Austrian School

I'm Moving...

2010-08-24T16:05:00.001-07:00

...to a new website -- well, truth is I already have. On July 23, I launched Scala Volpe Capital, at www.scalavolpe.com. It represents the fulfillment of a goal I'd had for a while to take this blog and expand the format into a full website, complete with my blog as well as other offerings regarding insight into my investment portfolio, multimedia presentations, breaking news from Wall Street, and more. This site, austrianschool.blogspot.com, will remain active for now, although I'll occasionally re-post some of my past Austrian School articles at Scala Volpe when I feel it's pertinent to the discussion.

I wanted to post once more at this site in order to thank all of the people who supported my efforts here at Austrian School. I assure you I'll continue to champion free markets, capitalism, and the liberty these ideals ensure our citizenry. Please come visit me at www.scalavolpe.com and let me know what you think of the new site.

Thanks again, and best regards to all of you,
Christopher Anastasio

Like The Matrix’s Spoon, There is No Recovery

2010-07-03T13:17:00.000-07:00

In the 1999 film The Matrix, there's a scene in which the main character Neo encounters a child who is seen bending a spoon simply by staring at it. Neo, confused by what he's witnessing, asks the child how this manipulation of reality is accomplished. The child offers guidance to Neo, with the conclusion being "there is no spoon." Neo recognizes that what he has been conditioned to believe to be true is not necessarily so.

This analogy brings us to our topic. Yesterday’s non-farm payroll numbers came in, and were about as disappointing as anyone had expected. Approximately 125,000 jobs had been shed, with much of the fluctuation attributed to the release of the temporary Census workers. Private employers added a modest 83,000 jobs instead of the 110,000 or so anticipated. In addition, the 9.7% unemployment figure fell to 9.5%.

What does this all mean? First off, we need to clarify the unemployment figure and why it dropped. The government’s unemployment figure unfortunately incorporates two oddities: the exclusion of the “underemployed” people in the country, and the “birth-death” ratio. To explain:

First, the underemployment aspect: this basically refers to the fact that if people are working less hours than they want to (they’re in a part time job but are seeking full time employment), they aren’t considered unemployed, just underemployed. Also, if they’ve been searching for work and have given up the search due to discouragement, lack of opportunity, or whatnot, they are no longer considered unemployed.

With respect to the birth-death ratio, what this essentially means is that when companies go out of business, the government automatically assumes all affected workers are hired thereafter, unless reported otherwise (such as when the individuals themselves report to the unemployment office). Of course, in reality, we know that in such economic times as we’re experiencing now, it’s foolish to assert that laid-off workers are able to immediately secure follow-on employment.

So you can see why it makes more sense to pay attention to the underemployment figure, which yesterday fell by a tenth of a percent, from 16.6 to 16.5%. Hardly anything to celebrate. Moreover, the anemic private sector job growth underscores the ineffectiveness of government economic policy.

So aside from this statistical nonsense that the government engages in to pad the numbers, the real question is, if we were supposed to be in a recovery, where are the jobs? The answer to this is simple: there is no recovery. The small amount of positive data that filtered in during early 2010 is anomalous, and suggests that during the lull in the housing market crisis and run-up to the European debt crisis (see my May 24 post), the maligned economy got a breather and some small measure of relief. But that relief is steadily disappearing.

Think of it this way: each dollar the government has spent (and here I’m mostly referring to the stimulus package begun in February 2009) is one less dollar available to the private sector. It’s important to understand that when the government spends money above and beyond what’s readily available to it in the way of taxes and so forth, it must borrow it or print it – neither of these activities comes without a cost to our economy, businesses and individual citizens. This is because the government’s spending brings ill side effects such as new and higher taxes, inflation, and misallocation of capital resources into ventures that are often less productive than those that might be accomplished by the private sector.

The fundamental question that is rarely asked is this: how many more jobs could we create if the capital reallocated by the government were instead available to the private sector? Every time a government official touts the latest job growth (or downplays the latest job losses), I ask myself “at what expense?” The simple fact is that as government has grown and thus become more costly to maintain, it is crowding out businesses and requiring more and more capital to operate. Obviously, this is money no longer available to companies to re-invest into their businesses and expansion of their workforces.

Simply put, the recovery isn’t over; it never was. There is much more hardship remaining in this economic climate. The next wave of the housing crisis is right around the corner, as new and pending home sales have plummeted with the removal of government subsidies, combined with looming mortgage defaults stemming from the Option ARM and Alt-A mortgages on so many banks’ balance sheets. The European debt crisis is in its infancy, with several more nations due to declare bankruptcy, introduce austerity measures, and request fiscal aid from the EU, IMF, US or whomever else might be willing to provide relief. China’s unsustainable economic growth will eventually slow down, producing a ripple effect across its trade partners and upsetting its internal economic (and perhaps even political) dynamics. Given all this, we must be prepared for continued difficulty in the growth of jobs and the economic recovery as a whole. Now that the administration has taken credit for the supposed recovery, it will be interesting to see who gets the blame for the second (and likely far deeper) dip in this recession.

That Light at the End of the Tunnel is a Train Coming

2010-05-24T19:26:00.000-07:00

This blog post focuses on the next round of shock waves that are heading straight for the US economy. It examines the causes, symptoms, and consequences of the next crisis – a crisis that will make you wish for the pleasantries of the Fall 2008 economic crash.

But before we get into that, it is useful to step back for a moment and apply some scrutiny to what is already a bad situation, irrespective of what the next crisis might be. Once you digest the enormity of the fiscal challenges we currently face, you will inevitably gain an even greater understanding of why the next round of crises will be so catastrophic. In actuality, you will realize that even if we don’t have another crisis like 2008 in the short term (which I severely doubt), we are still in for an economic tsunami nonetheless (it will just arrive later). Heads you lose; tails you lose even worse.

Let’s assume for a moment that the current economic climate – 10% unemployment, stock market correction completed, relatively stable consumer prices – continues just as it is. Establishing that, let’s look ahead to some of the metrics regarding our national debt (how much total monies we owe to all our creditors combined) and the national deficits (the annual differential between what our economic activity brings into the country, and what we spend); note that the figures cited have been rounded off:

Debt = $12,000,000,000,000
Deficit for FY11 = $1,800,000,000,000
Projected Debt for FY15 = $24,000,000,000,000
Projected Debt for FY20 = $36,000,000,000,000

Current interest rate on our Debt = approx 3%, equating to:
Annual Debt Interest payment (current) = $300,000,000,000 (12 trillion x 0.03)

Let’s stop there for a moment. Think about all the taxes, fees, hidden taxes, benefits costs, et cetera that you pay now, in order to help Uncle Sam service its $300 billion interest payment. As it stands, this is not too pleasant for most middle class families, which are hit the hardest by most (if not all) of these taxes. (If you’re wealthy, you barely notice your tax payments because either you have a lot of money and the taxes don’t hamper your lifestyle, and/or you can afford the best accountants to hide your money from the IRS and thus pay less tax than people earning a fraction of what you earn. If you’re poor, you pay little to no taxes because you don’t earn enough [of course, if you’re poor you have other problems]. So the middle class suffers the worst from the tax code, and don’t let any government propaganda dissuade you from this fact. When the “wealthy” see tax increases, it’s really time for the middle class to turn its collective pockets inside out.)

So, if $300 billion interest payments don’t feel so great for the average middle class family, what will it feel like when those interest payments Uncle Sam owes start to rise? Let’s look at some more figures and analysis:

Assume our interest rate on the Debt starts to increase, as just about everyone following this situation expects. Why is it going to increase? Because as our dollar remains weak and grows weaker, it buys less, which means our creditors need more in the way of interest payments coming in to balance out the loss of their purchasing power with the US dollar. So let’s assume that by the year 2015, the interest rate we pay on the Debt has doubled to 6% (a modest figure considering it would happen gradually over the course of 5 years):

Debt in 2015 = $24,000,000,000,000
Interest rate on the Debt in 2015 = 6%
Interest Owed = $1,400,000,000,000 (24 trillion x 0.06)

So you can see, our interest payment approximately 5 years from now under the above stated conditions would climb to $1.4 trillion, or nearly a 500% increase from what we owe today. What do you think would happen to you economically if Uncle Sam needed 5 times the amount of tax revenue from you compared to what it takes today? I dare say this would be unsustainable for the average middle class family. But wait, it gets better…

Now let’s say that by 10 years from now, the current interest rate has tripled to 9%, and we then calculate what’s owed in interest based in the debt/interest metrics for the year 2020:

Debt in 2020 = $36,000,000,000,000
Interest rate on the Debt in 2020 = 9%
Interest Owed = $3,240,000,000,000 (36 trillion x 0.09)

So in 2020, under the stated conditions, the government would owe $3.24 trillion in interest, or nearly 1100% more than today. What would happen to you financially if the government required 11 times the tax revenue from you compared to today? Obviously, nothing good could come of this for the average American.

