Extraordinary Popular Delusions and the Madness of Crowds

The title of this article is of course borrowed from the brilliant book of the same name written in 1841 by Charles Mackay. The book deals with 3 “delusions”: "National Delusions", "Peculiar Follies", and "Philosophical Delusions". While dealing with The Crusades, alchemy, witch-hunts and other follies, the parts that interest us most today are the economic bubbles he discussed -- in 1841 -- and the national delusions he chronicled.

Mackay devoted a chapter each to the Dutch tulip mania of the early seventeenth century, the South Sea Company bubble of 1711–1720, and the Mississippi Company bubble of 1719–1720.

There are those who cannot imagine learning anything about today’s stock market from a book published nearly two centuries ago. It might seem particularly quaint, looking back from our worldly vantage point, that Mackay cited a contract to purchase one single tulip bulb in 1637: 160 bushels of wheat, 320 bushels of rye, 4 oxen, 8 pigs, 12 sheep, 126 gallons of wine, 1000 gallons of beer, 4000 pounds of butter, 1,000 pounds of cheese and some furniture, clothing and silver tossed in as a sweetener. Of course, such silliness couldn’t happen in our time.

After all, who today would exchange even part of this largesse for a few shares of a dot-com company with no revenue, no earnings, and no adult leadership, brought public solely to enrich Goldman Sachs (GS) and the other big underwriters and now mercifully sunk beneath the horizon of our memory? Oh, that’s right – millions begged their brokers to include them in the IPO to be “allowed’ to buy shares priced at hope times greed times infinity.

But we’ve learned our lesson since 1999, right? For instance, no one buying a house at a Price/Earnings Ratio of 11 in 2000 (P/E in this case referring to the purchase price divided by the rental income) would then be dumb enough to pay 34 times rental income just 5 years later, right? Oops. That’s just what they did in San Francisco, San Jose, Phoenix, Las Vegas, Miami and lots of other places.

To students of history, the dot.com.bom was predictable in character if not in time. As was the housing decline. Trees do not grow to the heavens except in fairy tales and calls from your full-commission broker.

In fact, markets are cyclical, not linear. That’s why I now recommend food; energy; basic resources; base, precious and rare earth metals; materials to build the infrastructure in emerging markets and repair the crumbling infrastructure in developed markets; and health care, because once our most basic survival needs have been met, we’d like to stick around and enjoy such things for awhile. I also maintain a few put options (or calls to buy inverse ETFs).

You can trust government to protect your wealth. Or you can trust that food, energy, basic materials, gold and silver, and health care will rise as the inevitable inflation which follows non-stop printing of money and the diverting of funds to bankers on Wall Street.

Which companies within these select sectors are best? Some people, despairing of adding value by tearing into balance sheets and actually understanding the businesses in which they are investing, have deferred to mutual funds and ETFs. If this is your approach, may I suggest index ETFs which cover each of these sectors. “Active management” along with active expenses have left most mutual funds at the post vis a vis their ETF counterparts.

If you are willing, however, to seek the exceptional individual company via hard research and independent thinking, may I suggest: to feed the world -- grains, crops, livestock, soil enrichers like potash, nitrogen and potassium, and efficient irrigation all top my list. Potash Corp (POT), Deere (DE), Israel Chemicals (ISCHY.PK), Yara Intl (YARIY.PK), Nestle (NSRGY.PK) and Lindsay Mfg (LNN) are among my favorites.

For energy, I choose natural gas first, nuclear next, and then solar, wind, biomass, oil and coal – every single one of them. In the developing world, coal and natural gas are most abundant and cheapest and will therefore be the first choice of most users. Here are just a few representative issues: Exxon Mobil (XOM), BP, Conoco Phillips (COP), Royal Dutch Shell (RDS.B), Williams Partners (WPZ), Magellan Midstream (MMP), Boardwalk (BWP), OneOK (OKS), Chesapeake (CHK), EnCana (ECA), Imperial Oil (IMO), Natural Resource Partners (NRP), Penn Virginia (PVR), and Cameco (CCJ.)

