"Come, Watson, come! The game is afoot. Not a word! Into your clothes and come!"

– Sherlock Holmes

About this time two years ago I began to seriously work with Jonathan Tepper on our book Endgame: The End of the Debt Supercycle and How It Changed Everything. It came out the following March. I remember vividly that in November of that year, as crisis after crisis hit Europe, and the first of about 20 summit meetings which were supposed to solve the crisis was convened, that Jonathan and I worried that the book would not be out in time to actually catch the Endgame before it happened (at least in Europe).

Ah, such naiveté from your humble analysts. While we predicted (in general) pretty much everything that has happened so far, from Greece to Spain to Italy, the problems with "austerity" in times of crisis, the even larger eventual problems of postponing the day of reckoning, etc., we now must stand back and shake our heads in awe and wonder at the ability of European leaders to kick the can down the road. Given the serious nature of the problems, it is amazing (to us at least) that they have been able to keep the wheels from coming off. In the face of the powerful centrifugal forces that should have torn Europe apart, we must pause and give serious thought to why they have not done so already.

(In the book, we also discussed at length the problems in Japan and the US and looked at several other problematical countries, but we were not worried that those events would preempt our publishing deadline. Those problems are still in our future, but coming at us ever faster as times gallops on.)

For the last year I have been writing that it is not clear that Europe (with the probable exception of Greece) will in fact break up. The forces that would see a strong fiscal union are quite powerful. In today's letter, I will try to bring you up to date on some insights I have had in the 18 months since we did the final book edits.

One of the more frequent questions I am asked in meetings or after a speech is whether I think we will have inflation or deflation. My ready answer is, "Yes." Then I stop, which I must admit is rather fun, as the person who asked tries to digest the answer. And while my answer is flippant, it's also the truth, as I do expect both outcomes. So the follow-up question (after the obligatory chuckle from the rest of the group) is for a few more specifics. And the answer is that I expect we will first see deflation and then inflation, but the key is the timing. Today we will examine that question in more detail, as we look at how interest rates could actually be negative (!!!) this week in German and Swiss bonds and why the US ten-year has dipped below 1.5%. The very poor May employment number needs some analysis, too, and we'll check the prospects of a synchronized global slowdown. Rarely have I come to a Friday with so much data that simply begs for a more thorough look, but we will try to hit at least the most important topics.

Once to every man and nation, comes the moment to decide,
In the strife of truth with falsehood, for the good or evil side;
Some great cause, some great decision, offering each the bloom or blight,
And the choice goes by forever, 'twixt that darkness and that light.

– James Lowell, 1845

God grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.

– Reinhold Niehbuhr

"Happy New Year. We enter 2012 with a great deal of hope, but our hopes are not for more bailouts, or money printing, or any of the myriad policies that investors seem to hope will save bad investments and sustain elevated valuations. Instead, our hope is that in 2012, the market will finally "clear," in the sense that bad debt around the world will be recognized as bad and restructured; that overleveraged financials will be taken into receivership instead of forcing austerity on every corner of the global economy in order to make them flush again; that rates of return will rise enough to compensate and encourage saving – and high enough to encourage borrowers and other users of capital to allocate the funds productively. Of course, in order to restructure bad debt, someone has to accept a loss. In order for rates of return to rise, valuations must decline. In short, our hope is for events that will unchain the global economy from an irresponsible past and open the gates toward a prosperous future. Maybe that is too hopeful, but we are not entirely convinced that bailouts and 'big bazooka' will be as easily procured in the year ahead as a confused public has allowed in recent years."

– John P. Hussman, Ph.D. (hussmanfunds.com)

"Whoever cannot seek the unforeseen sees nothing for the known way is an impasse."
― Heraclitus, Fragments

Which path will we take? If we could only grow our way out of our sovereign debt problems. But growing debt creates even more problems if not dealt with, making it even more difficult to deal with; yet getting the debt and deficit under control brings its own form of pain. As I keep pointing out, there are no easy choices left. Some countries must choose between difficult and very bad, and others are faced with either disaster or calamity. Greece simply gets to choose what it wants to be the cause of a depression. Long and slow or fast and deep? Choose wisely.

