"Legal tender for all debts, public and private"

Karl Denninger is emphatic that there's going to be a deflation, not inflation, and investing in metals won't save us.

Part of his argument is that the money supply is determined not just by how much there is in the economy, but also by how fast it changes hands (its "velocity"). If the heartbeat of economic activity slows, the monetary pressure will reduce.

Denninger shares the growing concern that subprime losses could be of the order of $1 trillion, and believes

... we are literally weeks or a handful of months away from an utter implosion in the equity markets.

I believe we are very, very close to the precipice - and that nothing Bernanke or Paulson can do now will change the outcome. The opportunity to address this and stop it expired a few years ago, with the cumulative damage growing the longer regulators fail to act.

In which case, it's time to hold cash, which on American notes says is good "for all debts".

This reminds me of another quotation I can't source: "Would that I could be so certain of anything as he is of everything." I suspect he may be right on this one; then again, I would, since I've been feeling it in my bones for about a decade, before the official policy became to inflate our way out of all troubles.

Drinking in Last Chance Saloon

The Orient Saloon at Bisbee, Arizona

Michael Panzner alerts us to an article by Martin Hutchinson in Prudent Bear, which explains how the rotten apples in the banking barrel can affect the others. Here's a grim tidbit or two:

... If as now appears likely the eventual losses in the home mortgage market do not total only $100 billion, but a figure much closer to $1 trillion, then the subprime debacle becomes something much more than a localized meltdown...

Hutchinson suggests that in a bear market, "Level 3" assets may actually be worth as little as 10% of the banks' own declared estimates, and:

This immediately demonstrates the problem. Goldman Sachs, generally regarded as insulated from the subprime mortgage problem, has $72 billion of Level 3 assets; its capital is only $36 billion. If anything like 90% of the Level 3 assets’ value has to be written off, Goldman Sachs is insolvent. [...] Only the bonuses will survive, paid in cash and draining liquidity from the struggling company.

I observed a couple of weeks ago that "the Dow and the FTSE rise towards the end of the year, when traders' annual bonuses are calculated" and guessed that "the Dow will rise until bonus time". Watch for a rally of sorts and a final, determined suckout of bonuses, ahead of a forced, sober reassessment.

The top card's getting a mite dusty

Dimitri Speck (in Financial Sense) looks at the behaviour of gold when the stockmarket falls, and tends to the conclusion to which we've referred before: the gold price is rigged in order to allay fears when equities weaken. In short, it's a crooked card game.

That in itself is grounds for worry (nothing to hide, nothing to fear); and the desired result must be achieved by dumping bullion, which can't continue indefinitely. On this thesis, the crisis signal will be when gold stops dancing with the Dow.

Michael Panzner on Michael Panzner

Michael Panzner quotes USA Today quoting him, and I'll quote Michael too, since the advice seems sensible...

Predicting tough times ahead, Michael Panzner, author of Financial Armageddon, recommends that investors buy shares of companies that sell stuff that people need to buy no matter what's going on with the economy. Companies that sell soft drinks, tobacco, prescription drugs and toilet paper, for example.

Investors, he says, should play it safe, loading up on defensive stocks, socking away more cash and moving toward the safety of U.S. Treasury notes and bonds.

From copper nickel to gold dollar?

A lovely, cheeky idea from Antal E. Fekete in SafeHaven: have the Indian reservations switch from running casinos to minting gold coins, to rescue the integrity of the currency. Maybe PC considerations would inhibit a Liberty-Dollar-type Federal raid.

Interesting also that he echoes my "twang money" idea:

Thanksgiving 2007 is special because we are just re-learning the ancient lesson that no banking system can safely operate without gold. You cannot measure the quality and quantity of debt in terms of another, just as you cannot measure the length of an elastic band in terms of another.

Long or short crisis? Inflation or deflation?

Terry Gilliam's take on the old tale

An interesting post from Michael Panzner, commenting on the views of derivatives expert Satyajit Das. The latter thinks we're in for a 70s-style inflationary grind, whereas Mr Panzner leans towards a 30s-style deflation.

