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

Monday, February 28, 2011

Modern Monetary Theory Used For Evil

Reader Rajiv recently posted an interesting link in the comments section of this blog.  While Rajiv and I may differ on the success or merits of Modern Monetary Theory - which is also a political discussion - I think we both agree on the potential of its mismanagement.

As I have written about Modern Monetary Theory (MMT) in my post: Modern Monetary Theory , or How the US Monetary System Really Works, MMT, at its core,  really describes the operational system we have. But there are also proponents of the system or MMT'ers as they are often called, that understand the system's function, and want better government as a result. This I find admirable, and I also support the idea that people need to be educated about how our system actually works.

Thursday, February 24, 2011

Godfather of the Mortgage Backed Security (MBS) Speaks...Potential for a Flood of Foreclosures

CNBC interviewed Lewis Ranieri yesterday.  Ranieri is a pioneer of the securitization of mortgaged backed securities.  I was surprised at his openness during the interview.  Here is a summary of his points, video of the interview follows:

  • The housing market is still fragile
  • Lack of credit is to blame...  credit is still tight
  • On what could loosen credit: A transition of the existing market..  government involvement.
  • The magnitude of the current overhang is 6.5 million, add shadow inventory, and it is closer to 11 million, which is 4 years of overhang.
  • Regarding foreclosures I quote from the interview:
"Where we are currently, with the current state of affordability, and the current state of credit, we're going to double foreclosures, and politically, that's just going to be unacceptable...  because it's real people... if we go from 1.2 to 2 and half million foreclosures?  The system will just come apart at the seams.  Putting that many people out of their houses, causing that kind of destruction...  because remember we have hundreds of thousands of vacant houses... and a vacant house is a virus on the neighborhood.... it spreads and takes whole neighborhoods with it.  I mean there have been studies of whole neighborhoods where foreclosures became greater and eventually it took whole middle class neighborhoods and turned them into wastelands."

He does believe there are solutions to this problem.  One is an investor finance program, where local investors buy a foreclosure, fix it up and resell it.

I agree with Ranieri's description of the current housing mess, but as to his solution, not so much.  Earlier in the interview he suggested that one possibility is to transition to a government market.  But isn't it already, in effect nationalized?  And didn't Fannie and Freddie, both government sponsored entities, share in the creation of this mess?

But more importantly, there are two other issues that affect housing.  One is the creation of entire neighborhoods of McMansions located far away from employment centers.  With the increasing cost of oil, this is a recipe for disaster.  How will people continue to commute and pay a mortgage as gasoline costs rise? The second issue is employment.  Unemployed people don't buy homes.  And many people that do have a job are scared of losing it.  This represents a huge psychological obstacle to the housing market.  I believe there are many people still sitting on the sidelines because of job insecurity.  After all, for most Americans, this is either a Recession or a Depression, depending on their circumstances.  Most policymakers don't seem to be making the connection here.  They view the housing situation as a separate issue.

And there is one more issue that we need to consider.  Is home ownership still worth it?  Is a house an investment or a shelter?  What type of future financial expectations should we have when owning a home?  What if the government, and there is talk about this, decides to get rid of the mortgage interest deduction?  There have been estimates that removing the homeowner interest deduction could make housing fall another 20-30%!

There are no easy answers.

Here is the interview:

Wednesday, February 23, 2011

US and Canada Agree on Cross-Border Joint Military Cooperation for Potential Civil Emergencies

Hat tip to Jesse's Cafe for posting the link of the original article on his website.

From Canada.com:
Canada, U.S. agree to use each other’s troops in civil emergencies 
Canada and the U.S. have signed an agreement that paves the way for the militaries from either nation to send troops across each other’s borders during an emergency, but some are questioning why the Harper government has kept silent on the deal.

But first, a little refresher on a prior post of mine, from November 9, 2010: US Military Running War Games Based on Economic/Dollar Collapse Scenario.  In that article, I wrote:
James Rickards is Senior Managing Director for Market Intelligence at Omnis Inc. He has also served as a consultant to the various branches of the US Military, focusing on financial threats to national security. In this interview with King World News, he discusses recent US Militrary war games exercises based on global economic collapse and civil disorder, as well as World Bank President Robert Zoellick's recent comments on a gold standard, Fed QE2, the IMF and G20, the ongoing currency war, and recent gold market activity. 
Keep in mind that the US Military always prepares for possible threats. These war games have been named: "Unified Quest 2011." I don't want to be an alarmist, and I don't think we're facing anything like that anytime soon, but it's always best to prepare.
Source of Interview: HERE Source of War Game (Subscription req'd) HERE.

And so, I believe that the two are related to each other.  Operation Unified Quest 2011, and this recent agreement between the US and Canada may be part of the same crisis response scenario, that is, how to handle a potential economic upheaval or dollar collapse scenario that creates civil disorder.

More from the Canada.com article on this new arrangement:

Monday, February 21, 2011

The Collapse of Complex Civilizations

For those not familiar with Dr. Joseph Tainter, he is an Anthropologist and US Historian that wrote in 1988 the book: "The Collapse of Complex Societies."

The best way I can describe this approach to viewing the history of empires and complex societies is one of systems dynamics.  A complex society has multiple systems functioning within it.  Such systems include financial, agricultural, energy reliance, military, social welfare, infrastructure, etc...

