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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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

That liberal (Maixine Waters) is all about wrecking the U.S. economy. Goes to show how politicians act like spoiled little children, and with very little understanding of economics.

Needless to say, if Maxine has her way, we may as well get into the rickshaw business.

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.

When your dealing with an addict, you don’t trust their word when they say they’re going in the right direction when they won’t even admit they have an addiction problem.

That’s the problem with our financial system. Consumers are addicted to credit and money supply expansion policies. Wall Street enjoys the comfy ability to profit from deals financed with money minted out of thin air. The banking system enjoys being able to profit from loaning and deal-making with the money you think is there in the bank, ready for withdrawal when you want it. (No doubt, those banks really love their 10% fractional reserve requirement and having the Fed a the ready bail them out with fresh cash when the de-facto embezzlement is revealed when depositors actually decide to withdraw their supposedly liquid money all at once, as amid bubble-bursting environments they’re wont to do.) And, of course, Washington D.C. loves having a secretive, privately held central bank finance its shortfalls. What politician won’t practically sell the sun, moon, and stars to win an election, to hell with the future generations that will suffer when the tab for said free lunch comes due? Just print the difference, and let some other sucker figure it out down the road.

And that’s the problem. Down the road is arriving leaving us with no good options. And, so, above we have Glen Beck and Ron Paul soberly discussing the issue the other primary candidates pretend doesn’t exist because the only realistic solutions are too controversial to assure victory among the masses of voters, who most assuredly have made it clear they much prefer having their ears anoint with yet even more impossible to promises delivered in language soaked in honey. As such, Ron Paul and Glen beck will be dismissed as they are always, although we’ll admit it is a good sign that at least Glen Beck is catching on.

Nonetheless, the addicts out there– voters included — consider Ron Paul to be among the Tinfoil Hat Wearing Crowd (a title which yours truly has been labeled a few times). So the system continues to conjure up more ways of getting our addict more of the junk he craves, and the Fed — the dealer who has steadily and stealthily pilfered over 95% of the dollars value since its creation in 1913 — stands ready to give the addict his fix.

The addict, no doubt, loves the party — the good times of the high. But even more desperately, the addict wants to avoid the pain of cleaning up his act and enduring the awful reality that is withdrawal. Addicts will sell themselves into prostitution, and worse, to avoid cleaning up. And so, too, our actors in our economy resist reality — choosing instead to prop up asset prices based in fiction — houses, condos, irrationally priced securities –, and systems rooted in fleecing dollar holders and those on fixed incomes for the benefit of the few. Addiction is a bitch.

But we all know, feeding an addiction is not the path to restoring health, and unfortunately our addicted economy is long in the tooth in juicing itself up into artificial cycle-highs and juicing up more in warding off cycle-lows. No doubt our addict economy has swooned a few times; recently it almost fell over during the 2000-2002 fiasco, but for the good fortune of Alan Greenspan standing on the corner telling everyone that he had the good stuff that would make everything OK.

And so the next bubble crashes — a big one — rife with dislocations so massive one wonders if this time the addict will be forced to face reality… or if he’ll make it through another bubble with another fix. If he gets back up to his old ways, I’d not be betting on his good fortune lasting long.

What of the Fed? Congress? The people? The cry for another fix has been heard loud and clear. Its just a waiting game now.

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…

We’ve been hammering on this long before we started Vigilant Investor in April of 2005. Our primary theme: The U.S. Economy has been operating on a false paradigm that would catch up to it and result in serious pain.

Yet now we learn that Moody’s — smarting from loss of credibility due to reckless ratings in the mortgage backed debt market, and scrambling to regain face without exacerbating the problems it helped enable — is warning the U.S. it needs to scale back its roaring costs of entitlement. Surprised? Not if you’ve been a regular reader of Vigilant Investor or read the Ernharth Group 2007 wealth report.

Yet many intra industry types have mocked us and those like us, smugly laughing off our warnings as ridiculous, which today only serves to indict the paradigm in which the majority of people have been operating. Some even said we were cranks because our warnings lacked economics degrees, which only serves to remind me of the admonishments 10 years ago from the mainstream press, that folks like Matt Drudge were implicitly unreliable because they lacked journalism degrees.

Here we are today with a great majority of the most pertinent news and analysis coming not from the mainstream press, but from alternative sources like ours!

Yet if you have any doubts, consider the mistakes of the popular pundits, economists, and policy makers:

1. They failed to grasp there was a housing bubble.
2. They dismissed that it would impact the credit markets, let alone the economy.
3. They asserted subprime problems would remain contained.
4. They believed the market plummet of February 2007 was a one off event, indicating nothing more serious.
5. They believed the subprime market was too small to be a contagion for the credit markets.
6. They were bottom feeding on mortgage brokers and other financial companies in March of 2007 under the banner “The Worst is Over”
7. They were doubling-down bottom feeding on those same stocks in August following the collapse in June and July that finally exposed the problem as very serious.
8. They were promoting soft landing scenarios in September 2007
9. They continue to promote “the worst is over” type assessments, believing Fed liquidity will solve the problem.
10. They believe, if any mistake was made, it was the Fed failed to come to the rescue with more liquidity in time to help out.

