Read Reed Hundt’s book, “In China’s Shadow”

By D H Smith, on July 13th, 2009

If you want to understand Democrat fantasies in the absence of financial constraint or common sense, read Reed Hundt’s book, “In China’s Shadow.” Reed Hundt is a permanent member of the American political class, a Yalie, a partner in a high-powered law firm, head of Bill Clinton’s FCC, and a member of Barack Obama’s transition team.

Free money is Reed Hundt’s great idea. Muggins, that is you me, the hard-pressed American taxpayer, should buy everyone from Nome to Tierra del Fuego a pension, healthcare, and education. By these means, the United States will win in the economic competition with China that furnishes the title of his book and a small fraction of its other content.

No, it’s not a joke. People with power and influence really think this way.



2 comments   Book Reviews   , , ,  

Raze The Fed

By Trace Mayer, on July 13th, 2009

The FRN$ illusion is under increasing pressure.  In The Age Of Turbulence Alan Greenspan wrote on page 483, “But the dysfunctional state of American politics does not give me great confidence in the short run.  We could instead see a return of populist, anti-Fed rhetoric, which has lain dormant’.  Despite receiving no significant coverage in the evaporating government managed press Ron Paul’s bill to audit the Federal Reserve, H.R. 1207, has attracted 260 cosponsors.

GREENSPAN AND THE FED DESTRUCTION

Alan Greenspan occupied the position of Chairman of the Federal Reserve from 11 August 1987 to 31 January 2006.  During this tenure that spanned four presidential administrations derivatives ballooned as the financial markets shot towards space thinking they were free of the constraints of monetary gravity.  But gold’s gravity will not be defied.

Greenspan knew or should have known that the rise of the derivative markets would pose systemic risk to the fiat monetary and fractional reserve banking system.  Almost tongue in cheek he quips, “I fear that my successors on the FOMC, as they strive to maintain price stability in the coming quarter century, will run into populist resistance from Congress, if not from the White House.”

To combat this resistance Reuters reports that the Federal Reserve is going to hire Linda Robertson.  She is a veteran lobbyist, former VP for government affairs for evaporated Enron, assistant Treasury secretary for legislative and public affairs under President Bill Clinton and is currently at Johns Hopkins University as head of government, community and public relations.

ROLE OF GOVERNMENT

On page 481 Dr. Greenspan also hit on the real issue with regard to monetary policy:

I have always harbored a nostalgia for the gold standard’s inherent price stability – a stable currency was its primary goal.  But I’ve long since acquiesced in the fact that the gold standard does not readily accomodate the widely accepted current view of the appropriate functions of government – in particular the need for government to provide a social safety net.

The Industrial Age saw the rise of gargantuan welfare and warfare states which view humans as livestock which are reduced to ‘material input’ for the system which harvests their milk and meat.  Whether toddlers marching off to government schools, the youth marching off to Normandy or Vietnam, the middled aged marching off to the assembly lines in manufacturing plants or accounting firms, the aged being wheeled off to nursing homes or the fully depreciated being hauled off to their final burial place there was one commonality:  coerced taxation.

The premiment form of taxation to perpetuate this illusion of safety nets has been inflation.  The Federal Reserve with its little green coupons has been able to engage in confiscation through inflation which is a form of taxation without representation or due process of law.  Additionally, as William Grieder asserts in Secrets Of The Temple:  How The Federal Reserve Runs The Country the federal government and Federal Reserve deliberately induce recessions to lower inflation and interest rates.

EVAPORATING ILLUSIONS

Just ask the graduating college seniors with a commencement into the worst labor market in decades.  Even worse, the Wall Street Journal reports that their wages will be lower their entire working life.  Perhaps Obama, who they largely voted for, will buy them something besides Ramen to eat.  But really they should be happy to have even Ramen.

Next are the middle aged who are entering their peak earning years.  The responsible who got good grades and a good job, following the traditional path to be harvested, are now saddled with mortgages, declining home prices, being milked overtime by their employers without being given extra rations, perhaps have some medical related debt and know they will never see the benefits of Social Security or Medicare that gouge their paychecks.  The irresponsible are drowning in unreasonable credit card debt.  This group is debating whether to file bankruptcy or pay their debts.

The Baby Boom generation are entering their golden years with eviscerated 201Ks.  This group diligently saved for years and has seen the purchasing power evaporated in a matter of months.  The country they grew up in is a distant memory and the current state of affairs is almost unrecognizable.

The politicians realizes the cost benefit analysis of this demographic and since involuntary euthanasia is currently prohibited the federal government does the next best thing; it subsidizes genocide with multi-trillion dollar prescription drug plans to purchase death pills like Vioxx which was FDA approved and killed over 50,000 people.  If the Reaper does not visit soon then at least this demographic is kept in a comatose state.

Each of the demographics are being assaulted by the economic conditions.  All demographics are encountering incredible stress from monetary issues.  Each of the demographics is pitted against the other by the various government policies.  All are united as their faith in ‘the system’ and the illusion is rapidly evaporating.  Many wish they had an adhesive remover pen.

PROPER ROLE OF GOVERNMENT

Tough economic times require tough decisions.  Government is a parasitic organization and in the long run must have the consent of the governed.  The livestock are getting restless.  They are flailing, grasping and searching for better ideas; actionable ideas that will help heal their economic wounds.

On page 468 Dr. Greenspan wrote:

In my experience, the most important is the nature of our rule of law.  I do not believe most Americans are aware of how critical the Constitution of the United States has been, and will continue to be, to the prosperity of our nation.

The first step in healing the economic wounds is understanding that virtually everything the government, which acts almost completely outside the bounds of the Constitution and The Declaration of Independence, and its paid allies say is false. This step is essential to withdrawing consent from the costumed thieves, coercers, professional liars and killers; like former officer Johannes Sebastian Mehserle who is being charged with murder for the execution of Oscar Grant.  The withdrawal of that consent, even if exercised through civil disobedience, has a massive effect on the costumed parasites.

