The Foundations of the Current Crisis: Don't Shoot the Messenger

"If we win another such battle against the Romans, we will be completely lost"

-- Plutarch, Pyrrhus 21,14

I have a friend who is some sort of a project manager at BioWare. He is one of the most brilliant people I've ever known; for fun, he studies subatomic physics. In Russian. He's also a bona fide cynic and drinks copiously. So we get along just fine.

For those of you uninitiated, BioWare designs video games, and last night, my friend showed me a two-minute trailer for a new Star Wars game he is involved with. I was impressed.

"It cost us a million dollars to make it." He looked concerned -- as though he might have gone over budget. "And we're making three more in the next month."

"Don't worry," I said. "If you discount back the true future value of the project -- based on the inevitable inflationary price explosions marching at us like an army of angry Storm Troopers -- it's probably justifiable."

Another moment of silence ensued. "You know," I said. "I'd give anything to have your job."

He pulled his head back. "Why? It's just a huge load of stress."

"Yeah, but you believe in what you do."

"And you don't?"

"No." I thought about it for a moment, and then said, "I'm going against everything I've ever believed in. I'm a value investor, and yet I haven't held any stocks for over a year. I'm short the entire U.S. economy, and I'm making a lot of money, but it's a pyrrhic victory; every single day I hate being right that much more."

A lot of you obviously liked my last article – to which this is a follow-up -- and I want to thank you for your praise. But judging from the spectrum of attacks I've also received in the last week – ranging from "you're stupid," to "I hope God kills you," I'm guessing some people aren't terribly excited about my mathematics -- nor, perhaps, my Jeffersonian propensity to decry unjust governments. Nonetheless, $12.8 trillion is a lot of money, and in case you missed it the other 22 times I posted it, here's a link to an article that epitomizes -- in real dollars -- just how much trouble we're in. The only inaccuracy I can find in it is the premature estimation of how much the government has actually committed to this train wreck of an economy; a piece that appeared in Bloomberg on March 31 more realistically depicts how deep in the quicksand we've really sunk.

Again, for the record, I do not like the fact that the United States is losing its status as the premier financial power in the world. Likewise, I do not like the fact that the U.S. dollar is losing its status as the world's reserve currency. Nonetheless, the absolute worst thing any of us can do during a paradigm shift is shove our fingers in our ears and start singing the Star-spangled Banner at the top of our lungs; I am not going to sit idly by while "what-used-to-work" disintegrates around me, nor am I going to simply remain silent – for two reasons:

1. If I can help even one person make better decisions in this crisis, I'm going to.
2. Publishing my findings generates criticism, which can help refine the theories behind those findings.

Unfortunately, most of the criticism I've received over the last week has been more of the ad hominem variety than it has been of the constructive type. And that's a shame, because I know many of you read what I write hoping to gain perspective and insight into what's happening around us. Nothing facilitates that process more than healthy dialogue. I hope this week we can get closer to that objective.

THE FOUNDATIONS OF THE CRISIS: PAST, PRESENT AND FUTURE

I've discussed a lot of these points in earlier articles, but they bear repeating here. When governments create easy money, they necessarily distort demand – and by extension, prices. You want to know why tuition is so high? The government has created a market full of decidedly cheap student loans, driving demand for education exponentially higher in recent decades. And when demand increases, so do prices. There are other sectors of the economy that can thank governmental intervention for ballooning prices, as well – namely, healthcare and, you guessed it: housing.

Most people only see the housing bubble – and its ultimate collapse – as a self-contained crisis. In other words, when the deleveraging of the housing market stops, then the entire economy will correct itself and we can get back to business as usual. Unfortunately nothing could be further from the truth; the housing bubble was only the first phase of an economic crisis whose magnitude we can't even yet begin to fathom.

In battling the crisis, instead of taking the necessary steps to correct the very things that caused the bubble in the first place, the government has instead ramped up its policy of easing – driving rates almost to zero -- encouraging still more mal-investment by people who wouldn't otherwise consider placing borrowed capital into the economy. Toward this objective, the government has committed the $12.8 trillion dollars I referred to earlier. And its sole purpose? To confront this crisis – and this crisis, alone; the money won't be used for any historical obligations, nor will it be earmarked for any future budgets.

Do you know where the money is going to come from? I can say with a great degree of confidence that almost none of it will come from taxation, because there's absolutely no way the government could get even a fraction of that sum from its citizens.