In health care, the revolution of health in the West has come from ethical drugs, non-invasive technology, prevention and early interventions. That’s the way to invest. I like the biggies here: Roche (RHHBY.PK), Johnson & Johnson (JNJ), Merck (MRK) and Pfizer (PFE) come to mind.

Among the metals and mining companies, I recommend for your consideration Goldcorp (GG), Yamana Gold (AUY), Freeport McMoRan (FCX), Silver Wheaton (SLW), BHP Billiton (BHP) and Franco Nevada (FNNVF.PK). I also believe the mining equipment providers will do well as the mining firms wear out old equipment and seek new. Joy Manufacturing (JOYG) and Major Drilling (MJDLF.PK) merit a look.

Why do I suggest gently removing money from financials, techs and others that have done well and into these sectors?

Because in the past 22 years, every crisis has been dealt with by huge injections of liquidity into the banks and Wall Street with interest rates cut, often to negative inflation-adjusted rates of return. Whether it was the crash of 1987, the Mexican Peso Crisis in 1994, the Asian Currency Crisis in 1997, the Long-Term Capital Management bankruptcy in 1998, the dot-com bubble in 2000, or most recently the U.S. housing bubble, each crisis was dealt with by transferring money from honest taxpayers to reckless risk-takers who knew they would always be bailed out.

There is no such thing as easy money. Not in the long term. Yet that is what the Fed has been providing – easy short term money -- every time it looks as if we may have a normal contraction. And as long as we maintain such delusions, no matter how popular, we will continue to be subjected to bouts of madness in the markets.

Rather than allow occasional recessions and bear markets to rid us of the excesses of artificially-created bubbles, the Fed was the pusher to the junkies who needed just one more injection to get whole again.

As a result, we may now risk a double-dip recession. If the Fed manages to walk the tightrope they’ve set for themselves, it will be the first time in US history that runaway growth in money and credit has not been followed by a declining dollar and rising inflation.

Don’t get me wrong. I’ll enjoy the good times as much as everyone else -- I’m just making sure that while I party, I do so near the fire exits…

Full Disclosure: Long POT, YARIY, NSRGY, RDS.B, WPZ, MMP, BWP, OKS, CHK, ECA, IMO, NRP, PVR, RHHBY, JNJ, GG, AUY, FNNNVF, MJDLF.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless –our Investors Edge ® Growth and Value Portfolio has beaten the S&P 500 for 10 years running but there is no guarantee that we will continue to do so.

It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

Comments

[Tony Petroski:]

Solid article Mr. Schaefer. It's particularly useful to have some real stock picks included. Thanks.

Oct 14 12:37 PM

[tc1:]

Very well written article, Joseph-- thank you. That barter-rate for a tulip bulb in Holland generations ago is a real eye-opener on the irrationality of markets and their investors!

On such irrational markets, in line with your lucid observation about the dot.com bubble, I can provide a revealing personal example:

I vividly remember calling my father in Spring of 2000 and telling him of a relatively unknown young professor, one Robert Shiller, whom i had just seen on CSPAN talking at a bookstore about his new book, IRRATIONAL EXUBERANCE. I myself was no investor or student of the markets, though i do hold a psychology degree and have read fairly widely on progressive economics. Anyway, I informed my father that Shiller was predicting a nasty collapse of the dot-com bubble and the stockmarkets as well. I strongly recommended to my father that he take most of his portfolio and put it in much safer govt treasuries, which at the time were paying well over 6%. Alas, my dear father listened instead to the rah-rah boosterism of the financial media and to his broker at a certain (unnamed here) street brokerage, and so he decided to remain in the market-- primarily within NASDAQ stocks. "I just want to make another 10% in the market over the next few months and then I will re-allocate into safer investments," my father told me.

And then the bubble collapsed. By the time he passed on in Spring 2003, he had lost 60% of the family's portfolio.

