At least from a monetary perspective

This is a piece that I wrote in response to a request for a guest post over at ZeroHedge. It ran there yesterday garnering some nice attention and a diverse range of comments beneath.
Based on some of those comments, this article represents nothing more than my attempt to find an explanation that matches the data.

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My central thesis to this crisis, developed a few years before it even hit, is that the economic troubles are the symptoms, while the money system itself is the cause. My views on this are expressed in the opening of an article that I initially penned in 2006 but updated in 2008:

Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.
In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: Our monetary system must continually expand, forever.

The article above provides the big-picture backdrop that drives my long-term vision and thinking.  I raise it now so that you’ll understand that I principally view the economic world through a monetary lens.
The hot topic of the day is “Inflation or Deflation?” and the camps are firmly divided into groups of inflationistas and deflationistas.  When asked which camp I am in, I reply “Yes.”  Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.
From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.
While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.
And they are right; there is a black hole at the center.  If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow “go away” over the next 6 years.  This is indeed a massive black hole.
Yet everything just keeps perking along.  What gives?
The answer, I believe, requires us to ask a Zen-like question along the lines of, “What is the sound of one hand clapping?”  That question is, “If nobody recognizes a defaulted debt on their balance sheet, does it exist?”
Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist.  And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.
What does “deflation” mean in such a world?  Not much, as it turns out.  At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.
This is the world in which we currently live.  Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions.  If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.
But let me ask this:  What prevents the authorities from simply storing them out of sight forever?  Or at least long enough to allow the wave of liquidity to work its inevitable magic?  So far, much to my great surprise, they’ve managed to do exactly that, with hardly a squeak from the mainstream press (although the blogsphere is on the job, as usual).  I am now wondering if they cannot keep this up indefinitely.
So from a purely monetary perspective, money can only be “destroyed” if banks and other financial institutions are compelled to recognize the losses and take a hit to capital.  If the loss is not recognized, no money is destroyed.  At least it is not recognized as gone.
Perversely, when a bank sells a ruined loan ‘asset’ to the Federal Reserve, it is a double shot of money to the system – the money initially created upon the issuance of the original loan, which is still out there in circulation, and a second bolus when the Fed creates money out of thin air to buy the failing ‘asset’ from the bank.  One blob of money into the system when the loan is made, another when it is bought by the Fed.  One loan, two blobs of money.  Many have failed to recognize this feature of the Fed’s asset purchase programs.
So from this perspective, we could even argue that by employing the ‘pretend and extend’ strategy, coupled with an aggressive Fed purchase policy, it is possible that more money is being created than destroyed right now.  Which means that from a strictly monetary perspective, I am not yet sold on the idea that money is being destroyed at the rates sometimes implied by the deflationary arguments.
Also, the data is not really in support of that notion either:

Of course, this money needs willing lenders and borrowers, which brings us back to the matter of price deflation.
Out in the real world, where consumers and producers exist, the bursting credit bubble has severely cut off consumers’ access to and desire for new credit, and producers have dialed back excessive capacity and cut their prices in order to attract business and survive.
There is no doubt about this process, but here I would argue that falling prices are currently as much a matter of supply and demand as they are a monetary issue.  In other words, the price deflation that we are currently seeing is not a pure monetary phenomenon.
Which means I think we are in a bizarre hybrid world, where deflation should be the order of the day, but it currently is not, because its impacts are being held in abeyance by the simple expedient of pretending the losses do not exist.
My current outlook calls for productive capacity to continue to fall out in the real world, even as the Fed conjures more money into existence in the make-believe world of ‘high finance.’  (What are they smoking over there?).
Is this not a recipe for eventual inflation?  More money, but fewer goods and services?  History says ‘yes.’
All that said, I would not disagree with the notion that there’s another year or three of grinding along (where stock and bond prices are concerned), possibly down, but maybe not, before the monetary/goods imbalance comes charging out of the chute ready to throw off the unwary and trample them in a blistering round of inflation.
But it could be sooner than that.  Or later.  The point here is that we really don’t know, and because our monetary system operates on faith, it means that we have to be prepared for the fact that a shift could happen at any time.  Nobody can predict when a school of fish will suddenly turn to the left.  Who knows what final trigger will cause a critical minority to suddenly determine that they’d rather hold things other than paper?
For now, while I understand and appreciate the deflationist argument, the only thing that would convert me fully to that camp would be a sudden return to rigorous application of honest accounting.  If you derisively snorted at that last sentence, then we share the same assessment of the likelihood of that happening any time soon.
In order to answer the main question of this article, we regretfully have to turn to Dadaism* to develop an appropriately absurd non-sequitur:
“What is the sound of one hand clapping?   Insanely high stock and bond prices.”

