Will the truth about the "anti-capitalists" be heard? - Part 1

The mainstream news media often seem to me like boastful, lying Rumour at the start of Shakespeare's Henry IV Part II:

Open your ears; for which of you will stop
The vent of hearing when loud Rumour speaks?
I, from the orient to the drooping west,
Making the wind my post-horse, still unfold
The acts commenced on this ball of earth.
Upon my tongues continual slanders ride,
The which in every language I pronounce,
Stuffing the ears of men with false reports.
I speak of peace while covert enmity,
Under the smile of safety, wounds the world...

But last night's BBC TV news coverage of the protest camp outside St Paul's Cathedral was, for a moment, a bit more like what I'd call proper news: it allowed an inconvenient truth to slip through the propaganda sieve. A man told the camera that he'd been looking into the board of trustees that controls the Cathedral, and it turns out to include a number of important figures from the City of London's financial establishment. His assertion is supported by this from Ekklesia:

"St Paul's Cathedral, seat of the Bishop of London and the site of state funerals and other national celebrations, is a powerful top-down organisation. A tourist attraction charging an adult entry fee of £14.50, it takes around £16,000 a day from visitors. It has a hierarchy of clerical and non clerical staff and its trustees are a roll call of what are so often called 'the great and the good'. That many of them are bankers and financiers might be seen as more than a little unfortunate in the present stand-off."

This site gives details of the Chairman and Board of Trustees. It also gives a link to the 2010 accounts, where we find two further individuals who resigned last December: Barry Bateman, vice-chairman of Fidelity International Limited and a benefactor of Exeter University; and a Nigel Kirkup, who has moved on to the St George's Chapel at the royal castle of Windsor and about whom it is proving intriguingly difficult to find out much more.

The land on which the protestors have erected their tents belongs to St Paul's and in an interesting display of Christian anti-authoritarianism, Canon Giles Fraser told the police to move on. The Dean (who is on the Board of Trustees) felt forced "with a heavy heart" to close the Cathedral on Friday, and Canon Fraser seems to concur, while still maintaining that "financial justice is a gospel imperative."

This business of closing a world landmark because of "health and safety" considerations may be, on the face of it, not necessarily entirely apolitical - from either side.

I should like to see the protestors call that bluff - putting up red velvet ropes so that visitors could pass safely in and out of the Cathedral, which survived the Blitz and surely cannot be seriously threatened by the proximity of a few polythene tents.

In addition, perhaps the members of the Board of Trustees could be approached individually, to give their views on modern capitalism and how it has, or has not, benefited the community?

There's a smell about this, and it's not coming from the unwashed in their tepees.

Why am I reminded of Brian Haw, who spent the last 10 years of his life shaming Parliament with his anti-war protest. Even more shamefully, the authorities tried various dodges in retaliation: Westminster Council claimed he was an obstruction, and the Speaker of the House tried to invoke mediaeval laws guaranteeing the "safe" passage of MPs. The then Home Secretary David Blunkett announced he would outlaw "permanent encampments" outside Parliament as well as the use of megaphones.

So the - may I call them swine? - attempted to get him under the fresh draconian legislation of the Serious Organised Crime and Police Act 2005, only to find that it didn't apply to Haw since his protest had started before that Act. But it does apply to any of us who might try the same kind of protest. Anything, anything is fair to spare those in power the slightest embarrassment.

This thing is the tip of an iceberg. There is a great battle joined for democracy against corrupt, wealthy tyrants, and these protestors are, perhaps, among the first of our "contemptible little army".

Libya and the failure of British news

Am I alone in thinking that the West has just done things illegal and immoral in Libya, on the basis of lies and and half-truths told to us? Last night's BBC News had Jeremy Bowen and I-forget-who chatting away comfortably on location and the only question seemed to be whether getting Gadaffi killed had been (a) a good thing or (b) a very good thing.

These two gossiped agreeably like a latter-day Huntley and Brinkley. It would have been good to see the BBC fulfil its brief on balance and impartiality, for example by having one question the other's assertion that Lockerbie had been a Libya plot, rather than (say) an Iranian one, and asking why victim-father Jim Swire and Professor Emeritus of Scots Law Robert Black QC FRSE both feel that Abdelbaset Ali Mohmed Al-Megrahi is innocent and his trial a travesty of justice. Also, how a UN resolution to protect rebels in Misrata developed into NATO bombing raids on Sirte.

And why we got involved. EU empire-building? Securing Western oil supplies? Scaring the Saudis into withdrawing their support of Wahabi terrorism?

And what's going to happen next. Democracy? That's what Iranian students thought they'd get when they helped overthrow the Shah; instead they got a far harsher, fundamentalist government and Teheran's blood-fountain.

And why are we pretending to foster democracy abroad, in a week when all three major UK political parties are planning to instruct our Parliamentary representatives to vote against holding a referendum on the EU?

Money velocity, not quantity, caused the boom'n'bust

Reading "Extreme Money", the acclaimed new book by Satyajit Das, has highlighted for me the importance of money velocity.

As Das so clearly demonstrates (pp. 78-80), the banks altered their mortgage lending model in recent years. Instead of lending money and then holding that mortgage to maturity, they would sell it on for a sum that included the discounted value of future interest payments. This returned bank capital and depositors' money more quickly, which made it available for a new loan. Turning the money over faster massively increased the ratio of net profit to bank capital, so that the yield on banking activities outstripped other, one might say more productive, forms of enterprise. It became almost the only game in town, so that the economy has been skewed towards sterile financial hocus-pocus, instead of providing and exchanging useful goods and services.

The system created a boom, which could only be sustained as long as borrowers could absorb the increased quantity of loaned money. Asset prices boomed as fools sold on to bigger fools, and poorer-quality borrowers were suckered into joining. But we seem to have reached the limit of this pyramid scheme, and having run out of expansion room, the velocity of money is dropping and attention then turns to quantity instead.

The question now being asked - again, since we are in the throes of QE3 - is whether pumping extra cash into banks will balance the equation. If Wikipedia (see "money velocity" link above) quotes him accurately, I think the answer was given more than sixty years ago, by Paul Anthony Samuelson:

In terms of the quantity theory of money, we may say that the velocity of circulation of money does not remain constant. “You can lead a horse to water, but you can’t make him drink.” You can force money on the system in exchange for government bonds, its close money substitute; but you can’t make the money circulate against new goods and new jobs.

Banks have been given contradictory instructions: lend more, and build up your reserves. No wonder they take government support cash and buy safe, interest-earning government bonds with it. Effectively, the government is funding the gradual repair of bank balance sheets; it would be quicker and more honest if Uncle Sam and John Bull simply gave them enough cash to do the job.

But even that might not get the banks lending again. Would you, in their position?

