Vigilant Investor

“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.

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…

“Silver and gold, silver and gold
Everyone wishes for silver and gold
How do you measure its worth?
Just by the pleasure it gives here on earth!”

– Yukon Cornelius from “Rudolph the Red Nosed Reindeer”

Ah memories…Good old Yukon Cornelius from the classic, “Rudolph.” He certainly was a man who understood the value of real money. You’d also think he was reading current headlines.

Today we learn that GM posted a $39 Billion quarterly loss. Does this surprise us? Is George Bush going to win an eloquence contest? We’ve been warning about it for years. What else could an objective person expect from an industry, which for the better part of this decade has been accelerating purchases, which would normally take place in the future — via excessively low interest rates. Well — the future is now! You eat your seed corn – you’re going to go hungry down the road – maybe for a while. We smell lower interest rates – and an increased money supply (more inflation).

We also learn that several of the biggest and well known Wall Street banks and brokerage firms may be in MAJOR financial trouble. These firms — who took sub-prime mortgages — sliced, diced, and packaged large amounts of them into bonds, which they sold – and large amounts, which, they kept — are getting shellacked as mortgage defaults accelerate dramatically. While major losses are being announced – no one really knows how much a significant portion of this underlying sub-prime debt is really worth. Losses are estimated to end up in the hundreds of BILLIONS. We smell a major bailout – and an increased money supply (more inflation).

If that isn’t enough – today the Chinese announced they are getting ready to diversify out of the Dollar due to it’s continued plummet in value (hint, hint — due to inflation). Can’t blame them the Chinese – we think the Dollar – like all paper money — is going significantly lower against all things. It will be interesting to see what they buy. We think we have a pretty good idea.

Yes, that Giselle Bundchen is not just another pretty face. The supermodel is no longer accepting payment in Dollars. The Dollar is losing its status as the world’s reserve currency. However, since the rest of the world is also significantly inflating their currencies – we think Giselle will soon be heeding the sage advice of Yukon Cornelius. She’ll then be getting paid in real money.

“And you can kiss it Goodbye!”
— Former Pittsburgh Pirates broadcaster, Bob Prince

The legendary Bob Prince would utter that call, as Pittsburgh Pirates hitters of a bygone era would knock ‘em out of the ballpark. Today, you can say the same thing about your U.S. Dollar.

After the drubbing the markets took at the end of last week – things seem unlikely to get better. To be honest – odds are they will get a lot worse. The well-established housing slump continues its nosedive. Job losses seem poised to mount. President Bush has directed the FHA to guarantee loans for delinquent borrowers (a massive bailout). Foreign ownership of U.S. government debt is dropping. Nobody knows what time bombs tick regarding mortgage-backed securities, as massive amounts of adjustable mortgages begin to reset.

And — what we have long warned about – is in no uncertain terms, coming to pass. The Dollar is getting crushed.

The Fed – along with U.S. policymakers are stuck between a rock and a hard place. The lowering of interest rates to re-stimulate the credit based American economy would certainly have an inflationary effect. A bailout of mortgage borrowers & lenders (via money printing) would also. Not only would a further acceleration in price increases be the result of such policies – so would the continued degradation of the value of American savings. Even more disconcerting is the potential that foreign lending to debt addicted America would continue to dry up at an extremely quick pace. (Why get paid back down the road with far more worthless Dollars)? Like all bad creditors – the U.S. may soon be required to pay a higher cost (interest rates) to continue borrowing. And that is never good for the bottom line.

So – will U.S. policy makers swallow the necessary bitter medicine? Will they let more hedge funds sink? Will they not bail out Wall Street. Will they let homeowners who got themselves into ridiculous, unrealistic mortgages either tighten their belts and cut spending in other areas – or become renters again? Will they let home values sink to more realistic levels? Will they watch the cleansing effects of a recession (caused by the artificial bubbles they created) take its course? Will they let the Dollar fundamentally strengthen?

Or will they try to take the easy, short-term solution way out – by greasing the wheels via the easing of credit and printing of money?

