The Fat Man at the End of the Table

The US has a huge unmanageable deficit and growing debt. Twelve trillion and counting. This coincidentally is bumping up against their legislated debt ceiling. It will be ignored. This needs to be financed by selling more bonds at Treasury auctions. China and Japan have been the primary foreign purchasers of US debt so the big question is whether or not they will continue to feed the fat man at the end of the table? While they haven't stopped buying bonds yet, they are buying less and in shorter durations. Their confidence in the US is waning. Their actions speak of a lower tolerance for risk. To prevent an embarrassing auction failure, the Federal Reserve began a quantitative easing program, which is a fancy way of saying they participated at the auction by buying up the available debt with new money. New money dilutes the value of the existing pool of money. This explosion of money/debt creation, with it's attached interest, will be a growing burden for the taxpayer as debt servicing will consume a growing portion of the declining tax revenues. Normally this should signal a policy shift toward less government spending, instead the Obama government is expanding it's waistline. The U.S. is moving swiftly towards more government control. This is extremely concerning for investors around the world who have served up cheap credit over the past decade.

The currency markets are pricing in the weakening US dollar. It has been in a long term downward trajectory since it's high in 2002 when it topped at $1.20. After a few temporary interruptions it's now sitting around 75 cents. The Fed hasn't tried to defend the dollar by raising the interest rates to entice risk takers to buy more of their debt, nor has the government attempted to show any kind of fiscal restraint. So despite talking about their desire for a strong dollar, the actions display a willingness to let the dollar depreciate. This is likely on purpose as the preferred strategy to pay back the debt with devalued dollars and to promote exports. Debts are static. The conventional wisdom is that while the US buys time, the economy will hopefully recover, tax revenues will improve, and the debt will begin to shrink. It's a desperate gambit of a desperate nation. If this strategy fails, the dollar will be destroyed as the Fed will likely pump out as much money as the Treasury requires to prevent a default of some kind, making a mockery of the US dollar.

The effect of this hyper-inflationary monetary policy is that US imports will become more expensive. Think of oil in particular. As the cost of oil shoots up, costs of manufacturing and transportation rise in tandem, and while businesses will be reluctant to pass on that cost to a cash strapped consumer, margins will eventually get squeezed to the point where inflation of goods and services must take take hold. Many businesses will go bankrupt during this period of monetary inflation if they are unable lure enough customers into the stores. More layoffs, higher unemployment, less income, less income tax, weaker dollar and one can see how a death spiral manifests itself as assets deflate in value while costs inflate. A monetary collapse will wreck havoc on the global economy but the impact will most acutely be felt by the fat man. After decades of gluttony, he will have a heart attack. The US exported most of it's manufacturing base. They are proud, patriotic consumers and to this day feel they were doing the world a favour by eating it's products. This is the depth of their egocentricity. Now they are lecturing that we, the world, cannot rely on the US consumer anymore and we need to step up to the table and start consuming domestically while they digest the debt.

Other countries linked to the economy of the US need to react to this devaluation. China's growth is dependent on exporting cheap products to the US. They need to keep their currency pegged to the dollar to keep their exports viable. This takes a toll on their imports. Again think oil and commodities involved in manufacturing all that stuff they produce. They will feel the pinch as they struggle to stay competitive. They propped up the US dollar by churning the money made from it's exports back into Treasuries, thus financing the US government, keeping interest rates low, by keeping the demand for them artificially high. This investment flows back to them as long as the trade continues. As significant holders of US dollars, devaluation will impact the value of their large US dollar reserves. China will likely reduce it's activity in future Treasury auctions and keep the purchases on the short term duration to keep their long term risk contained. They will also diversify out of their US dollars by purchasing hard assets. Buying real resources with US dollars while it still has some value. Stock piling reserves of oil, copper, gold and other commodities for future production would be prudent and expected. As the US economy drags, their exports will diminish, having a significant impact on their economy. The Chinese government is resisting this rebalancing by keeping the Yuan pegged to the Dollar. As long as their currency is below the US, their exports will remain competitive. They are preferring to take the hit of inflation rather than gain the advantage of buying cheaper imports with a stronger Yuan but with a weaker economy. Other countries that got mired in debt have similar problems. They too are in the quantitative easing mode in order to buy some time, and are devaluing their currency to keep their exports competitive as well. Any country with a strong currency will see it's exports get priced out of reach. This unhealthy dependence on the US for it's own economic well being is a sore spot. Competition is fierce as they all race to the bottom.

