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.

We’ve monitored David Morgan for years. He’s been as right about the economic situation as we’ve been since our start in April 2005. Give it a watch.

Well, it looks as if we’re coming out of the calm before the more serious part of the mega economic storm we’ve predicted over the past few years.

We’ve heard a couple of analogies related to the economic crisis as it was over the past few months following the Herculean bailout of Bear Stearns by the Fed.  Indeed, the calm lulled many an expert (many of the same ones who were blindsided by the problems in the first place) to sound an “all clear” that the worst had passed.  For many of those, it was not the first time they called a bottom since last Summer when it grew clear there was a more serious problem that was not to be simply contained in the subprimes as most predicted.

As for this little respite of recent months, some called it the eye of the storm — Not bad.  But we are gravitating to the squall-line analogy.  Those are the broad wisps of clouds that push forth in advance of a hurricane.   When the early squall lines hit, you get intermediate breaks that would suggest to someone not in possession of a barometer or sattelite imagery that the worst has passed.   Yet, plain as day, the meat of the storm lies dead ahead.

That is where we stand today regarding this economic crisis.  The meat of the storm is now readying to make landfall. Batten down the hatches.

And, just for effect, here’s a weather report:  (Our comments italicized between headlines)

Federal Reserve blames high energy, food prices for a weak economy heading into summer

Uhh.. Maybe they should look in the mirro. And who is responsible for printing all the money that has reduced the dollar’s purchasing power?  The Fed!

Fed’s Kohn says inflation pshychology higher

Neo-keynesian meddlers at the Fed and in most of academia always worry about people catching on to inflation being baked into the system, so they spend a great deal of the time engaged in a confidence game.  Gigs up, though, on this one. Inflatino is out of the bag for the simple reason that the Fed has increased the money supply by well over 5X since 1980.  It was only temporarily vented into fun asset prices, like stocks, bonds, and real estate, and that was so long as the massive capacity in emerging markets kept making the gadgets we buy cheaper and cheaper.  But those dollars are out there, now.

Oil soars as high as $138 a barrel as dollar falls and Energy Department reports supply drop

Oh, you don’t say!  Looks like our warnings about Peak oil smacking hard into rising demand and far too many dollars have come true!

Why It’s Worse Than You Think

You know when Newsweek is on the bandwagon, its for real!

US sees a shadow of the Bundesbank

Wall St falls led by financials

London banks, builders and retailers savaged

“We should privatize the sanctions against Iran by launching a worldwide divestment campaign.“

–Senator John McCain, the Republican nominee for the presidency.

Military and economic Sabre rattling is the order of the day.  As if prices are not already distorted enough, the thought of another war in Iran should concern all vigilant investors!

• EU mulls asset freeze for Iranian banks
• Oil prices rebound on supply concerns, growing global demand and Middle East tensions
• Bush prods allies for tougher stance on Iran
• Arabs shocked by Obama speech stating Jerusalem “undivided capital of Israel“
• ‘Unavoidable’ attack on Iran looms, says Israeli minister
• Iran blasts Mofaz remark, warns of ‘painful’ response if Israel attack
• Olmert Hints U.S. Action on Iran Nukes is Near

On the issue of war with Iran, consider Jimb Lobe’s observations on its possibility.  Also, consider Llew Rockwell’s piece on the relationship between War and Inflation.

Do we have an opinion on should there be a war with Iran, or no war? Indeed, we do, but that does not matter. What matters is that readers consider what each alternative means to them in how they handle there own affairs.

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!

This is too ripe. From the Financial Times:

ECB voices ‘high concern’ over liquidity scheme
By Paul J Davies and Norma Cohen in London and Anousha Sakoui in Vienna
Thursday May 15 2008 17:45

The European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.

Who are these people trying to kid? The very essence of all the emergency action at CBs, including the Federal Reserve, has been to provide a way for banks (and now others) getting sucked under by toxic assets backed by plummeting collateral to find cash to bail themselves out. The Fed has entirely rewritten the rules, including going outside of the banking community by rescuing Investment Brokerage Firms. At one time the Fed required AAA Treasuries as collateral, but now it will swap those AAA Treasuries from its reserves and accept in its place those tens of billions in mortgage backed toxic waste that has no marketplace. And CBs claim to be caught off guard? What a joke!