Let's assume for a moment, sophisticated investor, that you have decided to stop day-trading because there's an increasing probability in this shark market that the bigger fool may turn out to be you. What longer-term investment might act as a safe haven for your gains?

• Western manufacturing industry, with its high costs of labor and regulation?
• Eastern manufacturing industry, so dependent on the once-profligate but now financially distressed Western consumer?
• Industrial commodities, which have soared in the busy economic boom but also because of leveraged speculation?
• Western real estate? Yes, the price-to-income ratio is dropping - but we haven't yet seen the drop in incomes that will continue the downward trend in nominal terms - especially as the borrower finds more of his limited income going on food and energy bills.
• Emerging markets real estate? One for the specialists, such as Marc Faber.
• Bank shares and sovereign debt? Junk bonds? Isn't that what got us into this mess?
• Agriculture? Maybe.
• Gold? Maybe - but what a rise it's seen in the last few years.
• Cash? Inflation isn't hitting everything - big-ticket items have gotten cheaper in real terms for decades. Here in the UK my first new compact car cost me £6,000 in 1989 and I could get another for that price now, with higher specifications. If you can pay your living expenses from income, maybe cash isn't such a crazy option.

For the way our governments (US/UK) are seeking to shore up the system doesn't look destined to work. The increased quantity of money, now used so cautiously and unproductively by the banks, is not going to offset the drop in velocity.

Later, if that money stays around and is not withdrawn quickly enough, then when we revive economic activity there will be a rush of general price inflation; but not, I think, for some years yet. Such inflation as we're seeing now has different causes and effects from the type we saw before, and has more to do with physical supply and demand rather than monetary expansion.

So some experts are predicting "troubles ahead", "unprecedented velocity collapse", a "double dip recession", or even a breakdown that will make us envy simpler, more sustainable societies.

I don't go with that last, but then again, I don't expect my house to burst into flame and yet I still have smoke detectors and fire insurance; so I do think it's good to build up easily-accessible emergency reserves against the possibility of temporary disruption.

There is no royal road to predicting economic developments. All the charts in the world are no use when the powers that be decide something different really has to be done. The system is not a machine but a poker game, and a crooked one at that. So I expect the course of events to be determined by a negotiation between the interests of the powerful, which in our democracies also (to some small extent) includes us, the ordinary people.

For now, I'm still holding cash and government inflation-linked bonds, but if the consequences of deflation are too painful for the populace, then the rules may well alter. Maybe, in time, we will indeed get hyperinflation, even though these days the currency is managed in a very different way from that of Germany in 1923. Dr Faber noted recently that gold and bonds rose together, a counterintuitive phenomenon he analysed as arising from fear of systemic collapse. This fear may also explain why India and China (among others) are boosting their holdings of physical gold, which is supporting the price even as other commodities deflate.

But that time of game-changing crisis is not, I think, with us yet.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Why "black swans" and "fat tails" happen more often than expected

The more system dynamics are repressed, the more likely it becomes that "improbable" events occur and "highly probable" trends dissolve or reverse.

Charles Hugh Smith

What are the chances of frozen peas being embedded in your kitchen ceiling? Vanishingly small - unless one of them gets stuck in the escape valve of your pressure cooker, as happened to a neighbour of ours, years ago.

Anatomy of a Hedge Fund

Last year, John Paulson, a hedge fund manager, made $5 billion dollars. There was a great deal of damage control on this news, including by Business Insider, explaining that $4 billion of that amount was gains from his own investment in his fund.

That lead me to the following analysis:

A typical hedge fund manager gets a 20%/2% to run the fund, which means 20% of the annual profit, and 2% of the value of the fund.

Assume no tax dodges, so that the investors (including the manager) pay 15% Capital Gains tax on the annual gains (directly from the fund).

Being confident in his own abilities, the manager invests his after-tax income in the fund.

At the start of a year, the investors have $M_old in the fund, the manager has $m_old, and the fund gains r%.

Capital Gains tax on the investor money is $0.15*r*M_old, 20% of the after-tax gain goes to the manager, and remainder gets rolled into the investor funds. The manager then gets 2% of the total.

For the manager, his share of the fund increases by $r*m_old, of which $0.15*r*m is Capital Gains tax. He also gains the 20% of the after-tax investor gains, and 2% of the fund, on which he pays a 35% tax rate.

Thus, we have

M_new = (0.98)*(1+(0.8)*(0.85)*r)*M_old

m_new = (1+(0.85)*r)*m_old+(0.2)*(0.85)*r*M_old+(0.65)*(0.02)*(1+(0.8)*(0.85)*r)*M_old

What is the result?

If the fund gains 20% per year, it only takes 16 years for more than half of the money in the fund to belong to the manager. At 10%, it takes 23 years.

Christine Lagarde's alter ego

Viewers of ITV's Dickinson's Real Deal will have been struck by the similarity between Chelsea antiques dealer and former drag queen Ian Towning, and the recently-appointed Head of the IMF, Christine Lagarde. Are they perhaps related?

Solar Flare Warning - world leaders go into hiding?

Ian Parker-Joseph relays news of a strong electromagnetic sunstorm that could potentially have catastrophic effects on our interconnected, electricity-dependent Western societies.

This would not be without precedent: in 1859, the strongest recorded solar storm, known as the "Carrington Event", caused telegraph systems to fail or be shut down. But the world then did not have electronics, and water and power supplies did not depend on electrically-operated and computer-controlled machinery.

The facts of the sun's storm and ejection of vast quantities of charged particles appear to be corroborated by the amateur heliological website solarham.com:

... and elsewhere, e.g. spaceweather.com, and pictures of the flare from 22 September here (example below):
Implications:

Should we avoid going outside? Not clear: according to this Wiki article, ultraviolet light replenishes the ozone layer by splitting O2, so it is when the sun is "quiet" that the layer thins and more UV light penetrates to the Earth's surface. But there may be more UV health risk if you live in high northern latitudes, where the ozone layer is already thin or holed.

Indirectly, health and safety could be compromised by the failure of electrical systems that govern and provide for so much in our urban lives. Should we lay up extra water and cold food? It wouldn't hurt.

I like IPJ's idea of cowardy-custard politicians cowering in underground shelters; let's hope nobody superglues the locks.

Humour: how the stockmarket works

CityUnslicker reproduces the following story; the earliest version online I can find is from 1st February 2001, but that references "Felix", which appears not to be the same-name student newspaper of Imperial College, London:

Once upon a time in a place overrun with monkeys, a man appeared and announced to the villagers that he would buy monkeys for $10 each. The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them.

The man bought thousands at $10 and as supply started to diminish, they became harder to catch, so the villagers stopped their effort.

The man then announced that he would now pay $20 for each one. This renewed the efforts of the villagers and they started catching monkeys again. But soon the supply diminished even further and they were ever harder to catch, so people started going back to their farms and forgot about monkey catching.

