9

Fiscal Drops in the Bucket Deficit

By The Mogambo Guru

07/28/09 Tampa Bay, Florida

I had just finished Final Lockdown Mode (FLM) here at Rancho Mogambo Bunker (RMB) and was starting to relax, or as much as a guy can relax when a guy is naturally skittish, paranoid and fearful and whose symptoms include rabidly obsessive total denunciation of the disastrous Federal Reserve for creating so much money, the traitorous Congress that allowed it so that it could deficit-spend the money, and the moron American voters that elected and re-elected and re-elected such loathsome, incompetent people to Congress.

I could see by the way I was getting worked up into another hissy-fit that I had not taken my medications as prescribed, a realization probably prompted by the way my wife was insistently banging on the door of the bunker and shouting, “Did you remember to take your pills like you promised?”

I was shouting back, “Yes!”, which was, of course, a lie, but for which I atoned by immediately taking the damned things, so from then on, it was her word against mine! Stalemate! Hahaha!

I was muttering under my breath, “Now, nothing can be proved except that I took the pills somewhere around that time, if you want to go to that extreme, and otherwise, just shut up about the pills! Hahahaha!” which showed that they were already working, as normally I would have said (and a lot louder), “So shut up, shut up, shut up about the pills or I’ll cram them down YOUR throat and see how YOU like taking your damned pills! Grrrrr!”

I knew then that I was probably becalmed enough to take a look at the change in Total Fed Credit, that miracle stuff that can magically appear on the books of the banks and which, if loaned, becomes money and debt which, particularly if it is excessive, causes higher prices, which is Bad, Bad News (BBN). I thought I was ready.

I was, alas, wrong.

Instead, my eyes were scorched when I read that TFC increased $34 billion in the last week! Gaaahhh! And as staggering as this is, the Fed itself bought up a whopping $37 billion in government, agency and toxic debt! The Fed monetized $37 billion in One Freaking Week (OFW)!

You will be “happy to know” that Ben Bernanke is absolutely right when he says that even buying up $300 of government debt by this Fall, on top of the $1.275 trillion that the Fed already owns, will just mean that Fed assets, as a percentage of total government debt issued, will be the smallest percentage in decades! It’s just a drop in the bucket compared to what is coming! Hahaha!

Now you know why I say, “We are freaking doomed!”

Almost predictably, the monetary base jumped by about $55 billion as a whopping $60 billion poured back into bank reserves. All in One Freaking Week (OFW), too! Yikes!

I know what you are thinking. You are saying to yourself, “Oh, shut up, Loud Yet Stupid Mogambo (LYSM)! The lunatics of the Obama administration have already budgeted a $1.8 trillion budget deficit, so where did you think the money was going to come from, you loser halfwit scumbag that nobody ever liked?” which is a statement where the first part is true, in that the lunatics of the Obama administration have already budgeted a staggering $1.8 trillion budget deficit for this year, so it must follow that the second part of the equation must also be true, namely that I am a loser halfwit scumbag that nobody ever liked, which I don’t think is true, but it sure would explain a lot of things!

Anyway, it is not just money being created, but the effect it has on prices, which go up, which people can’t pay because they are already spending all the money they have, and they get angry, like the 1-out-of-5 Americans that smoke cigarettes and how Florida, along with lots of other taxing entities, increased the tax on cigarettes by $1 per pack or more!

While this may make some people quit smoking (to their benefit), for the most part it means that the average pack-a-day smoker is going to curtail other spending to the tune of another $7 per week, worsening the recession/depression: If there are 160 million adults, and a fifth of adults smoke, then that’s another $224 million a week in lost private spending, $11.6 billion a year, which will not be spent by private citizens buying what they want and creating a real economy out of real supply and real demand, but will, instead, be spent by government buying what IT wants.

And while I could go on for hour after dreary hour that what the government wants distorts the economy, it is what we get in return that matters, and what we get from such massive expansions of the money supply is inflation in prices and a destroyed economy, which is why gold, silver and oil are the only obvious investment choices! Whee! This investing stuff is easy!

Inflationary Surprises

By Bill Bonner

07/28/09 London, England

We love surprises! But only when we see them coming.