Will it come from debt? How could it? Will foreign nations continue to lend to the United States, despite the fact that it is the largest debtor nation on earth? Why would they? In years past, the loans were justifiable because the American consumer bought so many foreign goods. But the American consumer seems to have lost his heretofore insatiable appetite for material things – specifically because he has nowhere to get the money! He can't borrow against his house. His credit cards are either maxed-out, or else the card companies themselves have reduced limits so severely that they're next to useless. So how will Americans continue the gluttonous shopping spree they have enjoyed for the last few decades? The answer is, of course, they won't. And there is absolutely no incentive for foreign nations to continue to loan money to the U.S. if Americans have no means by which to return those funds to the source.

So the United States will simply try to print itself out of this mess – and indeed, the presses are already smoking and groaning from the strain. But the government can't just print trillions of dollars, and lower rates to unprecedented levels, without expecting massive inflationary price explosions in the near future. Further, the Fed is not run by wizards; it is manned by human beings who are both fallible and politically motivated. Instead of cutting rates, Bernanke and his sycophants should have been raising them. Instead of printing money and buying long-term Treasuries, they should have been pulling currency out of circulation by selling the long-end of the yield curve. Unfortunately, the point of no return has come and gone, and we're all going to have to weather the coming storm together. I'm doing it by shorting Treasuries, and buying commodities. So far, I couldn't be more pleased with my returns since December. Of course, all of this is offset by the fact that I'm going to have to watch a lot of people suffer in the coming years. That prospect certainly doesn't thrill me.

I encourage you to take a long hard look at your commitment to your government and its currency. If you believe I'm wrong, ask yourself why you've come to that conclusion. Then carefully lay out your argument, because I assure you, I want to hear it. But if your reasons for defending the "almighty dollar" and the government that prints it derive from blind patriotism, dogmatism, and/or irrepressible empiricism, all I can do is wish you luck. I want no part of it. You can wave the stars and stripes until your arms fall off, for all I care. You can even call me a traitor (you won't be the first). But I say our corrupt government deserves its fate, and the tyrants (and their supporters) who are systematically destroying our currency much more aptly fit the description than do I.

Remember, I'm only one of many messengers who are presenting an extremely cogent and dire warning. Calling me names isn't going to affect the outcome – one way or another – and you certainly aren't going to hurt my feelings enough to make me stop writing. If anything, you're simply wasting your time, because the next article is just around the corner, and barring some miracle, I doubt its contents are going to be any more optimistic than its recent predecessors.

Disclosures: Author is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

Comments

[Grumley:]

Let us not forget that the Federal Reserve is comprised of the very banks we are bailing out. Did Benanke act maliciously? Probably. Is he a bad person? Who cares.

The sad truth is that the jig is up, and no amount of finger pointing is going to change what's coming. Paco is right about velocity. It is much deadlier than its inflation counterpart. Inflation is fueled by fundamentals, velocity is fueled by fear and panic. When people start shedding the dollar because they believe it will soon be worth less, it becomes a snowball that destroys everything. If velocity begins to increase it's time to grab a shovel and dig yourself a basement.

Jun 04 06:47 PM

[JohnAl:]

"I will spend a brief moment defending Bernanke here. He didnt' make the decision that the federal gov't spend massively in excess of the tax take. I am long tbt and I follow Paco so I like a lot of what he says. But many of these discussions demonize Greenspan and Bernanke and I don't know if I buy it."

During the 80's and 90's I was a Greenspan fan, and thought of him as a free marketer. But then, I was fairly ignorant back then.

Greenspan certainly understands markets and economics. No doubt about that, so he clearly is NOT a free marketer. If he were, he would not have ever taken the job of Fed chair. In so doing, he bought into the system that feeds the growth of FedGov. Without the Fed, there is NO way the federal government could have accumulated it's level of debt, and without that debt, there is NO way the politicians could have grown FedGov to it's current, smothering size.

Greenspan enabled it, and he knew what he was doing. Bernanke is doing the same.

Neither of these men are free marketers.

Jun 04 06:50 PM

[Paco Ahlgren:]

I'm sorry. That should have read "we'll find out IF he's wrong."


On Jun 04 06:17 PM Paco Ahlgren wrote:

> We'll find out when he's wrong when velocity returns. What will the
> Fed do to soak up all that currency? Sell Treasuries? Just when inflationary
> pressures are heating up?
>
> And what about our creditors. What do you think they're going to
> do?

Jun 04 08:43 PM

[Slick BRIC:]

A barrel of oil, not the US Dollar, is the defacto currency of the world. It has been for decades and I see little signs of that letting up anytime soon.

