When Do You Skip Gold?

We're Going the Wrong Way

Neal: He says we're going the wrong way... 
Del: Oh, he's drunk. How would he know where we're going?

-Planes, Trains, & Automobiles

Exploding deficits per capita with stagnant economic output per capita.  I would say this is scary to quite scary.  Ironically, our debt to GDP is expected to hit 100% on...Halloween.  Boo!

The "Big" Problem

Fascism should more appropriately be called Corporatism, because it is a merger of state and corporate power.  -Benito Mussolini

Fascism is capitalism in decay.  -Vladimir Lenin

I've noted numerous times on SG about the dangers of power in the hands of too few, most notably the Federal Reserve and our corporatist economy.  When viewing these charts, think about the ramifications of lobbying influence, the shaping of rules and regulation, the ability to limit competition by erecting barriers to entry, the power of political donations, the pricing power given limited consumer choice, etc.  While the charts below just highlight the banking and railroad sectors, the same can be said for healthcare, food (just four producers control more than 90% of the chicken and pork markets), autos, etc.  Too much power in too few hands is a danger to the freedom and liberties of the individual.

Banking:

Railroads:

The Big Bank Bailout Bluff

“Banks have done more injury to the religion, morality, tranquility, prosperity, and even wealth of the nation than they can have done or ever will do good.”

-John Adams

Because I think it is reasonably likely in the intermediate future, this needs to remembered when the time comes for potentially more bank bailouts -- any talk of the necessity of using taxpayer funds to "rescue" the big banks is a complete, fabricated lie.  It was true in 2008 during TARP, and it remains true to this day.  Any attempt at causing economic hysteria is meant solely to threaten economic armageddon in order to keep the status quo when the expiration date on that is long past due.

In this week's commentary John Hussman gives a little more detail:

Over the past three years, Wall Street and the banking system have enjoyed enormous fiscal and monetary concessions on the self-serving assertion that the global financial system will "implode" if anyone who made a bad loan might actually experience a loss. Because reversing this mantra is so difficult, policy makers are likely to continue fitful efforts to "rescue" this debt for the sake of bondholders, through mechanisms that are increasingly distasteful to the broader population. The justification for those policies will therefore have to be coupled with rhetoric that institutions holding these securities are too "systemically important" to suffer losses.

On this note, it is critical to remember that nearly all financial institutions have enough capital and obligations to their own bondholders to completely absorb restructuring losses without customers or counterparties bearing any loss at all. So keep in mind that the debate here is not about protecting customers or counterparties - it is really about whether the stockholders and bondholders of banks and other financial institutions should bear a loss. The "failure" of a bank only means that existing stockholders and bondholders are disenfranchised - the company simply takes on a new life under new ownership. Existing stockholders lose everything, unsecured bondholders typically lose something, and senior bondholders get any residual obtained as a result of the sale or transfer of the company. If the global economy is fortunate, the financial system two or three years from now will look much the same as it does today, but the ownership and capital structure will have changed almost entirely. A major restructuring of debt is the clearest path to long-term economic recovery, and the accompanying losses to those who recklessly made bad loans would be the highest realization of Schumpeter's idea of "creative destruction."

From that perspective, Warren Buffett's $5 billion investment in Bank of America preferred stock last week was essentially a defense of the old guard. Buffet observed, "It's a vote of confidence, not only in Bank of America, but also in the country."

Yes - to be specific, it's a vote of confidence that the country will bail out Bank of America in any future crisis. We should all hope that Buffett's investment is successful - provided there is no future crisis - and we should equally hope that Buffett loses the entire investment otherwise.

We'll see what happens.  I suspect Uncle Warren's investment in BofA will be tested in the next 18 months.

Stocks? Still Overvalued.

"He's mad, that trusts in the tameness of a wolf, a horse's health, a boy's love, or a whor's oath."

-The Fool, King Lear 

Or the charlatans on CNBC.  As the chart shows, we've been living in a period of stock overvaluation for so long that no one recognizes real value anymore.  This is also the reason why equity returns for the past decade plus have been so dismal, and why they will likely continue to be dismal until valuations get back to reasonable levels.

Mike "Mish" Shedlock also has some excellent commentary on why stock returns will likely continue to disappoint.  The main reason?  Demographics.  The biggest holders of equities are baby boomers, and they are likely to generally be sellers of stocks to fund their retirements.  That factor is likely to be a major headwind (in addition to the current overvaluation) for stock returns in the coming decade.

The "Success" of Bernanke's Quantitative Easing

"When God desires to destroy a thing, he entrusts its destruction to the thing itself.  Every bad institution of this world ends by suicide."  -Victor Hugo

I don't know about you, but I am fired up about the Fed's next round of money-printing, also known as "Quantitative Easing", or QE-3 for short.  Investors are already anticipating it:

U.S. Index Futures Climb on Speculation Bernanke to Signal Third QE Round

Aug. 22 (Bloomberg) -- U.S. stock futures rose, signaling the Standard & Poor’s 500 Index will rebound from its biggest four-week drop since 2009, amid speculation the Federal Reserve will unveil further measures to support the economy…

“The market is expecting another round of asset purchases and it will come,” said Matthias Jasper, head of equities at WGZ Bank AG in Dusseldorf.

But I jest.  We are coming up on the one year anniversary of "QE-2".  Ben Bernanke is scheduled to speak Friday at the annual Jackson Hole event, and mention of another round of quantitative easing is being hoped for by the Fed's Wall Street allies.  For those promoting QE-3 -- you must assume that interest rates being too high are the key impediment to economic growth?  That's the story you are going with?  That interest rates are too high?  Okee-dokee.  The 10-year Treasury is very close to 2.0% and mortgage rates are dropping to fresh all-time lows.  And the Fed's answer is to implement a policy designed to further lower interest rates?  That's quite the theory.

John Hussman did a nice job last week of summarizing just how "successful" QE-2 has been, and maybe provide a glimpse of what's to come with the next round (and the next, and the next...):

Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That's a nice sentiment, but it does overlook one minor detail. QE2 didn't work.

Actually, that's not quite fair.

-The Federal Reserve was indeed successful at provoking a speculative frenzy in the financial markets, which has now been completely wiped out.

-The Fed was also successful in leveraging its balance sheet by more than 55-to-1 (more than Bear Stearns, Lehman, Fannie Mae, Freddie Mac, or even Long-Term Capital Management ever achieved), and driving the monetary base to more than 18 cents for every dollar of GDP - a level that requires short-term interest rates to remain below about 3 basis points in order to maintain price stability ( see Charles Plosser and the 50% Contraction in the Fed's Balance Sheet ).

-The Fed was indeed successful in provoking a wave of commodity hoarding that affected global supplies and injured the poorest of the poor - particularly in developing countries.

-The Fed was successful in setting off a very predictable decline in the value of the U.S. dollar.

-The Fed was successful in punishing savers and the risk averse, and driving investors to reach for yield in risky investments that they would normally avoid were it not for the absence of yield.

-The Fed was successful in provoking those with strong balance sheets to pay down existing higher interest-rate debt, and in creating an incentive for those with weak balance sheets to issue more of it at low rates, resulting in a simultaneous deterioration of credit quality and compensation for risk in the financial system.

-The Fed was successful at boosting the trading profits of the banks that serve as primary dealers, by announcing precisely which securities it would be buying prior to Treasury auctions, and buying them on the open market a few days later from the dealers that acquired them. -

-The Fed was successful in creating a portfolio of low yielding securities that will be almost impossible to disgorge without capital losses unless the Fed holds them to maturity.

On proper reflection, the list of the Fed's successes from QE2 is nothing short of stunning.

It is beyond comprehension why anyone would wish for more of this recklessness.

Since the Fed enacted QE-2, GDP growth has been less than 1.5% annually, and the official unemployment rate has risen.  Quantitative easing is economically baseless, but in reading the bullet points above one can see why Wall Street and their media allies are such big fans.  It also exposes the rank hypocrisy of many of those who espouse "free markets" and "capitalism".  Many of them are nothing but welfare queens themselves.

 

It's a Little Late...

Wild swings in the market cause the average investor to make ill-timed decisions.  Better to stay conservative and diversified, and then sell-offs can be greeted opportunistically rather than fearfully.  When it comes to investing, think Pete Rose and Rod Carew, not Babe Ruth.  Striking out in investing means you may not get another at-bat.

When Noah started building the arc, it was sunny.  Preparing for a flood after 3 weeks of rain is an exercise in futility.

Commentary on the U.S. Downgrade

The markets worldwide got slaughtered today (actually, it's been a few weeks now).  Nearly everyone pointed to the downgrade by S&P of U.S. debt as the reason.  I think that's just a smokescreen for a much bigger fire.  And ask yourself, if the downgrade is so negative for Treasuries, why did they rally so hard today??

What ails us is far bigger than historic downgrades.

Worthwhile commentary from John Hussman today hit on more important topics, most notably this tidbit:

"Coupled with the slowdown in year-over-year GDP growth, the composite of economic and financial evidence we presently observe has always and only been associated with ongoing or immediately impending recessions. This is not an opinion or a viewpoint, but a fact of the data."

Very interesting considering everyone on Wall Street has been suggesting a second-half recovery.  We shall see.

And he also touched on the real #1 issue facing the U.S. (and global) economy: 

If there is one crucial point that should not be missed, it is this: the fundamental source of our economic challenges, from joblessness, to unresolved housing strains, to sovereign debt crises, is that our policy makers have repeatedly opted for fiscal band-aids and monetary distortions instead of addressing the core problem head-on. That core problem is simple: the careless encouragement of asset bubbles, and the refusal to restructure bad debt.

Encouraged by inappropriately easy monetary policy and lax regulatory oversight, the U.S. went on a debt-financed binge of consumption and unproductive investment that lasted nearly a decade. When that binge collapsed, policy makers ignored the fundamental need to restructure bad debt, and instead fought tooth and nail to defend bondholders and lenders who had extended credit carelessly. We are now left with a global financial system where the debtors are incapable of making good on those debts, and governments around the world are frantically trying to prop up bad debt with public funds and monetary policies aimed at distorting the financial markets even further.

…

The way that our policy makers address the recent weakness in the markets will tell a great deal about the prospects for a durable recovery. If the policy initiatives focus on subsidizing bad debt on the fiscal side, and distorting the financial markets on the monetary side, it would be best to use whatever short-term enthusiasm those proposals provoke as an opportunity to further reduce risk. The best policy responses are those that relieve some constraint on the economy that is binding. Another round of policies geared to creating an even larger sea of zero-interest liquidity, re-igniting asset bubbles, or further lowering already depressed Treasury yields, would be a signal of panic and incompetence from the Fed. If policy makers instead push to facilitate debt restructuring, coupled with pro-growth fiscal responses (e.g. R&D investment incentives, full funding of the National Institutes of Health, productive infrastructure investment, etc), yet another drawn-out cycle of distortion and crash might be avoided.

The Fed, the European Central Bank, the IMF -- these are the agents of the status quo and of large financial interests.  Their policies are ruinous.  I fear that instead of doing the right thing, policymakers will do the same thing they've been doing, only more of it.  The big picture is that we have wasted 4 years and untold trillions trying to hide the fact that nothing has really changed.  I could be convinced to go along with intelligent deficit spending (Hussman gives some ideas in his commentary) if it buys us time to restructure the underlying imbalances in the system.  But we've done nothing of the sort.  We've gone outside and put ice cubes on the thermometer and claimed we fixed global warming.

Despite that, it must be noted that I did put money to work today near the close.  That works for me, my risk tolerance, and current allocation.  Unlike most investors, I feel my eyes are wide open to the risks we face.  Careful out there.

The Debt, Deficit, & Default Disconnect

"The liberties of our country, the freedom of our civil Constitution, are worth defending at all hazards... We have received them as a fair inheritance from our worthy ancestors: they purchased them for us with toil and danger and expense of treasure and blood. It will bring an everlasting mark of infamy on the present generation... if we should suffer them to be wrested from us by violence without a struggle, or to be cheated out of them by the artifices of false and designing men."  -Sam Adams

I think the best thing about the debt ceiling debate was that it opened people's eyes to the realities of our fiscal problems and the limits of gov't.  More people are (finally!) engaged.  For example, how many people knew before that the federal gov't sends out 100 million checks per month to federal employees, entitlement recipients, and vendors?  Or that despite our own debt and deficit problems, we are kind enough to guarantee some of the debt of Israel and Egypt?

