The 2008 Bailout: The Pandora's Box of All Pandora's Boxes

If there ever was a Pandora's Box, the Big Bailout of 2008 has to be it.


[Thanks to 2highfestival.com for the image.]

How did we get here?

After a difficult time in the early 1900s, we began our drift away from sound monetary and banking policy by turning towards government for the prevention of business cycles.

We thought we were doing the right thing in creating the Federal Reserve. Since then, it has evolved into the monster it is today.

It started as a tool for maintenance of the stability of the banking system, but it has become the all-knowing, all seeing Poobah-Controller of the Issuance of Purchasing Media, in the place of what we had back then, the gold standard. In fact, we've gotten so far away from this standard that we officially abandoned it in 1971.

Today, it is increasing clear that the Fed has no real control of the money-creation process. Meantime, Congress has decided to come to the rescue of one failing institution after another, most recently General Motors. Ford and Chrysler will not be far behind.

Where will it end? How will this turn out?

No one knows; and the more the government messes around with this, the murkier the future becomes.

We are already in a good recession (see the statistics of the American Institute for Economic Research), and it may start out to be deflationary. But our leaders will not let price deflation happen. They will pump as much credit into the system as they think they need to keep prices and the economy stable. After all, that is their mandate. (See what I have to say about their mandate here.)

Yet deflation enriches us through lower prices. (It also means reducing the supply of purchasing media, but that's a separate story. See my discussion of this definition confusion.) If prices were to decrease, we would all be better off. For example, do you prefer the price of tuna fish at $3.99 a can, or $2.99? Duh.

Deflation (i.e. lower CPI) is not bad in and of itself. What is bad is what usually accompanies deflation. In most deflationary episodes we have recession and/or depression: Bankruptcies, decreased consumption, loss of jobs, stock market losses, bank closures.

But the Fed is forgetting that by "curing" the symptom of recession (i.e. by stopping price deflation) they are not necessarily curing the cause of that recession.

To cure this recession, Congress must allow the market to rid itself of a century of inflation. That can only be corrected through a deflationary process, even if it means we must undergo some recession. If the Fed and the Treasury try to keep it from happening, they will maintain the distortion of inflation instead of allowing it to cure itself.

What method will they use to accomplish this? They will try their darnedest to prevent deflation/recession/depression by turning on the printing presses (issuing fiat currency and credit) to whomever needs it the most, or cries the loudest, or threatens to close. They have borrowed billions, and created billions, in this effort. Where will it stop, now that the presses are running full speed?

Businesses are quickly learning that they must start screaming for cash. The cash is available. First come, first served. Yet by continuing the inflationary process and handing out cash, our own elected officials are fleecing us on a daily basis.

They will fund these bailouts with the raises we will not get, with the value we are losing on our houses, with the pension investments we bought at inflated prices and that have vanished.

Our salaries are now in negative growth, banks steal our savings every day through poor interest remuneration (they get cheaper money from the Fed), and our social security incomes and pension allotments are not keeping pace with the CPI. As my Dad used to say, "Stand still, little lambs, to be shorn." (For more about him, see my last post.)

In the longer run (when, I don't know), we the people must reject these shenanigans and turn to gold as a refuge against government destruction of the monetary units of the world.

That's the day Pandora will close her box. I hope I live long enough to see it happen.

Jackson Hole: Saving Us From Themselves

'As Nathan Mayer Rothschild was fond of saying, “I care not what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain’s money supply controls the British Empire.” '

Interesting quote from this article at SeekingAlpha.com, by one of my favorite gold bugs, Gary Dorsch, blogger at sirchartsalot.com.

Gary's article points out some of the data you don't get from the dailies and makes my case look all the more scientific. (Gadflies can always use a little support.)

What I find the scariest element of our present quandary is that top economists, including 34 central bankers, are in complete opposition to each other on (1) the problem, and (2) the solution. Take a look at this article if you care to watch how our top-notch economic-scientist central bankers are scrambling for their next move.


[Thanks to thebestlinks.com for the image.]