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* Dada was a protest by a group of European artists against World War I, bourgeois society, and the conservativism of traditional thought.  Its followers used absurdities and non-sequiturs to create artworks and performances which defied any intellectual analysis. The founders included the French artist Jean Arp and the writers Hugo Ball and Tristan Tzara.  Francis Picabia and Marcel Duchamp were also key contributors.
The Dada movement evolved into Surrealism in the 1920′s.

The Future of the Dollar

 Here is an outstanding, must-read regarding the dollar and economy. Warning, it is long and more technical than some other articles you have been referred to, but worth investing some time to fully understand. In my opinion, the issues discussed in this article are key to understanding our current situation and the manner in which it resolves.
It is hard to imagine a happy future for the dollar, and I was going to say that before Robert Fisk published his The Demise of the Dollar, in which he describes secret talks among central bankers and finance ministers of various countries on how to move away from trading oil in dollars.

Is Fisk’s report true? I have already been told once today that the story was a bit too “conspiratorial” to be taken seriously. The expected official denial followed quickly.

But top officials of Saudi Arabia and Russia, speaking on the sidelines of International Monetary Fund meetings in Istanbul, denied there were such talks. The two countries are the world’s largest and second-largest oil exporters.
Asked by reporters about the newspaper story, Saudi Arabia’s central bank chief Muhammad al-Jasser said: “Absolutely incorrect.” He repeated the same response when asked whether Saudi Arabia was in such talks.

The pols have chosen to cover up the problem

The disgraceful and unsustainable government sham continues. Rather than face up to problems, the government tries to hide them and create another credit bubble. This extend and pretend strategy cannot work although was easily predicted. Previous posts dealt with what was happening. This one, US Government Has Become Fannie and Freddie, is one example.

Political cowardice and the need to cover-up criminal activity made such predictions easy. Rather than face up, politicians and the Fed are trying to bluff their way through. This approach cannot work because the government is bankrupt and nearly out of options. Trying to add more credit to the system is like changing the title of an old movie and then being surprised when the ending is the same. There is no exit that doesn’t involve pain. Recognizing that and dealing with it involves the least economic pain. Avoiding the problem involves the least, short-term, political pain.
The pols have chosen to cover up the problem, hoping it goes away. In poker terms, markets hold 4 aces and the pols have a busted hand but think they can win the pot by bluffing. No chance! Unfortunately their all-in play will bankrupt the government and the country. The sources of new money to sustain this Ponzi scheme are drying up.
What we are witnessing at this point is a cornered and wounded animal, desperate to survive and willing to do ANYTHING to do so. Accounting gimmickry, cover-ups, lying about how bad the situation really is and other measures to perpetuate the scam are not working. As things become more desperate, more dangerous tactics will follow. This ending will not be pretty and will have historical ramifications that will reverberate for decades.

Former Fannie Chief Credit Officer Says FHA Is $54 Billion Underwater

In keeping with the warnings presented by Kyle Bass warned that the entire housing bubble is now being ported over to the taxpayer’s balance sheet, Edward Pinto, a former chief credit officer for Fannie Mae claims that the Federal Housing Administration will likely require a major taxpayer bailout “in the next 24 to 36 months” as it is likely to incur $56 billion more in losses than it can withstand.
For those that think the NINJA loans are a thing of the past, think again – the Fed is now actively encouraging just those same reckless standards that brought America to the brink:

The FHA program’s volumes have quadrupled since 2006 as private lenders and insurers pulled back amid the U.S. housing slump, Pinto said. The trend has left the agency backing risky loans and exposed to fraud in a “market where prices have yet to stabilize,” he said. The program insures loans with down payments as low as 3.5 percent and has no formal credit-score requirements.

The FHA Commissioner, David Stevens, is keeping to his side of the story, which is that everything is being properly accounted for, and there is no risk in the future of the Administration. Don’t expect this story to change until the next time the handout hat startrs getting tossed around legislators. In the meantime, the deterioration in loan standards keeps accelerating:

About 14.4 percent of FHA loans were delinquent as of June 30 and 2.98 percent were already being foreclosed upon, according to the Mortgage Bankers Association. The combined percentage for all mortgages was a record 13.16 percent, according to data from the Washington-based trade group, which said in releasing the figures the share of FHA loans past due is being suppressed by the large amount new debt.