But unfortunately, the picture I just painted was intentionally semi-inaccurate, because I left out one major item: all of our entitlement programs. Let’s take a look at those:

All entitlements = approx $43,000,000,000,000 (based on 2008 figures), comprised of the following component expenses:
Social Security = $6,600,000,000,000
Medicare/Medicaid/Medicare Part D (prescription drugs for seniors) =$36,300,000,000,000

So the calculations I made earlier were actually devoid of the other $43 trillion dollar bill the government has racked up for the three major promises it made to us in the Social Security and Medicare/Medicaid programs. All of these programs begin to kick in earnestly around the 2017-18 time frame, and the spending just skyrockets from there. Needless to say, when you factor these conditions into the prior calculations, you get some very bad news if you happen to be a taxpayer in this country.

Suffice it to say before we move on the next part of this post, that the Congress’ orgiastic spending spree has bankrupted the country – you just don’t notice it yet because the bankruptcy is mostly on paper…for now. The fiscal challenge I outlined above is not speculation; it’s going to happen, the only questions are, how soon, and what agonizingly painful remedies will be instituted?

Having said all the above, we now move to the more short term crisis that looms ahead. There are a variety of factors that will/could potentially contribute to this crisis, but the most likely triggers lie (once again) in the now-familiar area of the housing market, and a new problem, that being the European debt crisis.

The European situation, which warrants greater analysis than I provide here, looks bad now, but has only just begun. The bailing out of Greece alone took abundant gnashing of teeth and then a $1 trillion aid package…all that for one country. What will happen in Europe and the global markets when Portugal, Italy, Ireland and Spain require similar treatment?

Pair that bleak picture with the US housing market. Recall for a moment that in 2008, the softening and then collapsing housing market was a major contributor to the economic misery that followed. At that time, one of the primary instigating factors was the subprime mortgage market, which comprised approximately 2% of all mortgages on the balance sheets of various banks. However, today there are other insidious categories of mortgages that are about to become popular in the news: the Alt-A and Option ARM (adjustable rate mortgage). These kinds of mortgages comprise closer to 30-40% of all the mortgages on the banks’ balance sheets (depending on whose estimates you read). Obviously, considerably more exposure lies in these kinds of mortgages versus the subprime variety. (There's $2.4 trillion tied up in Alt-A mortgages alone.)

Let’s take a closer look at Alt-A and Option ARMs. What are they? Essentially, they are less reliable than “prime” loans, made to the most financially stable customers, and more reliable than “sub-prime” loans, made to the least financially stable individuals. In both cases, the key aspect for the sake of our discussion in these mortgages is the fact that the interest rate attached to the loan is variable (a “teaser rate”), and at some future date, will reset to a new amount, depending on the prevailing interest rates at the time and/or the conditions of the original mortgage agreement. (In many cases, the whole point of these loans was to lure an individual into the agreement with a low interest rate, and then make up for the abnormally low interest later by raising the interest rate – hence the term “teaser rate”). Most of these loans were made in the 2005-06 time frame, with resets occurring around the 5 year mark. Therefore, these loans will see their interest rates reset in 2010-11.

Essentially, this means that at some point, the mortgage holder will see his or her mortgage amount increase at some point in the future. If you are an average middle class family, holding one of these mortgages, and your monthly mortgage rises from $1500 to $2000 or higher, what will this do both to your finances and to the overall economy? Well, from the family finances standpoint, the increased amount will obviously impact the remainder of the budget, and may be prohibitive to pay in and of itself. On top of this fact, if you’re already under water on your home (you owe more than the house is worth), you may very well be incentivized to simply walk away from your home and instead choose to rent. (Estimates abound that by 2011 at least half of US homeowner will be under water. Just last week data came in showing 1 in 7 homeowners is underwater and may be headed for foreclosure.) If you did this, you would effectively be telling the bank that lent you the money (and then possibly packaged your loan into an overall securitized investment and sold it to some other financial institution/investor) that you would be defaulting on the loan and no longer planned on sending in anymore mortgage payments. Clearly, this would quite negatively impact the banks, particularly if it occurred on a nationwide scale.

The other impact that this higher mortgage payment will have lies in the external consequences to the overall economy. If 30-40% of US families holding these resettable mortgages suddenly experiences a spike in their monthly mortgage obligation, it translates into a decreased degree of spending elsewhere. (Post-2008 crisis, it’s likely most families will not opt to continue spending on credit, as they’ve experienced a shift in mindset from the last time this happened and taken to increased saving habits.) This decrease in spending will send ripples through the rest of the US economy, which is based heavily (approximately 70%) on consumer spending and service-oriented industries (versus industries that create items to be sold/exported, such as manufacturing).

Thus, as the housing market softens and possibly collapses (again), and banks begin to witness mounting losses on their balance sheets in the mortgage area, and the consumer once again tightens his belt to deal with the crisis, the economy will experience a massive seizure based on the inability of banks to lend or extend credit and the service sector of the economy experiences large scale reductions in spending, thus reducing profit margins and creating waves of layoffs. This vicious cycle would clearly result in higher unemployment, deflated prices and business profits, and an imploding housing market and banking system. In essence, from a fractal perspective it would look like the 2008 crisis, but the actual implications financially and economically would be far more devastating. (Nassim Taleb discusses the use of fractals in understanding potential black swan events in his book The Black Swan – definitely worth reading.)

Combine the above prognostication with the beginning portion of this post. What if the crisis of 2010-11 occurs as I described (or something close to it), but at the same time the US government is in the middle of an accelerating debt crisis and needed to raise more revenue through taxes? The pairing of an economy in freefall with rising taxes is simply unconscionable, as it would be the final coup de grace for any semblance of the standard of living we enjoy today. If the government didn’t raise this money through taxes, it would only have one other place to get the money (assuming that borrowing more and thus raising the debt/interest payments higher was no longer a viable option): inflation (printing money). Unfortunately, the amount of inflation required to pay this bill is so incredibly high, there is almost no conceivable way it wouldn’t produce massive inflation, and possibly hyperinflation, leading to prices soaring astronomically (see 1920’s Germany for the endless examples of buying a loaf of bread for millions of German marks, etc).

As you can see, the road ahead is bleak for the US, no matter what permutation of specific scenarios you use. Somewhere along the line, and that sometime is in less than 10 years, taxes must be raised a lot, or government spending has to be reduced to spendthrift levels (is that even possible for this reckless Congress?) and entitlements must be reduced substantially (is that politically possible in this country?), or some moderate combination of both. But all of these attempted remedies carry great consequences, and would absolutely demand that an American people now used to the government caring for it in old age/retirement/unemployment would be left holding the bag. Losses of retirement, medical, and unemployment benefits due to the worsening economy and reduced government spending would exacerbate the problem by leaving more Americans jobless and no longer spending their money in an economy that requires spending to function (recall the 70% figure). In other words, the effects produced by these economic realities are exponential and have a cascading dimension to them, which means each year the situation could become drastically worse than the year before (making 2012 much worse than 2011; 2013 making 2012 look enjoyable; 2014 making 2013 look like an economic paradise…you get the picture).

Black Swan Protection Protocol: An Approach for Weathering the Storm (continued)

2010-02-01T09:40:00.000-08:00

In my August 12, 2009 post, I indicated that there was a separate approach I was undertaking for shielding the money I had no desire to lose – I referred to this approach as “black swan protection protocol.” The genesis of this term lies in the writings of Nassim Nicholas Taleb, and specifically, his 2007 best seller The Black Swan: The Impact of the Highly Improbable. Let me state clearly that this blog post does not suffice for conveying the importance and material significance of Taleb’s conjecture. Nonetheless, I was sufficiently motivated by his insights to fashion a rough outline here of how I plan to follow his advice and why.