Mishkin thinks that, due to positive "[r]apid financial change, triggered by innovation and deregulation", all this wonderful lending has simply "outstripped the available information sources"; and so he wants to lower the target rate. Feldstein of the NBER [National Bureau of Economic Research, the major supplier of much of the statistics available] sees the bad writing on the wall and agrees the Fed should lower it by 1 percent. Shiller decries a classic housing bubble and seems to want something to be done. Leamer warns about the coming recession. Fisher from Israel says do something about the bubble before it explodes.

Then you have Mayer flipping off everyone's worries, saying this whole housing-boom thing was simply a sign that it's now cheaper to own a home than to rent one. (Sure.) Others say that the bubble is simply an effect of monetary policy but not the cause of any recession. (Right.)

Bernanke himself walks the tightrope between one side and the other, saying the economy can handle this and maybe we'll do something, maybe we won't.

The consensus seems to be summed up this way: We'll have to "rely on judgment more than models." Okay. But whose judgment are you gonna pick? I admit there's a consensus that now is not the time to raise rates; but whether to lower or not (and/or pump more credit into the system), they're all over the charts but seem to be leaning towards easing/pumping.

I get the heebie-jeebies when I read that a year ago "the Bernanke Fed ... heavily inflate[d] the broad US M3 money supply, after it decided to hide the figures from the general public in March 2006. Since then, the US M3 money supply has expanded at a 13% annualized clip, up from 8% when the Bernanke Fed stopped reporting the key figure." (Look at the charts if you don't believe him.)

I thought they were holding money supply steady. Why would they increase it, when they've supposedly been combatting the inflationary pressure all this time?

And then I cringe again when I read this:

"[China] has been a net seller of US T-bonds for three straight months by a record amount of $14.7 billion, the longest period of sales by China since November 2000."

This is not the time for China to bail out on our T-bonds (although I don't think they really will, given the amount they hold.)

And this is an interesting quote:

' “At some point, you have to choose between trusting the natural stability of Gold, and the honesty and intelligence of members of the government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for Gold,” said George Bernard Shaw in 1928.'

GBS is not my paragon of economic virtue, but I like his occasional common sense and wit. I might just add that today the marketplace is more savvy and may have already factored in much of this wisdom. No one can really predict how things will play out. But we can take our chances....

And this:

'Should you place your faith in Federal Reserve notes? “Money is too important to be left to central bankers. You essentially have a group of unelected people who have enormous power to affect the economy. I’ve always been in favor of replacing the Fed with a laptop computer, to calculate the monetary base and expand it annually, through war, peace, feast and famine by a predictable 2%,” said Milton Friedman.'

He's another one whose gift of gab--indeed in his case genius of gab--got him places; but I note that he had the remarkable ability to say opposite things within the same paragraph. Here we have a committed devotee of small government saying both "power is bad" and "use the power anyway." Why not just be consistent and recommend we get rid of both the central bankers and the central bank (i.e. throw out the centralized computer, too)? Why can't we just let it all go and allow people to write contracts in gold? End of problem. (Perhaps an oversimiplification....)

Bernanke's job at the head of our monetary policy is an impossible one; but he wanted the job, so now he's got to at least pretend he can handle it. I don't envy him. The higher you fly, the harder you fall.

Another Great Explanation of this Mess We're In

A fellow who goes by the name of Mr. Practical and who writes for, among others I assume, the Minyanville.com website, has a great piece about the structural problems that we are facing. (Some readers may have to go to the bottom of his page for the article.)

He touches upon two major glitches. First, you have the Fed's loose monetary policy of the last five to ten years. Second, you have the resultant over-confidence that this loose monetary policy spurred within the marketplace.

Mr. Practical advances the hypothesis that, "Government policy, including egregious money market operations for years by the Fed, never allowed the market to stop the increasing leverage and debt at a level sustainable relative to realistic volatility and inherent income levels generated by the economy (all the while exporting our income base to Asia)."

I agree 100 percent. And he also says this, with which I agree, in principle:

"As liquidity, generated almost exclusively by increasing credit, dries up we will hear more and more cries for government to solve the problems they helped create. As we speak I hear that Senator Dodd is meeting with Bernanke and Paulson to 'come up with solutions'. I really hope they don’t find any, for their solutions will at best delay the inevitable and quite possibly make it worse. The real solution, which will be ignored, is to just let the market sort things out."