I am reminded of Borges' short story, "Pierre Menard, Author of the Quixote". In this, a modern author attempts to re-produce the 16th century novel "Don Quixote" by Cervantes: not copying - writing it again exactly, but as though for the first time ever. Since Menard is writing in a different period of history, the same words have quite different meanings, implications and associations. To pen the identical lines today, spontaneously, would involve a monstrous effort. So Borges' tale is a wonderful parable about the near-impossibility of our truly understanding the mindset of the past, and how history can never be quite repeated, because the present includes a knowledge of the past that it takes for its model.

For those reasons, we'll never have the Thirties again, or the Seventies; but we might have a retro revival. And the differences may be as significant as the similarities.

Ken Kesey's bus (named "Furthur"), and part of the commercialised modern follow-up

Why the sea is salt, and why we are drowning in cash

We are said to be heading for a recession, so I had another look at Bank of England statistics for M4 - money supply as measured by private lending by financial institutions.

Since June 1963, there has NEVER been a quarterly period when M4 contracted. In fact, here are the only times in the last 44 years when UK quarterly monetary inflation ran at less than 5% p.a. equivalent:

As you see, mostly it was the nineties, with one instance in 1975 and three times in the sixties. The average rate for the whole series up to December 2006 is 13.47%. So the hand-mill never stops grinding.

But should it? Wikipedia gives an account of recession and the Great American Depression, and notes that during the latter period the money supply contracted by a third. Great for money-holders, bad for the economy and jobs.

This page points out that we tend (wrongly) to think of a period of economic slowdown as a recession, and says that technically, recession is defined as two successive quarters of negative economic growth. By that measure, we haven't had a recession in the UK (unlike Germany) for about 15 years - here's a graph of the last few years (source):

And then there's the stockmarket. It doesn't seem to reflect the real state of the economy - until you shift the lines, when for example the S&P 500 turns out to be a fair predictor of changes in GDP, as shown in a graph in a 2005 entry from this blog ("Capital Chronicle", by RJH Adams):

The same post also provides a brilliant graph of a measure of fair value for investors, known as Tobin's Q. Look at the wonderful opportunities presented by two world wars and the economic shock (blamed on oil prices, but maybe the causality is the wrong way round) of the 70s:

Mind you, looking at Wikipedia's Tobin's Q graph, the median market valuation since 1900 seems to be something like only 70% of the worth of a company's assets. Can that be right? Or should we take the short-sighted view of some accountants and sell off everything that might show a quick profit?

Nevertheless, it still feels to me (yes, "finance with feeling", I'm afraid) as though the markets are over-high, even after taking account of the effects of monetary inflation on the price of shares. And debt has mounted up so far that a cutback by consumers could be what finally makes the economy turn down. Not just American consumers: here is a Daily Telegraph article from August 24th, stating that for the first time, personal borrowing in the UK has exceeded GDP.

The big question, asked so often now, is whether determined grinding-out of money and credit can stave off a vicious contraction like that of the Great Depression. Many commentators point out that although interest rates are declining again, the actual interest charged to the public is not falling - lenders are using the difference to cover what they perceive as increased risk. Maybe further interest rate cuts will be used in the same way and keep the lenders willing to finance the status quo.

Some might say that this perpetuates the financial irresponsibility of governments and consumers, but sometimes it's better to defer the "proper sorting-out" demanded by economic purists and zealots. History suggests it: in the 16th century, if Elizabeth I had listened to one party or another in Parliament, we'd have thrown in our lot with either France or Spain - and been drawn into a major war with the other. We sidestepped the worst effects of the Thirty Years' War, and even benefited from an influx of skilled workers fleeing the chaos on the Continent. If only we could have prevented the clash of authoritarians and rebellious Puritans for long enough, maybe we'd have avoided the Civil War, too.

So perhaps we shouldn't be quite so unyielding in our criticisms of central bankers who try to fudge their - and our - way out of total disaster.