“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.

Its always a small sidebar in these type of crisis: the banks too small for the big guys to care.  Rather than being bailed out, they simply are absorbed at pennies on the dollar by the big boys whose hands are firmly in the till of the Fed.

Only three banks have failed year to date, but the third — ANB Financial, which controlled $2.1 billion in assets with $1.8 in deposits — much of it demand deposits like your checking account — is no small fry.  Expect more as the recession really takes hold and payments hit the skids on the extreme overhang caused by massive easy-credit-caused dislocations.  Seems the Feds expect more, as well:

“FDIC is planning to beef up its staff, including temporarily hiring up to 25 retired FDIC employees who worked in the agency’s more than 200-person division that handles failed banks. They will handle an anticipated increase in bank failures.”

Obviously the failure of Bear Stearns would have triggered cascading defaults given so many players were writing credit default swaps on securities that did not even exist, thus adding multiples to Bear’s actual debt market value — at least in terms of liabilities to those who were insuring the risk.   You can imagine 12 months ago those writing these derivatives never would have dreamed Bear Stearns could go under, and you can be sure there premiums were well under priced vs. the risk, yet still considered easy money.  Think there’s any coincidence that JP Morgan had been writing upwards of 45% of all credit default swaps in the market place and the fact that the Fed enabled them to keep Bear’s head above water? Imagine the liabilities that would have sucked JP Morgan down with the ship.

Again, some banks are small enough to fail.  Tough luck. Others?  Let the shell game continue.

You have to love Alan Greenspan.  Today he’s quoted as having declared the worst over for the credit crisis during a speech in New York.  Yet, at the same time he still thinks housing has a long way to go down, and will not be hitting bottom by year end.  Well, which one is it going to be, Sir Alan?   Given the implications of the latter, it certainly can’t be both!  Perhaps that’s why Mr. Greenspan is requesting the press not cover his speech comments?

Longtime readers of VI know where we stand on the issue, but as of late your writers have been busy in our full time consulting business — the economy unfolding much as we predicted to many people we’ve talked to over the years has brought much interest as you can imagine.  That aside, though, updates like this one will continue as our schedules allow.

Currently we’re taking the approach that we’re now amid a sort of eye of the hurricane situation, with one glaring exception.   The eye of the storm is welcome to those enduring the prior chaos, but even though it might appear that the worst is past, there are still plenty of signs that all is not normal.   Usually the eye represents the half-way point for a hurricane, but in our economic case, our estimation is that we are fortunate to be about 1/3 of the way through.  Just consider the signs:

• Oil Record Smashed: $126 Barrel
• Citigroup Plans to `Wind Down’ About $400 Billion of Bank Assets
• Citigroup Leads Wall Street Drive to Punish Taxpayers in Auction-Rate Debt
• UBS’s Exit Strikes at Heart of Municipal-Bond Market
• UBS Set to Cut 5,500 Jobs After First-Quarter Loss
• Swiss Re First-Quarter Profit Falls on Writedown
• Legg Mason hit by first loss in 25 years
• Bad Investments and a $7.8 Billion Loss at A.I.G.
• Commodities Aren’t in a Bubble, Demand Key Factor, Economists Say
• Mortgage crisis seeps to prime loans
• D.R. Horton swings to $1.3 billion loss
• Property Mogul Poised to Take a Second Fall
• Americans unload prized belongings to make ends meet
• Credit crunch to claim 40,000 financial jobs
• Bankruptcies and defaults gather pace
• GE to stop financing boat, motor home purchases
• Doubts Raised on Big Backers of Mortgages
• Home lender ResCap facing cash crunch
• Economic Troubles Affect the Vegas Strip
• Tight Credit Worries for a Hotel and Mall Operator
• Tropicana casino group files for bankruptcy
• Las Vegas used to be a recession-proof oasis. Not anymore
• Key facts about U.S. April auto sales
• Auto dealers face tough road for second-quarter sales

Does this sound like a real “all clear” signal to you?  We’ve been hearing the calls of “the bottom” since the implosion hit last summer with Bear Stearns at the epicenter.  These calls keep coming from the people who failed to see any of this mess arriving, and are the same ones who’ve continually misdiagnosed problems since then.