While the money supply is inflating, it is being contained within the banking system as they hoard the reserves at low risk. They borrow from the Central banks at zero per cent, while collecting a small tidy interest while they keep it on reserve. They need this cash in order to have any semblance of solvency because most of the big banks are taking a huge loss on real estate loans. The Fed is also buying much of their toxic mortgages. The big banks are being propped up while many of the smaller regional banks are going bankrupt. The 'too big to fail' banks are getting bigger. Financial power is being concentrated. The expected hyper-inflationary scenario won't play out until these reserves get loaned out into the general economy, however for that to occur, the demand for credit from businesses and individuals need to emerge. The consumer is maxed out, so the demand is not there, and they have already pulled forward future needs with credit, thus most of the needs are satiated. The governments feels they need to stimulate the economy by being the spender of last resort. Thus the supposed need for stimulus programs which puts more debt onto the already overburdened taxpayer. It all becomes rather circular.

The US will not have the funds and resources to maintain all it's obligations. The quantitative easing must end to prevent a complete loss of trust in the currency, if it's not already too late. In order to attract much needed investment back into the country, interest rates will have to rise. This will squeeze the indebted citizen. This will curb any chance of a recovery and this will not be politically popular. The other strategy to stimulate demand for US debt is to induce a stock market crash. This would hopefully push the money back into the traditional safe havens. Wealth will be wiped out but the government will have it's money to service the loans. One way or the other, the bills will have to be paid. As the citizenry get more desperate and angry, civil unrest will become more prevalent. Global trade will likely collapse as governments will feel pressured to keep jobs within it's borders. Economies will become leaner and more local. The rebalancing will occur. Meanwhile the fat man at the end of the table will suffer the hunger pains once he realizes the days of living off cheap super-sized junk food has ended, and hopefully he gets off the chair and starts working again to produce something for a change. Let us hope it isn't a war.

The Big Lie

Life begins fresh every morning as we turn on our television and radios. The past is yesterday's news. The DOW is over 10 000 again. Everybody with money still in stock markets cheer and pat themselves on the back for not selling at the panic low during the big scare. Memories are short. The DOW first breached the 10 000 level over ten years ago. It would be fun to go back and read what the stock market gurus and the legions of financial advisers were advocating in those ebullient years. The self proclaimed experts are loathe to revisit the past because it reveals their lies, deceit, bias, or just plain blind optimism. The short attention span of the mainstream media plays right into their hand. We went from all time highs, to near collapse, and back to huge profits and bonuses for the banking elite all within a year. This is crazy. A well functioning financial system should not be gyrating from one extreme to the next. The economists are convinced the economy is recovering and the compliant media are quick to report it. This only has the veneer of truth. Scratch the surface and you will find little substance. The narcissistic banking elite care not for the truth. For them, the facts are to be twisted and distorted to serve their own selfish interests.

Narcissists are happy until they don't get what they want. Then they huff and puff, create havoc, plead, sulk, and generally make the lives of everyone around them miserable until they get what they want. The wise person knows enough not to give in, otherwise it reinforces the bad behaviour. Money managers who were collecting huge bonuses were slapped back into reality in 2008. Their fantasy of endless profits and stock market gains came crashing down as a direct result of their greed and malfeasance. They pointed the finger elsewhere while they held out the other hand for a bailout. Politicians who are prone to short term thinking and self interest looked the other way, handed them billions of taxpayer dollars, and now the petulant are happy again, gloating even, basking in the pile of fresh money still warm from the printers. The political class are in cahoots with the money men. The problems that nearly led to the collapse of the global financial system appear to have abated. The stimulus and bailouts appear to have worked. The barometers of a healthy economy are suggesting a recovery. Stock markets have bounced back with ferocity posting incredible gains. The GDP numbers have turned positive. The recovery is underway, or is it? Just because a story is stated over and over again, doesn't necessarily make it true.

Stock markets have bounced back. That's a half truth however. After missing the tell tale signs of a looming economic crash, the experts are now smugly chiding everyone with money on the sidelines for not participating in the rebound of the equity markets. The message is clear. Time to reinvest in riskier assets where there is a return on your investment, so they say. Central banks have lowered interest rates to essentially zero. That's great for borrowers but not so good for savers. Everyone with savings who don't want to participate in stocks, takes the loss. What is an investor to do? Agents of the financial industry want our money. They will say anything to resist our urge to take it away from them and put it elsewhere. Contrary to popular belief, equities do not always give you better returns, even in the long term. The returns of all the major stock indices around the world are down over the past ten years. An even more startling fact, that is rarely brought to light, is that the DOW has returned nothing since the mid sixties once it has been adjusted for inflation. The trusting buy and hold equity investor who invested in the biggest of the blue chips has had to endure a lot of stress and risk for almost half a century only to come up even.