So, the question is, do you still believe them?

We admit we’re patting ourselves on the back, but we do so only to remind our readers that they need to seriously be thinking through this environment in the context that the majority of players have been operating under the delusions of a false paradigm.

How do we know? Continue Reading »

For your information, here is listing of relevant articles providing context for our fundamental economic environment…

Second wave of SIV liquidity problems looms

The funding problems for the structured investment vehicles (SIVs) that have been at the centre of this year’s liquidity troubles are far from over in spite of a number of banks stepping in to support their vehicles.

Retailers Face an Ominous Holiday Sign

Sales of women’s clothing, a traditional pillar of the holiday shopping season, are unusually bleak so far this year, according to a major credit card company, an ominous sign for the retail industry.

Single-family housing starts hit 16-year low

Housing starts fell 3.7 percent in November, with construction of single-family homes sliding to the lowest level in more than 16 years as builders scrambled to cope with a deep drop in sales.

Grocery Bills and Energy Costs to keep growing

Cost of cooking at home expected to rise by up to 4.5% next year. Meanwhile, the Energy Information Administration forecasts a 17.7 percent jump in crude oil prices next year, with a corresponding 10.7 percent boost in the price of a gallon of regular gasoline.

Southern California Home Prices Tumble in Nov

The median home price in six Southern California counties plunged 10.3 percent in November, marking the biggest annual drop for any month in 20 years, a real estate survey said Tuesday.

U.S. Corporate Defaults to Quadruple as More Companies Cut to Junk

U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003.

You know everyone is thinking it – so there, we asked it!

In an era where the world’s most famous supermodel insists on being paid in Euros (not Dollars), and rap stars flash Euros vs. Greenbacks – it’s a logical question. Especially when you consider that Gold/Silver backs NO government currency on the planet, and that as the U.S. continues to export inflation by printing/degrading the Dollar – foreign nations will follow suit to protect their exports, etc. In other words – ALL paper money is becoming more worthless by the day.

As OPEC nations meet, they discuss among other things, skyrocketing production costs. We also learn sentiment exists that OPEC has lost the ability to lower prices by increasing output. How can this be? Sure, demand has increased dramatically over the decade. However, we think the primary reason is that prices have a long way to go to accurately reflect the massive (and continuing) increase in the global money supply. In other words “real inflation” – not the bogus, rigged figures central bankers use.

Hey, say what you will – rap stars and supermodels are up on the latest trends. As soon as they catch on – they just won’t be wearing their bling – they’ll be getting paid in it. Either that, or they’ll be converting whatever “paper” they are getting paid in as fast as they can into Gold and Silver. It doesn’t take a genius to figure out what widespread behavior like that will do to the price of the precious metals.

As always – opportunity knocks!

Our long–term readers know we have continually cautioned about serious economic consequences to come. Not because we’re “doom and gloomers” – but because we feel the best way to take advantage of the truth – is to first acknowledge it. Our opinion has been that when these truths gain increasing acceptance – the full brunt of their effect will soon to be felt. While those in the mainstream conventional camp have long been in denial over unpleasant, troublesome, displeasing economic facts (i.e. the truth) – things are beginning to change.

In today’s New York Times, Bob Herbert writes an “on the money” op-ed titled, “Recession? What Recession?” In it he describes increasingly looming economic eventualities we have long warned about – and he does not sound optimistic – at all.

We feel the consequences of unhealthy, dysfunctional economic policies will, for the uninformed – and those in stubborn denial – have sadly devastating effects. One being their savings & purchasing power inflated into oblivion. However, for those who acknowledge the truth – and act appropriately — this is a time of incredible opportunity.

The window is closing. The boat is pulling away. There is still time. Are you prepared?

The short-term credit markets took a blow with the announcement yesterday that the liquidity troubled Cheyne Finance fund would seek protection. While still filled with cash, the fear is — as is so common among all players riding the Mortgage Backed Security (MBS) high wire — that it would be forced to put assets for sale to be marked at prevailing market prices.  Such would start a cascading series of margin calls, moves to convert to cash, etc.

Rather than come clean under current conditions, major players are hoping the credit market will fix itself by becoming fluid enough again to support mortgage backed security values closer to 100 cents on the dollar, which is typically how they had been held on the books via mark to model assumptions when leveraging up.   They’re they were marked — up until the credit crisis was exposed at Bear Stearns in June. This hope-and-a-prayer approach is all the more like a Hail-Mary football pass given so many players used leverage upon leverage when investing in these assets.  A contraction  of easy credit to support those values is Kryptonite to their once Super Human returns. Continue Reading »