We predict the latter. But they are running out of rope.

Kiss that Dollar Goodbye!

…A whole lot of liquidity.

Last week was ugly, but not unexpected. After what could just be the beginning of the long awaited market correction due to the unwinding credit bubble – we think the cavalry will ultimately come to the rescue. To be precise, a more modern cavalry. The kind that comes in helicopters – and drops a whole lot of money. While we wouldn’t be surprised to see the Dow drop to as low, or lower, than 12,000 – we are confident that “Helicopter Ben” Bernanke will fire up the engines. In the process the Dollar will be sacrificed.

Over the past several years, we’ve been writing about the dangerous effects, and false hopes, created by the massive expansion of liquidity. The average person couldn’t really explain why the price of their home (and portfolio) was going through the roof. Or why their grocery bill and the price of a cup of coffee steadily keeps rising. And why their paycheck, in general, just isn’t going as far. The reason obviously is one and the same. Simply, record levels of credit (much created out of thin air) injected into the economy is the culprit. Today, Americans (and the world) now begin to overtly learn the painful lesson that printing money does not create wealth. That an economy based predominantly on credit, will need more and more credit to keep it going. And that in the end – all this newly created money significantly (and steadily) dilutes the value of a currency – along with the hard earned savings of every investor. Like a junkie needing a bigger and bigger fix — the ending is often a sad one.

We don’t think the Fed will stand by and watch U.S. stock markets drop to zero. Nor will it sit by idly and watch the economy grind to a halt. If the upcoming weeks and months do in fact continue last week’s trend – the increased amount of liquidity could be dramatic. As could the decrease in the value of your dollar.

We’ll keep you posted!

As the equity markets continue to launch through the stratosphere — we have to step back and marvel. Friday’s Dow closed at 13,556 – posting gains for the seventh week in a row. (Heck, another 400 points or so and the Dow will again reach its inflation adjusted high from 2000)! Fueled by buyout fever, stock markets climb ever upward — and it appears no news is capable of changing their trajectory. Not record levels of debt, record budget deficits, massive trade deficits, negative personal savings rates, a bursting housing bubble, sub-prime mortgage woes, rising real inflation, slowing consumer spending, rising consumer credit, rising energy prices, a slowing economy, weakening dollar, and to quote Yul Brynner from “The King and I” “Etc., Etc., Etc.!”

Is this all madness? It depends on your definition of the word. In our opinion the answer is no. There is a logical and easily understandable explanation. It’s simply massive amounts of liquidity (much of it leverage/debt) being injected into the financial (and other markets). The reason the Dow sits at 13,556 and housing prices skyrocketed until recently — is also why gas, oil, and basically everything else is becoming so expensive. Simply put, if we were all playing Monopoly and decided to inject massive liquidity into the game – the price of Park Place and everything else on the board would soon skyrocket. It would not surprise us to see the markets continue their upward march. 20,000 Dow? Who knows! If the Dow does hit such a level, don’t be surprised to also see a $40 Pizza, $5 Cup of Coffee and $12 Beer.

Continue Reading »

“Never spend your money before you have earned it.”
– Thomas Jefferson

It’s been said that the stock market climbs a wall of worry. More aptly, it ought to be said that the longer the Bull – the more it is presumed that stocks, and the economy are invincible – and what would otherwise be bad news can largely be ignored. We, of course, don’t buy into this mindset – while it seems today that most investors (and the financial community as a whole) – do.

We’ve also always believed economics is far from “rocket science.” While Wall Street would have you believe it is a mystical, complex, study – we think it is in actuality, quite simple. If you understand your own personal, economy as an individual – you basically understand the concept of economics pretty well. Don’t spend more than you earn. Don’t go heavily into debt. Save money. Realize that you can’t spend yourself into prosperity, etc. And, if you hear or read things from “pundits” telling you that practicing the opposite of these basic concepts on a national or global economic scale are good things – don’t believe them!

