Saturday, May 22, 2010

The State Bailouts Continue

As I noted earlier, the bailout of bankrupt US states has already begun in a quiet program that has eluded the media's attention. That's not surprising because state bailouts would turn into an explosive issue if the American people understood how much of their money was being redirected to the most irresponsible states. Our pro-socialist media are loathe to report any story that threatens the central government's ability to allocate funds.

Now, the Economic Policy Journal is reporting that the federal government has begun funding state unemployment payments for 32 states. California, Michigan, New York and Pennsylvania account for 45% of the total to date. Although this funding is reportedly structured as a loan, it's actually a bailout. Every global bailout has been structured as a loan, but a true loan requires some expectation on the part of the lender that they'll be repaid. Anything else is a gift. Does any believe that California will be paying $6.9 billion back to the federal government? Does anyone believe that California will pay interest on that amount to the federal government?

Just like every other form of deficit spending and money printing that has occurred in recent years, the people who pay in the end will be US dollar savers. It's gotten to the point where it's probably pointless to keep repeating this theme, but the US dollar is toast. This money will pass from state debt, to federal debt, to monetization. People who saved their money will pick up the tab. If you are holding dollars in a bank account, or a CD, or cash in a sizeable amount, you will pick up the tab. Eventually stock and bond holders will pick up the tab too, as the value of their assets severely underperforms the cost of living.

Meanwhile, the calls for deflation are rising to a new crescendo in the financial media and among Wall Street prognosticators. The folks making these calls are simply providing cover for our central bank to print more money. Wall Street loves money printing, because a large chunk of that money goes straight to their balance sheet. That's why we get a huge market rally every time global governments announce some new massive bailout. And all that printed money piles up and up and up, until at some point people lose confidence and begin to spend it. That's when the US dollar dies.

Tuesday, May 11, 2010

ECB will sterilize bond purchases. Right.

The European Central Bank announced this weekend that they would begin printing Euros and buying up the besieged debt of various EU governments. At the same time, in an attempt to allay inflation fears, they said they would sterilize those money flows to prevent a sharp increase in the money supply and thus inflation. That statement is almost certainly a lie. To understand why, here's a little primer on monetary sterilization.

Occasionally an economy is faced with rapid increases in currency inflows, for example due to increased foreign investment or trade flows. If left to slosh around in the economy, that increased money supply can lead to a spike in inflation. Central bankers have a way to take some excess money out; they sell various debt instruments to the banks, and then either hold the resulting funds or exchange them in the foreign exchange markets. The relevant point is that the central bank is selling something, almost always debt instruments.

In their new bailout plan, the ECB has pledged to lower funding costs for over-indebted EU governments by buying their debt. So then, to sterilize they do what? Turn around and sell bonds or bills to remove that excess capital that they just injected? Whose debt do they sell? Where do they sell them? Will they buy Greek bonds and then immediately sell German debt to Greek banks, or French banks, or Spanish banks? While that may lower Greek debt costs, it's basically exchanging German debt for Greek debt. I don't believe that will be acceptable for Germans.

Practically speaking, any attempt at sterilization will end up being some kind of debt swap. The end result will be a convergence of interest rates across the EU, punishing the countries that have been better stewards of their economies, rewarding those who have spent themselves into insolvency. That will not work on anything other than a token scale. It is only there as a figleaf to cover the looming inflation risk of this debt monetization plan, in hopes the market continues to ignore obvious fiscal and monetary insanity.

Gold investors see through the whole charade. The price of gold in Euros has gone vertical in recent weeks hitting new highs nearly every day. The German delegates to the ECB can not be happy with this. They understand gold's message; once the printing starts, it can never stop and it cannot be sterilized. The Euro is headed the way of the German Papiermark.

Monday, May 10, 2010

In for a penny

If future historians regard this period as marking the demise of fiat currencies, then today will be a key date of recognition. With Europe's nearly $1 trillion bailout of countries and banks, plus the onset of Euro printing by the ECB, the final obstacle to unabated global monetary excess has been removed. The German memory of hyperinflation was our last hope, but their politicians bowed to external pressure instead of the desires of their own electorate.

I'm disappointed, but not surprised by what Europe has done this weekend. Socialism and easy money go hand in hand, and it stood to reason that Europe would follow the US, Japan, UK, and China down this road. Now every world government of enough size to change anything has placed their bets. In order to thwart the opinion of free markets, they went all in. This is not the sort of bet where you can later cut your losses and walk away. Unfortunately, it's a bluff. They have an unwinnable hand and the ironclad laws of economics are sitting on the other side of the table. The time for debating the fine points of policy are past. Future government decisions will revolve around how much to print and who gets the handouts. This won't stop, can't stop because the debt loads will only get worse.

Smart individuals around the world will begin to fully divest themselves of fiat currency savings. That process is already underway, it's been driving equity markets and precious metals and commodities. Within the next few years flight from fiat will accelerate. When it does, governments will up the ante again and start monetizing their debts en masse. In for a penny, in for a pound.

Thursday, May 6, 2010

Here Comes the "Liquidity"

Bank of Japan fires the first shot in the latest round of fiat money injections in response to the "Greek Crisis". The yen moved sharply higher against both the Euro and US dollar today, plus the Nikkei 225 was down about 4% at the open tonight. The JCB wasted no time in making sure those trends did not continue. It looks as if competitive currency devaluations are in full swing now.

Modern central banking could be practiced by a well trained dog. Stocks drop more than 5%, step on the $50 billion button, which then sends dump truck loads of free money to large money center financial institutions. Stocks drop 10%, step on the $100 billion button. Over 20%, hit the $1 trillion button repeatedly until stocks start going back up. I guess that's why they say dogs are a bankers best friend.

Gold Says Bad Inflation This Way Comes.

Today the US stock market dropped 3 percent, bond yields plunged, commodities dropped, and deflationists declared victory in the ongoing debate over inflation vs deflation. There's just one small fly in the ointment. Gold rose $23 per ounce, to nearly $1200. This happened on a day when the US dollar trounced every other currency, including those of commodity exporters like Australia and Canada. But gold is now the strongest currency of all, and is threatening the US dollar hegemony as world's reserve currency.

Why is gold at or near new highs in practically every major global currency? Is it a "safehaven" due to market panic, as the mis-informationists at CNBC would have us believe? No, that's not the reason at all. The move in gold is perfectly logical, calculating and rational. Gold is predicting governments' response to widespread insolvency, and what gold investors see is hyperinflation in our future. Notably silver also rose today, and silver is generally an economically sensitive commodity that falls with the other industrials. Now silver is beginning to trade as money too, moving in opposition to the industrial metals.

So why would gold see inflation when the media and economic "experts" are screaming deflation? It's very simple, actually. The case of hyperinflation in the Weimar Republic, circa 1920 is a good illustrative example. At that time, Weimar Germany was severely over-indebted due to the costs of losing WWI. The extreme levels of debt led, as is extreme debt's wont, to deflation. Lack of confidence in the economy caused lenders to stop lending, and consumers to stop consuming. People began to hoard cash and the velocity of money dropped. Prices dropped. Then, the central bank decided, not unlike Ben Bernanke, that they had a shortcut way to thwart the economic reality of too much debt. They'd just print more money to add liquidity to the system; get the banks lending again and everything would be hunky dory.

But, it didn't seem to work. The more the central bankers printed, the more people and banks hoarded money, and prices dropped more. The mark actually appreciated dramatically against other world currencies, despite the economy's precarious condition. As debt levels piled up due to war reparations, the population began to lose confidence in the government's ability to pay down debt and, ultimately, in its curency. So they pulled out their savings and began to buy necessities. Instead of hoarding useless paper, they began hoarding hard assets. A massive outpouring of marks flowed from every quarter and the velocity of money soared. Prices skyrocketed and within a year the currency was worthless.

Note that declining velocity of money is cited by every modern deflationist as the reason why Bernanke's already excessive printing can't cause inflation. It will be cited in the near future as the reason why Bernanke must print more, to revive our "animal spirits" and get the economy flowing again. And all that money will accumulate on bank balance sheets, or in money market funds, savings accounts and short term treasuries. But, the loss of confidence is beginning to build. Gold is the telltale. It's an inert metal, with no industrial use, doesn't draw interest or pay a dividend. No use at all other than as hard money.

Gold is signalling a global loss of confidence in fiat currencies, and the wave is building at a rapid pace. Governments are bailing out an ever wider swath of bankrupt entities, from pension plans to companies to states to sovereign govenments. In the process, they are destroying confidence in their own ability to pay off debt in real terms, and thus destroying confidence in their own currencies. The money is beginning to flow into hard currency, gold and silver, but soon it will flow into other more important assets like oil and food. Economic fundamentals will no longer matter. Once confidence in money is lost, it's almost impossible to regain. Given our central bank's predilection towards easy money, they will not be up to the task of reigning in run away inflation.