I would add that it is easy for us, in our commentator's ivory tower, to say what should be done in the abstract. But it would be very difficult to watch misery descend upon millions of relatively innocent people and do nothing, especially when your hide is at stake. Ben and his buddies must already dread the day they will be hung high and dry during the revolution that could follow their non-action, whether this fear is realistic or not.


[Thanks to tapestry.typepad.com for the photo.]

Ben must realize that he could repent, say his mea culpas, bite the bullet, and take the heat for all the Feds prior to his; but he won't. We can be sure that the temptation to "do something" will be irresistible, and we can place a pretty safe wager that it is us the taxpayers who will pay for this one--again.

As I have said in the past, perhaps this is justice of a sort, because after all, it is we taxpayers who voted the bums into office who created the Federal Reserve in the first place, and who empowered it to expand credit to the extent they have today. We are ultimately the responsible party. We must pay the piper and reform our government--which of course won't happen either.

What will more likely happen is just the opposite. The Federal Reserve will inflate us out of this crisis and the government will hand them new powers to "crack down" on the banking and financing industries. We are on that slippery-slidey slope and it is very hard to retract uphill, away from centralization.

And that's the bottom line.

Wha' Happened?

Okay, so China's stock market, being the first to wake up in the morning, started off a flame of panic across the world that ended in the West. Two things are weird about this one: (1) The cause -- or rather the match strike -- of this surprise is not readily evident, and (2) gold didn't react by moving in the opposite direction.

I guess people are so scared they think they'd better have cash for a few "seconds" until they figure out what to do next.

All of us gold bugs have been warning the world of the imbalances we perceive in the world markets but none of us can say how and when they will all unravel. Is this the beginning of the denouement? And why China?

What I see so far is this:


[Thanks to fiscalstudy.com for this photo of an ironically relaxed Doomsday Greenspan.]

Greenspan was giving a speech in Hong Kong. When Greenspan speaks, the East listens. Greenspan predicted an American recession by the end of the year.

No matter that his predictions have usually been wrong in the past; as usual, panics don't listen to statistics. And anyway, the underlying causes of the imbalances are what we goldies have been howling about for months and years now. (Start with my March 2005 archives and read forward.)

To run that by you again, there are two fundamental principles at work here:

1. The lack of an international hard monetary yardstick such as the gold standard; combined with
2. Human nature.

The two are a highly flammable mixture, even if they can waft together for years without a hitch as long as they don't come into contact with a match.

Out of this lethal combination come:

1. Inflating of and speculation in currencies that float (and those that don't, i.e. those that are pegged and/or otherwise manipulated);
2. Protectionism through currency manipulation;
3. Use of the money supply to ease market tensions (the Federal Reserve and other central banks do this all the time -- big mistake);
4. Lack of the discipline and will power to return strength to the monetary system once they have used it for No. 3 (the Fed governors are only human after all and hate to be the bearers of bad news);
5. Naivete of the voting public as to what is going on, which allows the power players to gamble all day long at our (the public's) expense.

Who is it that said: "The only thing we learn from history is that we don't learn from history." How many times do economies (and governments) have to tank for lack of monetary discipline?

Here is Bill Cara's article over at Seeking Alpha along these lines. I agree with him that:

"[T]he Gnomes are bulldogs, and they have put their terriers into the U.S. Fed and Treasury. I believe there will be one final attempt to print the way out of a market crash. Ergo; I see one final push in precious metal prices. But the end of the long-term global stock cycle is near. It has been driven by a credit balloon that cannot be pumped higher. The peak of the cycle would have occurred in May 2006 except for the programs of the U.S. Administration (including the Fed) to ramp up the money printing. [Katy's Caveat: I would have added the other central bankers who are playing the same game, i.e. Japan, China, et al. The Fed is not alone in this.] The sad thing is that at the end of the day, when inflated stock prices blow up, those holding debt will still be holding the same level of debt. The banks will be demanding payment. That's what bankers do -- real bankers, not trader-bankers."

Inflation Off the CPI Radar

Balance. Ah, money supply balance. We've been looking for a quick fix for this ever since we drifted away from the gold standard.