Insurance policy against both inflation and deflation

Deflation could be the biggest threat to the economy, but gold — usually an inflation hedge — is reaching new highs. That’s because smart investors aren’t playing the inflation trade, they’re buying currency crisis insurance.
With the amount being spent by the public sector, with the huge amounts of leverage still in the system, there’s a palpable fear that America won’t be able to meet its obligations. Relative to GDP, the amount we’re borrowing to finance deficits makes us look irresponsible.
When such economies hit a wall, investors make a run on the currency, typically moving their assets to a stronger currency, like the dollar.
But this time the problem is the dollar, along with other leading paper currencies, all of which are threatened by profligate fiscal and monetary policies. So some investors want out of the system entirely. Gold, as my colleague Neil Collins noted earlier, is a way to do that.
The gold market is small enough that a decision by a handful of money managers to increase their asset allocation from, say, zero to 5 percent can move the market. All the gold ever mined would fit aboard an oil tanker; its total weight of 125,000 tons amounts to a few hours’ output for the U.S. steel industry.
But economists tell us that inflation isn’t a risk now. Are they wrong? No and yes.
The conventional way economists view inflation is to look at things like “output gaps.” When the economy falls below a level of output it previously achieved, it is said to have unemployed resources. If you think of inflation as workers demanding and getting higher wages, which leads to higher prices for the goods and services they produce, then inflation isn’t a threat.
So economists tell us more borrowing and money printing won’t be inflationary as long as people are unemployed.
One problem: Their models ignore the fact that peak output was artificially inflated by a credit binge. Borrowing more to sustain an unsustainable level of spending borders on insanity, yet that’s precisely what such economic models tell us we need to do.
There’s an extra variable these models don’t account for — the Chinese and all major lenders to the United States. They don’t much care if our employment rate is below desirable levels. At a certain point, they may recognize that the United States is acting like a banana republic and choose to stop lending.
When that happens, we might see a “sudden stop” event: Capital inflows to the private and public sector cease as everyone races to get out of dollars.
Eric Sprott, CEO of Sprott Asset Management has $4.5 billion under management, $2 billion of which is invested in physical bullion — silver and gold — stored at banks in Canada. Another large chunk is invested in gold stocks.
He views gold as an insurance policy against both inflation and deflation. Central bank quantitative easing policies mean “we’re printing paper currency like crazy,” so he doubts the long-run value of fiat currencies.
On the flip side, if central banks pull back, you could enter a deflationary spiral, essentially a banking collapse, in which case “your deposits wouldn’t be returned to you. Better to have physical gold in your control.”
Most economists and investors still labor under the illusion that there’s a way out of debt that doesn’t involve a drastic reduction in the paper value of wealth. Smart investors aren’t so sure and want at least a portion of their assets out of the financial system.
A dollar crisis isn’t necessarily coming tomorrow, so there’s no guarantee gold’s price will keep going higher. Still, gold is a decent insurance policy against economic Armageddon.

Institutions and incentive structures

Arguably Macroeconomics is not economics. It deals with aggregates, statistics and mathematical models that purport to explain the behavior of the economy. But economics is not about aggregates, it is about human behavior. The building block for meaningful economics must be the individual, not some aggregate called Consumption or Investment. These aggregates are nothing more than the outcomes of millions of individual decisions. Aggregates do not make decisions, they result from decisions. They are statistical constructs only, often useful to summarize history. To the extent that they have correlation, (the incorrect premise of macroeconomics is that they are causally related), the correlation results from stability at the micro level. Institutions and incentive structures provide the framework that influences individuals. If these are stable, then aggregate outcomes will appear to be stable over time. But there is no causal relationship among aggregates that can be managed as if it were some giant machine.Yet, that is the basis for macroeconomics. If we “input” more Consumption, the “output” of the machine will increase. If we increase Government Spending, it will increase GDP. If we increase the Money Supply then …… Such is the world of macoreconomics. Unfortunately the underlying premise of macroeconomics, causality, is at best correlation. Macro management of an economy is based on a false premise.

An example of how the micro level affects the macro level is apparent in this piece that hit my email. Whether the story is true or not is immaterial. It demonstrates the thought processes of individuals when their incentive structure is changed. This behavior, magnified across all decision-makers (consumers and businessmen), is indicative of how aggregates are affected. Past correlations will not hold as a result. Policy makers in Washington will once again be “surprised.”