The aforementioned (unnamed) street brokerage manager subsequently failed to get the portfolio properly allocated to enjoy the 2003-7 recouping of market losses, and then put this same inherited IRA portfolio into a massive overinvestment within a risky Goldman Sachs "fund of funds" (ominously top-heavy with those terrible financial stocks) when the Crash of Fall 2008 occurred (i had vainly asked the financial manager to get us out of that GOIAX fund in mid-August, six weeks before the Crash).

Having to step in and myself take over the decimated inherited IRA portfolio (with the help of a new financial manager), i got us out of the market entirely in Oct 6, 2008 and then took just the approach you recommend here, Joseph: find great companies with solid balance sheets, great profit/operating margins, and healthy future growth prospects, and then boldly buy them on big dips.

This now seems (as all value investors have previously discovered) to be the only way to insure overall successful investing. And our portfolio has most spectacularly benefitted as a result these last 10 months.

Bottom line: no matter how much one might have willingly or reluctantly participated in market foolishness, there's always a better approach one can take-- using one's God-given smarts to invest in solid, successful companies... and then enjoy the eventual ride up, profit-taking along the way to lock in those gains.

Oct 14 02:30 PM

[tc1:]

Btw, like Joseph and his clients, I, too, am long certain stocks in agriculture, energy, precious metals, and healthcare, as well as in emerging markets (primarily Brazil [EWZ and BRF] and China [HAO and several ADR stocks]).

Oct 14 02:42 PM

[Jasper M:]

While Mackay's book is indeed a timely title to conjure with, I would remind the author that the collapse of every one of the manias he lists was DEflationary - mass removal of credit, and therefor money supply, from the system, by market forces, usually in Spite of the wishes of those claiming to manage such things.

Oct 14 02:49 PM

[The Geoffster:]

Good point. I was an inflationista last October but not even the Fed can print its way out of 58 trillion in public debt and whatever the "market" value of 600 trillion in notional derivatives is.


On Oct 14 02:49 PM Jasper M wrote:

> While Mackay's book is indeed a timely title to conjure with, I would
> remind the author that the collapse of every one of the manias he
> lists was DEflationary - mass removal of credit, and therefor money
> supply, from the system, by market forces, usually in Spite of the
> wishes of those claiming to manage such things.

Oct 14 07:42 PM

[Jasper M:]

Welcome, Geof . . . Fulfil your destiny, and JOIN Me, on the 'deflation side' . . . !
: )

By the way, my best guess re the derivatives is ignore it - most of the participants are. I imagine tat at some point the whole lot will be ruled illegal and unenforceable with a wave of a regulatory pen.

On Oct 14 07:42 PM The Geoffster wrote:

> Good point. I was an inflationista last October but not even the
> Fed can print its way out of 58 trillion in public debt and whatever
> the "market" value of 600 trillion in notional derivatives is.

Oct 15 01:33 AM

[Michael Clark:]

"in the past 22 years, every crisis has been dealt with by huge injections of liquidity into the banks and Wall Street with interest rates cut, often to negative inflation-adjusted rates of return. Whether it was the crash of 1987, the Mexican Peso Crisis in 1994, the Asian Currency Crisis in 1997, the Long-Term Capital Management bankruptcy in 1998, the dot-com bubble in 2000, or most recently the U.S. housing bubble, each crisis was dealt with by transferring money from honest taxpayers to reckless risk-takers who knew they would always be bailed out.

There is no such thing as easy money. Not in the long term. Yet that is what the Fed has been providing – easy short term money -- every time it looks as if we may have a normal contraction. And as long as we maintain such delusions, no matter how popular, we will continue to be subjected to bouts of madness in the markets."

Fear of death is driving the Fed. This is a viagra response to the natural processes of rise and fall, inflate and deflate, advance and retreat, ebb and flow. It DOES NOT eliminate the decline, it merely delays it. It is a kind of slash and burn policy, with the slashing and burning merely deferred for a time being.

