Au Contrarian

Transparency Has Landed

2012-01-29T11:49:00.001-05:00

See Frederick Sheehan's Interview on

"The Larry Parks Show" (Janurary 12, 2012)

Federal Reserve Chairman Ben S. Bernanke has finally achieved his childhood fantasy. He has passed into existence (note: not law, regulation, or any other formal apparatus that cannot be ripped from his bodice by the People's Representatives) a policy of achieving 2.0% inflation.

From a January 25, 2012, Federal Reserve press release: "The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate." (For the prelude to his ploy, see: "Presidential Rivals: Drop the 'One Percent.' Trumpet the 'Negative Four Percent.'" and "A Quartet of Fed Chairmen Body Slam Bernanke.")

"Personal consumption expenditures" are calculated by the Commerce Department. They have been rising at a 1.7% annual rate. This must be why the ad lib policymakers at the Fed drop-kicked the CPI (consumer price index, calculated by the Bureau of Labor Statistics) into the Potomac, since it is rising at a 3.0% annual rate. The pilferers might still have chosen the CPI, after dropping food and energy: a measure Chairman Bernanke often talked about. The ex-food, ex-energy CPI rose at a much-closer-to-target 2.2% over the past year.

Whatever the Fed's reasons for siding with personal consumption expenditures, the BLS states (in its December Consumer Price Index Survey) that food prices rose 4.7% over the past year. Dairy and related products rose 8.1% in 2011. From the American Petroleum Institute: gasoline prices have risen 9.5% over the past year. McDonald's announced on Tuesday that it is increasing prices again - it did so three times last year - due to higher costs. That probably includes transportation. The recently released Cass Freight Index (through December 2011) noted that North American freight costs "were up an astounding 18.8% against an increase in freight volumes of only 0.7%."

After the Fed press release, Burglar Ben held a press conference. This is part of his "transparency" ploy. Among other oddball comments, the math whiz claimed: "At levels of inflation this low, interest rates should fully compensate for the losses to savers." To approximate, current savings rates in the United States are about 0.0001%. The Fed's press release left a clear path for someone to bludgeon the Bernanke Fed. (Nobody will, but we can pretend.) From the aforementioned press release: "The inflation rate over the longer run is primarily determined by monetary policy...." Monetary policy is in the hands of a man who cannot subtract.

It is slowly becoming clearer that Alan Greenspan should be warming up in the bullpen.

A Quartet of Fed Chairmen Body Slam Bernanke

2012-01-20T07:47:00.004-05:00

This P.R. release barely needs comment. For the purported "transparency," see "Presidential Rivals: Drop the "One Percent." Trumpet the "Negative Four Percent."" "Presidential Rivals" quoted from a strategy session at which the FOMC [Fed Open Market Committee] gathered a consensus to not tell a soul outside the temple that it would officially adopt a policy to create inflation (i.e., "Inflation Targeting"). The Federal Reserve does not command the authority for this "transparent" maneuver.

Previous Federal Reserve Chairmen were dead set against the idea of any inflation. Back in those days (Before Bernanke), "stable prices" meant no inflation. (That every Fed chairman quoted below failed, and some failed terribly, to accomplish this mandate, should be seen as a warning of what will happen now that the Fed is determined to create inflation.)

How did we arrive at this point? The central banking industry has turned what we know to be true upside down. For instance, Bernanke preens about the advances of the science of macroeconomics, yet, no previous Federal Reserve chairman even mentioned the need to give himself a two or eight or twelve percent inflation cushion to prevent economic implosion.

In what follows, former Chairman Martin explained exactly what the "99%" should know. Their beef is a direct consequence of the very policy that the Federal Reserve will now enshrine in its "goals and strategy." Former Chairman Volcker was dismissed by the current generation of central bankers when he encountered their Orwellian distortion of the term "stable prices." Former Chairman Greenspan's comments of the Fed's forecasting record ("terribly discouraging") should alert readers to sell dollars and buy things: gold, silver, land, canned goods.

Fed Chairman William McChesney Martin (1951-1970) has been quoted here before. His Senate testimony on August 13, 1957, was a particularly fine diatribe. He was fighting a losing battle against Harvard economists who told politicians we needed an inflation rate of 2% to compete with the booming Soviet economy.

Martin warned the Senate Committee on Finance that recent inflationary pressures arose from strong economic growth fostered by "'imbalances in the economy' in which 'rising costs and prices mutually interact upon each other over time with a spiral effect.'" Martin went on. The person most likely to be injured in the inflationary cycle was the "'hardworking and thrifty...little man' on fixed income who could protect neither his income nor the value of his savings." Harvard and the senators had other priorities (themselves), but this is a condensed History of the United States in the 55 Years That Followed. (The conquest of the 99 %.) Regarding the target of a 2% institutionalized inflation rate, Martin said: "[Two] percent may not seem startling [but] the price level would double every 35 years and the value of the dollar would be cut in half each generation. Losses would be inflicted on millions of people, pensioners...all who have fixed incomes.... [T]hose who would turn out to have savings in their old age would tend to be the slick and the clever...."

It can at least be said the current Federal Reserve understands who wins and loses when the Fed stimulates inflation. Current New York Federal Reserve President Dudley talked up asset inflation on October 1, 2010. In the first sentence (ahead), the former Goldman, Sachs economist describes the "spiral effect" of irresponsible money-making before the bankers were bailed out. The second sentence addresses consequences to the "little man." Sentence #1: "The surge in home prices was fueled by products and practices in the financial sector that led to a rapid and unsustainable buildup of leverage and an underpricing of risk during this period." Sentence #2: "These dynamics in turn provided the fuel that caused house prices and consumer spending to rise much faster than income."

Federal Reserve Chairman Arthur Burns (1970-1978) was a "no-percenter." Leading up to the 1960 presidential race between John Kennedy and Richard Nixon, MIT economists Paul Samuelson and Robert Solow argued in favor of "moderate levels of inflation." In his 1959 presidential address at the American Economic Association Conference, Burns chided this politically opportunistic position by declaring any inflation was untenable. The M.I.T. professors, and inflation, won. Solow was one of Ben S. Bernanke's Ph.D. thesis advisers.

Federal Reserve Chairman Paul Volcker (1979-1987) bemoans today's central banking incumbents. At the spring 2006 Grant's Interest Rate Observer Conference, Volcker told the audience the upstarts were a puzzle to him: "A great mantra of central bankers these days is 'inflation targeting.' I don't understand that nomenclature. I didn't think central bankers were in the business of targeting inflation. I thought we were supposed to be targeting stability. We all say we are in favor of stability. You hear these speeches, Bernanke saying 'We are in favor of stability. That is why we are targeting inflation.' There is a certain semantic problem for me in that connection."

Volcker went on to say he had returned from a central bankers' synod in Frankfurt, Germany. On the topic of inflation targeting, he believes he was the only dissenter in the room: "The debate was me on one side and all of the central bankers on the other side." It was explained to Volcker "the importance of inflation targeting was to never go above that. There was an ironclad agreement to keep the inflation rate below that or below the target." This is nonsense. The professors will never be wrong. They have prepared for 2, 4, and 6% inflation. The "literature" (Bernanke loves to say that) has been peer-reviewed and published.

Volcker also told his audience: "I can remember my old professors at Harvard, in 1951 or so, saying a little inflation is a good thing. 'We don't want very much, but 2% is good.'" Chairman Martin addressed the 2% target in his August 13, 1957 testimony: "There is no validity whatsoever that any inflation, once accepted, can be confined to moderate proportions." Martin was thinking of an intelligent person or shrewd FOMC: Either was doomed. That is not the case today. Martin could not have imagined the existence of a Bernanke.

Adam Posen, one of the co-authors, along with Ben S. Bernanke, of Inflation Targeting: Lessons from the International Experience, believes inflation rates of "4, 5, or 6 percent a year, say, will [not] hurt growth. It is just not there in the data." He went on to say (in Challenge, July/August 2008) that researchers have found once "you get to an annual inflation rate of 10 percent - some would say 8 percent, some people would say 12 percent," you "begin to see significant negative effects on growth." This is all too stupid to discuss, but Posen, an American, is now serving on the Monetary Policy Committee of the Bank of England. Why? Is it only American universities that produce ideas so bad they are needed around the world to inflate paper currencies out of existence? (Another of Ben Bernanke's MIT thesis sponsors was Stanley Fischer, also an American, who has been shipped off to run the central bank of Israel. Israelis are hereby warned: gold and canned goods.)

Three years after speaking at the 2006 Grant's Conference, Paul Volcker told the New York Times the Bernanke Fed "is not really in control of the situation."

Now we turn to the Maestro: former Fed chairman Alan Greenspan (1987-2006). At the February 1-2, 2005, FOMC meeting, he opposed inflation targeting. The transcript has the ring of Paul Volcker's séance in Frankfurt. The younger generation of central bankers, who now monopolize the debate, had spoken. Greenspan, always the gentleman, did not say they are up after their bedtime, yet they are.

CHAIRMAN GREENSPAN: I don't see how we can define a specific number for price stability....and the reason is that inflation targeting presupposes an ability to forecast, which I don't think any of us have, or can have." [The obvious question here, oh, forget it. - FJS] "The vast majority of examples we are going to run into, if we go to inflation targeting, will be cases where suddenly price inflation is at the outer edge of the target, or indeed, has actually breached it - and other evidence on the underlying trends in inflation is not clear." Greenspan went on to say the Fed may see "contrary notions," meaning, indicators that inflation is both rising and falling.

The chairman who was never Time's Person of the Year continued: "Now, one of things we always forget, looking back, is how little we knew at the time things were occurring or about to occur. When I read the transcripts of earlier meetings, I am surprised, because I thought we were really knowledgeable about what was going to happen. Something happens and I say to myself, 'Well, we got that right; our forecasts were terrific and our insights were great.' When I go back and read the transcripts, I find that it just isn't so....Go back and read the 1979 transcripts....I found reading those transcripts terribly discouraging. My view of the extraordinary institution of which we are all part fell about 20 percent because some of the comments being uttered around this table were absolute nonsense. If you go back to October 1979 and read the transcripts from that time on, you will see how little everybody knew or thought they knew...."

It was on October 6, 1979, with consumer price inflation rising at a 12% rate, that Federal Reserve Chairman Paul Volcker announced the Fed would no longer peg interest rates, specifically, the fed funds rate. The FOMC would concentrate on controlling the supply of money. Looking back, Volcker's decision was correct. On October 6, 1979, the funds rate bounced within a target range of 11-1/4% to 11-3/4%. Cast loose, it rose to a monthly average of 17.6% in April 1980, fell to 9.0% by July, and traded at an average rate of over 19% in June 1981.

Greenspan continued: "I don't wish to downgrade the importance of the actions taken. They were tough and they were the right actions. But to presume there was great intellectual control over what was going on is completely undercut by reading the contemporaneous transcripts. That's just the way we are. We have a recollection of what we did which is, unfortunately, fictionalized. I've been in this business for too long!"

The Fed's genius for always being wrong is not a revelation to readers of Panderer to Power, but: Why does the Federal Reserve employ a single economist? It should stick to funds transfers.

Of course, Bernanke had never made an economic forecast in his life until he was chosen as Fed chairman, yet his economic predictions are televised and quoted and move markets.

Legendary investor Jim Rogers was interviewed on TV in May 2011. The interviewer asked Rogers something (long since forgotten) about a recent Bernanke forecast. Rogers, fuming that he (or, probably, anyone else) should be asked to analyze Bernanke's prediction, replied: "This guy Bernanke - YOU should do an expose - You should go back and just - EVERYTHING he said for eight years was wrong! It's astonishing....He's a great contrarian indicator!"

It is clear that Ben S. Bernanke has never given a moment's thought to the possibility his accommodating and manipulative policies may demand a similar decision to Paul Volcker's in October 1979. Nor could he possibly orient his mind to acknowledge that today's economy will react more violently. By the fall of 1979, interest rates had gradually risen for close to three decades. Today, floating rates would either (1) crush an economy dependent on low, low, low rates, (2) pass 19% about 10 minutes after the change in policy, or, first (2), and then (1).

A practical question: how can anyone really "invest" with government conduits around the world attempting to control every market: a mad hatter's scheme that is doomed, that has established price corridors convenient to a bureaucrat, will snap back in a vicious manner, but at an unknown time?

Chairman Bernanke was interviewed on "60 Minutes" on December 5, 2010. When asked with what degree of confidence he could prevent inflation from getting out of control, he replied: "One hundred percent." In 2008, the Chicago Tribune quoted globetrotting economist David Hale. Bernanke had told Hale: "We have lost control. We cannot stabilize the dollar. We cannot control commodity prices." In an earlier (March 2009) interview on "60 Minutes," Bernanke told America he had "never been on Wall Street." In 2006, Simple Ben enlightened Congress that Wall Street operated at a new, permanent high plateau: "The management of market risk and credit risk has become increasingly sophisticated.... [B]anking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks. The banking agencies will continue to promote supervisory approaches that complement and support banks' own efforts to enhance their risk-management capabilities." From personal knowledge, Ben believed every word in that statement.

What will they make of us in 100 years?

Presidential Rivals: Drop the "One Percent." Trumpet the "Negative Four Percent."

2012-01-12T08:09:00.002-05:00

Frederick Sheehan will be interviewed on "The Larry Parks Show," Thursday, January 12, 2012, from 7:00 to 7:30 PM, on Time Warner Channel 56, RCN Channel 83, and Verizon Channel 34.

Here is a topic begging for a presidential candidate's attention. It is simple to explain and to understand. The White House hopeful should grab the baton from the weary "one percent" couriers. In its place, "I'll stop those negative four percenters," will shine with "a cross of gold" in America's heritage. The "one percent" is a vague call-to-arms since it is not clear where the disenchanted should concentrate their energies. The "negative four percent" is directed at a single source.

An outline of what follows: First, will be an explanation of the negative four percent. Second, a look at the gestation of Inflation Targeting. Third, the constitutional question: is such an adoption within the authority of the Federal Reserve System? Fourth and finally, will be comments behind closed doors by Federal Reserve officials of whether the Fed should receive authorization by Congress for Inflation Targeting. A preview: on the whole, participants thought it would be best not to open this can of worms before the legislators. A future episode will explore the comments of four former Federal Reserve chairmen who either are (or were) enemies of such a leap into academic abstractions.

The formula follows. The Federal Reserve is rumbling towards an official "Inflation Target." On January 5, 2012, St. Louis Fed president James Bullard told Bloomberg radio: "I think we're very close to having inflation targeting in the U.S. This may be an opportunity to get something done that everyone on the committee can rally around."

Regular readers know the story behind the story. (For instance, see The 8% Solution and "Who Am I? What is Money? The Fed is Here to Help". Federal Reserve Chairman Ben S. Bernanke is the partial author of Inflation Targeting: Lessons from the International Experience.

Inflation Targeting (not normally capitalized, but it needs celebrity promotion) is a toy with which a central bank picks an inflation rate out of the air. The People are then subjected to a race against inflation. The rate might be any single-digit number other than zero. (Purists may claim zero is not a number, but this is a political campaign.)

Only two variables need to be explained and understood by the public. One is the interest rate; the other is the inflation rate. Put together, the Federal Reserve is vectoring towards an official policy of reducing Americans' personal wealth by four percent each year.

In fact, this Fed would hold short-term rates at zero forever, if the real world allowed it. Its policy permits no one in the United States to save. It would still be possible to retain one's savings and accumulated wealth with a zero-percent inflation rate. However, the Fed is about to instate an official policy of inflating prices and devaluing the dollar.

The inflation rate chosen for this presidential campaign is 4%. Thus, zero percent of interest earnings and 4% inflation equals a confiscation of 4% of American's personal property - compounded - each year.

Why 4%? The Bureau of Labor Statistics' consumer price index (CPI) is around 3.5%. There is no reason to insist on precision with the campaign slogan. According to John Williams of Shadow Government Statistics, if the BLS used the same methodology to calculate the CPI that it used in 1990, it would be over 7%. If the BLS used the same methodology that it used in 1980, the CPI reported by the media today would be 10%.

A different John Williams, this one is President of the San Francisco Fed, and, as of January 2012, a voting member of the FOMC, has publicly proposed an Inflation Target of 4% (See: Heeding Daedalus: Optimal Inflation and the Zero Lower Bound). He is the Fed's new poster boy.

Wall Street Journal reporter Jon Hilsenrath wrote a profile of John Williams (of the San Francisco Fed, not Shadow Government Statistics) in the January 9, 2012, edition. Hilsenrath relays the Fed's publicity releases to the public through the Journal. The "brainy" San Francisco Fed president "might consider an inflation objective even higher than 2% under some circumstances." This hardly does Williams justice. He has already proposed going much higher, but it apparently is not yet time to break that news.

Even more unsettling is the Federal Reserve's decision to pursue Inflation Targeting without review. How did it receive authority to construct a policy of currency debasement? Section 8 of the U.S. Constitution states: "Congress shall have the power... to coin Money." Leaving aside Congressional dereliction of said Section, the Federal Reserve is pursuing its confiscatory policy by stealth.

What follows is an unusual opportunity to read Fed officials' honest reasons (behind closed doors) for violating institutional checks-ands-balances. Inflation Targeting was the topic of discussion at the February 1 and February 2, 2005, FOMC meeting. In summary, they veered towards importing Inflation Targeting on the sly.

This is such a ripe topic for an ambitious candidate. It's on record. It is easy to understand: just a "0" and a "4." Americans know, or at least sense, they are being abused. A candidate can direct energies to a single, concrete source.

Vincent Reinhart, then a Federal Reserve staff economist, now at some think tank, presented "Considerations Pertaining to the Establishment of a Specific, Numerical, Price-Related Objective for Monetary Policy." Reinhart broached the question: "Should the inflation goal be decided by the Congress (presumably through the process of amending the Federal Reserve Act) or by the Committee?" Reinhart presented the pros and cons. One con: "In particular, is the Committee comfortable in seeking amendment to the Federal Reserve Act? Reopening the act could lead to other changes that the Committee might not welcome...."

Reinhart later added: "[A]n inflation target should be delegated to a conservative central banker. That seems to have been the equilibrium worked out over time, and you might not want to perturb that equilibrium now." Compromise of what, with whom, and the equilibrium not to be perturbed were not discussed. Let's take a guess since the period between 2005 and 2012 needs to be addressed. The Fed and Congressional oversight committees have reached a "see no evil, hear no evil, speak no evil" accord. If true, this is fertile ground for a candidate. If false, it is still fertile ground since the overseers are derelict.

Board member Ben Bernanke thanked the staff for its pro and con discourse. (Alan Greenspan would be chairman until January 2006.) Bernanke regretted it "was difficult to get precise empirical evidence on...whether or not low inflation is good in the first place." [Editor's note - This question was asked by the "conservative central banker" about to run amok bespattering America with his college thesis. - FJS]

Chairman Greenspan put an end to this silly distraction, stating that low-inflation and "sustainable long-term growth" are "as close to a generic macroeconomic principle that we can have." [Editor's note - The non-academic chairman had to waste his time telling the former head of the Princeton University economics department, who loves to remind audiences: "I am a macroeconomist rather than a historian," of the "the most generic macroeconomic principle that we can have." - FJS] [From the editor who won't stop butting in - The specific "macroeconomist/historian" quote just cited comes from page six of Ben S. Bernanke's Essays on the Great Depression. The professor wanted it understood up front that he has no patience or time for the history of the Great Depression. - FJS]

Janet Yellen, president of the San Francisco Federal Reserve (at the time; she is now vice chairman of the Federal Reserve System), thought the Fed could slide Inflation Targeting in the back door. In Yellen's words: "augmenting the status quo" could be pursued by "very carefully crafted language" from a 2003 speech by Federal Reserve Board member Ben S. Bernanke. Yellen's suggested course (in her mind) would explain "to the public why the Committee endorses an inflation objective that actually differs from true price stability." [Italics added - FJS.]

It is worth tucking that sentence away. It is not likely we will read another admission from a central banker that Inflation Targeting is a different species from "true price stability." Congress has established a mandate for the Federal Reserve to maintain "stable prices." Yellen made it crystal clear that the Fed ignores "true price stability."

Mark Olson, president of the Fed's Atlanta branch, was leery of telling Congress the FOMC was adopting Inflation Targeting in its mandate. Olson thought "if we tinker with any element of the Congressional mandate, we would do so at our peril." Olson told his cronies that when he went through his confirmation hearing in 2001, "at least one member of the Senate informed us that if they opened up the Federal Reserve Act, he would want a mandate that zero inflation ought to be the law."

Chairman Greenspan spoke, as was his wont, after all FOMC members had their say: "[T]he political issue bothers me a great deal." He did not say why. Possibly, he looked upon the day's discussion as exploratory in nature. He had less than a year remaining as chairman, so knew Inflation Targeting was a decision for the next chairman. Greenspan discussed operational problems of Inflation Targeting. These will be quoted in the next episode: discourses by former Federal Reserve chairmen about Inflation Targeting.

Markets Vanish - "In a Flash"

2012-01-08T17:39:00.002-05:00

What follows is the same warning broadcast in January 2011. In his January 6, 2012, Credit Bubble Bulletin, Doug Noland discussed the same topic: "The '08 crisis is considered a low-probability "tail event" - a so-called rare "black swan" or "hundred-year flood." Yet I would argue that such a financial crisis was in reality a high probability outcome. Bubbles burst - plain and simple. It is the act of predicting the timing of their demise that tends to be an exercise in low probability outcomes. This is especially the case when government policymaking is a major factor fueling Credit and asset Bubble excess...

Government interference extends unstable market conditions longer than would otherwise be true. By doing so, George Eliot's observation (at the bottom, here) is even more appropriate in 2012. - FJS - January 8, 2012

Following is a short excerpt from "War of the Nerds," which I wrote for the December, 2006, edition of the Gloom, Boom & Doom Report. I discussed the crises an investor ("Our Serious Investor") navigated from the 1960s to the present. Doomsday had been predicted since the dollar crises of the 1960s, yet risk had been transient. By the fall of 2006, it was obvious the U.S. mortgage market and banking system were in collapse, but securities markets were deemed riskless, as measured by bond and credit-default spreads. It is timely to resurrect the vanishing bond markets of 1914 and 2007 after the failed or distressed auctions since December 27, 2010, of euro zone, Chinese, and U.S Treasury bonds with 5-year and 7-year maturities.