If you read my July 15 post regarding Taleb’s ideas, the following may sound a bit redundant, but it’s worth exploring before moving into the details of the actual investment approach. The term “black swan” refers to the discovery in the 17th century of the first non-white swans, invalidating centuries of assumption that all swans were white. Thus, when Taleb speaks of black swan events, he is referring to an event which has the following attributes:

1) the event is completely unexpected
2) it is highly impactful
3) it is retrospectively distorted; that is, afterward it is rationalized as if it was or could have been expected

(IF YOU PREFER TO SKIP TO THE ACTUAL IMPLEMENTATION APPROACH FOR BLACK SWAN PROTOCOL, SCROLL DOWN SEVERAL PARAGRAPHS.)

One of the central themes of the book focuses on the following: the concept of two different realms of existence for humans: Mediocristan and Extremistan. An illustration works best for explaining these concepts.

Take 1,000 individuals randomly from society, tabulating their weight and averaging it out. Then take the 1,001st individual, who is the heaviest individual in the world (say roughly 1,000 pounds for the sake of argument). The average weight for these 1,001 individuals will not have changed substantially with the addition of the 1,001st’s weight to the total. This is Mediocristan.

Now take 1,000 individuals randomly from society and tabulate their net worth, then average it out. Take the 1,001st individual, who happens to be the richest individual in the world: Bill Gates, approximate net worth of $80 billion. What will happen to the average net worth? Rise dramatically, obviously. In other words, the addition of just one individual’s net worth changes the entire complexion of the situation instantaneously. This is Extremistan.

Here’s the basic point: human beings do not intrinsically recognize the kind of world we live in; we think we are living in Mediocristan, when we are actually living in Extremistan. In this sense, we underestimate the impact and importance of unforeseen, significant scale events. Evidence that we are living in Extremistan abounds: see 9/11, the 2008 financial collapse, the 1987 market crash, and so on and so forth. Whether it is due to human nature or evolutionary programming (or lack thereof), the simple fact is we do not effectively recognize the role and impact of randomness and black swan style events in our lives.

Taleb does an excellent job of exploring why this is the case in some depth, with one of the prime reasons being what he calls the “Platonic fold.” Essentially, this is the differential between what we know and what we think we know. When we act on what we think we know, rather than grasping the notion that we are treading into territory that we cannot possibly predict or explain adequately, we invite disaster or at the very least, a severe under-appreciation for the consequences or implications of a particular event.

Another key concept Taleb discusses is what he calls the “confirmation bias.” This refers to the fact that, because we do not see an event occur over a period of time, we assume it is not possible (if we can even imagine its possibility to begin with). Taleb uses this great analogy: a turkey is fed and well-cared for by its owner throughout the year, and the turkey comes to believe the owner has its best interest at heart; then, in late November, the turkey is slaughtered by the owner for Thanksgiving. The turkey experienced a confirmation bias, in that every day it was well-treated, it confirmed the notion that the owner had the turkey’s interest at heart. Obviously, this misconception is suddenly clarified, with tragic consequences for the turkey.

The real question becomes, what can we do about these conditions? As Taleb offers in his book, we can only attempt to build a more robust system that is less susceptible to the devastating effects of negative black swans. His prime example of this from a finance perspective resides in the notion that our banking system is severely over-leveraged and, by carrying the amount of debt that we currently have, as well as speculating in complex derivative financial products, simply begging for some catastrophic perturbation to occur to the system.

But the added problem here is that the banking and overall financial system has become increasingly interconnected in a global sense, thus vastly increasing the complexity of the system itself. A problem at one node, or bank, within the system, can quickly propagate throughout the entire system, causing distress to the system and turbulence in the financial markets. This kind of complexity must be countered with a more robust approach to the kinds of financial products and rule sets that are employed by the institutions themselves. In other words, the less complexity, the less the impact of the failure of a banking or financial institution on the overall system.

Again, I implore readers of this blog to read the book in order to gain a full appreciation of why Taleb’s conjecture is so critical to the health of one’s financial portfolio. There is simply no substitute for his insights.

(BELOW THIS POINT I BEGIN TO EXPLAIN THE THEORETICAL FINANCIAL APPROACH FOR EMPLOYING BLACK SWAN PROTOCOL.)

In deploying black swan protection protocol for my portfolio, I begin by identifying the money I have that I do not wish to subject to the risks of the marketplace; in other words, money I absolutely do not want to lose. Next, I identify the amount of money that I want to deploy for the active component of the black swan protection protocol (I’ll explain what this component is momentarily). These two figures comprise the bookends of what Taleb calls the barbell strategy: extreme conservatism at one end, extreme risk taking at the other.

On the conservative end, taking the amount of money I cannot afford to lose, I invest it into the safest securities available: CDs, money market accounts, and other savings vehicles (as safe as these can be given the overall tenability of the financial system). (One possibility here that Taleb mentions, though I would not personally choose, is the Treasury bond. Bonds will be the basis for the third and final financial bubble that is forming right before our eyes; however, to avoid digressing, I will save that topic for another post.) By investing in these extremely conservative positions, I have achieved the primary objective of capital preservation. While I will very well be subjected to purchasing power erosion due to inflation, that’s where the other end of the barbell approach comes into play, as we will examine now.

The central instrument behind the extreme risk end of the barbell strategy, and where the potential for significant gains resides, is the option. Investopedia describes options as follows: “A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).” It is crucial here to note that, in general, the further away the date of the option, the more expensive the option will be. For example, if I bought an option in February 2010 that assumed Microsoft’s stock price would rise $2 by April 2010, this option would be less costly to me than if I bought an identical option with an expiration of February 2011. This is due to the fact that the underlying contract price has more time to fluctuate. (As a side note, for terminology sake, the options that are further out on the calendar can be referred to as “long-dated.”) Conversely, the more far-fetched the outcome implied by the option (the further it is "out of the money"), the less expensive it will be. For example, if I bought an option in February 2010 that assumed Microsoft’s stock price would rise $22 by April 2010, this option would be less costly to me than if I bought an option assuming the price would rise by $2. (Option prices are calculated using an esoteric, opaque formula called Black Scholes, but the above pricing assumptions will suffice for this post.)

Thus, on the riskier end of the barbell, I would begin accumulating various options, including short-dated, long-dated and out of the money options, that positioned me for extreme events. For example, as of the date of this blog post, the Dow is around 10000. So I might buy options for this time next year (Feb 2011) indicating that the Dow would be at 9000, 8000, 7000, 6000, and 5000. Another example would be as follows: given my firm belief that the dollar will continue to be devalued through the reckless money-printing of the US government, I would purchase options for 2010 and perhaps 2011 assuming that gold prices would reach $2000, $3000, and even $4000 per ounce.

You might be reading the above examples and thinking that these are extremely untenable investment choices…and you might very well be right. But that is the point. The options I described above – which I must reiterate are only examples for the sake of illustration – would do one of two things: if they do not materialize for me, I’ve lost a couple of hundred dollars; if they do materialize, I’ve made tens or perhaps hundreds of thousands. As I continue to analyze the market and macroeconomic trends, identifying these kinds of potential black swan events, I continue purchasing the options I believe may materialize and rolling them forward further into the calendar years. For example, in 2010 I’d be buying 2011, 2012, and 2013 options; in 2011 I’d buy 2012, 2013 and 2014 options, and so on and so forth.

What’s created through this barbell approach is a method for preserving the bulk of your capital (say 80-90% on average) through conservative investments, and a method for realizing enormous gains through black swan protocol, with about 10-20% of the portfolio dedicated towards option purchases. The 3-10% a year lost to inflation in the conservative category is made up by the triple digit percentage gains in the second. Using the real world example of Taleb’s fund, portfolios would have lost some real value to inflation throughout the mid-2000’s, until 2008 when they gained 50-110% during the financial collapse. Thus, if you’d given that kind of fund $1,000,000 in 2005 (assuming 5% inflation), you might have dropped to $950,000 real value in 2006, $902,500 real value in 2007, then risen to anywhere between $1.35M and $1.8M at the conclusion of 2008. Your overall return after 3 years would be between 35% and 80%.

Again, the approach outlined here is basic in nature, and should be carefully considered for one’s tolerance toward enduring steady but relatively small losses with the anticipation of infrequent yet sizable gains. In addition, the use of options as investments requires some education and understanding, or the help of a financial adviser or broker. But in essence, the black swan protection protocol is in many respects the perfect hedge to a more traditional approach involving the purchase and holding of stocks, bonds, and other securities. After the 2008 financial crisis, it is fair to say that such traditional investments do not necessarily equate to safe investments.