We’re always wondering: how will we be surprised? What will happen that we don’t expect?

It’s easy to make money…if there are no surprises. You just put your money in something that is going up and let it go.

But surprises sink ships, marriages, military campaigns and investment portfolios. Things happen that you’re not prepared for…

A friend told of what happened to a mutual friend:

“I guess it was the embarrassment that bothered him most. I don’t know. He was happily married…or he thought he was. They had three children. They must have been married 10 years. And then, she announced she was a lesbian…and moved in with a woman.

“I imagine he was devastated. He didn’t seem to have any idea. But just think how you’d feel. You’d think that you were so awful you’d turned her off on the whole male sex. She wanted nothing more to do with any of them…”

Yes, dear reader, you have to watch out for the surprises…

Stocks have been rising since March 9th. Yesterday, the Dow went up another 15 points… The Dow now looks toppy…like it will go down again soon. But the rally may have further to go – maybe all the way to 10,000, as we originally guessed.

And yesterday’s rain of news brought forth another green shoot. New houses are selling again – with sales up 11% in June. Maybe it’s time to buy a house. Better yet…buy a huge house with a huge, fixed-rate mortgage! Sometime between now and the next 30 years a fixed-rate mortgage is bound to lose its bite. What are the odds that inflation won’t rise in the next three decades?

Last week, in Vancouver, we left listeners confused.

“Should I buy gold or not?” was the question one posed.

It’s a good question… we’ll turn to it in a moment.

First, the background…

Everyone knows that stimulus leads to inflation. And everyone knows that this is the most daring use of stimulus ever attempted. Ergo, it seems likely that we will soon see the most inflation we’ve ever seen.

But it’s not that simple. The story is too easy to tell. It’s too obvious. Too logical. Too easy to explain and too easy to understand. Under these circumstances, inflation would be no surprise!

At least…that’s been our worry. That too many people understand the inflation threat and are positioning themselves to avoid it. Everybody can’t be right. As they say on Wall Street, when everyone is thinking the same thing no one is thinking.

But is it true? Is it true that people fear inflation and that they are taking investment positions to counteract it? Alas, we don’t know…but perhaps not. Neither the yield on Treasuries nor the price of gold signals a panic about inflation. Just the contrary; they seem to be telling us that investors are complacent…that they’re aware of the inflation threat. They may be even sure that inflation is coming. But they seem to think that they can take action later – after inflation actually shows up. Seems reasonable, doesn’t it?

The inflation rate is currently MINUS 1.4%. That is, we’re experiencing deflation, not inflation. Why try to protect yourself against something that is such a distant threat?

Our guess is that this is what most investors are thinking: that inflation is coming, but that it isn’t here yet. They’re watching…they’re holding their fire…but they won’t be surprised by it.

But what if they’re facing the wrong way? While they’re keeping an eye on inflation, what could be sneaking up behind them?

Ah…keep reading…

Practically everyone anticipates rising rates of inflation. The adjusted monetary base of the United States has more than doubled in the past year. Deficits are staggering. The price of oil – at $68 – is telling us that inflationary pressures haven’t gone away. Gold, too, at $953, seems to be whispering – not shouting – a warning: watch out…

So, what’s the prudent thing to do? Shouldn’t you keep an eye on inflation, like everyone else…and participate in the stock market rally at least until it shows up? If you failed to join the rally, you missed an opportunity for a gain of 20% to 40%. Though a correction in the rally is probably at hand, wouldn’t it make sense to buy stocks…hold them until the rally ends or until inflation appears…and then jump into gold?

Yes…that seems sensible.

But where’s the surprise? Here’s one possibility: a much deeper and more persistent depression/deflation than people expect. Ben Bernanke told Congress that he had sought to avoid “a second Great Depression.” Well…what if he failed?

