Inflezzlement

Finally got back from my travels to read this great article by Michael Nystrom over at Kitco. It expresses my observations precisely.

Back in 2005 or so, I corresponded with the president of an economics think tank (who shall remain nameless) about the underlying dangers of securitization, and this article's position is the one I took. My interlocutor, on the other hand, preferred the stand that today's solid "Reagan-Revolution" economic foundation can withstand all of this. I guess only time will tell who is right. (For my explanatory description of securitization, see this previously published article.)

Someone else I know has made the following comment after reading Nystrom's article:

"Worth noting is that the house nonetheless has value, and that the big boys holding the paper get it, and that they are really big boys, capable (one hopes) of surviving the indigestion one gets from eating inked paper."

I respond that, given the nature of the securitization process, there is not enough underlying value of houses to save even a tiny fraction of securitization's investors.

The securitization process allows banks to unlink the creation of credit from its underlying collateral and tie it onto something as volatile and insubstantial as investor confidence--which we all know is infinite and addictive, much like a gambler's doomed optimism.

Securitization could work, but only with strict parameters. I compare it to the fractional reserve system, whereby a bank can create a multiple of purchasing media based on a certain reserve of cash and assets. It only works when everyone plays fair and the system's rules are strictly observed. The only problem is that today's securitization markets have no rules whatsoever (but I bet they will soon).

I believe that sooner or later we are headed for a day of reckoning; and what is putting it off is the naivete of the global banking world and of the public, who pretend to believe (or in the case of the public who actually may believe) that there are houses behind it all. I'm with Nystrom, i.e. that there are nowhere near enough houses, but instead only pyramid-scheme balloons of hot-air credit.

To what extent, no one seems to be able to quantify. That is the main problem. Personally, I believe that the amount of hot-air credit is unbelievably high, but I can't prove it; and this is a great tragedy. My father, economist Edward C. Harwood, tried to come up with a figure with his Index of Inflation, but for reasons I have yet to understand, his parameters are no longer applicable today. (The reason reported is that it is no longer possible to define "money." This seems a lame excuse, especially with the accuracy of the statistics that are now available. For more on E.C. Harwood, see his organization's website. His Index is still maintained and published by AIER, albeit with little fanfare or commitment.]

However, by Harwood's own common sense and by historical experience, it would seem clear that we are in for some more wild ride. It could take many forms. We might get a cyclical downturn, more or less violent; or we might get more asset bubbles first. Who knows?

Personally, I would speculate that the dollar (and perhaps all fiat currencies, i.e. those not based on some commodity like gold) will eventually tank, at least temporarily; but I admit there is a chance that this may not happen for a while yet, because so many people in the world either believe in fiat money more than it deserves, or they have too much of their own wealth tied up in forms of it to want to see it sink. To my eyes, they are just holding onto a lighter cement block, thinking it will not sink to the ocean floor like the heavier ones; but cement is cement, and like all rocks, it must also sink.

As for my friend's "big boys," these large banking institutions like Merrill Lynch, Bear Stearns, Citicorp, et al., are "too big to fail," as the saying goes. The Lender-of-Last-Resort US Gov will pump money (i.e. hot-air credit) into the system to save their butts--in fact, they have already done it, twice as recently as last week. Of course, this pumping just aggravates the eventual outcome as they renege on their promise to withdraw the temporary influx, and they may think they have no choice if things go sour.

The underlying principle is this:

"What goes up must come down."

Be careful; the dollar and/or our economy may not come down in the form of a deflation. The event might just express itself in a more gradual decline of purchasing power as people's savings and merited income-increases evaporate. Our present generation lacks the experience of deflationary times and may just go along with the long-term erosion/inflation of their wealth, rather than give up their reliance on their credit-gambler's illusion.

This is because the speed of our present erosion of purchasing power is like being bled to death by a leech: It's relatively painless.


[Thanks to scribalterror.blogs.com for the photo.]

It's like having the Gambino family pick up their monthly take, assuaging your justified irritation with promises of "protection."

So I will now invent a new economic term to describe this phenomenon. We already have:

Inflation
Hyperinflation
Deflation
Stagflation

Now we need this one:

"Inflezzlement"

I derive it from one of my father's favorite expressions: "Inflation is nothing more than legalized embezzlement." How right he was. And little did he conceive of how cunningly our money managers would later learn how to render it as virtually painless a process as it has become.