The secretive Federal Reserve is outside the bounds of the Constitution.  The FRN$, not a real dollar, is outside the bounds of the Constitution.  These are the primary tools used to oppress The People, who are the sovereigns, and keep them in their role as livestock.

Gold and silver are not mere barbaric commodities but essential checks and balances in the political machinery and played a vital role in the waning prosperity Americans currently enjoy.  British Sovereigns have that name for a reason.  Those who buy gold or silver seize sovereign wealth and asset their independence; they have a voice in the future.

Auditing the barbarous relic called the Federal Reserve and abolishing it and its little green ticket, the FRN$, will be great steps towards putting America the country back on a firm foundation for economic prosperity.

CONCLUSION

The age of turbulence has arrived.  The illusion so many have lived within is rapidly evaporating.  The Great Credit Contraction has begun (It seems Mr. Bonner of the Daily Reckoning has decided to use my phrase).  All the demographics are seeing their ability to enjoy life and pursue happiness impinged by economic conditions.  This Greater Depression, that we are only a couple years into, will likely leave an indelible impression upon those under 40 and radically alter their behavior for the lifetime just like those who went through the two decade Great Depression.

The Greater Depression need not continue into ‘the coming quarter century’.  The solution is extremely simple to start:  (1) remove any taxes on gold and silver, (2) remove legal tender status for the FRN$, (3) raze the Federal Reserve to the ground and (4) repeal the Sixteenth Amendment.

Will there be a difficult adjustment process?  Sure, it would be the destruction of a world reserve currency; but that is happening anyway just in slow motion.  Why prolong the pain and continue misallocating resources?  The turbulence would last perhaps for six months instead of a quarter century and then America will be back on its solid economic foundation and can become a tremendous wealth generator like it was.  Let your Congress Critter know your opinion; after all they work for you.



One comment   Monetary Policy   , , , ,  

TARP Warrants: A Boon for Taxpayers?

By Eldon Mast, on July 13th, 2009

On Friday it was announced that State Street Corp. became the first of 10 large banks to repurchase warrants held by the US Treasury. The warrants were put in place to assure that taxpayers are rewarded for their collective TARP loan to banks as the finance sector recovers.

The transaction occurred on Wednesday and cost State Street $60 million dollars. The proceeds flowed directly into US government coffers. The transaction sets the warrant bar for the nine other top banks who have collectively repayed $66B in rescue aid principal, but have yet to retire their warrant obligations by negotiating deals with the Treasury.

The State Street transaction equates to $30M per $1B borrowed. That could well mean that the other nine banks are looking at a collective $2B payback on their $66B.

The warrant deals are politically sensitive, with congress calling on the Treasury to drive a hard bargain on behalf of taxpayers. Banks have complained that valuing the warrants too highly could impede the goal of restoring health to the financial system. (I’ll use that line on my bank loan officer the next time and see how well it works)

For taxpayers (many of which viewed the bailout monies as a gift rather than a loan to the banks) are now reveling in the reality that they’ve just made a quick 3% gain in less than a year.

A quite healthy return in the current investment climate.

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Is a Deflationary Gold Standard Bad?

By Bron Suchecki, on July 10th, 2009

I’ve never really got why a gradual deflationary bias was a problem. Consumers know, for example, that just about any electronic good (computers, plasma screens etc) will get cheaper in the future, yet this does not seem to stop them from being made and bought. The fact that only those people who really really want the good will buy it and those are no so enthused will wait until it gets cheaper does not seem to stop business from making money.

If it was conspicuous consumption fueled by debt (and an inflationary bias) that got us into this mess, then would not a system with a deflationary bias be the solution? It has a built in frugality: your money will have more purchasing power in the future, so only buy today what you actually need. People would also only want to take on debt if they were actually going to be productive/efficient rather than just trying to bubble up asset prices. Now maybe if we can convince Greenies that a Gold Standard would work against consumerism and thus be good for the planet, we’ve got a chance.

The above thoughts were prompted by these comments left at this article Gold Standard … Debunked or Another Bubble?:

Dirk, on November 24, 2008 at 12:58 pm, said:

I’m happy someone gets it- that constraining global economic activity based on a single metal that doesn’t really correlate to economic activity makes no sense.

Clearly, the gold standard is deflationary in absence of either major gold finds, or major negative economic shocks. More goods and services chasing a fixed money pool will create massive downward pressure on prices. And downward pressure on prices and assets equals lower incentives for investment, more difficulty paying off debt, and a negative wealth effect that creates real economic stagnation.

Inflation, on the other hand, creates pressure to invest money- not hoard it. As long as a currency promises a future redemptive power, it will keep its value. Perhaps fixing currency values to a “total energy” metric- the sum of all oil, coal, gas, solar, nuclear, etc. reserves- would allow for both economic growth and a guarantee of some future redemptive power for something really useful.

16 Stanley Pinchak, on November 25, 2008 at 2:03 pm, said:

Wow so much muddled thinking in one place. It is amazing that my browser didn’t pop up a warning.

1) Any stock of money sufficient to be accepted by the public as a money and selected as the medium of exchange is capable of serving as money. There is no need to grow the stock of money. Despite this false criticism, the gold stock does grow at a predictable (by mining engineers) and low rate between 1% and 3% per year.

2) The purchasing power of a money is related to the stock of money and the demand for money. Its purchasing power is also related to the supply and demand for all other goods in society for which it is exchanged. Thus as productivity increases, the purchasing power of a stable or slowly increasing money will increase. This has the effect of making daily expenses of those with debts easier to bear.

The only time a debt would become harder to pay off would be if the debtor was in a field of employment where his pay decreased in line with the increase in purchasing power of money. This might be a possibility, but at the same time that human actors today judge their debt burdens based on future expectations of income, those operating under a regime of increasing purchasing power of money would be capable of determining their expected future debt load capabilities. Those who guess wrong in such a situation are no different than those who bite off more debt than they can chew under our inflationary regime.