The graph that is always trotted out showing the incredible gains is deceiving because it isn't adjusted for inflation. Those gains were only possible because of the loose monetary policies of the government and central banks. Inflate the money supply and the price of everything goes up, including stocks. Coupled with institutional encouragement of private retirement plans, the equity ball got rolling, drawing more and more people into it. Money that should have been put toward paying down large mortgages were redirected into speculative stocks. Even conservatively managed pension plans felt compelled to take on more risk to keep up with it's burgeoning obligations. Seniors in retirement or nearing retirement were encouraged to put a good portion of their nest egg into equities for growth. They were practically forced into it with interest rates so low. The financial industry became very profitable as a result of this new found tolerance of riskier assets. The all pervasive sell job pushed equities higher than they deserved to be. The systemic embrace of equities, coupled with loose monetary policies fuelled the stock market gains over the past couple of decades.

The modern financial system organized itself around the belief that sustained economic growth and the associated stock market gains would continue unabated. Witness the fallout and subsequent reaction of the latest downturn. From celebrating rapid gains in stocks and real estate, the near collapse of the entire system was followed by an unprecedented intervention of governments and central banks globally. Stock markets are not allowed to go down. They have become the barometer of our economic well being. Risk taking and stock market participation has been the elixir to cure all financial problems. As long as they kept going up, everyone was happy. However the dark side to all this pleasantry is that the future financial well being of the population was now directly linked to a fragile, temperamental market that historically has not provided much wealth to it's participants.

The stock market has bounced back. Don't be fooled though. It was orchestrated through secretive complex market machinations. The bankers and politicians needed the stock market to go up and they made it so. The latest rally was not fuelled by organic growth of a recovering economy or by widespread re-investment from the retail investor. Mutual fund flows are going into bond funds, not equity funds. Volume of trading is low. Goldman Sachs and their ilk are the savvy ones with the means to move markets. They were given access to cheap money and they were given a government guarantee that they will not fail. The system is rigged to loot the taxpayer and unwitting investors. The real economy is not healthy. Retail sales are languishing. Businesses are struggling. Unemployment remains very high. Real estate is still bottoming in the US. The banks are still holding toxic assets. The rosy GDP numbers include government spending which has been accelerating. Deficits are ballooning. Price to earnings ratios of stocks are at historical highs. Unless real substantial measures are put into place to reckon with the structural imbalances of the global economy, and the suffocating debts, there will be no lasting recovery. This so called recovery is a fabrication of epic proportions. The people at the helm are narcissistic, pathological liars. They are aided and abetted by a subservient financial press and a generation of trusting stock investors who want to believe that everything is just fine. Remember that those who make a market go up can make it go down. Stock markets have always been fraught with risk and that is more true today than ever.

Quote of the Week

Make no mistake about it: in this credit collapse we are witnessing the death throes of irredeemable currency. In vain have governments and their client banks tried, for hundreds of years, to graft this repulsive and degenerate bastard on the living organism of society. The result was always the same: the healthy organism rejected the unnatural implant in its own good time. The present episode is no different from earlier ones except, perhaps, in the degree of the conceitedness of the perpetrators, and in their contempt for the native intelligence of man.

Dr. Fekete

Faith and Money

The brain is a mysterious organ, capable of incredible functions. We often give it too much credit however, as it is largely run by it’s programming. Bad input produces bad output. Creative independent thought is rare. As such our view of the world is seen through the lens of our teaching, but that is tempered with our experiences. If our experiences mesh with our programming our beliefs are confirmed and strengthened. If our reality does not mesh with our programming, our perception of something is strained. The effect of such a strain can develop in various ways. An absolute denial of the reality gap can occur in which the belief is steadfastly held despite overwhelming evidence to the contrary. Occasionally our experiences are so extreme that the belief cannot hold up and there is a loss of faith. The land in between is a period of reflection, open mindedness, and indecision. Cultural inertia is very powerful but there are moments in time when reality is so at odds with the prevailing belief that it forces people to re-examine the default position, and if enough people do so, and adopt a new perception, a cultural shift will occur, and in time those who maintain the old belief will look foolish.

Currently a strain is developing on our perception of our financial system. Our cultural programming is being tested against a strong flow of evidence that challenges it’s very foundation. Our strongly held belief in the stability of the financial system is weakening. The mass of people are unaware of how dire the situation is, but make no mistake, those who are on the front lines are very worried. The high priests of the economy are squirming because their model, their belief system, is not meshing with reality. They keep pulling on the same old levers but the desired effect is not happening. When a model is failing, distortions reveal themselves such as gyrating stock markets that are unhinged from the fundamentals. Extreme measures are taken to react to the distortion which only serves to exacerbate the condition because they are not addressing the root problem. A crisis brought about by excessive debt and low interest rates cannot be cured by creating more debt and lowering interest rates to zero. Below the headlines, complex manipulations of the markets are ongoing in an effort to disguise the fragility of the old model. When pressed, Greenspan admitted his model was flawed. The only reason we have not had a complete meltdown is because the governments of the world have backstopped the financial system with unlimited guarantees. The underpinnings of the global financial system now rely on the government's ability to keep the faith, except that the math doesn't care how strong our faith is. It is what it is.