These systems, in the beginning, as they are being created give society a rather high rate of return.  As they are developed, their use is optimized and society benefits from this.  But over time, a hyper-complexity develops.  Manageability of these systems through regulations, protection, growth, and overall maintenance becomes complex as well.  And after a point, the costs of maintaining these systems become extractive.  The costs exceed the benefits.  A diminishing rate of return is reached.

Saturday, February 19, 2011

Cut Benefits to Bankers, Not Public Services

I found this interesting video from Nathan's Economic Edge.  Whereas I agree that Bankers in general have been irresponsible with their ability to create money from nothing, I'm not so sure government always has a better way to spend that money.  But there are government programs I believe in, like affordable healthcare for seniors, necessary infrastructure projects, and others.

I have to admit, a video like this makes Modern Monetary Theory look attractive.  But as I said, my concern with government taking over a larger part of an economy is the potential for the misallocation of capital.   Governments should focus on basic services instead.  As for Banks, they need to be held to a higher standard and regulated better in exchange for having such an "exorbitant privilege" as money creation.

Friday, February 18, 2011

Global Unrest: A Year In Pictures of World Wide Riots and Protests

Time has a funny way of making us forget about recent events.  The 24 hour news cycle constantly barrages us with new events, all the while, we forget what had recently transpired, and how it all may tie together.  

But when we read about history - the story we are told, although it took place over a span of years or decades, becomes clear.  We see the relevance and relationship of various events, and how these events often coalesce into a defining moment, a watershed event in history.  We read how people's lives change, even though, those very same people we read about, were easily swept up by various events and didn't see what was coming.  Most did not see the big picture.

We live in such times right now.  But most of us are too busy with everyday chores to notice what is happening.  Or we look at one news item, and then the next one, and we never tie the two together. 

And so in this post, I want to convey something that I think is transpiring globally.  I won't write about it in detail, but instead, I will tell the story in pictures.  These images were taken over the past 12 months.  They are images of protests and riots, all related to the Global Financial Crisis.  The one common thread in all of these images is an awakening that life, as we know it, is changing.  Living standards for many will never be the same again.  Employment may never be as high, or Pensions not as adequate, if available at all.  For others already in poverty, living standards may rise as they can no longer drop anymore - they hit rock bottom, and so their grievance is not losing grip of a lifestyle, but shaking off a life of poverty that has recently been magnified by rising food costs.

Corruption too, is a common thread.  Say what you want about government workers, pensioners, and the unemployed.  But you know what?  How critical can we be of the little people when the greatest theft in history - accomplished by the bankers of the world with the collusion of Central Banks and Treasuries, has just recently occurred?  Banker bonuses are at record highs again.  Yet the cost of the crisis is increasingly put upon the weakest of society.  I used to be critical of government workers.  As a private sector employee, I envied their vacation days, their pensions.  I still am envious to a degree.  But after seeing what has happened with the bank bailouts.  I am numb to it. I guess it's every man for himself until the whole system melts down.

Before this crisis, I would have considered it a well deserved victory if public sector employees in the US made a similar salary to private sector workers - and had similar vacation days and retirement.  But I just can't enjoy such a victory today knowing that Wall Street got what it wanted.  How can we challenge the government worker's demands if we couldn't succeed against Wall Street's demands?  What does that tell us about the society we live in?

That said, here are the images - beginning in Europe, going to the Middle East, and then to the US.  The recent images of what is transpiring right now in Wisconsin inspired me to write this post.  The US, after all, looks not to be immune from European style protests. 

Wisconsin, I believe is just the beginning.  Similar events will be playing out in US Statehouses across the country.  Click on "Read More" to see the images.

Thursday, February 17, 2011

On The Road To A Global Currency: The EU Throws its Hat in the Ring

Euractiv.com reports today:

EU to Back IMF-Led Plan to Rival US Dollar

A little background here for those that are not familiar with the Special Drawing Rights (SDR) - from the article:
The value of an SDR is derived from a basket of currencies, specifically, a fixed amount of Japanese yen, US dollars, British pounds and euros. 
Each year, the International Monetary Fund (IMF) decides which currencies enter the basket, and at what weight. At last count, there were approximately $308 billion-worth of SDRs.

In late March 2009, Zhou Xiaochuan, governor of the People's Bank of China, proposed using Special Drawing Rights as a worldwide reserve currency to replace the US dollar.
The advantage of SDRs is that they represent the global economy better than the dollar, which is prone to fluctuations in the US economy and US policy. Advocates claim that pricing oil in SDRs would prevent oil prices from spiking.  
The article continues:

Monday, February 14, 2011

China Puts War on the Table, Question's US Dollar's Future

In the past twenty-some years, since the fall of the USSR, there has only been one country that has repeatedly sent its troops abroad for military reasons.  It has been the US.  In 1989, the US invaded Panama.  Then the US led a coalition against the Iraqi invasion of Kuwait in 1991.  And now recently, the US has invaded both Iraq and Afghanistan, and has continued to occupy both nations.

I am not judging here; this is what Superpowers do.  Having the largest economies, and thus, the most disperse global interests, Superpowers have a need to maintain those interests, and to play the "world's police" to ensure global trade.  Bottom line: a Superpower has the most skin in the game and needs to exercise its power to maintain both its national security, and the smooth functioning of the global economy.  People may disagree with the methods, but the goals, I think are obvious.