Peter Schiff Announces Run for Connecticut Senate Seat

2009-09-17T05:56:00.000-07:00

http://www.schiffforsenate.com/index.php/site/news_detail/peter_schiff_announces_bid_for_us_senate/

The opposition has already issued statements criticizing Schiff, moments after his announcement this morning, including pointing out his lack of experience in Washington and politics. This lack of experience is one of Schiff's greatest assets in this race, as the Washington elites and career politicians have been the source of our problems through their misguided policies, decisions, and meddling in the economy. If Schiff is able to secure the Connecticut seat (and it will be difficult, given the four Republicans he will face for the primary before challenging Chris Dodd), we will be assured of at least one voice of reason in the Senate regarding our economy and the tough choices that lie ahead.

Why Doesn't the Federal Reserve Know What It Did with $10,000,000,000,000?

2009-09-01T10:16:00.000-07:00

If you enjoyed the clip from my July 23 post depicting Rep Grayson (D) excoriating Fed Chairman Bernanke, then you will certainly revel in his skewering of Fed Inspector General Elizabeth Coleman:

http://www.youtube.com/watch?v=cJqM2tFOxLQ

The clip is self-explanatory, but in short, the individual with the responsibility for internally auditing the Fed has no clue who received $1,200,000,000,000 in recent Fed loans, nor does she have the slightest idea how another $9,000,000,000,000 in off-balance sheet transactions in the last eight months came to be. The supreme incompetence on display at our nation's central bank should be frightening at best, and worthy of vigorous investigation at the very least.

Thank You Barney Frank, May We Have Another?

2009-08-19T11:53:00.000-07:00

Our Congressmen have obligated our children, grandchildren and great-grandchildren to a staggering debt load of over $11,000,000,000,000, and they are doing their level best to add to it every day. This has caused a severe reaction amongst many opponents of the current health care bill (in its myriad forms) and its associated cost, who have lashed out at their politicians, mostly through local town hall events. While the conduct of some of the individuals at these events cannot be described as polite or exemplary, the public has a right to be enraged at the profligate and reckless spending occurring in Washington.

But it seems the politicians aren’t taking the disrespect lying down. In fact, “the smartest man in Congress,” Barney Frank, is just plain not having it. Here are some snippets of Congressman Frank’s disgust toward the crowd assembled at his town hall event this week:

“On what planet do you spend most of your time?”

“Trying to have a conversation with you would be like trying to argue with a dining room table. I have no interest in doing it.”

“Do you really think that's thoughtful conversation? I thought you were thoughtful people who were here to have a conversation. I guess I don't understand.”

“What's the matter with you all? I don't understand your mentality.”

Thank you for putting us down, Congressman Frank. Thank you for putting us in our place. But I digress.

Democrats say these shows of anger are staged. (I guess that means the Republicans are the most organized party in America right now.) The Republicans say people are just upset, and none of the outbursts have been staged. (That’s probably a bit disingenuous.) The truth is somewhere in the middle, most likely, but that’s not the real point. The point is some citizens are finally taking the initiative to say what needs to be said, as the government continues to do everything conceivable to foul up the economy.

So to Barney Frank and the other politicians who have to go slumming at these town halls with the common folk, I’d say this: it’s one thing to steal $11,000,000,000,000 (and counting) from our generation and those to come; it’s another to insult us while doing it.

Exiting the U.S. Dollar: An Approach for Weathering the Storm

2009-08-12T04:31:00.000-07:00

If you’ve read some or all of the posts on this blog, by now you might be asking yourself “what am I to do about all this?” Given that, I’ve outlined below some thoughts on my own approach to the present economic realities, which you can adopt or discard as you wish. Note that my own philosophy behind investing is essentially based on three tenets:

1) virtually no exposure to the U.S. markets (you’ll see why as you read on)
2) exposure to foreign markets with all of the money that I can afford to lose
3) stockpiling into black swan protection protocols the money that I cannot afford to lose

(This post will address numbers 1 and 2; item 3 will be expounded upon in a later post.)

One of the underlying themes to my personal investment portfolio is simple: reduce my exposure to the U.S. dollar as quickly as possible. The reason for doing so is fairly obvious, especially if you’re a regular visitor to this site. The dollar is being devalued through deliberate monetary policy, for reasons ranging from “stimulation” of a stagnant economy to the need to pay off mounting debts by printing money out of thin air. This dollar devaluing means you are losing purchasing power steadily, even as your portfolio might be gaining in empirical value. In even simpler terms, inflation is going to reduce the real value of your portfolio. What good is having a net worth of $5M at retirement if your yearly living expenses have hemorrhaged to $500,000 a year due to inflation and a weaker currency? The bottom line is this: if you know the government’s monetary policy is to continue weakening the dollar in order to pay the ballooning interest off the crushing debt they have obligated us to, then a good policy for an investor would be to remove yourself from that currency and seek ones that are retaining more relative value.

To add to the urgency behind this flight from the dollar, there are several individuals whose opinion I value deeply who are actually forecasting, and in some cases building funds oriented towards, hyperinflation. (See 1920’s Germany for a great hyperinflation vignette...and yes, it unfortunately involves using a wheelbarrow to cart your money around.) Namely, Nassim Taleb’s Universa Investments (run by Mark Spitznagel), is actually developing a black swan protection protocol (see my July 15 post) that hedges against hyperinflationary scenarios. Marc Faber made an appearance earlier this year on a financial network and claimed that it is a near 100% certainty that the U.S. will experience hyperinflation—that it simply could not be avoided now that the government has created several trillion dollars out of thin air in such a short time span. Jim Rogers has trumpeted essentially the same message, labeling the dollar a “flawed currency.”

These predictions are nothing short of dire, but here’s why they really should be heeded: the individuals making the assertions have a remarkably good track record at being correct. Of course, contrast this to every forecaster and analyst you see on a regular basis on CNBC, FOX Business, and Bloomberg, where being wrong is the primary stipulation for employment there. (In fact, it would be entirely possible to make an investing career out of choosing the exact opposite stance to whatever you hear and see through these mainstream media outlets. That would be an interesting experiment, but I digress.)

I became cognizant of the above themes through individuals like Euro Pacific Capital president and owner, Peter Schiff, initially through his best seller Crash Proof, and then later through his web postings, video blogs and TV appearances. (Others, like Jim Rogers and Marc Faber, have been saying similar things on the financial networks and through other outlets.) Schiff’s philosophy centers on the notion that foreign stocks in particular afford a much higher potential for gain, given three basic realities:

1. foreign stocks purchased in the respective foreign currency provide protection from the rapidly-weakening U.S. dollar (foreign currencies move opposite to U.S. dollar fluctuations)
2. foreign stocks have the potential for paying more substantial dividends (upwards of 10% are not difficult to find; I own an Australian utility company that paid a 10.25% dividend in January 2008, and moved to 15% by the end of 2008)
3. foreign stocks in conservative industries have a reasonably good outlook for stability when coupled with the notion that the economies they are situated in are also more likely to be stable, based on increasing capital savings and productive capacity, as opposed to currency devaluation and reliance on consumer spending and debt assumption (such as in the U.S.)

It is important to note that none of the above is guaranteed to yield gains or meant to represent a one-size-fits-all approach for a potential investor. Each individual must evaluate his/her situation and decide upon what risks they are willing to assume. The point is, when examining economic fundamentals, it is not hard to distinguish between an economy like the one we have in the U.S. (based largely on consumption and over-leveraging, coupled with intentional weakening of the currency) and ones in places like China, Australia, New Zealand, and Japan. There, central banks have far less leeway in manipulating their currency, since none of them enjoys reserve currency status (like the U.S.). These economies are not running enormous trade deficits and racking up trillions in debt, thus there is greater stability to the underlying economic foundation and virtually no need to inflate the currency to pay back debts by printing more money.

An interesting phenomenon perpetuating itself these days on the financial networks, is that the talking heads who work there appear to believe there is only one country left to invest in on the planet. They have skewered guests (such as Schiff) who refuse to buy into the notion that the U.S. is the best place to invest right now, ignoring the fact that foreign stock markets have risen even more dramatically since the February/March lows compared to U.S. markets. Granted, the U.S. indices have shown significant growth, but those numbers need to be discounted based on the inflation that was created to generate such lift. On the other hand, foreign markets have not received nearly as dramatic a boost from our voodoo economic policies, and their growth is more rooted in an actual recovery. Thus, when you compare the S&P 500’s 44% rise since March to the Hang Seng’s dizzying 70% gains (China’s index), the difference is not only empirically dramatic but even more so once inflation is factored in.

