U.S. Economy on the Brink; Metals, Solid Currencies Are Best Option

The SEC banned short selling at 3 am, on Friday morning, propping up the share price of a long list of financial stocks, including Citigroup, Wachovia, WaMu, Morgan Stanley, Goldman Sachs, and about 794 others.  This rule will expire on October 2, 2008.  Christopher Cox, Chairman of the Securities & Exchange Commission, came out with a statement:

The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets.  The emergency order temporarily banning short-selling of financial stocks will restore equilibrium to markets.

There is only one problem.  It is not the short seller who is manipulating the markets.  The government, working with Wall Street investment bankers, is trying to manipulate the market.  They are taking a short-sighted and foolish path.  In fact, most short positions are taken not for the purpose of speculation, but, rather for hedging long positions.  Without the ability to short sell, institutional buyers will not buy long, and especially will not buy convertible bonds.  This means that it will be much more difficult even for solvent companies to raise private capital, and, after the initial short squeeze is over, stocks will slump in the longer run. 

Now, with an oncoming $700 billion bailout of financial firms, and a $1.8 billion total layout by the government to help struggling financial firms and their billionaire owners, America’s pretense to being a capitalist economy is shot full of holes.  Our markets are clearly not free.  Some participants in the market are favored over others, and the government is going to socialize the losses of financial firms, while allowing executives to keep the privatized profits.  Our leaders have adopted principles and practices reminiscent of the old Soviet Union, not the nation we once knew, loved, fought for, and believed in. 

The current situation did not develop overnight.  It has been brewing for at least 21 years, through both Republican and Democratic administrations.  First, there was the Greenspan put, a mantra that promised Wall Street players that the Fed would react to every little perturbation on Wall Street by handing out gifts, like cold hard cash, and interest rate cuts.  Second, there came Helicopter Ben, who promised to do money drops from aircraft, if deflation ever reared its ugly head.  These men, and their attitude toward micro-managing the stock market and the economy, created the moral hazard that directly led to irresponsible and foolhardy action within the financial industry.  The free market was not allowed to do its job.  Investment banks were supported, by low interest rates, and the free availability of the taxpayer supported federal funds.  This created ever-rising stock prices, collateralized debt obligations, Option ARMs, no-money-downs, and interest-only mortgages, as well as soaring home prices.  They called it “creative finance”, but, in reality, it was simply stupidity.

Most of the stupidity was denominated in dollars, but the real name of these little green slips of paper we use as currency is not really the “dollar”. Since 1913, and the formation of the Federal Reserve, the real name of our currency is the “U.S. Federal Reserve Note”.  If you look at one, you will see that printed at the top of the bill.  It just says that it is supposed to be “worth” a certain number of dollars, but, in truth, it no longer is.  The modern dollar is merely a claim upon the balance sheet of the U.S. Federal Reserve, the central bank of the United States.  The real “dollar”, in contrast, was a weight measure of exactly 371.25 grains of pure silver.  Later, in 1873, the dollar was redefined as a weight of gold approximately equal to 1/20th of a pure troy ounce of gold.  In 1933, some fifty years later, however, the U.S. government defaulted on the gold standard, and the resulting shock caused the Great Depression.  For more information on how the government lies about being on the gold standard, caused the Great Depression, see http://seekingalpha.com/article/94635-stagflation-or-deflation .  Since we’ve left the gold standard, the U.S. dollar has depreciated by 45 times, or 97.78%, in relation to gold.  What will it be worth 75 years from now? 

The founding fathers were wise men.  If we had never strayed from their dictates, we wouldn’t be having so much economic trouble now.  Article I, Section 10, of the U.S. Constitution provides, in pertinent part, that:

“…No state shall enter into any treaty, alliance, or confederation; grant letters of marque and reprisal; coin money; emit bills of credit; make anything but gold and silver coin a tender in payment of debts…” (emphasis added)

How then did we end up with a paper money system?  If we had been true to the vision of our Founding Fathers, we wouldn’t have had the first Great Depression, because the dollar would have been a gold coin.  There would have been nothing for the government to redeem.  They wouldn’t have been able to break their promise to the people, and people wouldn’t have lost faith.  Instead, that era would have consisted merely of a short panic-recession, and that would have been that.  We would also not be where we are today, because the fractional banking system, and creation of derivatives, in their present form, would be impossible if our money consisted of gold and silver coinage, and no paper bills.  The discipline of true scarcity of real rare metals would prevent the uncontrolled proliferation of money.

