
(debt) expansion. The alternative is only whether the crisis should come sooner as the
result of a voluntary abandonment of further credit (debt) expansion, or later as a final
and total catastrophe of the currency system involved.”            -- Ludwig von Mises

        You might wonder what on earth these two quotes have to do with each other. Well
I will attempt to link them. Together I believe they describe how in some games, like
world financial markets and politics, very few really have a good grip on what is going on.
What are the incentives of the key players? Are they playing by the rules? Or are they
bluffing? If you’re not sure, then, well, you’re …..

       Let’s start with the game first. Alan Greenspan, in some sense, really is a Maestro,
but the true monument of his success is shown in the chart below. Since Alan Greenspan
took the helm in 1987 paper assets owned by central banks have exploded upwards by
more than a factor of 5.

Market Notes by Chris Belchamber Investment Management LLC
          2/10/06 (www.ChrisBelchamber.com)

      Quality or Quantity?
       Paper money is the oil that greases a credit expansion in all its forms, from
government deficits, to uncontrolled debt expansion, to derivatives. Central bankers can
only control the quantity of the money they create...or the quality. They cannot control
both at the same time. Since they always tend to err on the side of quantity (who doesn't
like more of the green stuff?), quality suffers. Soon, there is more and more money
around....until eventually, even investors notice and they begin to worry about it. They
then want to exchange their money for things of unblemished quality - like gold. Gold
doesn't lose value for a good reason: its quantity is limited by nature. Rarely does the
world's supply of new gold exceed 2% or 3% per year...nicely – almost divinely - in line
with GDP growth.

       Alan Greenspan once knew this very well; he wrote essays about it in his
early days...noting that gold backing for currency was necessary to keep central bankers
honest. Otherwise, they won't be able to help themselves, he predicted; they will press
down so hard on the money quantity pedal that money quality will go haywire.

        No one pressed down harder than Alan Greenspan. He jumped on it with both feet.
More money and credit was created during his time at the Fed than under all the U.S.
Treasury secretaries and Fed chiefs put together. The value of the dollar - in terms of
what it will buy - was reduced by half during Greenspan's 18-and-a-half-year service.
Over the past decade consumer debts are up 121%, to $10.7 trillion, while real consumer
income was either stagnant or falling. The newly created money fuels all asset prices so
much that despite poor income levels and higher debt levels, most people think they are
suddenly more wealthy. What they did to make themselves more wealthy they are not
sure about, but somehow they come to believe that they can risklessly continue to
increase debt and stop saving altogether. Swimming in endless supplies of money with
rising asset prices makes most people giddy.

      Why be a Killjoy?
       While everyone is having so much fun why should we worry? Well the problem is
that there is a Newtonian law of nature that for every action there is a reaction. The only
comparable periods like this are the 1920s and 1930s in the US and the 1980s and 1990s
in Japan. As the Bank of Japan put it, “The magnitude of damage caused by the bursting
of the bubble is disproportionately larger than the gains obtained in the emergence of the

      From this perspective the best thing to do is to avoid the bubble in the first place.
How do we do this? Well, no less than the IMF did a study published in its “World
Economic Outlook” in April, 1993. This clearly pinpointed what creates a bubble – “a credit
expansion in excess of the expansion of the real economy”. They went on to say “To the
extent that asset price changes are related to excess liquidity or credit, monetary policy
should view them as inflation and respond appropriately. There is nothing unique about
asset prices that would suggest that asset prices can permanently absorb overly
expansionary policies, without leading to costly real and financial adjustment.”
Market Notes by Chris Belchamber Investment Management LLC
          2/10/06 (www.ChrisBelchamber.com)

      Where are the risks today?
       We have recapitulated Japan’s and America’s past disastrous bubble experiences in
order to make three things poignantly clear: First, all asset bubbles are the product of
credit inflation; second, the two worst bubble experiences in history have developed
against the backdrop of virtual price stability; and third, both central banks made their
obvious crucial mistake in focusing on low inflation rates and ignoring ongoing credit and
asset inflation.

       To this, we want finally to add a fourth point: America’s credit inflation since 2000
is the worst in history, as measured by credit growth relative to GDP growth. In essence,
the Greenspan Fed replaced the prior bad equity bubble with a much bigger and much
worse housing bubble.

       The specific effects of credit inflation on the economy and the price system depend
on the places where the credit deluge enters the economy. In Japan’s case, it grossly over
expanded construction and business fixed investment. In the U.S. case of the 1920s, it
over expanded consumer spending. Today, the unsustainable excesses are concentrated
in consumption and housing.

      There is a widespread perception that the U.S. economy under the Greenspan Fed
has gained unprecedented steadiness. In actual fact, U.S. economic activity has become
dependent as never before on rising house prices facilitating unbridled consumer
borrowing. This may temporarily create a semblance of economic stability and strength.
The reality is an extremely vulnerable economy and financial system.

      What next?
      Now the responsibility for all monetary matters falls to the new Fed Chair Ben
Bernanke and the problem here is that all his work on this issue has lead him to
conclusions that could be dangerously wrong. Ben Bernanke is like a new weather
forecaster who stands up and tells us that from now on there will be no more hurricanes.

       Clearly from his writings he disagrees with the Bank of Japan and the IMF when he
concludes that the US 1930s depression and the Japanese 1990s deflation were caused by
an inadequate monetary response to the fallout from the bubbles rather than the
excessive credit that created the bubbles in the first place. In short not only was excessive
credit not the initial problem, it is in fact the solution. Ben Bernanke seems to take no
issue with excessive credit growth at any time. Could he be Greenspan on steroids?

       We have described the major money supply issues that will be played out over the
next few years or decades. What investors have to do is to make sure they understand
the game they are in. In such a distorted financial world incentives and judgements can
easily lead us in dangerous directions. Generating a good income and saving for the future
Market Notes by Chris Belchamber Investment Management LLC
          2/10/06 (www.ChrisBelchamber.com)
is the key to long term prosperity. However, in an environment of consistent excess credit
expansion, it seems that saving is a waste of time and the optimal strategy is to leverage
oneself as much as possible to rising asset prices. For a time it is, but in the end it is not.

       For now the key to policy is to maintain high asset prices for as long as possible to
keep the dream alive. However, asset prices are no longer as cheap as they used to be,
and debt expansion produces a weaker kick to the economy than it once did. No doubt it
can always be extended further and possibly for several more years, but unless your
strategy is to die young you can no longer afford to believe in the never ending dream.
None of us will be served well to forget the basic principles of wealth creation and asset
management. We all need a durable long term income and savings plan and prudent and
flexible asset management.

       I realize this discussion has been somewhat unconventional and controversial in
relation to financial fashions today, but very few people study history a great deal. We are
simply reaching our conclusions from what has happened in the past. This may not be
what you are usually told and it may not be what you want to believe. Perhaps this is why
most people in the end lose money in the game. Make sure you’re not the Patsy.

         All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment
recommendations may change and readers are urged to check with their investment counselors before making any
investment decisions.

         Opinions expressed in these reports may change without prior notice. Chris Belchamber (the author) may or may
not have investments or positions in any assets or derivatives cited above.

         Communications from the author are intended solely for informational purposes. Statements made by various
authors, advertisers, sponsors, and other contributors do not necessarily reflect the opinions of the author, and should not
be construed as an endorsement by the author, either expressed or implied. The author is not responsible for typographic
errors or other inaccuracies in the content. We believe the information contained herein to be accurate and reliable.
However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty
of any kind. Past results are not indicative of future results.


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