So you might be asking how one can actually go about implementing this approach and achieving the three advantages I mentioned a few paragraphs above. While there is more than one brokerage firm that will invest in this manner for you, my choice was an easy one: Euro Pacific Capital. No other firm’s president has been more visible and more accurate in forecasting the present conditions and recent market volatility. Peter Schiff has been unwavering in his commitment to stating the truths about our economy and where we are headed, regardless of the criticism and scorn which has been heaped upon him (YouTube “Peter Schiff was right” and you will understand why I say this). But whatever firm you choose, talk to your broker about buying into foreign markets in the respective currencies, and begin fashioning your own shelter from the dollar.

To summarize, the long term outlook for economies that maintain solid fundamentals is simply going to be better than one that does not. As an investor, I want my money situated in sound economies with strong foundations, wherever that place may be. Such is the reason why I’ve implemented the kind of investment approach outlined above for the money that I wish to put into play in the market. As mentioned above, a future post will address what I am doing with the money which I absolutely do not want exposed to the systemic risks of the market.

Ben Bernanke Gave Foreign Central Banks $500,000,000,000 on Behalf of You and I...How Generous of Him

2009-07-23T07:24:00.001-07:00

Watch this first: http://www.youtube.com/watch?v=n0NYBTkE1yQ

I believe this clip speaks for itself. However, I also believe it is worth highlighting the following:

1) Most importantly, the private bank which oversees our banking system and much of the economy handed out half a trillion dollars to foreign countries, without anyone in Congress ever voting on it or even being apprised of it (until this hearing, and only after Rep Grayson had the wherewithal to ask). If we are interpreting the Constitution even remotely in the spirit of its text, then this is an outright violation of the Constitution.

2) So that might beg the response, "but the provision to do so is in the Federal Reserve Act, which amended the Constitution, so therefore it's ok." This is flawed logic to say the absolute least. If the Fed Reserve Act indeed makes this allowable, then shouldn't we repeal the Act? Why would any American citizen want a law that allows its central bank to give away billions of dollars to foreign banks (thus obligating future generations to the resulting debt burden)? Has any citizen witnessed a resultant economic benefit from this action? Also note that the Act was drafted by six bankers and one senator 99 years ago (in 1910). I have an inkling that the bankers wrote the Act to reflect their interests, not yours or mine. Just a hunch.

3) Rep Grayson probably deserves our support for questioning Bernanke in this fashion. Of course, to be thorough, his entire record on this subject should be scrutinized (which I have not done).

4) Rep Grayson is small proof that, once in a while, Congressmen actually read the relevant documents upon which they are making legislative and oversight decisions.

5) Bernanke does not appear to be confident in his knowledge of the legal authorities and Fed Reserve Act provisions affecting his chairmanship. But who needs to be when you can essentially commit the larceny of 300 million people and not be held accountable for it.

6) The Chairman of the Congressional committee (Barney Frank) sounds eager to end this line of questioning as Grayson's time limit expires.

7) It will be interesting to see how this kind of revelation affects the Audit the Fed bill (HR 1207) that Congressman Ron Paul initiated in February of this year. You can track the bill's progress here: http://www.govtrack.us/congress/bill.xpd?bill=h111-1207

Black Swan Conjecture

2009-07-15T12:56:00.000-07:00

I'm currently reading a book called The Black Swan: The Impact of the Highly Improbable, by Nassim Nicholas Taleb. Taleb was a trader and derivatives expert on Wall Street, before eventually releasing the aforementioned book, as well as Fooled by Randomness in 2001. I encourage people to learn more about Taleb and his black swan conjecture (you can Google/Wikipedia both items), as well as read the book.

In short, the title is derived from the fact that in 1697, Dutch explorers in Australia discovered the first black swans -- negating centuries of assumption that all swans were white. Taleb expounds on this by stating that black swan events fit the following three criteria:

1) the event is completely unexpected
2) it is highly impactful
3) it is retrospectively distorted; that is, afterward it is rationalized as if it was expected

If you're hesitant or wondering what the practical application is, consider the fact that Taleb's Universa Investments fund (he advises them but does not get directly involved in trading) saw gains between 50 and 110% by the end of 2008. Compare that to the standard 40-60% losses sustained by most fund managers and investment gurus during the same time frame.

To underscore the point, check out the following clip:

http://www.youtube.com/watch?v=_Jli7xPOvIA

It's worth watching the following clips as well:

http://www.youtube.com/watch?v=krU1wPb7i6c

http://www.youtube.com/watch?v=uX4P6I-7JTI

Finally, his website: www.fooledbyrandomness.com

I will continue to post on this general subject going forward, including some upcoming thoughts on utilizing the black swan conjecture in conjunction with strategies proffered by Peter Schiff and Jim Rogers.

Ben Bernanke Has Gotten Everything Wrong...So Naturally He's the Best Guy for the Job

2009-07-10T07:27:00.000-07:00

http://www.youtube.com/watch?v=HQ79Pt2GNJo

This must be why the administration strongly endorsed Bernanke recently as the best guy for the job, as they prepare to reappoint him as Fed Chairman. At least he's consistent.

I Guess the Greedy Oil Execs Took the Winter Off

2009-06-23T12:41:00.000-07:00

So you’re wondering, how are gas prices going up all over again? An average of approximately $2 just this spring has skyrocketed 50% in a matter of months, leaving us with a $3 average 2 weeks shy of the July 4 holiday weekend. A barrel of oil has risen from about $35 to nearly $70 in this same time period.

But what about the greedy oil execs? Did they take the winter off from their rampant greed, decrease gas prices for us, and then decide to jack them up just in time for your summer vacation?

Or maybe global demand went into a slumber during the winter and has awoken just in time for the summer driving season?

Or maybe the Middle East conspirators decided to spring back into action and manipulate oil prices, after conveniently taking the last several months off from their…conspiring?

Or maybe, it’s none of the above. Maybe, just maybe, the flooding of the global marketplace with trillions of dollars has forced up the price of a barrel of oil (which of course is denominated in dollars), thus resulting in higher gas prices being passed along at the pump. Scary thing is, those trillions have just begun to make their way into the economic system, so we’re only experiencing the leading edge of the resultant effects.

But the above explanation is the hardest to swallow, because what it portends for the country is far worse than the $3/gallon pain you’re feeling right now. What it means is the US government cure for the recession has in fact sealed our fate with the promise of significant inflation, sparked by the money printing orgy that started in 2008 and came to a crescendo in February with the latest stimulus bill and Fed Reserve Treasury bond buybacks that promise to inject trillions of dollars into the economy.

This would also explain why your grocery bill has been rising steadily as well, as commodity prices are linked to dollars as well. In fact, it is generally true that inflation is going to show up most drastically in those goods that an individual or entity cannot do without: things like food, energy, and health care cannot be excised from people’s budgets…you essentially must pay the cost whatever it is. Even higher education, perceived as mandatory in developed countries, suffers at the hand of inflation, as institutions sense unlimited demand for their product and continually raise tuition costs. These costs are then absorbed through greater and greater leverage on the part of the student and/or their family, who are then saddled with crushing debt obligations upon graduation.

Of course the government will continue telling you inflation is under control at the standard issue 3-4% figure they disseminate every few months, but tell that to the family of four living on $45,000 a year, spending $300 a week on groceries now versus $225 a few weeks ago, and $50 a week on gas as opposed to the $40 a week recently as well. It’s no secret that families living anywhere near the median household income cannot well absorb 50+% increases in their standard purchases, like food and energy. But that’s what your “stimulus” bill will now demand of you.

In fact, the pain our country felt during the recent Great Recession was mitigated by the fact that commodity prices fell, leaving us with cheaper gas and food bills to offset rising unemployment and loss of home equity. The coming depression will put us through a period where prices will rise significantly as people lose their jobs and their homes. Then we will know what economic misery feels like, and the 2008 meltdown will appear pleasant by comparison.

You Need to See This Movie

2008-08-19T17:40:00.000-07:00

http://www.iousathemovie.com/

Your Presidential Candidate Doesn’t Matter (Subtitle: You’ll Be Worse Off Economically in 2016 No Matter Who Gets Elected)

2008-08-05T21:12:00.000-07:00

That’s right – it doesn’t matter who’s elected President of the United States this coming November. At least it doesn’t when it comes to the economy and our present difficulties therein.

I’ve been in various social and professional circles where I hear a great deal of enthusiasm expressed for one candidate or the other. Invariably, I have provided the individuals participating in those discussions with much the same message as you see reflected in the title of this blog entry. As long as a country maintains a central bank that practices inflationary monetary policy, particularly as a tool for resisting recessionary forces, that country will experience growing economic pains, a weakening currency, and a widening gap between its haves and have-nots.

