Vigilant Investor

We’ll, we’ve talked about it for years here on Vigilant Investor.   Your chief editor here has referred to it in annual reports to clients in his private consulting practice:  When honestly looked at the U.S. fiscal situation implies inevitable, long-term insolvency.

I don’t come to this conclusion lightly, although I’m reminded of it by reading that President Bush has signed the bill allowing for the Freddie and Fannie bailout to go forward, which includes the debt ceiling being raised to $10.62 trillion.  Yes, with a T.

Now, we’ve pointed out the sleight of hand that goes on with reporting deficits in the United States. This leads most of the sheep to accept at face value that the official federal deficit hovers around $200-300 billion each year.  Granted, that’s no song, but the reality is far higher when you actually account for all the obligations decades of Congressional profligacy has chained to the U.S. taxpayers’ backs.

The whole number is over $54 trillion - some $175,000 per living person in the United States — once you actually stop with the facade that the obligations of Social Security, Medicare and Medicaid are somehow not worthy of being included on the balance sheet.  Broken down to a net present value of future obligations figure, we’re talking an annual deficit number closer to $4.6 trillion, a gargantuan figure that keeps building each year politicians pretend it really does not  exist because doing so will only scare the electorate.  That’s because fixing the problem will require draconian cuts and tax increases; although tax increases of the levels required to make a difference won’t work since they’ll only strangle what little economic growth is going on at the moment, further reducing revenues.

But, alas!  When it comes to politicians, they do have another “out” that can maybe work for another election or two: inflation!  By inflation, I don’t mean rising prices, but rather the cause of the rising prices: increasing money supply.    This is the easiest way for politicians to pay down the promises they and their predecessors have made, and in case you have not yet noticed, it’s been coming to a gas pump and grocery check out near you for a number of years now.  Heck, when you can print money and your official department of statistics filled with lackeys looking to keep the guys controlling their salaries happy, we’ll…  This might explain why Social Security recipients received an unconscionable 2.7% raise for their 2008 payments when the price of eggs, milk, and flour are climbing at well over 10 times that pace!

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Sober thinking from Jim Rogers. What’s most worrisome is how entrenched mainstream thinking is in the two journalists doing the interviews. While some might suggest that these two are just financial talking heads, their objections are straight from the standard list of most apologists of the fractional reserve financial system and the current spate of bailouts to “save the system from even worse.”

What a racket.

No doubt, there are quite a few problems behind why oil has jumped above $128 a barrel.  Never mind hooey arguments about greedy oil companies that resonate with the economic illiterates among the loudmouth media and the complaining voters.

While we don’t have much good to say about any politician on the matter of energy, we really can’t disagree with President Bush’s observations about pressuring the Saudi’s for more output:

“Our problem in America gets solved when we aggressively go for domestic exploration. Our problem in America gets solved if we expand our refining capacity, promote nuclear energy and continue our strategy for the advancing of alternative energies as well as conservation,” he said.

“One interesting thing about American politics these days is those who are screaming the loudest for increased production from Saudi Arabia are the very same people who are fighting the fiercest against domestic exploration, against the development of nuclear power and against expanding refining capacity.”

This, said Bush, after noting that Saudi output really is not the ultimate solution to the U.S. price problem.  Mind you, many in the U.S. Congress are wagging their fingers at the Saudis — like candidate Hillary Clinton — for not increasing their production significantly enough to alleviate U.S. price pressures, as if the world should rotate around the U.S. dilemma.  The same folks giving grief to the Saudis are the same ones who refuse to allow the U.S. to develop its own energy resources as Bush notes above.

Not that the Republicans have been any great movement as of late to get anything done themselves, with R candidate John McCaine having been a pivotal vote in the Senate preventing the development of Alaskan reserves.  Indeed, the U.S. has not built a new refinery in three decades, and refuses to allow development of both oil and clean burning coal, not to mention nuclear reactors.  Even environmentalists are preventing air windmills, much to the happiness of those with fancy homes on the coasts who loath having their million dollar views ruined by windmill farms harvesting the constant ocean breezes.

Hypocrisy aside, we’re not hearing one of the core causes for skyrocketing energy costs: plain old fashioned inflation. And by “inflation”, we don’t mean the modern misuse of the word to describe the consequences of inflation — rising prices –, but rather the actual cause of the rising prices: climbing money supply.   The world is now awash with dollars thanks to a steady thirty years of the Fed and the U.S. banking system creating dollar after dollar with its fractional reserve, fiat privilege.