It's that time of year when we start thinking about what the next may hold for us. I am reading and thinking a great deal about my annual forecast issue next week, taking some time off from my usual Friday missive; so this week we look at what I think is one of the best pieces of analysis I have read in the past few months. It is from a private letter for the Boston Consulting Group, and Dan Stelter graciously allowed me to let my friends read it.

Follow this thinking carefully and then think through their outline of what a country would have to do to leave the euro, which starts at the subhead entitled "What if… ?". Then ask yourself what do you need to do. The short answer from me is that you need to consider more what you already own rather than what you should buy.

At the end of the letter is a link to an in-depth review of what scenarios businesses should be considering, but it will also work for individual investors. Now, let me turn it over to Dan and David.

This week I am in Ireland and going from meeting to meeting with a wide variety of people. And this week's letter is a wide-ranging interview with me, conducted by that doyen of financial-world interviews, Kate Welling. She really is one of the best, and she has graciously given me permission to share the interview with you this week, while I am researching next week's letter on Ireland and Europe. I hope you enjoy reading it half as much as I did recording it.

(Sorry for the letter being late. There was a major technical difficulty. – The Editing Team)

But first, in the interest of full disclosure, I want to briefly note to my readers that I have joined the board of Galectin Therapeutics (Ticker: GALT), a small biotech company with unique potential technologies. I get asked from time to time to join a biotech corporate board, but have so far not done so, and the exception is now GALT.

Basically (to make a long story short), GALT has a deep repository of research performed in the USSR prior to the fall of the Iron Curtain, on carbohydrates. Russian and Eastern European scientists had traveled the world looking for new carbohydrates in plants, etc., and the research spanned many decades. When Russian science lost much of its funding, some of those famous scientists came to the US and brought this research, which was then quite new. In the West, we had concentrated on using proteins as drugs, ignoring by and large their lowly sugary brethren.

In an agonizingly slow process, funding found its way to this research, and some very interesting things were discovered about a particular type of carbohydrate that binds to and blocks a protein called galectin, which appears to cause cirrhosis. It seems to be found in the presence of cancer cells, and according to peer-reviewed research may be the cause of cirrhosis of all types, but specifically of the liver. Mouse and other studies suggest the blocking carbohydrate has the potential to be a cure for cirrhosis, and GALT will be in human trials next year with the very prestigious liver research group at Ludwig Institute in Brussels and plans to be in clinical trials next year for liver fibrosis. One of GALT's molecules also appears to dramatically reduce the side effects of chemotherapy for certain types of cancer treatments. (Phase-two trials indicated a unique combination of increasing median patient survival while reducing the number of severe adverse events by approximately 50%). GALT has an application pending with the government of Colombia, which suggests the possibility of use in Latin America soon).

These are wonderful things, of course, but not why I joined the board. In economics, Bastiat used to talk about "the things you can see and the things you don't see." What I "see" in GALT is what is not yet seen, and that is the treasure trove of data on carbohydrates, for which uses are so far only vague speculation. I see the potential for a lot of very interesting research, which will be very costly, but could have real impact, as their current cirrhosis drug candidates have. I should mention that the liver research is highly speculative, as there are no human trials, only mice, rats and human liver-cell culture studies. These are encouraging, to be sure; but as my doctor, Mike Roizen, constantly reminds me, to help temper my enthusiasm, "John, orange juice works in mice!"

Investing in small biotechs with "potential" is somewhat akin to investing in junior and exploratory gold mining stocks. If everything works out, the returns can be exhilarating, but the majority of them will go to zero, so you need to do a LOT of homework and have a diversified basket of them. I do that with biotechs. I love each one of my "investments," but I fully recognize that for a whole host of reasons they could go to zero. What can be a wonderful technology may not work in humans, or it can work but another company comes along and does it better and cheaper, or (more likely) they run out of money or have management problems.

GALT is a perfect example of what I look for. They have wonderful upside if the technology proves out, but will be a big disappointment if it does not. Clearly, I think there is something there, if I am willing to join the board. I also know that some of you will be tempted to "ride along." Let me say, do not, unless you go to their website, listen to their CEO, Peter Traber, explain the technology and company, read the independent research, and look at the board that chairman Jim Czirr has rounded up. GALT has had "issues" in the past, as my kids would say, and it has taken Jim some time, since he organized a take-over of the board, to get the ship headed in the direction it needed to go; but he is fanatical (almost maniacal) about it, which is of course what you must have. Dr. Traber, formerly in charge of global drug development for Glaxo, is a force in himself and relatively new as the CEO. I am very impressed with him. I really like the management team and the plans going forward. No guarantees of course that the good plans will work out the way we hope.