If governments do not stop printing now, stop the bailouts now, stop the deficit spending, this has only one possible outcome. The price of hard assets will spiral out of control, and will eventually be impossible to buy using fiat currency. Global hyperinflation and ultimately war over natural resources will ensue. Tomorrow, Germany holds a vote on whether to bail out Greece. I hope the German public opposition carries the day and Greece is allowed to default. We don't have many more chances to stop this insanity

Wednesday, May 5, 2010

The Fiat Money End Game

Incisive commentary in this article by Michael Rozeff on the subject of how our freely floating dollar will meet its demise. He does a good job of explaining why any course other than inflation is unlikely.

Regarding the IMF/EU bailout of Greece:

"The rescue team, which consists of the stronger countries and the IMF, are damned if they do and damned if they don't. Instead of banks being insolvent with runs occurring on them as in the 1930s and 2008, we have whole countries being bankrupt, but their paper is held by banks in France and elsewhere, so there is a contagion thing to worry about. If the EU lets default happen, there is a run against all the bonds of all the weaker countries. Their yields rise, and they have to default too, and then that weakens a host of banks and others who hold the paper, and then they demand to be bailed out. If instead they rescue Greece and others, then the rescuing governments have to issue more debt, or else the IMF does too, or else the ECB gets into the act too, and this weakens the stronger countries and drives down the euro."

Basically every low interest sovereign borrower in the world is taking on an exponentially expanding debt load to bail out higher risk borrowers, private, public and sovereign, who can no longer obtain affordable credit. We'll soon reach the stage where the low interest sovereigns, the US, Germany, France, Japan, the UK, are also unable to obtain affordable financing. In light of recent debt monetization programs, conducted under the technical sounding euphemism of Quantitative Easing, one may even surmise that we've already reached that point as governments fund their deficits through central bank printing. Debt to GDP ratios in this group are already high, and rising rapidly. Higher interest rates can't be tolerated, but the only way to prevent them is for central banks to buy their own government bonds. Once a country gets on that track, as the US, UK, and Japan have recently, it may prove impossible to get off.

On why governments choose inflation:

"Faced with handling mountainous debt levels, the governments either walk away from all bondholders everywhere, this is feasible, or else they inflate and pay them off in nominal terms, or some combination of these two paths. It's these two options that we need to think through as to their effects, in order to decide which one they are likely to choose. So far, the big guys, the U.S. and Britain and Japan and probably China, have gone for inflating. They're trying not to default outright. Why? The outright default basically ends the government's ability to pay pensioners, poor people, and keep government spending up. So it revolutionizes the government itself. It ends government as we know it for awhile, and as far as politicians are concerned who have only one life to live, that's too long."

This rationale is exactly right. Politicians have power only as long as they control the supply of money. Fiat printing allows politicians to enrich whatever constituency holds greatest potential to keep them in power. Outright default robs the government of the ability to borrow, which takes power away from the politician and puts it back in the hands of the individual. That will never be tolerated.

On how this globally interconnected debt fest has survived til now:

"The only reason that the smaller countries who default (there are many, many such defaults) have survived their defaults and kept going is that the bigger countries refinance them, through their banks and through the IMF and World Bank. But there's no one who can finance the U.S. if it defaults!!! So it won't default, because of the revolutionary results of shrinking the government drastically. Therefore, of the two options, it will choose inflation."

Practically every non-antagonistic country that has defaulted over the last few decades has been bailed out in some way shape or form by the international financial community. Default has been pushed under the rug, or more accurately under the much larger heaps of debt being steadily accumulated in the developed world. The private banking system has become more interconnected, more leveraged, and less tolerant of default from any source. So governments have added it to their unpayable bar tab.

The entire article by Mr. Rozeff is a good read.

Tuesday, May 4, 2010

Get Ready for QEII: Bernanke Strikes Back

The Euro plunged to new 52 week lows against the US dollar today, as traders finally began to acknowledge that sovereign debt loads pose a severe threat to the viability of the young currency. The Germans bowed to widespread pressure and agreeed to bail out Greece, despite clear evidence that Greece will never pay off its debt. Also, the ECB chipped in to help by trashing EMU rules about allowing junk rated sovereign debt to be used as collateral for central bank loans. These actions, together with the general air of confusion and desperation emanating from EU authorities, have served to send the currency on a downward spiral against even the hapless dollar and British pound.

Now that the Europeans have proven themselves worthy adversaries in the game of Beggar Thy Neighbor, dollar holders should prepare for the American response. In March, Barack Obama pledged to double US exports over the next five years. It's an honorable goal, but the best way to do it would be to make America competitive by stepping on the toes of some key democrat constituencies. Like the trial lawyers, and the environmentalists, and the labor unions and the high tax, wealth redistribution, pro-regulatory left wing base. In short, Obama would have to turn his back on his party and that seems farfetched. The cheater's way to improve exports is to devalue the currency, which fits right in with our central bank's long held tendency toward ever cheaper money. The fact that we've taken interest rates to zero will not be a hindrance to Bernanke, because he has a printing press. But now Europe has raised the ante in this fiat race to the bottom, threatening Bank of Japan and the Fed's battle for title of most accomodative central bank in the world.

The Euro's drop is now impacting the US equity market, and that impacts the wealth effect so carefully nurtured by manipulating stocks inexorably higher over the last 14 months. Ben won't stand idly by and watch all his good work go down the toilet. If the S&P drops much more than a standard 10% correction, I look for Bernanke to once again flood the US economy with dollars, driving stocks back up and sending a message that no currency will be allowed to underperform the US fiatsco. It's possible that he'll resume buying government debt or mortgage securities from the primary dealers like Goldman Sachs and JP Morgan. They've proven quite adept at sending stocks to the moon if given enough free capital to play with. Or Bernanke could buy stocks directly. That seems less likely because it would raise fears of government ownership of private corporations (not that we haven't already headed down that slippery slope).

Either way, when the economy and the stock market dips, have no doubt that more free money is close at hand. It's been that way for 20 years and it would be folly to assume otherwise until proven to be the case.

Monday, May 3, 2010

Finally, A Sign of Deflation!!!

According to Bloomberg, a nickel is now worth six cents. Isn't that great news, our money actually increased in value! Umm, just one minor thing; the increase in value is due to the soaring cost of the nickel in our nickel.

Too bad dollars aren't still made of silver. But, that's the whole point of fiat money, right? It allows the issuer to produce as much as it pleases and distribute it wherever it pleases, at no cost to anyone except those who hold it as a store of value.

Friday, April 30, 2010

You'd better let it deflate, Mr. Bennie.

Even though this blog is dedicated to the topic of inflation, there is a potential alternative reality in our future. We could have deflation and there's a whole subset of economists and pundits who fervently believe that's where we're headed. I've been preaching just the opposite, that we're headed for bad inflation, possibly hyperinflation that destroys 100% of the value of the US dollar. I believe that because the people in charge of making the choice have given every indication that they will print until we have inflation. But let's be clear about one thing; there is absolutely no middle ground. We will not have moderate inflation and growth over the next two decades. We have too much debt, too many unfunded obligations, too many overpriced financial assets, like stocks and bonds. Real (inflation adjusted) economic growth is going to take a huge hit, either with inflation or deflation.

Ben Bernanke believes he can engineer our way out of this with some tricky driving of the economy through the minefield. He's insane. The planet is riddled with insolvency. This is not fixable through sleight of hand and manipulation of the money supply. That Keynesian bag of tricks won't work this time. There is not enough capital to produce the growth to pay off the debt and there aren't enough suckers left to loan more money. All we have is Bernanke and his printing press. If Ben ever comes to his senses, we could still choose the better course of action. Let the economy deflate. It will be incredibly painful, as bad or worse than the depression. The alternative will be worse because we will still have an economic collapse, and we will have resource hoarding, a dead currency, and a population that has learned the wrong incentives for future stability. That combination spells disaster.

Today's market was a harbinger of what lies ahead if Bernanke and Obama don't rethink their mindset. Stocks dropped hard; oil and gold, corn, wheat, cattle, hogs, cotton, soybeans, and copper all rose. Bernanke this week refusing to even hint at raising interest rates, coupled with a massive IMF bailout of Greece, may represent a bridge too far in terms of dollar viability. If that's not the case now, it will be soon. Our currency is in a precarious position. If the government and central bank don't quit "stimulating" now, we're in for a dose of stagflation that will make all previous financial crises look tame. One of these days, hard assets will start moving up against the dollar and they won't stop. The markets are saying enough is enough. Does Ben Bernanke listen?

Thursday, April 29, 2010

Saudi Oil Exports Will Start to Decline.

Saudi Arabia is serving notice to the world that they are not going to be the engine that supplies our growing appetite for oil in coming years. The Saudis generally play their cards close to the vest when it comes to information about reserves and production capacity, but now they are saying that future exports will decline due to growing internal consumption. However, some experts believe that declining Saudi production will be the larger contributing factor. No matter the cause, when the world's leader in both reserves and production says that its external output will drop, there's a problem.