Oct 15 03:25 AM

[Michael Clark:]

I'm in the DEFLATION camp as well. You can't reinflate a popped balloon UNTIL YOU FIX IT.


On Oct 14 02:49 PM Jasper M wrote:

> While Mackay's book is indeed a timely title to conjure with, I would
> remind the author that the collapse of every one of the manias he
> lists was DEflationary - mass removal of credit, and therefor money
> supply, from the system, by market forces, usually in Spite of the
> wishes of those claiming to manage such things.

Oct 15 03:28 AM

[ArtfulDodger:]

Dear JS, the first six paragraphs are an excellent start to a somewhat crowded article with an awkard transition from there out.

However, I do agree with the concept you've been pounding home for quite a while of picking good, solid companies in specific sectors.

Your most informative sentence is perhaps this one, which I surely agree with: "I’ll enjoy the good times as much as everyone else -- I’m just making sure that while I party, I do so near the fire exits…"

No doubt, when the Fed begins gleaning its spillings, we better get our running shoes on.

A lot of stocks for investors to research.

Thank you for them and for your work.

Oct 15 10:35 AM

[Tack:]

The apprehension that the Fed will call back all their money, and the economy and markets will be left high and dry, is unsupported by any past history. In fact, it's exactly the opposite.

The Fed will in all likelihood fail to make timely adjustments to the money supply, and we'll begin an inflationary period. Whether moderate or severe will just depend on how laggard they are in their actions.

I sincerely doubt that the economy or stock market will collapse, but rather all non-currency assets will be gradually revalued upwards, as typically happens in inflationary periods. Only the dollar will be worth less.

This scenario has been repeated time and again throughout history. The price of everything, as measured in fiat currencies, only progresses higher over time. The idea that prices will decline systemically and stay there has no factual historical basis whatsoever.

As for "inflation-adjusted" returns, it's a meaningless concept because investors cannot control or affect inflation. They can only maximize their nominal rates of return and hope to keep up with or exceed inflation. There's no other discretionary choice.

Oct 15 11:25 AM

[Jimbo:]

Ah yes, "party near the exits" great phrase and great advice.

Oct 15 01:25 PM

[searcher:]

The 'house edge' for society of any stripe is inflation. Job number one to survive, if not prosper, is to at least pace inflation. Unfortunately, even that modest aspiration entails risk.

Oct 15 01:39 PM

[Tony Daltorio:]

But you are ignoring that when those bubbles collapsed, the monetary system was based on gold. Not based on a fiat currency like the dollar. Never in history, has a fiat currency gone up in value (deflation) over a long period of time. This time will be no exception.


On Oct 14 02:49 PM Jasper M wrote:

> While Mackay's book is indeed a timely title to conjure with, I would
> remind the author that the collapse of every one of the manias he
> lists was DEflationary - mass removal of credit, and therefor money
> supply, from the system, by market forces, usually in Spite of the
> wishes of those claiming to manage such things.

Oct 15 02:48 PM

[Jasper M:]

On Oct 15 02:48 PM Tony Daltorio wrote:

> But you are ignoring that when those bubbles collapsed, the monetary system was based on gold. Not based on a fiat currency like the dollar.

In the shorter term, not relevant. Even gold based systems can have Loads of excess credit creation (Exibit A, 1720's). And since even paper currency takes a finite amount of time to produce (as opposed to credit), it cannot rise as fast as collapsing credit disappears.

> Never in history, has a fiat currency gone up in value (deflation)
> over a long period of time.

Define "long". I expect the $US to go up for 3 years.
Some time after that, sure, once the credit supply dwindles to the same order of magnitude as the currency supply, THEN we will have inflation. But there is no way I am going to pass up this phase.