And more people are waking up to the reality that the argument over whether we cut $1.8 trillion or $4 trillion over the next 10 years is downright silly.  Both are meaningless and are but a small downpayment of what is to come.

This great graphic from Businessweek highlights just how deep the rabbit hole goes.  Over $200 trillion, in fact.  This massive disconnect between expected spending (and entitlement receiving!) and lack of revenues will be addressed eventually, and likely the hard way.

Exponential

"Compound interest is the 8th wonder of the world."  -Albert Einstein

Of course, Einstein meant that in terms of what earning compound interest can do for an investor.  It is the road to riches.  However, the other side of that coin is exponential debt and interest.  It is the road to ruin.

A Different Perspective on the Rally

"Money, when considered as the fruit of many years' industry, as the reward of labor, sweat and toil, as the widow's dowry and children's portion, and as the means of procuring the necessaries and alleviating the afflictions of life, and making old age a scene of rest, has something in it sacred that is not to be sported with, or trusted to the airy bubble of paper currency."  -Thomas Paine

It's amazing how much the people can be fooled if you only make them think they are wealthier than they really are.  The same policies that have driven up stocks are also stagnating home prices and have driven up the prices of food, gas, insurance, healthcare, etc.  Given the state of the economy, the need for illusion is deep.  Here is the Dow Jones Industrial Average priced in a currency that can't be printed:

A Day Late and a Euro Short

Germany (and France) ought not make policies that lead to collectivisation of European debts.  To do so will result in a massive flow of German taxpayer money to Greece, Ireland, Portugal (and eventually Spain and Italy).  Maybe I am wrong, but I don't see the German's standing for this (and that assumes the Greek, Irish, Portuguese, etc. people will completely abdicate their own sovereignty to European bureaucrats).  How would American's feel if massive amounts of taxpayer money was going to go Mexico and Canada to bailout their own fiscal foolishness?  When they dig deeper into what their government plans to do, individual Germans will be outraged.  Thank goodness history shows that angry Germans are the docile sort.  Hahaha.  Haha.  Ha???

-Great post from John Mauldin on Europe:

-Here's John Hussman's weekly short piece.  He discusses other things, but also noted that 3rd grade math essentially guarantees Greek and Irish default (at least).

-And one final one from Mike "Mish" Shedlock.

 

The Other Side of the Equity Coin

"People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome."  -George Orwell

I try my very best not to get locked into an overly biased viewpoint.  Too many people stubbornly stick to a particular viewpoint and refuse to see the other side or even hear reasonable arguments that contradict their own beliefs (political affiliation, gold bugs, etc.).  So while I have been very cautious on the stock market for some time (most recently HERE) due to what I see is poor valuation, I took note when Martin Armstrong noted the following last week:

JUST when you thought it couldn’t get worse, surprise – THE BEST IS YET TO COME! Yes, the sentiment is going to change. But the change on the horizon for the next 4.3 years is going to be very different. We are entering a phase of the Private Wave where confidence in government sinks lower still. The irony of these types of moves is that the economic decline continues, but the financial markets recover with a twist. Capital becomes leery of government debt and thus the private sector rebounds in the face of rising unemployment and worsening economic statistics. 

It is absolutely critical to understand International Capital Flows. The Dow rose between 1932 and 1937 and unemployment exploded to 25% going into 1935, the Dust Bowl tore the economy apart, and the economy was far from booming. There was a lift due to the devaluation of the dollar. This is also the famous bank holiday. Much of the news between 1932 and 1937 was BEARISH. Yet the stock market rallied as a HEDGE AGAINST untrustworthy public debt. Even the city of Detroit suspended all payment on its debt. It made good in 1963 with the help of inflation. We face similar crisis in the state and local governments. Unemployment will rise as the local governments (WHO CANNOT PRINT MONEY LIKE THE FEDS NOR BORROW FROM THEM) are forced into reality.

Now, it's important to remember that future stock market returns are a direct function of how cheap stocks are today.  While I respect Armstrong and his unique point of view, in my opinion it's vital to realize that valuations in 1932 based on the Shiller P/E were in the 5-7 range vs. the over 20 now.  So even though the economy was terrible throughout the 1930's, stocks were very cheap in 1932, forecasting solid long-term returns even in a poor economy.  That is not all all the case today.  Still, it's an interesting concept and might be a tailwind for stocks (or at least to help with a floor).

Fraudian Slip

"If you put the federal government in charge of the Sahara Desert, in five years there'd be a shortage of sand."  ~ Milton Friedman

Karl Denninger points out something that has been noted here: the so-called recovery is really nothing of the sort.  It's really more of a mirage.  The only thing that has picked up is federal government spending.  In fact, absent massive gov't deficits, GDP for the last few years would have been negative (red line).

It will be interesting to see how the deficit debate shakes out.  Remember, GDP = (I) Investment + (G) Gov't Spending + (C) Consumption + (Exports - Imports).  If we decrease "G", GDP will fall.  If we raise taxes, "I" and "C" will fall.  This is 3rd grade math type stuff.

What we've done for well over a decade is to increase G, I, & C using excessive leverage.  Government deficit "stimulus" juices the economy for a short period, but what we are left with is ever-greater debt with no additional means to pay for it.  That is why we find ourselves in the cycle of having to come up with stimulus plan after stimulus plan in order to combat the slowing economy (ie. QE in 2009, QE-2 in 2010, extension of Bush tax cuts in late 2010, etc.).  Despite what the Krugman's and Romer's of the world want, it's not sustainable.  We have been postponing the day of reckoning and making the inevitable worse.

If you ask me (which you haven't, but I'll offer up anyway), I like the take that Todd Harrison of Minyanville had today:

"There is a big difference between a real recovery and debt-induced policy that masks the underlying problems...We should swing the global debt guillotine, share the haircut, swallow the bitter pill and move forward as one, even if the sum of the parts won't be as big as the whole once was -- at least initially.

This would have profound consequences for the entire financial food chain but it's an inevitable step, and if policymakers don't make the right decisions, the market will eventually make it for them."

Land of Confusion

There's too many men, too many people
Making too many problems
And not much love to go round
Can't you see this is a land of confusion?

-Genesis, "Land of Confusion"

Remember, we need at least 150,000 jobs a month just to break-even with population growth.  June was another sub-par month with just 18k.  Wages were lower, hours were lower.  We now have 14 million American's looking for work and another 6 million that have just dropped out of the workforce entirely.  At some point the people will wake up and question the policies that are leading to this...

Greece Lightening, Go Greece Lightening

"History records that the money changers have used every form of abuse, intrigue, deceit, and violent means possible to maintain their control over governments by controlling the money and its issuance."  -President James Madison

I am thrilled to see Barry Ritholtz echo a theme we've hit on a few times here at SkipGold -- who the bailouts ultimately benefit:

Ahhh, the Greeks! Long considered the cradle of Western civilization, Greece is the birthplace of democracy, the founders of Western philosophical thought. The Greeks invented the Olympic Games, literature, political science, and too numerous too enumerate scientific and mathematical principles. The first coin was minted there, as was the university education, and the idea of theater and drama.

What they did not invent was Tragedy, but they are certainly embracing it today.

In that way, the Greeks are not so different than you or I. We Americans socialized the losses of our banks, while being so dumb as to leave the profits privatized. (The worst of both worlds!). Or the Irish, for that matter, who like us and the Greeks, were foolish enough to assume the bad debts of their reckless bankers.

Whenever you hear a Bailout being discussed, look to see who it is that is actually being bailed out. It is not the Greek people or even the Greek government — rather, it is the creditors of Greece. These are the banks mostly in Europe, primarily in Germany and France, but also includes Japan, China and the US.

Thus, it is no surprise that Greek people are rioting and the banks are rallying. They are the  beneficiaries of the Greek austerity, of the EU’s largesse, of the various rescue.

Greece has all sorts of problems, from their tax base to their economy. But the Greek people are savvy enough to know when they are being raped and pillaged. The media may not get it AT ALL, but the ones who seem to know the score are the rioters in the streets of Athens, Thessaloniki and Syntagma Square.

Greece! It is a shame there will be nothing left of you once the bankers finish picking over your bones . . .

 

How Artificially Low Interest Rates Hurt the Economy

"I think he knows what Rome is. Rome is the mob. Conjure magic for them and they'll be distracted. Take away their freedom and still they'll roar. The beating heart of Rome is not the marble of the senate, it's the sand of the coliseum. He'll bring them death - and they will love him for it."  -Graccus, The Gladiator

Some people think Bill Gross at PIMCO has a direct line to the Federal Reserve.  I don't know about that, but they do employ or consult with several former Fed officials, including the likes of Alan Greenspan.  So it's interesting that Gross tweeted the following last week:

One would think a nation that has been subject to multiple "once in a lifetime" bubbles over the past decade would wake up to the notion that maybe -- just maybe -- current policy is not only not good but might be bad.  So given that nearly everyone thinks the Fed's next intervention into the economy with "QE-3" will happen as soon as the stock market drops 15%-20%, I thought the great economist Martin Armstrong's warnings were worth noting: 

In this spirit where HOPE triumphs over EXPERIENCE, the USA is following the same demise based upon the same identical failed policies of Japan. Chronically lower interest rates destroy capital formation because they reduce the worth of capital (interest rates) artificially, removing the incentive to lend and thereby contributes to the economic destruction.

You would think that since this was the policy adopted by Japan that produced what will be a 26 year Depression that someone would wake-up and say hold on a minute. But no! We are plagued by people who only go to school and have never had a real job to see firsthand how the world really functions.

As I have warned that Communism stole the very future of the individual placing all decision making in the hands of the state. Under socialism, that same deprivation of liberty is the spirit driving the government. How they manage the economy is stripping all individuals of their liberty to plan for their own future just as sure as it was done under Communism. It is one thing to care about the poor and to try to help those in need, and another to suppress the entire population to force a centralized planning scheme to run the economy…

Artificially lowering interest rates wipes out capital formation and gives the incentive for capital to (1) hoard, (2) flee or (3) speculate. When interest rates were maintained at virtually zero, the capital migrates overseas for better returns. In Japan, the carry trade was huge, borrowing in yen at 0.1% and buying US government bonds at 7-8%. Today, money from the West can be lent fully secured into India to earn 15-17% when economic growth is 30%+.

When interest rates are kept artificially low, there is no incentive to lend even by the banks. Why take any risk for so little? Cash tends to hoard as we are watching in banks reach record levels. The elderly, who depend upon interest income, are robbed of their income to fund speculation and the exportation of capital with no economic benefit to the domestic economy.

Interest rates will naturally rise in regions on the fringe of the major economy where capital concentrates. As rates rise on the fringe, capital becomes attracted to what we might call today – EMERGING MARKETS. This was common during the Roman Republic as it is today and was so recorded in history by Cicero noting the lending of Brutus at 20% offshore compared to 8% in Rome. Interest rates decline during capital concentrations. To manipulate that to an artificially lower rate on theory of stimulating demand has NEVER been proven to work. By reducing them to such an extreme low position, this encourages capital to flee to the fringe economies seeking a decent return on capital. This causes capital to hoard lacking a rate of return domestically, and fosters speculation rather than domestic investment that would create jobs.

Consequently, capital will move both offshore and into domestic speculation such as stocks when capital appreciation offers a greater reward than interest. These are not difficult observations to make. The data certainly exists to illustrate very long-term findings as demonstrated above.

The greatest danger we face is that these brain-dead notions of how to manage the economy do more harm than good for they disrupt the natural balance within the economy. This is the same type of policy experienced in Australia where they imported a species to counteract an indigenous species that had no natural predator and disrupted far more than just the targeted species.