The biggest improvement that increasing purchasing power has is for savers and those on fixed incomes. Savers would earn interest + the difference in purchasing power between when they started saving and when they start consuming. This is the opposite of today where the difference in purchasing power subtracts from the interest and reduces the incentive to save. This will have the effect of greatly encouraging saving and the stock of loanable funds, driving interest rates to natural and sustainable low levels. This will benefit the saver/consumer in the future as well as the entrepreneur and the durable good consumer in the present.

Inflation on the other hand encourages debt based financing. It favors instant gratification, but since there are fewer savers since debt is the preferred method of financing, the purchases of today are not sustainable. The increase in consumption fueled by new money is not fully offset by the preferences of a ever shrinking class of savers who abstain from present consumption. This results in a business cycle like we see continuously under a system of bank credit expansion (ex nihlo). Inflation encourages capital consumption and not investment as Dirk claims. Empirical evidence of this is present in the dilapidated factories and rotting machinery of the American Rust Belt.

3) All business cycles (as in repeated and not caused by something like war or famine) are the result of fractional reserve banking and its concomitant ex nihlo credit expansion. There can be no stable and sustained economic growth under a fractional reserve banking regime. There will always be over-expansion combined with malinvestment, and and then retrenchment as the bad investments are liquidated. Attempting to tie a money to a commodity standard while maintaining a fractional reserve banking system is unsustainable. There will inevitably be calls for the creation of a central bank and lender of last resort as the bust causes bank runs.

The only viable solution is to realize that fractional reserve banking on demand deposit money is clearly a case of conflicting views of a contract and thus an untenable and invalid contract. How can a depositor demand a physical object which the banker (rightly?) assumes is lent to him for his purposes. A physical object must have a clear owner and can not be subject to control simultaneously by two parties of differing opinion under which direction to place the object. Thus demand deposits must be maintained in a warehouse fashion with 100% reserve maintained at all time. This eliminates the possibility of a bank run (in the historical sense and in the practical sense of potential damage to the depositor). Furthermore by limiting bank loans to funds deposited in time accounts (i.e. true saving) there will cease to be a business cycle.

4) The idea of a world central bank is superfluous with a free monetary system and 100% reserve banking. The main purposes of the central bank are to ease governmental expansion and to act as a lender of last resort. A world central bank will only lead to world bureaucracy. If banking is on a firm economic and legal foundation, there is no need for a lender of last resort. A world central bank is only an excuse for the establishment of world government. It can not prevent world wide business cycles while maintaining a fractional reserve banking system. Furthermore, if it maintained a 100% reserve banking system, it would still be subject to political considerations in open market operation and would still cause misallocations of resources, though not of the intertemporal kind as explained by the business cycle theory. The misallocations would result in privileged borrowers being able to bid resources from those who obtain the increase in the money supply last.

5) The myth that a gold standard would limit growth is preposterous. One of the greatest periods of economic (and population) expansion was obtained under a gold standard and under a period of increasing purchasing power of money (Cf. the 19th century). There is no theoretical nor physical restriction on the growth of economy based on a sound monetary system besides the subjective actions of individuals to save which allows for the implementation of longer and more productive production techniques.

The claim that unemployment is higher under a gold standard is also ridiculous. All non voluntary unemployment is the result of artificial restrictions on the movement of labor or its price. One must be careful not to make the mistake of comparing the unemployment rates of a central bank and fractional reserve banking boom period to an average or bust phase unemployment rate under the fractional reserve banking system which has persisted in the United States prior to its inception. Under a free market, all labor wishing to be employed will be. All state intervention attempting to reduce the ranks of the unemployed can only be obtained by reducing the well being of other actors in the economy. As such interventionist attempts to reduce unemployment, though they may increase productivity (doubtful), will not be optimal as compared ex ante in terms of the satisfaction of wants of all economic actors. On utilitarian and natural rights grounds, state intervention in the labor market is counterproductive, misguided, and should be avoided.

6) The idea that there is not enough gold to back all of the fiat currencies of the world is the most foolish statement of all. Logically one can take the stock of gold available and divide it by the weighted sum (by exchange rate) of the currencies of the world. This could provide backing for every single dollar, ruble, yen, etc. However, this is a bad policy, for the market should be left free to choose its own money, it should not be instituted from on high via state decree or central bank policy.

All that needs to be done is to eliminate legal tender laws and taxes on market selected monies. Since we have several thousand years of history showing that Gold and Silver are typically selected as money, we should start by eliminating taxes on them. If there is a push for a different medium of exchange, it should be treated in the same fashion. At the same time, all fractional reserve demand deposit banking must be subjected to traditional legal principles regarding property rights.

This means a reversion to 100% reserve banking. From these two changes, the market will perform the transition to a sound money with the minimum disruption and transfer cost. A state imposed system can only result in higher costs, as well as a retention of particular privileges for the state, most commonly in the form of a central bank, liable to interfere in the money supply through open market operations and subject to the political whims of demagogues.

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Initial Claims at Lowest Rate Since January – Auto Plants Restart

By Eldon Mast, on July 10th, 2009

The rate of new claims for jobless benefits fell to the lowest level since January, and a close look at the pattern of layoffs in the automotive industry provided additional good news for auto workers.

The government said that initial claims fell by 52,000 — a drop significantly more than any economists had expected. In addition, the new claims data appears to have been significantly effected by positive circumstances in the auto industry.

A Labor Department official said there had been far fewer automotive and other manufacturing layoffs last week than anticipated. Historically in July many auto plants are commonly idled. This year however many of those same plants sat idle earlier in the year as automakers entered bankruptcy and restructuring plans. Those plants are just now coming back on-line.

For instance, after emerging from bankruptcy protection and finalizing a deal with the Fiat Group, Chrysler resumed production of vehicles at seven assembly plants in the US, Canada, and Mexico the week of June 29. And GM attorneys are expected to lead the new General Motors out of bankruptcy protection on Friday with associated factory production restarts to follow shortly.

As the 2009 recovery gets underway, these auto plant restarts will no doubt lead to renewed optimism for US auto workers and further boost rebounding factory production.