The historian Niall Ferguson (The Cash Nexus, War of the World) has written a paper on the risk imbedded in sovereign bond spreads between 1848 and 1914: "Political Risk and the International Bond Market Between the 1848 Revolution and the Outbreak of the First World War." Published in the Economic History Review earlier this year, his exhaustive study of weekly great-power bond prices (United Kingdom, France, Germany, Austria-Hungary and Russia) comes to a surprising conclusion - the closer Europe edged towards war, the less the financial markets cared. Ferguson sees two distinct periods: from 1848 through 1880, the markets were anxious. Sovereign bonds were sold at the slightest scent of war. After 1880, the response to international tensions grew less and less pronounced.

....It is 2006. Our Serious Investor has grown calloused to once-in-the-history-of-the-universe events. Our Investor survived the dollar crises, the stock market collapse and deep recession of 1973-1974, the Business Week "Death of Equities" front cover, the $250 billion federal budget deficits of the 1980s, the frequent financial and derivative crises of the past twenty years (far more prevalent than between 1950 and 1970), the current $500 billion federal budget deficits, and the (prospective) $1 trillion trade deficit. Our Serious Investor has prospered. He gradually learned to shrug off the deteriorating macro world. He grew accustomed to the "Greenspan put" (that is, central banks will bail out any-and-all financial meltdowns), the risky adventures of hedge funds, the abandonment of debt covenants by bond issuers, the private-equity moon shot; he has, by now, grown so accustomed to the warnings that he keeps his head down, plugs away....

Ferguson's narrative of the countdown to war is a splendid chronology of how quickly the world can change: "It was not until 22 July [1914] - more than three weeks [after Archduke Franz Ferdinand of Austria was assassinated, on June 28, 1914] - that the possibility of a European political crisis was first mentioned as a potential source of financial instability in the financial pages of The [London] Times....

The 2-1/2% British consols rose from a 3.30% yield on July 7 to 3.31% on July 22 - a single basis point of fear.... Tensions rose on the exchanges and grew acute on July 27 when the Vienna and Budapest exchanges closed. The Sarajevo incident could still be interpreted as a local affair, but trading slowed on the other European exchanges. Now [British] consols rose to 3.45%. The St. Petersburg exchange closed on July 29 and the Economist considered the "Berlin and Paris bourses closed in all but name."

....A wholly unanticipated domino effect now engulfed London. The bond market did not seem to acknowledge this vaporization of liquidity: "....The Economist was especially struck by the widening of the bid-ask spread for consols (the gap between buyers' offers and sellers' asking prices) to a full percentage point, compared with a historic average of one-eighth of 1 per cent... "

The London market started to close on July 29. London clearing banks concentrated on funding their stock-exchange clients, eight of which failed by the end of the day. On July 30, the Bank of England raised its discount rate from 3% to 5%. On July 31, the Stock Exchange was closed and the Bank of England raised its discount rate from 5% to 8%.

As to how much we can trust the Greenspan "put": "[T]he British and Continental financial authorities pulled every trick." [Ferguson] furnishes a list of clever, arbitrary and confiscatory maneuvers, but, "systematic central bank interventions to maintain bond prices" only worked for a time. Government assistance "could only disguise the crisis that had been unleashed in the bond market; it could not prevent it." [My bold- FJS]

Ferguson scrapes up the debris: "For all save the holders of British consols, who could reasonably hope that their government would restore the value of their investments when the war was over, these outcomes [for French, German, Austrian, and Russian sovereign bond holders] were even worse than the most pessimistic pre-war commentators had foreseen. The fact that investors do not seem to have considered such a scenario until the last week of July 1914 surely tells us something important about the origins of the First World War. It seems as if, in the words of The Economist, the City only saw 'the meaning of war' on July 31-'in a flash'."

Aside from the origins of World War I, the last week of July 1914 surely tells us something important about investors today.

"The sense of security more frequently springs from habit than from conviction, and for this reason it often subsists after such a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened, is, in this logic of habit, constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent."

-George Eliot, Silas Marner

Volatility Lurks

2011-12-28T09:08:00.001-05:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

The European Union is putting its money where its mouth is. Never taking the slightest blame for euro woes, its New York employees are moving to new offices at 666 Third Avenue. The EU's United Nations delegation will "take about 45,000 square feet .... and pay about $60 a square foot annually for 15 years...." reported Bloomberg on December 23, 2011. Negotiations with its prospective new landlord, Tishman Speyer Properties L.P., are nearing completion. The real estate company should consider an anti-EU hedge at the moment the EU signs up.

Sixty Euro employees will occupy the space (per Bloomberg). This works out to a 25-by-30 square-foot office for each. "Austerity" is imposed on the lower 99%, but not yet in Brussels, Strasbourg, or points west.

The potential break up of the European Union is more a consideration for a landlord holding a fifteen-year lease agreement than for the average investor. Yet, current havoc and future bedlam are clearly underpriced in all markets. European and U.S. mispricings will be discussed here.

The S&P 500 volatility index - the VIX - is a measurement of volatility expectations. It has fallen 50% since the (latest) agreement to save the euro was announced. From 30.59 on December 8, 2011, (the Eurocrats trumpeted their fiscal union pact on December 9, 2011) the VIX fell to a 20.72 close on December 23, 2011.

Whether or not fiscal continence is the route to euro salvation does not seem to matter. As discussed in The Rotten Heart of Europe, the Euro establishment (Brussels, banks, and bond markets) vectored towards that conclusion. Having done so, the implied volatility of markets is a derivative of what negotiators accomplished on December 9^th.

European Voice, a Brussels-based, English-language newspaper "maintains an independent stance regarding the affairs of the European Union." So it claims. It is owned by the Economist Group. This disabuses the notion of neutrality. The Economist's heart, soul, liver, and spleen promote the European Union over national sovereignty.

Thus, Van Rompuy Sends European Leaders Draft of Fiscal Union Pact, published on December 14, 2011, distills the best efforts of euro fans to promote the fiscal union pact. We learn that Herman Van Romney, the president of the European Council, has (on December 14) sent a draft of an inter-governmental treaty that will seek to boost economic discipline in the eurozone. It will enter into force once nine of the 17 eurozone member states have ratified it. It contains tougher rules on economic discipline. [Underlined words to be explored - FJS]

Since the purpose of the pact is to convince skeptics of the euro's stability, Van Rompuy must be planning an early retirement. Maybe next week.

The "draft" will transmogrify into a treaty by March 2012. (This and what follows is gathered from European Voice.) How many of the still (somewhat) sovereign states will sign is unknown. We do know that most countries "have shown interest." Whether any more is expected of countries is not clear: "If a eurozone country does not ratify it, it will not be bound by the new rules." That's the problem with the euro today.

However, an EU official told European Voice that rejection by a country would "make life politically very uncomfortable for a non-ratifying member." Here is the mailed fist of the lifetime bureaucrat. The EU official continued: "It ["It' seems to mean the state's sovereignty - FJS] would not be durable for long." The second decade of the 18^th, 19^th, and 20^th century were marked by continental European skirmishes. Four-in-a-row looks plausible.

European Voice reports there are references in the treaty to "work jointly towards an economic policy fostering growth through enhanced convergence and competitiveness." Yet, these references - "remain vague." Please recall that markets, by and large, believe the Eurocrats will prevent a euro breakdown.

"Once adopted, the treaty will force countries to run a balanced budget and enshrine that rule in their constitutions." This is the out-to-lunch attitude of the bureaucrat: expecting, by the beginning of March 2012, the parliaments of nine - or is it 17? - European countries to cede their parliamentary authority (and the opportunity to hand out vote-gathering favors) regarding respective national budgets, at a time voters are ready to lop off parliamentary heads.

Standards to enforce fiscal discipline were ignored in 2005 when "Germany and France helped loosen the rules when they forced through the relaxation of the anti-debt stability pact..." (From: The Rotten Heart of Europe.) That was during a time of relative prosperity. Actually, it was a time when all countries could borrow and spend with abandon, the very problem that has caused the euro's decline.

In any case, an inter-government pact is unenforceable since "the European Commission cannot take member states to court when they breach budget rules." This is worth $60 a square foot?

Amidst this incoherence, gold and silver wallow. The VIX rose from a fat, dumb, and happy 17.56 on July 22, 2011 to 48.00 on August 8, 2011. It was during that time Standard & Poor's cut the credit rating of the U.S. government and the debt ceiling terrified the nation. Should another rating agency do so (Fitch has been making noises) one should expect volatility. (Washington Post headline, December 27, 2011: "Obama to Ask for Increase in Debt Ceiling")

Jim Bianco [Arborresearch.com], president and television star at Bianco Research, explained the potential problem in an interview with Kate Welling (Welling@Weeden). When a country loses its AAA-rating, Basel III capital requirements and central bank rules require banks to apply haircuts against the downgraded bonds. This would create a problem in repo markets, among others. Borrowers in the repo market (somewhere around $4 trillion for U.S. banks) would need to find additional collateral. (Here is the problem of falling standards of collateral leading to demands for more collateral, again.)

Bianco explained the potential rumpus: "Since [Moody's and Fitch] are still at triple-A, we can pretend S&P did nothing. The next downgrade, if Moody's or Fitch were to follow S&P's lead, would actually matter a lot.... The next one that issues a downgrade would make the U.S. a split-rated double-A-plus, which would change some of the rules."

If the VIX falls to 18, call options are worth considering.

U.S. Exposure to Europe - Unknowns Unknowns

2011-12-15T20:59:00.001-05:00

[T]here are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns - there are things we do not know we don't know. "

-Former United States Secretary of Defense Donald Rumsfeld, February 12, 2002

There were reasons to criticize Donald Rumsfeld's turn as Defense Secretary but this was not one of them, even though the media quoted and re-quoted this most sensible approach to uncertainty as proof of a retarded intellect.

As Eurocrats dissemble (see: The Rotten Heart of Europe), ratios that quantify U.S. financial system exposure to European insolvency are dated, even as they are published. Credit default swaps or loans may have been traded in the interim, may have been hedged, or may have slithered from For-Profit-or-Bailout Banks onto the Federal Reserve balance sheet (i.e., nuclear-waste securities). Aggregate bank balance-sheet figures may be gross or net (and we debate whether gross or net is the more consequential measure), may be the tip of an iceberg compared to submerged, off-balance-sheet liabilities, and ultimately, we do not know the timing of the Fed's $5 trillion academically certified money dump into the banking system.

These limitations have been compounded by a recently revealed "unknown unknown," at least to most of us. On December 7, 2011, Reuters published "MF Global and the Great Re-Hypothecation Scandal." Reuters' reporter Christopher Elias opened: "A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back." (Re-hypothecation will be described below.)

Some lessons here: First, if not for the money stolen from MF Global's customers, Reuters probably would not have set Elias on the trail to re-hypothecation. Second, it is when good credit is receding that such scandals come to light. (Madoff.) If not for the slide in European sovereign bond prices (the route by which MF Global's CEO leveraged and bet the solvency of his firm), MF Global would not have disappeared. Third, and very much related to the previous point, the world's good collateral shrinks by the hour. Fourth, the supposed bond "guarantees" that authorities bray about are a chimera. Quoting Elias: "Backed by the European Financial Stability Facility (EFSF), it was a clever bet (at least in theory) that certain Eurozone bonds would remain default free whilst yields would continue to grow." The EFSF is backed by words, not assets. The more that governments and international bodies vote to back spiraling guarantees, the less their guarantees are worth. Thus: good collateral as a percentage of paper and paper promises shrinks. Fifth, and very much related to points two through five, it is only the spiraling of financial leverage that prevents the financial economy from collapsing.

Re-hypothecation is a revelation in financial leverage. Most readers understand "hypothecation," even if they never heard the word. Elias explains: "By way of background, hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is 'hypothetically' controlled by the creditor, who has a right to seize possession if the borrower defaults." An example would be an investor who holds a margin account with a broker. If the value of the assets (shares of IBM) fall to a certain point, the broker requires that the investor put more money into the account. If the client does not put the required money into the account, the broker has the right to sell shares of IBM. The cash received in the sale restores the minimum level of equity required by the broker.

Elias explains the process as follows: "In the U.S., this legal right takes the form of a lien.... A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default."

Now we get to the scary part. Re-hypothecation, explains Elias: "occurs when a bank or broker re-uses collateral posted by clients... to back the broker's own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal." He quantifies the legal scam: "Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as 'churn'), the original collateral being used may have been as little as $1 trillion - a quarter of the financial footprint created through re-hypothecation.

Hot off the press (dated December 2011) is an IMF report: The-Non-Bank-Bank Nexus and the Shadow Banking System. Authors Zoltan Pozsar and Manmohan Singh give an example of how re-hypothecation works (on page 11 of the paper). A dealer holds a Treasury security as collateral which "comes with the rights for the dealer to repledge it." The dealer uses this collateral as his (the dealer's) collateral with an asset manager. The asset manager "may re-use the Treasury security to post collateral with another dealer..." On it goes, each party in turn using the same Treasury security as collateral. The IMF authors proffer: "Since these transactions are underpinned by a single piece of collateral, such daisy-chains may be referred to as dynamic chains." They may also be referred to as an illusion of credit that nonetheless has inflated asset prices from Shanghai apartments to Apple common stock to European and U.S. Too-Levered-To-Die Banks. Pozsar and Singh write the traditional thinking of how banks fund themselves "ignores the significant funding that banks receive from the asset management complex" that permit "both individual banks and the banking system as a whole [to] quickly lever up."

Understanding this lends credibility to MF Global Chief Executive Officer Jon Corzine's statements before Congress that he does not know where his clients' money is. Pozsar and Singh write: "The securities that asset managers invest on behalf of households are seldom left lying around passively in portfolios. In order to capture their value as collateral, securities are routinely lent out for use in the shadow banking system, a fact few households, whose securities are ultimately being lent, are oblivious to." [My italics, should you have nodded off during all the IMF talk. - FJS]

It is generally believed that U.S. banks are in much better shape than European banks today. Of what value is this? Back to Pozsar & Singh: "The repeated use of... collateral facilitates system-lubrication [and] also the build-up of leverage-like collateral chains between banks and managers."

A down drift of collateral values, which should be expected since there is no value to the compounded layers, may be a reason European banks are in such dire straits. (European Central Bank President Mario Draghi to the European Parliament on Thursday, December 1, 2011: "We are aware of the scarcity of eligible collateral.")

Bloomberg reported on December 13, 2011: "EU Banks Selling 'Crown Jewels'..." The banks are selling some of their most profitable arms (lines of business) to raise cash. Is this the fire sale of the century? Probably not. Selling profitable lines at discounts to their fair value today drags down prices which may lead to another round of discount sales, at even lower prices tomorrow.

Distorted pricing of assets by a leveraged financial system with few real assets has led to some strange observations. Izabella Kaminska reports in the Financial Times (alphaville) that it is not regulators or authorities, but "the markets themselves... [that] are demanding a re-collateralization in all funding areas." She notes: "[T]he latest trend towards gold collateralized bank loans shows in some ways the market is demanding the recollateralization of credit with gold." Kaminska notes: "Gold is switching places with [U.S.] Treasuries as the ultimate form of security."

It is surprising U.S. Treasuries still hold that princely position. The FDIC is now guaranteeing $53 trillion (not billion, but: trillion) of Bank of America's (transferred from its Merrill Lynch subsidiary) credit default swaps. This maneuver was executed by the Federal Reserve. This is both reprehensible and meaningless. Assume a 25% default rate on the credits and that Bank of America also defaults. A $13 trillion tax on Americans to make good on our guarantee is meaningless, other than to induce an immediate credit downgrade to F-.

Speaking of the Fed, specifically of Federal Reserve Chairman Ben Bernanke, he told Congress on November 2, 2011, that MF Global had been approved as a primary dealer by the New York Federal Reserve, "but we are not the regulators of MF Global," nor is there any reason the Fed should be overseers or regulators to such a firm. Authors Poszar and Singh placed dealers at the heart of the re-hypothecation racket. Oh, Ben! Aggressively stupid to the end.

From the close on November 30, 2011, to December 12, 2011, (when Kaminska wrote), the spot gold price fell about $90, from $1,746 to $1,659. Kaminska explained why: Right now: "Banks don't need gold as much as they need cash." (This relative lack of need for gold is what she refers to below as "surplus gold.")

As has been written many times "gold is the ultimate form of payment," and so it is being lent by banks "for its use as a funding instrument: collateral." Gold now is being lent by banks (repoed) at a negative rate. "The more negative the rate, the higher the cost of funding using the collateral." Kaminska concludes: "With surplus gold being put into the system, the price of gold has no choice but to stall."

Maybe Kaminska should have considered another possibility: as the panic for collateral worsens, the price might continue to fall. In fact, over the past two days (December 12 to December 14), gold has fallen another $90, to $1,567 (as this is written). If Kaminska's analysis is correct, the price of gold could spring back up, with alacrity.

With the European banking system near collapse, we may soon find just how exposed is the U.S. banking system to continental credit, credit default swaps, and "repeated use of... collateral facilitates system-lubrication [and] the build-up of leverage-like collateral chains between banks and managers."

There is no question that, if it was within their power, the Eurocrats would have absorbed every last bond and bank loan on a bank balance sheet that is trading at a discount. "Oh," they must be wishing "if only we had the arrogated authority of Federal Reserve Chairman Ben Bernanke." They know that when (not if) the Federal Reserve chairman is in a similar position to theirs, he will beckon $5 trillion of funny money into existence. This would exceed his authority, but after members of a Congressional committee read him the riot act, they will thank him for saving the system, even as the inflation rate passes 30% during the hearing, and he will be Time magazine's Hero-of-the-Year again.

As for the Eurocrats, they will find a way to do the same. They must: otherwise the pampered satraps in Brussels will have to move home and pay taxes.

But could this "known known" (speaking of both the U.S. and Europe) be a miscalculation? That is to say, could the parties mentioned miscalculate and not act in time to pump up the sinking structure of leveraged ether?

Possibly so. There is precedence. Benjamin Anderson, economist at the Chase Bank from 1920 to 1939, wrote about two such misjudgments in the 1930s, in his highly recommended book, Economics and the Public Welfare: A Financial and Economic History of the United States, 1914-1946.

On May 12, 1931, "there came an unexpected run on Oesterreichische-Credit-Anstalt," a large Austrian bank. To be noted: (1) Oesterreichische-Credit-Anstalt was forced into a merger with a weaker bank in 1929. This might be analogous to Bank of America's acquisition of Countrywide Financial, and, (2) quoting Anderson: "The Austrian government guaranteed certain of the investments." (Oh, those government guarantees again!), but "the merged bank had been inadequately financed... the big merged institution was still insolvent." Just as in Europe today: how good is the credit (collateral) of the guarantor? The bulk of a sovereign state's collateral is future tax revenues. From Greece to the United States, this does not inspire confidence today.

On May 14, 1931, the Bank for International Settlements coordinated support by central banks. "This made a great show of international cooperation... but the effect was bad when eleven central banks were providing among them only $5.6 million. Creditors grew more frightened, rather than less. If the thing were to be done at all, it should have been done adequately. The first principal of bank loans in a crisis is that if the borrower needs $100,000 to save him, you give him $100,000 or you give him nothing at all. You don't give him $20,000."

Here, as described above, is where the U.S. (today) can hyper-inflate at will, while Europe is encumbered. Back to Anderson and 1931: "Panics are not dealt with effectively through delay, through public discussion, and through fighting for position. A loan of $25 million made promptly at the first sign of panic would probably have stopped it. There came a time when $100 million would not stop it. By the time the Austrian government on May 29, [1931], voted the guarantee of $150 million, the credit of the Austrian government was so shaken that no one cared about the pledge. When on June 6, 1931, the Bank for International Settlements arranged to give a... 100 million shilling credit [$14 million - FJS] to Austria, the Austrian financial disaster was very little helped thereby."

German banks endured a run on June 1, 1930. "In the beginning of the run on Germany, again the effort of international banking cooperation was made. Again $100 million promptly provided by concerted action of British, American, and French banks, publicly announced and instantly made available, could have stopped the crisis. A month later $500 million would not have been sufficient."

There were squabbles: It is "in the French character and the French tradition that immediate acceptance of a contract proposed by another party is out of the question.... France delayed, and France delayed to long.... The German people, as well as foreign creditors, were engaged in the run on German banks." France was not the only culprit. Anderson criticizes New York bankers for being too timid and too late.

This was not the end for German banks. Publicized meetings among government authorities and official proclamations dragged into 1932: the Euro summits of the day. Hope sprang eternal that a reconstruction of German debts (and war repatriations) could be managed, but it was not to be. Anderson observed (literally: he was confidant to participants) that "governments move slowly and politicians look to the next election." He concluded: "If the governments had acted that winter, Hitler would never have come to power, and we should have saved the democratic regime of Germany." This was an unknown unknown.

The Rotten Heart of Europe

2011-12-08T20:39:00.003-05:00

To Americans, European problems may seem as remote as they did in 1939. There is a good chance, though, that the crumbling financial structure will not be "contained" or "ring-fenced": the latter being the common description of how Europe had isolated itself from Italy's difficulties. That lasted a week or so. We may soon discover the extent of American exposure to European financial insolvency.

The catalyst for this coming weekend's European Union meeting is the failure of Europe's daisy-chain finance. On Monday, December 5, 2011, Bill King (The King Report) wrote of the latest: "European solons are proposing another Daisy Chain Bailout scheme - bankrupt and near-bankrupt European nations will inject money that they must borrow from the IMF so they can in turn borrow the money that they borrowed and then lend to themselves." Wendy's toes are curled around the end of Captain Hook's gangplank.