The man increased his price to $25 each and the supply of monkeys became so sparse that it was an effort to even see a monkey, much less catch one.

The man now announced that he would buy monkeys for $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf.

While the man was away the assistant told the villagers. 'Look at all these monkeys in the big cage that the man has bought. I will sell them to you at $35 each and when the man returns from the city, you can sell them to him for $50 each.'

The villagers rounded up all their savings and bought all the monkeys. They never saw the man nor his assistant again and once again there were monkeys everywhere.

Now you have a better understanding of how the stock market works.

______________________________________________

If you think this is an overly cynical view of the investment establishment, remember that it has been re-posted by a City insider.

Also, at an Oxford college reunion some years ago, long before the credit crunch, I was talking to a fellow graduate who was "something in the City" about my bearish views and my thought that the East might eventually take over the business of the Western exchanges. He boasted that the City was adept at swindling foreigners and would manage to do so for years to come.

I'm just putting that on record. Hubris?

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

The US' credit rating, the peril of interest rates and the need for wholesale reform

As you know, S&P downgraded the US' credit rating to AA+ last month. That's still a lot better than most countries in this financially shaky world. But as long ago as July 2010 Dagong, a credit rating agency working for America's biggest foreign creditor, China, rated the US "AA with a negative outlook".

Here are a few graphs to tell the story of US public debt, and the cost of paying the interest on it as a proportion of gross Federal tax collections:

This next one might be a little surprising, even heartening:

That is greatly influenced by the long-term decline in interest rates:

For the period up to and including fiscal year 2000, the average rate on public debt was slightly over 7%, and has been reducing since the recession of the early 1990s in order to stimulate (and then rescue) the economy.

Now let's look at what interest would have been payable in dollar terms, if the rate had been (say) 7% throughout:

Had that 7% rate been applied throughout, this is what it would have taken out of the gross tax collections:

That is the big worry, and why I don't doubt that there's a lot of collusion and fudging going on behind the scenes.

But that doesn't make me a Tea Partier. This is not a story about wicked old government and how we'd be better off without it altogether.

The reason why debt has become particularly dangerous over the last couple of years, is that Uncle Sam has been trying to save our bacon. Perhaps he's done it in the wrong way, and should have let gambler banks go down - you have so many more second tier banks to take over, unlike here in the UK. Maybe it's not too late to for the US to do that, in a controlled way, even now.

And yes, we all need to look at social benefits, though again I'm not with the let-the poor-starve party. For example, we might just possibly question the profits of pharmaceutical companies (with their endless me-too variants on perfectly good drugs that are coming out of copyright); the profits and contractual get-out weaselling of insurance companies; the battening of lawyers on the medical system; the training costs and remuneration of the medical profession. There is more than one way to trim the fat, apart from abandoning US citizens to bankruptcy, ill-health and premature death. Can we please get away from an Orwellian Animal-Farm-style slogan-bleating of "private good, public baaad"?

I do have an issue with both the US and UK governments, not about their power and control but the exact reverse: their failure to moderate the growth of private debt over the last 30 and more years. Counterintuitively (if you think the Right is responsible with money), it was under President Reagan and Prime Minister Margaret Thatcher that total debt to GDP soared, as I discuss at length in a previous post here, and most of that was private debt. Fighting one foe, they failed to notice the manoeuvering of another, namely the psychopathic greed of the financial industry whose aid they requested.

I am reminded how Ireland's freedom was lost because the King of Leinster invited the Normans to assist him in recovering his throne in Wexford, in 1169. Guinness-drinking Irish sentimentalists may lament "the Saxon foe across the water", but their real enemy was the bloodthirsty, land-hungry, Viking-descended Norman, and King Dermot MacMurrough, who let him in.

Both public and private sectors are due for reform.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Tax-free inflation-protected deposit scheme (UK) still available!

Now that NS&I has withdrawn inflation-linked Savings Certificates, the Mail on Sunday looks around for alternatives. I'll give them a slightly closer look here, with links for you to click through. Please note that Yorkshire Building Society has a cash ISA version that means returns are tax-free even if you are a taxpayer!

1. Post Office Inflation Linked Bond - N.B. closing date 16 September (or earlier if fully subscribed)

• Single lump sum investment, £500 min., £1 million max.
• 3-year term: RPI+0.5%, annually, OR...
• 5-year term: RPI+1.5%, annually
• Backed by Bank of Ireland.
• RPI adjusted once a year in August, according to UK Office of National Statistics RPI index.

Drawbacks:

• No withdrawals allowed during the term
• Interest is taxable (but remember that you or your partner may not be a taxpayer)

2. Cambridge Building Society Inflation Linked Bond Issue 1 - N.B. closing date 15 September (or earlier if fully subscribed)

• Single lump sum investment, £5,000 min., £85,000 max.
• 5-year term: RPI+1.0%, annually
• Runs from 16 Sept 2011 to 16 Sept 2016
• RPI calculated according to UK Office of National Statistics RPI index over the investment period

Drawbacks:

• No withdrawals allowed during the term
• Interest is taxable (but remember that you or your partner may not be a taxpayer)

3. Yorkshire Building Society Protected Capital Account (PCA) Inflation Linked 8 Plan - N.B. closing date 15 September (or earlier if fully subscribed)

• Single lump sum investment, £3,000 min., £85,000 max.
• Managed by Credit Suisse International on behalf of Yorkshire Building Society
• 6-year term: greater of RPI and 16%, i.e. minimum return is 2.5% p.a. even if inflation is zero or negative!
• RPI calculated according to UK Office of National Statistics RPI index over the investment period
• Can also be accessed as a cash ISA (max. £5,340), for tax-free returns
• Can transfer other cash ISAs into YB inflation-linked cash ISA
• Can invest in cash ISA as well as non-ISA bond

Drawbacks:

• Early exit fees apply
• Interest is taxable (but remember that you or your partner may not be a taxpayer), UNLESS you opt for the CASH ISA VERSION

4. Santander Inflation Linked Bond Issue 5 - N.B. closing date 5 October (or earlier if fully subscribed)

• Single lump sum investment, £500 min., £2 million max.
• 6-year term: greater of 105% of RPI (over the term) and 8%, i.e. minimum return is 1.29% AER p.a. even if inflation is zero or negative!
• RPI calculated according to UK Office of National Statistics RPI index over the investment period

Drawbacks:

• Early exit fees may apply - contact issuer for details on 0845 765 4321
• Interest is taxable (but remember that you or your partner may not be a taxpayer), however according to the Mail article an ISA version is available - contact issuer for details

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Should Americans dump their dollars?

Karl Denninger comments today on Greece's alleged failure to roll-over her debt, Germany's weakness and the fatal over-extension of debt in the American economy.

I respect Karl's expertise and information, but am often put off by his (to me) excessive use of bold type, underlining and capitalised words, dramatic language etc. Nevertheless, he's making a couple of radical predictions.