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More Silver Linings In Alcoa Aluminum

By Eldon Mast, on July 9th, 2009

You may recall that the first two weeks of Q1 2009’s earnings season had the perma-bears calling for earnings disasters in the Q1 results. Much of the media piled on proclaiming that a “sucker rally” was in progress. We are still waiting on that proverbial next leg down…

But then the earnings season kicked off with Alcoa(AA) painting a quite rosy picture for 2009.

As we enter the Q2 earnings season, the jitters have continued in recent days. But again Alcoa kicks off the season with news that — for them at least — the results are better than expected. The aluminum leader said it lost 26 cents a share in the quarter, far better than the 38 cent loss consensus estimates. In after hours trading Wednesday evening Alcoa was up four percent on the good news.

Alcoa (AA) continues to claim that it’s distributors are showing increased buying interest. Alcoa CEO Klaus Kleinfeld reported last month that distribution channels are now speculating that they will be unable to adequately supply a revived global demand.

Distributors “know if the green shoots turn over to become demand, they will not be able to supply.” If that happens Kleinfeld said, “our distribution chain will generate this giant sucking sound of demand.”

It would not be the first time we’ve seen aluminum’s silver lining.



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It’s the Private Corporate Investment, Stupid

By Ajay Shah, on July 9th, 2009

The first graph in The setting for the budget speech tells the story of the importance of private corporate investment. The text there says:

The economic reforms of the early 1990s got private corporate investment up from the region of 4% to a peak of 10%. This six percentage point increase of private corporate investment generated a strong business cycle expansion.

The decline of private corporate investment back to values like 5% was the essence of the business cycle downturn of 2001-2002. After this, we have seen an immense expansion of private corporate investment — all the way to 16%. This is the essence of the benign business cycle conditions of recent years.

The most important question that will shape business cycle conditions in 2009-10 and 2010-11 is: by how much will private corporate investment decline? It is important to see that today, each percentage point of GDP is Rs.55,000 crore, so we are discussing massive numbers. If a decline of private corporate investment takes place from 16% to 10%, then this is a reduction of demand by 6 percentage points of GDP or Rs.330,000 crore. When private corporate investment goes down, the overall impact on GDP is magnified through multiplier effects.

The shocks to GDP that are generated by these fluctuations of private corporate investment are so large that monetary or fiscal policy, as presently organised in India, can simply not counteract them. The only place where public policy can make a difference to this is to identify the policy instruments through which private corporate investment can flourish.

Some say the budget has done a fiscal stimulus by expanding the fiscal deficit by 0.8 percentage points. Others say that in tough times, it’s not correct to engage in deficit reduction. These arguments have to confront the irrelevance of the direct impact of these fiscal numbers. Whether the fiscal deficit goes up by 0.8 percentage points or it goes down by 2 percentage points, these are tiny numbers when compared with the real prize: private corporate investment.

If we play things right, and persuade domestic and foreign investors that India is on the right track, then this would perhaps add five to ten percentage points to the investment/GDP ratio, which drowns out a 2 percentage points of GDP reduction in the fiscal deficit which (in my opinion) is a critical element of the policy stance required to reassure the private sector that India is on the right track.. And if we play things wrong, then a five to ten percentage points of GDP reduction in private corporate investment will drown out a 0.8 percentage points of GDP fiscal stimulus.

The key message: focus on private corporate investment, not on either monetary or fiscal stimulus. India does not have the institutional capability to use monetary or fiscal policy to do business cycle stabilisation on the scale that we are seeing in the West. Let us not transplant the intuition and rhythm of policy that we see in the US and the UK into our setting, where we have dysfunctional institutions. In the medium term, we need to do fiscal, financial and monetary institution building so as to have that kind of apparatus. In the short term, the only real lever we have, that can stabilise the economy, is the outlook for economic reforms.

What determines private corporate investment?

Suppose you spend Rs.100 to build a factory, and suppose (for the moment) that this is all-equity financing. Suppose you take the company public and the market gives you a valuation of Rs.200. In other words, the hard work that you put in to build the business using Rs.100 of risk capital has created wealth of Rs.100.

This ratio — the market price of a project divided by the cost of building it — is called Tobin’s `Q’. When Q > 1, CEOs and entrepreneurs would feel like building projects. The bigger Q is, when it’s beyond 1, the bigger the incentive to engage in investment. When Q is near 1 or below it, the incentive to invest withers away. The sword of entrepreneurship is guided by the eyes that seek out high valuations.

The price to book ratio of the broad market is a poor man’s Tobin’s Q. It is a poor estimator because while the numerator (market cap of Nifty) is correct, the denominator (the replacement cost of building the Nifty companies) is only roughly approximated by the book value of the Nifty companies.

This argument emphasises the clear and direct link between stock prices and the investment optimism of CEOs. When stock prices are high, CEOs are more likely to build factories, and vice versa. In other words, the path to high private corporate investment runs through high stock prices.

The chatter on television and newspapers frequently says “Oh, but a budget must not only be judged by what it does to stock prices” or “Oh, but the stock market does not understand these things“. I would emphasise two points. First, whether the stock market is right or wrong, it is the driver of how CEOs behave. So regardless of what we think about the quality of information processing of the stock market, it matters. Whether we like it or not, the stock market drives the resource allocation. Second, there is an enormous academic literature which gives us reason to respect the sophistication and capability of the stock market in information processing. The future is of course un-knowable, and every forecast of the future will have a substantial zone of error. But there are few better estimators of what might come, than the pooling of knowledge and opinion of millions of financial market participants in an open, transparent setting.

So what are stock prices saying?

The graph (click on it to see it more clearly) superposes Nifty and the S&P 500 indexes. Both indexes start at 100 on 1 May 2009. The S&P 500 index shows little movement, which suggests that the dominant story lies in domestic events.

When the election results came out, Nifty achieved values like 118 in the graph, i.e. 18% up compared with pre-election conditions. This was good news for Tobin’s Q and thus private corporate investment. It was the best news possible for the outlook for business cycle conditions.

Why did we feel optimistic at the time? It was felt that two scenarios had been avoided: the scenario of confused / weak governance with attendant political problems, and the scenario of a UPA-1 where economic reforms were blocked by the CPI(M). The hope that UPA-2 would do better gave us higher stock prices, going all the way to 27% up compared with pre-election levels.