 

Hoarding and fleeing of capital.  Speculation in overvalued stocks and commodities.  The punishment of investment and savings ($1 million in 2-year Treasuries gets you just $6,000 of annual income; happy retirement!).  This is official policy, and it is largely cheered.

The Never-ending Emergency

“I believe it is better to tell the truth than to lie.  I believe that it is better to be free than to be a slave.  And I believe that it is better to know than to be ignorant.” -H.L. Mencken

Not just a few months ago our tax-aphobic Treasury Secretary wrote a propaganda piece op-ed in The New York Times called "Welcome to the Recovery".  The problem is this -- we've never actually had a recovery.  We replaced 10% of the economy annually with government borrowing to a degree that has only been seen a few times in our nation's history.  That is not a recovery, that is stealing future production and bringing it forward to today.  It is not sustainable, and it eventually has to end either by choice (what I hope we do) or by force (bad results; see Greece, Ireland, etc.).

One could perhaps make an argument for deficit spending IF, and only if, we actually restructured the underlying imbalances in our economy -- a massive overhaul of the tax code, a restructuring of the banking system, a break-up of the "too big to fail banks", a restructuring of the massive debt load at the consumer level, investments in energy independence, etc.  But we did none of that.  All we did was indescriminantly throw $4.5 trillion into the economy with virtually nothing to show for it except for a can further down the road.  It's a tragedy.

Barry Ritholtz shows how big the deficit spending has been relative to other "emergencies" we've experienced.  And remember, this deficit spending was supposed to be "temporary" until things got back on track.  Only we are now on year 4 of 10%+ deficits.  One would think the Treasury Secretary penning a piece with the title he used in the NY Times would be a signal we should be paring back on gov't spending.  If not then, when?  Perhaps he knows something.

The Problem with Big

"Fascism should be more appropriately called Corporatism, because it is a merger of corporate and state power." -Benito Mussolini

"Fascism is capitalism in decay." -Vladimir Lenin

Chris Whalen's latest post hits a theme I've tried to highlight here at SkipGold -- the dangers that both big government and big business pose to the health and dynamism of the economy.  The dangers of big government are more known, but large corporations can be just as threatening.  They work hand-in-hand with government policymakers to enact legislation regarding rules and regulation, taxation, dollar policy, tariffs, etc. that effectively create a moat around their own business.  Policies of the Federal Reserve favor the large Wall Street banks but are literally suffocating small community banks.  Campaign contributions ensure this unfortunate dynamic.

Small and medium businesses are not as able to deal with the higher costs and red tape that all those policies impose.  Growth is slowed.  Innovation is throttled.  Higher costs and taxes are paid by others (post HERE noting co's like GE pay nearly nothing in taxes).  Democrats, of course, tend to favor big government and their big corporate donors.  But even the GOP, while paying lip service to terms like "free markets" and "capitalism", unquestionably favor their big corporate donors over their smaller, less politically active competitors.  Chris, in his "In Defense of Free Market Fundamentalism", has more:

The rapid commercialization of American society since WWI and the rise of the corporation as the dominant model in the global political economy raises many challenges for those who struggle to protect individual liberties. First and foremost it is necessary is to understand the distinction between true individual choice as economic actors and people being swept along by a consensus about economic policy that is molded by the public relations apparatus of government and large corporate enterprises...

Large corporations tend to avoid risk and over time try to control markets and even governments to protect their interests. While the vast majority of business people, who run smaller enterprises, are honest and support a civil society (and generate the majority of jobs), the captains of the largest corporations often take actions antithetical to a democratic society and their shareholders.

Far from being an achievement of the era of laissez faire economics, the rise of the large corporation is a throwback to the period of monarchism and tyranny before the industrial revolution...

Just as large, mature organization tend to lose the ability to innovate and thus destroy shareholder value, the economic thinking which celebrates big government and cartels in finance and industry is slowly killing the private sector in America and diminishing the rights of individuals. In the difficult debate over economic restructuring and renewal which must occur in the US over the next several years, we ought to begin with an assessment of elemental principles. Americans need to leave aside labels like left and right, and start asking basic questions about what mixture of policies will best enhance the economic and political lives of individuals.

Once we understand that many of the problems we face today as communities of individuals called nations come about due to concentrations of power in large governmental and corporate enterprises, and the corruption of these structures, then people on all sides of the supposed political debate are going to discover new common ground.

The entire piece is well worth the read.

Looking for Noah

"Just as it was in the days of Noah, so also will it be in the days of the Son of Man. People were eating, drinking, marrying and being given in marriage up to the day Noah entered the ark. Then the flood came and destroyed them, sweeping them all away."  -Luke 17:26-28

The complacency that we have as a nation and the lack of action we demand from our supposed leaders continues to amaze me.  We have nations in Europe blowing up economically for all to see, yet we continue to think "that can't happen here".  If we don't make some changes, I assure you the flood will come here eventually.  And consider how fast it can happen -- in 2009 Greece was borrowing money for 2 years around 2%.  Today that costs them over 20%.  That should be a warning to clowns like ex-Treasury Secretary Larry Summers and uber-idiot Paul Krugman, who have been recently advocating taking advantage of low Treasury yields to borrow trillions more in order to undergo a huge new stimulus program.  A problem of too much debt cannot be solved by more debt.

Absolute Return Partners out of London puts out a must-read piece every month.  This month is no different with their "Five Misconceptions Squashed".  This one in particular caught my attention:

The sovereign debt crisis is a European problem:  

No, it is a global issue! 

Moving on to the problems in Europe, few would disagree that Greece is stuck in the deep end of the cesspit right now. So deep, in fact, that there does not seem a way out for them. But, as we all know, Greece is not alone. Other eurozone members are not far behind in the ugly contest, but that is about as far as investors agree. A small but relatively vocal minority is crying wolf on countries such as the UK, US and Japan, but the vast majority beg to differ. Here is my take on it. 

To begin with, in order to fully comprehend the magnitude of the sovereign debt crisis, one has to acknowledge that debt/GDP is a misleading measure of sovereign states’ ability to repay their debt. There are several reasons for this. As a starter, the numerator in the equation (the debt component) does not pick up all sovereign liabilities. For example, here in the UK, unfunded pension liabilities to civil servants are not included in the official debt numbers. UK debt/GDP would jump by almost 60% if one added those liabilities to the equation. 

Secondly, the ratio is a backward looking indicator. We all know that age-related liabilities will grow dramatically in years to come. Such liabilities are completely ignored in the debt/GDP ratio. Thirdly, and most importantly, what really matters are government revenues, not GDP. In the corporate world, in order to measure a company’s ability to repay its debt, you monitor debt/revenues and debt/EBITDA. Applying the same logic to sovereign debt, you should focus on debt/tax revenues instead. 

Think about that -- when totaling up all debts and liabilities, only Japan (a bug in search of a windshield) and Greece (the biggest basket base on earth) are worse than the United States.  In fact, Portugal and Ireland have better ratios and they had to be bailed out!  I assure you, there will be no one to bailout the U.S. if we do not get our fiscal house in order.

GE: Friend or Foe?

"The current monetary system is a collectivist top down tyranny...the clever and the nimble play this system for what it's worth."  -Jim Grant

The corporatocracy that exists in this country is strangling growth.  They buy politicians and enact policies for the benefit of the few large companies and their insiders.

Bruce Krasting noted another advantage they have:

Shark Bite - GE Style

Some ugly data from Citizens for Tax Justice on corporate taxes paid in America. A chart from the report (link-PDF). 

The conclusions:

From 2008 through 2010, these 12 companies reported $171 billion in pretax U.S. profits. But as a group, their federal income taxes were negative: –$2.5 billion.

All but two of the dozen companies enjoyed at least one no-tax year over the 2008-10 period, despite reporting substantial pretax U.S. profits in those no-tax years.

Eight of the twelve companies reported net tax benefits over the full three-year period.

It’s old news that America’s biggest corporations pay little in taxes. It’s been well documented that GE is a functional tax deadbeat. I don’t think these big companies are cheating on their taxes. It’s the tax code that those same big companies (and their lobbyists) have written over the years. 

IMHO two things are needed:

1) There has to be a minimum tax on current year corporate profits. I don’t give a damn what paper losses these companies can engineer from prior years. If they are in the green in a calendar year they can reduce their tax obligation with deductions, but not below a minimum rate. I would suggest that the minimum be set at 10%.

Note: I think there is not a snowballs chance in hell that a minimum current year corporate tax could get passed. The opposition would be too great. My fallback position is that there is never a possibility that a US company benefits from a negative tax rate. If a company has a loss carry forward let them carry the cost, not the country.

2) President Obama has to dump Jeff Immelt (GE CEO) as his economic adviser. This fat cat of all fat cats is sitting on the President’s right hand side. Jeff’s influence and power has been elevated as a result.

I see it differently. I see GE/Immelt as a predators. They’re not friends of this country. They’re the enemy. 

Perhaps Bruce is going a tad overboard with the "enemy" talk.  But it's inarguable that GE's complaining about paying a too high of a tax rate is a joke.

There has been a lot of talk recently about the corporate tax rate.  The data says that small business and large domestic companies largely pay their fair share of taxes.  It's also clear that the belly-aching from large multinational corporations about taxes should ring hollow.  Because they don't pay any.

There and Back Again -- A Story of Market Valuation

"It's a dangerous business, going out your door. You step onto the road, and if you don't keep your feet, there's no telling where you might be swept off to."  -Bilbo Baggins, The Lord of the Rings

There was a very nice piece by John Hussman this week.  His commentary dealt largely with stock market valuations and historical bull and bear markets.

In short, peak-to-peak earnings growth throughout all cycles for decades has been about 6%.  Powerful secular bull and bear markets are not necessarily driven by earnings growth as is widely believed, but instead by expansion (bull) or contraction (bear) of market valuations.  That is, what multiple investors are willing to pay for earnings.  The most accurate measure of stock market valuation over the decades has been the Shiller P/E ratio (price to earnings).

As Hussman notes, at the start of secular bull markets, the Shiller P/E has historically been around 7.  This was the case in the late 1940's and in the early 1980's.  These secular rallies have averaged about 18 years in duration and end with a Shiller P/E over 24.  Think about that for a second -- that means in secular bull markets the stock market more than triples due to valuation expansion alone!  Investors get more and more confident about the economy and markets and are willing to pay more and more for every dollar of earnings.  That is what drives the stock market.

Long, secular bear markets, on the other hand, start with high valuations -- generally with the Shiller P/E over 24 -- and inevitably conclude on average 18 years later with sub-10 Shiller P/E's.  Wash, rinse, and repeat.  Earnings have been in a growing trend over this whole time, so each stock market peak and valley is generally higher than the last, which accounts for a generally rising stock market in the U.S. over the long haul.

While this is all interesting and important from an investment perspective, my greater point is that market valuation is the key to future performance.  Buy when valuations are low (1950's and 1980's) and solid, long-term future returns are almost guaranteed.  Buy when valuations are high (late 1990's and early 2000's and 2007), and you are bound to be disappointed by future returns.  And that valuation range has spent well over 90% of the time with a Shiller P/E between 7 and 24.

But here's the key.  The Shiller P/E, as we sit here and now, is about 24.  Yes, the level from which prior secular bear markets have historically started.

So the idea of the here and now being the start of a long-term secular bull market is HIGHLY unlikely.  This is certainly no guarantee going forward, but there is a lot of history behind that.

Also, perhaps you should ask yourself whether the economic outlook for the U.S. today is far better than it was in decades past that might render history moot.  I hardly think so, but you can formulate your own opinion on that.  But even when we had the type of growth in the U.S. like we've had for the past 70 years, when the Shiller P/E reached current levels stocks stagnated for a decade or more.

Something to think about.  We'll see if this time is different.

Hussman also had this to say:

The importance of aligning investment strategy with prevailing conditions was nicely summarized by Howard Marks in a letter to investors last week (I've repeatedly quoted Marks in recent weeks, as something of an endorsement of his recent book The Most Important Thing, which is well worth reading):

"One of the things that makes investing interesting is the ever-changing nature of the route to profit, the pitfalls that are present, and the tools and approaches that should be employed. Conscious decisions regarding these things should underlie all efforts to manage capital, and they must be revisited constantly as circumstances and asset prices change. What's right today?