To quickly summarize: when inflationary policies are instituted, and money is created out of nothing, that money flows to entities that can utilize it before its price-raising effects seep into the larger economy. These entities (investment banks, corporations, the wealthy) can invest it or capitalize it in a fashion that is advantageous to them, such as by investing in real estate, stocks, derivative investments (options, collateralized debt obligations), or anything else for that matter. Then when the added money trickles down to the consumer (read: you and I), we are left with one thing: higher prices. Less purchasing power. Smaller paychecks. Whatever you want to call it, it’s not good.

Given the above, here’s a question for you: which candidate is talking about the activities of our central bank in the context of our economic woes? Which candidate has come out denouncing the inflationary policies of the Fed Reserve? Which candidate has advised against resisting the natural, corrective recessionary forces underway in the US market? You guessed it…none of them.

So where does that leave things? Well, it basically means that your economic situation is going to deteriorate over the next few presidential administrations, no matter which one of the candidates is at the helm. The underlying, root cause of our economic distress is not just absent from today’s political discourse -- if it is broached it’s met with mockery, disgust, or apathy (exhibit A: former candidate Ron Paul in any Presidential debate from the last year or so). Worse, our society discourages reading in favor of mind-numbing entertainment, so it is unlikely the masses will independently awaken to the effects of central banking anytime soon. Educating oneself in the area of financial literacy is also difficult, due to the complete lack of outlets for this subject. (Anyone still wondering why our schools don’t teach basic financial literacy?) Efforts in this area are left to the self-directed (see previous comment re: reading vs. entertainment).

Allow me to proclaim with even more emphasis the following: no matter who becomes President – Barack Obama or John McCain – your economic situation will be worse after the presumptive two terms that individual will serve. By worse, I mean some combination of the following conditions: less home equity, devalued investments in stocks and bonds, lower purchasing power, less available savings, more reliance on credit to buy the essentials, you name it. It won’t be pleasant.

David Walker Doing Yeoman's Work

2008-06-11T13:43:00.000-07:00

David M. Walker, the former head of the Government Accountability Office, has been conducting a "wake-up tour" across America, attempting to shine a light on the fiscal challenges facing our country. I encourage you to watch his appearance on 60 Minutes, which occurred last year, at the following link:

http://www.youtube.com/watch?v=QxoP_9W6FC8

Also, check out this link:

http://www.petergpetersonfoundation.org/

Walker is currently leading the Foundation's broad efforts in the areas of enhancing "public understanding of the nature and urgency of selected key sustainability challenges that threaten America’s future, to propose sensible and workable solutions to address these challenges and to build public will to do something about them."

The UN Got it Right

2008-05-16T07:18:00.000-07:00

I hate to admit it, but it's true. I read an article today titled "World economy on thin ice - U.N." with the accompanying subtitle "The United Nations blames dire situation on the decline of the U.S. housing and financial sectors." What is the significance of this, and how accurate is the assertion?

To answer these questions, one must go back at least as far as to the 1944 Bretton Woods conference, at which the US was granted the status of holding the world's reserve currency. As mentioned in a previous posting on this blog, the reserve currency status essentially translated into the fact that foreign currencies would be linked, or "pegged," to the US dollar; commodities such as oil and gold would be priced in dollars; and these dollars would be redeemable in gold if a country so chose to make the conversion. An advantage of this system for the US has been the fact that we are allowed to maintain a "current account deficit" -- mainly, carry a trade imbalance by importing far more goods than we export. (In even more simplified terms, consuming much more than producing.)

In the 1960's, the US underwent a significant increase in federal spending, as Presidents Kennedy, Johnson, and Nixon indulged in "guns and butter" programs that ratcheted up the federal budget deficit. These expenditures included the Vietnam War, Medicare and Medicaid, various other Great Society initiatives under LBJ, and so on and so forth. With all this spending, and not enough economic output to match it, the US went to the tried and true method of simply printing the needed currency.

This decision did not sit well with foreign countries that, by way of the Bretton Woods system, were forced to accept US dollars as their reserves. You see, with all of the money-printing occurring in the '60's, the dollar was steadily being devalued, thus decreasing the value of foreign countries' monetary reserves. It was then that many of these countries approached the US government and demanded redemption of their US dollars in gold. The problem was, there wasn't enough gold in our possession to redeem all of our creditors.

So how did we solve this dilemma? Simple: President Nixon simply decoupled the dollar from the gold standard in 1971. This action amounted to the US government telling members of the world economy "trust us" when it comes to our currency; in other words, trust us that our word is good when we say the currency is viable, and can be accepted as a legitimate form of payment with the backing of the full faith and credit of the US and its Treasury.

Fast forwarding about 35 years, and here we are with foreign countries stockpiling US dollars in their reserves, with little choice but to trust the US that our economy and our currency are healthy and able to withstand the recent perturbations in our financial system. As the article pointed out, these perturbations include the overall credit and housing crises that have wracked our economy. Both of these crises can be traced back to the monetary policy of the US Treasury and the Fed, due to the expansion of credit and the money supply, and the resulting debasement of the currency as inflation naturally follows.

Or is the only choice to trust us? The dollar as reserve currency is not carved in stone, and already, entities like the economic Group of 7 (G-7) have hinted that extreme weakness in the dollar could lead to significant changes in the global economic system. Change such as de-emphasizing the dollar as reserve currency, and possibly switching to another, stronger alternative. If this becomes the case, the consequences for our economy will be dire in comparison to what we are experiencing today. The reason being, once other countries are no longer obligated to accept the dollar in their economic transactions, there will be little reason to accept it at all, as it will be worth so little these countries will have lost any incentive to deal economically with the US. And why should they? We hardly produce anything anymore, and our massive appetite for consumption could gradually be replaced by other emerging economies with more robust currencies and trading potential. It will be at that point that the standard of living for Americans will plummet, and our economy will resemble those of third world nations. Then we will understand what the term "Great Depression" really means.

Al Qaeda Understands the Gravity of Our Economic Situation

2008-05-03T17:45:00.000-07:00

Now that I have your attention...

I'm posting an excerpt from the 2004 book "Imperial Hubris: Why the West is Losing the War on Terror," by Michael Scheuer. The book is an incisive examination of US foreign policy in the Middle East, but that fact aside, and given this blog focuses on economic issues, I want to hone in on a 2002 quote by al Qaeda's Abu-Ubayd al-Qurashi as provided by Scheuer. This quote appeared in the al Qaeda publication Al-Ansar and augurs prophetically as our economy teeters in 2008:

"On the other hand, we find that God has graciously enabled the mujahedin to understand the [American] enemy's essence and nature, and indeed his center of gravity. A conviction has formed among the mujahedin that American public opinion is not the center of gravity in America....This time it is clearly apparent that the American economy is the American center of gravity. This is what Shaykh Usama bin Ladin has said quite explicitly. Supporting this penetrating strategic view is that the Disunited States of America are a mixture of nationalities, ethnic groups, and races united only by the 'American Dream,' or, to put it more correctly, worship of the dollar, which they openly call 'the Almighty Dollar.' May God be exalted greatly above what they say! Furthermore, the entire American war effort is based on pumping enormous wealth at all times, money being, as has been said, the sinew of war."

Food for thought...how does America sustain a war that costs anywhere from approximately $500 billion to $1 trillion a year, while simultaneously meeting enormous fiscal social obligations to its populace and funding a gargantuan bureaucracy...while producing and saving little if anything?

Fire Up the Printing Presses

2008-05-03T16:42:00.000-07:00

So this past week the government distributed tax rebate checks to the populace early, in order to attempt to jump start the ailing economy. The checks, part of an "economic stimulus plan," have made the whole of our citizenry unwitting participants in their own economic distress.

Before examining that statement closer, let's begin by firmly establishing the fact that any classical economist must surely be rolling over in his or her grave right now at the notion that an economy can be stimulated by the printing of fiat (paper-not-backed-by-anything-but-forced-to-be-accepted-by-government-decree) currency, thus adding to already staggeringly high levels of inflation. This illusion of wealth has consistently proven to be the downfall of once-vibrant economies and nations, yet our country remains in a halcyon state of economic perception.