Don’t count on these same rascals to correctly call anything, especially Honest Al Greenspan who is doing whatever he can to salvage his eroding reputation as the man who tamed inflation and the business cycle.  In reality, he merely compounded the distortions on both ends.

Recessions are like earthquakes — better to have the pressure relieved in many smaller releases.  In the real world, you rarely feel earthquakes since most are so mild.   Consider that the natural business cycle, where you have normal ups and downs. Only problem is the meddling policy maker find those not politically tenable while the banker finds their restraint terribly inconvenient, so in cahoots they inflate and create boom / bust cycles. Everyone loves the highs these injections give the economic addict, but nobody likes the abyss of withdrawal. And the abyss is deep.

Instead, Fed policy under Greenspan and now Bernanke is all about holding off any release of tension as long as possible.  In an attempt to sustain the unsustainable (overly inflated asset prices backing the entire Wall Street system) they’ll go back to the old inflationary tricks and rewrite the rules for the Fed without any Congressional authority.   The tension only compounds, and eventually the release will be much uglier thanks to their meddling.

We expect serious consumer pull back as more jobs are hacked in the face of tight credit. We also expect stagflation — the Fed, its Wall Street backers, and the Dependent politicians in D.C. will do what they can to punt this problem into some future administration’s lap. Problem is, they appear to have finally run out of rope.

Hence, as the eye of the storm passes, get ready for the worst 2/3′rds of it.

Stay Vigilant!

“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.

 Leave it to the British to hit the economy with such a bold declaration.  Granted, in the United States all policy makers are very fond of saying something to the effect that this situation and the subsequent policy reactions  are the most drastic since World War II.  World War II?  We think this is a polite way of saying “since the Great Depression,” while hoping folks won’t go all panicky on the situation as they load their bunkers and prepare for the worst.

Granted, contemplating the concept of “bunker” has been more or less what Vigilant Investor has been doing since April 2005 — which by the way, today marks our 3rd anniversary since going full bore on the internet. Prior to that we published to our client base only as the Ernharth Wealth Report discussing the emerging Great Credit Bubble with issues dating back to 2001.

But what of this Great Depression talk the British press had jumped on?  Let’s take a look.

We knew things were bad on Wall Street, but on Main Street it may be worse. Startling official statistics show that as a new economic recession stalks the United States, a record number of Americans will shortly be depending on food stamps just to feed themselves and their families.

Well… Of course this is an issue, but what’s new about food stamps?   So, it would look as if this alarming headline really does not address the issue of Depresssion and Unemployment in a more relevant fashion other than to lament for the poor … so we will address this issue briefly.  Is another Great Depression a reality?   Let’s start from where this article begins: with the unemployed — a figure that hit 25% during the 1930s.

America has slowly been subsidizing an underclass for decades.   One wouldn’t know this is happening using the official unemployment figures because,  as we’ve reported over the years, the unemployment stats published by the government have been so politicized that the chronically “not working” are simply removed from the official figures, categorized instead as discouraged workers.  Those folks are  not unemployed, since unemployed, you see, implies someone is actually looking for a job.  So, if you’re not looking for a job, you can’t be unemployed.  So you must be something else.  Discouraged perhaps?  Discouraged it is!

The last real figures calculated using older methods like those used during the depression put U.S. unemployment (meaning those capable of working and not) closer to 13% vs. the official number running dramatically lower.  And that does not account for the only employer with long term growth strength in the U.S. — the government, which has also done a slight of hand by hiring otherwise unemployed folks in various welfare to work schemes — reminiscent in its own way to FDR’s give a man any job routine.

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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…