"First, should you prepare for prosperity or not? By prosperity I mean a return to the happy days of the 1980s and '90s, when reported economic growth was strong and consumers were eager to spend. My answer is that we're not likely to see anything like that, in large part because in those decades the gap between stagnant incomes and vigorous consumption growth was bridged through buying on credit. Instead, in the years ahead I think (a) growth in employment and incomes will be sluggish, (b) consumers should be restrained in their borrowing as a result of having experienced the crisis, (c) consumer credit shouldn't be available as readily, and (d) borrowing against home equity will be much less of a factor, especially because home equity is so scarce.

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

"And that brings me to my third question: what tools should you employ? I think we're back to needing the cautious attributes, not the aggressive. An unusually large number of thorny macro issues are outstanding... with all of these, plus prices that are fair to full and investor behavior that has increased in aggressiveness, I would rather gird for the things that can go wrong than ensure maximum participation if things go right. (Of course that's not an unfamiliar refrain from me.)

"We can never be sure what will happen – and certainly not when – but it's important to be prepared for what's likely to lie ahead. And understanding the inevitable pendulum swing in the way investments are viewed – from weeds to flowers and back – is an essential ingredient in being able to do so."

Sage advice, if you ask me.  Keep your feet, and don't get swept away.

Hyperinflation Exaggeration

"If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence." - Bertrand Russell

It seems to me that a cottage industry of people believing we are heading for hyperinflation sometime soon in this country has gotten more vocal over the years.  While I think much of their criticism of Washington monetary and fiscal policymaking is valid, I do not think we are heading for hyperinflation (ala Weimer Germany) or a "collapse in the dollar" anytime soon.  I do think we will face much higher inflation and the pains that go with that in coming years, likely starting in the next 3-5 years.  That pig, as they say, is in the python.  Past decisions by the Federal Reserve and Congress almost guarantee it.  But a hyperinflation is unlikely.

Here is a great post by Mike "Mish" Shedlock of Global Economic Analysis highlighting just that.  Well worth the read in today's times of hyperventilating commentators and hucksters of investment services.

After reading Mish's post, if you still think hyperinflation is coming our way, consider this quote from the great book When Money Dies by Adam Fergusson (a fascinating read).  It hammers home the dangers of hyperinflation:

"In hyperinflation, a kilo of potatoes was worth to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food more needed than freedom."

Got that?  Prostituting your kids.  Rampant theft.  A collapse of dignity.  Moral decay.  If I even thought the possibility of hyperinflation was coming our way soon, I wouldn't be sitting here writing this post.  I'd be screaming from the rooftops and marching in the streets to prevent it.

Fortunately, I don't think that's the case, and I suggest you ignore the dire warnings of the hyperinflationists.

Sign of the Times

"A nickel isn't worth a dime these days."  -Yogi Berra

While the entire piece is a must-read, I thought this comment at the end of John Hussman's weekly commentary was particularly interesting.  Woe be the fool who saves and invests.

As a side note, in the U.S., 3-month Treasury bill yields are now down to 2 basis points.  This means that $1,000 investment in 3-month bills now gets you a nickel of interest over the life of the investment.

$1 million will get you $50, and $10 million will land you $500.  Considering that savings and investment are the backbone of a productive economy, what a twisted web of perverted policies we weave.

True Finns

"Speaking the truth in times of universal deceit is a revolutionary act" - George Orwell

Finland recently had an election and the party that gains the most was the True Finn's, largely on opposing the sovereign bailouts going on in Europe.  Timo Soini, head of Finland's True Finn Party, had this op-ed in The Wall Street Journal this week: 

When I had the honor of leading the True Finn Party to electoral victory in April, we made a solemn promise to oppose the so-called bailouts of euro-zone member states. These bailouts are patently bad for Europe, bad for Finland and bad for the countries that have been forced to accept them. Europe is suffering from the economic gangrene of insolvency—both public and private. And unless we amputate that which cannot be saved, we risk poisoning the whole body.

The official wisdom is that Greece, Ireland and Portugal have been hit by a liquidity crisis, so they needed a momentary infusion of capital, after which everything would return to normal. But this official version is a lie, one that takes the ordinary people of Europe for idiots. They deserve better from politics and their leaders.

To understand the real nature and purpose of the bailouts, we first have to understand who really benefits from them. Let's follow the money.

At the risk of being accused of populism, we'll begin with the obvious: It is not the little guy that benefits. He is being milked and lied to in order to keep the insolvent system running. He is paid less and taxed more to provide the money needed to keep this Ponzi scheme going. Meanwhile, a kind of deadly symbiosis has developed between politicians and banks: Our political leaders borrow ever more money to pay off the banks, which return the favor by lending ever-more money back to our governments, keeping the scheme afloat.

In a true market economy, bad choices get penalized. Not here. When the inevitable failure of overindebted euro-zone countries came to light, a secret pact was made.

Instead of accepting losses on unsound investments—which would have led to the probable collapse and national bailout of some banks—it was decided to transfer the losses to taxpayers via loans, guarantees and opaque constructs such as the European Financial Stability Fund, Ireland's NAMA and a lineup of special-purpose vehicles that make Enron look simple. Some politicians understood this; others just panicked and did as they were told.

The money did not go to help indebted economies. It flowed through the European Central Bank and recipient states to the coffers of big banks and investment funds.

The same dynamics are going on here in the U.S.  And here is the key to remember about bailouts -- bailouts are not for the benefit of the debtor; they are for the benefit of the creditor.  THAT is who gets bailed out.  And here are the creditors for Greece, Ireland, Spain, and Portugal, and this is the only reason those countries are being bailed out.

The benefactors of the bailouts are not the countries and taxpayers given loans.  They already have too much debt, so more will only cripple them further for longer.  No, the real benefactors of the bailouts are the shareholders and bondholders and managements of large German, French, and British banks.  The warlords at the IMF, World Bank, and ECB (and the Fed and Treasury here) make sure their constituents (the big banks) don't take any losses.

ADDENDUM: Truly some Orwellian things are going on.  Soini's original op-ed piece has been completely scrubbed and edited.  Check it out HERE.

Man on Fire

"Bureaucracy defends the status quo long past the time when the quo has lost its status."  -Laurence J. Peter

Barry Ritholtz at "The Big Picture" blog was on fire this week.  He had two great posts highlighting two of our huge problems.  First, in "Jezebels Undermining Financial Overahaul", Barry notes that we don't have a two party system but one party that kneels at the alter of the Corporatocracy:

The ongoing attempt to turn the nation over wholesale to our corporate overlords continues apace. Leading the charge are the Republican harlots, who seem to have never met a corporate phallus they could not find new and clever ways to debase themselves to.

Aiding their charge are Democrat trollops, who have tried to out-GOP the GOP as fellatrix in search of campaign contributions. Ever since the Clinton-era embracing of Wall Street, representative democracy, at least as far as flesh and blood humans are concerned, has suffered greatly. We are a one party nation, morphed into a Corporatocracy, with laws and regulations written by the Corporate campaign donor, for the benefit of the Corporate donor. You humans are merely cannon fodder, who exist mostly to buy corporate products and pay taxes.

The national government has become a giant grift, populated by Jezebels and strumpets. We have a holodeck version of reality, a smash and grab financial policy, an endless stream of corporate giveaways, tax loopholes and bailouts.

That the sheeple tolerate does not mean they are dumb or foolish, but it does speak to the eradication of Democracy. The complete institutionalization of this process has created some angst, but an embedded policy of Bread & Circuses usually serves to distract the masses. We can throw the bums out every two years, but it matters little. A new set of bums merely push the buttons and pull the levers of the machinery — but it is the machine itself that has become so corrupted. To quote P. J. O’Rourke “Voting just encourages the bastards.”

Today, we learn of more Republicans blocking appointments to all manner of regulatory oversight offices. Because, you know, bankers can self-regulate. And Democrats lack the balls to ram through someone like Paul Volcker to oversee the 5 years-olds we call bankers. They would not want to offend the overlords. Rule 1 in modern politics: Never upset the donors.

The threat to our once great republic is not our deficit or our extended military or terrorism or China — it is our phlegmatic, wheezy, impotent leadership (and I use that last word lightly). The lack of vision, the inability to recognize reality, the selling out to the highest bidder in Washington DC — THAT is our biggest worry. Any of the aforementioned problems could be handled if only the political classes had not sold their collective souls for a handful of shiny beads.

When it comes to financial regulations, our choices are the Party of Make Believe versus the Party of Castrati.

Well said, Barry.  And in "How to Handle a Financial Crisis Like Sweden", Barry notes what should have been done to the large banks (and still could, under leadership that isn't bought and paid for by the powers that are keeping current policies in place):

I have long been in the Swedish camp when it comes to food (meatballs with lingonberries) women (tall blondes) and financial crises (prepackaged bankruptcy, no bailouts for banks).

While the Japanese have lots to offer (Sushi, Anime, and reliable cars), their approach to financial panics was to nationalize all of the debt, prop up insolvent corporations, and continually kick the can down the road. Ever since their 1989 Real Estate/Bank collapse, their economy has been paying the price for bad policy decisions.

Its been two and a half years since our credit crisis, and we now have enough distance to see the results of various policy choices different nations have made. The Irish made a horrific decision to completely transfer the losses from their reckless bankers to the taxpayer, and are suffering under the weight of about €25,000 for every man woman and child in the Ireland. Similarly, the U.S. assumed much of the responsibility for irresponsible bankers and their reckless leveraged bets. Our economy has muddled along with subpar growth, weak job creation, and a nagging suspicion that another crisis is likely sometime in the future.

And then there is tiny Iceland.

Bankrupted by the global collapse, Reykjavik made the more painful, but ultimately better, Swedish choice of putting their insolvent banks through bankruptcy...

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

 

How To Lose Money in a Great Investment

"To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest rewards."  -Sir John Templeton

Research has confirmed repeatedly that individual investors perform much worse than the overall markets.  Certainly some of the disparity is due to large (and often hidden) fees and expenses.  But the biggest component is that the vast majority of investors do the exact opposite of what should be done -- they buy when markets are hot, over-owned, and overvalued, and they sell when markets tank, fear is rampant, and stocks are cheap.  In effect, they buy high and sell low.  This herding behavior can be very harmful even when investing in a very successful mutual fund.

And here is one of the finest examples of this phenomenon I've ever seen.

Consider the CGM Focus Fund run by well-known money manager Ken Heebner.  From Jan. 1, 2000 to Dec. 31, 2009, Heebner's fund returned 18.2% annually.  In a decade that produced virtually 0% stock market returns, that is truly astounding performance.  That means that $100,000 invested over that period of time turned into $532,000.  I, for one, would gladly take that 432% gain.  One can reasonably conclude that the average investor did very well in that fund, correct?

But you would be wrong.  The average investor in the fund didn't ride that out.  They were moving in and out at almost exactly the wrong times.  Over and over.  Buying after it ran up and selling in fear on downturns.

Now consider the hypothetical investor in Heebner's fund that started with that same $100,000.  We know a buy and hold investor turned that into $532k.  But what did the actual average investor have for returns?  At the end of the decade he would have had $525,000?  $400,000?  $300,000?

How about $31,200.  Yes, the typical investor in the GCM Focus Fund lost 11% annually -- 69% in total and 94% less than the fund as a whole!

Makes you wonder how individual investors are managing in mutual funds that don't return 18.2% annually.

See the short 2-minute video for more HERE.

"Stankflation"

Peter Atwater is a former Treasure of a large regional bank and posts often at Minyanville.  His most recent post is worthy of a read:

While economists and financial pundits debate ad nauseum whether the outcome of the Federal Reserve’s extraordinary measures will be inflation or deflation, I’d offer that for the average American the outcome has already clearly been stankflation – inflation in the things they need, like food and energy, coupled with prolonged and pronounced deflation in the value of their homes and their real wages.