One is a very severe US stockmarket drop ("half -- or more", "try a 90% loss on for size"). Another is the consequent failure of insurance-based guarantees, including (a) annuities and (b) the FDIC.

Unlike here in the UK, where bank deposits are guaranteed by the Government, in the USA depositors are protected by a company, the Federal Deposit Insurance Corporation, so the value of the guarantee depends on the value of the assets held by the FDIC.

I touched on this question of FDIC underfunding in 2008 (following "Mish") and 2009 (following Karl himself) and if Karl is right, the moment of truth could be drawing near.

Yet there are others, including Charles Hugh Smith, who contrariwise expect the dollar to strengthen as the world trading system unravels, or at least to survive because its collapse would properly collapse the system.

We do live in uncertain times. My instinct would be to hedge my bets, but the conventional methods employed by investors - insurance-type hedging - may not work in a very unstable situation. Consider counterparty risk.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Children's language development and the importance of teachers

Via James, I have just come across this absolutely fascinating 10-minute talk.

It demonstrates that there is a vital and very early window of learning in which babies acquire the typical sounds of their native language - has to happen well within the first year of life.

But partway through the talk, there is a piece of research showing that audio / TV make virtually NO difference to learning new sounds, it HAS to be through direct human contact.

To me, a possible implication is that this connection of learning with the social part of the brain is that it may also be true for later learning.

Perhaps teachers cannot be replaced by computers, after all - despite this new project in the USA by a private company looking to get into educational provision.

NS&I withdraw Savings Certificates

On 28th May I said the clock was ticking for those who wanted to get into NS&I Savings Certificates; it's now stopped. Received by email today:

"Dear Mr Norfolk

As you’ve registered to receive updates from NS&I, I’m writing to let you know that all current Issues of NS&I Savings Certificates were withdrawn from general sale at close of business on 6 September 2011.

The latest Issues of Savings Certificates had been on sale for almost four months (since 12 May 2011) and have been very popular. When we launched the Issues we expected the amount invested to be substantial, and our expectations have now been met.

We’re sorry if you haven’t been able to invest on this occasion, but we will contact you again as soon as the next Issues go on general sale.

You can see the current rates for all NS&I accounts and investments on our interest rates page.

Yours sincerely

Garry Bond

Head of Customer Management"

To me, this makes clear that the Government is not really much interested in protecting savers; a point I made to Douglas Carswell MP back in May.

I'll let you know when these Certificates are on sale again - I guess it'll be early in the next tax year, i.e. April/May 2012, after "sales targets" have been set by the Treasury.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Never, ever give up

WEDNESDAY UPDATE: a half-starved black cat has appeared at the kitchen door of our hard-to-get-into garden. After some food and drink, she is now laying siege outside. We have already progressed to the cardboard-box-and-blanket-in-the-garage-and-get-some-catfood-in stage.

_____________________________________

Discovered last month, a dog living on Africa's highest mountain. And back in 1950, a kitten followed a party of climbers to the top of the Matterhorn:

Perhaps I shouldn't quit, after all.

Why Tony Blair was PM, and Jack Straw never will be

"In 2005, a year after Belhadj’s rendition, Jack Straw declared there was ‘no truth’ in claims of British involvement, while Tony Blair maintained there was ‘absolutely no evidence’." - Daily Mail

Blair, with his Prince of Orange tan and ever camera-ready face, is slippery; Straw, with his worn, domesticated look is slippery as defined by Ross Noble: a bit like a slipper.

Straw gets into trouble; Blair, as a teacher at his public school said, "... is a superb actor. He’s good at getting others into trouble but avoiding it himself. He’s a s*** and Labour will regret it if you choose him."

Perhaps I should be glad that Blair, described by Clarissa Dickson-Wright as a "mimsy psychopath", got where he did; glad that the bankers have brought the country down and yet are themselves prospering better than ever; glad that MPs cheated on their expenses; that my share of the vote will soon go from 1 in 72,000 to one in 80,000; that the law is an ass, that the police have become better at public relations than public protection, that nurses are too busy to feed and water their patients, that the DPP has decided to turn a blind eye to euthanasia.

For where the authorities and institutions of this world are concerned, I want liberation from trust. I wish the reverse of Mark 9:24 - "I disbelieve; help thou mine belief". So many of us write to the papers (press men tell each other we're nutters), comment on web posts (and are derided by Private Eye's "From the message boards" column) and, of course, write our own citizen's-journal pieces for no money and which are read by almost nobody.

What a weight will be lifted from our shoulders when we finally give up, and ape our betters in the cold pursuit of self-interest.

Sweet and sour economics

An Australian lawyer has commented on my inaugural post, which was a review of Michael Panzner's prescient "Financial Armageddon". He (or she) says:

I got a copy of this book. I found it somewhat depressing. Don't get me wrong, it was realistic and all. Thing is the scenarios were done in a pretty pessimistic way—at least for my liking.

My reply:

Sourness tends to go down badly with the enviably vigorous and cheerful Australian, but remember the irrationally exuberant times in which this book was written - in a way, it was a spoonful of vinegar to make the toffee mixture right.

Three of the four problems are finally in public debate; the question now is whether the derivatives market will be brought under proper control before a disruption there causes a crisis that the current economic system can't handle. Theoretically there is a counterparty for every bet, but if someone welches on a big one (and the derivatives market is inconceivably enormous) there could be a domino effect.

Depression is often swallowed anger born of frustration, which in turn comes from trying to fix things that are out of your control. The real lesson of this book is to turn to the things you can fix yourself. Get out of debt, develop more than one line of income, build up emergency reserves of cash, tools and supplies, build up and nurture your social network, consider where you should be residing in case society becomes unstable, and remember (as we were beginning to forget in those days) that life is not just about money. Especially when fiat money in its present form may be an endangered species.

What housing shortage?

Panellists on Radio 4's Any Questions? and Charles Moore in this week's Spectator magazine agree (with lots of others, it seems) that there is a housing shortage in the UK and the only question is how to satisfy it. I beg to differ, or at least think we can question the assumption.

1. "According to The Empty Homes Agency, there are an estimated 870,000 empty homes in the UK and enough empty commercial property to create 420,000 new homes", according to the BBC website section on Homes.

2. There are over 245,000 registered second homes in the UK, according to Schofields home insurers.

3. The 2001 census showed that average home occupation in England and Wales had declined from 10 years before, from 2.51 to 2.36 persons.

4. According to the official Housing Survey of 2008/9, 7.7 million households were couples with no dependent children; there were also 6.2 million single person households (up from 3.8 million in 1981).

5. The same survey showed that the average (mean) dwelling had 2.8 bedrooms, rising to 3.0 bedrooms for owner-occupiers. Fewer than 3% of households were defined as overcrowded.