The creditworthiness of the fractured institutions is not trusted: the commercial banks, the national central banks, the ECB, the EFSF, and most importantly, the Bundesbank. On November 23, 2011, the Bundesbank attempted to auction €6 billion of 10-year German government bonds. It received bids for €3.8, or 61% of the total. Neil Jones at Mizuho Corporate Bank Ltd. in London told Bloomberg: "If investors do not wish to buy bunds, they do not wish to buy Europe." Right-ho.

The purpose of this dispatch is to dispel rumors that current front-page treaty talks have any economic meaning. The European and U.S. stock markets react with a 3% or 4% gain after vague announcements, but we are getting closer to a day when the false prophets are stripped bare.

The euro cannot survive in its current form. To understand this, we will return to its introduction. Some dates: The 1992 Maastricht Treaty formally established the intent of a single currency. The euro acquired electronic legitimacy on January 1, 1999. For instance, it was henceforth used in electronic bank transfers. The national currencies were locked at a specific rate to the euro on that date. On January 1, 2002, euro coins and bills became legal tender.

The euro was introduced after the finances of 10 (or 11, we'll skip over this) countries had "converged," meeting such criteria as national budget deficits less than 3% of GDP and a debt ratio less than 60% of GDP. It is now the currency of 17 European countries. Most, if not all, played games to meet these requirements. This was not a secret.

The preferred method of cheating has been to fabricate or ignore. On June 5, 2000, when Greece was admitted into the not very exclusive euro club, Austrian Finance Minister Karl-Heinz Grasser told reporters: "Greece will become a member for sure. It meets all the requirements for membership." A leading requirement was to not tell reporters the truth. French Finance Minster Laurent Fabius offered a more discreet assessment, as would be expected from a graduate of the École Nationale d'Administration (the training ground for advanced French bureaucrats): "Greece has made a huge improvement."

The euro, and more generally, the European Union, has been a bureaucratic racket from the beginning. Brussels protects its own interests first. It does not weigh the success of its ventures by how the masses subject to its mandates fare. The euro had its flaws, but the paper pushers never answer for mistakes. Like the Federal Reserve or the Gang of Four, they are unaccountable. (The latter offers some hope.) Human tissue is Play-Doh in their hands to be molded into what Superior Persons call their "European Project.

When trouble loomed, the Eurocrats looked the other way: "Except for being told by the EU and ECB to get its financial house in order, Greece was not punished for cheating. In 2005, Germany and France helped loosen the rules when they forced through the relaxation of the anti-debt "stability pact," despite knowing that Greece had been above the 3% threshold for the previous three years." (Gold Alert, May 27, 2011)

The great flaw was already evident: countries could spend and tax as they wished (or didn't wish) while issuing bonds as if they were as creditworthy as the Bundesbank. It is only natural that Italy shoveled out bonds, borrowing and spending, until its debt grew to be the third largest sovereign bond market in the world, without a chance now of repayment at par.

Former European Central Bank Chief Economist Otmar Issing was quoted by Bloomberg on May 26, 2011: "Greece cheated to get in, and it's difficult to know how we should deal with cheaters." In fact, this is a matter of character, not law: "The grand plan outlined by France and Germany on Monday for European Treaty change breaks no new ground in terms of ideas - all the proposals already exist in various legal acts, the only problem is they have never been observed in practice." (Reuters - December 5, 2011)

The Eurocrats are meeting this weekend to discuss a treaty that will - do nothing, even in today's frantic quest to sign a scrap of paper that will satisfy potential bond buyers. A carrot was dangled, but quickly withdrawn. From Ambrose Evan-Pritchard in the Daily Telegraph: "[German Chancellor Angela] Merkel seems to have backed off on demands that budget breaches will be justifiable before the European court, so the Treaty chatter is mostly Quatsch, betises, and eyewash.

By the way, the effectiveness or necessity of rules is not discussed nearly as much as whether they are breached. The rules seem to be an end in themselves. The real problem, of divergent national economies operating in a single financial system, while countries spend and tax with very different priorities, has not changed. It remains - just talk.

Recall that the catalyst is disintegrating finance. Aside from the Bundesbank auction, an unknown number of banks cannot borrow from each other, so are drawing on the European Central Bank, which, itself, is highly leveraged, is holding Greek and Italian bonds at par, and is cheating on its constitutional restriction that it cannot bail out nations. Europe has begged around the globe for capital investment, to no avail. Portugal carried its tin cup to Angola, a former colony. The Angolans responded "nyet." Thwarted by its African sidekick, Lisbon officials validated Angola's wariness by confiscating €5.6 billion from Portuguese pension funds to fill its budget gap. Isn't technology wonderful? Tanks and troops slogging across continents warned of such heists in the past. Americans beware.

Of importance: the financial woes are REAL; the advertised solution is pretense. There is no financial "solution" as the loungers and idlers at European Union cocktail parties would define solution. They want a "fix" under the assumption the European Project could not possibly suffer from a design flaw. They designed it.

The Belgian bureaucrats expect the ECB to deploy enormous monetary firepower (€2 to €5 trillion) to relieve them of all this financial talk. To do so would break the law, not a consideration eurocrats or eurocratic periodicals mention. Bernard Connolly, in The Rotten Heart of Europe: The Dirty War for Europe's Money (1995), wrote that monetary union "is not only inefficient but undemocratic. A danger not only to our wealth but also our freedoms, and ultimately, our peace. The villains of the story... are bureaucrats and self-aggrandizing politicians." Monetary union "is a mechanism for subordinating the economic welfare, democratic rights, and national freedom of the European countries to the political and bureaucratic elites whose power-lust, cynicism, and delusions underlie the actions of the vast majority of those who now strive to create a European superstate."

Connolly is now an economic consultant (Connolly Insight) who wrote this book after his eye-opening experience inside the Eurocracy. There is a single copy available on Abebooks, for $1443.52.

It was 97 years ago when German Chancellor von Bethmann-Hollweg asked the British ambassador in Berlin, Sir Edward Goschen, why England would defend Belgium's neutrality. His Majesty's Government had signed a treaty to do so, in 1839. Bethmann-Hollweg replied this was a "scrap of paper."

It has been a deplorable century for the law, agreements, and treaties since that confrontation in 1914, the same year the International Gold Standard unraveled. Now, the stellar leadership mentioned above and in the United States are worming their way to a poetic conclusion. Currencies will not be worth the money they are printed on.

The SEC's Day in Court

2011-12-01T06:29:00.001-05:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

Mists gather over dubious government practices. The collapse of MF Global should have scared the wits out of U.S. investors. If you haven't panicked yet, there is still time. Since public discussion of its demise lasted about 45 minutes, we are left to speculate. A possible, but sketchy summary might run: a securities firm, run by the former senior partner at Goldman Sachs, took a leveraged position in speculative bonds that caused the eighth largest bankruptcy in U.S. history. Thousands of brokerage customers, who believed their accounts were segregated from MF Global's account, are left to conclude (given the silence of government agencies), that their money is gone. And, MF Global may have done nothing illegal (protected within the boundaries of CFTC Rule 1.29).

Now, the good news: a government employee - a judge - who is fighting for the common man.

Judge Jed S. Rakoff of the United States District Courts of the Southern District of New York struck a blow against the Securities and Exchange Commission and in support of the "public interest." The Securities and Exchange Commission had asked the Court to approve a Consent Judgment between Citigroup and the S.E.C. Judge Rakoff (cutting to the chase) wrote he could not do so: "An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts - cold, hard solid facts, established either by admissions or by trials - it serves no lawful or moral purpose and is simply an engine of oppression."

Judge Rakoff summarized the lawsuit of U.S. Securities and Exchange Commission vs. Citigroup Global Markets: "According to the S.E.C.'s complaint, after Citigroup realized in early 2007 that the market for mortgage-backed securities was beginning to weaken, Citigroup created a billion-dollar Fund (known as "Class V Funding III") that allowed it to dump some dubious assets on misinformed investors. This was accomplished by Citigroup's misrepresenting that the Fund's assets were attractive investments rigorously selected by an independent investment adviser, whereas in fact Citigroup had arranged to include in the portfolio a substantial percentage of negatively projected assets and had then taken a short position in those very assets it helped select." There is more, but this gives a sense of Citigroup's conduct.

The settlement required Citigroup to disgorge its ill-gotten profits and to pay the S.E.C. a $95 million civil penalty. This is pocket change for a bank that makes or loses $10 billion a quarter. Judge Rakoff said as much: "If the allegations are true, this is a very good deal for Citigroup; and, even if they are not true, it is a mild and modest cost of doing business."

Judge Rakoff's rejection of the Consent Judgment is in contradiction to past and current practices: the securities firm under investigation (all of the big ones, all of the time) engages in a questionable practice; the SEC investigates; the parties agree to a settlement, the defendant neither "admitting nor denying the allegations of the complaint..." (All quotations are from Judge Rakoff's Opinion and Order, unless otherwise noted.) The November 29, 2011, Financial Times addressed the context: "Citigroup did not admit or deny wrongdoing - a standard practice for four decades in SEC settlements."

These side deals are rubber-stamped by the Court even though it "has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment.... [T]he court has become a mere handmaiden to a settlement privately negotiated on the basis of unknown facts."

Judge Rakoff hints such agreements are privately negotiated within the White Shoe Club: "Although [the charges against Citigroup] would appear to be tantamount to an allegation of knowing and fraudulent intent... the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence...."

This "deals a double blow to any assistance the defrauded investors might seek to derive from the S.E.C. litigation, in attempting to recoup their losses through private litigation, since private investors not only cannot bring securities claims based on negligence... but also cannot derive any collateral estoppel assistance from Citigroup's non-admission/non-denial of the S.E.C.'s allegations." ["Collateral estoppel assistance": The S.E.C. structured the settlement so that private litigants cannot use any admissions/statements Citigroup made during this S.E.C. action.]

This helps explain why every bank CEO and director sat in front of post-meltdown, Congressional committees and pleaded idiocy. They "never saw it coming." That was negligent, which cannot be litigated. The dumbbells have escaped (at least, until now) charges of "knowing and fraudulent intent" since it was beyond their comprehension that mortgages on which the buyer never made a single payment (common by early 2007) should not be bundled and sold to the public. It was quite a sight to watch Bob Rubin, former partner (and certified genius) at Goldman Sachs, testify he was denser than Wall Street shoe shine boys.

Judge Rakoff chastised the S.E.C. for abusing the public interest: "[I]n any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world propaganda reigns, and truth is confined to secretive fearful whispers." If Heaven were on Earth, the Bureau of Labor Statistics would face off against Judge Rakoff and defend its unemployment, inflation, and G.D.P. propaganda.

Like other failing, doddering, American bureaucracies, the S.E.C.'s counter-argument hurt more than it helped: "[T]he S.E.C. suggests that, if the public interest must be taken into account, the S.E.C. is the sole determinant of what is in the public interest..." This shows an organization that is so accustomed to reigning outside the law that it could only muster a nonsensical, circular, self-aggrandizing argument in front of a judge who is determined that the S.E.C. must operate according to the laws of the United States: "[T]he S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges.... [T]his court must not... grant judicial enforcement to the agency's contrivances." [My italics - FJS]

If only the bankrupt customers of MF Global can find such an advocate.

Ted Forstmann

2011-11-23T10:25:00.002-05:00

In a world where evidence often shows the bad do well, memories of a good, rich man may lift the spirits of the disillusioned.

Ted Forstmann died of brain cancer on Sunday, November 20, 2011. He was 71. Obituaries and tributes that describe his life are accessible in newspapers and elsewhere.

We met at Michael's in New York after the publication of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession. "I really enjoyed your book," were his first words. This was gratifying, since the number who have read the book is probably in double-digits.

Ted was a former friend of Alan Greenspan's, so, it was especially nice to hear, "You were very fair to him." I told him this was not difficult since Greenspan's own words condemned his Federal Reserve chairmanship. Recording his life and statements before 1987 (the year he became Fed chairman) was evidence enough that he lacked personal character to a sufficient degree for the Wise Men to satisfactorily conclude Alan Greenspan would act as expected. I went out of my way to suggest higher motivations for Greenspan's blemishes, allowing the reader to decide in which direction the evidence fell.

In Ted's opinion: "His own words showed how confused he was."

Ted thought my chapters about the 1980s were accurate. This was received with some relief. Few played a more central role than Ted, during the period I proposed (in Panderer to Power) as the sharp break in American finance. In particular, 1984 to 1986 was the time when Wall Street corruption was institutionalized. Alan Greenspan's participation in the S&L swindle (in 1984 and 1985) was akin to a Triple-A, minor-league, first baseman batting .360: the consulting economist was major-league material.

(From a letter written by New York Senator Daniel Patrick Moynihan on August 15, 1990: "Consider the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) more commonly known as the 'S&L bailout bill.' Has there ever been an equivalent phantasmagoria of evasion, avoidance, incompetence, muddle, and panic, all with the nice overlay of swindle? From a Treasury Department once handled by Alexander Hamilton! The largest scandal in the history of the national government; for which no one is responsible. That being the first sign of a government whose true energies and talents are directed elsewhere.")

There were more pages in Panderer to Power about the 1980s than some wished. Yet, the times and the man were Siamese twins. A grounding in that period is a foundation to understanding the final and accelerating finish of venerated U.S. institutions today: financial, academic, media, and government.

Without saying it should be so (to the best of my recollection), Ted supported my conclusion that Too-Big-To-Fail banks should be shut. He didn't know his banker anymore: "I don't know what a bank is. I've been doing this for 30 years. I went for a loan for one of my companies recently. The room was filled and I couldn't figure out if there was a person, a banker, who decided [whether I would get] the loan. None of them knew who I was."

Ted did not think derivatives should exist "except to hedge gold, crops [or similar physical materials]."

I had not known, until reading the New York Times obituary, that Ted Forstmann "coined, if inadvertently, a phrase that set the public image of the leveraged buyout industry. While he was golfing in the late 1980s with Richard L. Gelb, then the chairman of Bristol Myers, the discussion turned to a surge in takeovers by buyout firms. 'What does it all mean?' Mr. Gelb asked Mr. Forstmann. 'It means the barbarians are at the gate,' Mr. Forstmann replied. 'And they'll be coming for you next.'"

The obituary quoted from a Wall Street Journal column that Ted wrote in 1988: "Watching these deals get done is like watching a herd of drunk drivers take to the highway on New Year's Eve."

I graduated from business school in 1985 and played a bit part in the leveraged buyout spectacle. As a bit player though, with investment bankers grasping for every company's business (even to the unlikely degree of wooing a very junior analyst), I knew the gossip. Ted Forstmann was in the thick of deal-making at that point (Forstmann, Little), but his name was above reproach.

Ted thought younger people today combine a strange mix of materiality and immateriality. People he talked to in their 30s or 40s wanted to make money. They didn't really care about producing or making something.

Ted thought Alan Greenspan, via the Federal Reserve, was the central spigot of our current plight. In Ted's words: "They print the money. When they print too much, it goes into activities that aren't economic. When the interest rate is too low, people aren't careful. Borrowers can pay back in depreciated dollars. They barely need to put any of their own money into a project. If interest rates are 7%, they need to calculate its potential profitability."

Ted recommended Nicole Gelinas's book: After the Fall: Saving Capitalism from Washington and Wall Street. He thought she successfully made the case we did not need a slew of new financial regulations. If the Federal Reserve and other regulators had enforced the rules then in place, there would not have been a financial crisis. These are wise conclusions that could never penetrate the interests in Washington, Wall Street, academia, and the media. For each of these parties, such an acknowledgement would reveal their failure to halt the obvious beforehand. (See Moynihan, 1990, above.)

I presumed Ted did not think Federal Reserve Chairman Ben Bernanke was an improvement. Whenever his name was mentioned, Ted either winced as if he had bitten into a lemon or exhaled a low moan.

Ted was disappointed, but maybe not surprised, that I saw no other solution than to let prices, including assets and incomes, settle at a lower level, at which point the U.S. will be competitive again. This may have been a reason he simply could not speak at the mention of Ben Bernanke's name.

Ted Forstmann was a sterling example in a tarnished field.

Gold Stocks

2011-11-02T13:31:00.002-04:00

A compelling argument to steer clear of gold and silver miners is their poor management. "Those companies are run by a bunch of miners. They don't know how to manage a company." Most often this criticism refers to gold miners' seemingly insatiable desire to issue new shares. By issuing new shares, a company reduces the value of shares already in the hands of the public. For instance, a company has issued 10 million shares of common stock. Now, it sells another 10 million shares. The profit-per-share to current shareholders (before the new issue) is cut by one-half.

This argument sometimes stops here. By not looking further, the necessity to raise more capital over the past decade is not addressed. During the 'oughts, the price of gold was too low for many of the miners to continue prospecting - without receiving more funding. To this, the complaint often goes: "If miners weren't such a bunch of miners!, they would have stopped prospecting, and let the price of gold rise to a profitable level."

Long-time shareholders also lament that miners too willingly issue shares. Common stock is only one way to meet accounts payable. The managers of mining companies can, and have, borrowed from banks, from the bond market, and from private investors. They have sold mining rights, and used other means to get money.

The tendency of gold-mining managers to behave like diggers rather than owners is less important today. Thus, the reasons stated above to not own miners is less compelling. "Gold and Silver Stocks" discussed some reasons why this is so.

Several miners have announced they will pay or increase dividend distributions to shareholders. Implicit in this trend is the recent profitability of gold mining.

Many miners are now able to finance their capital expenditures from cash flow. Where this is so, the digger-managers are less likely to act in contradiction to interests of the common shareholders. The Gold Stock Analyst has discussed companies that are now able to meet capital needs from cash: Goldcorp, Yamana, Newmont, and New Gold (funded by Goldcorp) are a few.

Not by any means are all gold and silver miners in this position. Nor should they be. Miners that issue shares in the future should not be summarily dismissed by shareholders. The companies are in different stages of the prospecting-to-production cycle and hold different opinions about internal growth or growth by acquisition. But all in all, gold and silver miners are in a much better financial position than during the Evil 'Oughts. If Simple Ben runs the Fed just awhile longer, $10,000 gold will solve all financing questions.

What They Are Doing

2011-10-24T07:18:00.002-04:00

The Euro and You described a fundamental problem of world finance. The quantity of debt grows as the quality recedes. The problem of bad loans is no longer just the pre-2008 mortgages, CDOs, and LBOs. Debt issued after the bust is defaulting, such as Greek sovereign bonds, issued in June 2010. Some securities are born to part investors from their money, but it's remarkable the extent and variety of such instruments issued in 2011. The world choked on similar bonds and derivatives only three years ago, many of which are still held at false prices on financial institutions' books.

Of all the past century's downgrades, none has been greater than the borrower's promise that stands behind a "security," a word that once credibly described a paper contract backed by appropriate collateral. In Debt and Delusion, Peter Warburtin wrote: "It is easy to forget that, as recently as in the 1960s, the government budgets of the OECD countries were in approximate balance and that net issues of debt were comparatively rare. The outstanding stock of debt in public hands was a meager $800 billion at the end of 1970. At that time debt issue was typically reserved for the financing of large construction projects or investment by power generation companies by publicly owned companies." Today, PIMCO's Bill Gross manages $244 billion in a single bond fund.

The starting pistol was sounded on August 15, 1971, 40 years ago. On that date, the United States broke its long-standing promise to pay one ounce of gold to a foreign government that redeemed $35 for the same. (The ability of American citizens to redeem dollars for gold with the U.S. government was modified during World War I and ceased after the War.) As a prelude to the loosy-goosy financial contracts today, it is worth reviewing the wording of the contractual relationship between the United States government and the holder of its currency before and after. (A book should be written on the parallels between the century-long degradation of language, the American legal system, money, credit, debt, and the American people.)

The face of a $20 bill, a gold certificate, issued in 1882, stated: "This certifies that there have been deposited in the Treasury of the United States, twenty dollars in gold coin, repayable to the bearer on demand." The bearer of $20.67 received one ounce of gold in exchange. This is a simple legal contract. It is easy to understand. There was no theory. No economists were employed to interpret what did not require interpretation.

A 2011 Federal Reserve Note states: "This note is legal tender for all debts, public and private." As contracts go, this makes no sense. Nor does it make sense to a three-year-old. My extensive survey of three-year-olds did not uncover a single child, who, in exchange for a $20 bill, preferred another $20 bill rather than receive a one-ounce gold coin. (The current value of the one-ounce coin versus that of the $20 bill is not germane to this survey.)

The abstraction of money is related to the manner in which securities today are often backed by abstract or non-existent collateral. Contradictory theories employ at least 100,000 economists (probably multiples of this figure), among whom, there may not be a handful who ever write or think about money. Read (if you must) the theoretical papers or newspaper columns of these imposters. They retreated into a soothing bubble bath of differential calculus generations ago.

Many of the malignant securities issued in 2010 and 2011 have fallen into disfavor. Credit markets have suffered loss of liquidity, momentary or protracted. These issues, collateralized by hope and imagination, are on the books though, often at institutions that already hold wads of securities still valued at wishful prices (for purposes of accounting, capital requirements, and falsifying the institutions' dubious solvency). We should expect that when Federal Reserve Chairman Ben Bernanke revs up his money machine, more will flow.

It is a safe bet that Ben is preparing to welcome more unmentionable securities on the Fed's balance sheet. ("Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy...." - Wall Street Journal, October 21, 2011.)

Guessing at why the Fed will splurge is a chicken-or-egg game. Is the Fed preparing for a downdraft in the stock market with its tried-and-false response: by creating more money? Or, is it preparing to transmit (by electronic keystroke) more dollars to absorb securities held at banks, insurance companies, money-market funds, and mutual funds that should be carried at a much lower value?

The Fed washed its hands of credit analysis on January 6, 2011, when it issued its weekly H.4.1 "Factors Affecting Reserve Balances." The federal agency that vaunts its "transparency" (i.e.: the Fed) implanted a note that transferred all capital losses to the taxpayer. The January 6, 2011, "Factors Affecting Reserve Balances" stated that beginning on January 1, 2011, all capital losses in the Federal Reserve's mangy and non-transparent portfolio would henceforth be transferred to the Treasury Department. In a sense, this is only an accounting frivolity, since the taxpayer ultimately pays for the New York Fed's reckless mismanagement of its highly leveraged portfolio (103:1); that could soon, absent the January 6 sleight-of-hand, mirror Enron's jambalaya.