We’ve had a sharp decline, from indexed values of 127 to an indexed value of 112; a decline of 12%. In other words, a bit less than half the gains have been erased. This is not good for Tobin’s Q and hence not good for the outlook for private corporate investment and hence not good for the outlook for business cycle conditions.

Worldwide, there has been a political shift away from left parties given that voters are nervous about economics and want top quality leadership in terms of economic policy. When the going gets tough, voters turn to The Man. In India also, this should be seen in the context of a long-term secular decline of the vote share of the Left: both trend and cycle are going against the left. A key reason why the UPA-1 won the election was the benign business cycle conditions that prevailed 2004-2009, and the fiscal bounty that came with it. Conversely, things will be very painful in political terms if business cycle conditions go back to 2001-02 levels. It is odd for India to have shifted towards giving more power to the left within the Congress at a time like this.

Early in this blog post, I show the most recent available data which proxies for private corporate investment: the monthly time-series for IIP capital goods and for imports of capital goods. Both these are quite dated. In a few months, we will know what happened to the month-on-month changes of these two series in July and August, which would reflect the consequences of the budget speech.

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Another $1B for Commercial Real Estate

By Eldon Mast, on July 8th, 2009

According to reports in the online version of the Wall Street Journal, one of the largest real-estate investment trusts in the US is seeking to raise $1 billion to invest in commercial properties.

Vornado Realty Trust, one of the biggest real-estate investment trusts in the U.S., says, it would seek “high quality assets at distressed prices.”

Vornado is already a major commercial landlord in East Coast markets, most notably New York and Washington DC.

The reports come less than a week after Blackstone Group (BX) said it had finished raising $4.3 billion, for its Blackstone Real Estate Partners Europe III fund. (“BREP Europe III”)

That placement will aim to exploit the real estate recovery by “taking advantage of the inevitable recapitalization of the property sector” according to Blackstone.



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Inflation With Gary North Or Deflation With Mish

By Trace Mayer, on July 8th, 2009

READER REQUEST

A few days ago I received an interesting request from a reader (PP) the answer to which could comprise a book.

Gary North recently posted an article [June 24, 2009] critiquing Mish’s views of deflation in which he posted and commented on John Exter and his pyramid.  That is the only time I’ve seen that pyramid outside of your website.  North previously criticized the “Pushing on a String” perspective in the below article [June 20, 2009 and for our discussions I add a December 27, 2001 article] …which was directly addressed [June 22, 2009] by Mish.  Given your use of the pyramid and familiarity with Mish, I would welcome  your thoughts on these issues — especially in the form of a blog post.

I am sorry for the loquaciousness of this response but I think it will adequately address a few of the material issues.  The attempt to read, digest, analyze, synthesize, hone in on the key issues, distinguish and contrast these two prolific and intelligent writers has proven a formidable task and this response is fairly brief for the book it could be.  The main issue is inflation or deflation; whatever those are.  Even worse is the intellectual dead end they lead to.

“Roast me! Hang me! Do whatever you please,” said Brer Rabbit. “Only please, Brer Fox, please don’t throw me into the briar patch.”

SUMMARY OF MR. NORTH

Dr. North leads off with an assertion implying Mish’s inferiority because of his photography accomplishments.  This ad hominem attack is baseless and irrelevant.  The written word stands or falls on its own merit irrespective of its source.  I always try to keep my attacks and assertions deeply rooted in ideas and arguments.  While I occasionally name those whose ideas I attack, like Mr. Mankiw and Mr. Krugman with their 0% interest rate lunacy, I try to keep the focus on logic, reason and explanation.

In 2001 he raises a great issue.  ”Economists are part-time verbal magicians, kind of like Harry Potter, except that they don’t have any power. … This raises the question of what constitutes money.”  Then he quotes Greenspan testifying about the problems with defining what money is.

In 2009 he brings up John Exter and not in a favorable light.

His argument remains the central pillar of the deflationist camp – a tiny band of intrepid non-economists who have seen their founder’s prediction refuted by the facts in every year since 1973. But economic events since mid-2008 seem to indicate that Exter may have been right, they insist. … At any time, the FED can get all of the banks’ money lent.  But the FED knows that this will double the money supply within weeks.  This will create mass price inflation.  This is the central fact in the inflation vs. deflation debate.  Until the deflationists answer it with a unified voice, they will remain, as their predecessors remained, people with neither a theoretical nor a practical case for their position.

Since when did things that have not yet happened become ‘central facts’?  Anyway, the article directed to Mish is primarily about inflation, deflation and gold and contains an earlier version of the pyramid.

He asserts:

So, there is no historical evidence — none — that gold does well in times of price deflation, unless there is a government-run gold standard, which means a fixed dollar price for gold guaranteed by the government. … In times of deflation, gold’s price will fall. … The only argument against a falling gold price in a time of general price deflation is John Exter’s: “pushing on a string.” He says there will be a rush for gold as the most liquid asset. Here is his pyramid of solvency. … It was an untested theory in 1973.  It remains untested.  Notice that Exter put currency just above gold.  This theory is logical.

SUMMARY OF MISH

Mr. North does a good job of synthesizing Michael ‘Mish’ Shedlock’s assertions.

“To summarize Mish’s scenario:

1. The debt pyramid will implode.

2. The Federal Reserve will not be able to stop this.

3. There will be serious, bankrupting, depression-creating monetary deflation.

4. There will be long-term price deflation.”

As Mish observes there is a difference with Mr. North:

Of those watching money supply, some concentrate on Base Money supply as Gary North does, others M2, M3, MZM, or even Austrian Money Supply as a measure of inflation. Interestingly, there are even two different versions of Austrian Money supply with a pretty big difference between the two versions.

Every one of them is wrong.

We have a credit based economy and anyone watching money supply and not watching credit is simply wrong. This is a statement of fact, not idle conjecture. Only those watching and expecting the collapse in credit and understanding the role of gold got things correct. This is a very small group of people.