6. According to a 2005 Home Office study, there were 310,000 - 570,000 illegal immigrants in the UK, a figure which MigrationWatch thought to be underestimated by 15,000 - 85,000. This is a separate issue from the 8.7% of the population who are economic migrants to the UK, and whose real net contribution to the economy (after taking into account all benefits to which they and their dependants may be entitled) is a matter of debate.

We are not in the situation we faced in 1945, when soldiers returning home from war squatted on military sites and even caves. The modern "housing shortage" is an arbitrary notion.

Real and imaginary threats to America

These are wild times and there are definitely things to worry about, but unfortunately the rains of misfortune are also bringing many crazy worms to the surface.

For instance, one story doing the rounds is that the 5.8 quake of 23 August 2011 (I was in Long Island at the time and it was mildly interesting) was caused by a nuclear explosion. For some, this segues into talk of a vast secret network of underground tunnels, stolen nuclear weapons and some kind of underground battle. Illuminati, aliens, the lot.

Worse, the excitable conspiracy theorists appear to be doctoring the data. See the alleged seismograph readout in the link above, which looks most odd because (unlike with normal earthquakes) there seem to be no p-wave tremors before the major shaking; then see the actual readouts from the Seismological Observatory at Virgina Tech. To save you the bother, here they are:

What are the nutters thinking when they do this? Are they like those mediaeval monks at St Denis, Naples and elsewhere, who created and manipulated effigies so that they appeared to speak to the faithful? Believers themselves (we must hope they were not simply cynical), they considered it their duty to perpetrate pious fraud in order to foster the faith in others. Is that what we have here, now?

Yet it seems there are more mundane, yet real, threats we should guard against. For example, according to this article (htp: Robert Wenzel) it seems that the United States government is choosing where to hold a trial for Julian Assange, according to vested local interests that may influence the kind of jury he will face. If true, this makes a mockery of justice - and my reading of John Grisham's fiction suggests that such manouevres are quite believable, perhaps common.

Meanwhile, Americans are thrown into a panic by the Islamic bogeyman, who in the worst atrocity on US soil ten years ago claimed under 3,000 lives. Every life counts, and we have New York fire and police in our extended family, so I don't for a moment undervalue the horror of what was done that day. Yet look at the year 2000 for comparison: the 9/11 toll is less than deaths ascribed to asbestos (3,750), medication errors (7,391), chewing tobacco and snuff (7,430), alcohol (85,000), infections acquired in hospitals and long-term care facilities (90,000), medical errors (98,000), adult obesity (111,909) and active smoking (389,290). Should the Patriot Act include provisions for hunting down and destroying brewers, tobacco companies, insulating firms, doctors, nurses and the makers of Twinkies?

The real threat to America is its own government, which uses fright tactics to cause its citizens to abandon their Constitutional safeguards against tyranny. The battle may be lost here in Britain, where our unwritten constitution has been so easily and quickly subverted; but I would urge my American friends to go back to those yellowing documents stored in Washington DC, so that "government of the people, by the people, for the people shall not perish from the earth." If you do not throw down your coat and stand to fight here and now, then where and when?

Who's bailing out Uncle Sam?

Just a couple of graphs to show which foreign countries have most increased their holdings of US Treasury securities.

The UK seems the odd man out, bearing in mind its own financial difficulties, but it is widely suspected that much of the UK's holdings are cat's-paw transactions on behalf of China.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Is gold still fairly priced?

At the time I first accepted Richard Daughty's argument that gold represented a great buying opportunity, I didn't have the money available. So, seeing the phenomenal rise in the price over the last few years, have I missed the boat?

It depends. Yes, if what I want is the chance to buy in well below trend and "make a killing"; but perhaps not, even now, if I'm merely seeking something that may protect my savings against inflation.

There are so many ways to define inflation, especially if you are a government incentivised to keep the official figure low. But let's take a look at one monetarist measure, the Mises Institute's "True Money Supply", and compare that to the price of gold since 1971 (the year of the "Nixon shock"):

According to the above, gold is just about on its long-term trend line; not a bargain, but that's not the issue here. However, that trend does include the dramatic spike of 1980, from which peak it took some years to climb down. So let's re-do the line from 1985 onwards:





Seen this way, we're a little above average at the moment, which is perhaps why Marc Faber is hoping for a near-term pullback of $100 - $200; but it's not egregiously high, which doubtless explains why he still sees it as his favourite investment.

Another straw in the wind is a comment by an investment banker on a recent blog-piece of mine entitled "Cash: the investment of the century". "Wolfie" says (Aug. 17):

"I'm currently 100% cash but I think the time has come to break cover and take a 30-40% gold holding. A storm gathers."

I certainly have to take seriously an industry insider who is clearly as bearish and cash-based as myself, but wouldn't you know it, I've been in the USA for the last fortnight and unable to do anything about it up till now.

Perhaps it's "a sign" that I was in NY for Tuesday's 'quake and had to fly out of Newark two days early, just ahead of Hurricane Irene. In any case, I'm now considering following Wolfie's suit sometime soon, even though I don't like the price much. For in the mass of unused money in bank holdings lodged with the Federal Reserve, and also with the more fortunate of transnational corporations who have been fleecing the American consumer for decades and blaming the Chinese who get to see only 15% of the action, lies true storm force potential.

I think we have some time yet before the cloud of cash makes landfall - I've been eyeing 2016 as the approximate end of the real underlying recession - but I shan't delay my preparations quite that long. As the ancient Greek saying goes, there is no borrowing a sword in time of war.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Nail that journo!

This site allows you to spot lazy journalists rehashing other people's news stories.

Htp: Autonomous Mind.

NY quake explained

Lloyd Blankfein dropped his wallet.

Don't tax the wealthy, use their wealth instead

There's a crisp and witty summation of the fiscal quandary we're in, from our man in San Marcos today.

I'm beginning to wonder whether simply taxing the elite is the best solution. That only means taking from A and giving to B, which A will resist and which turns B into a resentful and useless benefit recipient.

Little wonder that the rich are seeking some other way to spend their assets. The group of billionaires that have pledged half their wealth to global charity are, it seems to me, trying to buy God and our good opinion, but it doesn't quite work for me.

I'd have been more impressed if George Soros hadn't (quite legally, of course) swindled some of his fortune from the British public on Black Monday. I'd be pleased if Bill Gates spent some of his stack on ensuring that his software products work properly, instead of repeatedly launching them with multiple holes below the waterline: it's only a matter of time before my new Windows 7-equipped netbook has its working memory entirely filled with "critically important updates" and "service packs", and meantime it works jerkily as the machine juggles my use of it with behind-the-scenes internet downloads of these monster corrections.

So my suggestion, as I commented on Jim's piece, is to put the rich to work:

"I think the issues are productive employment, the over-concentration of wealth, and the parking of the latter in established (global and foreign) businesses instead of new (domestic) ones.