Numerous reports say that Saudi's (and the world's) largest oil field, Ghawar, is now in decline. Another indication of potential declining output was when Saudi Aramco began exploration efforts in the Red Sea, an area it had previously ignored to focus on low hanging fruit in the eastern province. Saudi production has been stagnant in recent years, although that is attributable in part to OPEC quotas. But if the world's largest oil producer is running into supply constraints at a time when the world's central banks are pumping record quantities of fiat scrip, the inflation picture will take on a ominous new dimension.

Tuesday, April 27, 2010

Iron Ore Producers Threaten to Cut Supplies

China says that iron ore producers Vale, BHP Billiton and Rio Tinto are threatening supply cuts if steel companies don't accept their price hikes.

“They adopted a threatening policy,” Luo said. “If you don’t accept iron ore prices before a deadline, they threaten to cut supplies. Is this iron ore negotiations?”

Global commodity consumers had better quickly get used to hard bargaining over prices. As the world is being flooded with fiat currencies, commodity producers are going to demand a higher price for their scarce product, as they should. They have no need for monopoly money. If China wants good prices, they should price their contracts in yuan and conduct responsible monetary policy. If they continue to peg to the US dollar, they should expect prices to continue rising because the US central bank is not going to conduct responsible monetary policy.

The World Steel Association called on authorities globally to examine the iron ore market after Brazil’s Vale broke with a 40-year custom of selling on annual contracts and won a 90 percent price increase from Japanese mills. The Chinese government this month said it was investigating the possibility that BHP Billiton, Rio Tinto and Vale may be monopolizing supplies of the steelmaking ingredient.

They can examine and file complaints to their hearts' content. Producer nations are not going to accept trash fiat for hard assets. Not gonna happen.

The Wall Street Journal notes commodity inflation.

This article in the Wall Street Journal documents the blatant inflation that is sweeping around the world.

An unrelenting rise in the cost of raw materials—largely driven by mounting demand from Asia—is cutting corporate profits, hitting stocks and, in some cases, pushing up consumer prices.

One glaring example is the sky-rocketing cost of rubber, a major tire component, which has climbed nearly 74% this year after rising 92% in 2009. Industry analysts and some tire makers, including Goodyear Tire and Rubber Co., in Akron, Ohio, and Bridgestone Corp., in Tokyo, have warned investors about a potential hit to profits.

A similar concern faces firms that buy other rapidly rising raw materials. Palladium, which goes into car exhaust systems, is up nearly 39% this year, potentially boosting costs for U.S. car makers as they seek to emerge from their slump.

Lumber, a major cost for home builders, is up nearly 59%. Analysts at Raymond James lowered their ratings on three home builders last week, in part citing "surging lumber costs."

Iron-ore prices also are rising, while oil and copper prices have tacked on to last year's huge gains.

Data on producer prices released by the Bureau of Labor Statistics on Thursday shows how rapidly the pressure on corporate America is mounting. The producer-price index showed that crude goods such as iron ore, construction sand and pulp shot up 44.5% year-over-year, the fastest rate since 1974. Including energy and food costs, crude goods prices rose 33.4%.


Rubber's rally is driven by booming demand in China, where car sales rose 56% in March compared to a year prior, according to IHS Global Insight, as well as elsewhere in Asia. ....Goodyear raised prices up to 8% on some tires last week, citing higher raw material costs, and rivals have done the same.


Meantime, home builders are facing rising costs, even as the industry tries to claw its way back from the housing slump. The gains in lumber prices have added about $2,400, or 1.1%, to the price of the median home, according to the National Association of Home Builders.

Listen closely tomorrow when Ben Bernanke says he sees no evidence of inflationary pressures. Americans need to store these statements very securely in their memory so that there will be accountability for what comes next.

Now it gets interesting.

The US stock market dropped about 2% today as European credit markets came under broadening pressure. The realization is growing that, without the benefit of a printing press, practically none of the Western European nations are solvent. For that matter, neither is the USA, or Japan, or the United Kingdom. It's not a liquidity issue, or a growth issue, or a housing crisis. What we have is a full blown, irrevocable, unavoidable, global, sovereign debt crisis.

The Euro zone is the first manifestation of this catastrophe because EMU countries handcuffed themselves into a situation where they did not individually have the ability to print their currency at will. The effect is as if they borrowed money in a currency other than their own. Sovereign borrowers like the US and the UK have been able to kick the can down the road, hiding their own insolvency by printing money out of thin air. Japan has survived by printing and by borrowing from their own people's vast savings at practically zero return. The Greeks, Portuguese, Italians, Irish, Spaniards, they don't have those choices. Unable to debase the Euro without the consent of the Germans, they'll have to default the old fashioned way; stiff your creditors.

Now I think that a nice round of big fat sovereign defaults would be a good thing in the long run. With the rise of socialism in the western world over the last few decades, spurred on by a global media machine that never saw an unncecessary government expenditure, people have actually forgotten that borrowed money must eventually be repaid; a reminder is in order. Politicians have played right along, assuring their hapless constituents that as long as the economy was growing at an exponential rate, as long as debt/GDP was shrinking, everything was fine. Two minor problems. Economies can't grow exponentially forever in a closed system, i.e. planet Earth, without running into resource constraints. And debt has been growing at a faster exponential pace than the economies. Now the economies have stopped growing and the debt is growing faster. That spells default. Massively globally interconnected, bank destroying, conflict creating, default.

Today, the defaults are beginning. Greece is the canary in the coal mine, but the rest of us are nothing but bigger canaries. In the US we have two options going forward. We can bite the bullet and admit that there is no chance of growing our way out the accumulated debt burden. This will be very painful for some very powerful people, people who wield a lot of money and influence. Or we can invoke the memory of John Maynard Keynes, print more money, lots more money, and increase the debt and money supply faster than our economy can grow. That is the genesis of inflation, actually it's the definition of inflation, and it will be very painful for lots and lots of little people who don't have their congressman's personal number on speed dial. Which path do you think we'll choose?

Today, gold hit a new all time high in terms of the Euro, very close in terms of the US dollar. Tomorrow, Ben Bernanke gets his latest chance to tell us which path the United States has chosen. Don't listen to Ben's words; he's a liar. Watch gold for the next few weeks and you'll have the answer.

Thursday, April 22, 2010

Questions I'd like to ask Ben Bernanke

Here are some questions I'd love to ask Bernanke. I've taken the liberty of providing Ben's answers since he'll never actually answer questions like this.

Me: What is your estimate of inflation for the next 10 years?
Ben: It's difficult to predict economic variables over a long time period. Our job is to respond to the data as we get it.

Me: Okay, what is your target rate for inflation over the next 10 years? What rate of inflation does your policy aim for?
Ben: Our stated inflation goal is 2%.

Me: For how much of that 10 year period do you anticipate that real interest rates will be negative? Currently savers are lending their money to the banks at zero percent, while inflation is running 2% year over year. We lose money, or donate to your banker friends, every day due to loss of purchasing power. How long will retirees and the risk averse individuals be required to fund the bonuses of your friends?
Ben: It's unfortunate that savers aren't getting a good return, but my mandate is to do what's best for the country.

Me: Repeating the question, for how much of that 10 year period will savers get a negative return on their money?
Ben: Interest rates will remain at exceptionally low levels for an extended period of time.

Me: I see. So what would be your advice to a retiree who can't tolerate the blowup of another liquidity induced asset bubble created by the federal reserve? What about the millions of Americans who don't trust their money to the Wall Street sharks? How much risk do they have to take on just to maintain the value of their dollars, much less make a small return? Should they run the risk of buying overvalued stocks, which currently return more every week than their money market fund returns in a year? Or should they just chew up their savings and depend on the state for support after the money's gone?
Ben: We don't see any evidence of significant mispricing of any asset classes.

Me: All due respect, Ben, you and your institution have missed two of the three largest bubbles in US history in the last decade. Your assurances are worthless.
Ben: The S&P 500 is still 20% below 2007 levels. That doesn't suggest a bubble.

Me: Uh, Ben, 2007 was a bubble. It was a very big bubble. I know you are blind to them in progress, but now you can't see them in retrospect either?
Ben: It wasn't a bubble, it was a credit crisis. It was due to an imbalance of savings by the Chinese, which they imprudently loaned to American home buyers.

Me: And keeping the Fed Funds rate at 1% for a couple of years while housing prices were going up 20% a year had nothing to do with it?
Ben: My mandate is to do what's best for the country.

Me: So what is your response to critics who say that your policy right now is brewing up a bad bout of inflation. Negative real interest rates, printing money to buy overpriced assets, massive government fiscal stimulus, all leading us toward high inflation, possibly hyperinflation?
Ben: The risk of inflation is low. We are more concerned about deflation.

Me: Deflation would be bad for your friends in the banking business, eh?
Ben: Yes, and that would hurt the rest of us.

Me: Don't you mean the rest of "you"?
Ben: Whatever.

Me: Is the price of gold suggesting deflation, near all time highs and rising?
Ben: The price of gold reflects concern about the economic system.

Me: Oil? Up 150% in the last 13 months?
Ben: Speculative activity can temporarily misprice assets?