But the post WWII era has ended, and so too, the post USSR era.   But a new development has been taking place: we now have China rising as a Superpower in its own right.  And with that rise, China's interests in Asia, as well as the rest of the world, are also rising.  And so, China will increasingly find itself protecting these interests and as a result, will also find itself in conflict with the existing Superpower paradigm: the USA, and US Dollar dominance.

Recently the IMF said the SDR should replace the US Dollar's dominance.  This is desperate appeasement, in my view.  It is hollow.  The SDR is a global "virtual" currency representing the US Dollar, the Yen, the Pound Sterling, and the Euro.  Other nations are left out, but promises that they will be included are being made.

It seems to me that China is having none of this.  At the end of the day, geopolitics and protecting one's interests is what matters, and a global currency that represents the Western world plus Japan, in my view, can never successfully accommodate the Chinese yuan. China and the US have increasingly competing interests, and the SDR approach, I believe will be a failure.  Furthermore, the four main currencies of the SDR, representing the US, the UK, Japan, and the Euro, are increasingly "basketcases" that also represent highly indebted countries with enormous social welfare programs that are either unfunded, or will need currency depreciation to fund.  How can the SDR, a global currency, function when the underlying currencies are highly volatile?

As for China's view, to further prove my point, a Chinese Party Magazine recently stated:

"Peace in China Not Gained by Giving in, only Through War."  The article that mentions this story is from "The Asian Age."  I do not have access to the original article, and so, I will quote from the cited article I found.  Here it is, emphasis mine:

Thursday, February 10, 2011

The ENDGAME: Bernanke, Zimbabwe, the US Dollar, and Gold - How It Will Play Out

Recently I wrote about Ben Bernanke's speech to the Press Club where he claimed credit for the stock market's rise yet said other factors - not QE - had contributed to the surge in food prices that have caused political turmoil in developing nations.

And so, according to Ben Bernanke, and much of the main stream media, we should have cause to celebrate.  Yet just 5 years ago, there was a stock market that also rallied - it outperformed every other stock market in the world.  Here it is:

Pretty Impressive huh?  But is that how we should judge an economy?  Purely on the performance of the Stock Market?  During that historic stock market rise in Zimbabwe, this is how people lived their everyday lives:

A multi million Zim Dollar Dinner:

But what if you didn't have a job to pay for things?  After all, whatever money you had in your mattress became worthless as the value of a 10 Zim Dollar bill equaled the value of a million dollar bill, later to be replaced by the billion dollar bill, etc...  So what did you do?  You panned for gold:

I want to be clear:  it is highly unlikely that the US will experience that kind of hyperinflation. Peter Schiff and others have been right about many things, but on this, he is wrong.  I have written about this in my post: Don't Discount the US or the Dollar Just Yet.  In that post I said that the US still has the largest gold reserves in the world, and also hosts what is called "custodial gold."  Custodial gold is gold held under the NY Branch of the Federal Reserve and is gold that belongs to other countries.  And so the US has access to more than enough gold should there be a severe currency crisis, a war, etc...  I would call it the biggest Insurance Policy in the world.  Next to nuclear weapons, gold is the only other type of Insurance that a Superpower can have.

You see, when the US went off the gold standard in 1971, it still held onto its gold.  Frequently, it encouraged other countries to sell theirs.  And why not?  As a superpower, you need to maintain a competitive edge over everybody else.   For example, in England, the Chancellor of the Exchequer, then Gordon Brown, sold off much of England's gold at the worst time.  

China knows this.  So does Russia.  That's why they are scrambling to buy any and all gold they can find - in discreet ways, so as not to cause a severe price shock in the gold market.  But deep down, they all know that eventually, as the interest payments on debts worldwide skyrocket, that ultimately the fiat paper system will collapse.  There is no way the West will be able to grow out of this.  Japan and the US may be able to print away while Europe self imposes austerity, but eventually, the lopsided trade arrangements and lopsided accumulations of debts and surpluses will all even out.  And if such imbalances can't be evened out smoothly, they will even out in a collapse.

But back to Bernanke.  Bernanke will be known as the fool that destroyed the fiat paper system.  He may already know this - that he may one day become a scapegoat.  Recently he criticized Congress for running a fiscal deficit larger than QE2.  What was that about?  Bernanke knows that we live in a fiat money world, and that debts do not finance many national governments the way most people think.  The US Government, you see, prints (electronically) money whenever it buys stuff.  The US Bond market only exists to manipulate interest rates and to pay trading partners that hold a surplus a return on their dollars - and so they want more dollars.  But eventually, the currency will suffer.  And Bernanke wants Congress to get that blame, or at least share in that blame when it happens.

So is the Stock Market's rise an indication of good times ahead?  Not really.  Just look at Zimbabwe. It is the result of QE, not organic, sustainable growth.  Bernanke wants the stock market to rise, and so he pushes down interest rates by buying Treasuries and prints money.  In that process, savers, such as grandmothers that want to live off the interest on their savings, are being robbed.  The interest rate on Grandma's savings account is being artificially suppressed by Bernanke.   The stolen wealth from grandma is then funneled to Wall Street banks that use computerized programs to speculate in the stock markets.  It's theft by clandestine means.  But the market rallies, and the gullible people celebrate that all's well... for now.