I believe those looking to the US to regrow revive the global economy are very misguided. Before this recession, the global ecomony was being grown mostly through the BRIC economies. This has resumed. The FXI has seen its double-bottom and seems clearly on pace to renew its upward trajectory. As the BRIC accumulate wealth and the market power that accompanies it, they will surely become more effective and efficient at internalizing that wealth amongst their 10 of billions of potential. Whether and how quickly US consumers, and along with them, the US economy recouples with this trend is ultimately of minor significance in the long-term, grand scheme of things.
I am long (and very content to stay so) with, among other things, DXO, OIH, UYM, and EEB.

Jun 04 11:38 PM

[Slick BRIC:]

To restate one poorly worded comment,

"As the BRIC economies accumulate wealth and the market power that accompanies it, they will surely become more effective and efficient at internalizing that wealth amongst their 10's of billions potential consumers, a significantly educated and sophisticated mass at that."

I also have been long for awhile now, and intend to remain so, on SEA fwiw.

Jun 04 11:47 PM

[Carlos Lam:]

On Jun 04 06:39 PM Thomas J. Gordon wrote:

> I understand the comments of people who think that no good can come
> of creating paper/electronic money in excess. Intuitively I buy
> what you're saying. How can it create real economic wealth to simply
> print extra money? But I am saying a hard money, no caca, person
> like Milton Friedman did find at least one case where he was for
> a rapid expansion of the money supply. We should ask Anna Schwarz,
> she's still alive.

Your question presupposes the existence of a central bank. A better question is: would the Great Depression have been as bad as it was if there had been no central bank to begin with?

Jun 05 05:07 AM

[diogeron:]

Goverment intervention is responsible for the increase in HEALTH CARE? That's probably because we have a single payer system like France and we have the most comprehensive and best health care in the world. Oh, wait. We don't.

Jun 05 08:45 AM

[TinyTim:]

"When governments create easy money, they necessarily distort demand – and by extension, prices"

Best current example: Govt gives out $40 coupons for digital TV convertor boxes. Price of boxes immediately goes to $50. The manufacturing cost of the boxes is approx $20. I pay $10, mgr gets $30 profit.

Jun 05 10:23 AM

[TinyTim:]

"When governments create easy money, they necessarily distort demand – and by extension, prices"

Best current example: Govt gives out $40 coupons for digital TV convertor boxes. Price of boxes immediately goes to $50. The manufacturing cost of the boxes is approx $20. I pay $10, mgr gets $30 profit.

Jun 05 10:24 AM

[Alpha&Omega:]

Thanks you for the courage to write the article and respond to the various comments. I would help me and other readers to get your perspective on how the approach you are taking is in any way anti-American? I do not feel that avoiding US stocks and investing in TBT, DXO, UGL is anti-American. Specifically can you outline for your readers how buying TBT is Anti-American or in any way potentially hurts Americans or the USA? Perhaps if you can articulate a case that buying TBT is not harmful to America but rather sends a message that we find the current administration to be anti-American in its practices and creating an anti-business / anti-investor environment. If this resonates with your readers, we can join your approach and perhaps we can "vote" with our investments since our voting block seems to have very few other means to express ourselves?

Jun 05 10:43 AM

[Jimbo:]

We get the government we deserve. Several years ago the Sainted Jimmy Carter appointed a certain South Florida attorney to the federal bench. This Judge was later charged with taking bribes in connection to a case before him. He was acquitted on trial but his fellow judges thought he was committing perjury under oath.He was tried by the U.S. House(controlled by Democrats) and removed from the bench. He then ran for the U.S. House seat in his district and has been seated in the U.S. House for several years. Obviously he benefits from seniority. These are the kinds of people we are sending to Congress to appropriate money to bribe the voters. Why do i keep thinking it is the year 600 and we are living in the last days of the Roman Empire?

Jun 05 11:14 AM

[ain't no fo...:]

"Why do i keep thinking it is the year 600 and we are living in the last days of the Roman Empire?"

because we lounge in front of our HELOC-financed wide screens watching our favorite spectator sport, which is cage fighting?

Jun 05 03:48 PM

[Paco Ahlgren:]

Looks like they blocked your last account, Ray. They're going to block this one too, I imagine, but before they do I'll let you know this: I own millions of dollars worth of real estate in Austin, so I maintain a real estate license to facilitate purchases, sales and leases. I don't normally list properties that aren't my own. The listing you see is one of mine.

I suspect whatever drives your angst just took on a whole new magnitude of severity; I mean, for a bad writer, I sure have sold a lot of books. And for a "failed" real estate agent, I sure do have a big portfolio...

See you on the other side.