Me: I thought you didn't see any mispriced asset classes?
Ben: Not broad classes.

Me: Oh. What about copper, up about 200% over the same period? Nickel, iron, farmland, silver, platinum, palladium, coal. All up sharply and rising faster.
Ben: Those are just signs of economic recovery.

Me: But not enough recovery to tolerate anything other than free money.
Ben: No.

Me: So is the stock market signalling deflation? The Nasdaq 100, the highest beta growth stocks are up 100% in 13 months. High growth stocks hate deflation. How do you reconcile that?
Ben: Markets can sometimes get a little ahead of themselves. We at the Fed see an economy still at risk of deflation.

Me: But Apple Computer, with a market cap of a quarter trillion dollars and a PE ratio in the upper 20's is not a sign of a bubble. Retail indexes hitting all time highs. Stocks jumping 10-15% a day, after running up 300% in the last year.
Ben: I can't comment on individual stocks.

Me: Do you own gold, Ben?
Ben: No comment.

Tuesday, April 20, 2010

America’s Economic Recovery Is a Rotten Sham

Sometimes you find someone who says what you think better than you can express it yourself. Justice Little of Taipan Publishing Group has a few choice words for how our government has achieved the "economic recovery" that we're experiencing. His sense of outrage is expressed quite well in the lengthy rant at the following link.

America’s Economic Recovery Is a Rotten Sham

Well said, Mr. Little.

Monday, April 19, 2010

State Bailouts are in Full Swing.

While European authorities and taxpayers wring their hands and wrangle over how to handle the bailout of EU member Greece, the US is quietly forging ahead with bailouts of profligate state and local governments, and the effort is rapidly gaining steam. It started with "Build America Bonds", an Obama plan that subsidizes the interest cost of municipal bonds, effectively lowering the cost of state and local borrowing at federal taxpayer (eventually dollar saver) expense. These federal handouts have become quite popular and are now the fastest growing segment of the muni bond market, with over $95 billion issued in just a year. Wall Street likes them too due to their ability to raise fat fees by handling issuance, often charging higher fees than traditional muni bond deals according to the Wall Street Journal.

Mainstream media coverage of the Build America subsidy has been predictably low key and mostly favorable, choosing to focus on "job creation" rather than the pernicious impact of piling more debt on an insolvent debtor nation. Not surprisingly, Obama is now considering making the Build America program a permanent part of America's welfare state and even expanding the eligibility of the bonds to a broader range of uses. Local governments are enthusiastic about that prospect, and what's not to like for local politicians. Federal subsidy of municipal debt enables irresponsible spending, while non-constituents pick up part of the tab. That's a free lunch, until the whole system breaks down.

But, as we wind our way down the road to serfdom it was inevitable that a partial subsidy of interest would prove inadequate for truly favored constituencies. Thus, local school districts have discovered an even fatter plum, Qualified School Construction Bonds. As Bloomberg reports, these instruments allow the federal government to pick up as much as 100% of the interest cost of the debt.

"Qualified school bonds “are just about the lowest cost of financing on earth,” said Jean Buckley, president of Tamalpais Advisors Inc. in Sausalito, California, the financial adviser for the Los Angeles offering." That statement is, of course, completely incorrect. The cost is not changed, only the individuals bearing the burden of that cost. Thus, the city of LA (and the state of California) gets the free use of your money for their benefit, without any accountability to you. That is the definition of taxation without representation.

"Underwriters led by Goldman Sachs Group Inc. will market the school bonds. A group led by Citigroup Inc. will market the tax-exempt debt." This pattern that has become disgustingly familiar to those of us drawing zilch on our dollar savings; free money raining from the heavens on those appropriately situated in our entitlement society, being distributed (with an appropriate cut off the top) by others who are similarly situated. Will anyone be surprised when this program is also expanded to uses beyond school districts?

Once again, America outdoes Europe's socialists in a grand way. We don't require austerity from our over-indebted states; we don't even have a serious debate about the wisdom of enabling their promiscuous spending. Instead, we give them a federal handout with no strings attached and every incentive to over spend at an even greater level since the cost is being dispersed to people who don't vote in local elections. It is in the interest of every local electorate and politician to procure and spend as much US subsidized debt as possible. Underlying the whole process is the near certainty that many of these municipalities will eventually default on the debt anyway (just as home owners receiving mortgage modifications continue to default), leaving federal taxpayers to step in and bail them out. Eventually, all of these costs will be born by savers of US dollars, as neither local, state, or federal governments have any capacity to repay this debt.

Sunday, April 18, 2010

Inflation Update: Sunday 4/18/10

Global resource grab continues
China continues to buy access to global energy supplies. Hoarding of resources is one of the most damaging aspects of inflation. Both individuals and countries can participate, in the anticipation that prices will rise in the future. The resulting shortages contribute to the inflationary impact of too much money chasing too few goods. Thanks to Ben Bernanke, this process is now in full effect. As America's currency weakens at the desire of our central bank and the Obama administration, Americans will find themselves outbid in this global race to procure commodities.

India contemplates raising interest rates for the 2nd time in a month
Once you get behind the curve, it is extremely tough to put the inflation genie back in the bottle. Bernanke thinks he has this solved by talking down inflation expectations, as if people won't notice when their paycheck loses purchasing power. Unfortunately, America can't tolerate rapidly rising rates to fight inflation and we have already lit the fuse.

Protectionism continues to perk along as EU threatens more tariffs against China
The Europeans can't print money, but they can drive up inflation through other means while keeping interest rates negative. There's more than one way to skin a cat.

Another base metal making two year highs
Nickel up 60% in the last two weeks, 100% over the last 12 months as world demand now outstrips supply (or maybe it's just the speculators). Time for Bernanke to reassure us about how our inflation expectations should remain low.

Canadian bank buys three failed Florida banks
That's' an idea. Maybe we can sell off our assets to strong currency countries. Any bidders for California?

EU wants in on the currency devaluation game
Bernanke sets the standard and the fiat rabble fall in line. Beggar-Thy-Neighbor 2.0 is just beginning.

Thursday, April 15, 2010

BRIC Leaders Explore Regional Monetary Arrangements.

The leaders of the Brazil, Russia, India, and China held a summit in Brasilia this week. Among the topics discussed was how to facilitate trade among the developing economies. Here is part of the statement released by the group:

In the interest of promoting international economic stability, we have asked our Finance Ministers and Central Bank Governors to look into regional monetary arrangements and discuss modalities of cooperation between our countries in this area. In order to facilitate trade and investment, we will study feasibilities of monetary cooperation, including local currency trade settlement arrangement between our countries.

These are early steps, but nonetheless a firm indication that China intends to make the yuan available for international trade. Given China's strong trade balances and its rapidly growing oil (and other commodity) consumption, I believe that the yuan will quickly surpass the dollar as the leading petro-currency. When that happens, the US bond market will meet the fate of every terminal debtor, and our hapless dollars will rapidly disappear as a reserve currency.

It won't take wholesale dumping to initiate the greenback's demise, just a loss in confidence from the marginal buyer of dollar based assets. The time to prevent that process has, most likely, already passed. Federal and state governments' inability to face fiscal reality got the ball rolling. Ben Bernanke's foray into the nether world of debt monetization introduced sufficient doubt to assure the outcome. The availability of a more sound alternative will be the coup de grace.

The Housing Crisis is Over

The US mortgage crisis is effectively over. We'll be cleaning up loose ends for another year or two, but mechanisms are in place to ensure that neither delinquent debtors nor their lenders are at risk of any systemically damaging losses. Housing prices have bottomed and will soon follow the stock market's V shaped recovery. Average Americans will, once again, be able to buy a home on a zero down, four percent FHA guaranteed mortgage with assurance that they can sell it two weeks later at a profit. The media will continue to focus considerable attention on this issue, in their fashion of looking backward instead of ahead, but the recovery's a done deal.

How can I be so sure? Reading articles like this one makes it sound as if the problem is still acute.

"Bank of America is considering temporary payment-reduction periods of up to nine months for the unemployed. In March, the Treasury ordered a three-month reduction for those receiving unemployment benefits. The period could be extended to six months.

Almost 500,000 struggling loan customers have not supplied information or taken other basic steps to qualify for mortgage help. About half of them have not made a payment for more than a year, or owe more than 50 percent of the value of their homes. Fully 1.44 million of its mortgage customers are 60 days or more delinquent - nearly 14 percent of the 10.4 million first mortgages the company services."

But these problems have all been addressed by the government. Let's break it down.

Problem #1: Housing prices have dropped and homeowners are underwater.
Solution: Flood the economy with money, hold interest rates at zero. Drive investors out of money markets and into risky assets like stocks. Wealth effect kicks in (Ben loves this part). Investors search for other assets that look cheap. Hey, houses have been beaten down, maybe they're cheap. Let's trade up to a better house, it's a good investment. Or just take out a home equity loan to pay for that new boat. 4.8% 30 yr fixed is hard to beat. Heck put the money into the stock market. It returns 5% every month.