Let's discuss inflation for a moment. Inflation is good...if you're one of the first entities to receive the freshly printed paper currency. This is because you have the transient opportunity to spend or invest that money before the effects of the inflation have seeped into the economy and prices have subsequently risen. A very good analogy here -- albeit one borrowed liberally from "The Creature from Jekyll Island" -- would be manifest in a game of Monopoly. Assume there were two participants in the game, and one of the participants opened a second Monopoly board game and took all the money from it for his own. By doing this he would immediately have magnified his purchasing and investing power. It's likely he could buy up all the real estate on the board before the other participant even had a chance to compete. Now consider what would result if both participants got their hands on the money simultaneously. Given the theoretical perfect timing of this event, all of the prices on the board for real estate and luxury items and whatnot would rise in unison. Thus, the extra money would have allowed for nothing but the payment of higher prices for the desired assets.

The problem with the second part of the analogy is that, in America, the average taxpayer doesn't even get that much of a break. You see, you and I are the last to receive the money on the financial totem pole in the form of our paychecks, and therefore, we are indeed left with the risen prices. But unlike the Monopoly analogy, we do not have the benefit of receiving a commensurate increase in wages to cope with the inflation. So each year, prices rise, goods become more expensive, and our wages fall further and further behind the price curve. Eventually, we turn to credit to be able to afford the things we want in life. When was the last time your friends, neighbors, or family members bought their car in cash? Or their plasma TV? New furniture? Vacation? Anything? The reality is, if you're anywhere near the median income in America, you buy necessities with your paycheck and finance almost everything else by loan or credit card. And now, with the latest financial debacle left steaming on middle America's doorstep, even the necessities like food and gas are rapidly cutting deeper and deeper into household budgets.

I'm sure by now most of you have seen the video clips on TV of US Treasury checks rolling hot off the printing presses in voluminous sheets. Those who save their check will soon regret it, as spiraling inflation will make the saved money increasingly worthless. The 2% the bank is giving you in your savings account will hardly make a dent in the 8-15+% inflation we're experiencing. Sure, the economic data like the Consumer Price Index (CPI) -- the official government barometer of inflation -- tells you that inflation is only 2-3%. (Isn't it amazing how the CPI is always either 2 or 3% every month? It hardly ever changes...in the context of a $14 trillion economy, shouldn't it fluctuate just a little bit?) The problem with this statistic is that it does not include the three things you care most about: food, gas, and the cost of your home. Interestingly enough, home prices died a recent death vis-a-vis the CPI...by 2006 they were going so high so fast the government just excised them from the CPI lest it end up skyrocketing. (They replaced them with rent prices.) Presto!...a little accounting adjustment here and there and we're right back at...2 to 3%.

Hopefully I've talked you out of saving the welfare check you just received. (If I haven't, save yourself the cost of an inflated postage stamp for mail-in deposits and just stuff the check under your mattress...same deal.) No, these checks are more likely to be spent by consumers on everything from the necessities to luxury items. And you might ask why I said earlier that these consumers are unwittingly participating in their own economic distress? The government printed this money with nothing of value backing it; therefore, the paper money will circulate into the economy, eventually raising prices and leaving cash-strapped consumers shaking their heads at the gas pumps and grocery aisles in 6 months, wondering how gas and food prices just jumped another 20%. The consumer has become the method of delivery for the inflation in this scenario: the government printed the worthless money, you spend it and inject it into the money supply.

Lastly, as if the above weren't bad enough, most of the items Americans will be buying with their checks at Wal-mart, electronics stores, and so forth are made in China or by other burgeoning economies. So not only will taxpayers be facilitating higher prices to be paid at a later date, but they will also aid in the enrichment of foreign countries. This is the reality within the US economy, one that is based 70% on consumer spending with a hollowed-out production base that has largely relocated to distant shores.

You and I Aren't Part of the "Economy"

2008-04-27T04:14:00.000-07:00

Or at least not in Mr. Don Luskin's mind, or most other pundits for that matter. You see, for these experts, the economy is already rebounding, earnings reports from major corporations like Google are beating estimates handily, the housing market is poised for an upturn, and the Wall Street investment banks are raking in profits again.

Consider the following quotes from Mr. Luskin's piece dated April 18, titled "Economic Recovery Already Underway." This piece was unfortunate in that Mr. Luskin has been known for libertarian economic views and overall support for the ordinary citizen from an economic perspective...thus making this piece all the more puzzling:

"And yet now, a month later, the economy has not gotten worse. Compared to the bleak expectations then, even just hanging in there would have been an upside surprise. But it's more than that. Things actually are getting better."

"Other than [GE's earnings disappointment], the news has been terrific. Look at what's come out of the technology sector the last couple days. Intel (INTC3), IBM (IBM4) and Google (GOOG5) all surprised big time on the upside. No falloff in world-wide technology demand at Intel and IBM. And no falloff in the consumer sector for Google."

"Industrial production was reported as rising 0.3% last month, when it was expected to have declined. That's a key recession indicator and it's just not indicating. The high-tech component of industrial production has been especially strong, currently at all-time highs."

"The worst is over. It's more than over. Consider what's happened in the banking sector. With Merrill Lynch's big write-off yesterday, and Citigroup's (C6) this morning, cumulative bank and broker losses from subprime lending and related credit craziness has come to something like $250 billion."

"They'd like you to believe that America has no economic future, that our best years are behind us, that we've run out of tricks. But it's not true. And Google's big earnings report yesterday proves it."

And the most inane...

"So what if there was some excess home building and home buying? So what if some stupid banks made some stupid loans, and some stupid home buyers took those stupid loans and now can't pay them back? It's a problem, I suppose. But in the end it's a side show. The economy marches on."

First and foremost, we need to find out where Mr. Luskin buys his gas and groceries. Apparently, it's much cheaper than where you and I are buying it. Or maybe people like Mr. Luskin are paid so handsomely that 100+% increases in their grocery bills don't register when they balance their budget. The fact that the above-quoted commentary makes nary a reference to spiraling costs of consumer staples is a startling omission to say the least. It's as if the daily challenge faced by the American consumer to make flat or only slightly increasing wages extend far enough to purchase the essentials is inconsequential to the economic state of affairs in America.

Having said that, let's examine some of the statements from his piece.

"No falloff in the consumer sector for Google." Of course there isn't...or at least not yet. What is being ignored here is that consumers are relying on credit, probably nearly exclusively, for buying the things that they want. Budgets are strained by the purchasing of food and gas, as well as paying the mortgage and car note, so the credit card becomes the only means of acquiring what the middle class desires. Eventually, as the credit crisis trickles inevitably down to the consumer level, the bridling of consumer spending will show up in Google's numbers. Plenty of other sectors have already begun feeling the crunch from less spending by their usual customers. In fact, the WSJ just reported on this phenomenon in the restaurant sector last week.

Mr. Luskin points to the industrial production indicator as a sign that there's just no recession in sight. The problem with this assertion is that it ignores the fact that the production in question may not necessarily be aimed at US consumers; the production output may very well be aimed at selling the products overseas to healthier economies. Even more so, to suggest that no recession is upon us simply because an economic production indicator rose by 3 tenths of a percent is bordering on irresponsible. Perhaps Mr. Luskin could sit down with and convince middle and lower income families of this fact...but I doubt it.

Regarding the Merrill Lynch and Citigroup write-offs, it's as if Mr. Luskin is celebrating the fact that another $250B of investment banking sludge has been successfully sloughed off and dumped onto the shoulders of the American taxpayer. Only in the world of the monetary elite is this an accomplishment worth touting. You see, the $250B that was "written off" is really handled roughly in the following fashion: the banks declare the loss; the Fed assumes the responsibility for the debt; the Fed monetizes it through the printing of money and addition of the loss to our overall national debt; the taxpayer experiences rising prices from the resulting inflation and higher taxes to pay off the burgeoning government debt.

"And Google's big earnings report yesterday proves it." So goes Google, so goes America. This facile connection between a Google quarterly earnings report and the state of the US economy belies the fact that the average American is meaningless when it comes to the perceived strength of the US economy.

As if the previous resolutions regarding US economic growth were not enough, the piece ends with a declaration of minimization of the housing bubble and the resulting credit implosion that it manifested. What Mr. Luskin and other experts fail to realize is that the credit crisis' worst effects have yet to find their way into our economic system. The bulk of ARMs have not reset -- but they will do so over the next 18 months. The impingement of people's budgets by higher mortgage payments has yet to be fully realized. The aftershocks will spread to their ability to purchase food, of which prices are already rising sharply; buy gas to get to their jobs or travel destinations; pay off car loans and credit card balances; and ultimately, stop buying the goods and services that are considered non-staples. This last item will show up in reduced consumer spending numbers, of which 70% of the US economy is based upon. When this occurs, the economic stagnation fostered by the housing bubble and credit crisis will be upon us in full force.