But Ben Bernanke can't keep this interest rate rigging game going on forever.  Just look at the interest rates on long term US Government debt.  They have been rising since last October.  Bernanke wants to keep rates below real inflation.  That's how grandma's retirement savings get pilfered.  But he can't do this forever.   As rates rise, as inflation rises, and unemployment stagnates, Bernanke will be stuck.  The only way to push rates down once again will be a catch 22.  Additional QE  programs to buy bonds will be judged as inflationary - so he fails there.  If he tries to get ahead of inflation by raising rates, unemployment will skyrocket as he chokes the economy with higher rates.

So what else can Bernanke do?  Blame Congress.

Our fate will not be like Zimbabwe's.  We will not have hyperinflation, but we will have severe inflation before the currency crisis hits.  The biggest domestic danger the US faces is the collapse of the FIRE (Finance, Insurance, and Real Estate) economy.  When rates rise, the values of real assets can drop, as the monthly payments on the loans used to purchase those assets skyrocket along with rates.  Our economy has been artificially managed to rely on asset value growth and consumption.  Inflation will limit consumption, and higher rates will trigger more loan defaults and increase debt payments.

So I have some bad news for you.  At the end of the day, there is no solution to a fiat paper driven credit bubble that also created massive global trade and debt imbalances.  The system does not slowly morph into something else.  The system will eventually reach a critical state, and collapse.  And that's when gold kicks in to arrest a Zimbabwe-like hyperinflation.  I can see the dollar, once again, becoming backed by gold before hyperinflation could set in.  And at a very high value at that.  

Wednesday, February 9, 2011

Peak Oil and Wikileaks: Serious Concerns About Saudi Arabia's Reserves

I want to begin this post with a repost of an article I wrote last September, 2010, The Inextricable Relationship Between Energy and Money:

Modern civilization is based on the continued growth of what I call the "Trinity" of money, credit, and energy.  Credit, of course is what drives money.  Money is lent into existence, that is, one man's loan is another man's savings.  The two can not be separated.  Savings cannot be created without someone, somewhere in the system, taking on debt.  This applies to individuals, corporations, and governments.

So what of energy?  Energy is the real world, tangible engine of growth.  Energy feeds us, it transports us, it builds things, in essence, it IS the economy.  Money is what we use to measure our progress, to allocate resources, to "keep score" so to speak.

Without a constant, affordable supply of energy, balance sheets, budgets, asset valuations - all get affected.  If you think of an economy as a system of inputs and outputs, energy is the greatest input that creates wealth.  But energy is not free.  It takes energy to extract energy - i.e. coal, oil, gas, etc...

And just as a monetary system needs to grow to survive, so too does the supply of energy need to grow to allow the monetary system to grow.  And that supply of energy doesn't just have to grow, but it has to grow at best, at a constant cost.  That is, if the cost of extracting energy rises, then that impacts the ability of the money supply to grow.

Think of it this way.  I have an investment.  At first, for every dollar I sink in to that investment it yields me $1.50 - I'm doing pretty well.  But what if, over time, there is a diminishing rate of return?  What if I only receive $1.25 for each dollar of input?  Or less?

That is what is happening to industrial civilization today.  It is taking more energy to produce energy.  The easily accessible oil and natural gas is diminishing, and we are now extracting more difficult sources of energy.  And on top of that, there are billions of more people in the world today that want that industrial lifestyle, and hence, need the same energy usage.

So what does that do to a monetary system based on irredeemable currency, born of credit?  How does that impact future growth?

Monday, February 7, 2011

So What's Up With Gold?

It looks like the price of gold has settled in a range where it is trading sideways.  To me, it reflects a market suffering from some sort of bi-polar disorder.  Add some Middle East instability, QE2 helping to push up the stock market, a simmering EU crisis that lately hasn't made many headlines, and dubious unemployment figures coming out of the US Bureau of Labor Statistics, and what do you get?

Sideways movement.

But the overall trend, if one looks back ten years, is definitely to the upside.  And unless you think the global pension crisis, EU debt crisis, massive trade imbalances, massive Central Bank interventions, etc... are ending anytime soon, it's not looking to me that gold has peaked. Far from it.

I don't believe in short term forecasts on price movements - most people get those wrong.  I choose to look at overall macro trends, and to me, there is definitely an endgame that is unavoidable.  But I also believe that we are heading towards massive volatility.  Gold could even severely drop for awhile.

I still believe that gold will re-enter the global monetary system, in some form.  And that ultimately, the price will not plummet when this occurs.  I have covered my reasoning for this in my post back in September 2010: Gold Will Be A Bubble Until It Isn't.  I still stand by that.

I recently read an article that reminded me of that post I wrote in September last year written by Robert Lenzner for Forbes:

Gold Is Not The Ultimate Bubble Yet

In the article, Lenzner concludes with:
The ULTIMATE GOLD BUBBLE will occur when and if confidence in the dollar plummets due to an inability of dealing with the nation’s debt load or there is a sudden horrific spike in inflation, ie oil prices double to $200 a barrel– or some insane terrorist act frightens the holders of paper money into hoarding gold. 
A more reasonable ultimate bubble would be the decision to create a new global currency, which would have a serious weighting in gold. Think gold as a monetary reserve. It’s happening but gradually, not as a sudden panic. 