Roger Lowenstein in The New York Times:

“The US economy is not only shedding jobs at a record rate; it is shedding more jobs than it is supposed to. It’s bad enough that the unemployment rate has doubled in only a year and a half and one out of six construction workers is out of work…

“The Federal Reserve now expects unemployment to surpass 10 percent (the postwar high was 10.8 percent in 1982). By almost every other measure, ours is already the worst job environment since the Great Depression…

“In terms of its impact on society, a dearth of hiring is far more troubling than an excess of layoffs. Job losses have to end sooner or later. Even if they persist (as, say, in the auto industry), the government can intervene. But the government cannot force firms to hire.”

Job losses result in fewer purchases…which result in fewer sales and earnings…and that leads to more job losses and falling prices. That’s what a depression is all about.

Currently, we look at that -1.4% inflation rate as a fluke…an aberration. And most people are sure the feds will stir up the inflation rate soon. But what if the feds are more incompetent than we realize? What if they can’t cause inflation? The Japanese couldn’t. And they never had deleveraging consumers to contend with. In other words, their households were never so deep in debt that they had to cut back spending in order to pay down debt. But they cut back anyway…and Japanese prices fell.

Nor did the Japanese have an entire world economy that was deleveraging. Instead, they were able to continue supplying goods to eager consumers in the United States…and making profits.

America’s economic situation is much more dangerous…and potentially much more deflationary. We could be entering a period of falling prices that will last for many years.

So, should you buy gold or not?

Ten years ago, we suggested a simple Trade of the Decade. Buy gold on dips; sell stocks on rallies.

This was not the best trade you could have done. There were huge run-ups in stocks and in oil, for example. Many investments would have paid off more. Google was probably the biggest hit of the period.

But the Trade of the Decade looked to us like the safest, surest thing you could do with your money at the turn of the century. Gold was at a record low; stocks were at a record high. What could have been easier?

And it turned out to be a decent trade.

The decade is not finished. So, we’ll stick with our trade a bit longer. Our guess is that we’ll see some additional profit when the stock market turns down again. But gold’s big day still may be a long way in the future.

So, if you are looking for quick profits, gold is probably not a good buy. It’s a monetary metal. It is fundamentally a protection against paper money and financial distress, not a real investment…or even a speculation.

Since we rate the risk of financial distress very high, we buy gold – as insurance. But we do not expect a major bull market in gold soon. Later, after deflation and depression have surprised investors and squeezed inflationary expectations out of them, we will buy gold as a speculation. Then, investors will be surprised by how fast inflation comes back.

Until tomorrow,

Let’s Break up the Fed

The Federal Reserve has done a terrible job at financial regulation. Why give it more power?

AMAR BHIDé

The Obama administration’s plan to increase the powers of the Federal Reserve, says one critic, is like giving a teenager “a bigger, faster car right after he crashed the family station wagon.” Treasury Secretary Timothy Geithner disagrees. He argues that the Fed is “best positioned” to oversee key financial companies, and that the Obama plan would give the Fed only “modest additional authority.”

Mr. Geithner is right about one thing: The Fed’s power is already vast.But it wasn’t even well-positioned to supervise the likes of Citicorp. Broadening the Fed’s responsibilities won’t help. Instead, we should think of how best to dismantle an overextended Fed.

Though advanced economies like ours require organizations capable of taking on a wide range of activities, there are limits. As Frank Knight, the great Chicago economist, pointed out in his 1921 classic “Risk, Uncertainty, and Profit,” individuals who control large organizations have to delegate many decisions to subordinates. Entities like hedge funds, where individuals such as George Soros make most of the consequential choices, are exceptions.

Therefore, good judgments about people—picking the right subordinates, refereeing staff conflicts, evaluating performance, and so on—are crucial.

Good judgment requires experience, not just exceptional intelligence or raw ability. Although many lessons about managing people can be applied to different fields, good judgment also requires some specific expertise. You can’t manage plumbers without knowing something about plumbing.

Unfortunately no one can learn everything about everything. Yes, Lou Gerstner turned around IBM without any prior experience in the computer business. But he had decades of general management experience, was an exceptionally quick study, and had to come up to speed in just one industry. Individuals who can learn how to effectively lead conglomerates, especially during periods of transition, are exceedingly rare.

