Back to the Constitution - and its underlying principles

A fine rhetorical performance by Bob Basso (htp: Karl Denninger), reminding Americans that the issue isn't money, but liberty and national integrity (as in holding the pieces together).

I agree with everything before the tea-bag (never as good as leaves, old chap) and the call to buy guns; some might go further.

Götterdämmerung

The British Prime Minister has become a desperate man. Whether it be the countless borrowed billions dashed at an economy he has personally supervised in its progress towards ruin; the chainsaw systemic attacks on personal liberty; the arrest of an MP in the House of Commons for the offence of performing his constitutional duty; the tour of foreign countries to "gild o'er" his failures at home; and now the attempt to meddle with the royal succession in order to divert some of his deserved unpopularity onto an institution that gives us continuity with a past he has assiduously sought to obliterate; all combines to show a man floundering, willing to sacrifice all others to maintain his wretched office for a few more miserable years. The Birnam Wood of financial collapse is, however improbably, marching towards Dunsinane; how apt that he should have chosen to domicile his family in Fife.

Divided consciousness

It's a strange feeling. I go about my daily work as though everything is normal - meetings, calls, teaching, memos, make a cuppa for others - and then I remember the financial volcano beneath our feet. One or the other must be a fantasy, yet I neither run away nor stop following the crisis on the Net. I hate the fuzzy-headedness you get from doublethink.

The Federal Reserve is out of control

Here is a very worrisome point:

None other than disgraced senator Ted Stevens was the poor sap who made the unpleasant discovery that if Congress didn't like the Fed handing trillions of dollars to banks without any oversight, Congress could apparently go f*ck itself — or so said the law. When Stevens asked the GAO about what authority Congress has to monitor the Fed, he got back a letter citing an obscure statute that nobody had ever heard of before: the Accounting and Auditing Act of 1950. The relevant section, 31 USC 714(b), dictated that congressional audits of the Federal Reserve may not include "deliberations, decisions and actions on monetary policy matters." The exemption, as Foss notes, "basically includes everything." According to the law, in other words, the Fed simply cannot be audited by Congress. Or by anyone else, for that matter.

For the full horror of the runaway financial train, see the Rolling Stone article here.

Brown's Britain: we can shut down your life

htp: Paddington

"Good time to invest," say fund managers

"The markets are not about to race away but one of these days they will, so don't wait for ever. Eventually, there will be the mother of all rallies." - Mark Dampier, Head of Research, Hargreaves Lansdown

"Safe to go out at night again" - Dr Acula, Transfusion Times.

... but wear a very thick scarf, says Marc Faber.

An immodest proposal

In a forthcoming issue of 'Human Nature' is an article 'Mathematical talent is linked to autism'. It includes discussion of the Viennese pediatrician Hans Asperger, for whom the condition is named. The syndrome, to various degrees, appears to be common in those successful in art and science, including mathematics.

Given that there is a great social need for such talent, and that it appears to be strongly genetic in origin - should we start a breeding program?

When the music stops, a dollar collapse?

Brad Setser's analysis is that Americans have been repatriating their dollars even faster than foreigners have been getting rid of theirs:

"Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets."

At some point, the balance of these cross-currents will change, and then? Maybe the turning point will come when Americans are forced to sell financial assets to meet living expenses and medical costs.

Meanwhile, Tim Iacono comments on a proposal to substitute the dollar as the world's reserve currency, with drawing rights from the IMF, i.e. a mixed bag of currencies. China's central bank seems terribly keen.

I have a sense of something being held up, but not for ever.

Let's move to Russia

I've said it before: you get the clearest explanations from someone who is in a hurry to move on to something else. Here is Dmitry Orlov on why Russia will survive:

It seems that the Russians are better-equipped to survive financial collapse than just about anyone else. They have formidable reserves of gold and foreign currency to soften the downward slide. They have a dwindling but still sizable endowment of things the world still wants, even if at temporarily reduced prices. They have plenty of timber and farmland and other natural resources, and can become self-sufficient and decouple themselves economically should they choose to do so. They have high-tech weaponry and a nuclear deterrent in case other nations get any crazy ideas. After all the upheavals, they have ended up with a centrally-managed, natural resource-based, geographically contiguous realm that is not overly dependent on global finance. Yes, the Russian consumer sector is crashing hard, and many Russians are in the process of losing their savings yet again, but they have managed to survive without a consumer sector before, and no doubt will again.

I'm almost tempted to live there. My grandparents' farm, overrun by the Red Army in 1945, is somewhere in that weird, tiny sliver of the Russian Federation stuck between Poland and Lithuania like a stone in your shoe. I'd need a heavily-armed gang to take the farmhouse back from whoever took it over after the hick troops stole everything in it. But maybe it's not there any more - probably it's covered with concrete now, the tyrant's material of choice. Still, life goes on; it's outlasted communism and looks set to outlast Western capitalism.