The wealthy need to start spending - investing in new factories and technologies and getting people back into decently-paid work."

Cash - the investment of the century

There's been comment recently about how the ordinary investor has been abandoning the market, in some cases with an undertone of contempt for the poor saps who are missing out on those incredible gains to be made just around the corner.

The banks who from time to time attempt to poach my clients often use past performance an an indicator of future returns, while of course covering themselves by the usual disclaimers. Typically they cherry-pick among terms of 1, 3, 5 and 10 years.

Let's see how the graph for the Dow would look over various time periods, and compare it with cash in your bedsock. To be fair, let's ignore the interest you could have earned on cash, and the dividends on stocks; as a special favour to the Dow, so being especially unfair to cash, let's also ignore the offer-bid spread and the fees and charges loaded onto the investor.

Over the last 12 months:, you could have made a good profit - well, you could if you'd got out a month early:
... over the last 3 years:
... over the last 5 years:
... and since January 2000:

"Mish" today points out that we are in deflation, if you are a monetarist, since credit and asset values have contracted. Inflation scares suit those who are running what some call a "wolf market" - come out, little pigs, it's all clear now.

What inflation? The consumer - and the inflation indices - may notice a rise in food and energy prices, but that's not what your nest-egg is for. Look at house prices - still going down in the UK and the USA - and all the other big-ticket items that in recent years were purchased with borrowed money.

I think Mish is right, for now. The concern I have - and it's reflected in the soaring price of gold - is what governments will do in their desperation once giving money to busted and corrupt banks (and governments) is finally seen as worse than useless. Can the bond market really dictate terms in an economic collapse, or will governments across the world break their currencies with the final splurge of money-printing that third-party control by central banks is designed to prevent?

Until that time, and despite the temptations of commodities, maybe cash-holders should hold the line while the enemy advances. A lot depends on your personal plans, of course; we're hoping to move house and such cash savings as we have may continue to appreciate against the thing we want. So really it's about relative values - comparing asset A with asset B - decided by you, not some index that doesn't reflect your priorities.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Where "should" the stock market be?

There's a flap on about market declines. I think it's because the traders are kids.

Take a look at the graph below, which shows the Dow since the end of WWII. Bearing in mind that in real terms, a thousand points on the Dow was worth more in the past than today, where do you think we ought to be, if the market was "normal", or better yet "sane"?

Adjusting for inflation (CPI-U), and looking at the Dow's progress from August 1945 to August 1980 (around when the Great Inflation really started), then extrapolating, I figure the Dow should be a shade under 3,000 points today.

The rest is, effectively, monetary bubble - which is not to say it can't continue.



INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

China downgrades American credit to "A"

Half a world away from the USA, China's Dagong credit rating agency can afford to be blunter than Standard & Poor.

Their view, shared by many in the West, is that the problems have not been solved but damagingly deferred; $4 trillion needs to be cut from the public budget within 5 years; QE3 is inevitable and "will throw the world economy into an overall crisis". Accordingly, on August 3 Dagong downgraded the US rating further, to "A, with a negative outlook".

If the Western rating agencies dare to echo that view (and some see last week's S&P's re-rating to AA+ as an attempt to break the news gently), it could be the trigger for a more serious selloff in the stock and bond markets. Disaster for many, opportunity for some - perhaps.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

In a nutshell - the investment crisis

A bear market is one where the odds of losing are greater than the odds of winning; they built Las Vegas on the back of it. So the gambling will continue, a few will do well and most will lose their wad. The difference is, Wall Street won't serve you drinks.

Crash? What crash?

The hackneyed news media deadlines are trotted out again: "x billion wiped off shares". How quickly we forget.

Below are the charts for the FTSE and the Dow from their recent low points in March 2009:

The FTSE closed Friday 49.4% higher than 29 months ago; the Dow, 74.8% higher.

I think that ultimately, both will (in real terms) plumb depths significantly deeper than they did in 2009, but it will not happen in one go, and it will take a long time.

The stockmarket is not a store of money: A has already paid B for ownership of the shares, and the money went into B's bank account. The money is not parked on Wall Street or Paternoster Square, it merely passes through it.

On the way, it's purchased either the promise of a future income stream (and how reasonable is that hope in an unravelling world economy?) or the chance to sell on to a bigger fool (in the hope that it hasn't already happened).

Remember, you don't have to be in this game. I should like to know where the traders' and bankers' bonuses are invested at the moment: do they eat where they cook?

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Gold and its correlation to debt and GDP - updated

Jesse offers a chart showing an apparently close relationship with the price of gold and the growth of US official debt, thus:


He wonders how this might look in relation to debt/GDP, and I give below gold's correlation with GDP and with debt in its broadest sense (TCMDO, ignoring intragovernmental lending) in the period 1952 - 2010:



I would suggest that gold's basic correlation is with GDP, but with wild swings reflecting debt-fuelled manias and financial crises. On this showing, and despite what looks like a meteoric rise over the last few years, gold is merely coming home and is not yet overpriced in the long view. This, as I understand him, is what Dr Marc Faber also thinks.

Not having had the money at the right time, I missed the opportunity to climb aboard gold when it was severely underpriced; but may do so soon, merely to preserve some of the value of our savings.

I'm not so much a gold bug as a most-everything-else bear. When the system stops lending cheap money to the riverboat gamblers with dusty top cards on Wall Street, I'll be interested in genuine investment.

UPDATE:

Here's the price of gold compared to the growth in Total Public Debt Outstanding since fiscal year 1929 - this includes intragovernmental debt (please click to enlarge):









INVESTMENT DISCLOSURE: None - YET. Still in cash (and some inflation-linked government savings certificates), and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Banks' final grab: the land

UPDATE: It's happening! Unbelievable!

_________________________________________

Robert Wenzel comments approvingly on a course of action mooted in a meeting of primary dealers and the US Treasury held at midday today. The idea:

"Dealers suggested that the Treasury might be able to repo their MBS portfolio to raise cash."



Yes, I should think banks would like to suggest that: have the government that bailed them out, now sell the MBS (mortgage-backed securities) back to them at fire-sale prices. 31 million mortgages - about half of all the mortgages in the USA - delivered into the hands of the swindlers.



What daring. It is almost Biblical in the scale of its impudence.



For the record, let's list these players:



BNP Paribas Securities Corp.

Barclays Capital Inc.

Cantor Fitzgerald & Co.

Citigroup Global Markets Inc.

Credit Suisse Securities (USA) LLC

Daiwa Capital Markets America Inc.

Deutsche Bank Securities Inc.

Goldman, Sachs & Co.

HSBC Securities (USA) Inc.

Jefferies & Company, Inc.

J.P. Morgan Securities LLC

MF Global Inc.

Merrill Lynch, Pierce, Fenner & Smith Incorporated

Mizuho Securities USA Inc.