Looking at the money supply graph, you can see that the various measures of U.S. dollars have been on a steady rise since the 1980s, and especially ramped up in the 1990s.   Most were lulled to sleep about the ugly effects of inflation due to two factors, both of which served as siren songs for the unsuspecting public and the herd of sheep hitting their record bonuses on Wall Street:

1. Inflating nice asset prices like stocks, bonds, and houses
2. Exported inflation dollars bought cheap goods made abroad, a honeymoon that lasted until the last few years, when foreign nations were flush to the gills with dollars and ready to part with them to buy things that were not so easily printed and common — and very essential, like energy!

“The Federal Reserve as other central banks is obviously taking onto its balance sheet a lot of mortgages these days.” “Well, the creators of the Federal Reserve system would be rolling over in their graves if they knew the Federal Reserve is buying mortgages.”
– Former Federal Reserve Chariman Paul Volcker

Whether or not the creators of the Fed would be rolling over in their graves is debatable in our opinion. Like Andrew Jackson — we believe central bankers have always been dangerous, incompetent meddlers. We feel the Fed should never have been created — and and that it continues to prove itself as bungling as any other central planning committee. But we digress…. That said, the former chairman’s grave concern over the central bank taking on billions of not so hot private debt is quite valid.

Volcker went on to warn that recent intervention by the Fed in securities markets might compromise it’s independence. He went on to say that the Fed’s inability to contain inflation will create a 1970’s like scenario. Again, he’s right there. We’ll also add, it’s too late Paul — the nationalization of the US private debt has begun. When politicians, who’s outlook is only as far as the next election — get involved, the trend will only accelerate. So to will corresponding inflation and Dollar degradation.

Beyond the blatant example of the Fed’s $30 Billion bailout of Bear Stearns — we now see Senator Christopher Dodd proposing the creation of an FHA program to insure refinanced mortgages following partial forgiveness of the loans by lenders. OK, let’s think about this. In an environment where U.S. foreclosures have risen 65% over the past year — and private banks/lenders are preferring to seize homes rather than renegotiate with already defaulting borrowers — the Federal Government is going to step in with money it does not have (but will be all to happy to print) — to back already bad debt.

Also, earlier this month, the Fed agreed to accept securities backed by student loans pledged as collateral for Treasuries the central bank would in turn lend to Wall Street Investment Banks. Let’s analyze that deal. Investors had become far less willing to finance student loan debt at pre-existing prices — due to liquidity issues, the economy, and the fact that consumers (including students) are hurting — and are therefore higher credit risks. The cost to finance such loans would have to naturally go up. Wall Street investment banks (you know, the ones who paid themselves billions in record bonuses over the past year) were less willing to hold onto securities they owned backed by this type of debt. However, if they tried to sell it — they would sell it for a loss. No worry, the Fed would lend/swap them Treasuries for the riskier (and worth far less) student loan backed securities.

Effectively, you have the government, or quasi government institutions backing substandard debt with money it will have to print. That spells one thing — accelerating inflation — and the always accompanying confiscation of private savings. And we’re not talking the low single digit inflation figure the government “calculates” (and bases Social Security payment increases on). We’re talking about the inflation you see in the supermarket ($4 for a handful of blueberries anybody?) — and at the gas pump.

When we hear the Treasury Secretary, or the Chairman of the Fed talk tough on inflation and defending the Dollar — we just smile. When we hear political candidates blaming oil companies and “speculators” for rising prices — we smile again.

We think the next 3-5 years will be quite interesting.

“I think we were really on the verge of a financial collapse of unbelievable proportions that we haven’t seen since the 1930’s.”
– Former U.S. Treasury Secretary Paul O’Neill describing the Bear Stearns bailout in an April 16, 2008 interview on Bloomberg

Read that quote again by Paul O’Neill – because, yep folks, that’s really where things stand. Our financial system effectively patched together by an inflationary, money printing band-aid. And, as the real estate markets in England, along with those in Spain, Ireland, et al. continue to melt down, we maintain our belief that the whole fiasco is far from over. (Our regular readers know we said the same when conventional pundits said the worst was over in 2007).

The interesting thing about economics is that people have been conditioned to believe in the charade that it is a mysterious, complex, science – and to be successful at understanding it, explaining it to the great unwashed, and at running large portfolios – one must be a superior mathematician educated at the most prestigious of universities. As we watch the same geniuses educated at said universities – some of whom had supposedly developed mathematical models which had eradicated risk – continue to drive hedge funds (and at least one major Wall Street brokerage firm) valued in the $ billions straight over the cliff – we say – “oh really?”

We instead choose to take Harry Truman’s quote — “There is nothing new in the world but the history you do not know” – to heart when we look at economics. History is in fact the study of human behavior – of what has worked, and what has failed. To ignore historical facts one must be either arrogant, a fool – or an arrogant fool. So, as Sir Alan Greenspan and his knights at the Fed Round Table repeatedly cut rates earlier this decade – we warned that the unfolding scenario looked a whole lot like Japan in the 1980’s and 90’s! A Stock market bubble, followed by a stock market crash – and subsequent economic pain. Then came massive interest rate cuts to supposedly “stimulate” – which instead caused a real estate bubble – followed by a real estate collapse, and a severe, prolonged recession.