Though I should say that in the UK, the nutso socialist element must be seeing this as an opportunity to start the Millennium. I have been wondering whether it's possible to take American citzenship while continuing to live here, so that I might have some residual civil rights when my neighbours have lost theirs.

America, see the issue for what it is: not money, but democracy and freedom.

What am I missing?

I am just a mathematician, so my evaluation of economic models is restricted to the analysis of the equations. However, it seems to me that, in a perfect transaction, the selling price must be at least the value to each party.

Clearly, the value to the buyer must be greater than that to the seller. This is usually achieved by adding value. For example, a manufacturer purchases raw materials, or a wholesale merchant moves goods to where the buyers are.

That being said, I do not see where the added value is in the investment market, for a typical investor. The present value of future earnings and stock price are the same for both sellers. The only reason for the purchase is then an imagined increase in price beyond inflation, i.e. finding a bigger sucker.

Is the whole system just a house of cards?

Fractional reserve speculation

Fractional reserve lending, as "Sonus" explains so clearly here, became possible when people accepted receipts for gold as payment, instead of insisting on having the gold itself. This opened up an exciting opportunity for the guardians of gold and silver; they could issue receipts for which there was no gold or silver at all, and get other people to accept them as payment. Then we ended up with a world in which you could borrow money that didn't exist, but when the scam burst, you'd have to pay it back with the roof over your head. Now there are voices calling for the return to money actually backed by something that might limit its growth; this will pass.

In much the same way, speculation in shares has changed. Once, investor A bought a share in a company from B, held it and received dividends. But the financial market exploded when it became possible to trade in shares without actually having the certificates.

Speculator C can "short" a share - agree to sell it to A (without yet having ownership) for $1, later buy it from B at 5oc (he fervently hopes), then when settlement time comes, A ends up with the share and C pockets the profit less trading expenses. (C can also "go long": agree to buy a share from B at 50c, sell it to A for $1 later, then comes settlement time when the share ownership is officially transferred).

C can multiply his bet if he trades "on margin", in effect making only a small down payment on his share speculation. If the margin is 10%, then he can (promise to) buy or sell 10 times as many shares, and (if his judgment is right), make 10 times the profit when settlement is made.

C experiences success in conditions of a bull market and expanding money supply. C is now trading in big, big quantities, with shares he doesn't own for most of the time, and cash he mostly doesn't have. C has gone beyond mere shares, and is simply betting on movements in the market. C has become a trader in derivatives; in effect, a high-rolling gambler. What a wonderful world! So much nicer than the school he went to! C has an abundance of worldly goods, worldly girlfriends and envious colleagues who laugh at his jokes. C has taken to introducing himself on the phone as "Nick with the big swinging d*ck". C is young, and has never known things to be different. C is complacent; C has become reckless.

But oh dear, if some of his enormous bets go wrong. C has losses, multiplied by the inverse of his margin, plus his trading expenses. Maybe C doesn't have enough money in his account to cover his losses. Maybe C has been trading with another gambler, D, and now can't pay him. Suddenly D is in trouble, too. And both have also been playing around the green baize with traders E, F and G; maybe with the whole alphabet of gamblers, maybe with the Greek and Cyrillic alphabets too.

But before he busts himself (and possibly his employer into the bargain), C has influence (since it is known that he never gets it wrong - until the day he does): news of his bets affect the market, especially when the market is nervous. When C shorts a share big-time, he can start a run - even if the company was basically OK before then.

Which is why Denninger is now calling for a return to the custom of getting the stock certificate when you buy the stock.

Good luck with that; and with ending fractional reserve banking. Denninger argues against the latter here, and prefers a system of minimum cash margins; perhaps it would be more logically consistent if he advocated the same for short-selling.

Personally, I'd go for whipping the money-changers out of the temple; but they always return.

Gold: the tide is turning

Julian D. W. Phillips maintains that central banks are beginning to restock their reserves of gold.

Private hoards of the yellow metal are beginning to rival national ones: the world's largest gold ETF, SPDR, is well into the top 10 - Bloomberg reports it's now overtaken Switzerland. But there is some question of how much of SPDR's holdings are actual physical gold.

Gold doesn't earn interest, which is one reason why China hasn't yet (apparently) leapt in, though Commodity Online says that country has been considering it.

Some say that the Chinese government likes to declare policy changes via apparently unofficial sources. It's worth noting that the China Gold Association called last November for an expansion of national holdings of gold beyond its present level of 600 tonnes.

China's recent switch from Agencies (local and State bonds) to Treasuries, and from long-dated Treasuries to short-dated ones, seem to indicate contingency planning for a worst-case scenario in which the US loses control of its budget and money supply.

The motivation to plan for the worst, is high. China's official holding of US debt, large as it is, is understated, according to Brad Setser, who believes that much of the investment in US Treasuries by the UK and Hong Kong are actually on behalf of China.

In the same way, I can imagine that China might wish to hedge its bets on America by quietly boosting its gold purchases, using intermediaries to take positions in large gold investment funds. This would be a typically quiet and indirect way to improve its own security without making open moves that could panic the market. And the funding for these purchases might come from selling US/UK government bonds back to us, thanks to "quantitative easing".