I agree with Lenzner "more reasonable ultimate bubble" and that it is indeed happening, and gradually so. Central Banks are becoming net buyers of gold for a reason. To them, it represents a debt free, counter-party free (pure) asset that relies on no other government's credit rating or currency (mis)management. To the Central Banks and Treasuries of the world, gold is insurance. It has only been forty years since gold has completely left the international monetary system.  For the thousands of years prior to that, there was never a period in history when  the entire world traded with pure fiat.  And so, privately, countries fear that this recent, fledgling global fiat experiment may end badly.

So when economists and governments make light of "gold bugs" as irrational worriers, you have to look at what they do, not what the say.  Governments, especially those in most developing nations, are buying the stuff.  They're worried.  But they can't tell you why they're worried, for such a statement could create a self fulfilling panic.

And so gold muddles along, exasperating those that trade it short term, or those that believe the "end is nigh" and they want that gold coin to turn into a jackpot tomorrow.  I am genuinely worried about how these global debt and trade imbalances play out.  History tells me that such imbalances are like negative stored energy.  That stored energy, created by a massive global credit bubble and massive trade imbalances - the largest in history - will not simply fizz out. Bubbles don't deflate.  They pop.  And there are societal and political repercussions to that.  I hold gold as insurance.  And like any type of insurance, I worry about having to rely on it.

Gold is not the bubble that will pop.  The current fiat paper debt based monetary system is the bubble that will pop.  That's what most neo-Keynesians and Monetarists are getting backwards - they see gold as the bubble, not credit.  But can you blame them?  It's not like they "saw this (crisis) coming."  And so how can anyone really believe them on how this monetary/debt crisis ends when they never saw it begin in the first place?

Saturday, February 5, 2011

Ben Bernanke's Actions are a Threat to US National Security and World Stability

Author David Korten's When Corporations Rule the World is a book that I read about fifteen years ago.  He covered such topics as the rise of the US after WWII, the financialization of the American Economy, the plight of the American worker, and the disproportionate wealth between the West and the developing world.  As we look at events today, I would say he was extremely prescient on many topics.

But I bring up Korten for a reason.  There was one passage in the book that really struck me, emphasis mine:
“There are two common ways to create money without creating value.  One is by creating debt.  Another is by bidding up asset value...” 
Price is determined by demand.  “In an economy awash with money and investors looking for quick returns, that demand is substantially influenced by speculators’ expectation that other speculators will continue to push up the price.  Nicholas F. Brady, who served as US treasury secretary under President George Bush, observed ‘If the assets were gold or oil, this phenomenon would be called inflation.  In stocks, it is called wealth creation.’  
…  Now, although any one individual can sell a stock certificate at the prevailing price to buy groceries, if everyone with money in the stock market decided to convert their stocks into money to buy groceries, much the same thing would happen as happened on October 19, 1987.  The aggregate value of their stock holdings would deflate like a pricked balloon. 
The 'money' - the buying power – would instantly evaporate.  What we are dealing with is a situation in which market speculation creates an illusion of wealth.  It conveys real powers on those who hold it – but only as long as the balloon remains inflated.” [p.191-192] 

My recollection of the above quote from Treasury Secretary under Reagan and Bush I, Nicholas Brady: ‘If the assets were gold or oil, this phenomenon would be called inflation.  In stocks, it is called wealth creation.’  was due to an article I just read from Barron's Magazine, here's the title:

Bernanke takes credit for stock's ralley, disavows commodities' rise.

From the article:
Proving Lincoln's adage you can fool some of the people all of the time, Bernanke asserted to the credulous DC press corps that while the Fed's purchases of Treasury securities played a role in the rise in stock prices since last August, they did not affect the prices of commodities, notably food. Moreover, he rejected the premise that the civil unrest seen in Egypt and Tunisia could be attributed to Fed policy, which the questioner contended was responsible for higher food prices.

The author of the Barron's article Randall W. Forsyth, continues successfully, in my view to critique the Fed Chairman, despite Bernanke's own explanation for the rise of commodities, which he covers in the article.

I agree with Forsyth, and I also believe that there is a supply and demand issue as well due to increased demand in the developed world and recent bad weather.  But nonetheless, the speculation of commodities has contributed to the rise in prices.  Ben Bernanke can't have it both ways.  He can't say that only stocks can benefit from his actions.  No one has that kind of control.  The money flows to wherever it finds high returns - regardless of how that money was created.  We saw that in the summer of 208 when oil peaked at $147 a barrel.

In 2008, we witnessed a meltdown on Wall Street.  If I take the (true) capitalist view to explain what transpired in 2008, I come up with this narrative:

Wall Street big banks and investment firms were a failed business model that deserved to end.  This business model was parasitic, not beneficial to the US productive economy - the Main Street, small business economy, that provides most of the job creation.  These big banks were also in the business of measuring risk whenever they speculated or lent money.  Their measurement of risk was extremely flawed.  As a result, they failed, just as a small businessperson would fail if he decided to sell snowcones to an Eskimo.

It's really that simple.  That's why we have a capitalist system.  Bad decisions are punished, good decisions are rewarded.

But what did we get after these banks failed?  The complete opposite.  Failed Bank CEOs walked away with millions in their pockets as the rest of society suffered.  The too big to fail banks were saved at the expensive of the average American citizen so they can rob and plunder the people another day.