This mismatch between what even the most talented minds can learn and the challenges of controlling widely disparate businesses has helped bring our financial system to the brink of collapse. The great names in finance once had distinctive identities and capabilities: Salomon Brothers was the champion in bond trading; Merrill Lynch’s thundering herd was tops in retail brokerage; Morgan Stanley and J.P. Morgan’s white-shoe bankers built formidable blue-chip client lists; and Bear Stearns’s PSDs—poor, smart and driven staff—cultivated scrappy entrepreneurs. Willy-nilly diversification turned these focused outfits into highly leveraged, unwieldy agglomerations of unrelated fiefdoms.

Likewise, the Fed has been incapacitated by its transformation into an omnibus enterprise with responsibilities ranging from boots-on-the-ground regulation to high-level monetary policy. The Federal Reserve Act of 1913, which created the Federal Reserve System, did so to forestall financial panics rather than pursue macroeconomic policies. The gold standard defined monetary policy. The Fed was merely meant to “provide an elastic currency” by serving as lender of last resort in times of crisis. The Act also assigned the Fed routine responsibilities for maintaining and improving the financial system—examining banks, issuing currency notes, and helping clear checks.

The adoption of Keynesian and monetarist ideas by central bankers and elected officials subsequently cast the Fed in a proactive macroeconomic role. William McChesney Martin, who served as chairman from 1951 to 1970, said that the job of the Fed was “to take away the punch bowl just as the party gets going.” This might have been wise in theory, but it wasn’t mandated by the law. In 1977, an amendment to the 1913 Act explicitly charged the Fed with promoting “maximum” employment and “stable” prices. The Humphrey-Hawkins Full Employment Act that followed in 1978 mandated the Fed to promote “full” employment and while maintaining “reasonable” price stability.

Legislation also has increased the Fed’s responsibilities for overseeing the mechanics of the financial system. The Bank Holding Company Act of 1956 gave the Fed responsibility over holding companies designed to circumvent restrictions placed on individual banks. It was tasked with regulating the formation and acquisition of such companies.

Congress further tasked the Fed with enforcing consumer-protection and fair-lending rules. The Fed was made the primary regulator of the 1968 Truth in Lending Act that required proper disclosure of interest rates and terms. Similarly, the Community Reinvestment Act of 1977 forced the Fed to address discrimination against borrowers from poor neighborhoods.

The expansion of bank holding companies into activities such as investment banking and off-balance-sheet exposures to complex instruments such as credit-default swaps also required the Fed to increase the scope of its supervisory capabilities.

In principle, an exceptionally talented theorist might capably run a Fed focused just on monetary policy. Setting the discount rate and regulating the money supply are centralized, top-down activities that do not require much administrative capacity. But without deep managerial experience and considerable industry knowledge, effective chairmanship of a Fed that relies on far-flung staff to regulate financial institutions and practices is almost unimaginable. The vast territory the Fed covers would challenge the most exceptional and experienced executives.

As it happens, the Fed has been led for more than 20 years by chairmen who had no senior management experience. Prior to running the Fed, Alan Greenspan started a small consulting firm and Ben Bernanke was head of Princeton’s economics department. Given their understandable preoccupation with monetary and macroeconomic matters, how much attention could they be expected to devote to mastering and managing the plumbing side of the Fed? While the record of the Fed’s monetary policy has been mixed, its supervision of financial institutions has been a predictable and comprehensive failure.

The Fed’s excessively broad mandate also has thwarted accountability. The CEOs of Citibank, AIG, Bear Stearns, Lehman and Countrywide are all gone—albeit with too much delay and with no clawback of unmerited compensation. At the Fed, no high-level heads have rolled. Mr. Geithner was promoted to treasury secretary. Mr. Bernanke is treated with great deference as he solemnly testifies that if it weren’t for the Fed, the crisis would have been much worse. But then, how can anyone be held responsible for failing at a job no human could do?

At the very least we should split the monetary policy and regulatory functions of the Fed, as was done through the Maastricht Treaty that established the European Central Bank. What we need now is a debate about how to break up the Fed—and some of the sprawling financial institutions it supervises—in order to make both the regulator and the regulated more manageable and accountable.

Mr. Bhidé, a visiting scholar at Harvard, is the author of “The Venturesome Economy” (Princeton University Press, 2008). He is currently writing a book about the financial crisis.