Problem #2: Potential homebuyers already have too much debt.
Solution: Have the US government take over the home mortgage market. Fannie and Freddie and FHA. They can keep lending standards low, low down payments. Don't worry about your FICO score, the government knows that housing is important social policy. Also, have the government subsidize new homebuyers using deficit spending (this program will not end any time soon).

Problem #3: Lenders are wary of getting burned again by home borrowers.
Solution: As noted above, we don't need private lenders. The government is in charge now. But for the few remaining private lenders, put a government guarantee behind practically every mortgage they write.

Problem #4: Mortgage rates are at historically low levels, what if they begin to rise. Won't that hurt housing sales and drive prices back down?
Solution: Mortgage rates won't be allowed to rise. Bernanke has already spent $1.5 trillion of brand new money to keep rates low. He'll spend more as necessary. Plus, now that the government controls the mortgage market, we're no longer dependent on market pricing.

Problem #5: Couldn't the government lose lots of money if it underwrites mortgages at low rates, same as the lenders who made bad loans during the last housing bubble?
Solution: This has already been anticipated and addressed. On Christmas eve 2009, the Obama administration announced that Fannie and Freddie were being given a blank check from the US government to cover future losses. Home mortgage losses will certainly be massive, but the US government has a printing press. There won't be any need for unpleasant Congressional votes when the hundreds of billions of red ink start to roll in. Probably at some point, Fannie and Freddie will cease filing SEC reports and the public won't even have to concern themselves with government losses on our mortgage portfolio.

Problem #6: Banks have already taken a huge blow to their capital due to mortgage blowups. They're impaired even though the government has allowed them to hide their impairment via accounting whitewash. How can banks expand our credit card limits if they're capital constrained?
Solution: Have Ben Bernanke lend banks hundreds of billions of taxpayer dollars at zero percent, then turn around and borrow it back from them at 4%. Banks balance sheets will heal quickly. Allow banks to use their prop trading arms to game the stock market using their unlimited free funds. It's a profitable game if you have the right software. If a small bank fails, have Sheila Bair basically give the assets to a larger bank while the government absorbs the excess liabilities. These are all very effective ways to make the banks very profitable again.

Problem #7: Banks still have bad mortgage risk on their books due to high unemployment and underwater mortgages at high risk of defaulting.
Solution: Design a mortgage modification program that allows lenders to take a small principal writedown (about 10%) on at-risk mortgages, and in return give them an FHA guarantee on the remainder of the loan. If the borrower defaults anyway in the future (most of them do), government will pick up the tab.

Problem #8: What if all this doesn't work and home prices continue to fall?
Solution: That's why we have the world's pre-eminent expert on deflation running our central bank. The solution involves a helicopter (hovering over Wall Street) and a shovel.

As you can see, our government has been quite ingenious in addressing every potential problem that the housing crisis could pose in the future. The crisis is over.

Wednesday, April 14, 2010

Slouching towards Zimbabwe.

Despite the skeptics, the US Federal Reserve and Treasury and Congress and the White House have successfully reflated our bubble economy. There's near unanimous agreement that we've turned the corner. Corporate earnings are soaring, consumers are spending money they don't have, stocks are hitting new highs every day, many of them all time highs. This is the definition of a boom period.

The deflationists swore that it couldn't happen, that human animal spirits were crushed. They were stolid as Congress threw unprecedented hundreds of billions of deficit spending at favored constituencies. They were unmoved by Treasury bailouts of entire swaths of the financial system. They were oblivious when Fannie and Freddie practically nationalized the US housing market. They were unfazed when Ben Bernanke injected nearly 2 trillion newly printed dollars into our economy, like a high powered enema forcefully delivered through our too-big-to-fail banking portal. But they were wrong.

Despite our belief in modern man as a creature of reason and forethought, humans generally survive the way we always have. We take advantage of the opportunities of the moment, because tomorrow brings no guarantees. We do things the way we learned and we don't change until change is forced upon us. If Congress gives us money to spend, we'll spend it on trinkets and gadgets. If Fannie Mae lets us live in our homes without paying the mortgage, we'll continue to go on vacations and act as if nothing has changed. If Bernanke gives away unlimited free money to investment bankers and traders, they'll use it to drive markets until they pull in the suckers looking for more than the pittance available in the money markets.

People don't fear debt until they've experienced privation from too much debt. We don't fear easy money until it becomes worthless. Lives are too short and global changes take too long to manifest. Most of the time it's more productive to ignore broad problems and carry on as before. Politicians know these things, they use our inertia to their advantage. Thus, they ignore the widening gyre of our economic cycles as they loose another blood-dimmed tide of fiscal and monetary recklessness upon America.

Monday, April 12, 2010

Inflation Items: Monday 4/12/10

Brazil’s Real to Rise as Rate Increase Spurs Carry Trade
"Annual inflation has accelerated for four months and has been above the central bank’s target of 4.5 percent in all three months of 2010. Consumer prices rose 5.17 percent in March from the same month a year earlier, the government’s statistics agency said last week. " Bernanke's dollar inflation tide is rising quickly on foreign shores.

BOJ disagreement over loose monetary policy

“there was no solid justification for enhancing easy monetary conditions,” according to the minutes of the March 16-17 meeting published today in Tokyo. ““The market may also increasingly come to consider that the bank would take whatever policy action the market has anticipated.”
Someone should explain to these dissidents that the need for inflation is the justification. Creating inflation is the national policy of most of the developed world now. Keeping the "market" fat and happy is an inviolate rule of this process.

Rate pressure high in India
The Indian economy is booming, as are inflation pressures. More consumers to climb on Ben's cheap money, expensive commodity train.

China coal imports continue to rise.
High growth overwhelms environmental concerns. That will never change.

US Investors flock to Canadian Bonds causing record foreign inflows
"In the year ended Jan. 31, net foreign inflows into Canadian bonds were C$86.3 billion ($85.9 billion), the most for a 12-month period since at least 1988, according to Statistics Canada. Three-quarters of the inflows came from U.S. investors." Ben's effluent is sloshing across the border to the north.

Sunday, April 11, 2010

Bet the Farm on a Housing "Recovery".

Pundits like Robert Schiller keep diligently explaining to the American people why the price of things may drop. Deflationists like Mike Shedlock post day after day on the parallels to the great depression. Too much debt, they say, will eventually cause the value of the US dollar to rise. Consumers are tapped out, jobless, bad sentiment, etc., etc. Ben Bernanke is the leader of the choir, reminding us at every photo op that our demise is imminent if the fed hesitates for even a moment in their valiant dollar printing defense against evil deflation. And year after year, decade after decade, the US dollar merrily spirals lower and lower in value, accelerating as we approach the event horizon of US hyperinflation.

Folks like Shedlock and Shiller just don't get it. Anyone who thinks we'll have significantly declining future prices of houses, or oil, or stocks, or bonds, or gold, copper, anything...they just don't get it. Even when Ben Bernanke dumps another load of monetary diarrhea on their heads, they don't get it. When Obama and Congress announce repeated economic "stimulus", spending money we don't have and never will, they don't get it. The US dollar is dead. Our government will never allow the dollar to increase in value vs any item that sits on the left side of our national balance sheet. Because if they did, it would be immediately apparent that America is insolvent. Our people, our banks, our states, our federal government, they're all insolvent. The only way we can continue to roll over debt is to by inflating the value of our assets to keep up with our growing liabilities, and the liabilities are on the upsloping arm of a parabola. That's why the brief price declines of 2008 were addressed using such violent means, the assets had to re-inflate before the balance sheet was tallied up.

I suppose that one could posit, for the sake of exploring all possibilities, that we could admit our mistakes and reverse course. Bernanke could come out and say, "Well, the fed has erred over the last 20 years. Our easy money policy pulled too much consumption forward and now we have to allow the economy to deflate. To encourage savings and real capital investment (not market speculation) we must let interest rates rise again. We need sound money to repair America's loss of global competitiveness." In some alternative universe, Obama might say to the American people, "We are not going to default on our international debts, not via inflation or repudiation. Instead we're going to buckle down and honor our obligations. It will require a shared sacrifice from every American. We have to consume less, much less, in order to pay down our debts, starting right now or it will never happen."

Those are things that could theoretically happen, but they won't. There has never been any indication from any politician or the federal reserve that those options are on the table. Because they're not. That's not the way politics works. Nobody ever admits to a philosophical fallacy and this change would require a reversal of everything we've been told over the last 50 years. Instead, we are reassured that the fed is resolved to fight deflation and the president is resolved to fight depression and unemployment. The actions behind those words have been consistent and unwavering.

Eventually, much sooner than the public understands, the dollar will reach that event horizon. The forces of ballooning debt service, unfunded government obligations, declining natural resources in the face of growing global demand, global trade imbalances, demographic shifts and, finally, debt monetization, will spaghettify our fiat currency in an astonishingly rapid process. That's the downside of masking cancer pain with a narcotic, when the pain finally comes it will come hard and fast and the underlying disease will be beyond remediation. The fed and the US government will be swept aside in a flood of lost confidence. And then we try to pick up the pieces and start over.