For example, Americans have been encouraged to continue spending. They’ve been told that it’s good for the economy. We ask, how is that good for the average American, when his/her personal savings rate is negative? When the average Baby Boomer has total savings of around $50,000? Ask yourself, if you have minimal savings, are currently not saving, and are going increasingly into debt – should you cut your spending, pay down your debt, and start saving more – or should you continue down the same path your are on? Come on!

What’s really alarming is that the credit based U.S. economy cannot afford to have the average American to get his financial house in order. That’s right, this economy is running on fumes as is – and it is largely dependant on the strung out, debt laden, savings poor American consumer continuing on. If the average U.S. savings rate actually went anywhere near it’s historic level of 10% (from the current minus 1%) — the economic slowdown would be severe. Actually, even a climb to a 5% average savings rate would still have a devastating effect. This is what it’s come to. The U.S. economy has become so dependant on leverage — that a return to sanity (savings) would likely cause an extremely painful re-calibration. For an analogy, think of an addict going through withdrawal. The end result is a return to normalcy – but the journey to that place is painful.

That said, the junkie here (American consumer) is still hooked on his drug of choice – credit. The ballooning money/credit supply has allowed him to spend via zero percent financing for automobiles, cheap mortgages, and home equity extraction — all of which have artificially driven the economy over the past several years. But now he’s getting tapped out. The high is wearing off, and he needs another fix. He can’t get his home re-appraised at a higher level to extract more “equity” because prices are falling. He has no savings. So he turns to the lender some would consider one step closer to loan sharks – the credit card companies. (If you think the comparison to loan sharks harsh – what would you call lending to people and charging them interest rates from 10 to 30+ percent)? In 2006, revolving credit in the U.S. increased 6.5% (doubling the prior year’s increase). Last week, MasterCard announced that their first quarter profit jumped 70%.

Again, it’s not “rocket science” to see where this trend is heading. The endgame doesn’t look pretty.

The latest data released today shows that the New York Fed’s Factory Index stays near a two-year low, Japan’s export stocks rise, and China’s economy grew at a 10% rate last quarter. American retail sales are up, and the savings rate lingers around zero. All the while, total U.S. Credit Market Debt is at an all time high.

Translated – Americans are either spending all the money they earn (or can borrow) – and it does not look like they are buying many things made in the U.S.

The U.S. Homebuilder Confidence Index falls to the lowest level of this already terrible year, and U.S. homes going into foreclosure have doubled compared to the first quarter last year.

Translated — People who build homes aren’t feeling too good about their business prospects. They shouldn’t – since the housing backlog is about to increase as lenders are forced to put more homes back on the market which they have foreclosed on – while at the same time they tighten their lending standards.

Gold breaks through $690, Silver $14 an oz. Both precious metals (i.e. real money) – look to break key price levels. Oil stays resiliently above $60. Prices in the supermarket and at the gas pumps are increasing steadily – and picking up pace. The Fed is concerned about the economy slowing – yet per the recently released minutes from its Open Market Committee meeting, perhaps more worried about rising prices.

Translation: Unlike the classic Mullet Hairstyle (Kentucky Waterfall, Tennessee Top-Hat, or Hockey Hair — depending on your preference) – which is all “business up front and party in the back” – the massive amount of credit infused into the economy is just the opposite. As a nation, we’ve had the “party up front” running up the tab — but now we are forced to confront the rising prices and other serious consequences, which are part of the “business in the back.”

More key economic data to come this week – and of course, we’ll be happy to tie it all together for you in simple, plain English

“Those who do not know history are doomed to repeat it.” Yes, that phrase is a cliche and overused. I’ve always liked Mark Twaine’s read on it: “History doesn’t repeat, but it sure does rhyme a lot.”

Whichever you prefer, we talk day in and day out here at Vigilant Investor and on our Podcast about the serious problems of the economy and, especially, the dollar. To understand what is in store for the dollar and how it has been made possible, you need to understand the context of the dollar in history. Most importantly, you must understand the present nature of banking and the private central banking cartel that manages the system, called the Federal Reserve.