While Chairman Bernanke acknowledged that “It is very hard to blame the American people for being impatient,” I am are afraid that his repeated use of the word “transitory” discounts just how long stankflation has been most Americans’ New Normal.

Late last fall, I expressed concern about how, in the aftermath of the banking crisis, fiscal and monetary policy actions had contributed to an “increasingly dangerous asymmetric economy."

But a recent New York Times/CBS News poll, suggesting that Americans are more pessimistic about the nation’s economic outlook and overall direction than they have been at any time since near the bottom of the banking crisis, got my attention as it confirmed my fears that despite a doubling of the stock market since March 2009, the vast majority of Americans just don’t feel better. In fact, thanks to rising food and energy prices, many feel even worse.

With many of our nation’s top political and economic leaders today seemingly surprised by the continuing negative social mood in the country, perhaps this chart from MacroMavens might help them to better understand the toll stankflation is taking on Main Street:

Beginning eight years ago, the plight of those with significant financial assets in this country began to significantly decouple from that of the average American, as artificially low interest rates lifted the S&P 500 (along with housing) to new highs. But note that the rise in housing prices during this period (2003-2007), did not raise America’s social mood to a new high along with it.

Needless to say we all know how the events of 2008 universally affected Americans, as both financial asset and home prices fell across the board. But I would encourage policymakers to take a very serious look at what has happened since early 2009 as financial assets have soared while societal mood has stagnated near its 2009 lows, particularly as Bloomberg notes, “readings below minus 40 coincide with a recession."

We can all debate the contributing factors to this asymmetric recovery (dollar debasement, the lack of a housing market recovery, higher food and energy prices, high and prolonged unemployment etc.) but as this chart shows, for America’s Average Joes, their continuing stankflation bears seems no relationship to the market recovery trumpeted by Wall Street and Washington.

One might have thought, given the inherent pro-incumbent bias that exists at the Federal Reserve (thanks to its dual mandate), that Chairman Bernanke might have tried to close the stankflation gap this past week (at least in the short run) by talking up the dollar in an effort to let some air out of both the stock market and commodity market. Needless to say, given his press conference comments (and the subsequent market reaction), that didn’t happen.

For those suffering from the plight of stankflation, Chairman Bernanke’s “stay the course” message (not to mention NY Federal Reserve President William Dudley’s “Let them eat i-Pad” comment from a few weeks back) must clearly sting.

But Washington (and I would add Wall Street) would be wise to appreciate the societal tension which now exists due to the recovery “gap” between the Haves and Have-Nots suggested by the chart above, particularly with 2012 elections ahead. Recently, the Wall Street Journal offered examples from both Greece and Finland where “the political elite have not really listened to the people” resulting in adverse electoral outcomes to incumbents.

Rather than debating whether inflation is transitory or not, Washington needs to appreciate that for Main Street America their stankflation has been anything but transitory. And after eight years in recession, those suffering from stankflation are likely to be open to any candidate who is prepared to act on their behalf. 

As they say in London “Mind the gap." And increasingly, I am afraid that the stankflation gap has grown too big to be ignored.

Debt Ceiling Terrorists

“I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.”  -Thomas Jefferson

I recently noted:

There is talk that if Congress doesn't raise the debt ceiling soon that the U.S. could default.  Not true.  That is propaganda being promulgated by those that have the most vested interest in the U.S. maintaining its irresponsible deficits (mainly politicians and large corporate interests).  A default by the federal government would only come about if the Treasury Dept. was unable to pay the principal or interest that is due.

Now consider that the U.S. federal government will take in around $2 trillion in tax revenue this year.  Even if interest rates rose to an average of 4%, the interest cost would be ~$550 billion this year.  And any debt coming due could be refinanced, as the total debt outstanding wouldn't change.  The problem is we borrow 42 cents for every dollar spent.  That deficit would indeed grind to a halt.  Not raising the debt ceiling does not mean default -- it only forces the federal government to immediately live within its means (God forbid, eh?).

Well, that propaganda is already becoming even more ridiculous than I thought possible.  In an interview with Bloomberg this week, former Bush Treasury Secretary Paul O'Neill claimed that:

"people who are threatening not to pass the debt ceiling are our version of Al-Qaeda terrorists. Really. They're really putting our whole society at risk."

Uhhh, who are the terrorists here, Paul?

So if you are for the unsustainable status quo, you are red-blooded, patriotic American.  And if you think we need some reforms related to our spending and deficits that will prevent us from driving off the cliff...well, I guess you ought to expect a knock on your door from Homeland Security.

And here's a story that highlights the fact that Wall Street firms are distributing reports to politicians in Washington claiming "Doomsday" if the debt ceiling is not passed soon:

Yet much of Wall Street is treating imminent default as a serious threat to the country's, if not the world's, financial well being. In recent weeks, [megabank] firms have been scrambling to issue reports predicting apocalypse unless Congress allows the country to borrow ourselves into oblivion.

And let's be clear so everything is on the table -- no industry makes more money and benefits more from miscreant Congressional and Federal Reserve policies than Wall Street:

As one long-time Wall Street economist recently told me, "Goldman is the worst," but every major firm's economic department now overtly "supports government spending stimulus and Fed pump-priming" as the path to economic nirvana.

Which gets us closer to the real conflict: The free money the Federal Reserve has printed and the massive government spending under Obama have been very, very good to Wall Street.

The Fed's policy of printing money and keeping interest rates at rock bottom give the banks access to borrow cheaply to support their operations, even if they don't lend that cash to Main Street. And Wall Street firms are making real money underwriting bonds, thanks to the stimulus, not to mention the various "green" spending programs that are at the heart of Obamanomics.

Fiscal reform in Washington would be doomsday, indeed -- for Wall Street bonuses and spendthrift politicians.

Of the 1%, By the 1%, and For the 1%...

...brought to you by the Federal Reserve.  The "Quote of the Day" from Ed Yardeni of Yardeni Research, Inc.:

“The Fed is still your friend if you are invested in cyclical stocks, commodities, and foreign currencies [or a banker]. If you eat food and run your car on gasoline, the Fed will continue to hurt you. If you are looking for a job, you may be wondering why it is still so hard to find one despite all the money the Fed has spent so far on QE 2.0. If you are retired and living on interest from your CDs, then you are getting really squeezed between rising food and fuel prices and the Fed’s zero interest rate policy. In other words, the Fed seems to be doing everything to widen the gap between the Haves and Have Nots than to lower unemployment and boost economic growth, which remains “moderate” according to yesterday’s FOMC statement.”

This is why on a day when GDP came in about 1/2 of what was projected a few months ago and jobless claims unexpectedly rose again, the stock market continued to ramp.  Good news is good, and bad news...well that might even be better (i.e. more "QE" is likely).  The dollar and middle class continue to be sacrificed for the benefit of the few monied interests.

These policies are also why we are seeing headlines like this nearly two years after the recession officially ended…

Americans Raiding Retirement Funds Early

Nearly one-fifth of full-time employed Americans have raided retirement accounts in the past year to cover emergencies.

…and why it's harder to get a job at McDonald's than it is to get into Harvard and why Wal*Mart's CEO is saying things like this:

Wal-Mart shoppers, many of whom live paycheck to paycheck, typically shop in bulk at the beginning of the month when their paychecks come in.

Lately, they're "running out of money" at a faster clip, he said.

"Purchases are really dropping off by the end of the month even more than last year," Duke said. "This end-of-month [purchases] cycle is growing to be a concern.

Wal-Mart which averages 140 million shoppers weekly to its stores in the United States, is considered a barometer of the health of the consumer and the economy.

To that end, Duke said he's not seeing signs of a recovery yet.

Spin City

Clearly I am still a tad naive, as I was hoping Ben Bernanke's press conference this afternoon would actually shed some insight into the monetary madness being showered down on all of us in this grand experiment.  I mean, there are just so many good questions to ask the guy.  But from my vantage point, the press conference seemed orchestrated, with questions cleared beforehand to avoid any curveballs or missteps.  CNBC gave Bernanke an "A" in all four categories in which they graded him.  So, unfortunately, we are not left with much new from the man in charge of saving the western world.

Todd Harrison of Minyanville, however, conveniently provided much more clarity to the press conference by translating Bernanke-speak for the masses:

Our Fed Chairman is holding court today on the heels of the “move along folks, nothing to see here” policy announcement. While we give the Federal Reserve credit for the attempt at transparency, we’ve attempted to translate some of his more salient points for the casual observers in our midst. 

Below, please find our interpretations of his press conference: 

Said: Bernanke expects a 'relatively week' first quarter.
Meant: We''ve spent trillions of dollars and folks are finally waking up to the fact that a rally doesn't equal a recovery. 

Said: He says most of the 1st quarter slowdown was 'transitory.'
Meant: Blame it on Japan. 

Said: Bernanke says a strong dollar is in the US and the global interest.
Meant: Focus on what I say, not what we've done. 

Said: The dollar fluctuates.
Meant: Yeah, fluctuates down! 

Said: Bernanke is unsure of when tightening will begin.
Meant: Your guess is as good as mine. 

Said: Higher gas prices is 'creating hardship,' it's a 'bad development', and 'bad for the recovery.'
Meant: Take your pick: you can have higher stocks or higher prices at the pump. 

Said: Commodity increases reflect geopolitical uncertainty.
Meant: Read Minyanville. 

Said: Bernanke reiterates that underlying inflation remains subdued.
Meant: (Sorry, I can't type, I'm laughing too hard with commodities, as measured by the CRB, 85% higher in the last two years.) 

Said: Bernanke says Fed maintains a highly accomodative policy.
Meant: We'll keep printing until China makes us stop. 

Said: FOMC is 'confident' it has tools for tightening.
Meant: I'll ask for your confidence... again. 

Said: Bernanke believes base price inflation will ease.
Meant: ...If we take their oil wells. 

Said: Bernanke says the labor market improving gradually.
Meant: You're fired! 

Said: Bernanke is concerned about "medium-term inflatinon."
Meant: I'm sorry... what? 

Said: Bernanke says "we are digging ourselves out of a deep hole on jobs.
Meant: And digging a deeper hole on both the deficit and credibility front. 

Said: Bernanke is watching Europe very carefully.
Meant: The sovereign sequel is very real. 

Said: Bernanke says Fed Monetary Policy is not out of the ordinary.
Meant: (Rubbing my eyes and ears!) 

There's more, but I'm having a hard time hearing "moderate," "transitory," and "subdued" any more, so I'll hold my tongue... for now.

Much clearer.  Thanks Todd!

The Vice Grip on Washington

"Watch money. Money is the barometer of society's virtue. When you see that trading is done, not by consent, but by compulsion--when you see that in order to produce, you need to obtain permission from men who produce nothing--when you see that money is flowing to those who deal, not in goods, but in favors--when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you--when you see corruption being rewarded and honesty becoming a self-sacrifice--you may know that your society is doomed." --Ayn Rand

Here's why the large corporate and other special interest grip on Washington has only gotten tighter -- they employ an army of lobbyists.  It's their world, we just live in it.  Didn't somebody once say that "lobbyists will not have a place in my Administration"? 

America's Lost Decade

“If those in charge of our society - politicians, corporate executives, and owners of press and television - can dominate our ideas, they will be secure in their power. They will not need soldiers patrolling the streets. We will control ourselves.”  -Howard Zinn

Although we have recently had modest monthly job gains, here's a great post from Bill at Calculated Risk that sheds more light on the labor market and income levels:

There are currently 130.738 million payroll jobs in the U.S. (as of March 2011). There were 130.781 million payroll jobs in January 2000. So that is over eleven years with no increase in total payroll jobs (factor in population growth and it's worse).

And the median household income in constant dollars was $49,777 in 2009. That is barely above the $49,309 in 1997, and below the $51,100 in 1998. (Census data here in Excel).

Just a reminder that many Americans have been struggling for a decade or more. The "aughts" were a lost decade for most Americans.