After the 2008 credit meltdown, the Fed, led by Simple Ben, fought for greater regulatory control of the banking system. The cranks who warned against Federal Reserve regulatory authority have been vindicated, on a comically inflated scale.

Wild-and-wooly securities that cratered after the credit cycle turned (circa 2007) are back, for instance: low doc, cov lite, payment-in-kind toggle notes, the proceeds of which pay private-equity firms up-front dividends. Century bonds (Mexico, the University of Southern California) sold swiftly, never a good sign. "Synthetic junk bonds" warned the Financial Times" resemble transactions linked to U.S. mortgages, which proliferated before the crisis" and "staple deals" counseled the Wall Street Journal "came under sharp criticism during the buyout boom for causing a number of conflicts of interest" have been structured by the banks that Ben Bernanke regulates. This highlights the greatest conflict of interest: the false claim that the Federal Reserve regulates the banks.

One security in the pipeline (possibly on hold during the current market mayhem) is a "synthetic deutsche mark," that would "create shadow trading in legacy currencies in a synthetic market." Paul Volcker said somewhere the only financial advancement of the past 30 years is the ATM card. Comparing the collateral behind Peter Warburtin's bond market to the absence of such behind the synthetic deutsche mark (a currency that ceased to exist over a decade ago) outlines the enormous waste of capital, human ingenuity, and savings over the past 40 years. With nothing learned, this will continue, until uncollateralized paper spawns a New Era in post-fiat origami.

Harrisburg Fails to Get the Word

2011-10-18T07:53:00.002-04:00

Municipal bondholders have something else to worry about. If Occupy Wall Street has legs, and, if labor unions handcuff the protestors' agenda ("Major Unions Join Occupy Wall Street Protest" - New York Times, October 5, 2011), will that effectively downgrade general obligation (G.O.) bonds another notch? That is unlikely. In fact, trends over the past few months have shown states and municipalities are more inclined to meet general obligation bond payments as long as they possibly can. Union workers who press municipalities into bankruptcy (the Harrisburg, Pennsylvania bankruptcy might be interpreted as such) should take heed.

States and municipalities are averse to filing for bankruptcy. If they wobble, the courts remind them of their priorities. The State of Minnesota could not reach a budget agreement this past fiscal year (ending June 30, 2011). In advance, a June 29, 2011, District Court expressed its opinion: "Only minimal levels of staff and operating expenses that are necessary" should continue. "All others are recommended to close." Of "activities recommended to continue" number one on the list (although it is not stated if the sequence is in order of priority) was "bond payments and related activities."

Minnesota political alliances belie such a full-throated bondholder decree. The attorney general petitioned the District Court for an Opinion; the governor opposed the attorney general's Petition, arguing executive and legislative authority over budget priorities are not judiciable. In private, the political actors agreed that payments to bondholders were more important than paying a single salary. (The impasse, during which bondholders were paid and non-critical state employees were idled, lasted until July 20, 2011, when an agreement was reached.) Such a cordial behind-the-scenes concord can be expected in other states and municipalities. The consequence of not paying bondholders includes the assumption they will be unable to issue general obligation bonds for several years and, even then, at higher interest rates.

A second reason to remain current is to retain control. When a municipality enters bankruptcy, the court can exert enormous control over the legislative bodies. The court will decide who gets paid in the case of Harrisburg, leaving aside for the moment the Commonwealth of Pennsylvania's legislative and legal attempts to thwart the bankruptcy filing, as well as the mayor of Harrisburg's legal action against the city counsel's decision to file. (Note: this discourse addresses situations when it is not necessary to default. There will be many situations when there is no choice.)

This "clearing of the decks" allows us to suppose the court adapts the "Municipal Financial Recovery Act Recovery Plan [for the] City of Harrisburg" submitted (by several concurring organizations) on June 13, 2011. Since Harrisburg's finances are no better than four months ago (at best), the court may save itself some time by reviewing this 422-page, 11-megabyte plan.

Among its conclusions, the Plan states: "[T]he City must [note: "must"]... outsource [its] commercial sanitation collection; eliminate [its] Park Ranger program; combine Park Maintenance in the Department of Public Works..." These are only a few of many structural changes. Henry Kravis has a bigger heart.

The Plan does not shrink from expressing its disgust at backroom City deals by certain politicians: "The City must contain fast growing employee compensation by immediately challenging the extensions made by the previous Mayor immediately prior to his leaving office that increased compensation for employees despite the looming financial crisis..."

The nexus between previously negotiated employee compensation - particularly by unions - and the dwindling revenues to fulfill their legally negotiated pay and benefits (both parties signed), will be a battle royale. Although the Plan does not state a specific reduction, it is unambiguous in regard to which is Peter and which is Paul: "[T]he city is forced to reduce its existing operating budget by a minimum of $2.5 million to pay debt service and compensate for lost revenue...."

Although not generally mentioned, both the municipalities and the unions understand which comes first. The unions know it is better to press their demands up to the point before default and (possibly) bankruptcy. This puts them in accord with the politicians' top priority: to make bond payments. A central figure in the mid-1970s, New-York-City negotiations recalls: "Union leaders need to look as tough as they can. When they have to back down, they vilify the city's negotiators. It's a macho thing."

Why, then, did Harrisburg file for bankruptcy, given that many parties did not think it was necessary? This is a big country and not everyone gets the word. Mistakes will be made. That's why they are where they are.

The 8% Solution

2011-10-13T20:39:00.001-04:00

The terminal stage of Dr. Frankenstein-style central banking is disgorging ridiculous claims of authority motivated by reckless efforts to retain control. One such pincer attack is the Federal Reserve's purported 2% inflation target. Behind our very eyes, this fictional mandate is being raised, all the more reason that savers need to speculate, not a welcome prospect with both inflationary and deflationary influences expanding and bound to burst.

A certainty of this age (post-Western-Civilization) is the ease with which libertine policies escalate to fantastic proportions even as they are failing. The Federal Reserve mumbles its 2% inflation target while the "economic literature" has sown the garden for an 8% inflation rate, in the name of "price stability."

To be more precise, "inflation" to the Federal Reserve is conveniently defined as the consumer price index - without including food and energy. This 2% or 8% target should be understood as a negative interest rate. The Federal Reserve will (through its current policy, although this will boomerang at some point) hold Treasury yields at zero-percent. It will target inflation at 2% to 20%.

In The Beginning, at least in this short narrative, a Harvard economist told a Senate committee the United States must accept a 2% inflation rate as the cost of prosperity. That was in 1957, a very good year to wrap such a career-advancing declaration inside a Cold War mandate. "Growth" would defeat the Soviet Union.

Federal Reserve Chairman William McChesney Martin did not agree. On August 13, 1957, Martin warned that recent inflationary pressures had risen from a period of strong economic growth fostered by "'imbalances in the economy' in which 'rising costs and prices mutually interact upon each other over time with a spiral effect.' . . . The person most likely to be injured in the inflationary cycle was the 'hardworking and thrifty...little man' on fixed income who could protect neither his income nor the value of his savings."

Martin was doomed to lose this battle and the media misunderstood hemorrhaging inflationary tendencies. Inflation was National Worry #1 when the business editor of the New York Times calmed his readers: "Luckily, the Government has the ability and the wisdom not to let inflation break into a gallop as it has happened recently in other countries." That was in 1966.

President Richard Nixon held a farewell gala for Martin in 1970. The soon-to-be ex-Federal Reserve chairman sobered up the tipsy revelers when he removed the punch bowl during his valedictory speech: "I wish I could turn the bank over to Arthur Burns [the next Fed Chairman] as I would have liked. But we are in deep trouble. We are in the wildest inflation since the Civil War."

Moving ahead, Professor Ben S. Bernanke wrote a book that was well received in the right circles: Inflation Targeting: Lessons from the International Experience (2001). One of his co-authors was Frederic Mishkin. Those in the know understand the implications of Mishkin's cooperation. The book propagated the awful euphemisms ("the zero-bound" and "inflation targeting") used to disguise their mandate to inflate. Rather, they could have simply stated: "Let's ruin the dollar."

Some economists took exception. Lee Hoskins, president of the Federal Reserve Bank of Cleveland from 1987 to 1991, wrote: "Pundits, economists, and some Fed officials often talk about the fight against inflation or the battle against it or the need to contain it as if it is some preternatural event. The Fed does not have to battle or contain inflation, it creates inflation.... So when a Fed official says the goal for inflation should be 2 percent, he is explicitly choosing to create that rate of inflation." ("Zero Inflation: Goal and Target," 2005) Hoskins is not a regular on CNBC's short list. (See "The Education Gap.")

Federal Reserve policy of 2% inflation is a product of failure and verbal repetition. Bernanke's Fed needs room to maneuver ("infinite bound"), and a wide fairway to compound its broadening failure, while not losing credibility. Thus, this fictional authority is repeated over and over. Current Federal Reserve Governor Janet Yellen: "This increase in core inflation was below the 2 percent rate that I and most of my fellow Fed policymakers on the Federal Open Market Committee (FOMC) consider an appropriate long-term price stability objective."

Note the structure of Yellen's statement. She hides the arbitrary ("consider an appropriate") under legal cover ("price stability"). The Fed and its accomplices in the professorate train the public mind through such repetition.

Even with 2% inflation touted as a mark of price stability, higher figures are working their way into the public conscience. N. Gregory Mankiw, a Harvard economics professor who consistently establishes new lows in personal integrity, wrote a column in the April 19, 2009, New York Times: "It May Be Time to go Negative."

It should be remembered that Mankiw made his proposal because Federal Reserve Chairman Ben S. Bernanke's grand theory was failing. In October 2011, we know it has failed. Bernanke's foolish interpretation of the Great Depression has done nothing to halt the housing bust. It is far worse today than in 2009, and probably about to take another tumble. This was an inevitable consequence of the credit binge, of which Bernanke's Fed has no understanding. We have paid a heavy price for this ignorance. Investment continues its drift towards short-term trading gains and not into industries that need long-term investment to prosper. The result: a country with an inflation-adjusted median income that is 6.7% below that of June 2009.

In his 2009 column, Mankiw wrote: "[T]here is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates - interest rates measured in purchasing power - could become negative. Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. Ben S. Bernanke, the Fed chairman, is the perfect person to make this commitment to higher inflation...." That's enough. Mankiw consistently makes Eddie Haskell's syrupy conversations with Ward Cleaver sound like General Patton's misadventure with the hospitalized soldier.

Note that Mankiw was behind the times. He needed to justifying negative interest rates even though such a course is inconsistent with the Fed's mandated goal of "price stability." No insufferably pliant economist would make that mistake today - note Yellen, above.

It is obvious that Mankiw is vying to head the Fed, with such maneuvers as his recently announced post as Presidential candidate Mitt Romney's economic adviser. Romney has stated he will jettison Bernanke. (Romney's other adviser is Glenn Hubbard - See: Inside Job) The resourceful Bill Black, author (The Best Way to Rob a Bank is to Own One: How Corporate Executives and Politicians Looted the S&L Industry) and currently professor of Economics and Law at the University of Missouri - Kansas City recently quoted from a paper written by Mankiw in 1993: "[I]t would be irrational for operators of the savings and loans not to loot."

Harvard economics professor Kenneth Rogoff, author of This Time is Different: Eight Centuries of Financial Folly, told Bloomberg News on May 19, 2009: "I'm advocating 6 percent inflation for at least a couple of years." Rogoff has not changed course, recently advocating 6% inflation in the Financial Times.

Mankiw was quoted in the same article as declining to "put a number on what inflation rate the Fed should shoot for, saying that the central bank has computer models that would be useful for determining that." The "model" trick is the mental ghetto that permits fourth-rate economists to become Federal Reserve chairmen.

But Mankiw is on to something. Why pin yourself to a rate, when triple-digit inflation may be required to really ruin the country?

The following sequence is a lesson in how bureaucracies insinuate their failures into accepted policy.

Stanley Fischer, current Governor of the Bank of Israel, doctoral Ph.D. thesis adviser to Ben S. Bernanke and to Greg Mankiw (at MIT), with stops at every institution of impeccable prestige among the anointed (chief economist at the World Bank, vice chairman of Citigroup) professed in 1997 that: "The fundamental task of a central bank is to preserve the value of the currency." That is the first sentence in "Maintaining Price Stability," a paper published when Fischer was First Deputy Managing Director of the International Monetary Fund. Five paragraphs later (wasting no time) Fischer wrote: "Barro (1995) and Sarel (1996) do not find a clear negative relationship below 8 percent inflation..." That is, as long as it remains at 8 percent or below, inflation is not a burden to economic growth.

We can be sure the conclusion rested on the result of some computer model. Barro (1995) and Sarel (1996) cited as their authority Fischer (1993), which is noted later in Fischer (1997).

In 2001, IMF economic researchers Mohsin S. Khan and Abdelhak S. Senhadji wrote a staff paper "Threshold Effects in the Relationship between Inflation and Growth." The authors declare "[F]irst identified by Fischer (1993)" [addressing inflation below an 8 percent rate], "inflation does not have a significant effect on growth, or it may even show a slightly positive effect." Note the change from the (1997) model Fischer from whom they quote: from "do not find clear negative relationship below 8 percent inflation," to "it [8% inflation] may even show a slightly positive effect." This sequence was arranged by Sheehan (2011)

In 1978, Federal Reserve Governor Henry C. Wallich spoke before the graduating seniors at Fordham University. His topic was inflation. Wallich explained the loser is labor. "Inflation becomes a means of exploiting labor's money illusion."

His speech is interesting in a contemporary context. The Wall Street protestors, who are probably building igloos in front of the Nome, Alaska city hall by now, are on to something; or, it seems, some things; but they are diffusing their influence. One of the protestors' tendencies leans towards a government solution. This is a barren tangent. A supersized government uses supersized banks to remain supersized.

Wallich told the Fordham students, that government is one of the winners in an inflation. From this Federal Reserve official: "It [inflation] allows the politician to make promises that cannot be met in real terms, because, as the government overspends trying to keep those promises, the value of those benefits shrinks." This creates a "diminishing ability of households to provide privately for the future.... One may ask whether it is not an essential attribute of a civilized society to be able to make that kind of provision for the future."

Wallich went on to emphasize "the increasing uncertainty in providing privately for the future pushes people who are seeking security toward the government." If alive today, he would not be surprised the protestors are looking to the government for help. Wallich (1914-1988) grew up in Berlin and lived through what he warned against (1978).

Wallich added that inflation "creates a vacuum in the private sector into which the government moves." He worried that the consequences of the inflation would be "a shift into the third dimension, away from democracy and toward authoritarianism."

In Wallich's Germany, Joseph Goebbels (1897-1945) spoke at Nuremberg (1934):

"It is no sign of wise leadership to acquaint the nation with hard facts over night. Crises must be prepared for not only politically and economically, but also psychologically. Here propaganda has its place. It must prepare the way actively and educationally. Its task is to prepare the way for practical actions. It must follow these actions step by step, never losing sight of them. In a manner of speaking, it provides the background music. Such propaganda in the end miraculously makes the unpopular popular, enabling even a government's most difficult decisions to secure the resolute support of the people. A government that uses it properly can do what is necessary without running the risk of losing the masses."

The Golden Constant

2011-10-07T08:23:00.003-04:00

The following is a brief outline of "Gold and the 'Flations," published in the April 2005 Gloom, Boom & Doom Report.

General talk has it that gold is a hedge against inflation. We might take this a step further and conclude that a unit of gold will purchase a constant basket of goods when prices are inflating.

Standard advice does not include gold in one's asset mix during non-inflationary periods. The evidence presents a more complicated picture.

Taking the data alone, gold has been a better wealth gatherer, and preserver, during deflations than inflations. (The following discusses gold vis-à-vis goods prices, not asset prices.) That is beside the point today: Gold has consistently been of greatest value during times of disintegration.

Roy W. Jastram, professor of economics at the University of California, Berkeley, spent two decades collecting data and sifting through the evidence. He published his conclusions in The Golden Constant (1977). (There is a recent successor book that is not consistent with Jastram.)

Jastram's interest was the value of gold in relation to purchasing power. Given most, if not all, paper currencies' decline in this regard, the author's findings are worth studying.

First, over long periods of time, gold maintains its purchasing power. "The intriguing aspect to this conclusion is that it is not because gold eventually moves towards commodity prices but because commodity prices return to gold." The author called this "the retrieval effect." The implication today is the price of goods, which have increased in the low single-digits over the past decade according the government, will catch up to the 18%-or-so annual increase in the spot gold price over the same time. Gold and Silver Stocks made the case that the miners are primed for heady gains. The farcical characters ruining the world's paper currencies make an even better case that gold is headed to 36,000 (as prophesized by Glassman and Hassett. They identified the wrong market. )

Second, gold has held purchasing power to a greater degree in deflationary periods than during inflationary times. That distinction is not important today, since this is a time of disintegration. Thus, we come to the heart of the matter:

Third, "gold has served as a financial refuge in political, economic, and personal catastrophes." The current collapse of central banking, the practitioners of which are destroying the world's financial system in an attempt to salvage their reputations, fits all three. Jastram labeled this the "Attila Effect."

That is the case, pace Jastram, for owning gold and the miners today.

Following are some very brief comments on Jastram's methods and review of his figures, originally published at much greater length in "Gold and the 'Flations."

Jastram collected data from two countries to produce his "purchasing power of gold." These were England (1560-1976) and the United States (1800-1976). England is a country "for which data are available over unusually long spans of time" and "with constant political boundaries for many centuries." Jastram recognized the United States cannot "match all of the attributes cited earlier for the choice of England" but "it is fully justified by its great importance both as a national economy and as an economic influence on the rest of the world."

He approached this excursion into economic history as a statistician: "I do not presume to take on the role of an economic historian or a monetary economist as well." Nonetheless, patterns of monetary behavior under analogous historical events do repeat themselves.

In England, the purchasing power of gold declined during inflationary periods: 1623-1658: -34%, 1675-1695: -21%, 1702-1723: -22%, 1752-1776: -21%, 1793-1813: -27%, 1897-1920: -67%, 1933-1975: -25%.

Again, in England, the purchasing power of gold rose during deflationary periods: 1658-1669: +42%, 1813-1851: +70%, 1873-1896: +82%, 1920-1933: +251%

The numbers require interpretation. Gold has been a much better hedge against inflation than is shown. For instance, during the inflationary period of 1933-1976 in England, gold lost 25% of its purchasing power but prices rose 1,434%. (As to what might have kept pace with inflation, "crime" comes to mind, the tendency at Too-Big-to-Fail banks.)

Importantly - for the investor and shopper - Jastram concentrated on periods that lasted a generation or more. He was "not concerned with a transient swing of upward or downward price movements of short duration, but rather with fundamental changes in price levels of substantial duration." He emphasized that gold is an ineffective hedge against yearly commodity price increases.

Jastram's findings should be compared to the traditional investment adviser's rationale for owning or not owning gold. As outlined:

Gold is a poor hedge against major inflations.

Gold appreciates in operational wealth in major deflations.

Gold is an ineffective hedge against yearly commodity price increases.

Over long periods of time, gold maintains its purchasing power.

Gold has no equal during times of disintegration. The "Attila Effect" is coming soon to stores near you.

Measuring Financial Productivity

2011-09-30T06:49:00.001-04:00

"An Absolute Zero" discussed the relationship of credit growth to economic growth. (The measurement used in the article was the change in non-financial domestic debt divided by the change in nominal Gross Domestic Product.) The productivity of credit has sharply deteriorated over the past 30 years. In fact, the additional credit creation today may actually be a cause for economic shrinkage rather than growth. It is making us poorer.

There are other ways to look at the efficiency of finance. I would like to hear from anyone who has given this some thought.

Josh Friedlander, friend and Online Editor of Absolute Return magazine, has already chipped in. Josh writes: "I really loathe GDP." That makes two of us. If given the opportunity, I would ban the government from calculating GDP. Josh goes on to ponder whether GDP "probably [gets] some rise simply from the transfer of (newly issued) government securities from one place to another.... [B]ut maybe this is exempt from GDP." I don't think issuance of government securities changes total GDP, but would like to hear from someone who knows.

Josh asks whether I've "done this analysis as a ratio of debt to government revenue. Agreed, taxes change, but that's how I'd value the U.S. if it were a business."

The tables I found for tax receipts are organized by fiscal year. Some more research would surely turn out monthly figures which would be comparable, but my entire staff is draped in black so unable to function. Some Red Sox thing.

Back to the measurement used: the change in non-financial domestic debt divided by the change in nominal Gross Domestic Product. There are at least two advantages to using GDP in this comparison. First, it is widely recognized as a measure of growth. Second, since it is a widely publicized economic number it is manipulated - to the government's advantage. Thus, the measure of financial efficiency used in "An Absolute Zero" understates the deteriorating relationship of new debt to economic growth. It is better to err on the conservative side.

Error in such comparisons must be accepted. There is no perfect measurement. Economic numbers are always estimates and patterns within the object being measured change over time. The employment figures, for instance, are not an exercise in counting every working noggin in the country. Cutting-and-pasting from the Bureau of Labor Statistics website: "The confidence interval for the monthly change in total non-farm employment from the establishment survey is on the order of plus or minus 100,000... there is about a 90-percent chance that the "true" over-the-month change lies within this interval."

Now, for those who watch Bubble TV, think of all the hoopla when the employment numbers are announced each month. What an exercise in fatuity. (Bill King - The King Report - just reminded his readers of an August 19, 2009, story in The Onion: "CNBC: Anyone Who Owns a Suit Can Come on Television" From the story: "'Just come on down, run a comb through your hair, and if you're here by 8 a.m., we'll have you on Squawk Box at 8.15 making stock picks. But don't forget your suit!'")