Saturday, April 10, 2010

Bernanke the Bubble Slayer.

For those of you who were concerned that the federal reserve's free money policy would create our third consecutive massive asset bubble, worry no more. Ben Bernanke is on the case. That's right, the man who, at the peak of the greatest housing bubble in history, said that home prices were healthy and sustainable, is on the hunt for any signs of irrational exuberance. Hopefully, the signs of the next bubble will be more obvious than a TV show called "Flip this house", more clear cut than no documentation, negatively amortizing, no money down home mortgages. The highest household debt levels in history will not be enough for Ben's discerning eagle eye, nor market prices that trend in one direction for months or years at a time without any significant pullback. See, these are all signs from our previous disastrous bubbles, and Ben Bernanke couldn't see them. So, let's see if we can find any evidence that our current free money policy might be already introducing distortions into asset pricing, on the outside chance that the fed's economic wizards may have missed something.

Hmmm. I notice that Apple computer stock is trading at an all time high, much higher than at the peak of the housing bubble, when liquidity from housing finance was sloshing around in the economy. Bernanke says that the economy is weak, the job market is in bad shape, consumers are strapped; we need exceptionally low interest rates for an extended period of time. Yet somehow, this company that makes expensive discretionary consumer gadgets like cell phones and mp3 players is printing money. There seems to be a bit of a dichotomy between Ben's perception of the economy and Apple's stock price, but I'm sure there's no bubble involved here. After all, history is replete with examples of $220 billion dollar companies that warranted a high growth multiple valuation.

What's that, you say lots of other consumer stocks are soaring too? Companies like Staples, Target, TJX, Whirlpool, Nordstrom, Coach, Amazon, and many others, soaring near or beyond all time highs? These aren't defensive stocks, they're consumer cyclicals and they say the economy is booming. In fact, the RTH retail ETF is very near its all time high set at the peak of the housing bubble. How can that be? The consumer is over-leveraged, tapped out, jobless, but these stocks are soaring? Well, Ben says he doesn't see any assets classes that are significantly mispriced, so it's just an enigma that will be solved at a later date.

What about commodities, any bubblish signs there? Let's see oil in the mid 80's, up 150% from the lows, at a level never seen before the housing bubble. Copper near the highs of the decade (near the housing bubble levels, imagine that and we're not even doing much construction now), up nearly 200% from the lows. Iron ore contract price hikes of 100% recently. Precious metals near all time highs. And what about soaring farmland prices, noted by (our only hawkish) Fed president Thomas Hoenig recently? Agricultural commodities have been restrained so far, but someone is betting big on a change there too. Obviously none of that contraindicates zero interest rates for an extended period from the world's central banker.

How are other economies reacting to a veritable flood of the world's reserve currency? China and India are both booming; they've had to reign in liquidity to cool things down. Australia is overheating, raising interest rates to slow down the wild west mining boom. Indonesia's central bank sees a stock market bubble. British producer prices were up 10% year over year in March. Global financial markets, paper assets, are on a 45 degree slope to heaven as dollars drive that old familiar "wealth effect" paradigm. Ben likes paper asset inflation, it's good for what ails us (he learned that from the maestro). Until it bursts, but that's a problem for another day.

All in all, we're very fortunate to have Ben the Bubble Slayer on the job. We can all rest easy that Ben doesn't see any evidence of bubbles yet. And when he does, you'll be the first to know, after Lloyd Blankfein and Jamie Dimon, of course. They're too big to fail.

Friday, April 9, 2010

Gold is signalling deflation?

There have been a steady stream of financial pundits claiming that deflation is the greater risk to our economy. These folks are essentially carrying water for the federal reserve in their never ending quest to inflate away the value of the US dollar. Why would the fed want to do that? Because they serve the over-indebted banking industry and the over-indebted US government, and inflation would repair those balance sheets at the expense of US dollar savers. It's happening already as the fed pays savers zero percent while inflation steadily accelerates around the globe and banks can invest that free money in much higher yielding treasury notes or stocks. Instant cash flow. So Ben Bernanke constantly warns about deflationary pressures as he plies his friends with free dollars to use as they see fit.

But, what about gold? It has no industrial value, no intrinsic value other than the fact that it has served as a hard currency for millenia. How do we reconcile the fact that the US dollar has lost 97% of it's value vs gold since the two were de-linked and that seems to be accelerating? How do we explain gold pushing toward new all time highs if deflation is just around the corner? Some say gold is a crisis trade, that it reflects panic and as the economy gradually improves, gold will return to simply jewelry metal. But, if the US dollar were expected to hold its value during a crisis, or gain, there would be no reason to own gold. The fact is, gold is only a crisis investment to the extent that our central bank responds to crisis by accelerating the destruction of our currency even beyond their normal pace. Global gold investors understand that the price of gold is not a reflection of the value of a chunk of heavy yellow metal, but rather the value of a slip of green paper whose production has become completely untethered from our real economic growth.

Lately it's become apparent that the dollar price of gold is unrelated to the dollar movements in FX markets. Gold is a hard currency, it doesn't care about dollar-yen or dollar-euro. If renminbi were openly traded, that would probably be the best correlation with gold and in the future we'll see that become apparent as the dollar loses its function as a global trading currency and the renminbi becomes freely exchangeable. When China gets ready to put the economic hammer down on the USA, just as we did on the USSR, they will make the renminbi available for international exchange. It's very unfortunate that our demand for pain free capitalism has led us to this point.

Ben Bernanke can't control the price of gold, neither can Obama or Geithner. They may try, via manipulation of futures prices etc, but eventually the demand for physical gold will destroy that charade. It's already happening as savvy observers note that we have set our currency on a path to zero. Eventually, gold will be unbuyable in US dollars and it's probably not that far away.

Thursday, April 8, 2010

The Real Dollar Devaluation Has Begun.

The NY Times is reporting that China has decided to let the yuan float higher against the US dollar. There has been debate about a declining dollar for years as the US federal reserve trended steadily toward a policy of free money, appropriately distributed as the feds saw fit, of course. Market watchers have vigilantly peered at their forex screens, watching the dollar-yen and dollar-euro and dollar-pound, ever observant for some sign of our currency's demise. It was great sport for the speculators, and distracted their attention from the currency that was truly headed for ascendancy as the world's next reserve currency, the Chinese yuan.

Whether the dollar goes up or down a few pennies against the Euro is irrelevant. They're both dying currencies, destined to take their place in the dustbin of history with the Zimbabwe dollar and the German Reichsmark and the old Chilean Peso. The dollar-gold cross rate has been telling the dollar's fate for several years now, but the mainstream media attributed that to loony gold bugs who didn't understand how things worked. But, among fiat currencies the Chinese yuan has been slowly building strength, unnoticed because of the Chinese government's pegging of the yuan to the dollar. However, unlike America, China has a strong economy built on savings and real industrial growth. They make things the rest of the world wants to buy, at competitive prices. They actually having a thriving foundation to back the yuan. America backs her currency with requests for a handout so the citizens can afford to consume some more.

Finally, the yuan-dollar peg has become untenable. China can't continue to import inflation from the US, as Ben Bernanke implements his grand printing scheme to save us from another depression. China has real fundamental growth, they don't need a massive dilution of their currency on top of that. America has no real growth and no prospects for growth unless we adapt structural reforms to make American business competitive on the world stage, so we will attempt to paper over that reality with our garbage dollars. The destruction of the dollar has now begun in earnest and will accelerate as the Chinese gradually open up the yuan for direct exchange.

In coming years the Chinese economy will dominate world trade. As the Chinese become the top oil consumers on the planet, the yuan will replace the dollar as the petro-currency. Oil producers, and producers of every commodity will demand payment in a hard currency that is driven by international trade. America will stubbornly cling to our misguided ideals of the socialization of risk, making us unable to compete with global producers who are less encumbered by government and lawyers. We will struggle to pay for basic commodities and our Keynesian economists and Nobel Laureates will be shocked to learn that high rates of inflation are completely compatible with a shrinking economy.

Wednesday, April 7, 2010

Indonesia's Central Bank Sees Stock Bubble.

The head of economic research for Indonesia's central bank says that the country's stock market is in a bubble, according to an article from Bloomberg. Officials are considering capital controls to stem the flow of hot money into Indonesia's market and avoid longer term damage to the economy.

“The actual stock price now is actually exceeding the fundamental value,” Perry Warjiyo, who was a member of the International Monetary Fund’s executive board before taking his current post in July 2009, said in an interview in Jakarta.

Other governments have been reducing liquidity recently too, including those in India, Australia, and China.

The Indonesian central bank has touched what amounts to the third rail in American politics. No central banker or government figure in this country is allowed to question the valuation of American markets, even after serial asset bubbles have led to damaging misallocation of capital and caused our current debilitating debt crisis. Instead, the world's reserve currency central banker spends his time justifying ever looser monetary policy, even as he exports inflation and blows up new bubbles in equity and commodity markets at home and around the globe.