And I'd like to think every U.S. policymaker wakes up every morning and reminds themselves of the following:

There are currently 7.25 million fewer payroll jobs than before the recession started in 2007, with 13.5 million Americans currently unemployed. Another 8.4 million are working part time for economic reasons, and about 4 million more workers have left the labor force. Of those unemployed, 6.1 million have been unemployed for six months or more.

No net job growth in more than a decade.  Well over 20 million American's underemployed. Still down over 7 million jobs from 2007.  Real incomes have shrunk over the past 12 years (consumer spending was supported for years by home equity cash-outs and now by record levels of government handouts).

What continues to astound me is that few still question the Federal Reserve and its reckless monetary policies that are the spark for all the booms and then the inevitable, devastating busts.  The Fed's easy money policies that have driven irresponsible consumption and speculation have been a substitute for real savings and investment that are the backbone of any healthy economy.  This has had a profoundly negative impact on our economy, as the labor and real income data show.  And because of the bailouts, the ultra-wealthy get to keep their spoils while the lower 98% keep all the costs and risks.

And while the stock market climbs, consider an asset that more than just the top 10% of American's own: Housing.

The inflation-adjusted median home price is currently 38% off its 2005 peak. That's a $100,000 drop. In fact, a home buyer who bought the median priced single-family home at the 1979 peak has actually seen that home lose value (8.5% loss).

How do those feel who got duped into buying a house because the government offered up a $8,500 tax credit last spring?  Sorry, but you are now underwater on your mortgage.  Thank Uncle Sam for that one!

One day, American's will awaken from their television-induced coma and realize what damage the massive deficits coming out of Washington (both parties!) and the Federal Reserve's reckless monetary policies have done to this country.  I just hope it's soon.

Banks Gone Wild (and Why Paying Back TARP Doesn't Mean Jack)

“Banks have done more injury to the religion, morality, tranquility, prosperity, and even wealth of the nation than they can have done or ever will do good.”  -John Adams

To my friends who say the big Wall Street banks should be allowed to return to practices similar to before the financial crisis because "they paid back TARP", I say hogwash.  TARP was a smoke & mirrors, no-strings-attached giveaway to the financial oligarchy.  The damage to the economy from an unreformed financial sector was and is continuing to negatively impact the economy in a material way. Please consider the commentary from Simon Johnson, professor of Entrepreneurship at MIT:

Inflation Explained

Scene: Economics class taught by Ben Bernanke. After a late night of studying, a student falls asleep in class. This sent Bernanke into a tizzy and he came over and pounded on the desk, demanding an answer to a question he had just posed. The student, shaken but now awake says "I'm sorry Professor, I missed the question -- but the answer is to print money..." 

GDP & the Heft of Uncle Sam

Although GDP (Gross Domestic Product) is used as the primary measure of our nation's total economic output, I don't think most people are familiar with the equation.  It's relatively simple:

GDP = C+I+G+(X-M), where

C = Consumption

I = Investment

G = Government

X = Exports and M = Imports

It should be clear from this equation that when the "G" excessively borrows and spends (or even "C"), it can give the illusion that GDP is higher than it otherwise would be.

Over the last few years, our GDP growth has been impacted negatively by Consumption and Investment, as is normal in most recessions.  We have had a little bit of positive contribution from the (X-M) component, as our exports have increased.  But by far the largest influence on GDP growth as been the "G".  In fact, excluding Government spending, the rest of GDP would would have been negative over the last few years, including 2010.

For now, this massive but unsustainable "G" allows Washington to tout economic growth.  Essentially, what the government has done is borrowed GDP from future years and brought it to the present day (remember, they have elections to think about!).  But consider a few things:

1) If you cut "G" now, it will have an immediate impact on economic growth, and it will be decidedly negative (however, we will be better off in the long-run for it, but that is not in the scope of this post).  However, if we do not cut "G" now, we run the risk of the markets eventually cutting us off, ala Greece and Ireland.  In this case, "G" would be massively cut and in a very disruptive way.

2) All government spending growth above sustainable, normalized growth from the rest of the economy is false growth, as we will have to tax someone in the future to pay for it.  Those taxes will be a direct subtraction from either the Consumption or Investment part of the equation.  You see, for every dollar you are taxed, that is one fewer dollar spent ("C") or saved ("I").  It's really that simple.  In addition, all that debt has to be paid back with interest.

Consider this: The government over the past few years (and will also this year) has had an annual deficit of $1.5 trillion+.  That is well over 10% of GDP and is a number in a league only with countries like Greece and Ireland.  To say you have a strong economy with government deficits of over 10% of GDP is like saying you are a healthy Stage III cancer patient.  They don't exist.  There are certainly things you can do to change your fortunes, but to say things are "all good" is just delusional.

We were told in 2008 that these deficits would be temporary until the real economy took the economic reigns.  And yet here we are 3 years later with even higher deficits.  Large deficits have allowed our leaders to print up false claims of economic prosperity and drive asset prices higher, but in reality it's nothing but intentional distortions of economic truth and more unsound credit issuance that will come back to bite us when we eventually have to pay it back.

Is There a Nobel Prize for Hypocrisy?

Perhaps one of the few times I would agree 100% with our current Commander in Chief.  Couldn't have said it better myself:

"The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better."

-March 20, 2006, Senator Barack Obama

All of the points he makes apply 10-fold today.  Too bad he doesn't have the same conviction in the center ring as he did when he was lobbing comments from the peanut gallery.

Breaking the Shackles of Serfdom

"A creditor is worse than a slave-owner; for the master owns only your person, but a creditor owns your dignity, and can command it." -Victor Hugo

Few people know their way around Washington and the banking system like Chris Whalen, founder of Institutional Risk Analytics.  So I thought it was interesting that he is for towing a very hard line on raising the debt ceiling.  Not doing so, say the likes of Treasury Secretary Tim Geithner and the heads of Wall Street banks, risks financial armageddon (such threats ring eerily similar to the taxpayers extortion that was TARP).  Often a voice of reason in a sea of deception, Whalen says otherwise:

Why Congress should vote no on raising the debt ceiling

There is a specter haunting the industrial nations, too — the specter of debt default and deflation. All of the powers of the post-WWII regime of neo-Keynesian economic management have entered into a holy alliance to exorcise this specter: Fed Chairman Bernanke, European Central Bank Head Jean-Claude Trichet, Democrats in the American Congress and the German centrist tendency under Angela Merkel.

All of these champions of the status quo ante are, ironically enough, serving as agents for the bond holders of the largest US and EU banks, the clients of PIMCO, Black Rock and even my friend David Kotok at Cumberland Advisors. These agents of the global creditor class are betting on the likes of Bernanke, Trichet and Merkel to collect their debts for them like so many China gunboats — and thereby plunge hundreds of millions of people into penury for decades to come.

It is no small irony that the interests of the banks and bond holders in the US are being protected by a Democrat from Chicago named Barack Obama. Far from being a leftist, Obama is a global technocrat who turned out to be the most perfectly compliant stooge for the interests of the large banks and institutional investors. With Timothy Geithner at Treasury and former JPMorgan banker William Daley at the White House, the only decision Obama needs to make every day is what shirt to wear...

Politicians and central bankers in the U.S. and Europe are determined to make sure no bank or bank bondholder takes a loss, ever (as noted before, bondholders of Bear Stearns, A.I.G., Countrywide, etc. have all been paid back, in full, by the American taxpayer).  "Too big to fail" is a chronic economic disease.  The result will be debt servitude for the rest of us for a decade, perhaps more.  It's time to revolt.

Read Whalen's full piece HERE.

Student Loans: Getting the Backhand by the Handout

"Gold is the money of kings; silver is the money of gentlemen; barter is the money of peasants; but debt is the money of slaves." -Norm Franz

Indeed, debt is the money of slaves, and we are creating them by the millions each year with the helping hand of our federal government.  What do I mean by that?  Read on, young grasshopper!

There is only one form of consumer debt that has been growing over the past couple of years, and it is exploding.  It's student loans.

I thought this re-post from fall of 2009 was appropriate given that fact.

How the Federal Government Causes Skyrocketing College Tuition

According to Wikipedia, "Stockholm Syndrome" is a psychological response sometimes seen in hostages, in which the hostage shows signs of loyalty to the hostage-taker, regardless of the danger or risk in which they have been placed.  I think many American's suffer from a similar condition when they view their "benevolent" government's programs as being beneficial for them, but the actual result is something far less benign.  Consider the following:  what two industries have witnessed the most cost inflation over the last few decades?  I think you would be hard-pressed to find any major part of the economy that has had costs rise faster than healthcare and higher education (my grad school program tuition nearly doubled from ~$27k to well over $50k since 2002!).  Coincidence or not that no two sectors of our economy have more government programs, funding, and influence than healthcare and education?  I think there is absolutely NO coincidence.

Peter Schiff, head of Euro Pacific Capital and Senatorial hopeful in the state of Connecticut, gives a must-watch video blog on how the government has been the major reason why college tuition has skyrocketed.  You may or may not agree, but hopefully it gives you something to think about even when it comes to the supposed "good" government programs [and this type of "benevolent meddling" across the economy is now happening on a far grander scale than I could have imagined a few short years ago]. 

The Absurdity of the Budget Compromise

The headline at NPR read: "Deal Averting Shutdown Proves Compromise Is Alive, If Not Well".  Indeed, what compromisers, what determined heroes, what warriors of Washington!  How they can get out of bed everyday and make these difficult decisions is truly a testament to the fortitude and ingenuity of humankind.

Only not so much.  Somewhere a few decades back the idea of "statesmen" serving us in Washington died.  What a loathsome, self-serving breed of politicians we have in DC today.  Perhaps never in the history of Washington have so many people worked so hard for so long...and accomplished so little.

Two sides of the same coin, I've said about the Democrats and Republican's.  Both just bought and paid for by slightly different big-monied constituents (but mostly the same).  Fights ahead remain for raising the debt ceiling (likely next month) and then the budget fight for the coming fiscal year starting in September.  Let's hope a larger slice of the pie is dealt with.

In Defense of Capitalism

"The inherent vice of capitalism is the unequal sharing of its blessings.  The inherent virtue of socialism is the equal sharing of its miseries."  -Sir Winston Churchill

Great friend, comedian, and entrepreneur Rajiv Satyal gave a brief critique of Michael Moore's movie Capitalism: A Love Story and asked for my thoughts.  Here is my email response to him:

The thing that bothers me the most is that people like Moore put up our current system as "capitalism" and then blame all the problems and corruption we currently have on it.  Let's be clear --- we do not have free markets and capitalism in this country.  And we are failing and falling behind as a nation because of that.  Capitalism involves risk and reward, success and failure. When you take risks that don't pan out YOU FAIL.  You do not get bailed out by well-placed government agents like Robert Rubin, Tim Geithner, Hank Paulson, Alan Greenspan, Ben Bernanke, and Larry Summers.  What we have -- and this goes for Republican and Democrat administrations alike -- is a type of crony socialism.  You keep your rewards and socialize the risks if they don't pan out.  The Federal Reserve and bought-and-paid-for politicians by large corporations (most particularly Wall Street banks) aided and abetted excessive leverage and risk taking (and still do).  There was a wink-and-nod understanding that Greenspan and then Bernanke would bailout the banks if the shit hit the fan -- this was widely known as the "Greenspan Put".  It happened with the Mexican peso crisis, the "Asian Contagion", Long-Term Capital Management, Nasdaq crash, housing bubble, etc., etc.  Investors became conditioned to being bailed out.  And even today bondholders in Bear Stearns, AIG, and many other firms were made whole by the bailouts.  Yes, taxpayers are making sure Bear Stearns and AIG bondholders and others will lose no money!  That is tragic and IS NOT CAPITALISM.  What happened was that the wealthy and well-connected got bailed out by Main Street, and we are paying for it to this day with massive budget deficits, punitively low interest rates for savers, and a mostly stagnant economy with high unemployment.  It sucks, and it pisses me off, and to blame "capitalism" for it is just ignorant.