Modern Kremlin watching includes the change in relative importance of economic numbers. GDP, the monthly employment figures, and the CPI are ascendant. Thus, they should be treated with the greatest skepticism. Income is rarely mentioned. Given that income, as a whole, have not risen since 2008, it is wise of the government mandarins to ignore it. The media's reason for not pursuing such a hot lead is a mystery. At least The Onion is publicizing the root of the problem.

A descending figure is productivity. In the late-'90s, an exhilarating productivity announcement (+0.1% was all Bubble TV needed) was good for a $50 boost to Webvan and theGlobe.com. This was Fed Chairman Alan Greenspan's doing, in a complicit alliance with heralded economist Michael Boskin. (See "Economists Serving Their Political Masters") The torturous destruction of GDP and productivity can be reviewed in "The Government's New Math: 3.5% - 5.1% = 1935." Chapter 12 of "Panderer to Power" is devoted to the subject.

Today, the quarterly productivity announcement is barely discussed. Again, this is for good reason, from Washington's point-of-view. Productivity is falling. Non-farm business productivity per hour fell -0.6% in the first quarter and by -0.7% in the second quarter of 2011. If this were 2000, Webvan might have gone out of business three weeks sooner. As an aside, I don't think we can measure productivity today. It may have revealed some trends when a large proportion of America's work was shipped from River Rouge.

Comments on how to measure the change in the efficiency of finance over the decades are welcome. This includes the return on capital, and on equity, even though one only need be alive to see the obvious deterioration in how we allocate our capital investments.

An Absolute Zero

2011-09-27T08:55:00.000-04:00

The Federal Reserve Open Market Committee (FOMC) concluded a two-day meeting by initiating "Operation Twist." The FOMC's press release explained: "The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."

This announcement initiated sell programs in almost every market. There are many reasons for this reaction, one of which was the recognition that every initiative has failed, and now, all they can think to do is drive down yields that are already below 2.00%!

A reason for the Fed's failure is the array of topics that never enter the mind of economists such as Federal Reserve Chairman Ben S. Bernanke. These include money, credit, debt, and capital.

The productivity of capital is an important consideration, one which most people understand, in their own words. A bank does not lend money to a business that can not earn its way to paying back the loan. A potential borrower understands the banker's hurdle. (This refers to the majority of smaller banks in the country where the officers lose their jobs or worse when the bank fails if it adopts such a strategy.) An investor buys shares of common stock in a company that will produce the most from the least. The higher the profits produced per share, the more the shares should be worth.

Ben & friends do not think this way. During the Fed's quantitative easing schemes, the additional debt has produced nothing. The Federal Reserve, including the Board, the FOMC, and the thousands of Ph.D. researchers may not know even know of this relationship, but there is a growing understanding, intuitive or quantitative, that sees the Bernanke Fed as failing by a greater degree with every new initiative.

During the 1980s, the change (rise) in non-financial domestic debt divided by the change (rise) in nominal Gross Domestic Product was 2.2. That is, for every $2.20 borrowed, the United States produced $1.00 of additional goods and services (nominal). In the 1990s, debt was less efficient. It took extra debt to accomplish the same. The ratio (rise in debt-to-GDP) was 2.7:1. Between 2001 and 2008, even more debt was needed to produce more stuff: the ratio rose to 4.2:1.

The Fed has been rolling out its various quantitative initiatives since early 2009. The ratio of debt to production has been 3.7:1 (through June, 2011). But, the increase in transfer payments (1-in-7 Americans now receive food stamps, Cash for Clunkers, shovel-ready bank bailouts) exceeds the rise in nominal GDP by a wide margin. As a measure of financial efficiency, the ratio is now meaningless.

The additional debt being manufactured is not producing any additional goods and services. The more Bernanke applies his senior thesis to the real economy, the less the economy is able to pay down old debt, much less manufacture additional goods and services to pay down the new debt.

The Fed has pegged short-term interest rates at zero; Operation Twist is an attempt to drive long-term rates to zero (or, close to it); the rise of incomes in the United States since 2008 has been zero; "real" GDP growth since QE1 has been less than zero; the FOMC is an absolute zero.

Somebody in the past couple of weeks, I forget who (my apologies), compared the central bankers' Mad Hatter policies to the strange physical transformations when approaching absolute zero (-273 Celsius). Solids, liquids, and gases behave strangely.

We have arrived at that point with financial markets. The Authorities have lost control of the markets they have been manipulating. Desperate tactics, with untold unintended consequences, such as the Swiss National Bank doubling its monetary base last month, ensure more fanatical outbursts from the Fed, the ECB, and the Bank of Japan. In this setting, gold fell more than $150 last week. Other than remote islands, this is the best bargain around.

The Financial Times Discovers Gold Stocks

2011-09-21T07:04:00.002-04:00

Having read "Gold and Silver Stocks", the Financial Times decided to follow the trend with "Investors Bet Miners Will Follow Gold's Gain." (September 20, 2011) The article discusses efforts of gold miners to distinguish themselves from Gold ETFs: "[G]old miners are beginning to respond to their share-price underperformance. The most popular response is to raise dividends, offering investors one thing an ETF cannot: a yield." (See "Gold and Silver Stocks" for the same discussion.) The Financial Times continues, discussing two companies that are increasing dividend payouts, Newmont Mining and Gold Resource Corporation.

These are the same two miners discussed in "Gold and Silver Stocks." The Financial Times relays Newmont Mining's Monday announcement (September 19, 2011) that it will pay out an additional 10 cent dividend for every $100 above $2,000 an ounce. The FT discussed a novel dividend payout being considered by Gold Resource Corporation. The miner "might start paying dividends in physical gold."

This is fine but the FT story may cause confusion. The reason for owning gold is easily misunderstood. This ambiguity will continue to be the greatest problem for potential and current owners of precious metals. Gold will be bought and sold at the wrong times by many of the misinformed. (Note: what follows only fleetingly addresses an important consideration - prices and cash flow should rise.)

A lack of precision may lead to a misunderstanding just as a truth may stumble into a half-truth. A half-truth is often more dangerous than a lie.

Quoting from the FT: "Investors increasingly buy gold as a form of insurance against further economic turbulence. Mining companies - which can miss production targets, suffer strikes, accidents and higher taxes, or see their profits eroded by cost inflation - appear to offer less protection against this scenario."

The sequence is correct. It runs from (first sentence) gold to (second sentence) gold stocks. Gold stocks derive their price from gold, but they are stocks. The second sentence is a good synopsis of why the derivatives (gold stocks) have performed so poorly in comparison to the metal. Their attraction lies with the probability that these shortcomings have been excessively discounted.

The FT describes gold as being bought as a "form of insurance against further economic turbulence." That is true but not the whole truth. One might interpret this to mean "I should own some gold as a hedge against further volatility [my stocks might go down 30%]. I don't care about volatility because I read Stocks for the Long-Run, so I don't need to buy gold"

Quoting from "Gold and Silver Stocks": "The real story is that gold is money but only speaks up when the credibility of states and their currencies deteriorate."

The great minds at the central banks, by manipulating every market under the sun, have lost control of the world's financial system that, they apparently thought was a chalkboard theory. Official interference has failed. Last week, the great minds showered European banks with dollars, because some European banks are having great difficulty borrowing dollars. This massive flood has not regenerated trust. Siemens disclosed that it withdrew more than 500 million euros from French commercial banks and deposited them at the European Central Bank. (The ECB, itself, is extraordinarily leveraged. This should not simply be dismissed as a "boys will be boys" curiosity.)

From Reuters: 9/19/11:LARGE CHINESE BANK STOPS TRADING WITH SEVERAL EUROPEAN BANKS DUE TO FEARS REGARDING EUROPEAN DEBT CRISIS - Sources say the unidentified Chinese bank has stopped all swaps and foreign-exchange forward trading with Societe General (GLE.FP), Credit Agricole (ACA.FP), and BNP Paribas (BNP.FP). The bank has also stopped trading with UBS (UBSN.VX) due to worries about UBS's loss from the new rogue trading affair. (Remember the hastily planted rumor, just last week, and for the 63^rd time, that China was buying Europe's debt?)

We are witnessing the insolvency of the fractional-reserve banking system, at the highest level. (At the lowest level, local banks and small insurance companies should be buying precious metals. Tell the regulators to scram.) It would be a mistake for the average investor to buy and sell gold and gold shares depending on one's view of market volatility over the next month or year. Gold, silver and other inanimate objects are assets without liabilities. Unlike dollars, these...things, do not bear the government's Lewis Carroll promise: "This note is legal tender for all debts, public and private." The dollar's value is a derivative of the loony professors who run the country. Choose your weapon.

Gold and Silver Stocks

2011-09-17T08:04:00.001-04:00

The prices of gold and silver shares are derived from the price of their reference metals. The referral method has gone astray, akin to a renegade ETF.

Osiris Investment Partners L.P. in Boston, under the authorship of Principal and Managing Member Paul Stuka, wrote to clients on August 18, 2011. The XAU Gold Index was down 6% for the year-to-date, and the GDXJ Gold Stocks Index of smaller gold miners had fallen 10%. On that same mid-August date, gold - the real stuff that hardly anyone owns but of which everyone within the media's range is expected to express an opinion - had risen 26% in 2011.

The gap between gold and the diggers will close - when is hard to say. In which direction we will discover. The view here is that the stewardship of paper currencies, the medium in which gold, silver, and oil (crude, canola, and palm) are priced, has never been in worse hands. This is saying less than might be thought since it was not until 1971 that official money went untethered from impartial restraint (usually, gold). Alas, the world is slow to grasp central banks are peopled by political hacks (as Senator Harry Reid called then-Federal Reserve Chairman Alan Greenspan in 2005, but equally true of today's empty suit) so now is the time to make money.

Money is to be made by holding anti-dollars. Federal Reserve Chairman Ben S. Bernanke continues to decompose before our eyes, stating on September 8, 2011, that the United States is blessed with lower inflation than other countries and "Low inflation means that the buying power of the dollar, in terms of domestic goods and services, remains stable over time." It does not take a trial lawyer to see the inconsequentiality, inconsistency, or mendacity in that labored claim. Ben may be fishing turtles from the local creek, painting his barbarous equations on their backs, and selling them at the local five-and-dime (which would still be overvaluing his scholarship by at least a nickel), but shoppers at local farmer's markets are paying the price for purchasing with dollars.

Osiris Investment Partners went on to write: "[S]ince the early 1980s, when the XAU Index was first constructed, until the fall of 2008, this ratio remained in a range of .16 to .38, even during the depths of the gold bear market. [That is the ratio of the XAU Gold Stock Index divided by the price of an ounce of gold in U.S. dollars. - FJS] During the financial crisis of 2008, this ratio dropped briefly to .09. Since that time, it has traded up to .16, but it has never exceeded the former floor. As I write today the ratio is .114. In other words, the gold shares are currently the cheapest that they have ever been, excluding a one-month period in the fall of 2008. On a fundamental basis, gold stocks have historically traded at 10 times or more annual cash flow. We are presently seeing many companies priced at one to three times potential forward cash flow, if they can execute their plan. Clearly, not all of them will realize the potential. However, many will."

Of the cash flow, Erste Group, (Erste Bank, Vienna: "In Gold We Trust;" July, 2011; Ronald-Peter Stoferle), estimates the "aggregate free cash flow of the 16 companies in the Gold Bugs Index will amount to [$8.5 billion] this year and will increase to [$14 billion] by 2013." Erste Group continues: "The companies in the Gold Bugs Index currently command an estimated 2011 [price-to-earnings ratio of] 14x, which is expected to fall to 12x in 2012. This is extremely low in terms of its own history (average PE 2000-2010: 33x) and in relation to many other sectors." (The Gold Bugs Index consists of 16 mining companies that do not hedge their gold production. This is not necessarily true of the miners in the XAU Index.)

Potential investor seek the potential catalyst. What might that be?

First, the correlation among sectors in the S&P 500 has never been greater. ETFs and high-frequency trading rule the waves. Machines trade stocks in bulk, with little distinction among industries and companies. Such periods of over-zealous gimmickry and of intimidated investors are often good times to buy stocks that will later assert their superior characteristics.

Second, gold- and silver-mining shares are underowned in relation to one-stop-shopping ETFs. The miners know this. Shareholders have enlightened management: they need to pay out dividends to distinguish themselves as real companies. Recently, Newmont Mining stated it will increase its dividend by twenty cents per share for every $100 rise in the price of gold. Gold Resource Corporation has set a target of paying out one-third of its cash flow in dividends to shareholders.

Third, the argument of whether the world is inflating or deflating is tangential to the price of gold. Better expressing the "price of gold": how many units of paper currency (such as the dollar) does it cost to buy an ounce of gold? (We are returning, now, to the reference metal). Gold has performed better in deflations than inflations, but the cause and effect that this relationship addresses ("gold is an inflation hedge") may be misleading. Monetary, military, and political chaos have more often corresponded with deflationary than inflationary times. The real story is that gold is money but only speaks up when the credibility of states and their currencies deteriorate.

Fourth, the proportion of people who own gold and silver is small. (Particularly so in the United States, but that is not the point, here.) This is the greatest flaw of the "gold in a bubble" chorus. There has been no panic into gold, or, more likely for the Average Joe, into gold shares. At some point, the sight of Bernanke may be worth a quick $500-an-ounce trading profit. It should be, already.

Harvard Deconstructed: The Taming of the Zoo

2011-08-31T10:31:00.003-04:00

The Atlantic magazine has illustrated the unsustainable growth of student debt in the chart below. In David Indiviglio's August, 18, 2011, article, "Student Loans Have Grown 511% Since 1999," the author notes: "Obviously the number of students didn't grow by 511%. So why are education loans growing so rapidly? One reason could be availability. The government's backing lets credit to students flow very freely.... [U]niversities are raising tuition aggressively since students are willing to pay more through those loans."

Indiviglio concentrates his attention on the future problem for the students, though that is secondary, except, of course, to the students in hock and out-of-luck lenders. Colleges and universities in the United States are a short sale. Great Courses are a long. The latter is the model to ponder.

The number of colleges will plummet. This is due to the loss of nerve, confidence, substance, direction, integrity - will that do? - of teaching in America. Just look at that chart: what a picture of insatiable greediness and self-indulgence among the colleges. No thought to the unbearable debt deposited on their students.

Angelo Mozilo, the grand poobah of subprime mortgages, is correctly vilified for coaxing financial naives into debtors' prison, but the same tactics by the education establishment goes unremarked. In another Atlantic article, "The Debt Crisis at American Colleges," authors Andrew Hacker and Claudia Dreifus write: "[C]olleges have embraced a host of extraneous activities - from obscure sports to overseas centers - and tacked most or all of their tabs onto students' bills. Unlike businesses, which cut losing operations, colleges simply hike their tuitions." Will former Harvard Professor Elizabeth Warren's ill-defined federal agency, watchdog over slatternly marketing hoaxes by financial institutions, apply the same standards to deceptive, college sales practices?

A century ago, John Jay Chapman, Harvard alum, was a pain-in-the-neck to Harvard College President Charles William Eliot. He tried to sack the president. In 1909, Chapman wrote that his college had diluted its resolve to teach the truth: "The men who control Harvard to-day are business men, running a large department store.... Devising new means of expansion, new cash registers and credit systems - systems for increasing their capital and the volume of trade....The wonderful ability of the American business man for organization is now at work consolidating the Harvard graduates into a corps which seems to have the same sort of enthusiasm about itself as a base-ball team.... (This is excerpted from "The Hundred Year Bubble," a dissertation originally published in the January 2010 issue of the Gloom, Boom & Doom Report on America's unwillingness to set limits over the past century, and the parallel inflation of money, self-improvement, self-delusion, and self-gratification.)

Chapman's alarm may be difficult to understand today, but he had the advantage of living during a sharp break in the then-nearly-300-year history of Harvard College: before and after it took the low road. Eliot was an early exemplar of the "New Education" thesis that sought a "universal utility" in American education. This inflation of mission and of human potential, captured in Eliot's substitution of vocabulary for thought, is collapsing.

Others also rued the dangerous downgrading of the American mind at the universities. In 1908, Albert Straus, then partner at the investment firm of J.W. Seligman and Company, told a Columbia University audience: "[W]e are slaves to our phrases; what begins by being a metaphor ends by dominating our thinking...[W]e often reason about these matters as though the pictures that our words call up were real." And Straus never saw MTV.

Colleges today have set many missions for themselves, not many of which are in the interests of their students. They disguise their reluctance to teach with slogans and images: "empowering students to achieve professional and personal success in dynamic careers and in a diverse global society by providing a comprehensive and supportive educational experience, fostering academic integrity, and encouraging lifelong learning." (Berkeley College, Boston) Only by carrying the imprimatur of a college, or of a government bureaucracy (really, one in the same, they are slaves to each other), does the public accept such a pile of flotsam as making sense. (Yes: Bernanke and his fellow imposters.)

A globally-known investor wrote to me after "Scarlett O'Hara's Risk-Free Rate" that Harvard is finished and will be insolvent. The collapse of America's colleges, and of the primary- and secondary-school farm systems, will probably be a good thing overall, difficult as it will be to understand during the unfolding: It may clear out the zoo.

In the July 2011 edition of the Gloom, Boom & Doom Report, Marc Faber quoted a study from the Goldwater Institute that found between "1993 and 2007, the number of full-time administrators per 100 students at America's leading universities grew by 39 percent, while the number of employees engaged in teaching, research, or service only grew by 18 percent."

In the Summer 2011 edition of City Journal, Heather MacDonald writes: "This past academic year, for example, a Bowdoin College student interested in American history courses could have taken 'Black Women in Atlantic New Orleans,' 'Women in American History, 1600-1900,' or 'Lawn Boy Meets Valley Girl: Gender in the Suburbs,' but if he wanted to take a course in American political history, the colonial and revolutionary periods, or the Civil War, he would have been out of luck."

Noteworthy is the larger topic Mac Donald discusses in "Great Courses, Great Profits." A company called Great Courses is making gobs of money selling recorded lectures by college professors who teach "Plato, Aristotle, Cicero, Paul, Erasmus, Galileo, Bacon, Descartes, Hobbes, Spinoza, Dante, Chaucer, Spenser, Shakespeare, Cervantes, Milton, Pope, Swift, Goethe, and others..." This may not be materially different from the lectures John Jay Chapman attended in the 1870s. Those who pay Great Courses receive no degree, no padding to their resume, no Delta House invitations, no country-club dormitory suite, no indulgent, grief-counseling administrators, and no future business network.

Macdonald goes on to write that college faculties wring their hands because the curriculum has been "problemetized." There is some resistance to such courses as "Queering the Alamo."

"My dear James," wrote Chapman in 1907 to his friend, Harvard professor William James (The Varieties of Religious Experience), "Eliot has boomed and boomed - till we think it's the proper way to go on. He must, or lose foothold. Well, why not a man who does not boom? Is boom the best thing in life? Is it all boom? Is there now and to be nothing ever but boom, boom, boom? Is there not something that operates without money - not anywhere?"

The Spring 2011 edition of The Trinity Reporter, alumni magazine of Trinity College (Connecticut), includes a full-page pitch to alums under the picture of a 2004 graduate (name withheld, to spare his family further publicity for this embarrassing incident) screaming like Janis Joplin and tearing his white shirt, blue blazer, and blue-and-gold school tie off to reveal a muscle-bound chest covered with a gray "Trinity" gym shirt. "Blue and Gold Is In Your Blood," shrieks the copy: "Let's keep that competitive spirit alive and show our rivals why Trinity College is among the Top Ten schools in alumni giving participation in the country."

There is really no need to comment on the consummation of Chapman's foresight. The fulfillment of Chapman's letter to Dear James has regressed to the least common denominator.

What might we gain from Sherman's march through the academy? A taming of the zoo. Twenty years ago the author and critic Harold Bloom (The Western Canon, 1994) was interviewed by the Paris Review. Quoting Bloom: "I watch MTV endlessly." This enemy of "The School of Resentment" - feminist literary critics, new historicists, poststructuralists, deconstructionists, semioticians, laconists, and poetry slamists - saw MTV as the real vision of what this country desires: "no matter how many [performers] are on the screen, not one of them feels free except in total self-exaltation." Time to short March Madness?

Scarlett O'Hara's Risk-Free Rate

2011-08-20T23:26:00.001-04:00

The death of the long-established risk-to-reward asset categories was the subject of "It's Over." From lowest to highest: cash, bonds, and stocks, are the pecking order of institutional investment policies. Pension plans and endowments that have wandered into warehouses and gas-pipeline management often retain the outline as a mental diagram. The assets with the highest assumed risk (using statistical measurements) are expected to produce the highest return. The genesis for this construction is the Capital Asset Pricing Model (CAPM), a deeply flawed academic theory.

"It's Over" struck a nerve with readers who have suffered from its domination of asset management over the past three decades. Some gave speeches denouncing it, some forsook advancement, and many endured business-school indoctrination in bewilderment.

The CAPM is not worth further examination (other than the necessity to understand the structure of the institutional mind). However, there is one train of thought that should be considered by the average investor: the incapacity of the model to consider discontinuities. There is no room to "be prepared for the next time the world turns over." That happens every generation or three, and it is happening today.

Quoting from "It's Over":

"There is also the much larger problem of constructing an asset pecking order with rigged asset returns and yields. The market rate for Treasury bills is not zero. The coming dislocation that institutional and retail investors face is, to most if not all, incomprehensible. Consider the reconstruction of Scarlet O'Hara's Capital Asset Pricing Model after 1860. She discovered what can happen to chimerical fortunes built on the backs of government-fixed, zero-percent, risk-free rates."

Each morning the news in the U.S. and Europe veers closer to the closing scene of George Bernard Shaw's Heartbreak House. Recent market turbulence indicates recognition, but the disappearing euro and dollar are treated in the media as a distant political argument among economists, the most destructive group of cross-border planners imaginable. The Federal Reserve, U.S. Treasury Department, European Union, and European Central Bank are acting in unison - that is, in their own short-term interests. Doing so, the independence and viability of personal assets, pension plans, municipalities, colleges, and museums - you can add to this list - are at stake.