Oct 15 06:32 PM

[IT'$ OVER!:]

What if they have all long ago realized it's over anyway, and they are just delaying, as long as they can, the inevitable correction that will destroy the US Empire. Just like the many empires before us collapsed in the cesspool of corruption, mismanagement and greed. They have seen this unstoppable conclusion, and decided to ride the rise at any cost. Like a funky chasing the fix. They know there is no way of correcting it. Our debt, the obligation to our social programs, the slow dis-education of the middle class, our unmanagable economy. You cannot for certain know the future, but you can watch what present produces and get a general feeling for the direction we will be, and that feeling drives those in power to continue to inject. This crisis will go the way of all others, it will be stimulated, revived, botoxed and repackaged. Every time this is done, it makes the inevitable fallout worse, and that is where we are heading, and they know it.

Oct 15 07:44 PM

[derryl:]

Tack wrote,
"This scenario has been repeated time and again throughout history. The price of everything, as measured in fiat currencies, only progresses higher over time. The idea that prices will decline systemically and stay there has no factual historical basis whatsoever."

The deflation we are talking about is not the idea that prices will decline and stay there forever. It is the historical precedent of the 1930s balance sheet depression where asset prices (stocks and real estate) collapsed and took decades to recover to their 1929 nominal prices. CPI does not change in direct relation to money supply (productivity gains can produce more goods to absorb increased money without prices rising, for e.g.). Asset prices do. So it's asset prices that inflate and deflate, not CPI prices.

Loan defaults and personal and bank bankruptcy all destroy money supply. Money supply and GDP move together, both up and down. So when money supply is contracting/deflating GDP contracts/deflates with it. Unless there is some renewed exuberance among borrowers to take on new debt to re-expand the money supply and the economy, the contraction can continue for a very long time. That's where we're at right now, overindebted, losing jobs, defaulting and going bankrupt, and unwilling or unable to take on more debt.

A balance sheet recession happens when too many people took on more debt than they can repay, especially if their income takes a hit, and the asset prices that were supported by that debt-money collapse. Those collapsed-value assets are the collateral the banks were holding against the loans and when the assets are marked to a 20% down market value the banks don't have enough capital to extinguish the losses so they are insolvent. By law they are then taken into receivership and restructured or dissolved, but now bailouts that are presumed to be funded by future taxes keep 'too-big-to-fail' insolvent banks alive.

The Fed has created something over $1 trillion of new money to buy toxic assets from failing banks, but this new money ends up on the asset side of bank balance sheets where they must hold it against their liabilities on the other side of the sheet. The banks were failing because the value of their asset side was shrinking. The Fed replaced shrinking assets (mortgages and other loans the banks had made) with "cash".

But banks have to HOLD their assets, or trade or sell them for better assets, so they can meet their liabilities as demanded. So the banks have to hold the Fed's cash, or trade it for a better asset. As an asset cash is sterile for the banks, it pays no interest. What asset is as liquid as cash AND pays interest? Treasury debt for one. And "excess reserves" deposited at the Fed which now pays interest. Any way you slice it this new Fed cash is locked into banks' balance sheets and cannot 'escape' into the economy and contribute to inflation.

Meanwhile bank capital is being destroyed liquidating loan losses. People are paying down their debts which extinguishes both the debts and the deposit money that those bank loans created. Money supply is deflating and GDP is deflating with it.

The Fed can reflate equities markets by making free money available to GS and JPM to game the markets, but this rally is a mile deep and an inch wide. The government can generate some GDP and real estate blips upward with cash for clunkers and $8000 first time homebuyer grants, but on the one hand these are just pulling forward future demand which will leave holes in the future, and on the other hand these are being financed with your future tax payments which will produce holes in your spending later.

This is not "the economy" growing. This is just a transfer of debt from private borrowers (who have quit and gone home) to public borrowers who want to keep playing.

After a really good run since 1947 we have finally reached terminal debt. The economy has reached its debt ceiling and cannot or will not borrow any more. Rapid population growth and productivity growth in the postwar period easily absorbed all the new debt-money that was being created as America's middle class took on mortgages and raised families. That trend is over and there is no new impetus of sufficient scale for renewed economic growth on the horizon.