In 1920-1921 the U.S. suffered one of its worst Depressions ever.  Nobody got bailed out and the economy suffered through a very painful 18 months.  Those who took the risks got punished, as they should.  But then that was it.  We regrouped and had "The Roaring '20's".  Then 1929 we crashed again, but instead we bailed and subsidized and stimulated ourselves into a 10 year depression that ended with WWII.  But as its been said, "The only thing we learn from history is that man doesn't learn from history".  I contend that had we not bailed out the banks in 2008, we would have had a greater, sharper, but much shorter recession that would not be putting the future of our country's fiscal health in serious jeopardy.  I firmly believe at this point in time we would be well into a real, sustainable economic recovery.

And I would also say to those who currently believe that the coast is clear -- not so fast.  The current economy is entirely dependent upon unsustainable deficits and massive monetary printing, and the consequences of those policies are ahead of us, not behind.  The banks that were deemed "too big to fail" before are much larger now.  The systemic risks are larger, not smaller.  We have put band-aids over gaping, festering wounds.  Optically things may look better, but it's only a mirage.  What will policymakers do when we inevitably hit the next downturn?  We have few bullets left.

And this is all because we did not allow the capitalist system to work.

We had a capitalist system in this country once.  It worked wonders and made us the wealthiest country in the history of the world.  We ought to try it again.

Eat the Rich?

"The liberties of our country, the freedom of our civil Constitution, are worth defending at all hazards... We have received them as a fair inheritance from our worthy ancestors: they purchased them for us with toil and danger and expense of treasure and blood. It will bring an everlasting mark of infamy on the present generation... if we should suffer them to be wrested from us by violence without a struggle, or to be cheated out of them by the artifices of false and designing men."  -Sam Adams

This video puts into perspective how completely out of control the spending and deficits of our government has become.  Deep and wide is the hole we've dug ourselves.  Anyone can make a mistake, but only a fool persists in his errors (video on YouTube is HERE).

America's "Freedom Packages"

“Of all the enemies to public liberty war is, perhaps, the most to be dreaded, because it comprises and develops the germ of every other. War is the parent of armies; from these proceed debts and taxes; and armies, and debts, and taxes are the known instruments for bringing the many under the domination of the few. In war, too, the discretionary power of the Executive is extended; its influence in dealing out offices, honors, and emoluments is multiplied; and all the means of seducing the minds, are added to those of subduing the force, of the people…. [There is also an] inequality of fortunes, and the opportunities of fraud, growing out of a state of war, and … degeneracy of manners and of morals…. No nation could preserve its freedom in the midst of continual warfare."  -James Madison

Obama gave a 20 minute speech this week on opening yet another front in the Middle East (yes, I realize Libya is in N. Africa; close enough) and never mentioned the word "oil" once.  Make no mistake about it, that's the only thing this is about.  I would rather us just be honest about it and say, "Look, we have a $14 trillion economy and it needs something to drive it.  Until we are able to harness the hot air and bullshit that comes out of D.C., that something is oil, and we will do whatever we can to secure it for our use."  That's the truth, freedom and democracy around the world be damned.  The Constitution is but an afterthought these days, as Congress doesn't even declare war anymore.  But then again, truth is the first casualty of war.

I've said before that it's an indictment of our lapdog media and their dereliction of duty that it takes a left-leaning comedian to point out the hypocrisy of our policies.

The Daily Show - America's Freedom Packages
Tags: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

Using a Short Fuse on a Big (Debt) Bomb

It is incumbent on every generation to pay its own debts as it goes.  A principle which if acted on would save one-half the wars of the world.”  -Thomas Jefferson

The always original Bruce Krasting takes a look at the inevitable and predictable debt blow-up in Portugal, and what it means for us.  This is a slightly different look at our debt situation:

Everyone knew that Portugal would have to roll over and accept a bailout at some point. It was inevitable that this has happened. The lines crossed some time ago. Portugal has too much short-term (ST) debt. The cost of rolling it over (if possible at all) would be too high. Debt service at free market rates would kill the country. So there is no sense in keeping up the charade any longer. It was Portugal’s dependence on ST debt that did them in. This chart shows how the maturity schedule of existing debt simply overwhelmed their capacity to refinance.

What would you call this? ‘Mismanagement’ comes to mind. The Portuguese Treasury put the country at risk. Rather than point fingers it would be ‘nicer’ to conclude that Portugal had no option but to borrow short-term. It would be fair to blame the economic leaders of the EU. They knew for years that Portugal’s ST debt was a time bomb. The lessons of Greece and Ireland and their dependence on money with a short string are fresh in their minds. 

Okay. You got that? ST debt = death. The greater the reliance on ST financing the greater the systemic risk. Now look at the US debt profile. Compare it to Portugal. Who looks worse to you?

So we have to fund our $1.5 trillion+ annual deficits plus rollover all that ST debt each year.  So yes, if you do the math, the U.S. Treasury will be selling over $4.0 trillion of debt in 2011 alone!

If you were able to borrow money at near historically low interest rates, you'd want to lock in that rate for as long as possible, yes?  The Treasury, however, doesn't want to increase interest rates by dumping massive amounts of our unsustainable deficits into the longer-term debt markets.  So they are financing all our debt at the short end of the curve.  The good news is that it temporarily results in an interest expense that is next to nothing (2-year Treasuries yield less than 1%).  The bad news is that when (not if, when) interest rates spike, our interest cost is going to explode very quickly and cause even more massive deficits.  Unless we change our ways, eventually we will hit the wall, too, just like Greece, Ireland, and Portugal.  Tick, tick, tick...

The "Silver" Lining

One of the best leading economic indicators is new home sales and starts.  In fact, new home construction and the subsequent sales has typically been one of the main activities that has driven the economy out of recession.  Except not now.  On March 23 it was announced that the February new home sale figure came in at the lowest of any month in the history of the report (yes, it's seasonally adjusted).  And the figure is actually far worse, since the sales figure is not population-adjusted.

What's amazing is that the recession officially ended nearly 2 years ago, and we are still posting numbers like that.  Auto sales also remain way down off the peak, which is often another key post-recession driver of economic advancement.  Clearly this "recovery" has been turned on its head.

Instead, what has been rocketing to higher levels are the precious metals.  They are very sensitive to monetary policy, particularly its errors.  Most people know by now that gold has been on a huge run.  I've called it "the silent sentinel", as it calls B.S. on the lies of our policymakers.  But if gold is Batman, then silver is its Robin, and it has been on a tear, too.

The huge ramp really started in August, when Bernanke's QE-2 was announced.

So our typical economic drivers are clearly not driving this "recovery".  No doubt by now you know I think the economy is being driven almost entirely by unsustainable deficits and money printing.  The divergence of real economic indicators vs. the action of the precious metals prove this out.

A Closer Look at the P/E Ratio and Profit Margins

"If you torture the data long enough, it will confess to anything."

-Ronald Coase

I've been asked a great question about stock market valuations, specifically about the P/E ratio (probably the most followed valuation metric).  As I've mentioned time and time again, valuations are the key to determining future returns, so this is an important concept.  Many commentators on tv note that stocks today are "cheap" because the P/E ratio is in the 14 area, which is about the long-term average.  Yet I have noted a few times recently (see HERE) that the Shiller P/E is a near-record 24, materially higher than 14.  So what gives?

Well, both are actually correct, but the Shiller P/E is more accurate.  The answer lies in profit margins.  The Shiller P/E factors in a normalized profit margin picture.  The commentators on tv are giving you the actual P/E ratio, which is incorporating profit margins that are currently near all-time highs.  

Over time, profits cannot grow more than the economy (nominal GDP).  Sometimes profits grow more quickly, but then there is the inevitable give back.  John Mauldin noted last week:

As the brilliant Jeremy Grantham says, and I am paraphrasing, corporate profits are among the most mean-reverting of all statistics. And this makes sense unless capitalism is broke. High profits entice competitors to come in and take market share by selling for less.

If corporate profits went back (mean-reverted) to their longer-term average, P/E ratios would be close to 24 at today’s prices. Corporations have some room to absorb some price increases, but at the expense of the bottom line.

As 2000 and 2007 can show you (widely touted as being "cheap" stock markets, too), following the reported P/E can be dangerous to your wealth.

The Stock Market Does Not = The Economy

I just want to make a quick point.  The title is it.

It's getting old watching financial teevee and having the propaganda army from Wall Street and Washington say that the stock market is "looking beyond" or "discounting" the problems in the Middle East, or Japan, or Libya, and that they won't impact the global economy.  The stock market is not an all-knowing crystal ball.  Consider that the housing market peaked in late 2005/early 2006.  The stock market, however, soldiered on for nearly 2 more years amid assurances that the housing market issues were "contained".  Until they weren't.  And then "kaboom".

Look, policymakers in Washington know that the greater public views the stock market as THE thermometer for the health of the economy.  Therefore many policies put in place over the past year have the goal of manipulating the stock market higher.  The liquidity and firepower thrown at the markets and economy over the past few years is astounding, and it is encouraging speculation in all financial assets and commodities.  But keep this in mind: The stock market is not the economy.  CNBC and other stock market infomercials are notorious for making simplistic linkages between the stock market and gross domestic product (GDP). They tell us that any event that stimulates GDP growth inevitably drives stock prices up, and any event that hurts GDP growth pushes stocks down (what matters is valuation, regardless of what the economy does, as shown HERE).

Believe it or not, during the Great Depression investors saw some of the greatest annual returns in history.  It didn't mean the Depression was over.  And ponder this: what was the single best performing stock market in 2007?  It was Zimbabwe.  Here's a chart:

What a utopian place that must be, eh?  But the odd thing about Zimbabwe was that it's economic output had been cut in half over the preceding 5 years, tourism and farming had been destroyed, production collapsed, and the unemployment rate was estimated in the 80% range.  Store shelves were empty.  The country was suffering through a horrific hyperinflation.  But CNBC-Zimbabwe* was euphoric, and noted that the stock market was predicting good times and that current policies must be working.  The central bank chief was hailed as a savior.  "More, more, more money printing" the financial elite demanded.  And they got it...to the eventual destruction of everything.

My point is absolutely, positively, not to say we are going into a hyperinflationary spiral or that we are like Zimbabwe.  My point is that looking at the stock market to gauge the health of the economy is a dangerous road to follow.  Think about it: If the stock market told the whole economic story, there would be no need for any further economic analysis of any kind.

*there is no CNBC-Zimbabwe, but I have no doubt about what it's propaganda would have been.

Playing with Bubbles

In one of his great Monday morning missives, John Hussman discusses "The Anatomy of a Bubble".  The bottom line is that regardless of what the economy does, when stock valuations are reasonable, investors can expect reasonably satisfactory investment returns.  Yes, regardless of what the economy does.  On the other hand, stocks that reflect high valuations will greet investors with very disappointing returns over the subsequent 5-10 years. If there is one cardinal rule to investing, it's that your future returns will depend upon the valuation of what you purchase.  One would think that two massive stock market bubbles in the past 12 years would have taught investors that, but one would be wrong. Here's the key chart from Hussman:

Presently, the Shiller P/E stands at 24. Be careful how you interpret the data in the table for Shiller P/E's above 24, since these levels were almost never observed in data prior to the late-1990's market bubble...

Indeed, outside of the bubble period since the late 1990's, the only historical instance of Shiller P/Es materially above 24 was between August and early-October of 1929. The closest we got to 24 in post-war data was in mid-1965. While prices went on to achieve moderately higher levels (lagging earnings growth, so that the Shiller multiple fell), the mid-1965 valuation peak is widely viewed as the starting point for a 17-year "secular" bear market during which the S&P 500 achieved total returns of less than 5% annually through 1982, despite severe inflation. That's a good reminder that stocks are not a very good inflation hedge during periods when inflation is rising, particularly when stock valuations are already elevated and are priced to achieve poor returns. Stocks only "benefit" from inflation during hyperinflations and during sustained and anticipated inflations. In other cases, the eventual adjustments in economic activity and valuations overwhelm the "beneficial" effect of inflation on earnings.

As Hussman further emphasizes, these returns are for the next 5 & 10 year periods and says nothing of what can happen in the short-term.  We have a madman at the monetary wheel and a bunch of drunk Congressmen in the back seat.  Who knows how long this ride can go before someone "jerks the wheel into a god*&m bridge abutment" (what movie, anyone?).