Morgan Stanley & Co. LLC

Nomura Securities International, Inc.

RBC Capital Markets, LLC

RBS Securities Inc.

SG Americas Securities, LLC

UBS Securities LLC.



You'll note that six of them are now Limited Liability Companies (LLC), the latest to convert being Morgan Stanley (as of May 31, 2011). Apparently, this has a tax advantage for derivatives dealers; but I wonder whether not having shareholders while also avoiding personal liability is an equally important consideration, as we approach the endgame, when bank shares may finally burn up.



Imagine what Thomas Jefferson and Andrew Jackson would say, if they could see how in the Land of the Free a tiny elite not only owns most of the cash, bonds and shares, but now aspires to seize the real estate. America is approaching a peak of wealth inequality and mass servitude comparable to the condition of England in the eighteenth century, but without the hopes offered by the Industrial Revolution.



INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

When investing, remember inflation

The lowest point (so far) in the above monthly sequence was February 2009. But we've still lost a third in real terms overall since the start of the Millennium.

And what does this shape suggest to you about future returns?

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

The Stock Market made simple?

A correspondent on Usenet took umbrage recently when I referred to traders as (possibly necessary) parasites on the economic system. That he used to be one probably had something to do with his outrage, but I meant the term in the biological sense, in that traders generate no wealth, nor provide any real service, at least in my simplistic understanding.

Perhaps the illuminati here can shed light on my misunderstanding by considering the following simple scenario:

1. MomandPopCo decide to expand, and so release an IPO of 2,001 shares. They keep 1001 to have majority control, and sell the rest for $100 per share. With a 1% fee charged by the brokers, they realize $99,000, and the latter get $1,000
2. A short time later, Amy sells her 100 shares for $105 per share to Bob. She gets $395 in profit, and the brokers get $105 for their service.

Questions:

1. Where does all of the money come from?
2. Why does Bob pay more for the shares than Amy did?
3. Why was Amy able to charge more than she paid?

The answers are clearly(?):

1. From the investors.
2. Unless Bob is an idiot, he assumes that the stock price will either further increase, or the dividends will cover his costs.
3. Amy must be taking the discounted value of the future dividends of the company, or we are starting yet another bubble. This is easier to see if the company is buying and raising cows for sale, being a transaction of finite duration.

Notice that the company does not benefit at all from the second transaction. Even if their stock goes up, they cannot sell any more without losing control.

Hedge fund titans admit they don't know what's going to happen

George Soros is retiring, closing his fund to outside investors and returning their money.

Some say it's because he's become old (81) and cautious, other suggest it's to avoid being regulated by the Securities and Exchange Commission, but he himself has said “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis.”

Stanley Druckenmiller, one of Soros' former fund managers, also threw in the towel last year, and he's only 58.

Closing hedge funds is a trend, and the issue now even has its own website: The Hedge Fund Implode-O-Meter. I see this as further confirmation that it is no longer "business as usual" in the investment world. It is, perhaps, like that stage in WWII when senior officials on the losing side prepared fake IDs and packed gold and art treasures for their flight; that is, it's no longer about gain, but about hanging on to what you've taken.

This, I think, is part of what's behind the current US budget crisis. Agreed, public spending is out of control, but that has been so for a very long time. What's forcing us towards disaster is the overall level of debt, of which much the greater part is private credit. Players in finance and politics colluded to encourage the housing and credit bubbles, which disguised the failure to nurture domestic production and balance imports with exports. Fees, interest and selling securitised debt, plus capital gains on inflated assets in a booming economy, made many people rich, and some super-rich; and they bought the government and regulators.

The ordinary Joe's real wages stalled for 30 years and more, but loading him with easy credit (and sending his wife out to work) kept the show on the road. Now, it seems, the objective is to get him to pay for everything, without asking his masters for any of the money they made out of the game.

If the elite succeed, they keep their extraordinary wealth and Joe suffers. Actually, it looks as though they cannot lose, since most cash, bonds and equities are owned by the top 1% of the population. Even their houses will tend to retain most of their value, since the only people who can aspire to buy them are other people with lots of money.

Inflation would hit cash and bonds, but the rich also have most of the equities and nice houses. Deflation would amplify the power of cash and (provided there is no default) attractiveness of bonds, and the rich have most of that, too.

So why do we feel that we're at some break point? I think it's because the balance of opportunity and threat has altered significantly.

Firstly, there's nothing much more to steal; expansion is no longer a prospect.

Second, the economy may not rebalance without an increase in taxation, and I should think some of the wealthy are on the lookout for the possible imposition of capital controls that would prevent them from fleeing abroad with their money. The more far-sighted are already renouncing their US citizenship.

Third, if the system cannot survive without some redistribution of wealth, but those who have it hold on too hard, there may be a breakdown in the social order. Last year, Marc Faber and Ron Paul were each predicting such problems, Faber recommending moving out of cities because they are such easy targets for attack.

I agree with them. I think that when irrational greed and resentful desperation meet, there can be no good outcome. We are planning to move soon to somewhere pleasanter, but also, we hope, safer. We are beyond knowing what to do with our savings, other than to diversify so that we don't lose everything, and not to entrust it all to third parties.

Looks like the super-rich hedge fund managers think the same way.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Pensions Review Summary

Gambling on sovereign default may seriously disrupt equity and bond markets

IMPORTANT: Please note the disclaimer below before continuing!

Matters are coming to a head in the financial markets.

The yields on Spanish and Italian government bonds recently exceeded 6% for a while; at 7%, it is estimated, Italian public borrowing becomes unsustainable and Italy then joins Greece in the category of countries doomed to at least partially default on their obligations.

On the other hand, it's possible that the 7% point will not be reached, or if it is, not for long. So much depends on market confidence and as is well known, fear may trigger a crisis that is otherwise avoidable.

But so can the greed of speculators. While Britain's 1992 "Black Wednesday" made George Soros a reported USD $1 billion, the cost to the UK of its attempts to support the pound against his and others' shorting is estimated at over £3 billion sterling. He has since developed a reputation as a philanthropist; we could wish for a less expensive way to fund a benefactor. *

The difficulties in Europe come at a most unfortunate time for the USA, since there is now a showdown between President Obama and Congress over raising the debt ceiling for American public borrowing. The President has indicated that a deal needs to be struck by this Friday to give time for enactment by the August 2 deadline, which I guess will really mean more last-minute hard negotiating over this weekend. Brinkmanship is a dangerous game to play: it nearly blew up the world in the Cuban Missile Crisis of 1962, and then as now, everything depends on both sides remaining sane.