So from here into the foreseeable future debt growth will trend downward and GDP will sink with it, unless the Fed comes up with some innovative QE program that can reduce total debt without simultaneously collapsing asset prices and the banking system. The secular trend is deflationary. CPI prices will inflate only if the dollar declines and oil and other imports become more expensive (stagflation). But asset prices are in a secular decline and only a renewed period of inflationary real economy growth can reverse this trend.

Oct 15 07:49 PM

[Tack:]

Just two quick rebuttals:

1) The current situation is nothing --not even close-- like the '30's deflation. In the '30's the money supply, due to a tragic government mistake, contracted from 1929 to 1935, whereupon it began to exapnd again, but didn't even reach 1929 levels, again, until the end of 1938. This was the proximate cause of the deflation, and the government's lack of recognition of the mistake they made, followed by a rather tepid attempt to correct it, resulted in many years of deflation and stagnant economic circumstances.

There was debt contraction then, and debt contraction now, but, now, there''s been a flood, worldwide, of currency introduction that will have dramatically different consequences than the '30's.

The trouble is that in today's impatient world if we don't see the logical and inevitable effects of these actions in a few months or a year, we immediately conclude that 'this time it's different," and formulate new theories. It's not different, and the consequences of a monetary flood will be the same as they've been in all other economic contractions, but possibly more so this time, given the unprecedented magnitude of the monetary largesse.

2) Everybody repeats over and over, ad nauseum, that all that new capital is tied up on bank balance sheets and isn't and won't be used for anything other than to counterbalance worthless paper, that, if it were marked own to true market values, would make many banks insolvent.

There are two problems with this argument: a) the mark-to-market values that critics espouse were/are nothing more than the result of highly-manipulated and thinly-trade debt indices that clever shortsellers used, in conjunction with CDS positions, to decimate bank balance sheets and the market. They bear no relationship whatsoever to classical valuations based on actual cashflows being received and expected to be received by the actual note holders. That's why holders of debt assets re unwilling to dump them at nonsensical prices, thankfully, as this would result in the destruction of the financial system because fictitious losses, represented by "market" values, would suddenly be realized; b) for those that wish to track such information, the beleaguered debt indices that created all this angst have been steadily rising for several months, narrowing the gap between the genuine value of debt assets and the hysterical values previously created in the markets. Soon, this will result in the banks having excessive reserves that will start to be released back into earnings and will result in the banks being overcapitalized.

When the foregoing happens, banks will start looking assiduously to put all that "dead" money to work. Coupled with increasing confidence by the vast majority of people employed, this will result in an increase in loan demand that will find amply funds to service it.

The real risk for this economy, as with previous periods of monetary largesse, is that the government will fail to make timely reduction in the money supply until the demand-inflation cycle is well under way, so we'll get the same inflation that has followed most recessionary recoveries.


On Oct 15 07:49 PM derryl wrote:

> Tack wrote,
> "This scenario has been repeated time and again throughout history.
> The price of everything, as measured in fiat currencies, only progresses
> higher over time. The idea that prices will decline systemically
> and stay there has no factual historical basis whatsoever."
>
> The deflation we are talking about is not the idea that prices will
> decline and stay there forever. It is the historical precedent of
> the 1930s balance sheet depression where asset prices (stocks and
> real estate) collapsed and took decades to recover to their 1929
> nominal prices. CPI does not change in direct relation to money supply
> (productivity gains can produce more goods to absorb increased money
> without prices rising, for e.g.). Asset prices do. So it's asset
> prices that inflate and deflate, not CPI prices.
>
> Loan defaults and personal and bank bankruptcy all destroy money
> supply. Money supply and GDP move together, both up and down. So
> when money supply is contracting/deflating GDP contracts/deflates
> with it. Unless there is some renewed exuberance among borrowers
> to take on new debt to re-expand the money supply and the economy,
> the contraction can continue for a very long time. That's where we're
> at right now, overindebted, losing jobs, defaulting and going bankrupt,
> and unwilling or unable to take on more debt.
>
> A balance sheet recession happens when too many people took on more
> debt than they can repay, especially if their income takes a hit,
> and the asset prices that were supported by that debt-money collapse.
> Those collapsed-value assets are the collateral the banks were holding
> against the loans and when the assets are marked to a 20% down market
> value the banks don't have enough capital to extinguish the losses
> so they are insolvent. By law they are then taken into receivership
> and restructured or dissolved, but now bailouts that are presumed
> to be funded by future taxes keep 'too-big-to-fail' insolvent banks
> alive.
>
> The Fed has created something over $1 trillion of new money to buy
> toxic assets from failing banks, but this new money ends up on the
> asset side of bank balance sheets where they must hold it against
> their liabilities on the other side of the sheet. The banks were
> failing because the value of their asset side was shrinking. The
> Fed replaced shrinking assets (mortgages and other loans the banks
> had made) with "cash".
>
> But banks have to HOLD their assets, or trade or sell them for better
> assets, so they can meet their liabilities as demanded. So the banks
> have to hold the Fed's cash, or trade it for a better asset. As an
> asset cash is sterile for the banks, it pays no interest. What asset
> is as liquid as cash AND pays interest? Treasury debt for one. And
> "excess reserves" deposited at the Fed which now pays interest. Any
> way you slice it this new Fed cash is locked into banks' balance
> sheets and cannot 'escape' into the economy and contribute to inflation.
>
>
> Meanwhile bank capital is being destroyed liquidating loan losses.
> People are paying down their debts which extinguishes both the debts
> and the deposit money that those bank loans created. Money supply
> is deflating and GDP is deflating with it.
>
> The Fed can reflate equities markets by making free money available
> to GS and JPM to game the markets, but this rally is a mile deep
> and an inch wide. The government can generate some GDP and real estate
> blips upward with cash for clunkers and $8000 first time homebuyer
> grants, but on the one hand these are just pulling forward future
> demand which will leave holes in the future, and on the other hand
> these are being financed with your future tax payments which will
> produce holes in your spending later.
>
> This is not "the economy" growing. This is just a transfer of debt
> from private borrowers (who have quit and gone home) to public borrowers
> who want to keep playing.
>
> After a really good run since 1947 we have finally reached terminal
> debt. The economy has reached its debt ceiling and cannot or will
> not borrow any more. Rapid population growth and productivity growth
> in the postwar period easily absorbed all the new debt-money that
> was being created as America's middle class took on mortgages and
> raised families. That trend is over and there is no new impetus of
> sufficient scale for renewed economic growth on the horizon.
>
> So from here into the foreseeable future debt growth will trend downward
> and GDP will sink with it, unless the Fed comes up with some innovative
> QE program that can reduce total debt without simultaneously collapsing
> asset prices and the banking system. The secular trend is deflationary.
> CPI prices will inflate only if the dollar declines and oil and other
> imports become more expensive (stagflation). But asset prices are
> in a secular decline and only a renewed period of inflationary real
> economy growth can reverse this trend.

Oct 15 10:12 PM

[William Flax:]

Those who argue for a deflationary scenario are sadly misguided. The only true deflationary scenario that actually reversed the damage of inflationary monetary policy and speculative mania was that which followed the fall of Rome. The pattern since is very clear. Even taking America--which until recently was relatively better off--contrast the Dollar at 1/20.67 ounce of gold with the current dollar at 1/(1045-10720 ounce of gold, in only 76 years of market and monetary cycles. Does anyone really believe that in 2016, just to pick a year, gold will be below $1,000 an ounce.

The politicians in Washington have undermined our freedom & birthright by taking the control of our own destiny out of our individual hands by economic gamesmanship. We may always have been dependent upon them to protect us from foreign foes, but what has led to the present mess was the result of an unconstitutional & unconscionable pursuit of uniformity in society, one of the things the Founding Fathers rose against, when it was directed out of London rather than Washington. Moving the site of the unconscionable intrusion makes it not one whit more tolerable.