Bernanke, and Greenspan before him, professes to be unable to spot an asset bubble in progress, something the Indonesians seem to be able to do. Amazingly, when the bubble starts to pop the fed has no problem spotting it immediately and leaping into action to fix the problem (ie, reflate the bubble). No one seems willing to admit that bubbles have become the status quo of our markets for the last 15 years, and the crashes are simply the economy's attempt to return them to a sustainable state.

Unfortunately, Bernanke is unable to keep overvalued asset prices up on a real basis, so he has decided to create the perception of growth via inflation. Over consumption has destroyed America's savings and elevated asset prices are necessary to maintain the illusion of a sound national balance sheet. Otherwise, foreigners would stop loaning us cheap credit and politicians wouldn't be able to spend freely. Just as our banks can't tolerate mark-to-market accouting for their mortgage assets, our consumers and pension plans and insurance companies can't tolerate true equity valuations. The truth would reveal that our liabilities far outweigh our assets. We will not begin repairing our national balance sheet until we accept the concept of growth through savings, sacrifice, and deferred consumption.

Tuesday, April 6, 2010

Underfunded Pensions Equals Inter-generational Warfare

An article in today's Wall Street Journal says that California's three biggest public employee pension funds may be currently underfunded by 500 billion dollars. Like all such calculations, the results from this Stanford University study depend on the assumptions used to obtain future assets vs liabilities. However, there is no debate that, after a decade of poor stock market returns America's public pension system is deep in the hole. The chances of getting out of this hole via improved returns are slim.

Take a look at some simple numbers. Say a pension fund contains $100M in April 2000. For simplicity, assume no employee contributions or payouts will occur over the next 20 years. The fund manager projects compounding 8% returns for his assets, not unreasonable given the massive 20 year bull market in US equities. To ensure that 8%, he is invested half in the S&P 500, half in 10 year Treasuries. On April 1, 2010, he expects to have $216M available, and on April 1, 2020, he expects to have $466M, which will be the present value of his future liabilities on that date, thus the fund is 100% funded.

After 10 years, the treasuries are now mature and the fund has $90M from the principal and coupons. The S&P component, including dividends, is worth about $50M, right where it started. Total value of the fund is $140M, $76M less than the earlier estimate. The plan is 35% underfunded. That is a rough estimate of what has actually occurred over the last decade.

What can the manager do to get back to 100% funding, keeping in mind that his is one of many funds in the same situation? Well, he can lobby his local taxpayers to pay more into the plan, but that seems unlikely. The taxpayers are already strapped, and they don't see why they should pay more to support public employees who make significantly more than they do on average. Furthermore, the private sector has to eat any underperformance in their own retirement plans, which are defined contribution rather than defined benefit. So, the taxpayers say, "Hell no, we won't pay more!"

Maybe the manager can ramp up the investment returns to get back to 100%. What return is required to turn $140M to $466M in 10 years? Turns out to be a little over 12% per year, compounded. That seems steep, but maybe doable? There are a couple of problems. Ben Bernanke has driven interest rates down to 4% on a 10 year Treasury note. If the fund manager uses his previous allocation of half and half, he'll need a 16% annual return on the equity side to average 12% return in the fund. In an economy where government debt is crowding out private investment and taxes are rising and health care costs are soaring, 16% seems impossible unless inflation kicks up to about 10% a year. Then only a 6% real return would be required from the stock side, which is more doable. As long as the plan benefits aren't indexed for inflation, 10% inflation over the next 10 years might do the trick. Of course, pensioners would get their check, but it would have lost 70% of it's purchasing power over the last two decades, assuming 3% inflation for the first decade and 10% for the second decade.

Third option; change the fund's allocation with a heavier weighting of risky assets, like stocks or junk bonds. The problem with that is risk increases commensurately and the fund could end up in worse shape than before. Most plans aren't comfortable with increasing risk in search of higher returns, and wisely so. Some may take the chance, and some of those will completely blow up.

Fourth option; the plan defaults on its obligations and pays out whatever is available to members. Kick the plan over to the feds and let them bail it out for the rest. Only problem there is the federal government is in no better shape to pay than the local/state government, unless once again inflation has rendered those payouts less valuable.

So, what's going to happen. Will young workers agree to pay even more onerous taxes to bail out pensions, on top of spiralling healthcare and debt service costs from other government entitlement programs that have ballooned since the year 2000? Not only will they refuse, the demographic curves make them unable to support the larger cohort of retiring baby boomers. It's not possible. Will state, local, and federal governments default, tell public employees, "Sorry, you were lied to and we can't pay?" That would lead to serious discontent among a large group of voters and politicians hate unhappy voters.

Inflation, however, seems very attractive for politicians and younger voters. The retirees would gripe about it, but who do they blame for their loss of value? Ben Bernanke's long gone. Politicians say, it's not my fault, they caused this 10 years ago. Young people aren't as concerned, since their income keeps pace with inflation. They adapt to a world where savings are to be avoided and debt embraced. High inflation will impoverish almost all of the elderly and make them dependent on the state for everything. Over time it will destroy America's savings and capital base, and thus ultimately the work ethic that made America a dynamic economy. But, due to inability to face the tough choices up front, this is the course that Ben Bernanke and the federal and state governments have chosen.

Monday, April 5, 2010

Inflation Items: Monday

Airfares rising sharply
Prices may climb even higher in coming weeks as carriers add a fuel surcharge to cover surging oil prices. But, dont' worry, those nice fat 4% treasury note yields should cover it.

Peabody Energy ups bid for McArthur Coal
I guess they didn't get the memo that the commodity bubble's about to crash.

Phillipine inflation accelerates
Central bank keeps interest rates at a record low anyway, yielding a negative real rate of return (before taxes of course). That'll teach those savers a lesson.

New Zealand commodity export prices rise for 13th straight month
Up 50% year over year. Good thing we don't buy any of their stuff.

Crude oil hits new 17 month highs on economic outlook
I wonder where oil will be by the time the Federal Reserve decides to raise rates.

Chinese central bank advisor says no question US dollar will "go south"
I guess they feel pretty good about their investment in US government debt.

Brazilian bank plans 10 yr US dollar bonds
Seems like every third world country and corporation want to borrow dollars. Align yourself with the biggest printing press, seems like a good policy.

How Many Fed Governors Can Dance on the Head of a Pin?

There has been endless debate among market observers about whether the fed is diligent in fighting inflation. Some say inflation is nowhere in sight, indeed it is all but impossible to get inflation with a high output gap, i.e., when US production is so far below full capacity. Others say that rapidly increasing money supply raises the risk of inflation down the road, and that commodity prices may already be signalling higher inflation expectations. Given this diversity of opinion, it seems impossible to reach a consensus on the risk of inflation and the fed's willingness to keep inflation at bay.

Of course, financial markets over the last 15 years have proven to practice a form of selective amnesia when it comes to the desire for easy money. They rationalize away the fact that, our central bank has not only failed to fight inflation, it has repeatedly encouraged it during the Greenspan/Bernanke era. First in the form of a stock market bubble, then as a combined housing/stock bubble. No sooner does one burst than the fed busily sets about creating the next. These bubbles are simply inflation forcing its way into whatever asset is most amenable, sometimes with a little encouragement from the government.

What the deflationists fail to acknowledge is that our reserve currency status has been the only thing preventing broader US inflation for two decades. Foreigners lent us money cheap and we bought their cheap goods. Meanwhile, our internal cost of doing business has risen, making our goods increasingly uncompetitive in the global marketplace. But now, our status as a poor credit risk has been exposed by the massive housing defaults. The era of cheap foreign credit is gone, thus so are the cheap foreign goods. A strong currency would be helpful, but we don't have anything the rest of the world wants.

During this process there has never been a period where the fed could be accused of being too restrictive. The concept of "taking away the punchbowl" is completely outmoded for modern fed policy. We're so addicted to free dollars now that the idea of high interest rates is laughable. The stock market would drop and consumption would follow. Bernanke, like Greenspan before him, much prefers being a "rock star" for the markets. The accolades for his daring market rescue are Ben's morphine. Hard money would be naloxone for Bernanke and the markets. It's just too painful all the way around.

Look at what's taking place. Consumer discretionary stocks are soaring, many hitting all time highs. The Nasdaq 100 has recovered almost all of its decline from the peak of the liquidity bubble in 2007. Commodity prices are soaring across a broad range of assets; industrial metals, energy, agricultural. Oil prices are at a level never seen before 2007. Emerging economies, among the first to feel the effects of dollar inflation are booming. And as all this happens, Ben Bernanke says he will keep interest rates at zero "for an extended period of time". Left unsaid, is that if the equity market drops, he'll begin printing money again.

Federal Reserve policy is inflationary. It has been inflationary for a long time. It is explicitly guaranteed to be inflationary for a long time to come. It is already causing inflation and that will only get worse. Free money is inflation by definition. Any debate to the contrary is either self-serving or simple minded. Like the stock touts say, don't fight the fed.