It's ironic that a financial elite, having looted the economy for decades and left it pretty much unworkable, then blames the losers and expects them to pay all the costs of putting things right, and that without delay. What nonsense: America's problem is private debt, which over the last 30 years has so enriched some of these born-again pecuniary Puritans. Yes, public sector workers have enjoyed great salaries and pensions compared to the People of Walmart (though please, say nothing about the top 10 hedge fund managers whose average earnings are $1.75 billion); but what fortunes have been made on the back of arranging mortgages on their increasingly crazily-priced houses? It takes two to tango; and the same number to quarrel, as we now see.

Well, the reckoning is coming, even if some won't pay their fair share of the bill. As "Mish" reported yesterday, the yield on the US Treasury 30-year bond is increasing and he is predicting a bond market revolt "sooner than anyone thinks".

And, scarcely believably, here come the speculators again. They made money packaging debt, making sausages with as much old roadkill as fresh meat in them; then they made governments pay for the consequences; now they gamble on which countries will go bust as a result. Last month, Martin Hutchinson reminded us that he'd warned in 2008 about credit default swaps, especially the ones that are "naked", i.e. insure events that would not in themselves result in any loss to the investor. This simply gambling, and it makes a bad situation worse; it did so, he argues, with Lehman Brothers and others, and will do so with Greek debt, where the loss on default will have added to it the cost of an estimated $100 billion in side bets.

Now there are those who will argue that the CDS market, though enormous ($60 trillion in 2008, half that now), isn't a dangerous one, exactly because it's a gambling operation. Loser pays winner, so it's a zero-sum game.

But it's not.

Firstly, there's the question of mispriced risk. Hutchinson explains: "Wall Street's risk management looks at normal price fluctuations and then assesses the maximum possible risk as a modest multiple of the daily fluctuation, it was completely inadequate in measuring the risk of a CDS book. That, in a nutshell, is why AIG went bust and had to be bailed out with $170 billion of taxpayer money."

Then there's the interaction between the speculators and the authorities. Goldmans Sachs was compensated by the taxpayer for losses on AIG debt, in addition to claiming on its CDS on the same. It's like getting paid twice on an auto repair job. Rather questionable, that.

And there's the risk of outright fraud, which is how rogue trader Nick Leeson destroyed Barings, Britain's oldest investment bank: he hid his losses in a secret account and increased his bets to try to recoup them. That put Barings' capital at stake in a way that the naive, old-fashioned management failed to foresee.

Which leads us to the problem of contagion. Banks can go bust, but their depositors are protected (subject to limits) by the FDIC. Not only does that puts the taxpayer on the hook, but the FDIC, being a corporation with limited assets, may itself become insolvent if the scale of losses is too great (in fact, that was the position only two years ago). We then have either partially-busted depositors, or (if politics forces it) a further burden on what under the circumstances is likely to be an already-distressed public budget.

And what if insurance and pension funds have to pay out on CDS contracts? As Hutchinson points out, banks have limited balance sheets, but the funds that represent security for the nation's savers have much more to place at risk in contracts that many of the fund managers won't properly understand or calculate - which made them such suckers for packaged debt (CDOs and variants). "Fool me once, shame on you; fool me twice, shame on me." Hutchinson, who ran a derivatives desk in the 1980s, assessed CDS as a "sophisticated scam". So I should like to know the total downside of CDS for pension and life companies. Could this result in massive extra welfare support for retirees?

Derivatives are the fourth horseman in Michael Panzner's apocalypse, or "Financial Armageddon" as his March 2007 book titled it (reviewed here in May of that year). The market, recently estimated at $601 trillion, is worth some 8.75 times the world's GDP (or nearly 40 times that of the US), so a relatively small percentage imbalance as per some of the ways illustrated above, represents a huge potential problem. The subsector including interest rate and CD swaps is expected to grow by 10% within a couple of years, according to Citigroup (itself a name to conjure with, in the light of recent history).

Will the Dodd-Frank Act prevent all problems in future? Not, I'd have thought, with many of the nation's brightest brains employed on Wall Street and perpetually looking for ways to game the system. I don't know the loopholes and weaknesses, but I'm betting on that talent, human nature and the fabulous scale of the incentives involved, to find them out.

One way or the other, the money looks as though it's going to run short. This will lead to increased reluctance on the part of lenders, and so raise interest rates and tank the market in existing bonds. Coming back to Martin Hutchinson, he wrote on Seeking Alpha at the beginning of this month, predicting an "epic" crash in September or December, though if things go wrong in current budget negotiations that date could come sharply forward. It seems inevitable that such a crash would also impact on equities, what with deleveraging and the depressing effect on demand of a severe deflation.

Will a mooted QE3 help? I'm not sure. What did QE2 do? The banks got a raft of money from government, couldn't find anyone who they wanted to lend it to and parked it at the Fed to get safe interest. In effect, the State is rebuilding the banks' reserves for them, on the drip. But as real estate continues to dwindle in price, the bank reserve ratios may actually worsen despite all this help. And whatever the outcome of current budget negotiations, the private debt ceiling seems to have been reached already, so the frightened consumer is hardly likely to shore up the economy with extra demand.

I cannot envisage how this can continue for much longer*, unless the government takes back from the Federal Reserve the right to issue money, in which case rip-roaring inflation is a possibility, followed by a total reset, as in Germany in 1923. But avoiding that is surely the point of a central banking system: not to have a Chancellor Havenstein operating 2,000 presses 24/7 printing currency with face values in the billions, truckloads of which were still waiting to move out on the day he died. Dropping dollars by helicopter might work in this terrible way (though C-5s would be more commodious); shoving money into the banks hasn't done so.

Perhaps the strategy will be debt default, but again I can't somehow picture the virtuous depositors being allowed to keep their dollars and see them multiply in spending power, even though at least one New Yorker appears to hold $100 million in a checking account. Is that a vote for cash as the best asset?*

Hutchinson's latest post advocates gold (an each way bet if you think deflation ends with a currency crisis), buying a house (even though he thinks it'll go down in value) and finally, a put option on Treasuries. Like me, he's struggling, really: gold is above its long-term inflation-adjusted trend, houses seems to be a bad investment for ready cash (unless you're one of the growing number of bottom-fishers snapping up distressed properties at 40% off) and options carry counterparty risk, which is where we came in.

In the event of a full-scale disaster, all bets are off. All I can suggest is diversification among all assets, plus holding some away from banks and other fiduciary institutions. And, of course, hope. ________________________

*Though I'm confused, it seems I'm in good company here:

"...even such "legendary" hedge funds as Soros' $25 billion Quantum are about as clueless as everyone else. Bloomberg reports that "the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private."

The reason: "“I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis,” Soros, 80, said in April at a conference at Bretton Woods organized by his Institute for New Economic Thinking. “The markets are inherently unstable. There is no immediate collapse, nor no immediate solution."

- Zero Hedge
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INVESTMENT DISCLOSURE: None, except for (UK) NS&I Index-Linked Savings Certificates (similar to US TIPS). Otherwise, still in cash, and missing all those day-trading opportunities.

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