Today, it's all "managed" by our central bankers, who take a few measurements and "presto!" -- that's how much money we need in circulation. Let me take you on a little Fed trip.

Imagine this mathematical formula:

p + i = P

where:

p = the cumulative prices of a specific set of things measured by the Consumer Price Index (CPI) at the beginning of a time period

P = the cumulative prices of those same things measured at the end of the time period

i = the difference between the two


For the lay people, let's play with this:

i = P - p

Divide the whole thing by p and you get the CPI "rate" or r:

i/p = P/p - p/p
i/p = P/p - 1 = r

Example: If an item is priced at $2.25 on 1/1/06 and the same item is priced at $2.36 on 1/1/07, we have:

p = $2.25
P = $2.36
i = $0.11

.11/2.25 = 2.36/2.25 - 1 = .049

Therefore r = .049, or 4.9%

This is a simplified version of how the Federal Reserve calculates the "rate of inflation."

This calculation is an essential part of the process the Federal Reserve uses to determine monetary policy, which in turn is essential to the health of the American -- to wit the global -- economy. To make a long story short, the Federal Reserve determines how much money supply is circulating in our economy by juggling with various means of credit production that I have described in previous posts. (Start with the March 2005 archives for a better understanding of money creation and history.)

Our US Federal Reserve has made a critical assumption in using the CPI as an important element to determine monetary policy. They have assumed that, by selecting a representative sample of items that consumers purchase, they can watch the prices of these items increase or decrease and draw conclusions therefrom concerning the appropriateness of the quantity of money in circulation.

I take issue with this assumption in its present format. Here is why.

The calculations above are great on paper; but they work only as concerns prices p and P for some specific items, i.e. those products the Fed has put into their CPI basket. What about products x, y and z? Is the money supply irrelevant to the p and P prices of x, y and z? Conversely, are the changing prices of x, y and z irrelevant to the money supply?

Remember that in its CPI calculations, the Fed has taken P and p for only those items that are included in the government's list of things to be measured, which list is supposed to represent a basket of consumables that everyone uses. But what if important quantities of consumer dollars are increasingly spent on purchasing things OTHER than those that have customarily been in our government's basket? What if the prices of those things are increasing much faster than the CPI? What does that say about our money supply?

Here's another situation where we get into trouble with our CPI: What if consumers begin to buy products produced outside the country at prices that are temporarily cheaper than they would be at home? This is obviously a good thing for consumers; but what happens then to the CPI, upon which the Fed relies to determine monetary policy? What if the government's basket contains these exceptionally and temporarily cheaper items? (Because it does.)

You will ask, what examples are there of products x, y and z? There are many. For example, x could be stocks of Microsoft Corporation. These are not in the CPI basket. They could be office space. This is not in the basket. Z could be T-shirts from China. And q could be leveraged credit derivatives. And I could go on.

But, you say, I've seen somewhere that the Fed's basket now includes the increased prices of homes, which means that the Fed is taking certain recently ballooning asset prices into account. But I ask you what about the record Dow Jones average? On the othe side of the coin, what about the low prices for Wal-Mart and Target Chinese-made clothing? And what about the trillions and trillions of dollars worth of credit derivatives and yen "carry-trade" speculation now taking place in financial spheres? Are these not consumables? Are these not bought with our money supply? Are these items somehow exempt from Federal Reserve observation? And if so, why?

How do we determine how much of the money supply is being sucked into those? How do we determine if the money supply is adequate -- not too much, not too little -- if we have no way of measuring all prices for all things?

In other words, what happens to the CPI when the prices of certain things expand outside the Fed's radar?

The answers to my questions are unknown, and even the Federal Reserve board of governors would admit this, as strange as that may seem. But then, you ask, why do they persist? Well, I don't know; and I'm not sure that they do either. And thus, in my view, this is where the dung begins to hit the fan.

This is the essence of what I see as the world's biggest economic problem today. A few key central bankers of the world (the US, Japan, China and probably a few others) are ignoring the importance of the price fluctuations of items outside of their basket of goods. These three central banking institutions are the most important money managers in the world, and they are collectively allowing excess credit to circulate around the globe in a manner that is unprecedented, invisible and monstrous.

At some point, this stork will come to roost and lay an egg of inestimable size.