To further emphasize how poorly stocks perform over the long-term when P/E's are as high as they are now, Mike Shedlock provides the following chart:

So here we sit, with a Shiller P/E of 24.  Stocks are priced for absolute perfection.  History says returns going forward will be very disappointing.  I don't know about you, but a world with massive budget deficits, exploding debt, money-printing central banks, revolutions in the Middle East and North Africa, and nuclear issues in Japan doesn't strike me as one I'd like to take a chance on that "perfect" outcome.

In addition, remember that pension plans in the U.S. are underfunded by multiple trillions, and most of them assume annual returns in the 8% range just to even have that funding deficit.  With the 10-year Treasuries at mid-3% range, the expectation is that stocks need a 12.5% annual return to make up the difference.  The odds of that are slim to none, IMHO.

Broken Window Fallacy

"He's mad, that trusts in the tameness of a wolf, a horse's health, a boy's love, or a whor's oath." -The Fool, King Lear

Or the moron's on financial TV.  

At first I dismissed the guest on CNBC as a crackpot idiot.  But after hearing it a few dozen times in the financial media, including from PIMCO's Mohamed El-Erian and former Treasury Secretary (and former Obama advisor and large contributor to the financial and economic woes of the past few years) Larry Summers, my patience has been pushed too far.  Their argument is that the silver-lining of the Japanese earthquake and tsunami disaster is that eventually the country will rebuild and will be a net positive for the resurgence of the global economy.  It is total and complete rubbish and is a great example of the bankrupt theories of the Keynesian clowns that inhabit Wall Street, Washington, and most prominently in academia.

French economist Frederic Bastiat coined this economic ineptitude "The Broken Window Fallacy".  He noted that a broken window in a bakers shop is not economic progress, contrary to what Paul Krugman might believe.  Yes, the baker will have to pay someone to fix the window, and that person will have money to spend, but it will be at the expense of whatever more productive spending or investment the baker would have done.  On a larger scale, if a company losses an entire plant in a hurricane, the company and the overall economy are poorer as scarce resources, valuable capital, and productive labor are used to create what was already in place.  The company will have similar infrastructure in place as before, but now have less savings and/or more debt and lost opportunity costs and potentially fewer customers (people will buy a GM, Ford, Hyundai, etc. instead of buying a Toyota or Honda if they aren't able to produce as many as they want).

Think about it this way: If the destruction and rebuilding of valuable infrastructure can be a positive economic catalyst, why not have a major national program to destroy and rebuild buildings?  If Katrina destroying New Orleans can be good for GDP, by all means let's give a major American city a months notice to get out and let's nuke that puppy.  Think of all demand we could create for all the hotels, airfare, fast food, etc. that would be needed.  And the construction jobs!  Hell, why not just declare war on ourselves???

See where I am going with this?  Natural disasters and their destruction are a net negative, period.  Japan will rebuild, and yes, some of that activity will feed into economic figures.  But make absolutely no mistake about it -- Japan will be much poorer for it.  In the end, Japan will have similar infrastructure in place (and if it's nicer than before, then it will cost more and it will come at the even greater expense of other, more productive uses) yet have hundreds of billions in debt more than before with no more ability to service that debt.  Perhaps instead of rebuilding, that same capital could have produced a cure for cancer.  Or a new, efficient automobile.  We will never know.

Only in the theoretical world of ivory tower economists can shattered buildings, twisted bodies, wasted farmland, and potential nuclear fallout somehow be an economic positive.  It is ridiculous on its face.  Yet this theory persists from the halls of Princeton and Harvard to PIMCO's headquarters in Newport Beach.  And we wonder how we've been led astray?  The commentary I have witnesses this week about Japan's rebuilding confirms to me why we are in such dire straights regarding our own budget and deficits.

 

Destination HyperInflation?

"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people."  -Fredrich August von Hayek

"Money, when considered as the fruit of many years' industry, as the reward of labor, sweat and toil, as the widow's dowry and children's portion, and as the means of procuring the necessaries and alleviating the afflictions of life, and making old age a scene of rest, has something in it sacred that is not to be sported with, or trusted to the airy bubble of paper currency."  -Thomas Paine

There are very important debates going on about inflation vs. deflation vs. hyperinflation and what role policymakers at the world's major central banks should play.  I suggest you follow this development at least to some degree, as the potential to impact you and your finances is enormous.  In a world of fiat currencies with countries drowning in debt where central bankers can print hundreds of billions of dollars in mere seconds, the consequences can be staggering.  The always must-read John Mauldin had commentary out this week dealing with just that:

After looking at inflation across all countries and analyzing all hyperinflationary episodes, the lessons are the following:

*Metallic standards like gold or silver show no or a much smaller inflationary tendency than discretionary paper money standards.

*Paper money standards with central banks independent of political authorities are less inflation-based than those with dependent central banks.

*Currencies based on discretionary paper standards and bound by a regime of a fixed exchange rate to currencies, which either enjoy a metallic standard or, with a discretionary paper money standard, an independent central bank, show also a smaller tendency toward inflation, whether their central banks are independent or not...

It is extremely important to note Bernholz’s conclusion. Hyperinflations are not caused by aggressive central banks. They are caused by irresponsible and profligate legislatures that spend far beyond their means and by accommodative central banks that lend a helping hand to governments.

Our Congress and occupiers of the White House for the past few decades, and particularly for the past 10 years (regardless of party) clearly qualify under the "irresponsible and profligate legislatures that spend far beyond their means".  But only in recent years has the Federal Reserve begun to monetize that spending with its "quantitative easing" programs (they have blown multiple massive bubbles, but that is not the point of this post).  The most recent round of $600 billion of quantitative easing, also called "QE-2", started in November and is scheduled to end in June.

At this point, I think high inflation starting within the next few years is "baked in the cake".  If you look at energy and food only, one could argue it's already started (this is being offset by the continued deleveraging by U.S. households).  While $600 billion seems like a lot -- and it is -- I don't think that is a level that brings hyperinflation into play.  But, but, but.  Starting in June the federal government is going to have to sell over $1.5 trillion a year of debt to fund our massive deficits, plus roll over a few trillion a year in looming maturities, without the Federal Reserve as a buyer.  The question is what happens if the Treasury has difficulty selling bonds at favorable rates and/or we hit another economic rough patch (inevitable) and there is pressure on the Fed to act?  Is our Federal Reserve independent and responsible enough to pull in the reigns of monetizing?  I have serious doubts, as it seems like Tim Geithner and the Treasury and Ben Bernanke and the Fed have been working hand-in-hand for years now.  There is no reason to think they won't going forward.  And events like the riots in the Middle East, the European debt problems, and now the tsunami in Japan will certainly give the Fed cover to do QE-3 if they feel like it.

Two anecdotal stories jumped out at me this week that highlights what makes me nervous about this potentially dangerous relationship.  First, William Dudley, President of the Federal Reserve Bank of New York (and former chief economist at none other than Goldman Sachs!) ran into a "let them eat cake" moment during a speech in Queens.  Reuters reports:

The president of the New York Federal Reserve Bank doesn't normally face a raucous crowd.

But in Queens, New York, on Friday, William Dudley was bombarded with questions about food inflation, and his attempt to put rising commodity prices into a broader economic context only made things worse.

"When was the last time, sir, that you went grocery shopping?" one audience member asked.

Dudley tried to explain how the Fed sees things: Yes, food prices may be rising, but at the same time, other prices are declining. The Fed looks at core inflation, which strips out volatile food and energy costs, to get a better sense of where inflation may actually be heading.

So, Dudley sought an everyday example of a price that is falling.

"Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful," he said referring to Apple Inc's latest handheld tablet computer hitting stories on Friday.

"You have to look at the prices of all things," he said.

This prompted guffaws and widespread murmuring from the audience, with one audience member calling the comment "tone deaf."

"I can't eat an iPad," another quipped.

See, who cares if you can't feed your family because food and energy prices are skyrocketing due largely to Fed policies, go to the mall and buy a fu&%$ng iPad to offset it!  What a world these clowns live in!  If inflation is higher than they want or would thwart inflation-generating policies they want to enact, well then, just change the definition of inflation to exclude food and energy.  Full steam ahead.  Nevermind that food and energy hits people harder the further down the socio-economic chain you go.  And seniors on fixed incomes and savers getting horrible investment returns?  Necessary casualties of the Fed's inflation war.  The ivory tower must be higher than I thought.

It is widely believed by many (including me) that the Fed's current monetizing has been a catalyst for higher oil and fool prices, both directly with a depreciating dollar and indirectly as speculators try to anticipate the inflationary effects of money-printing and as individuals horde goods in anticipation of an inflationary future.  Besides hurting the average American consumer, some of the other knock-on effects include riots and overthrown governments in the Middle East and Africa ("Other than that, Mrs. Lincoln, how was the play?").  The Fed's cluelessness continued with Atlanta Fed President Dennis Lockhart noting the following:

Fed's Lockhart: Oil shock could lead to QE3

If oil prices continue to climb, it could force the Federal Reserve to make a new round of asset purchases, according to Atlanta Fed President Dennis Lockhart.

Appearing at the National Association of Business Economics in Arlington, Va., Lockhart said that while he doesn't think additional purchases are currently warranted, more stimulus could be needed if oil prices continue to climb.

"If [the rising price of oil] plays through to the broad economy in a way that portends a recession, I would take a position we would respond with more accommodation," Lockhart said at the conference.

This is the circle of doom.  The Fed prints money, which causes prices to rise (or really, the dollar to depreciate in value vs. real goods), which negatively impacts the economy as consumers spend more on food and energy and less on other goods, and so the Fed tries to further stimulate with easy-money policies.  Wash, rinse, and repeat.

While it will go in fits and starts, there is no question that we have started down the slippery slope of monetizing government debt that is leading to inflation.  QE-2 ends in June.  What will the Fed do then if the economy isn't self-sustaining (which, as noted most recently HERE, I believe it is not)?

I don't know what will happen.  But there is one question you need to ask yourself:  Do you trust your government and Ben Bernanke and the Federal Reserve to do the right thing?  I, personally, have grave doubts.

The Land of the Free Ride

I awoke on the roadside,
In the land of the free ride,
And I can't pull it any longer,
The sun is beating down my neck

-"Bling (Confessions of a King)", The Killers

Research outfit TrimTabs made the following observation yesterday:

"In a research note, TrimTabs highlights that government social benefits —including Social Security, Medicare, Medicaid, and unemployment insurance—were equal to 35% of all private and public wages and salaries in the 12 months ended January, up from 10% in 1960 and 21% in 2000."

Not exactly the rugged individualists that we often envision ourselves, eh?  Slouching towards socialism is more like it.  Perhaps we are already there.  TrimTabs continued:

“We have no quibble with the view that the U.S. economy is expanding at a moderate pace,” says Madeline Schnapp, Director of Macroeconomic Research at TrimTabs.  “But we believe Wall Street does not fully appreciate the degree to which growth depends on government support...We think very few market participants understand that the economy has become heavily dependent on government largesse,” cautions Schnapp.  “We are hardly convinced that the recovery can persist without outside aid, so we expect the Fed to roll out QE3 shortly after QE2 ends at the close of June.”

More than anything I'd like to see the economy be self-sustaining.  But despite all you may hear from the financial media, an economy that 1) is dependent on federal deficits of $1.7 trillion (a Greece & Ireland-like 10%+ of GDP), 2) has a central bank printing $600 billion over a 7 month span, 3) needed an extension of tax cuts that the Left said didn't help the economy in the first place, 4) has record #'s of people on food stamps, and 5) is paying out a historic amount of money to the citizenry is by default not self-sustaining.  Perhaps that will change soon, but that ain't the case right now.

Addendum: Apparently American's are not buying what Washington and Wall Street are selling.  Bloomberg has a report out on a poll that notes "Only 1 American in 7 has faith a lasting economic recovery has taken hold and a plurality say they are personally worse off than they were two years ago."