Before closing this entry, it is important to analyze another of Mr. Luskin's points. Early in his piece, he references the Bear Stearns collapse in the following paragraph:

"Just a month ago yesterday, markets opened to the news that the firm Bear Stearns (BSC1) had been vaporized and for no better reason than that investors had arbitrarily lost confidence in the venerable brokerage firm and all withdrawn their money from it at the same time. It was only the Federal Reserve stepping in with $30
billion in risk capital that prevented the Bear collapse from taking down world capital markets."

For no better reason than investors lost confidence? Amazingly enough, Mr. Luskin has found a way to foist the blame for the bank's failure onto you and I. Perhaps it was not enough to suggest throughout the piece that nothing is amiss in the economy while ordinary citizens struggle -- rather, adding insult to injury was called for as well. Bear Stearns' collapse is rooted in faulty investment decisions and downright financial alchemy that produced securitized debt that had no legitimate underpinnings for being packaged and sold to investors in the first place. To blame the BS collapse on investors is like blaming the Titanic sinking on the ship's wait staff.

Mr. Luskin doesn't stop there, however. He goes on to say that the Fed saved the day by injecting "$30B in risk capital" into the firm to prop it up. First off, what does he mean by "risk capital?" This term evades my understanding; perhaps the reader can illuminate it for the good of all. That aside, this comment makes forfeit any possibility that Mr. Luskin understands how the Fed works. The Fed has no capital in its "vaults." What it does have is the obligation to monetize US government debt and print money. Apparently, it now has the obligation to save any and all irresponsible large banking institutions as well. So the $30B of largess that the Fed supposedly provided to BS was simply a fresh sheet of money rolling off the printing press, creating the dual effect of rescuing a Wall Street titan while resulting in inflation in US and world markets. In other words, the taxpayer, not the Fed, unwittingly bailed out BS by shouldering higher prices and a greater tax burden.

I would close by asking the reader, the next time he or she is hearing or reading some report on the state of the US economy or the plight of the consumer, to listen for the reasons being given as to the current state of affairs. More importantly, pay attention to those reasons not being provided.

Watering the Garden While the House Burns Down

2008-04-26T16:02:00.000-07:00

As mentioned previously, the US central bank, or Federal Reserve as it's known, has the power to expand the money supply through the monetization of US government debt. This is a complex way of saying the Fed prints money against the amount of government debt it assumes on behalf of the US Treasury, and subsequently injects the printed dollars into the money supply. (Read "Creature from Jekyll Island" for an excellent description of how this literally occurs.) The result is that, with the increased amount of dollars circulating through the system, prices respond accordingly and move upward in reaction to the increased amount of capital in the economic system.

By now you've likely heard about the rice rationing at Costco and Sam's Clubs in the US, and the soaring commodities prices around the world that are causing food riots. These events are directly related to the Fed increasing the money supply and expanding credit through the artificial lowering of interest rates. But how, you might ask?

To answer this, we must go back at least as far as 1944. (1910 might be more appropriate, as that was the year the Federal Reserve Act was formally conceived of by several bankers and one US Senator; or even to the late 18th century when Thomas Jefferson and Alexander Hamilton stood on opposite sides of the fence regarding central banking; but to do so would be to digress too far from the topic at hand.) In 1944, with WWII nearing its conclusion, the world powers who were the presumptive winners of the war convened at Bretton Woods, New Hampshire to discuss the economic world order post-WWII. One of the major decisions made at this conference was that the US dollar would be the world's reserve currency. Other foreign currencies would be pegged to it, and commodities would be denominated in it. Thus, today you see oil, as well as commodities such as wheat, corn, sugar, coffee, rice and so on, priced in dollars. It should be relatively clear then that any significant fluctuation in the supply of the US dollar would cause noticeable price movement in commodities. As the Fed prints dollars, these dollars eventually make their way into global circulation, affecting markets all over the world. The more dollars in the system, the greater the share oil and other commodities producers will claim through the act of raising their prices.

Lately, there have been a few events that will precipitate the printing of more dollars: the $150B economic stimulus package (many taxpayers will be receiving their checks this week), the $200B Bear Stearns bailout, and various bailouts aimed at homeowners facing foreclosure due to the credit crisis. Of course, one must also take into account other massive federal expenditures, such as the $3 trillion Iraq war, to even begin gauging the total debt that must be monetized by the Fed.

Therefore, it should be no surprise that oil and commodity prices are spiraling upward, leading to cost pressures in third world countries and subsequent shortages and riots. For more well-off countries such as ours, it means potential rationing, longer lines at grocery stores, and a larger percentage of our personal budgets being allocated to the basic necessities such as food and gas.

Amusingly enough, none of the so-called experts on television, or in the print media, are applying the appropriate degree of focus to this aspect of the problem, if they are even mentioning it at all. (Exception to this rule: Peter Schiff of EuroPacific Capital. Catch him every time he is on CNBC, Fox and the like and you'll get an accurate dose of reality.) In fact, the Wall Street Journal has taken to describing the problem as "inflationary psychology," as if the rising prices were a result of some form of mental perturbation amongst consumers. CNBC panelists speak of the soaring prices as if they were caused by voodoo magic, outside the realm of basic economic principles. Any and every other plausible explanation is posited -- unusually high demand, bio fuel consumption, production shortfalls -- besides the one that is right before us: the expansion of the money supply by the Fed.

And so as the title of this post suggests, the focus is being placed on the wrong, or certainly less important, areas when attempting to answer the question of where the rising costs at our gas pumps and grocery stores are coming from. Until we can recalibrate this focus, the situation will remain a mystery to our populace and the wrong remedies will be prescribed by those with the power to alter the status quo.

Welcome

2008-04-26T13:30:00.000-07:00

The author of this blog is not an economist nor do I pretend to be. Rather, the inspiration for this blog is derived from two places. The first is from reading several books on the subjects of economic theory, monetary policy, and investment-related topics. These books include "The Road to Serfdom" by Friedrich August von Hayek; "Wealth of Nations" by Adam Smith; "The Creature from Jekyll Island" by G. Edward Griffin; "Crash Proof: How to Profit from the Coming Economic Collapse" by Peter Schiff, as well as numerous politically-themed books such as "The Greening of America," "The Ninth Wave," "The Fifth Estate," and others. The second inspiration is from being a first-hand witness to the gradual deterioration of the state of the US economy. As a consumer, taxpayer, and patriotic citizen, it has become increasingly difficult to observe current and past economic events without attempting to contextualize them.

You may be curious as to the title of the blog. The Austrian School (AS) of economics is described, among other ways, in the following manner on Wikipedia: "Austrians view entrepreneurship as the driving force in economic development, see private property as essential to the efficient use of resources, and usually (if not always) see government interference in market processes as counterproductive." Since becoming familiar with the AS over the last couple of years, I have begun to look at the happenings in our economy through this lens. If you are willing to apply the proper scrutiny to the US economy, you will see that the AS principles are de-emphasized at best, non-existent at worst.

One of the great AS contributors, and a renowned economist of his own right, F.A. Hayek was "known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought in the mid-20th century." I strongly urge anyone reading this blog to read "The Road to Serfdom," Hayek's seminal work.

A core principle espoused by Hayek is that the expansion of credit, or the money supply, by central banks causes inflation and the "boom-bust" monetary cycle. In the US, our quasi-private central bank known as the Federal Reserve, sets interests rates artificially in response to perceived market conditions, and prints money that is ultimately injected into the monetary system. The process by which it does this will be discussed later in this blog; for now, it is simply important to understand that the inflation that we experience in our economy is caused by this debasement of our currency by its creation out of thin air.

As a counterpoint to the AS and Hayek's views, I encourage the reader to research the Keynesian view of economics, as espoused by its purveyor, John Maynard Keynes. This economic way of thought more closely resembles the current US system. The reader will find that this blog often contrasts the AS and Keynesian schools of thought, through real-world examples and instances in today's economy.

In closing, it is not realistic nor feasible for me to attempt to summarize or describe all of the pertinent details and concepts surrounding the above topics. Rather, the above should serve only as an entree to the overall subject matter, and hopefully encourage the reader to examine these items in greater depth. In providing the above summary, the reader can now view future posts on this site in the proper context.