The debt-ceiling debate in the U.S. was the most pointless waste of air since Elizabeth Taylor divorced her twelfth husband. First, the debt-ceiling question is not the same as the question of whether the federal government will make good on bond payments, but the two became hopelessly intermingled.

Separating the two: A country that spends one dollar for every 59 cents in tax receipts cannot freeze its level of spending. As a practical matter, cash-matching of inflows to outflows was not possible with over 45 million Americans receiving food stamps, consumers having drawn down savings by $149 billion between September 2010, and April 2011 (during a period when inflation-adjusted spending fell), when 64% of the population is unable to put $1,000 together in an emergency (The National Foundation for Credit Counseling, August 12, 2011, Chicago Tribune), and with a military currently deployed in over 100 different countries. QED.

Second, the federal government did not waver from its commitment to meet bond payment obligations. This was not clear from listening to the media, or the U.S. Treasury Secretary, who bears the duty to defend the nation's credit, integrity of the dollar, and integrity of his office.

Standard & Poor's implicitly downgraded the U.S. Treasury Secretary along with the nation's credit. On July 10, 2011, Treasury Secretary Tim Geithner settled the bond-payment question on Meet the Press: "Let me make this clear: The U.S. is not going to default. We are a country that pays its bills. We're going to meet our obligations." He contradicted himself on July 27, 2011, as stated in The King Report: "[B]y August 2, [2011], Treasury Secretary Tim Geithner says the government will run out of money to pay all its bills, including obligations to bondholders. "On July 28, 2011, Bloomberg reported: "The U.S. Treasury will give priority to making interest payments to holders of government bonds when due if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official." This was the case all along.

The double-talk was issued by a Treasury Secretary who did not pay his taxes until a Senate committee requested that he do so (the Internal Revenue Service reports to Geithner) and who acknowledges: "I never had a real job," (April 2010).

Europe is even more distraught. This is a real, current crisis. The Eurocrats will do anything to prevent a dismantling of the euro; yet, it is coming to an end, or, about to be reduced in scope. The unelected authorities may be able to delay the inevitable, but that will require an enormous amount of money printing. Estimates of €1 trillion to save the Italian and Spanish banking systems are common, but, no one knows the side effects beforehand. Estimates of write-offs and losses over the past few years (Citigroup, Fannie Mae) have generally come up short.

French President Nicholas Sarkozy's statement on August 16, 2011, that the size of the current bailout fund (EFSF) is large enough (€440 billion) is not credible. It is not clear if €440 billion is large enough to prevent Greece and Portugal from rupturing. It is possible that the August 16 meeting between Sarkozy and German Chancellor Angela Merkel ended with an agreement that it is time to cut bait. (They also dismissed "Eurobond" monetization, but euro-salvation initiatives never quite die.) They may have decided expansion of the money-printing adventure will drag France and Germany into the abyss.

Whether or not this is the case, European markets will be chaotic in the months ahead (as they will in the U.S.), with a good chance capital controls will be instituted to prevent Europeans from moving their money elsewhere: an example of a rare occurrence that has not been anticipated by the usual investment strategy. Swiss franc and gold movements show where the more alert European money is moving. Gold has risen from $1,500 on July 5, 2011, to over $1,800 on August 18, 2011. The consequences to U.S. banks, in such an intertwined financial world, are being discounted in the market.

Should an Iron Curtain of capital controls surround Europe, U.S. authorities may issue some gobbledygook nonsense of how Europe's unfortunate decision forced the United States' hand. Doing do, captive financial assets, with limited avenues of dispersal, will drift into 10-year Geithners and the common stocks of National Champions selected by the United Auto Workers and the chairman of the President's Council on Jobs and Competitiveness, General Electric Chairman Jeffrey Immelt.

Now, the star of the show:

To Scarlett O'Hara, her family's plantation in Georgia (Tara) was as risk-free as it comes. Probably to Mr. O'Hara, too, who did not contemplate hard times. When Scarlett wanted to chase other long-term assets (Ashley Wilkes), she told her father "plantations don't amount to anything." Mr. O'Hara fumed: "Land is the only thing in the world that amounts to anything, for 'tis the only thing in the world that lasts, and don't you be forgetting it!" This sounds like an old Fannie Mae ad, not to confuse the honor of Mr. O'Hara and Jim Johnston.

Scarlett's father favored the Capital Asset Pricing Model of the day (100% plantation weighting; risk-free, perpetual, cotton-backed dividends) as did the other, local, wealth-management offices. The plantation owners could not wait to beat those Yankees. (Lincoln and Hamlin, not Jeter and Rivera.) Defeat did not cross their minds. The book value of Tara and Twelve Oaks (Ashley Wilkes' family plantation) was chiseled in stone, just as the historical stock-market and bond-market returns stamped in indelible ink by Jeremy Siegel, Rex Sinquefield and Roger Ibbotson, are as immutable to asset allocation today as they will be gone with the wind tomorrow.

Rhett Butler was what might be considered a contrarian thinker. It is approaching a truism today that a contrarian thinker does not mean much more than common sense. That is, once every generation or two, the world blows up. So it was with Butler, who told the war-whooping plantation owners: "I have seen many things that you have not seen. The thousands of immigrants who would be glad to fight for the Yankees for food and a few dollars, the factories, the foundries, the shipyards, the iron and coal mines - all the things we have not got. Why all we have is cotton and slaves and arrogance. They'd lick us in a month." His comments were not appreciated, and why would they listen to this disreputable financier (which he was), lounging as they were at Twelve Oaks: "the beautiful white-columned house that crowned the hill like a Greek temple."

The South marched off to war and Rhett Butler bought cotton. Scarlett did not approve. She told Rhett he was "vile and a mercenary."

Butler disagreed: "Mercenary? No, I'm farsighted. Though perhaps that is merely a synonym for mercenary. At least, people who were not as farsighted as I will call it that. Any loyal Confederate who had a thousand dollars in cash in 1861 could have done what I did, but how few were mercenary enough to take advantage of the opportunities! [To deflect hostility after preventing money from leaving the European Union (and from the U.S, later), the euro authorities will blame the mercenary Europeans who are buying Swiss francs and gold. Such an accusation always goes down well with loyal, though not far-sighted, citizens when they suffer relative impoverishment at the hands of the authorities. - FJS] As, for instance, right after Fort Sumter fell and before the blockade was established [that prevented leakage from the Confederate financial system - FJS], I bought up several thousand bales of cotton at dirt-cheap prices and ran them to England. [Butler shipped his assets offshore - FJS] They are still there in warehouses in Liverpool. I've never sold them. I'm holding them until the English mills have to have cotton and will give any price. I wouldn't be surprised if I got a dollar a pound."

Scarlett's reply sounds typical, though far more original, than that of a Wall Street airhead on CNBC: "You'll get a dollar a pound when elephants roost in trees."

On the 220-year-chart of cotton prices in the 2010 CRB Yearbook it looks as though cotton rose from around 10 cents a bushel in 1860 to $1.05 a bushel a couple of years later.

Scarlett, clinging to her ERISA-sanctioned policy, which was therefore legally risk-free, retorted: "[I] don't need your advice. Do you think Pa is a pauper? He's got all the money I'll ever need..." This could be an occasion to discuss the topical question of what is money? (see:"Do you think Ben Bernanke is J.P. Morgan?", but Butler, (or Margaret Mitchell), is an expert in the field.

Rhett, with a better historical sense than Scarlett, (even while she, herself, unschooled, would have been shocked at the narrow-minded, ahistorical theories of modern economists), replied: "I imagine the French aristocrats thought practically the same thing until the very moment when they climbed into the tumbrels."

Meanwhile, back at Tara, Mr. O'Hara had stuck with the plantation owner's CAPM: "The South had always lived by selling cotton and buying the things it did not produce, but now it could neither sell nor buy [because of the union blockade of southern ports - FJS]. Gerald O'Hara had three years' crops of cotton stored under the shed near the gin house at Tara, but little good it did him. In Liverpool it would bring one hundred and fifty thousand dollars, but there was no hope of getting it to Liverpool. Gerald had changed from a wealthy man to a man who was wondering how he would feed his family and his negroes through the winter." When it rains it pours: "With the new fall of currency, prices soared again. Beef, pork, and butter cost thirty-five dollars a pound, flour fourteen hundred dollars a barrel....[W]arm clothing, when it was obtainable had risen to such prohibitive prices that Atlanta ladies were lining their old dresses with rags and reinforcing them with newspapers to keep out the wind."

Butler knew what he wanted in a girl and he made sure he got it - a woman who knew how to make money during bad times: "I'm going to be a rich man when this war is over, Scarlett....I told you once before that there were two times for making big money, one in the upbuilding of a country and the other in its destruction. Slow money on the upbuilding, fast money in the crack-up. Remember my words." There were probably similar reminders when investment banks paid credit-rating agencies for AAA ratings on CDOs.

Rhett's concept of money was so old that it's new: "I've made money enough, and it's in English banks and in gold. None of this worthless paper for me." The Confederacy had been reduced to paper money, not necessarily a road to ruin but given Rhett's belief: "the Confederacy is doomed....It had to go and it's going now," he took the only course of action a man with common sense would follow.

Rhett's far-sightedness was not well received: "It simply made everyone furious that an old speculator who always said nasty things about the Confederacy should have so much money when we were all so poor." If the Powers That Were had paid attention to the "nasty things" Rhett Butler willingly shared with anyone who would listen in 1860, he would have remained a shady, wealthy, but unimportant figure.

On the battlefield, writing to his wife (Melanie), Ashley Wilkes expressed contempt for the leaders whom he had trusted: "I see too clearly that we have been betrayed, betrayed by our arrogant Southern selves, believing that King Cotton could save the world. Betrayed too, by words and catch-phrases, prejudices and hatreds coming from the mouths of those highly placed, those men whom we respected and revered - 'King Cotton, Slavery, States' Rights, Damn Yankees.'" Ashley had trusted the Confederacy's Committee to Save the World (see February 15, 1999 cover of Time magazine )

Rhett's sermons were not in vein. Parlor discussions at Tara praised Southern advances but Scarlett listened in contempt. "They haven't any idea what is really happening to themselves or to the South. They still think, in spite of everything, that nothing really dreadful can happen to any of them because they are who they are - O'Hara's, Wilkeses, Hamiltons. [Or: Harvard, Princeton, the Fed. Or: pension plans, endowments, family offices. Or: stocks-for-the-long-run, Too-Big-to-Fail banks, Treasuries, money-market funds. - FJS] Oh, They're all fools! They'll never realize! They'll go right on thinking and living as they always have and nothing will change them....They don't change to meet changed conditions because they think it'll all be over soon."

Scarlett was witness to the fall: "The charred remains of [Twelve Oaks] had crowned the hill in white-columned dignity. The deep pit which had been the cellar, the blackened field-stone foundations and two mighty foundations marked the sight...Ashley had married his bride here but his son and son's son would never bring brides to this house....The House was dead."

This will be the lament of unfortunate trusts and endowments that mistakenly believed they have apportioned their assets for perpetuity.

Tara may have met the same fate but Scarlett had spirit - and was ruthless, inexhaustible, and refused defeat. Nevertheless, she needed aid and solicited her TARP: Rhett Butler. During her same train-of-thought quoted above ("Oh, they're all fools!"), Scarlett concluded: "They think God is going to work a miracle for their benefit. But He won't. The only miracle that's going to be worked around here is the one I'm going to work on Rhett Butler."

Rhett was not forthcoming: "I couldn't give [you money] if I wanted to. I haven't a cent on me. Not a dollar in Atlanta. I have some money, but not here. And I'm not saying where it is or how much. But if I tried to draw a draft on it, the Yankees would be on me like a duck on a June bug..."

From a zero-percent, risk-free rate, money could not be had at any price.

Much later in the book, Rhett explains in textbook fashion his refusal to participate in Scarlett's miracle. Only a sampling is included here. It springs to mind that the author wrote a long story while concealing a coded tract on how to preserve financial independence, legally or illegally, during a time when the government has exceeded its legal authority: "If I'd drawn a draft they could have traced it somehow and I doubt if you'd have gotten a cent. My only hope lay in doing nothing. I knew the money was pretty safe, for if worse came to worse...I could have named every Yankee patriot who sold me bullets and machinery during the war. Then there would have been a stink because some of them are high up in Washington now."

On that score, Rhett tells Scarlett how he secured his release from a post-War federal prison: "I employed a delicate system of blackmail on a friend in Washington who is quite high in the counsels of the Federal government. A splendid fellow - one of the staunch Union patriots from whom I used to buy muskets and hoop skirts for the confederacy.... [H]e hastened to use his influence, and so I was released. Influence is everything, Scarlett. Remember that when you get arrested. Influence is everything, and guilt and innocence merely an academic question."

And so it goes.

Margaret Mitchell, author of Gone with the Wind, was very much surprised that her book was even publishable. She wrote to a reviewer at the time [1936]: "I wrote the book nearly 10 years ago.... It seemed, to be quite frank, pretty lousy and I never submitted it to any agent or publisher.... I wrote the book when the Great American Boom was at its height and the high tide of the Jazz Age was with us. Everyone I knew had a car, a radio, an electric ice box and a baby that they were buying on time (everybody except me!). Heaven knows I didn't foresee the Depression.... I was writing about an upheaval I'd heard about when I was a small child. For I spent Sunday afternoons [hearing about men and women who survived the War and Reconstruction].... I heard them talk about friends who came through it all and friends who went under.... And all during my childhood, I'd been told to be prepared for the next time the world turned over.... So I suppose that explains why I wrote a book about hard times when the country was enjoying its biggest boom."

It's Over

2011-08-14T10:17:00.002-04:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

Standard & Poor's downgrade of the United States Treasury Department is a harbinger of changing times. The institutional mind has been trained to operate within the framework of the Capital Asset Pricing Model (CAPM). The CAPM is a formula, designed by professors, that assigns assets to distinct and simple categories. It filled a need when the investment management industry drew in the masses. Not, in this case, the mass of investors, but the mass of so-called investment professionals, that include consultants to pension plans, endowments, and foundations. Most of the well-compensated consultants have little understanding of investing, so substitute vocabulary for thought. The same is true of the professors who hand each other Nobel Prizes and collect seven-figure consulting fees for pontificating.

In the October 2002, issue of Marc Faber's Gloom, Boom and Doom Report, I wrote an essay about the Capital Asset Pricing Model and its companions (e.g., efficient markets), that doused the homogenized investment industry which had contributed to the then-current consequence (in October 2002) of a runaway housing mania. Quoting from that 9,000-word dirge: "Indexing is an obvious conclusion to efficient markets. Since companies do not matter, the asset class is all. Indexes are also practical. We all have some idea of what's going on today when we hear that the Dow is down 200 points. From that rudimentary average have been added the Standard & Poor's 500, the Russell 1000, 2000, and 3000. Dozens of offspring met the demand for ever more microscopically defined asset classes that fill the mauve, turquoise, and magenta slices of the consultants' pie charts."

The CAPM includes a "risk-free rate of return." The risk-free asset is, in its simple form, a United States Treasury bill, which has more recently been noted for its "return-free risk." Both in theory and in fact, Standard & Poor's downgrade of the United States from AAA to AA+ is another death rattle for the CAPM. (The downgrade itself has little real meaning, aside from its influence on minds.) This action foreshadows the declassification of assets according to such dreary concoctions as "mid-cap growth," comparative asset benchmarks, and the hierarchy of asset classes that equate higher return with higher risk (e.g., cash, bonds, stocks).

There is also the much larger problem of constructing an asset pecking order with rigged asset returns and yields. The market rate for Treasury bills is not zero. The coming dislocation that institutional and retail investors face is, to most if not all, incomprehensible. Consider the reconstruction of Scarlet O'Hara's Capital Asset Pricing Model after 1860. She discovered what can happen to chimerical fortunes built on the backs of government-fixed, zero-percent, risk-free rates.

The authorized hierarchy is a reason that Treasury yields fell after Timothy Geithner was downgraded on August 5, 2011. Europeans peering over the precipice owe professors and the (so-called) investment professionals - in reality, they are all a bunch of bureaucrats - a kick in the behind for their simplifications. European banks are not required to allocate tier 1 capital against government bonds since sovereign debt is risk-free. So, they bought like there was no tomorrow. Tomorrow has arrived and European banks are furiously ridding themselves of Greek, Portuguese, Italian, French - and anything else that isn't German - sovereign bonds (so, risk-free!!!) that have left them on (or over) the brink of insolvency.

The classification game is finished. In these waning hours of western civilization, gold is safer than government bonds. It also has much higher return possibilities than the unlimited supply of 0.001%, 10-year Geithners - take that, CAPM! Many institutions will sink, including governments. Sovereignty is not what it used to be. Some of the universities where highly decorated professors teach will cease to exist. This is a deleveraging world. It does not conform to the categories. Periodic bursts of insight, such as market behavior of the past two weeks, are preceded by months of mental hibernation.

Looking at that October 2002 diatribe in the Gloom, Boom and Doom Report, probably for the first time since I wrote it, brings to mind all the frauds - central, commercial, and investment bankers, in particular - who claim: "We never saw it coming." The two most recent Federal Reserve Chairmen, Greenspan and Bernanke, have most adamantly insisted, during sworn testimony, that not only did they not see "it" coming, but also, that nobody - yes, nobody - could have seen the credit bubble before it burst.

There were many readers of the October, 2002 issue of the Gloom, Boom, and Doom Report who had already identified the housing bubble. Telephone calls and emails came from all points of the compass. They saw it coming in Hong Kong, London and Madrid, but not at the Fed. Quoting myself from the 2002 essay (this is inevitably an instance of self-promotion, but, inseparable from another attempt to expose these mental and moral midgets):

"Most people who have seen the Internet bubble inflate and burst, who have seen the Nasdaq bubble inflate and burst, do not recognize, even though similar characteristics and atmosphere surround them, that the U.S. real estate market is a credit bubble (of which the stock market bubble was a sibling) and it is living on borrowed time."

"America is broke. We could really stop right here. For an investor, a helpful rule-of-thumb is to own real money (cash, gold, a company trading at its cash value) and squeeze debt-dependent conglomerations until they gag and choke."

I wrote several pages about the then - October, 2002 - obvious housing and credit bubble. Following is one paragraph:

"There never has been a time, since World War II, when homeowners have held less equity in their residences than they do today (about 55%). Is 'homeowner' a dated description? There is an incredibly well tuned mechanism at work here. The savings rate of individuals fell to zero a couple of years back. The ready reason was the stock market -- who needed to save? That money lost, the Average Joe tapped his home equity line. This is unfortunate; a chance to regain his financial solvency is lost. As Nicholas Retsinas of the Center of Housing Studies at Harvard noted, "With real-estate prices up, you would think that Americans would be rolling in home equity. But as fast as they lay hands on it, they are borrowing it out." Not only is this a source of credit, but also the interest rate structure is so low and the borrowing terms so aggressively profligate (loans of 120% of appraised value are hot, Fannie Mae and Wells Fargo have restrained themselves at 107%, interest-only loans for the first 15 years are a big hit) and so flagrantly unscrupulous (the Philadelphia Inquirer reported of brokers tracking down more aggressive appraisers) that the village idiot is living a very princely existence. (Need it be said that buying on infinite margin, house prices have risen according to a structure that might be called the home carry-trade?)"

I was already trying to expose the most destructive American who has ever lived. An effort, I might add, that was a waste of time:

"Greenspan is still talking about the New Era producing miraculous leaps in the timeliness of information, yet he couldn't tell there was a bubble when the Nasdaq traded at a 400:1 price-to-earnings multiple."

"'What Greenspan says is what the market does.' That eight-word proposition that so many believed was all they cared to know. Now, a growing number have second thoughts. This may have been what prompted him to deliver what has become known as his "Jackson Hole Speech" on August 30 [2002]. He claims there is no way he could have seen a bubble coming, seen it when it was here, or done anything about it even if it cuddled up beside him and offered to buy lunch. He claims he couldn't have known about a bubble since that knowledge is available 'only in history books and musty archives.' What are we to make of that? Maybe, bred in a republic, he is confused about his [then recent] British knighthood and thinks it requires him to play the role of court jester. Why hasn't some politician grilled him, at least to evaluate his mental faculties? Maybe they fear the precarious financial state of the union is positively correlated to our confidence in the head of the Fed. To rant now may cause real capitulation and a liquidation of over leveraged and non-performing assets. (Compared to a shoe factory, a new 6,000-square-foot house is not all that productive. It is an asset that fills up previously empty air.)"

Even in 2002, the Most Destructive American - who still appears on the Sunday-morning talk shows, still enjoys periodic love-ins with Maria on CNBC (subsidiary network to NBC, where Greenspan's wife pulls strings), continues to write tripe in the Financial Times, has read (so-called) academic papers (thus validating his importance) at the Brookings Institute and Counsel of Foreign Relations - was working hand-in-hand with the housing industry:

"In other words, chaotic lending and borrowing reigns, although few see it as such. We have it on the authority of David Seiders, Chief Economist of the National Association of Home Builders, whose stentorian late-July blast comforted the wary: 'The time has come to put this issue to rest. The nations [sic] home builders have said it, the [r]ealtors have said it, and Alan Greenspan has said it once again, in no uncertain terms: there is no such thing as a current or impending house price bubble.'" It is an odd feeling to correct my grammar nine years later. Why didn't you catch that, Andrea? (Andrea was my top-notch assistant who proofread countless tirades against empty suits and on behalf of gold. If you are looking for someone with such talents, please let me know. )

The following two extracts are a warning of how faith-based investors continue to think today:

"[Greenspan] sought... adulation like the celebrities who grace the covers of People magazine. He filled the role of fashion model to perfection. He was known for what he was rather than what he did. He was the man who forever moaned incantations to the New Era and New Economy, and he drew legions of followers, agape as we were to this new technology, of which we did not understand the actual importance, but he unfailingly did."