Mish has also tacked the definitional quagmire with his post Inflation What The Heck Is It.  In his post Nonsense About Gold Backwardation, Ameros, Yuan Devaluations, etc. he stated “There is nothing special about backwardations. Period. OK they are rare in gold. So what?”

MY ANALYSIS

I will address these definitional issues, the inflation versus deflation argument and the role of gold as money.  I am a wordsmith; words are my domain.

DEFINITIONS

A reason why most individuals have such trouble with economics is that correct economics is rare!  Most economists are employed by large government funded institutions.  Still others work for large banks.  There is a status quo and they are not to disrupt it.

Let’s face it:  Most ‘economists’, like Mankiw or Krugman, are court economists.  The stone-cold truth is it is in the financial best interest of most finance professionals, economists and other academics for you to remain clueless to basic economic law.  There is a strong conflict of interest between you and them.  On the bright side, I think neither Mish nor Dr. North are court economists.

Mr. North correctly frames the issue, ‘what constitutes money’, but fails to proceed with any meaningful economic rule statements and consequently the analysis which flows is scattered and unfruitful.  Mish asserts rule statements, some I agree with and some I do not, the analysis that flows is coherent, although some is faulty, but overall it is extremely pragmatic and practical.

For example, in the first chapter of my book I address the inherent faultiness of Chartalism, the difference between a transaction being settled versus extinguished and assert an element of basic economic law that “Money must have intrinsic value by being a tangible asset.”  What flows from this underlying premise is the ability to distinguish between money, money substitutes and illusions; all of which can be currency.

With that foundation in place then I march along through inflation and deflation.  In this point, Mish is correct that the ‘money supply’ means all different things to all different people, even among the Austrian school.

In the first chapter I assert “Rather than spill bottle after bottle of ink, I will provide a general roadmap for this area.  I will tend to stick to the fundamental Austrian School of economics.  They define inflation as an increase in the money [conflating money, money substitutes and illusions] supply and deflation as a decrease in the money supply.”  Notice how the distinguishing characteristics either broaden or narrow the currency or money supplies?

FUNDAMENTAL ECONOMIC LAW

With that foundation in place and still not out of chapter one I strike at the key issue.

Physical law presents conflicts that require an either/or answer.  For example, either the sun revolves around the earth or the earth revolves around the sun.  Both cannot be correct.

This same immutable law applies directly to determining which asset-the FRN$ or gold-is the risk-free allocation of capital.  This is the single most important decision an investor can make.

When the United States packs the emergency kits for Navy fighter pilots, it includes hundred-year-old quarter-ounce British Sovereigns.  Why?  Because at all times and in all circumstances, gold remains money.  However, with the FRN$ as the world’s reserve currency, most financial professionals assert the FRN$ is the risk-free asset.

What do Mr. North and Mish consider the risk-free asset?  In other words, how do they price things?  Do they use the ‘dollar’?  What is a dollar?

WHAT IS PRICE AND WHO CARES?

Both Mr. North and Mish seem to price assets like houses, stocks, cars or food in FRN$.  Mr. North may need to read The Golden Constant, which oddly is free of bias, to get his facts straight and because he is not a photographer but a serious economist I suppose he has plenty of free time to study select economic works.

But the real issue, both theoretically and practically, is value not price.

In The Golden Constant Professor Jastram examined 416 years of Anglo-American price data and established a statistical relationship using a price series construct for both gold and wholesale commodities.  The conclusions on page 175 were very interesting.

First, gold hedges major inflations poorly.  Second, during major deflations gold increases in operational (ordinary daily transactions) wealth.  Third, gold’s ability to hedge yearly commodity price increases is ineffectual.  Fourth, over long periods of time gold maintains its purchasing power and fascinatingly this is not because gold advances to commodity prices but because commodity prices gravitate toward gold.

As Professor Jastram observed on page 130, “As we have said, the purchasing power of gold depends on the relation of commodity prices to gold prices. A close scrutiny of this relationship over time discloses an affinity of a curiously responsive character. It could be called the ‘Retrieval Phenomenon’, meaning that the commodity price level may move away higher or lower, but it tends to return repeatedly to the level of gold.”

But Mish also misses this point.  As I discussed on a Contrary Investors Cafe interview and wrote about in Gold In Backwardation:

Contango is supposed to exist because of gold’s inherently negative interest rate.  The future price of gold is generally the spot price plus the future value based on the currency’s interest rate, minus cost of storage and a premium for counter-party risk.  For example, if the interest rate is 12% APY and gold is $100/ounce then gold’s futures price for delivery in one month would be $101+CPR=$100+(.12/12*100)+CPR.  As counter-party risk or the perception thereof increases, like an exchange’s potential failure to deliver, there is greater demand for present delivery of gold. … The question becomes:  If I earn no interest on my dollars, euros, yen, etc. and lose purchasing power from inflation then I have a negative real rate of return.  If I have a negative real rate of return then why should I own fiat currency instead of gold?

Gold or silver can go into backwardation and come out of it.  A rising fiat currency gold price used to sound the warning call of fiat currency problems.  But as Dr. Alan Greenspan testified before Congress in 1998, “central banks stand ready to lease gold in increasing quantities should the price rise.”

This raises the issue of the central bank gold price suppression scheme which has been proven by Gold Anti-Trust Action Committee.  As Harvard trained attorney Robert Landis asserts, “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.”

Now backwardation in the monetary metals is like the canary in the coal mine.  Sustained backwardation will signal the failure of the rig.  This will not be a garden variety exchange rate adjustment like Argentina in 2001 or Weimar Germany but instead the collapse of a worldwide monetary system; the largest in history.  But for now the Fear Index, discussed in Chapter 11 of John Rubino’s The Collapse of the Dollar, is still extremely low relative to historical trends.

OSTRACISM

It is like I am a lone three-eyed fish in the investment and financial commentary world.  I assert that gold is not a portfolio asset but that everything else is.

Oil is produced for fuel; wheat for food.  Feet and yards are used to perform mental calculations of distance; grams and pounds are for mental calculations of weight.