It’s Crunch Time for Israel on Iran

After years of failed diplomacy no one will be able to call an attack precipitous.

JOHN BOLTON

Legions of senior American officials have descended on Jerusalem recently, but the most important of them has been Defense Secretary Robert Gates. His central objective was to dissuade Israel from carrying out military strikes against Iran’s nuclear weapons facilities. Under the guise of counseling “patience,” Mr. Gates again conveyed President Barack Obama’s emphatic thumbs down on military force.

The public outcome of Mr. Gates’s visit appeared polite but inconclusive. Yet Iran’s progress with nuclear weapons and air defenses means Israel’s military option is declining over time. It will have to make a decision soon, and it will be no surprise if Israel strikes by year’s end. Israel’s choice could determine whether Iran obtains nuclear weapons in the foreseeable future.

Mr. Obama’s approach to Tehran has been his “open hand,” yet his gesture has not only been ignored by Iran but deemed irrelevant as the country looks inward to resolve the aftermath of its fraudulent election. The hardliner “winner” of that election, President Mahmoud Ahmadinejad, was recently forced to fire a deputy who once said something vaguely soothing about Israel. Clearly, negotiations with the White House are not exactly topping the Iranian agenda.

Beyond that, Mr. Obama’s negotiation strategy faces insuperable time pressure. French President Nicolas Sarkozy proclaimed that Iran must re-start negotiations with the West by September’s G-20 summit. But this means little when, with each passing day, Iran’s nuclear and ballistic missile laboratories, production facilities and military bases are all churning. Israel is focused on these facts, not the illusion of “tough” diplomacy.

Israel rejects another feature of Mr. Obama’s diplomatic stance. The Israelis do not believe that progress with the Palestinians will facilitate a deal on Iran’s nuclear weapons program. Though Mr. Gates and others have pressed this fanciful analysis, Israel will not be moved.

Worse, Mr. Obama has no new strategic thinking on Iran. He vaguely promises to offer the country the carrot of diplomacy—followed by an empty threat of sanctions down the road if Iran does not comply with the U.S.’s requests. This is precisely the European Union’s approach, which has failed for over six years.

There’s no reason Iran would suddenly now bow to Mr. Obama’s diplomatic efforts, especially after its embarrassing election in June. So with diplomacy out the door, how will Iran be tamed?

Mr. Gates’ mission had extraordinary significance. Israel sees the political and military landscape in a very inauspicious light. It also worries that, once ensnared in negotiations, the Obama administration will find it very hard to extricate itself. The Israelis are probably right. To prove the success of his “open hand,” Mr. Obama will declare victory for “diplomacy” even if it means little to no gains on Iran’s nuclear program.

Under the worst-case scenario, Iran will continue improving its nuclear facilities and Mr. Obama will become the first U.S. president to tie the issue of Israel’s nuclear capabilities into negotiations about Iran’s.

Israel understands that Secretary of State Hillary Clinton’s recent commitment to extend the U.S. “defense umbrella” to Israel is not a guarantee of nuclear retaliation, and that it is wholly insufficient to deter Iran from obliterating Israel if it so decides. In fact, Mrs. Clinton’s comment tacitly concedes that Iran will acquire nuclear weapons, exactly the wrong message. Since Israel, like the U.S., is well aware its missile defense system is imperfect, whatever Mr. Gates said about the “defense umbrella” will be politely ignored.

Relations between the U.S. and Israel are more strained now than at any time since the 1956 Suez Canal crisis. Mr. Gates’s message for Israel not to act on Iran, and the U.S. pressure he brought to bear, highlight the weight of Israel’s lonely burden.

Striking Iran’s nuclear program will not be precipitous or poorly thought out. Israel’s attack, if it happens, will have followed enormously difficult deliberation over terrible imponderables, and years of patiently waiting on innumerable failed diplomatic efforts. Absent Israeli action, prepare for a nuclear Iran.

Mr. Bolton, a senior fellow at the American Enterprise Institute, is the author of “Surrender Is Not an Option: Defending America at the United Nations” (Simon & Schuster, 2007).

