The State Bailouts Continue

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

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

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

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

ECB will sterilize bond purchases. Right.

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

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

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

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

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

In for a penny

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

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

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

Here Comes the "Liquidity"

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

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

Gold Says Bad Inflation This Way Comes.

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

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

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

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

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

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

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

The Fiat Money End Game

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

Regarding the IMF/EU bailout of Greece:

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

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

On why governments choose inflation:

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

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

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

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

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

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

Get Ready for QEII: Bernanke Strikes Back

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

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

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

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

Finally, A Sign of Deflation!!!

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

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

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

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

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

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

Saudi Oil Exports Will Start to Decline.

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

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

Iron Ore Producers Threaten to Cut Supplies

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

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

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

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

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

The Wall Street Journal notes commodity inflation.

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

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

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

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

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

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

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

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

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



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

Now it gets interesting.

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

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

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

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

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

Questions I'd like to ask Ben Bernanke

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

America’s Economic Recovery Is a Rotten Sham

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

America’s Economic Recovery Is a Rotten Sham

Well said, Mr. Little.

State Bailouts are in Full Swing.

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

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

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

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

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

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

Inflation Update: Sunday 4/18/10

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

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


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

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

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

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

BRIC Leaders Explore Regional Monetary Arrangements.

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

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

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

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

The Housing Crisis is Over

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

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

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

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

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

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

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

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

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

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

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

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

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


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

Slouching towards Zimbabwe.

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

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

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

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