On Jun 05 03:46 PM raytaythemd wrote:

> ...aw, c'mon, Paco -- lighten up, son!...what's wrong with explaining
> why you're such a grump on the economy?...really, there's nothing
> disgraceful about being a real estate agent:
>
> centraltexasvalue.com/...
>
>
> ...even if you do have only one listing...I know times are tough
> for everyone -- especially real estate agents...a man's gotta earn
> a living somehow -- right?!...by the way you never did say if you
> kept copies of that cable access TV show you did back in the 90's
> -- "The Free Market"...why, I heard your prognostications on that
> show were a pure wonder!...so, come on, now -- put on a happy face!...

Jun 05 05:06 PM

[raytaythemd:]

..."I own millions of dollars worth of real estate..."...why I know that, son!...no doubt that's why you're out there in Vegas giving those workshops on "The Death of the Dollar: How We Can Survive the Coming Collapse"!...why, those mortgage payments can just plain wear a man out, can't they?...it's just like you said: "He can't borrow against his house. His credit cards are either maxed-out, or else the card companies themselves have reduced limits so severely that they're next to useless."...it's just plain depressing!...and, personally, I'm eternally grateful that you take the time out from counting all your money to sit down and produce these streams of economic conciousness for all the rest of us impoverished plebeians...although, I must say, given the length of your deliverances, perhaps you should have changed your name to "Marcel" instead of "Paco"...and I don't understand why you keep griping to seekingalpha about my posts...why, I still remember the first time I saw one of your articles...I was just sitting there reading it and then..."then something distracted me – glimmering in the afternoon light, pulling my eyes to the edge of the board, gently reminding me..."...yes, indeed, "gently reminding me"...gently reminding me this boy's got more manure than an Indiana hog farm!!!...but that's okay!...cause you're going to need a lot of it to sell a house appraised at $426,000 for $549,000!...not to mention $549,000 for 1,900 square foot house on a tenth of an acre???!... jumping Jehosaphat!!...does it come with an oil well or something?


On Jun 05 05:06 PM Paco Ahlgren wrote:

> Looks like they blocked your last account, Ray. They're going to
> block this one too, I imagine, but before they do I'll let you know
> this: I own millions of dollars worth of real estate in Austin, so
> I maintain a real estate license to facilitate purchases, sales and
> leases. I don't normally list properties that aren't my own. The
> listing you see is one of mine.

Jun 05 07:26 PM

[Paco Ahlgren:]

Ray, maybe we should compare tax returns sometime? I don't know what else to offer you. You seem angry about something, but I can't figure out what it is. Are you mad because I'm successful? Are you mad because I'm making money in this failing economy? Are you mad because I write compelling (and accurate) articles? Are you mad because I get good reviews? Are you mad because I own a house (or twelve)?

Do you want me to change my name?

Why don't you just do us all a favor and tell us what it is you want? Watching you create new accounts so you can vent is sort of like watching mosquitoes breed. You obviously have a lot of time on your hands, but frankly, the rest of us don't. Just cut to the chase, man. Toss us a bone! Exhibit some authenticity!

If nothing else, friend me on Facebook. At least then I can have real fun with you! :-)

Jun 06 01:43 AM

[Lawrence of...:]

It's worth bearing in mind that not all of the world's leaders are cut from the same cloth:

www.ft.com/cms/s/0/f4d...

Jun 06 06:12 AM

[nova:]

We all agree: we, the US economy, have reached and passed a point of no return.
There is no way America will be able to pay back to its foreign creditors. There is no doubt about it.

The only important question left: what is next? How far are our government and elected officials ready to go continuing their totally reckless and utterly near-sighted policies.

PS
At least the leaders of Germany's Weimar Republic could blame outsiders for their ills (the foreign occupation of their territory and totally bandit reparations imposed on them). Whom will our leaders blame? Osama bin Laden?

Finally, the last 30-years of Chinese rise was just incredible taking into account of no prior historical or cultural foundation for it. Well, my first boss in America was a Chinese immigrant from Taiwan. He was very a respectable scientist and an honest and fair man.

Jun 06 11:10 AM

[Hot Richard:]

Hot Richard eargerly awaits the collapse. It is a gate we must pass. If you aren't careful, it might not be your only time through.

Jefferson would be an anarcho-capitalist if he lived today. And he'd be right.

Jun 06 09:19 PM

[Hot Richard:]

"How far are our government and elected officials ready to go continuing their totally reckless and utterly near-sighted policies."

All the way, brother. All the way and then some.

Jun 06 09:45 PM

[marctacoma:]

Hey Paco
I think your a great writer. Ray must be a liberal because for some reason they refuse to acknowledge fact or logic, something I never understand. Anyway, keep up the good work! I wish you were a relative or something.

Jun 10 04:30 AM