Friday, April 2, 2010

There's a Lot of Ruin in a Nation

New mortgage mod plan continues the wealth redistribution from middle class taxpayers to banks

Recently the Obama administration announced a new mortgage modification plan, designed to reduce the outstanding principal owed by homeowners who were at risk of default. The announcement was greeted with little fanfare and some skepticism, since previous efforts at mortgage modification had met with minimal success. A big part of the problem has been that financial institutions are unwilling to make mortgage changes that force them to recognize damages to the value of their mortgage backed security (MBS) portfolios.

Remember, these MBS's are the securitized instruments that caused (at least proximally) the global financial system to freeze up when everyone realized how poor the lending standards behind the individual mortgages had been. When trillions of dollars in MBS packages plunged in value, the American banking system became basically insolvent, as the value of bank assets shrunk below the level of their liabilities. Since that time, the US government has been using a wide swath of programs to hide the degree of bank insolvency while frantically transferring wealth from the US taxpayer to banks. In order to buy time while the wealth transfer was enacted, the government strong armed the financial accounting standards board (FASB) into modifying mark-to-market accouting rules, allowing banks to carry damaged securitizations on their balance sheet at values above what they would bring in the marketplace.

Of course, changing an accouting value is not the same thing as changing the true value of an asset. Banks were still sitting on these toxic loan packages as homeowners continued to default and home prices continued to decline. Eventually the true worth would be known unless the housing bubble could be quicky reinflated, which isn't likely despite the government's valiant efforts using OPM (other people's money). So now, as Ben Bernanke has wound down his contribution of $1.25trillion purchases of MBS, another government agency has stepped up to the plate to continue the fleecing of middle class. In an article on The Market Oracle website, Mike Whitney explains the new source of taxpayer largesse for bankers:

"Here's how it works: The new program offers incentives to banks and other deep-pocketed investors (in mortgage-backed securities) to slash the principal on underwater mortgages which keeps people from strategic default or foreclosure. Sounds good, right? But here's the catch: When the mortgage is refinanced, it's converted into a FHA-backed loan which provides an explicit gov-guarantee. So, for a slight loss on the face-value of the MBS, the investors (ie--investment banks, hedgies, etc) are able to resuscitate their moribund securitizations (MBS) and reap hefty gains. It's like taking Fido's steaming pile on the front lawn and turning it into the Hope Diamond. Abracadabra!"

Loan guarantees are an especially obnoxious form of government spending, because taxpayers don't even realize it happened. No assets are held in reserve to back up these new liabilities, because unlike the private sector the government just says, "Hey, we have a printing press, we're good for it". These new FHA obligations won't show up on most national debt counters. They won't even result in new taxes, or complaints about greater budget deficits. They'll just be buried deep in the bowels of the FHA, off balance sheet...until they blow up again. That's the reason the bankers love this program -- mortgage mods are proven to redefault in high numbers because a lot of these toxic mortgages were never close to being viable loans. They were based on house price appreciation that didn't happen.

So now, by taking a small haircut on individual loans, banks will see their loan portfolios and MBS gain in value as they become incrementally backed by FHA guarantees, courtesy of working Americans who had no involvement with either side of the loan. And when the financial institutions inevitably call on the FHA to fulfill those guarantees, our already unpayable debt will go up or our central bank will print more dollars to fund the gap. No matter which, this is just another form of dollar debasement waiting for us down the road. As Adam Smith said, "Young man, there's a lot of ruin in a nation". The US government, in their fervent quest to socialize risk, is searching high and low for new sources of ruin to bestow upon our people.

Inflation Items: Good Friday

Oil, coal, industrial metals, agricultural commodities are ripping higher this week. Long duration government debt is shooting higher, US 10 yrd yield punching close to 4%. Natural resource buyouts are happening left and right, as developing economies stage a frantic grab for global supply. Consumer stocks are hitting new highs, including many all time highs. Meanwhile, Ben Bernanke's accelerator is stuck wide open as we hurdle down the freeway toward an inflation bonfire.

More companies reporting healthcare reform costs.
This will only get worse as time goes by. We didn't fix the healthcare cost problems, we made them bigger. The new costs will be passed on to consumers.

Steel prices will be rising soon, after a 90% hike in iron ore costs
Interesting that the EU is investigating the major iron ore producers for "competition issues". Governments have spent like proverbial drunken sailors, taken on so much debt that it casts doubt on the viability of their currencies, and now they get a little huffy when prices start to spiral. Unfortunately for them, the owners of these resources don't have to sell at the buyers' preferred price. Coal prices are rising sharply too, which will further add to steel price inflation. Maybe governments can just issue more debt and subsidize car prices to keep consumption rising in the face of these crystal clear economic signals from the market place.

Meanwhile China is buying every natural resource that's not tied down to secure supply.
Something tells me they don't see prices dropping much. They will eventually let the yuan float and then they'll buy up the rest with their strong currency, as weak currencies get priced out of the global markets.

Speaking of floating yuan
Forward rates are rising. I wonder what will happen to US inflation when all those Chinese import items start increasing in price. What will happen to our bond market? Be careful what you ask for.

Indian consumption of resources is surging too
Add another 1.2 billion consumers to this global stimulus train.

Another steep iron ore price hike
The Asians are paying up. Who wants it most? Get out your wallet.

Canadian dollar is strong.
Strong currencies are backed by hard assets and economies with goods for international exchange. The currencies will fluctuate, but the trends will remain.

China won't "kill the market"
Of course they won't. They are not going to abandon the playing field and allow Western economies to dominate resource utilization. The free ride is over.

Chinese will pay up for iron
They may not like it, but they know why it's happening and they know they can afford it. This is very similar to the economic competition between the US and USSR during the cold war. Only now, we're the hidebound economy and the communist upstarts are the vital producers with the advantage.

Danger, Will Robinson!! China's overheating!!

It's a common theme in the financial media these days. Danger!!! China's gonna implode, they're growing too fast, they have to slow down, they're overheating, commodity prices are going to crash. It's basically wishful thinking from the leveraged Wall Street money and their media mouthpieces, hoping that the Chinese will return to being good little peasants, squatting over their turnips on a half acre of land and leaving the oil, iron and copper for the big boys. This is also Ben Bernanke's grand vision, that we can successfully channel all of his free money into paper assets and home prices, without shooting ourselves in the foot with inflation on the stuff we buy from the rest of the world. The wealth effect cures all ills in Ben and Alan's world.

Unfortunately, we've played this hand one time too many. For decades, citizens of developing countries have dutifully toiled for pennies a day, providing America with the fruits of their labor in return for IOU's. As we were the world's economic dynamo, they figured we were good for our debts. Every time our economy slowed, our central bankers just lowered the interest rate and provided easier credit so Americans could borrow more. It had the nice corollary effect of driving stock and home prices higher, which buttressed the illusion of a strong household balance sheet. But then a strange thing happened. Ordinary Americans who didn't own a printing press started defaulting on their obligations because, just like our government, they had overextended their balance sheets. And not by a little, more like historic proportions of household debt.

Even worse, there is very little that America can make and sell to the rest of the world at competitive prices, so in addition to having too much debt and no national savings, we will have great difficulty repairing our trade deficit to pay down our foreign debts. While we were living the good life on borrowed money, those foreign peasants became the dynamo of world production as our manufacturing muscles atrophied. Regulation, environmental restrictions, taxes and the tort lottery would have driven our inflation higher long ago, if not for the fact we bought an increasing amount of our goods and materials from somewhere else. For the last couple of decades financial engineering has been our growing national plum, but global respect for Wall Street's product is withering on the vine. Our GDP is a fiction based on easy money, liar loans and inflated asset values. Understated inflation and overstated productivity have shielded these facts for a long time. Now, the story has been fully elaborated for public viewing and the details can't be hidden behind a veil of Federal Reserve secrecy and government deficit spending.

So, our IOU's, our US dollars, are losing their purchasing power for the output of other countries' labor. This can't be easily measured by the exchange rate vs other currencies, since many of them are fighting dollar devaluation by devaluing their own currency. Other governments have adopted the same Keynesian myth that free money equals prosperity. Or at least they profess to believe that, because it enables their ability to distribute national wealth as they see fit. Either way, dilution of value is the end result and that is definitely showing in the cost of hard assets.

The Chinese are buying up natural resources at a phenomenal pace, and not simply to sell them to the US on the cheap. The Indians are doing the same to a lesser degree. Other Asian economies are also growing, and their populations want to live like we do. They want more than just basic food and necessities. They want to own cars and big screen TV's. What they don't want, is to work hard, make all these things, and then sell them to Americans who have nothing to offer in return except IOU's of dubious value.

Is China overheating? It's possible. But, the reality is that they are starting to claim an increasing piece of the global resource pie for their own use, and that's not going to change. Which means our costs will continue to rise. What's more, they are not going to extend credit to the US on the same terms as before now that we've proven to be a deadbeat borrower. And with the onset of Ben Bernanke's money printing experiment with no national earnings power to back it up, our US dollar IOU's are losing their global luster. Buying hard assets with monopoly money will become increasingly expensive no matter what happens short term in China.