Sound familiar?

What next? We see the bailouts continuing — simply because the alternative is the severe and necessary corrective pain to clean out the mess and get prices of all things back in line. And what politician, Wall Street banker, investor, or voter wants to deal with that reality? And bailouts spell inflation. Not the fudged low-ball inflation that’s used to calculate Social Security payment increases or “official” economic growth. We’re talking about real inflation. The rapidly rising kind you are seeing at the supermarket and the gas pump on a daily basis. As these inflationary bailouts continue – look for prices of all things tangible to increase dramatically.

Commodities bubble? We think not – because bubbles require excessive stockpiles/inventory/supply – and we don’t see that at all – in anything. And we see inflationary (money printing/bailout) policies accelerating.

Oil at $125 in the near future anyone? $5 Dollar gas at the end of the year? Food prices continuing through the roof? It would not surprise us at all.

Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
– Bloomberg (March 26, 2008)

The reason you want solid collateral to secure a loan is obvious. You want to protect adequately against the borrower’s potential inability to pay you the loan back. How interesting that the Fed is taking 30 $ Billion of illiquid mortgage securities as collateral from otherwise insolvent Bear Stearns to bail the Wall Street firm out. As intriguing (alarming) — is the Treasury’s encouragement of Fannie Mae and Freddie Mac to buy more mortgage-backed bonds.

We ask — who in their right mind would lend out their own money backed by such risky collateral? Who today would buy mortgage backed bonds with their own money?

Ah, there lies the rub! It’s not their money which backs these shenanigans – it yours!

We’ve continually warned about the bailout addicted U.S. Another voice of clarity and reason all along has been Bill Fleckenstein. As usual, he nails it in his latest commentary, “Catering to the Bailout Nation.” BTW, Bill’s recently released book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve – is definitely worth a read! We wonder — has anyone ever been un-knighted? Can they do that?

Any reasonable person knows that bailouts beget more (and larger) bailouts. Like a drunk having another drink, it’s just going to make the hangover (and resulting inflation) even worse.

Also, ask yourself this one – why are big Wall Street banks getting bailed out (with taxpayer money) – when the 5 largest recently paid themselves 39 $Billion in bonuses?

Think long and hard about the answer to that one – because you are paying for it – in overt taxes, and the great hidden tax – accelerating real inflation.

With today’s 75 basis point rate cut – we see continued evidence as to whom the Fed really serves. As we have long said, it’s not you and I – it’s the Big Wall Street Banks. The “Big Rip-Off” of your savings continues. Jon Markman gets right down to it…

“The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.”~ Ludwig von Mises, Human Action, p. 576

That’s a big problem today. Everyone loves the big party that is ginned up by easy credit and expanding money supply. What they fail to understand is that the bust is the essential, corrective phase to the massive clustering of bad business and investment errors that were encouraged by misguided economic policy. Granted, it’s a painful process, but necessary to restore sound economic health.

But the illusion of knowledge leads most participants to fight the correction tooth and nail, and to support policies that redirect whatever productive assets remain working for the economy towards supporting the exposed, unsustainable activity of the prior bubble.

At best this is a temporary fix, and is no more sustainable or a lasting solution than is giving an addict suffering the symptoms of withdrawal another dose of the drug to which he’s addicted.    Just like the addict, our economic reality must be embraced for what it is or else that reality will be unceremoniously forced on our citizens, except with them having even less control over the situation as punishment for the extra delay.

Unfortunately we’re in the latter stages of our addiction to credit and easy money.   The economy staggered out of the dot com bubble and was going to recession to restore order, but Alan Greenspan and crew short circuited that recovery, and as dramatic an increase in credit and money as ever was injected into the economy to keep it on its feet.   A new, far larger bubble replaced the old one in technology, one that applied to all things related to credit.  As such, another dose to ward off our current withdrawal may simply send the patient reeling into the gutter of an overdose.

Does that sound too extreme? Tell me, then, what purpose dose it serve to keep asset prices with no basis in reality artificially high vs. clearing at a natural, free market price?

Why keep assets at values that are entirely dependent upon expanding credit rather than genuine economic productivity — credit that itself comes at the expense of the productive sector given it is created by inflation? Why not let normal economic order be restored?

Why enable a system that clearly cannot sustain itself without garnering purchasing power from the functioning economy to continue the ruse?

These are all questions that are answered quite simply if honest:   Because going through withdrawal is a real bitch, but the only way to pay for ones past economic sins.