But it's no longer a US Domestic issue.  Wall Street's banks are provided with liquidity not to re-invest in America, but to continue speculating, and to continue to finance the speculation of others.   What is another  result of this?   We now have a new threat to the National Security of the US.  The developing world is now suffering from the bad decisions of the big banks.  It is not just affecting the average American anymore.

If the big banks were not saved, if QE was not implemented by Ben Bernanke as a back door bailout of these banks, then oil, food, etc... would not be as expensive as it is today.  These big banks are not re-investing their bailout money in America.  They are using this money to do what they do best: to make money from the destruction of the rest of the world.

Friday, February 4, 2011

John Williams of Shadowstats Calls for the "Great Collapse"

Here's an interview that took place just less than a month ago.  I don't agree with everything that John Williams says here, but I do have a lot of respect for him and his website shadowstats.com.  I am posting this interview as an alternative view.

Williams points out all the dangers we are facing, and his website tracks such metrics as inflation and unemployment in a much more accurate way then the government provides.  You have to keep in mind, the US government, over the past 30 some years, has altered, on multiple occasions, the methods used to measure such things as inflation and unemployment.  The end result of course is to paint a better picture of the economic situation.

My one major point of contention with John Williams is that the US, as holder of the largest gold reserves in the world, can never experience a true hyperinflation.  If the US finds itself in a currency crisis, it can easily back the US Dollar with gold.  The price of gold however, would need to be well over $5,000... maybe even $10,000 and above.  It all depends on what money supply metric the US uses:  M1, M2, etc...  Such a scenario would involve extreme inflation, but not Zimbabwe type hyperinflation.  Only pure fiat can experience true hyperinflation, never a gold backed currency.

I also want to mention that if the US did take that route to snuff out a potential hyperinflation, the US Economy would still suffer tremendously as it is all too reliant on an easily expandable fiat monetary system.  Take that away, and the financial industry gets crushed.  Maybe that's not a bad thing after all?

John Williams is giving a timeline for severe inflation to take off within the next six to nine months.  Sounds crazy, but you know what?  The US Ten Year Treasury Note yield just spiked over 3.6%.  We may have hit a bottom in yields last Autumn.  Maybe Bernanke doesn't have the control he thinks he does.

Here's the interview:

Bernanke: Failure to Raise Debt Limit "would be catastrophic"

I have often said that the US, barring complete incompetence, can never default on its debt. Well, it looks like Ben Bernanke is worried that the US Congress may be more incompetent (or self serving) than most think.

How else can one explain his recent statement:
"Beyond a certain point ... the United States would be forced into a position of defaulting on its debt. And the implications of that on our financial system, our fiscal policy and our economy would be catastrophic," he told the National Press Club.
But Bernanke also qualified this statement by addressing the budget deficit issue:
"I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we have to deal with in order to make progress on this fiscal situation," Bernanke said.

Ben Bernanke is right.  Failure to raise the debt limit would create the conditions for default. The debt limit however, is an artificially self imposed constraint for the US.  Why?  Because the US is not debt constrained like you and I are.  The US government, unlike us, can print its own currency to pay for the things it needs to buy.  It actually does this all the time.  But please, don't let the little people know about this.  This is a trick of the elites.  More on that later.

So this debt limit, an artificial construct, still has real world implications.  To exceed the debt limit would destabilize the sovereign bond market.  After all, it would signal a "default" on the part of the US, however real or imagined.  I say that because even though the US can, and does print at will, the system still needs to "look" sustainable.  We make the system "look" sustainable whenever we measure the economy or the US fiscal and solvency "crisis" using certain metrics like debt to gdp ratios, budget deficits, national debt figures, and entitlement expenditures.  And so, the market's perception becomes everyone's reality.  If the market thinks your country is insolvent, then you will pay higher interest rates for everything.  Unless of course, an outside source (IMF, ECB, in case of the EU) steps in to artificially manipulate the market.  Cause and effect.  Simple as that.

Thus, the US needs to raise the debt limit once again, as it has done countless times in the past.  But there is another issue that Ben Bernanke fears.  That's deflation.  You see, the private sector can not increase its savings or have extra money available to pay down debts unless the public sector takes on debt.  As I have said before, it's basic double entry book keeping.  If the US can not sell more debt due to the debt limit constraint, then the US Congress also in effect, imposes limits on its spending.  That means less money in the economy for you and I.  Unless you're a large bank.  Those critters always have sneaky ways of getting, or just creating money.

So what happens to the money supply if the US stops spending in this environment?  It stops growing.  To make matters worse, the US is a trade deficit country.  So it needs to "finance" its consumption through debt (money) growth. And finally, the US private credit market is still suffering.  Bottom line: there is no other source of money growth other than the US Government thru deficit spending and quantitative easing.

Economies, unlike say, the human body, need to grow forever.  But like the human body, an economy needs a blood supply.  You can't expect the economy to grow if you stop the blood supply from growing.  Things break down.  A deflationary debt collapse ensues as there is less money available to service existing debts.  Debt defaults spread, creating a feedback loop of further debt defaults, ending in a deflationary collapse: a severe contraction in GDP, much like the Great Depression of the 1930s.

So why is Congress bickering, and why is Bernanke (unsuccessfully) trying to paint a dire picture for the average person?  Because the average person has no idea about how the monetary system actually works.  The average person suffers due to this ignorance.