Oct 16 11:52 AM

[ebworthen:]

Good article and on the money.

A crisis creates the need to recoup losses or desire to be greedy, and yet the opportunity for a mere few to actually do so.

Oct 16 09:21 PM

[fjd10595:]

There was debt contraction then, and debt contraction now, but, now, there''s been a flood, worldwide, of currency introduction that will have dramatically different consequences than the '30's.

I have to admit that your comment was long, and thus I did not read it fully, but I say this: the liquidity that has been added cannot have lasting effect until it is loaned or put to work in the economy. You say the 'banks will soon loan to the vast majority still employed'. I guess so, assuming that they want the money. Is is possible that we are about to embark on a multi year, or decade, time frame in which we spend more and save less? I would expect deflation, or something near it, for an intermediate period of time.

On Oct 15 10:12 PM Tack wrote:

> Just two quick rebuttals:
>
> 1) The current situation is nothing --not even close-- like the '30's
> deflation. In the '30's the money supply, due to a tragic government
> mistake, contracted from 1929 to 1935, whereupon it began to exapnd
> again, but didn't even reach 1929 levels, again, until the end of
> 1938. This was the proximate cause of the deflation, and the government's
> lack of recognition of the mistake they made, followed by a rather
> tepid attempt to correct it, resulted in many years of deflation
> and stagnant economic circumstances.
>
> There was debt contraction then, and debt contraction now, but, now,
> there''s been a flood, worldwide, of currency introduction that will
> have dramatically different consequences than the '30's.
>
> The trouble is that in today's impatient world if we don't see the
> logical and inevitable effects of these actions in a few months or
> a year, we immediately conclude that 'this time it's different,"
> and formulate new theories. It's not different, and the consequences
> of a monetary flood will be the same as they've been in all other
> economic contractions, but possibly more so this time, given the
> unprecedented magnitude of the monetary largesse.
>
> 2) Everybody repeats over and over, ad nauseum, that all that new
> capital is tied up on bank balance sheets and isn't and won't be
> used for anything other than to counterbalance worthless paper, that,
> if it were marked own to true market values, would make many banks
> insolvent.
>
> There are two problems with this argument: a) the mark-to-market
> values that critics espouse were/are nothing more than the result
> of highly-manipulated and thinly-trade debt indices that clever shortsellers
> used, in conjunction with CDS positions, to decimate bank balance
> sheets and the market. They bear no relationship whatsoever to classical
> valuations based on actual cashflows being received and expected
> to be received by the actual note holders. That's why holders of
> debt assets re unwilling to dump them at nonsensical prices, thankfully,
> as this would result in the destruction of the financial system because
> fictitious losses, represented by "market" values, would suddenly
> be realized; b) for those that wish to track such information, the
> beleaguered debt indices that created all this angst have been steadily
> rising for several months, narrowing the gap between the genuine
> value of debt assets and the hysterical values previously created
> in the markets. Soon, this will result in the banks having excessive
> reserves that will start to be released back into earnings and will
> result in the banks being overcapitalized.
>
> When the foregoing happens, banks will start looking assiduously
> to put all that "dead" money to work. Coupled with increasing confidence
> by the vast majority of people employed, this will result in an increase
> in loan demand that will find amply funds to service it.
>
> The real risk for this economy, as with previous periods of monetary
> largesse, is that the government will fail to make timely reduction
> in the money supply until the demand-inflation cycle is well under
> way, so we'll get the same inflation that has followed most recessionary
> recoveries.

Oct 20 08:21 AM

[Tom C.:]

I wish there would be more references to the work of the late Charles Kindleberger of MIT who wrote several editions of "Manias, Panics and Crashes." The last edition was in 2005 but is being updated by his collaborator. This work includes Mackay and all such events since then right up to the dot com bubble. www.amazon.com/Manias-...

Oct 22 12:34 PM