Why is gold produced?

Gold is produced to perform mental calculations of value. In other words, as these three charts of over twenty in my book show; I price assets in gold and silver to evaluate their value.

GREAT CREDIT CONTRACTION

With these principles firmly in place I can give a cursory treatment of The Great Credit Contraction.  First, I have updated and adapted with estimations the liquidity pyramid.  Any eye trained in monetary matters should immediately recognize the signifgance of this graphic.  When first published the article was immediately placed on the home page of Seeking Alpha.  Jim Sinclair of JSMineset.com opined, “A very good, simple and clear representation of the problem lacking a practical solution.”

Click here for a full-size easy to read version

In summary, during The Great Credit Contraction capital, both real and fictitious, burrows down the liquidity pyramid seeking safety and liquidity.  The lack of public interest in learning how to buy gold is a prime indicator that this has only begun.  I am asserting that gold, silver and other commodities will be used as cash balances before this is over.  Both fiat currency and fractional reserve banking pose risks to cash balances which are completely eliminated through monetary evolutions, like GoldMoney, in the Information Age.

An example of asset value evaporation from loss of liquidity is Auction-Rate securities or the myriad of assets on the balance sheets of banks.  The various bailouts are designed to exchange assets lower in the liquidity pyramid for those higher.  Sure, there are currently currency controls on the FRN$ and as it continues evaporating more will likely be implemented.

This is why we have seen a decline in the price of homes, stocks and commodities in both FRN$ (illusions) and in gold (money).  I have been loquacious enough and I devote chapter 5 to discussing this phenomenon.

CONCLUSION

Mr. North seems mired in definitional chaos and lacking on the ability to clearly, concisely and accurately state the rules.  This precludes a coherent analysis and conclusion.  When he does attempt to state his factual assertion, such as there is ‘no historical evidence — none — that gold does well in times of price deflation’, it is contradicted by the excellent academic work found in The Golden Constant.  Typical of those on weak intellectual ground is his reversion to ad hominem attacks about photography which appeal to emotion and feeling instead of logic and reason.

Mish on the other hand seems able to accurately state the rules, analyze the situation and form a conclusion.  However, he either seems to not completely understand gold’s monetary role or does not think it is currently a material issue.  If it is a timing issue, like his critique of Peter Schiff being wrong is a timing issue, then Mish is not wrong but like Schiff has not yet proven right.

By analogy Mish is like a shotgun.  An adaptable lethal weapon used for short and intermediate range issues.  On the other hand, Schiff and myself are more like sniper rifles.  While I may disagree with Mish it is likely, as he pointed out once, violent disagreement.  I think we are in an epic, perhaps millennial, deflationary credit contraction.

On page 14 of The Ascent Of Money Niall Ferguson writes:

Are we on the brink of a ‘great dying’ in the financial world – one of those mass extinctions of species that have occurred periodically, like the end-Cambrian extinction that killed off 90 per cent of Earth’s species, or the Cretaceous-Tertiary catastrophe that wiped out the dinosaurs?

I have long asserted that the last layer of the liquidity pyramid to evaporate will likely be the FRN$ illusion because it is the world reserve currency.  Along with political currency illusions will likely be the practice of fractional reserve banking.

When or how that will happen is impossible to predict because it is based on the human action of billions of individuals.  But fiat currency, fractional reserve banking and central banks are barbarous relics of an less sophisticated age.

Currently there are functioning alternative digital commodity currencies, like GoldMoney, with extremely slow velocity.  But in the Information Age with Twitter, Facebook, etc. they will likely explode on to the scene; perhaps going viral and resulting in the derivative illusion rapidly dissipating.  It is not difficult to imagine them completely changing the monetary landscape; like an iceberg that flips.  Other barbarous relics like the journalism and music industries likewise undergoing rapid creative destruction.

Therefore, the critical question is not whether there will be inflation or deflation.  The vital questions for your portfolio is whether and when will there be a currency collapse and how to best prepare yourself.  It would be nice if those far-sighted gold bug Cassandras were still all alone but they are now being joined by Establishment Chicken Littles such as Paul Volcker, Peter Peterson and Stephen Roach.

Political currency always fails in either a deflationary depression or a hyperinflationary explosion.  Ultimately, investors ensconce themselves at the tip of the liquidity pyramid within an invincible and immoveable golden forcefield which is immune to both.  Those who fail to move their wealth may see entire fortunes rapidly evaporated.  Some already have.  Indeed, The Great Credit Contraction has only begun.

Then Brer Fox heard someone calling his name. He turned around and looked up the hill. Brer Rabbit was sitting on a log combing the tar out of his fur with a wood chip and looking smug.

“I was bred and born in the briar patch, Brer Fox,” he called. “Born and bred in the briar patch.”

And Brer Rabbit skipped away as merry as a cricket while Brer Fox ground his teeth in rage and went home.

Disclosure:  Long physical gold and silver, indirect long interest in GIS and no position the problematic GLD or SLV ETFs.

NOTE:  As is customary in the industry if either Dr. North or Mish would like a review copy to respond then I would be happy to provide it if you contact me.  But as I mention in the first chapter:

There are plenty of ways to spill ink, so if anyone attempts to confront my assertions, it would only be courteous for him or her to use the definitions I propose without deflecting the discussion to a different and possibly tangential irrelevant issue.  In the event of rebuttals to my assertions in this book, I will limit my participation to substantive and not semantic arguments.

That means my hobbies of golf and sailing will not receive any response as they are irrelevant ;)

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The Land Of Plenty

By Trace Mayer, on July 7th, 2009

MORAL FOUNDATION

Immortal words were penned 233 years ago by the luminary Thomas Jefferson:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness.

Much has changed in the course of human events.  The once young nation endowed with incredible natural infrastructure, abundant natural resources and unbounded borders provided the opportunity for Atlas to carry the world.

NATURAL INFRASTRUCTURE

A few years ago I floated down the Yangtze river from China’s former capital Chongqing to Wuhan.  It is one experience to read about China’s rise and another to walk amongst, float by or fly over that growing dragon.  China is spending billions of dollars to tame this flooding beast and on other similar terraforming projects.  While Russia has plenty of land little is usable, they have only one convenient river and scant access to the oceans.