But, as Mises notes, rather than embrace the bust as the restoration of economic healthy as anyone organizing an intervention with a real drug addict, contemporary finance pros and populist sentiment alike clamor for more of drug that got us into this nasty spot in the first place.  Party On!
All said, any short term benefits derived from policy that merely reallocates existing wealth through inflationary confiscation / bailouts and reallocates it in order to support all the errors exposed as unsustainable over the last 12 months, will have long term, unhealthful  consequences as yet more burden is placed on the legitimate producing economy to support ever more garish malinvestment.

Stay Vigilant, and Think it Through!

It doesn’t get any more rich than this… Cramer on there being no housing bubble!

Goes to show how off base pop culture economic analysis can be. Don’t forget how the media earns its living: Advertising. Throwing a wet blanket on the bonus party on Wall Street is not going to be promoted. They’ll cover it as it happens and in retrospect, but they’ve give guys like this 95 more times the coverage, and laugh off the critics.

Here’s part II
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“How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy? How could an investor in California’s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation’s largest state with its obvious ongoing taxing authority?”

That’s from a Financial Times opinion piece written by Bill Gross. (Read it while you can for free at Yahoo; the links never last all that long…) Gross makes a good point about the myth that had been the monoline insurers — Ambac, MBIA, and a few others — who provided their ratings to the bonds they guaranteed.

You’d have to live under a rock these days (at least if you’ve been paying attention) to not have heard about how they’ve all been hit by guaranteeing mortgaged backed securities and CDOs squared, etc., and that they’ve simply not got the capital that’ll be required to cover the losses. Moreover, as we’ve reported for weeks, MBIA has been raising capital at junk bond rates, making their own AAA ratings from S&P and Moody’s a joke. (The same can be said for Ambac. At least ACA was dropped appropriately to the junk level it is.) MBIA this past week printed up another 82 million shares of stock for those willing to throw the company $1 billion as they scramble to keep their AAA rating. MBIA’s stock has plummeted by 80% since last October, and were down 10% alone on the news that shares would be diluted.

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The last six weeks are unprecedented to the degree banks have shored up their reserves by borrowing. That’s what we can learn from the Fed’s own H.3 Table 2 Report (Dated January 31, 2008) where nonborrowed reserves have actually turned negative for the first time.

What you’re looking at in the graph above (click for a larger version) cover the last few weeks, and is the difference between actual reserves held by banks (the dashed line), the reserves required by the Federal Reserve system of said banks (solid blue line) and then the actual amount of reserves the banks have on hand that are not borrowed (the red line “Nonborrowed Reserves”).

You can see that since December 5, 2007, banks have literally gone negative in their nonborrowed reserves. In other words, real reserves held at the Fed on behalf of banks are negative. Banks have less than zero on deposit!

One can go back through the history of these figures through 1959 and see that nothing remotely close to this type of event has happened. In fact, the ratio generally stays fairly close to 1:1, meaning very little of the reserves normally held are actually borrowed. Never before has it gone close to negative.

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Here’s a clip of Prudent Bear’s David Tice explaining why he thinks the markets are in a free-fall to Bloomberg T.V.

Here are the headlines:

Stocks Dive on Worries of U.S. Recession; Wall Street Unassuaged by Fed’s Interest Rate Cut

Wall Street plunged at the opening of trading Tuesday, propelling the Dow Jones industrials down about 400 points after an interest rate cut by the Federal Reserve failed to assuage investors fearing a recession in the United States.

Asia Stocks Fall, Extending Global Slump as Bear Market Spreads

Asian stocks plunged for a second day, sending the region’s benchmark to its biggest decline since April 1990, on concern the global economy is slowing.

Asian Markets Extend Losses Amid Worries That US Is Headed for Recession

Global stock markets extended their shakeout into a second day Tuesday, plunging amid worries that a possible U.S. recession will cause a worldwide economic slowdown. The dramatic declines were expected to spread to Wall Street, where stock index futures were already down sharply hours before the trading day began.

WASHINGTON (AP) — The Federal Reserve, confronted with a global stock sell-off fanned by increased fears of a recession, cut a key interest rate by three-quarters of a percentage point on Tuesday, the biggest one-day move by the central bank in recent memory.

The Fed said it was cutting the federal funds rate, the interest that banks charge each other on overnight loans, to 3.5 percent, down by three-fourths of a percentage point from 4.25 percent.

You just knew these guys would deliver. Now the question remains, who will bite on the liquidity? Or will this just be pushing on a string?

Our guess is that, one way or the other, the money supply will increase. Likely, U.S. securities will be repatriated to the U.S. from foreign central banks, and the Fed will simply hold them vs. sell them. $287 billion came back that way last year. In come the bonds, out go the dollars.