And if you do the research for yourself and like what you see, then be patient. Do not chase the stock price. Pat Cox of Breakthrough Technology Alert introduced me to the company and I bought a few shares, a long time ago. I intend to buy more over the next year; but as a director, I will allocate an annual amount and buy them on a regular, prearranged basis regardless of share price, and will not start to do so for some reasonable time after this announcement. So, I have a mixed bias. As a director I want to see the company shares do well, but I hope they don't get too high, for a while at least. (It's much like my monthly gold purchases: I am glad to see gold is down, as I get more of it when I buy!)

Don't buy if your time horizon is measured in less than years. If you feel the need to look at charts and current prices, then I suggest you pass. I have no idea what the stock will do in the short term, nor a timetable for reportable results. You can see the website at www.galectintherapeutics.com. You can request a copy of the independent research by emailing your request to squeglia@galectintherapeutics.com or calling the company at 617-559-0033.

As will be clear below, I had finished an earlier version of this week’s e-letter, but the events of the last few minutes require a few paragraphs. As I write at the end of the letter, Bloomberg kept their satellite truck here in Maine, as they had got advance warning of the downgrade by S&P of US debt and wanted to interview a number of the economists here, including your humble analyst. I can’t rewrite the letter at this late hour, but will send you additional comments on Monday. And you can go to www.bloomberg.com and see everyone’s remarks, including mine. It will be there somewhere, they promise me.

And now, a few questions and observations are in order.

First, as I walked to the area where the Bloomberg was shooting to go on, Jim Bianco and John Silvia told me that S&P had downgraded the Fed. I laughed and said, “If you guys want to make me look like a fool on TV, you have to at least make up a credible lie.” They kept insisting it was true. I finally asked Mike McKee of Bloomberg and Barry Ritholtz, who was on-air, if it was true. They claimed it was, too. I was still wondering if they were setting me up, but even Roubini (who wouldn’t do that to me) said it was true.

So, if the Fed, which doesn’t issue credit and can print money, can be downgraded because it holds AA+ debt, then why and how in hell can the ECB, which holds hundreds of billions of euros of the junk debt of Greece and Ireland and insolvent banks not be downgraded on Monday? And the Bank of Japan? REALLY? What are these guys smoking? Do we now downgrade GNMA? Of course. And the FDIC? What the hell will repos do on market open? The NY Fed says it won’t affect anything. Don’t ask me, I just work here. And how can you rate France AAA? And still give AA or more to Italy when the market is saying they are getting close to junk?

Side bet for Monday. This could make me look like an idiot, but I think treasury yields fall as the risk-off trade increases. Can this come at a worse time for a nervous market? By the way, maybe you want to go long Kimberly Clark, as they make Depends (the adult diapers here in the US, for my non-US readers), because sales are going to skyrocket all across the financial markets.

Can we say Endgame, gentle reader? Madness. And now on to the regular letter. More to follow Monday.

__________

This week I write from Maine, where, when we landed in the float plane at Leen’s Lodge in Grand Lake Stream on Thursday, we learned that the market had closed down 512 points. I was in the plane with Nouriel Roubini and Jim Bianco (plus a Fed official to be named later), where for whatever reason we could get reception on and off (no phone works at the lodge). We were just watching the market fall. It is fun to sit next to Roubini as a market crashes. He knows ALL the market crash jokes.

So, as is my normal routine for this fishing trip to Maine, I take the week off and invite a guest columnist in. This year it is Keith Fitz-Gerald, whom I have heard speak twice and have started reading. He has lived all over the world and spends a lot of the year in Japan, and is a true expert on emerging markets. I am a fan of investing in emerging markets (as I agree they are the future) but do not consider myself anywhere close to Keith’s level of expertise. So this week we take a look at the case for emerging markets.

If you are interested in subscribing to Keith’s letter and learning more about emerging markets, you can go to https://purchases.moneymappress.com/MMRKFGSHORT4950to79/LMMRM800/. It’s fairly inexpensive and my readers get half off. Now, let’s jump in, and I will end with some closing comments.