The elites, especially the banking elites, are well aware of this.  They know they can grow the money supply whenever they need a bailout.  But what of the upcoming entitlement programs? What about pensions, medical care for seniors, unemployment benefits, etc?

Well, even the US faces constraints.  The US can't grow the money supply faster than the economy can grow. That would invite strong inflation as there would be much more money available than things to buy.  I believe this is already happening.  So there are limits. And with those limits, things will need to be cut.

What things?

The things the little people need.  Like medical care for seniors, unemployment benefits for the unemployed, police forces, safe and clean parks, etc..  And so, the ignorance of the little people will lead to the demise of their own living standards.  

And they'll eventually accept these cuts evetually.  Why?  Because of their ignorance. Because they think the US Government is debt constrained the same way they are.  After the elites are finished plundering the government, "fiscal sustainability" will be the new catch phrase that the little people will adopt.  And they will welcome it, and the Stock Markets will continue to rise as poverty sets in.  But fiscal sustainability is not the real issue here.  The real issue is the value of the dollar.  You can't print with abandon without devaluing the currency. So there is a fine line here, a conflict.  You need to grow debt, but you need to maintain the dollar's value.

So in the end, the little people will be forced to suffer to maintain the value of the dollar.

Then the US will look like Egypt does today.

Doubt what I'm saying?  There is a chart that shows the wealth disparity found in most countries around the world.  It is called the GINI Coefficient.  From Wiki:
The Gini coefficient is a measure of the inequality of a distribution, a value of 0 expressing total equality and a value of 1 maximal inequality. It has found application in the study of inequalities in disciplines as diverse as economics, health science, ecology, chemistry and engineering.
It is commonly used as a measure of inequality of income or wealth.[3] Worldwide, Gini coefficients for income range from approximately 0.23 (Sweden) to 0.70 (Namibia) although not every country has been assessed.

(click on chart for larger image)

If you look at the chart, it shows that the US is already worse than Egypt.  Sure, the US standard of living is much higher than Egypt's and so, the average person in the US is still better off than the average person in Egypt.  That's true.

But as the US middle class gets decimated due to unfair trade agreements, lax immigration policies, a once again rising in strength parasitic banking system, the upcoming inflation that will hit the US Dollar, and diminishing entitlements, the average American will one day ask: "What happened to the American Dream?"  

Thursday, February 3, 2011

Modern Monetary Theory and Why We Have a Debt Based System

I have decided to write once more a series of posts involving Modern Monetary Theory (MMT), or as I like to describe it: how the US monetary system actually works.  For those that are not familiar with this, I have written an intro titled:  Modern Monetary Theory , or How the US Monetary System Really Works.

My post yesterday contained a link from the Fiscal Sustainability Teach-In which was held last April, 2010.  That link had Economist Bill Mitchell's presentation on "What is Fiscal Sustainability."  That presentation was also followed by a question and answer session by some prominent economists.  It is not necessarily difficult material to understand.  What hinders most people in understanding MMT is the amount of disinformation, perpetuated by the media and politicians, that is out there.  We have all been conditioned to misunderstand how a modern monetary system works.

And so, I will occasionally write about my views on MMT, as described by Bill Mitchell in his presentation.  There will be several topics to be covered, and I hope this series sheds some light on what dangers, both economic and political, our current monetary system inherently contains.  No monetary system is perfect, none have shown to have a perpetual lifespan, and a monetary system is only as good as the government that controls it.  And so, we need to be mindful that there is also a distinction between theory and actual practice.

That said, I want to tackle the biggest issue we face first: Why do we have a debt based system?  And what I mean by that is why does the US need to conduct Treasury sales.  Why doesn't the US government just "print," electronically or physically, the money we use?  After all, the US government is not operationally constrained.  It creates money whenever it spends.

In his presentation, Bill Mitchell makes this point about sovereign deficits, debts, and ratios to GDP:
And what really needs to be exposed in this discussion are that all those constraints are voluntary. And in a fiat monetary system, the national government doesn’t have to issue any debt at all. And so fiscal sustainability can’t be caught – a pure concept of it – can’t be caught up and tied in with any of these voluntary constraints. 
In theory, what Bill Mitchell is saying sounds like great stuff. After all, isn't the interest on the national debt growing out of control? And to a large degree, much of the interest that the Federal Reserve receives through US Treasury purchases is returned to the Treasury anyway! But does that mean we are in the clear? And now that the Federal Reserve is the largest holder of US debt, should we feel secure knowing that most of the interest on that debt will be returned to the US Treasury?

Not necessarily.

A mistake economists make is to overlook noneconomic factors that have a tremendous economic consequences.  All too often economists and other analysts view their topics in a sterile environment, unaffected by other exogenous factors.

But there is one factor that cannot be ignored regarding the US Government's use of a Treasury market:


Bill Mitchell is correct when he says that the world's monetary system changed in 1971:
And when you think about it, the whole discussion of fiscal sustainability in the mainstream media and in our governments, in our parliaments, are all applying the logic – and what’s taught students in our universities out of textbooks – are all applying the logic that related moralists to a monetary system that ended in 1971.  
That's very true. Never before in the history if the world has the entire global economy functioned on purely fiat currency - currency that is nonconvertible. Yet we find ourselves constantly discussing economic topics in a gold standard era.