But, be that as it may. We are no longer on the gold or silver standard.  But, our government has even debased the paper standard that we are on now.  About a year ago, the Federal Reserve balance sheet consisted almost solely of U.S. Treasury bills.  Treasury bills are not gold or silver, but they are highly liquid instruments that supposedly have the “full faith and credit” of the taxation power of the U.S. government, and have a broad market.  They can be bought and sold, and easily converted to cash. 

Last week, the Federal Reserve injected a total of $180 billion into the stock market, for the ostensible reason that the money markets “seized up”.  It was not the first injection.  They inject billions every day, except, last week, they injected an unprecedented volume of cash.  Most probably, this was done to prop up stock prices.  See, http://www.newyorkfed.org/markets/omo/dmm/historical/tomo/temp.cfm.  With help from arbitrary new SEC regulations, the government induced the biggest short squeeze in history, and the Fed succeeded in using its $180 billion to pump up the DOW by about 800 points in two days.  The Federal Reserve balance sheet, however, is now composed of about $200 billion worth of Treasury bills, and $739 billion in highly default prone mortgage backed securities.  Last week, having bailed out so many of the financial companies, the Federal Reserve also needed some bailing out.  So, the U.S. Treasury sold another $100 billion in new Treasury bills to recapitalize the Fed.  If the Treasury continues to do that, it will squeeze private debt obligations out of the market, driving up interest rates, and preventing private companies from raising capital on the debt markets.  The only alternative is to simply print money, without regard to promising to pay it back.  This will trigger hyperinflation. 

The Fed cannot declare bankruptcy in the same way as an individual or a company.  It can’t file in a court of law, beg a judge for forgiveness, and get a little slip of paper, a few months later, saying that it is forgiven for its debts.  But, it is surely bankrupt.  The only way to recapitalize it is to print money.   That wouldn’t be so much of a worry, except that we must remember that the so-called dollar is really a “Federal Reserve Note.”  It is a claim upon the Federal Reserve balance sheet.  That balance sheet supports the value of the U.S. dollar, and, it is very close to insolvency.  More detail on the Fed balance sheet can be found at http://www.federalreserve.gov/releases/h41/Current . 

One thing is sure.  The economy is falling apart, and the more the government intervenes, the worse things will become.  I believe the best course of action is to sell out of index funds and stocks, and buy GLD, SLV, physical gold, silver, precious metals mining stocks, companies that own agricultural land, Swiss francs, and other solid foreign currencies.  All the world’s paper currencies will probably devalue in the near future, but the dollar will depreciate much more than most of the others. 

The United States of America stands on the brink of either hyperinflation, or economic depression.  The end result may well be worse than the Great Depression because, at least, back then, the Federal Reserve did not allow itself to come close to insolvency.  In either scenario, the wise man will NOT be holding many cash dollars, CDs, bonds, retail stocks, banks, insurance companies or most other stocks.

Comments

[Smarty_Pants:]

Spot on! Only point I would add is that the FED/Treasury are trying their best to push us down the road toward hyperinflation as a 'rescue' for the bankers. If Congress approves the bailout legislation as proposed, that's the path we're going to travel.

Summary of current approach to MBS problems at major banks:

"I will gladly pay you Tuesday, for a margin loan today."

A wee bit of humor for those old enough to remember watching Popeye cartoons as a kid.

2008 Sep 23 12:29 AM

[iknoknot:]

what hints should we be wary of, that indicate the next round of expected gata.org referenced gold manipulations are beginning?

none of the US-banks/central-banks... can afford to have their fiat currencies fail, and will certainly do what the have to, in concert, to break any major move to substantiated money systems...

and how do we counter those moves and protect what little we have left?

thoughts?

--ikk

2008 Sep 23 04:16 AM

[Alex Stanczyk:]

Wow, great article.

"Since we’ve left the gold standard, the U.S. dollar has depreciated by 45 times, or 97.78%, in relation to gold. "

www.rapidtrends.com/bl.../

2008 Sep 23 10:22 AM

[copperpenny:]

Oh Dear the blame game! As a society we want things fixed and quickly. Frustration tolerance would serve us well in the long term. Greed can keep us alive in a psychobiological perspective, but coupled with short sighted massive denial feeds behavior that is self destructive and has undermined the state of our political and economic system. Faith has been undermined and has a tendency to feed complacency . Hard assets look appealing. I hope we gain some wisdom from this current fiasco.

2008 Sep 24 12:53 AM