"[Greenspan] met a willing audience, one that was quite content to believe his testimony even though his speeches were nearly impossible to understand, even by the most astute Fed watchers. He speaks in hieroglyphic abstractions. Common sense should have told his legions of admirers to act prudently, but that was not the mood of times. As Samuel Johnson reflected, 'In time some particular train of ideas fixes the attention, all other intellectual gratifications are rejected, the mind, in weariness or leisure, recurs constantly to the favorite conception, and feasts on the luscious falsehood whenever she is offended with the bitterness of the truth.'"

"Do you think Ben Bernanke is J.P. Morgan?"

2011-08-02T08:11:00.002-04:00

On July 13, 2011, Federal Reserve Chairman Ben S. Bernanke was questioned by members of the U.S. House Financial Services Subcommittee on Domestic Monetary Policy.

Chairman (of the Committee) Ron Paul asked: "Do you think gold is money?"

Chairman (of the Federal Reserve Board) Ben Bernanke responded: "No.... Well, it's an asset."

Chairman Bernanke went on to equate holding gold to owning Treasury bills. In his mind's eye, Bernanke could see the Federal Reserve's balance sheet on which gold and Treasury securities line up in the asset column. He could not have offered Congressman Paul a more sincere answer. But, this is the same man who told 60 Minutes: "I've never been on Wall Street." And, the same man who told a 2006 conference that money no longer played a role in monetary policy, to which the (then) vice president of the European Central Bank walked to the podium and called the statement "pointedly foolish."

Congressman Paul asked Chairman Bernanke, well then, why don't central banks hold diamonds. Bernanke responded: "Tradition."

Tradition appeared before the Pujo Committee in 1912: J.P. Morgan. (To be clear, this is J.P. Morgan - the man - who operated J.P. Morgan - the bank - until his death in 1913, and who midwifed General Electric, Westinghouse, U.S. Steel, the Natural History Museum, the Metropolitan Museum of Art, the Pierpont Morgan Library and had relieved Europe of its Raphaels, Van Dycks, and Gutenberg bibles.) Appointed by the House Committee on Banking and Currency, Congressman Arsene Pujo's inquiry was in temper with the times. The Panic of 1907 had sparked wider interest in bestowing authority over the banking system to a government appointed body. This movement would culminate in the Federal Reserve Act in 1913.

The committee's lead attorney, Samuel Untermeyer, questioned the star witness, J.P. Morgan.

Explaining to Untermeyer the difference between credit and money, the man who prevented a United States Treasury default in 1895 and saved the banking system from collapse in 1907 replied: "Money is gold, and nothing else."

Three words. Six words, counting the qualifying phrase that nailed shut the coffin to the qualifications and equivocations that relieve bureaucratic economists from accountability and expanded their incapacity over the past 40 years to make either a helpful or interesting statement.

Morgan had nothing else to say since he had precisely and comprehensibly answered the question.

A 2002 study by the International Monetary Fund concluded: "[T]he aggregate price level in the United Kingdom and the United States was virtually the same in 1700 as in 1900." During the century after J.P. Morgan died, the Federal Reserve, somehow authorized to replace gold with Federal Reserve Notes, has destroyed 98% of the dollar's value. This was progress.

The Panic of 1907 was resolved by J.P. Morgan, the apex of which was the Knickerbocker Trust failure in consonance with bank runs, calls from country banks on their correspondent New York banks, call rates on the stock exchange rising above 100%, and European selling of American stocks, the proceeds exchanged for gold in New York vaults, which was then loaded on ships sailing for Europe.

By now an old man, suffering from the flu, sneezing, coughing, cigar surgically attached to his lips, Morgan assembled a high command around his library desk at Madison Avenue and 36^th Street. For approximately six days and nights the group decided which banks (and trust companies) "were hopelessly overextended and should be allowed to fail, and which were essentially healthy and could be saved." (Jean Strouse, Morgan: American Financier.) The U.S. Treasury had advanced $31 million to stem the panic, but that was the extent of government involvement. If Morgan miscalculated, Jacob Schiff predicted, it would "make all previous panics look like child's play."

Morgan told solvent bankers how much they must contribute to shore the weak banks. Occasionally, a financier balked. One banker told Morgan his reserves had fallen below the legal limit. Morgan fumed: "You ought to be ashamed of yourself to be anywhere near your legal reserve. What is your reserve for at a time like this except to use it?"

Morgan's actions were Olympian, autocratic, undemocratic, and he repelled progressive economists, who knew what was best for Americans. Irving Fisher, a celebrity economist at Yale, wrote in 1907: "The world consists of two classes-the educated and the ignorant-and it is essential for progress that the former should be allowed to dominate the latter." This impulse was considered democratic. Chairman Bernanke, former head coach to Princeton University's economics inductees, is successor to this lineage, as certain of its truth as was Fisher.

The colloquy between Ron Paul and Ben Bernanke elicited the best macro, market-timing advice since March, 1933, when Leon Trotsky made the blue-ribbon call of the 20^th century. The revolutionary, murderer, author, and future ice-pick recipient told international investors to (effectively) short the British Empire, the pound sterling's time had passed, and to go long the dollar and the American empire. If FDR was listening, even he must have shook his head in disbelief.

On July 13, 2011 Chairman Bernanke explained: "The reason people hold gold is protection against tail risk, really, really, bad outcomes. To the extent that the last few years have made people more worried about the potential of a major crisis, then they hold gold as a protection," said the greatest tail risk to the West since Genghis Khan.

What a Business

2011-07-22T13:30:00.003-04:00

Steve Wynn, chairman and CEO of Wynn Resorts, is a man who knows how to build and grow casinos. His father ran bingo parlors. Over the years, Wynn has built (and sometimes sold) and owned (or owns) The Golden Nugget, The Mirage, Treasure Island, The Bellagio, The Wynn, Encore; all in Las Vegas; and The Wynn in Macau, a territory re-acquired by the People's Republic of China in 1999. The CEO "considered moving the company's global headquarters to Macau" in 2010. 'Til now, he has stayed put, but his July 18, 2011, Wynn Resorts investor conference call implied Wynn remains restless.

He told investors the Obama "administration is the greatest wet blanket to business and progress and job creation in my lifetime. And I could prove it and I could spend the next three hours giving you examples of all of us in this marketplace that are frightened to death about all the new regulations,[as] our healthcare costs escalate, regulations coming from left and right, [with a] President that... keeps using that word redistribution."

His was not a partisan pitch: "I am a Democratic businessman.... I support Harry Reid [the Democratic senator from Nevada], I support Democrats and Republicans, and I am telling you that the business community in this country is frightened to death of the weird political philosophy of the President of the United States. And until he is gone, everybody is going to be sitting on their thumbs."

Wynn claimed you're damned if you do and damned if you don't: "[I]t is Obama that is responsible for this fear in America. The guy keeps making speeches about redistribution and maybe we ought to do something to businesses that don't invest, they are holding too much money. You know, we haven't heard that kind of talk except from pure socialists. Everybody is afraid of the government and there is no need soft-pedaling it. It is the truth. It is the truth."

Wynn has been investing, but is at odds with the current rhetoric. "The administration in Washington... [is] attacking China where, in the case of my Company, the vitality of capital to improve Las Vegas has come from [building The Wynn casino in Macau]. You know, it is the double whammy. American companies that have ventured abroad to broaden their markets are bringing money - have reinvested much of that in America." Here, Wynn in referring to administration threats aimed at U.S. companies that invest profits abroad.

The [Chinese] State Administration of Foreign Exchange, only a high-speed train ride from Macau (or, soon to be), stated on July 20, 2011: "We hope the U.S. government will earnestly adopt responsible policies to strengthen international market confidence, and to respect and protect the interest of investors." Steve Wynn might have written that himself.

The tendencies during a period of deleveraging are to hibernate rather than spend, to cut costs. Salaries and benefits are the largest costs at most companies. Without question, additional reasons for job stagnation are regulation and the health-care bill. This week, Lockheed Martin announced it is cutting 6,500 more jobs (in addition to 2,000 earlier this year), Cisco reported it is axing 6,500 now and another 4,000 later. Borders, which still has 10,000 employees, announced it is being liquidated. A potential buyer could not come to terms over this past weekend. Its bid to buy Borders failed. The price offered was undoubtedly discounted for the reasons stated by Wynn.

Steve Wynn came to mind in 2008 and has remained under consideration since. Knowing nothing about the man, the question was purely hypothetical: What does he think of the Too-Big-Too-Fail CEOs whining "I couldn't see it coming" in Washington? Again, not knowing Wynn, it was easy to imagine him punching his fist through the television set as he watched these welfare cheats testify.

Wynn is a study in contrast to the government-salvaged banks. A casino operator would not last one day if he employed the same so-called "risk controls," VaR models, and out-of-control leverage that drowned Goldman and Citigroup. He knows Washington will not bail out a casino. Therefore, he runs Wynn Resorts as a business while Jamie Dimon runs J.P. Morgan like a speculator at The Golden Nugget.

Central Falls Leads the Field

2011-07-18T09:16:00.002-04:00

Despite the band aids, the trend towards insolvency continues. Central Falls has reached a dead end. Applications are manifold.

Central Falls, Rhode Island, faces a plight that should be studied for its application elsewhere. It is nearly out of money. This is common news today, whether in Greece or California. The various parties are assumed to possess a means to carry on. This is assumed because it is generally so. The banks had the Fed; General Electric had the Fed and the FDIC; Greece has the ECB; California is prepared to launch a bridge loan.

Quoting the New York Times (July 11, 2011): "The impoverished city, operating under a receiver for a year, has promised $80 million worth of retirement benefits to 214 police officers and firefighters, far more than it can afford. Those workers' pension fund will probably run out of money in October...."

The retirees face a bleak future: "Central Falls, like many American cities, has not placed its police and firefighters in Social Security. Many have no other benefits to fall back on."

The inability to meet payments, as is true across the western world, was evident decades ago. The parties refused to think through the consequences of their actions: "The city, just north of Providence, is small and poor, but over the years it has promised police officers and firefighters retirement benefits like those offered in big, rich states like California and New York. These uniformed workers can retire after just 20 years of service, receive free health care in retirement, and qualify for full disability pensions when only partly disabled."

The previous paragraph reflects poorly on the grand wizards of Central Falls. The Times noted: "Central Falls...filled mostly with immigrant families, struggles on a median household income of less than $33,520 a year.... The typical single-family house... is worth about $130,000."

Although this was a news story, the Times reporters, Mary Williams Walsh and Abby Goodnough, could not restrain their fury: "It is hard to see how anyone thought such an impoverished tax base could come up with an additional $80 million for retirement benefits. If the city were contributing the recommended amount to the plan each year, it would take 57 percent of local property tax revenue."

That is hindsight. We are used to expedients: delayed pension contributions; 8% projected investment returns; economic recoveries around the corner; market recoveries around the corner; real-estate appreciation (higher tax receipts); higher tax rates; bank loans; bond issues; state bailouts; federal bailouts.

These avenues are closed. The state of Rhode Island "has an investment-grade credit rating, but it is in no position to bail out a string of teetering cities, or take over their shaky local pension funds the way the federal government does when some companies go bankrupt." The Pension Benefit Guaranty Corporation is the backstop to private pension plans. None exists for public plans. (Could there be a Christmas Eve Special - see emergency decrees on December 24, 2009, when no one was looking - that sweeps all public pension benefits into Uncle Sugar's side pocket? No doubt. Minds in Washington are much slower than in Central Falls.)

The state of Rhode Island may follow its mendicant municipality's plight: "Rhode Island must ...stabilize its own pension fund, which continues to require more and more cash each year, despite four overhauls since 2005 that were supposed to get the cost under control. The Securities and Exchange Commission is investigating. If the state turns out to have understated its commitments, it could deliver a new jolt to bond markets still nervous after two traumatic years."

Rhode Island is reluctant to seek federal aid for itself (a possible source of funds for Central Falls): "State lawmakers are trying to contain the damage, mindful that it would be a bad time for any state to seek help in Washington." As a practical matter, one in four of the cities and towns in Rhode Island are in "some degree of distress." A well-funded state would not know where to start.

A bright side to Central Falls' requiem is that it must make decisions today that most others will avoid as long as possible.

An example of the latter is Cambridge Hospital in Cambridge, Massachusetts. The Boston Globe (July 11, 2011) reported: "A state Superior Court judge has ruled that the owner of Cambridge Hospital can't move forward with its plan to cut retiree health benefits for 289 nurses, a decision being hailed as a victory by the Massachusetts Nurses Association."

The judge is delirious. He would fit right in with the empty suits at the European Central Bank. Living in a world of make-believe, he (and they) interpret laws and freeze reality as if it were 1953. (Under Massachusetts law, courts are to interpret pension benefits within "reasonable expectations" of the beneficiary.)

Cutting to the chase, the owner of the hospital is down to its last buck. "An accounting change... would increase the hospital system's costs by about $30 million over the next three years. The proposed cut [40% of the current benefit] prompted the union to reject a 'last and final' contract offer last summer."

As with Central Falls, the avenues to acquire cash are shut (extrapolating from the article). The judge decided to ignore the facts and make matters worse for the nurses. Matters will be worse because, as the old adage goes, if you're going bankrupt, it's better to be first.

The citizens of Central Falls are not going to rust. They need to think. The city may be able to sell or lease assets. It could ignore federal laws and regulations imposed on cities unless Washington funds its impositions on Central Falls. Of this, there is no chance. The feds would probably be more fearful of this tactic gaining publicity than of prosecuting city officials. Such an ultimatum would probably cut Central Falls spending by 50%. The city could issue scrip to employees and suppliers. Scrip is "emergency money" that was used across the United States in the 1930s. (See: Standard Catalogue of Depression Scrip of the United States, by Ralph A. Mitchell and Neil Shafer.) Merchants chose whether or not to accept it. It was often accepted during the 1930s, at least for a time, when a solution beckoned.

In general, the better solutions will accrue to those who sell first. Early sellers will get better prices. At some point there will be a flood of selling. It is impossible to know when that will be. As a guess, sometime after the next 30% stock market dive. This, as a guess, will happen after the U.S. government, stock-market support operation fails. All government support operations fail.

The sellers will include leveraged companies, banks (all are leveraged, by definition, in a fractional reserve system), pension plans, the so-called "rich" (many need to sell surplus houses and golf-club memberships to pay tuitions), endowments, hospitals, colleges, the sports industry, and municipalities. The latter will have to sell or lease highways, parking garages, bridges, sewer systems, water systems, utilities, and many other services traditionally provided by states, counties and towns: from garbage to schools.

There is a visceral resistance by municipalities to such thinking: The private sector is not to be trusted. Central Falls may be fortunate in selling to the enemy before prices plunge. A great buyer's market is in the making.

The Euro and You

2011-07-11T08:46:00.001-04:00

Greece may seem a long way from Newport Beach, California. Well, it is. But, we live in the global village, or some other dim construction. In his June 16, 2011, edition of The Credit Strategist, Michael Lewitt explained "the interconnected nature of global financial markets render Europe's problems the world's problems.... [T]here is no longer any periphery."

Lewitt also writes: "The list of interconnections goes on and on....[G]lobal regulators... have no real sense of what type of contagion effect would occur if Greece were to default. No doubt they believe it is significant enough that they are willing to do virtually anything humanly possible to prevent this scenario from unfolding."

That is demonstrably correct. Since 2007, global bureaucrats have broken any law that has hindered their attempts to ward off our inevitable reckoning. Attempts to prevent a euro eruption have become preposterous. The European Central Bank (ECB) is clearly in extremis.

The interconnections that start with Greece and the ECB wind their way through the European, then U.S., banking systems, government bond yields, and the dollar. Extrapolating the script ("that they are willing to do virtually anything humanly possible..."), the ECB will print euros like never before (and never after, since its credibility will be nil.) Doing so, the ECB will enlighten the perplexed as to the central, financial tendency since 2007: the proportion of "money good" financial paper to the expanding universe of IOU's is dwindling. As the percentage of worthy paper declines, the relative affection for government issues that would otherwise fail a screen test are, instead, improving. Specifically, the deluge of euros will, all else being equal (an escape clause of Greenspanian inspiration), drive U.S. Treasury yields down.

A week does not go by without the ECB reducing its standards of collateral. The cost is not only its credibility as a central bank (which, in any case, it is not) but in the composition of its deteriorating balance sheet.

To make matters worse, Greece is the smallest economy among the impoverished PIIGS: Portugal, Ireland, Italy, Greece, and Spain. Since others will probably follow Greece, the current impasse is all the more discouraging. The Greek government cannot meet its July interest payment obligations to banks, central and commercial. It can no longer borrow from banks or in the bond markets. (This is also true for Ireland and Portugal, and possibly others.) The Greek government has bills and salaries to pay. The ECB is doing its all to avoid default. This presents a dilemma: the further it goes in preventing (in fact: forestalling) a default by the Greek government, the more it compromises its legitimacy by breaking its own rules and ruining its balance sheet. A credit-sensitive bystander would say the ECB's legitimacy and balance sheet are cases of the emperor wearing no clothes but conventional opinion being afraid to state the obvious.

Remembering that the euro is an experiment - a currency that is only 13-year-old and not issued by a sovereign government - the European Central Bank should, above all, adhere to the highest standards of integrity.

Let's go back a year. After a meeting at the European Central Bank on May 6, 2010, the ECB confirmed its commitment to never buy sovereign (government) and corporate debt. On May 10, 2010, The ECB announced an unlimited program of buying sovereign (government) and corporate debt. On the same day (May 10), the ECB and IMF announced a $957 billion "shock-and-awe" loan program to calm markets. Said one European Union official: "We shall defend the euro whatever it takes." The double-talk from European Union and ECB officials still pours forth. As St. Augustine or Bernie Madoff said: "Once you go down that road, you can't stop."

Market prices insist the ECB and Jean-Claude Trichet (president of the European Central Bank) are paragons. Wide-awake Europeans disagree. Donald Coxe (Coxe Advisors LLP) wrote in his May 26, 2011, edition of "Basic Points": "As the citizens of the economically strong countries (and citizens with wealth to lose across the entire Eurozone) reflected on their personal financial conditions, they recognized a new fundamental risk: Their pay-checks, pensions, life insurance, bank deposits, bond investments, and cash were euro-denominated."

The ECB's balance sheet stands behind the euro. To generalize, as long as it is trusted, the euro will trade at par in commercial transactions. (In contrast, it was common when U.S. banks issued their own currencies for businesses to apply a discount - maybe 15% - to a currency from another state: for instance, to an issue from a Cincinnati bank when used to buy onions in New York.)

On the left-side of the ledger, the ECB holds €1.9 trillion (about $2.6 trillion) of assets. On December 31, 2010, it posted €82 billion in capital and reserves. The leverage ratio is 23:1. If the value of ECB assets falls by 4.3%, it will be insolvent. ("Insolvent": the last time around (2007-2008), The Authorities successfully cooed the media into stating the financial system had "liquidity" troubles. This was true but it was a secondary problem. The primary problem was the too-big-to-fail banks that failed.)

What do those assets consist of? The ECB holds €480 billion of asset-backed securities (ABS) and €360 billion of "non-marketable financial instruments." That comes to 44% of total assets. These asset-backed securities are not the old reliables, such as the once highly-radioactive ABX.HE 07-01. That is, an index composed of sub-prime mortgages that was bundled in 2007 (the '07'), and sported a price that sank in tandem with the rising default rate of the mortgages it housed. No, these are vintage 2010 securitizations, in which year the ECB permitted European commercial banks to bundle their bad mortgages and mortgage securities, sell them at par value to the ECB, which then paid fresh euros to the banks.

As for "non-marketable financial instruments," these presumably include the Portuguese government bonds issued in 1943 and due for repayment in the year 9999. The bankers in Lisbon surely broke out a vintage port when they unloaded the 1943's that settle 8,000 years from now. What else did European banks jettison, accepted at par by the ECB? After ridding themselves of €480 billion - one-half a trillion - of their worst mistakes, how can the banks still be in such bad shape?

Another peculiar "non-marketable financial instruments" are the "own-use" bonds sold by Irish banks to the ECB. These are bonds that Irish banks issue to themselves and then sell to the ECB in return for euros. This arrangement may be difficult to grasp at first since it is so new. An example: Allied Irish Bank (AIB) issued a €2.87 billion "own use" bond on April 26, 2011. (The Bank of Ireland wrote a €2.0 billion own-use bond on the same day and followed with a € 2.2 billion offering (sic) the next day. The program is scheduled to last through August 2011.) By issuing this bond, AIB owes itself €2.87. The €2.87 was used as collateral for cash - euros - wired from the ECB. The Irish government provides the collateral by guaranteeing these bonds. The Irish government has no money and it cannot print euros. Only the ECB can authorize money printing. In what must be quite an understatement, the Irish Independent observed: "Own-use' bonds are popular with banks because they can continue to access funding at the ECB's one percent interest rate even when they have run out of the high-quality collateral typically demanded in Frankfurt." For its part, the ECB insists all of these loans are properly collateralized. One understatement follows another: "This makes some eurozone states uncomfortable, since any losses on the money advanced by the ECB would have to be funded by all 17 states."

This refers to the ECB relationship with the central banks of the countries feeding at the euro banquet. The national central banks must pony up for any losses incurred by the ECB: How long will Trichet and entourage collect ECB paychecks after the call goes out for emergency funding? Again: "they are willing to do virtually anything humanly possible..."

The other 56% of the assets on the balance sheet (there may be some double-counting here) includes loans of €106 billion to the Irish central bank. On its December 31, 2010 balance sheet, the Irish central bank showed €70 billion in an "Emergency Liquidity Assistance" account, funds forwarded from the ECB.

At the end of 2010, the ECB also held outstanding loans of €92 to the Portuguese and Spanish central banks (€48 billion and €44 billion, respectively). More collateral (the Colossus of Rhodes?) stood behind the €90 billion in Greek assets held by the ECB.

The list of unconscionable deceits by the Euro authorities is long, but that may be enough to indicate the euro is heading south. That is before looking at the European banking system which has already suffered from bank runs, depositors have withdrawn money and caution builds in the interbank lending market (one reason U.S. Treasury yields remain so low.)