Likewise South America has some of the most fertile land in the world which imbues the lungs of the earth with its life sustaining power but those same jungles partition the continent and have prevented a unified trading zone.  While Brazil’s Iguazu Falls are majestic they do not help trade very much.

But the United States has a natural irrigation system and transportation waterways.  The terrain is easily suitable for farming, carving tracks for railroads and an interstate highway system was, relatively, almost effortlessly constructed.  Capital that other countries have to spend terraforming is instead allocated by the United States to investments, like research and development for millions of patents or wonder weapons.  Additionally, the United States financial markets have mushroomed.

BREADBASKET FOR THE WORLD

In 233 years the world population has swollen from less than a billion to almost seven billion.  The Japan Times reports that Canada produces 145% more calories of food than it consumes and the United States is close with 128% while the island nation of Japan has recently dipped to 39%.

People eat or people die.  During tough economic times food is usually the last expense to be cut.  General Mills (GIS), Kellogg (K), ConAgra(CAG), Tyson (TSN)  and Kraft (KFT) all appear to be doing fine despite the worsening economic environment.  Commodity prices have retreated but the price of sugary corn cereal appears to be fairly sticky.  This financial analysis will use data from financial statements prepared in accordance with fair-value lying standards.

Kraft needs to get their administrative expenses under control and the debt millstones on the balance sheet could make maneuvering difficult considering the constipated debt markets.  Despite yields of 4.6% with Kraft and 3.4% with Kellogg they are evaporating stockholder equity although Kraft is doing it fastest.

While ConAgra yields 4% and has declining revenue they have taken preemptive steps over the past couple years by cutting general expenses by 8.8% which has increased their net income by 74.3% respectively.  It is good to see management that understands that it is net income and not sales that matter.

Cashflow is king and the food companies have decent yields.  Both General Mills with 3.40% yield and Tyson with 1.30% yield have been generating stockholder equity.  But General Mills is encumbered with long-term liabilities that are 128% of stockholder equity while Tyson’s ratio is 74.4%.

With the Fed failing with quantitative easing and the specter of hyperinflation it is the basics that are important.  Food, clothing and shelter.  Should the FRN$ enter hyperinflation it will be food, gold, silver and guns that will likely perform best and the food companies will probably weather the storm just fine.  Hyperinflation is only the end of the world for some while others may notice only minor disruptions because they have already switched to alternative monetary structures like GoldMoney.

Therefore, as long-term buys these solid blue chips, in order of favoritism, are a good value:  ConAgra at 0.56gg,  Tyson at 0.37gg, General Mills at 1.66gg and Kellogg at 1.29gg.

PEAK OIL SPECTER

But these food calories are generally transmogrified from imported oil.  As a result of almost free energy Americans feast on food from thousands of miles away and wash it down with water from Fiji.

The American economy seems only dazed from its first impact with Peak Oil and oblivious to the unyielding wall it just hit.  Those unacquainted with the topic may want to read Twilight in the Desert by oil investment banker Matt Simmons, The Long Emergency by James Howard Kunstler or the novel World Made By Hand.

American oil production has been in terminal decline since 1971.  Worldwide production appears to have peaked in 2005.  The current crude oil stockpiles and recent demand destruction are immaterial to this foreboding storm.  In the geo-political scheme this issue is guiding many of the decisions from Washington to Moscow to Beijing and Tehran.  The gold to oil ratio does matter.  Many may take our complex oil powered systems, like food production and distribution, for granted.

AMERICA IN DECLINE

The American Empire rose from a land of plenty governed by the Constitution which Gladstone said is “the most wonderful work ever struck off at a given time by the brain and purpose of man” (pg. 323).  The entrepreneurial minded people governing themselves under a moral law and endowed with abudance of food, natural resources, rivers and tributaries generated more wealth and advancements than in all of recorded history.

But then their domestic oil production peaked, their rogue President declared their promises to pay gold would not be honored and the essential checks and balances in their political machinery, gold and silver, were banished from the monetary realm.

As a result the federal government is completely out of control while state governments from New York to California are absolutely insane.  For example, California is now issuing state-registered warrants with Bank of America accepting these California IOUs while the non-favored banks keep failing with over 50 in 2009.  This is just another pass-through bailout by the federal government and probably intended to keep one of the largest economies in the world from issuing a California Dollar with a Bear on it.  But what is a dollar anyway?

While the July 4th tea parties are getting ready to start the real political fireworks will most likely be in 2012 or 2016.  After 4-8 years of Washington intentionally exacerbating the greater depression the meager 78M baby boomers will square off against 95M Millennials with the former wanting to preserve a failed system while the later are entering their peak producing years and will want to press the reset button.  During all of this chaos hopefully the food companies will be able to keep food on the shelves.

CONCLUSION

America is a land of plenty unique in all the world.  With out of control government and a slow motion currency crisis the future does appear ominous.  As the derivative illusion of wealth evaporates there has been a return to basics with the growth of survivalism in the suburbs.  While many companies have been and will be eviscerated by America’s decline during The Great Credit Contraction; instead of buying gold the food companies, particularly General Mills, Kellogg, ConAgra and Tyson may fair better at generating wealth.

Humanity occasionally takes detours as it climbs from the swamps of tyranny to the celestial stars of freedom, peace and prosperity.  The out of control and insane governments are becoming destructive of the ends of safety and happiness of the heirs of the Founding Fathers.  It is the right of those heirs ‘to alter or to abolish it, and to institute new government’.  Despite the current threats and any potential political fireworks, the country America will be a major world power long into the future.

Today we watch hordes of Tehran’s youth march.  Tomorrow it will likely be America’s.  Why?  Because mankind will be what they were born to be:  free and independent.  Happy Independence Day!

Disclosure:  Long physical gold and silver, indirect long interest in GIS and no position the problematic GLD or SLV ETFs, K, CAG, TSN or KFT but may be picking up some CAG or TSN.



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