The Gates of Political Distraction

Obama’s mistake was falling for a culture war diversion.

• By THOMAS FRANK

The essential point about Gates-gate, or the tempest over last week’s arrest of Harvard professor Henry Louis Gates Jr., is this: Most liberal commentary on the subject has taken race as its theme. Conservative commentators, by contrast, have furiously hit the class button.

Liberals, by and large, immediately plugged the event into their unfair-racial-profiling template, and proceeded to call for blacks and whites to “listen to each other’s narratives” and other such anodyne niceties even after it started to seem that police racism was probably not what caused the incident.

Conservatives, meanwhile, were following their own “narrative,” the one in which racism is often exaggerated and the real victim is the unassuming common man scorned by the deference-demanding “liberal elite.” Commentators on the right zeroed in on the fact that Mr. Gates is an “Ivy League big shot,” a “limousine liberal,” and a star professor at Harvard, an institution they regard with special loathing. They pointed out that Mr. Gates allegedly addressed the cop with that deathless snob phrase, “you don’t know who you’re messing with”; they reminded us that Cambridge, Mass., is home to a particularly obnoxious combination of left-wing orthodoxy and upper-class entitlement; and they boiled over Mr. Gates’s demand that the officer “beg my forgiveness.”

“Don’t you just love a rich guy who summers on the Vineyard asking a working-class cop to ‘beg’? How perfectly Cambridge,” wrote the right-wing radio talker Michael Graham in the Boston Herald.

Conservatives won this round in the culture wars, not merely because most of the facts broke their way, but because their grievance is one that a certain species of liberal never seems to grasp. Whether the issue is abortion, evolution or recycling, these liberal patricians are forever astonished to discover that the professions and institutions and attitudes that they revere are seen by others as arrogance and affectation.

The “elitism” narrative routinely blind-sides them, takes them by surprise again and again. There they are, feeling good about their solidarity with the coffee-growers of Guatemala, and then they find themselves on the receiving end of criticism from, say, the plumbers of Ohio.

The Gates incident was a trap that could not have been better crafted to ensnare President Barack Obama, who is himself a loyal son of academia’s most prestigious reaches, and to whom it was immediately obvious, even without benefit of the facts, that the Cambridge police “acted stupidly” in the situation.

Mr. Obama’s way of backing out of his gaffe was just as telling: He invited Mr. Gates and the policeman who arrested him to the White House for a beer, the beverage so often a gauge of a politician’s blue-collar bona fides. One symbolic gesture, hopefully, can exorcise another.

Class is always an ironic issue in American politics, and the irony this time is particularly poignant. We are in the midst of a great national debate about how to make health care affordable; almost nothing is more important to working-class Americans. “For the health of the nation, both physically and economically, we need a system with a public option,” Leo Gerard, president of the United Steelworkers, wrote recently in the Huffington Post. “And we need it now.”

But whether working families get it now depends to a large degree on Mr. Obama’s personal popularity. And now comes Gates-gate, this latest burst of fake populism from the right. Waving the banner of the long-suffering working class, the tax-cutting friends of the top 2% have managed to dent the president’s credibility, to momentarily halt his forward movement on the health-care issue.

Umbrage at a Harvard professor’s class snobbery, in other words, might derail this generation’s greatest hope for actually mitigating the class divide.

Another irony: Long before he became a hostage to the culture wars, Henry Louis Gates had another career as a pithy commentator on the culture wars. The false appeal of victimization was something he understood well. In “Loose Canons,” his 1992 book on the subject, he joked that his colleagues should “award a prize at the end [of a conference] for the panelist, respondent, or contestant most oppressed.”

But when he sits down for that can of beer in the White House, it is another passage from his book that I hope Mr. Gates remembers. Speaking for liberal academics, he wrote in 1992 that “success has spoiled us; the right has robbed us of our dyspepsia; and the routinized production of righteous indignation is allowed to substitute for critical rigor.”

Today the cranking out of righteous indignation is a robust growth industry, and it threatens to do far worse than cloud our critical faculties. Help us to put the culture wars aside, Professor Gates. Too much is on the line these days.