Here, specific and vulnerable bank exposures will be ignored and attention directed to one term: credit-default swaps. Nobody knows who owes whom what. This is 2008, again. Since then, United States politicians passed a financial reform bill that is taller than the Washington Monument, but credit-default swaps remain unregulated, uncollateralized, unmonitored, and requiring no capital. They may be bought, sold, and traded by, between, and among banks, insurance companies, pension funds, endowments, and hedge funds.

Credit-default swaps are the reason various parties want the negotiaition of Greek debt to avoid a "credit event." If a credit event is triggered, the insurer pays the owner of the CDS. Leaving European banks aside, U.S. banks have written $34.1 billion of credit-default insurance on Greece, $54 billion on Ireland, and $41.2 billion Portugal sovereign debt.

Europe has an additional problem, not of prominence in 2008. Once triggered, the vintage 2011 CDS need to be settled in euros, not dollars, as was generally true when Lehman and AIG were on the front page. Federal Reserve Chairman Ben S. Bernanke has magnanimously announced the Fed has opened unlimited swap lines should Europe need them. (On our behalf: there is no recourse by the Fed if another central bank fails to pay us back. Thank you, Marshall Auerbach, for explaining this and other peculiarities.) However, Simple Ben cannot advance euros. Only the ECB can do that (through the national central banks).

To sum up, if an agreement cannot be reached to resuscitate Greece, the ECB will print billions of euros so that banks can settle CDS claims. To prevent this hypothetical Greek failure - really, to avoid a CDS credit event - the ECB may need to buy up the Greek debt. (Unintended consequences for doing so may spring to mind. The list is longer than that of scorned securities currently accepted by the ECB.) In either case, the world will be plastered with a new batch of euros, with any nervous investor noting the rapidly sinking proportion of trustworthy collateral. Thus: the case for U.S. Treasury bonds, which are backed by a central bank and Treasury with no more credibility than Trichet's horde. Simple Ben will not let the opportunity of international panic pass without matching new euros with new dollars. This is why gold and silver were invented.

It is possible The Authorities can squeak through now, hand Greece a bridge loan, and claim the paper chase is not a credit event. It will be a bogus claim, but so far, the majority has been willing to go along. That won't last, though. In fact, doing so makes matters worse. Greece will be loaded with even more debt it cannot repay, reducing the proportion of money-good paper in the world. The same is true for the other PIIGS.

The Education Gap

2011-06-28T11:24:00.002-04:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

On June 22, 2011, the Federal Open Market Committee (FOMC) concluded a two-day meeting. This was followed by the obligatory press release. That statement was followed by a press conference featuring Federal Reserve Chairman Ben S. Bernanke. CNBC, in the person of Maria Bartiromo, interviewed three former FOMC members later in the day:

LEE HOSKINS, President of the Cleveland Federal Reserve branch, 1987-1991.

WILLIAM FORD, President of the Atlanta Federal Reserve branch, 1980-1983.

ROBERT HELLER, Federal Reserve Board of Governors, 1986-1989.

There was no disagreement among the three. There was one subject that all three emphasized: Simple Ben's QEII-Money-Flooding-Zero-Interest-Rate Policy (MFZIRP) has left the economy in a worse state than if he had done nothing at all.

Following are some of their comments:

LEE HOSKINS: I think the Fed is doing great damage by running negative real interest rates so long. That's a misallocation of capital.... The Fed made it real clear today they don't control employment and they don't control real GDP. They should stick with trying to control the one thing they can and that's inflation.

[At this point, BARTIROMO, sounding a bit like Bernanke might in a similar discussion, asked what the Fed should do about the fragile economy. HOSKINS continued, repeated what he had already said, in a manner that suggested he was speaking to a four-year-old]: The Fed doesn't control real growth, they don't control employment. The only thing over time the Fed can control is inflation. If we try to saddle the Fed with a bunch of other responsibilities, we're going to hurt the one thing that the Fed can control over time. If they control inflation, then the business community and individuals will make decisions that will expand the economy. But, the uncertainty surrounding negative real interest rates and what [they do] to capital markets and the dollar seem to be a real negative to this policy.

WILLIAM FORD: Nothing the Fed has done has helped positive GDP growth. It has not fixed the housing crisis by lowering rates to historic low levels. It has not promoted business investment, borrowing and spending. It's killed the dollar without helping exports a lot and that's causing inflation of import prices to go up. Most importantly, they are hurting America's elderly people by having 14 trillion of personal savings accounts of all kinds subject to interest rates that are 5 percent below where they normally are two years after the recession is over. That's costing elderly people about $300 billion. It's reduced GDP because they don't have the money to spend.

BARTIROMO asked ROBERT HELLER about the "reacceleration the chairman [i.e., Bernanke] is expecting in the second half." The second half of 2011 commences this Friday:

HELLER: There's a bit of regeneration of the strength in Silicon Valley. A lot of it is really based on Twitter and Facebook. That isn't real strength in the overall economy, teenagers talking to each other more....Overall, I think the economy will have a hard time facing the headwinds. The Fed should be running positive real interest rates.

Inflation Asides

2011-06-27T09:16:00.002-04:00

A note from a reader:

In 1977 I accidentally ran into a high school friend of mine who had taken an advanced degree in mathematics and statistical analysis. He was working for [Federal Reserve Chairman Arthur] Burn's Fed. He informed me that he was working on a new methodology of calculating the inflation rate. When I asked what it was based on he demurred saying it was "Classified Secret." I was truly stunned. He did imply that, when done, the new methodology would greatly reduce the reported value. Sure enough, during the Volcker Fed, the new methodology was introduced and has been modified since then to greatly reduce the reported numbers. It made the Volcker effort at controlling inflation seem much more effective than it actually was.

However, if one takes 1965 as the starting year for the present acceleration of inflation it can be shown that, on average, the cost of living has gone up about 1400%. And, the total money supply has also grown - up to 2008 - about the same. So, a person willing to do the research can always by-pass short-term obfuscation and see the truth through widely available published costs of living.

Furthermore, there is qualitative inflation on top of the quantitative. Now, the Fed constantly claims that a rise in costs is offset by a rise in quality and so cancels out. This has been true in the field of micro-electronics. However, in key areas of food and housing this is not so. In particular many food costs have been hidden by a reduction in amount and quality of the item. Just look at the reduction in the size of a can of tuna fish since 1965. The best tuna has gone down from 8.5 to 5.0 oz while rising over 1600% in price while the quality has suffered so that producers use every trick in the book to make lesser cuts of the fish look like albacore. So the actual rise in price is much, much more than the nominal rise.

Another thoughtful note from a reader:

Thanks for your good work. I just read your piece "Sick Minds" on Safe Haven and it occurs to me that a price index should only measure price changes of a fixed basket of goods. A consumer price index should be based on how the median household spends its income at time A and how those prices change going forward. That includes taxes! Another price index should be generated for the median household of seniors.

The current gov't approved methods are for a subsistence price index (SPI).

Clearly the government can't be trusted to provide meaningful statistics and this should be farmed out to universities. Government meddling into how the statistics are generated should be outlawed. The universities should face peer review on whatever series they are charged with generating. Get rid of the BLS and the other government statistics generators and fund the universities for this work.

My reply:

Thanks, I agree with what you write with one reservation: whether the academics could be trusted. Celebrity economists - the Fedheads, Nobels, CNBC heroes - would be the go-to "experts" who would fashion the peer structure. These supercilious windbags already live off government money that funds their economic departments, academic chairs funded by Interests (the Alan Greenspan Chair in Economics at New York University, funded by hedge-fund manager John Paulson, who made his fortune off the mortgage collapse), their web of memberships on corporate boards, their insatiable appetite for continual exposure on CNBC, the money they receive to write studies for vested interests (e.g., the Stiglitz, Orzag(s) thumbs-up for Fannie Mae; Mishkin's celebration of Iceland's banking system) - I hope that someday this scandal is seen for what it is, at which point the academics could be trusted to establish such a peer review.

If we reached that point, we might also be able to trust the BLS, but I'm with you in trashing it. I think Sir John Cowperthwaithe, Britain's financial secretary to Hong Kong in the 1950s, was on to something. He did not allow his government to collect statistics for fear the statistics themselves would define policy. In the U.S., this is seen in our infatuation with "growth" no matter the human and material wreckage choking in the gutter, a sure sign of our government's and of the economic establishment's senility.

Sick Minds

2011-06-23T12:38:00.002-04:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

DOW JONES NEWSWIRES - June 22, 2011 - "Lawmakers are considering changing how the Consumer Price Index is calculated, a move that could save perhaps $220 billion and represent significant progress in the ongoing federal debt ceiling and deficit reduction talks.

"According to congressional aides familiar with the discussions, the proposal would shift how the Consumer Price Index is calculated to reflect how people tend to change spending patterns when prices increase. For example, consumers tend to drive less when gas prices increase dramatically.

"Such a move is widely seen by economists as resulting in a slower rise in inflation. That would impact an array of federal programs that are linked to CPI including the Social Security program and income tax brackets set by the federal government."

Social Security payments must be reduced. Promises were made - by lawmakers - that are beyond the government's (the taxpayer's) ability to pay. The latest scheme is a ploy by cowardly elected representatives who surreptitiously cut benefits for those most in need: the old and the frail.

First, the logic is indefensible: Gasoline prices rise; higher prices are unaffordable; people drive less; less gasoline is consumed; the Bureau of Labor Statistics (BLS) reduces the weighting of gasoline in the Consumer Price Index (CPI) calculation; this cuts gasoline's (and, other products that are rising in price) influence on the CPI; the Consumer Price Index falls. Ergo, Chairman Ben S. Bernanke, in a future and "dreary" press conference (the adjective used by the Wall Street Journal to describe his session with reporters on June 22, 2011), states that inflation is falling.

Second, as mentioned above, this is hidden from public view. The official, government CPI which is used to increase Social Security benefits (e.g., if the CPI rises by 2.0%, next year's Social Security checks go up 2.0%), will understate costs, reduce the ability to buy gas further, which will reduce gasoline's proportion in the CPI even more.

By the way, this also reduces the inflation credited to owners of TIPS, or TIIS (Treasury Inflation-Protected Securities). The change reduces the value of TIPS.

It would be interesting to know if the amount spent on gasoline actually falls. The amount of gas (in gallons) might be less, but the increase in price could mean the dollars spent are proportionately greater to total costs. You can be sure the BLS has devised a method that has eliminated the possibility, which leads to:

Third, this latest scam is part of a long-running ploy to reduce Social Security benefits without inconveniencing politicians. Chapter 12 of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession is the history of Social Security and inflation manipulations between 1983 and the mid-1990s. From Alan Greenspan's 1983 Social Security Commission through Michael Boskin's contorted changes to the CPI measurement (1995), Social Security payments have already been reduced well below what they should be. One estimate, by Richard Karn, author of Emerging Trends Report, calculates that Social Security checks would have been 43% higher by 2006 if not for the chicanery of the scandalous Boskin Commission, a decade before.

Fourth, this latest effort shows the talk about reducing the deficit, cutting spending, and reaching an agreement on the debt ceiling is exactly that - talk. (As if you needed to be told.) Lawmakers may pat themselves on the back for this gift from the BLS, but a $220 billion spending cut is a drop in the ocean (and, probably a projection over the next 20 or 50 years). Social Security needs to be addressed by increasing, and by a substantial amount, the age at which retirement benefits can first be collected. Starving the old and the frail is not only a sick policy, it is also camouflage to win the next election.

What They Are Saying

2011-06-17T08:35:00.002-04:00

It was not difficult for an observer to understand Armageddon beckoned by 2006, as long as the observer listened to practitioners rather than theorists. The theorists: government bureaucrats and their sycophants, clog the media's arteries. Those who listened to practitioners were prepared in 2007.

The same is true today. Following are two groups of practitioner opinions: those from 2006 and 2007; then, those today.

WHAT THEY SAID:

"The enormous monetization of hard assets has created a massive amount of liquidity....Together with [the rising demand for income in the developed world], these factors are reducing the relative expectations on equity..."

-Sam Zell, in December 2005, who cashed out with a $39 billion sale of Equity Office Properties to Stephen Schwartzman, December 2006

"We have low interest rates, tons of money in both private equity and debt markets.... But when it ends, it ends badly. One of those signs is when dummies can get money and that's where we are now."

-Stephen Schwartzman, February 2006, who paid Sam Zell $39 billion sale for Equity Office Properties in December 2006 - then really cashed out.

"Clearly I'm exaggerating here, but what's the difference between a $30 billion and a $300 billion deal? It's just a few more phone calls."

-Ed Keon, Prudential Securities, September 2006

"The world is flooded with too much capital. It is virtually impossible to find any asset class that offers attractive value to investors."

-Goldman Sachs, "Outlook for 2007", January 2007

"[Carlyle] Group's fabulous profits are not solely a function of our investment genius but..... [from] the availability of enormous amounts of cheap debt."

-Bill Conway, co-founder, Carlyle Group, memo to employees, early 2007

"This is better than it gets for the private equity industry....Of all the bubbles, the bubble in the credit market today is one of the greatest - it is beyond any rational measure."

-Steven Rattner, Quadrangle Group, April 2007

"The private equity world is in its golden era right now."

-Henry Kravis, July 2, 2007. Spoken when Kohlberg Kravis Roberts & Co. (KKR) and Texas Pacific Group (TPG) received financing for the peak buyout in 2007: the Texas Utilities $45 billion LBO. It is fine to censure Henry, but the banks were willing.

WHAT THEY ARE SAYING:

"Unlike then [late 2008 and early 2009]... we have hardly any room for maneuver. Policy rates are already at zero and central bank balance sheets are bloated. Although private sector debt has started to decline, public debt has taken its place, with sovereign fiscal positions already on an unsustainable path in a number of countries. In short, macroeconomic policy is in a vastly worse position than it was three years ago, with little capacity to combat a new crisis..."

-Bank for International Settlements Annual Report, June 28, 2010

"There's some crap getting done. It's surprising to me this early in the cycle that some of that could be happening."

-David Jacob, executive vice president, S&P,Grant's Interest Rate
Observer, February 11, 2011

"The steep rise in farmland prices we have seen in recent years creates the potential for an agricultural credit problem down the road."

-Federal Deposit and Insurance Commission, March 2011

"Carl Icahn is returning all his capital to his investors: 'Given the rapid run-up over the past few years and our on-going concerns about the economic outlook, I do not want to be responsible to limited partners through another possible market crisis.'"

-Carl Icahn, March 9, 2011, The King Report

"I really find it amazing that we're almost back to where it was, where there is so much leverage finance going on. There's just way to much leverage, way too much risk-taking with other people's money."

-Carl Icahn, May 27, 2011, interview on CNBC

"'Banks are leveraged 20 to 1 and their portfolios are mainly comprised of government bonds and mortgages,' the founder of Sprott Asset Management said. 'House prices keep going down, the number of people underwater keeps getting worse. That leverage is going to work massively against anyone whose lender is in that area. The dominoes are starting to fall.'"

-Eric Sprott, Sprott Capital Management, May 13, 2011, Bloomberg Hedge Fund Briefs

"Mr. Carney said... that the world is by no means out of its financial crisis and won't be for years. Systemic risk remains high..."

-"Mr. Carney" is Bank of Canada Governor Mark Carney - who holds the equivalent position to Federal Reserve Chairman Ben S. Bernanke. This was said at an "off-the-record" meeting but a dishonorable attendee squealed. It is worth noting that Mark Carney is a veteran of Goldman, Sachs & Co., so understands the financial system, unlike his American counterpart who would only recognize a financial crisis if someone stole his ATM card.

"Should you worry more about losing money or missing opportunities? That's an easy one for me. First, the macro uncertainties tell me we won't be seeing a highly effervescent economy or market environment. Second, people's increasingly aggressive behavior tells me to seek cover. And third, since I don't see many compelling cheap assets, I doubt there will be gains big enough to make us kick ourselves for having invested too cautiously."

-Howard Marks; Chairman, Oaktree Capital; Memo to Oaktree clients;
May 25, 2011

"'Another financial crisis is 'inevitable,' Mark Mobius, head of Templeton's Emerging Markets Group told CNBC Tuesday. 'The financial problems caused by the subprime mortgage crisis 'have not really been solved. Banks that were too big to fail have gotten bigger. Bank balance sheets around the world are not that healthy. So you have the situation which, if not corrected, will result in another crisis.'"

-June 7, 2011, CNBC.com

FLASHBACK: "Mark Mobius, the portfolio manager at Templeton Emerging Markets group, said in Paris that recent volatility of Internet stocks could be indicating a crash for the sector. 'I think we are nearing the time, that is my guess, and it will be big,' Reuters quoted him as saying. 'Some stocks will be 90 percent or 50 percent down.'"

-New York Times, March 30, 2000.

"'It's probably the most attractive financing that we've ever done, Kravis said.... The financial markets rebounded much faster than the economy.' "

-Henry Kravis, talking about funding for Del Monte takeover,
March 4, 2011, Bloomberg

FOUR DAYS LATER, March 8, 2011, Wall Street Journal: "A humiliating endgame for the largest leveraged buyout in history may come sooner than investors had anticipated.... Even owners Kohlberg Kravis Roberts & Co. and TPG have acknowledged the deal has become an albatross. KKR has already written down the $8 billion equity investment by 80%."

-The banks are more willing than ever.

CORRECTION: The subtraction calculation (net birth-deaths) in the government's Employment Situation Report is more byzantine than shown in Playing Old Maid. One part of the equation has been seasonally adjusted and one has not. The spirit of the distortion remains unchanged.

The Consumption Bust

2011-06-07T16:15:00.002-04:00

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

There is no end to the indicators showing the consumer is up against it. Negative home-equity, incomes, layoffs, food inflation - oh, this is a tale of woe. And so, the plaintive cry: "Is this the bottom?" That seems doubtful, actually impossible, given the math.

There will be no addition or subtraction here, but an observation. The bottom - for stocks and people - does not follow a panic. An example is the stock market bottom in March 2009. After a panic (stocks) or a spree (spending), a long period of lethargy and revulsion follow. Then the juices flow again.

The government preempted this cycle after the Internet crash, mortgage bust, and with its stock market boost in March 2009. From there, the S&P 500 doubled. That was fun for some, but it defied nature. Wither QE3?, is the question of the hour. For those who are hopeful the Fed will leave us alone, there are signs the cycle is drifting towards recovery. That is - the requisite period of lethargy is upon us.

The following comes by way of my youngest sister, last seen playing Old Maid at the age of four (Playing Old Maid); now, doing her part to keep America alive, by shopping.

She called me after leaving Target, a go get'em retail chain fulfilling its patriotic duty: It sold $67 billion of paraphernalia last year. My sister's exit conversation follows:

Target cashier: "Did you find everything you wanted?"

Sister: "No."

Target Cashier: "That's OK. You saved some money."

Playing Old Maid

2011-06-04T07:45:00.002-04:00

When my youngest sister was four-years-old, we taught her how to play Old Maid. She learned quickly but played the game like - a four-year-old. When she was dealt the Old Maid, her little thumb would push it a couple of inches above the others in her hand. She did this with a giggle since her maneuver was tricking us (in her 4-year-old mind) into taking the Old Maid. She succeeded; someone would remove it from her hand so that she could say: "Ha, Ha, you have the Old Maid!"

Today, the Bureau of Labor Statistics (BLS) has a four-year-old mind. This morning, June 3, 2011, it released its monthly Employment Situation Report. The very first words were: "Non-farm employment changed little (+54,000) in May..." Nowhere in the 38-page report does the BLS state that the addition of 54,000 jobs was actually a loss of 152,000 jobs.

The BLS invented 206,000 jobs. The Bureau has constructed an equation called the "Net Birth/Death Model." Its purpose is to count "Business births." That is, new jobs in new businesses net the number of lost jobs in "Business deaths": companies that went out of business.

This figure plays a large role in how Americans are told to think about the economy. CNBC did not look beyond the first sentence this morning when it announced The Number: +54,000. It did not mention the 206,000 net birth-death jobs. The Wall Street talking heads who were then interviewed were also ignorant. Last month, on May 6, 2011, the BLS April Employment Situation Report opened: "Non-farm payroll employment rose by 244,000 in April..." The +175,000 net birth/death jobs were not mentioned by Bubble TV and maybe not by any other major media outlet.

There are those who say the net birth/death (NBD) figure is a sophisticated calculation. No doubt it is; but is it accurate? If it is, why does the BLS never mention that NBD jobs were added when it manufactured The Number? Why does it so diligently hide it?

The initiative for the NBD calculation addressed a real problem. The BLS is not equipped to include "business births" in its monthly Employment Situation Report. It makes sense to adjust The Number, but the BLS, like most of Washington, is detached from the economy.

In June 2011, it is ridiculous to conclude the U.S. economy is adding more jobs than it is losing. Yesterday, on June 2, 2011, the National Federation of Independent Business (NFIB), a trade group of smaller businesses, released its latest survey results. (I have found the direction of the trend in the monthly NFIB survey offers a good indication of the direction of the economy.)

Some of the highlights from the June 2, 2011, NFIB release:

"Chief economist for the National Federation of Independent Business (NFIB) William C. Dunkelberg, issued the following statement on May job numbers, based on NFIB's monthly economic survey:

"After solid job gains early in the year, progress has slowed to a trickle. The two NFIB indicators-job openings and hiring plans-that predict the unemployment rate both fell, suggesting that the rate itself will rise.

"Meaningful job creation on Main Street has collapsed.

"With one in four owners still reporting 'weak sales' as their No. 1 business problem, there is little need to add employees, especially with the uncertainty about future labor costs arising from new regulation and legislation."

The Bureau of Labor Statistics pushes the Old Maid above the other cards in its hand each month. It takes five seconds to type "net birth death" into the BLS website's search engine and read this month's NBD number. Yet, it is not mentioned by the media or by Wall Street talking heads. The Bureau of Labor Statistics has every reason to look at America and proclaim: "Ha, Ha, you have the Old Maid!"