What's sauce for the goose, is sauce for the gander.

Hold dollars?

Karl Denninger argues that the failed stimulus will lead to accelerating deflation in the US. His prediction is that demand for the dollar will soar and other currencies will collapse instead. He thinks this will hit US exports and the economy will be crippled, so Americans need to hold in-the-hand folding money - lots of it, maybe a year or two's basic expenses! - away from the bank.

He may be on the wrong medication - the current state of the world's finances is a great impetus towards paranoia and depression; but if he's even half right, we need to start making those quiet, regular cashpoint withdrawals and (for non-Americans) visiting the bureau de change. And not living in the city.

Where is all the money going?

I read recently that both in the US and the UK, a significant part of the "quantitative easing" is repurchasing sovereign debt from foreign holders. In other words, money is being created to buy back government bonds from overseas investors.

This says two things to me: (a) the new money thus created is not going to help kick-start our economies, and (b) foreigners are losing confidence in us and want out, before inflation and defaults shrivel the value of their investment in us. As to the latter point, I said last August that I thought the Chinese wouldn't let themselves be swindled.

So I suspect we are still headed for slump, currency devaluation and, eventually, high interest rates.

Maybe a new currency, to whitewash the mess and make further progress towards some New World Order political grouping - Oceania, Eurasia etc. Any news on the Amero?

Alle aussteigen!

As the Dow heads cheerily in the direction of 9,000, some may consider this an opportunity to get off if they missed the stop last time round.

Or have the wise actions of our leaders solved all?

Simple Science

The Laws of Thermodynamics for the layman:

First Law: You can't win.

Second Law: You can't even break even.

Translated to money terms, they are still true, but all too many didn't believe it. That's what put us in our present mess.

Once we clear up the meltdown, perhaps the sensible approach would be to base the economy officially on energy. After all, it effectively is already. For example, the price of gold merely reflects the energy expense of extracting it.

Bonner: 1966 - 1982 , and Dow 5,000

Bill Bonner, in the Daily Reckoning, confirms what I've said here many times: we need to measure investment performance in inflationary terms, and done that way, the last cycle ran from 1966 to 1982. The implication for us now?

We only bring this up to warn readers: these major cycles take time. So far, the Dow has only gotten down to the ’66 TOP. Now, it has to get to the ’82 BOTTOM…adjusted for inflation. Where would that be?

Well….as we recall, the Dow was barely at 1,000 when the bull market began. And if [we] adjust that to consumer price inflation, we come to a 2,000 – 3,000.

However, the 1982 bottom was higher than the 1932 bottom, so I'm hoping it will be no worse than 4,000. Having said that, the levels of governmental and personal debt now are quite unprecedented.

Here's the graph I did last October, again:

Good and bad borrowing

Karl Denninger covers a lot of ground - perhaps too much in one posting - in his attempt to clarify fractional reserve banking and its consequences.

What seems to me a major point in his conspectus, is the difference between borrowing for production, and borrowing for consumption. If you borrow at 5% to get a machine that makes you 10% profit, that's fine; but borrowing for a private house to live in, a car for personal use, music and TV, alcohol and weekly groceries - madness.

Quietly edging towards the exits, before the general panic

Htp: Michael Panzer, for this:

They are taking cash out of the bank in preparation for a long-haul bad time. A friend in Florida told me the local bank was out of hundred-dollar bills on Wednesday because a man had come in the day before and withdrawn $90,000. Five weeks ago, when I asked a Wall Street titan what one should do to be safe in the future, he took me aback with the concreteness of his advice, and its bottom-line nature. Everyone should try to own a house, he said, no matter how big or small, but it has to have some land, on which you should learn how to grow things. He also recommended gold coins, such as American Eagles. I went to the U.S. Mint Web site the next day, but there was a six-week wait due to high demand. (I just went on the Web site again: Production of gold Eagle coins "has been temporarily suspended because of unprecedented demand" for bullion.)

Like I said over a month ago: "this is a time for individuals to make their own quiet plans and preparations."

Did we make things worse?

I am by no means an expert on anything, except a small branch of mathematics. However, I have spent my life watching people and animals, and have come to my own conclusions.

We in the US prize the individual over society (until they do something really bad), and so are not very accepting of the fact that humans, like wolves, elephants, and most other primates, are mostly pack animals.

In a pack of wolves or wild dogs with a calm, assertive leader, there are very few fights, and co-operation is the norm. The common role for the alpha females is the nurture and protection of the young. For the alpha male, it is protection of the pack from outside threats, and control of the aggressive adolescent males.

The liberalization of divorce laws in the 1960's shifted the balance of power in middle-class homes clearly to the woman of the house. One wrong move, and the man could lose his family, home, and most of his earnings. The pop psychology of the time told us that 'fathers were not needed to raise children', partly to assuage guilt.

Is it not possible that the removal of assertive leadership over teenage males has made some of our social problems worse?