The minds of the financial gurus and the legions of followers are going through extraordinary lengths to rationalize the desperate measures that go against their own preaching. Free market capitalism and stock market gains were heralded as the gospel when profits were generated from the risk taking. Now that those risks are not being rewarded, but are instead bankrupting them, everyone who has taken a loss is looking for a government bailout. People forgot what risk is. You can't enjoy the big gains without the associated risk of big losses. The big banks made a series of bad bets and now they have gaping holes in their balance sheets. Few people know how deep these holes are since the truth is shrouded in secrecy. The money pledged thus far may not be enough. Bankers don’t trust bankers anymore. They don’t want to lend to each other because internally they know how dire the situation is and they don’t want to risk their capital with another bank that might be in a similar position. The government was forced to guarantee all loans. The credit freeze is loosening as a result. There is a calm. By that measure there has been an improvement. One thing is for certain, we will not know how bad things truly are until the bitter end, at which point it will be too late. Denial is the name of the game here. The central banks are in full blown damage control. The world is in a crisis brought about by taking on excessive risk and debt at all levels, and now the high priests in their wisdom are transferring that debt load from the banks onto the public. They are unwilling to claim responsibility for the failure of their policies. Instead they talk as though this was an unexpected act of God that could not have been foreseen. Not true. There was a chorus of intelligent, informed, outspoken people who sounded the alarm but they were dismissed as doomsayers. The public are becoming skeptical. For now they are cautiously holding onto their faith but there is a strain.

The economic model that we have been living under for the past few decades has been an experiment in financial engineering. The Central bankers and governments adopted an interventionist economic model. Rather than leaving the money supply stable and paying only for what we can afford, we as a society have bravely steered a course toward the path of least resistance. If there is a recession, stimulate the economy by spending more. If we can't afford something, borrow to get it. If there isn't enough money, print some more. We grew up with an ever improving standard of living or so it seemed. Many of us don't have a memory of hard times. We were led to believe that the modern economy can be managed to avoid significant downturns. A cult of buoyancy has evolved. Markets are not allowed to go down. The government always intervenes. The problem is that every time they intervened to correct an imbalance, it triggered an unintended consequence that required yet another intervention. Intervention after intervention required more and more adjustments to maintain the economic model. The underlying problems were only delayed, manifesting itself in a more extreme way down the road.

Meanwhile the money supply has continued to grow because it's easier to give away money than it is to take it away. The subsequent inflationary pressure has grown as well. Rather than abandon the constant financial meddling that created these imbalances, the government chose to meddle with the statistics that demonstrated the unpleasant effects of their meddling. Inflation and unemployment rates are no longer measured as they were in the past. If the price of beef goes up, that doesn't count because we can still afford chicken. If the price of a car goes up, that doesn't count because we are getting a better quality vehicle. If a worker has been out of a job for over a year, that doesn't count, because he is no longer considered an active job seeker and therefore is not unemployed. The statistics have been massaged to underestimate the reality. That has only served to disguise the failure of their policies, keep the population misinformed, and benefit those in control. For example, if the government is obligated to keep pensions indexed to inflation and the inflation rate is in the double digits, that cuts into their budgets. It's easier to manipulate the statistic down rather than ask the taxpayers to pay more and to receive less. The economy has not performed nearly as well as we have been lead to believe. Most of the perceived gains have been the result of excess credit and creative book keeping. This approach has been systematic for quite awhile now and the strain of the debt burden is at last revealing itself in a catastrophic way.

Our standard of living will deflate back to where it deserves to be. Where that will be, no one really knows. We are in uncharted territory. The day of reckoning will come and we haven't seen it yet. The governments intervened in an unprecedented extreme way. Look around you and ask yourself if your world has changed in an appreciable way. Chances are it hasn't, yet this financial crisis is real. The underlying problem has not been fully reckoned with. As long as the global economy is geared toward feeding a consumptive US that is out of money, there will not be a substantive recovery. A structural rebalancing needs to occur. If I, and the folks I pay attention to are correct, the next leg down will break the faith of the people. A cultural shift is underway and those who continue to invest according to the old gospel will look foolish. Most financial experts and advisers have lost credibility because they failed to see the worst financial crisis in modern history, yet they insist that they can forecast the nuances of a nascent recovery. The culture of credit is being discredited. The holy churches of the financial world are in decay.