The video above tells the story. I cannot stress how important the subject matter is for all to understand in the context of the vigilant investing of all things: your money, time, votes, family, business, etc, etc. Take 41 minutes out of your day and learn why.

Don’t have time to watch it now? Dowload it here, and upload it to your iPod for your next commute, run, plane ride, etc. There really is no excuse!

Stay Vigilant!

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See you Friday!

That’s right. Tonight’s 9:00 p.m. (ET / NYT) show is our final Wednesday nighttime show. Starting next week, we’re moving to Friday’s at 3:20 p.m. (or so) for our hour-long version of V.I. Live.

In the meantime, there’s still tonight’s show! We’ll be discussing recent development, the market and economic environment, as well as history and politics. Listen, chat, call in and participate! As always, for the details click on our Talkshoe link below. Arrive early to download the Talkshoe chat interface.

As for next week’s hour program, tune in Friday, December 22, at 3:20 p.m. ET (-5 GMT), live around the world! That is, of course, if you’re not already in your car driving to your relatives for Christmas. If that’s the case, make sure to subscribe to our podcast via iTunes where the show downloads automatically. That includes both our weekly show and our daily 15 minute updates. Downloads are usually available 60-90 minutes after show time. Just plop us on your iPod every a.m.

While most in the U.S. were relaxing with their feet up for the Thanksgiving holiday, the rest of the world hammered the dollar downward this past Friday. Today, the Dow Jones Industrials had its worst day in four months, shedding 158 points as the dollar continued its fifth-straight down day, hitting a 20 month low against the Euro.

When the Dow plummets 150 points in the face of a sudden dollar capitulation, we wonder if the gig is finally up. Odds are that the crack is not yet here, but when you follow the macro fundamentals that we do as students of the Austrian School of Economics, you know a plummet is a distinct possibility since the U.S. economy itself is a house of cards with a gargantuan credit-bubble as its foundation. The likelihood of a serious correction in equities, at least, is only increased by the abject indifference from a majority on Wall Street and Main Street, as affirmed by numerous sentiment indexes showing record-high bullishness, and further noted by the near record lows on the VIX.

Vigilant Investor regulars know most of the backdrop to this unfolding story already, but you too will enjoy some timely pieces that have hit the wires in the last couple of days. Neither should go unread, and both should be forwarded to friends and loved ones with hopes that readers will start to rethink their core assumptions.

The first piece is from an Austrian School pro, Sean Corrigan,” Commodities, Crises, and Cycles“:

Albert Hahn once referred to this phenomenon of ‘inflation without inflation’ as being the most dangerous type of all, since it was almost guaranteed to lull policy makers and financiers into the most enormous of errors.

But, of course, despite the fundamental lack of equity involved, the masses have been taught to clamour ceaselessly for a regime of easy money, for this gives rise to the illusion of ‘making bread from stones’ - as Keynes, the most persuasive modern advocate of this fateful ruse, once put it.

Easy money is popular because it fosters a period of feverish economic activity through lowering the rate of interest well below the level which would serve to match the supply of genuine savings to the demands arising from the most compelling entrepreneurial investment schemes in strict sequence of their merit.

When money is easy, many more undertakings can be launched than are strictly warranted by the resources available.

This gives rise to the intoxication of a boom for so long as we can defer the crucial question of how all this will be funded - that is, supplied with the necessary real resources - as opposed to merely being financed; that is, furnished with the extra, fraudulent credit needed to contend for an unaugmented pool of such scarce resources.

Live now, pay later

A great part of the appeal is that, with no-one having to undergo the rigours of conscious abstinence today in order to provide for a greater plenty tomorrow, inflation is a means of burning the candle at both ends - of living a gloriously indulgent Rake’s Progress.

Inevitably, what is consumed in the flames which illuminate the revelry is nothing less than hard-won capital. It is only later, when the taper gutters and goes out, that the true extent of the impoverishment which has paid for such a Bacchanal is fully revealed.

