The Foundations of the Current Crisis: Don't Shoot the Messenger 41 comments
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"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:
- If I can help even one person make better decisions in this crisis, I'm going to.
- 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.
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This article has 41 comments:
paco many people find themselves in your shoes. i am an american. till the day i die i am an american and i choose to continue to be one. i am disappointed that the economy is the way it is, but it no way, shape, or form will i put my head in the sand (plug ears and sing) just so i can go to sleep better at night. i hope if i go to a doctor he will tell me i have cancer and not lie to me just so i leave smiling. we have found ourselves in a place where ben can not artificially suppress rates with his monetary policy- even though he has tried extensively. so now we are trying to buy back treasuries with no avail and the gov will soon be the only buyers at treasury auctions - they were a third of the buyers at yesterdays auctions. we found ourselves in a liquidity trap
we will continue to feel qe and the USD will continue to suffer the consequences. and by USD i mean you me and everyone else.
As for questions about your patriotism, there's nothing unpatriotic about trading on the expectation that the future value of the FRN will drop when the government and the fed are doing what they're doing to my grandchildren.
Unless, that is, it's now unpatriotic to display common sense.
What other choice do they have? As I have asked, rhetorically (and answered) in several articles: where will the $12.8 trillion come from if they don't monetize it?
On Jun 04 01:31 PM Thomas J. Gordon wrote:
> Paco, Yesterday Bernanke said "The Fed will not monetize the national
> debt". Do you have any comment on that?
all he is doing is monetizing our debt
What about commercial real estate? I own a basket of apt. blldgs which I can not short or sell. No buyers.
On Jun 04 12:25 PM conceptwizard wrote:
> Well spoken, I think more people have begun to realize that we are
> in deeper dodo than we originally thought. Never has any empire had
> more debt offshore in the history of the world. It should be a National
> Security issue, if the creditors start selling dollars and stop buyng
> treasuries that will break our currency back and leave the Fed buying
> debt until we default. The people who hold our debt are no particular
> friends of USA if there isn't anything in it for them. Russia &
> China don't have any love for the US and they are the biggest two
> creditors. Who needs nucular weapons when you can take a country
> down without firing a shot. The USA is cowtowing to China for these
> reasons, what a spot our leaders left us in. How can we be taken
> seriously worldwide if other countries know our biggest vunerability.
Thanks for the input. You are are right: the bottom line is that we will never be able to pay this off.
On Jun 04 02:46 PM Grumley wrote:
> This is the first time I've published a reply. I always look forward
> to your articles Paco. I have to say I though, I don't think most
> disagreements stem from a sense of patriotism, some perhaps, but
> most are simply the result of being naive. A friend said to me the
> other day "I have to think the government has a plan B and plan C."
> I tried to point out that we are already on plan F. The bottom line
> is that people do not realize that no government in history has ever
> paid off the kind of debt that we face. They either default or print
> it. And printing it is the same as defaulting. We will NEVER be
> able to pay this off, so a fiscal recovery by responsible means is
> impossible. Once people begin to grasp this fact, I suspect the
> tide will change.
What really scares me, and I mean REALLY scares me, is that all fiat currencies in history have failed. All of them. When the United States closed the gold window in 1971 all currencies, including the US dollar, became fiat. And lifespans of an unbacked, fiat currency is roughly 40 years. Get your calendar and start counting backwards. All curriences are in trouble. How long will it take for people to realize that one?
Bernanke is cut from the same clothe.
People will never truly understand the causes of this crisis and the dangers of bank credit expansion and bubbles if they continue to believe, in error, that Greenspan was a free marketeer.
On Jun 04 03:59 PM Thomas J. Gordon wrote:
> 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. I don't think they have some
> secret agenda to debase the currency, for which they get some kind
> of personal financial reward. Greenspan has many and high quality
> free market credentials. I say in one of my articles that he drank
> tea in Ayn Rand's apartment. If the federal gov't was spending only
> what they take in in taxes I don't think they would even think about
> expanding the money supply. Yesterday Bernanke took political risk
> by reading Obama/congress the riot act about deficit spending. I
> personally give the guy some credit.
On Jun 04 03:59 PM Thomas J. Gordon wrote:
> 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. I don't think they have some
> secret agenda to debase the currency, for which they get some kind
> of personal financial reward. Greenspan has many and high quality
> free market credentials. I say in one of my articles that he drank
> tea in Ayn Rand's apartment. If the federal gov't was spending only
> what they take in in taxes I don't think they would even think about
> expanding the money supply. Yesterday Bernanke took political risk
> by reading Obama/congress the riot act about deficit spending. I
> personally give the guy some credit.
And what about our creditors. What do you think they're going to do?
On Jun 04 05:50 PM Thomas J. Gordon wrote:
> Paco, if we're taking off the economic gloves, here let's go at it.
> When a financial panic like q42008 happens, velocity drops like a
> brick. MV=PQ. A no caca (spanish), hard money, person like Miltion
> Friedman begged the Federal Reserve in the 30's to expand the money
> supply in response to the financial panic of 1929. Friedman said
> the decrease in the money supply of 30% between 1929 to 1930 was
> a big cause of the Great Depression. So I would argue that Bernanke
> was just not making an earlier, revealed mistake.
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.
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.
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?
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.
"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.
> 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?
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.
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.
because we lounge in front of our HELOC-financed wide screens watching our favorite spectator sport, which is cage fighting?
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!...
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.
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! :-)
www.ft.com/cms/s/0/f4d...
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.
Jefferson would be an anarcho-capitalist if he lived today. And he'd be right.
All the way, brother. All the way and then some.
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.