But we also need to understand what were the geopolitical consequences of the change that occurred in 1971, with the end of the gold standard of Bretton Woods under the Nixon Administration.  Up to that date, governments worldwide that accumulated surpluses through trade had three options:  They held onto the currency, or they converted that currency into gold, a pure asset, or sovereign debt denominated in that currency which paid a return: interest.

And so, the US in 1971 unilaterally told the world it would no longer exchange dollars for a fixed price in gold.  And the result was that foreign held surplus dollars would be recycled into US Debts.

Under the gold standard of Bretton Woods, the US's trading partners had an advantage.  Whenever they felt the US overstepped its bounds in money creation, they could easily exchange their dollars for gold.  As the gold was quickly being depleted, the US was forced to shut the gold window.

This represented a geopolitical advantage to the US in the medium term.  By strengthening the US Treasury market worldwide - as it became the only choice left for trade surpluses due to the new irredeemable dollar, the US could much more easily export its inflation.  Don't get me wrong, the US was able to do this under the prior gold standard, but there was a built in "opt out" clause, so to speak.  As a trading partner of the US, you could choose to exchange your US surplus dollars for gold instead of buying US debt.  Those that did got gold for $35 an ounce.  Not bad!

But can the US really wipe out the US sovereign debt market and just issue currency as Bill Mitchell suggests nations are capable of doing?  Yes, but the geopolitical repercussions would be severe.  With the current debt based system, not only can the US export and control its inflation, but through debt issuance, it can also affect trade relationships.  The US can buy whatever it wants without really selling as many things of value in return!  But it's not just the US.  The US-China trade relationship can be described as a vendor financing scheme as much as the Germany-Greece relationship is.  As I have said before in other posts, fiat money allows trade imbalances to grow to dangerously high levels.  The re-balancing of such distorted trade relationships are more likely to end in disaster than in a smooth re-balancing transition.

But for the US, having the world's reserve currency requires that you run a trade deficit.  After all, as the world economy grows, more US dollars need to be printed.  If the US only exported, the amount of dollars worldwide would shrink as the US accumulates a dollar surplus.  It's the same logic that describes a government's debt is always equal to it's private sector's savings.

The US, as global superpowers are want to do, wants to maintain its superpower status.  It's debt based monetary system allows it to consume much more than many other countries.  The sustainability of such a system is another topic.  I don't think it is sustainable.

But the bottom line is that the US needs a debt based system.  The economics of such a system reinforces the geopolitical goals of a superpower.  That system, however, is being tested right now as the Federal Reserve becomes the largest owner of US debt.

To ask the US to issue money without having a Treasury Market is to ask the US to step down from its role as a world power.   Good luck with that.

And if it did, the US would have to start increasing its exports real quick, because that FIRE Economy of big banks, big law firms, hedge funds, and real estate professionals and others would come crashing down.  But that's another topic, for another day.

(Just a quick note.  There are other reasons for a Treasury market, re-capitalizing banks in a way that confuses the average person, targeting rates, etc... but I just wanted to focus on the geopolitical consequences in this post.)

Wednesday, February 2, 2011

Modern Monetary Theory: Bill Mitchell and Fiscal Sustainability

A few readers of this blog are well aware of Modern Monetary Theory (MMT), and I have noticed many others have come to this blog through their Google searches on MMT.  I have addressed my concerns on MMT, or rather to be more exact, how our current monetary system (for many, not all, countries) actually operates.

I share many of the social and political value preferences that MMT'ers hold.  And from what I am learning about Economist Bill Mitchell, I think there is a lot that I agree with in the political sphere.  My only concern are the faults of the Modern Monetary System and its fueling of the financialization (ponzification?) of many Western Economies.  This "ponzification," to me, represents one of the greatest thefts in world history.

But I don't want to get ahead of myself here.  I just wanted to post a link to Bill Mitchell's presentation on Fiscal Sustainability.  I will be writing several posts on this presentation - on where I agree, and where I disagree with Bill Mitchell, and MMT overall.  Don't get me wrong, on paper, it's a great system.  I just have many doubts on the theoretical possibility of a sovereign's moral stewardship of an electronic fiat monetary system.  Especially one that exists in a post industrial economy.  But I'll get to that in future posts.

Here is the link, for those that have a couple hours to kill to view the presentation.  There is also a transcript of the presentation for those that prefer to read at their speed instead of viewing the video:


On another note, a lot is transpiring in the Middle East, particularly Egypt.  As I have written before, this can be viewed in many ways.  But as it related to the current global monetary system, the repercussions can be dramatic.  The US Dollar and Oil are tied together.  The US Dollar derives much of its power through its use as the primary currency in global oil transactions.  If there is a transmission mechanism for the exportation of inflation - energy is the one - as energy affects the costs of everything.  And so, as goes the Middle East, so too goes the US Dollar.  But it can also get more out of control than that.  This can also affect Western Industrial Civilization.

I am going to hold off on writing on that topic for now.   I don't have much more to add than what I have written a few days ago, so I prefer to see how things unfold in the coming days.  Then we'll have a better view on where we're heading.

Make no mistake.  It is becoming a very dangerous world.  The world, despite cheap money fueled rising stock markets, is still extremely fragile.  Don't let the markets fool you.  We are approaching a chaotic period.  Just this week, Secretary of State Hillary Clinton called in most US Ambassadors for a meeting in Washington, DC.  This is unprecedented.