Frustratingly, the date of that day of reckoning cannot ever be predetermined - a fact which makes Cassandras of those of us who tend to fret about its inevitability.

The last point resonates with many of us sounding the alarm, to no avail.

Our other snippet is from a better known hedge fund contrarian, Bill Fleckenstein, in his most recent Contrarian Chronicles, “The upside-down logic of Wall Street“.

“Part of me thinks that the current mini-mania in equities is a response to Fed-induced liquidity. And yet, when I discuss with my good friend Jim Grant what the big central banks of the world are doing — Japan’s, the United States’ and Europe’s — he suggests that they really aren’t spewing out liquidity as aggressively as people think. Of course, if they were, one might expect commodities to be on more of a run than they have been. To me, they seem to be suggesting that the world economy is slowing down at the margin.”

Therefore, I’ve concluded that what we may have is the illusion of a liquidity fest. The stock market is acting as though there’s an enormous fire hose of liquidity gushing forth — when, what might actually be the case, is that a wanton derivatives/credit/lending mania is in full force.

Markets in motion may stay in motion. If, however, the source of the propulsion is mispriced and badly structured credit, things can come to a sudden stop. But if that were to occur, the Fed at some point would ride to the rescue with plenty of liquidity. That is Marc’s point and is, of course, the point of my pet saying that in a social democracy with a fiat currency, all roads lead to inflation.

Again, please read both pieces noted above. Together they will get you up to speed on why playing the consensus curve at the moment might cost you. While the herd may be totally oblivious or disdainfully indifferent, vigilance will pay off in the long run.

Officially understated inflation is starting to gather pace. CPI and PPI numbers both showed increases, and today’s Treasury Market would appear to be reacting to the news rather badly.

As we’ve been saying for some time now, we are very likely in a recession, and have been for some time - even if the official, statistically manipulated numbers have indicated otherwise. The market is only finally beginning to digest the reality that inflation - even when measured by core CPI - is on the rise. With other recent figures, an economic slowdown would appear to be gathering as the economy gravitates towards the inevitable inertia that follows unsustainable activity gained from ginned-up money supply and loose credit.

The economy has become addicted to that rise in liquidity, and like any addict, the initial dose eventually loses its punch. More of the addictive substance is always required just to get the same, initial high feeling. Eventually, the addict needs more and more, but the longer it goes, the more damage it does to the addict - and in our analogy, that’s the economy.

The Fed realizes the predicament. It is the dope dealer in this story. The Fed - a cartel of large banking interests - mints money out of thin air into the financial system, with much of it loaned via its banking buddies on Wall Street. Those banking interests take a fat cut of each as it passes through. When you are talking trillions of dollars in the system, that’s a profitable business to be in, especially when creating new dollars merely involves adding a few digital numbers into a computer. Continue Reading »

So much in the U.S. economy has been dislocated thanks to the asinine monetary policy being run by the Fed with full support of conventional economists. By dislocated, we mean our finite wealth resources — our capital stock of savings — has been artificially knocked out of its natural place. From that, we can infer that efficiency of utilization has declined, and resources have been wasted. How you weigh the consequences depends on if you are considering from the U.S. perspective or a global perspective.

Now, first time readers of Vigilant Investor may be asking, why is this important? Why should I care? The answer is simple: if the assumptions upon which your investment valuations are based are faulty, it implies that eventually once the market sorts that information out, their will be a correction.

Some might respond, but are the markets not supposed to be efficient? After all, is that not what we are told by modern asset allocation theory, from Wall Street, to Main Street, all the way to mainstream consumer magazines, and on to “Saint” John Bogel of the index heavy Vanguard Fund family?

To that we would respond, at best markets can be efficient only on average, keeping in mind that “average” does not mean “always”, although much of the retail investment industry acts as if the averages apply to everyone and all circumstances. We have come to often refer to this as “What, Me Worry? Syndrome”.

Of course, we are not alone: Warren Buffet once observed Continue Reading »