The Employee Meeting:
I would like to start by thanking you for attending this meeting, though it’s not like you had much of a choice. After all, attendance was mandatory. I’m also glad many of you accepted my invitation to your family members to be here as well. I have a few remarks to make to all of you, and then we’ll retire to the ballroom for a great lunch and some employee awards.
I felt that this meeting was important enough to close all 12 of our tire and automotive shops today so that you could be here. To reassure you, everybody is being paid for the day — except me. Since our stores are closed we’re making no money. That economic loss is mine to sustain. Carrington Automotive has 157 full time employees and around 30 additional part-timers. All of you are here. I thank you for that.
When you walked into this auditorium you were handed a rather thick 78-page document. Many of you have already taken a peek. You were probably surprised to see that it’s my personal tax return for 2008. Those of you who are adept at reading these tax returns will see that last year my taxable income was $534,000.00. Now I’m sure this seems rather high to many of you. So … let’s talk about this tax return.
Carrington Automotive Enterprises is what we call a Sub-S – a Subchapter S corporation. The name comes from a particular part of our tax code. Sub-S status means that the income from all 12 of our stores is reported on my personal tax return. Businesses that report their income on the owner’s personal tax return are referred to as “small businesses.” So, you see now that this $534,000 is really the total taxable income – the total combined profit from all 12 of our stores. That works out to an average of a bit over $44,000 per store.
Why did I feel it important for you to see my actual 2008 tax return? Well, there’s a lot of rhetoric being thrown around today about taxes, small businesses and rich people. To the people in charge in Washington right now I’m a wealthy American making over a half-million dollars a year. Most Americans would agree: I’m just another rich guy; after all … I had over a half-million in income last year, right? In this room we know that the reality is that I’m a small business owner who runs 12 retail establishments and employs 187 people. Now here’s something that shouldn’t surprise you, but it will: Just under 100 percent … Make that 99.7 percent of all employers in this country are small businesses, just like ours.
Every one of these businesses reports their income on a personal income tax return. You need to understand that small businesses like our s are responsible for about 80 percent of all private sector jobs in this country, and about 70 percent of all jobs that have been created over the past year. You also need to know that when you hear some politician talking about rich people who earn over $200,000 or $500,000 a year, they’re talking about the people who create the jobs.
The people who are now running the show in Washington have been talking for months about raising taxes on wealthy Americans. I already know that in two years my federal income taxes are going to go up by about 4.5 percent. That happens when Obama and the Democrats allow the Bush tax cuts to expire. When my taxes climb by 4.5 percent the Democrats will be on television saying that this really isn’t a tax increase. They’ll explain that the Bush tax cuts have expired .. Nothing more Here at Carrington we’ll know that almost 5% has been taken right off of our bottom line. And that means it will be coming off your bottom line.
Numbers are boring, I know … But let’s talk a bit more about that $534,000. That’s the money that was left last year from company revenues after I paid all of the salaries and expenses of running this business. Now I could have kept every penny of that for myself, but that would have left us with nothing to grow our business, to attract new customers and to hire new employees. You’re aware that we’ve been talking about opening new stores in Virginia Beach and Newport News . To do that I will have to buy or lease property, construct a building and purchase inventory. I also have to hire additional people to work in those stores. These people wouldn’t immediately be earning their pay. So, where do you think the money for all of this comes from? Right out of our profits .. Right out of that $534,000. I need to advertise to bring Customers in, especially in these tough times. Where do you think that money comes from? Oh sure, I can count it as an expense when I file my next income tax return . But for right now that comes from either current revenues or last year’s profits. Revenues right now aren’t all that hot … so do the math. A good effective advertising campaign might cost us more than $300,000.
Is this all starting to come together for you now?
Right now the Democrats are pushing a nationalized health care plan that, depending on who’s doing the talking, will add anywhere from another two percent to an additional 4.6 percent to my taxes. If I add a few more stores, which I would like to do, and if the economy improves, my taxable income … our business income … could go over one million dollars! If that happens the Democrats have yet another tax waiting, another five percent plus! I’ve really lost track of all of the new government programs the Democrats and President Obama are proposing that they claim they will be able to finance with new taxes on what they call “wealthy Americans..”
And while we’re talking about health care, let me explain something else to you. I understand that possibly your biggest complaint with our company is that we don’t provide you with health insurance. That is because as your employer I believe that it is my responsibility to provide you with a safe workplace and a fair wage and to do all that I can to preserve and grow this company that provides us all with income. I no more have a responsibility to provide you with health insurance than I do with life, auto or homeowner’s insurance. As you know, I have periodically invited agents for health insurance companies here to provide you with information on private health insurance plans.
The Democrats are proposing to levy yet another tax against Carrington in the amount of 8 percent of my payroll as a penalty for not providing you with health insurance. You should know that if they do this I will be reducing every person’s salary or hourly wage by that same 8 percent. This will not be done to put any more money in my pocket. It will be done to make sure that I don’t suffer financially from the Democrat’s efforts to place our healthcare under the control of the federal government. It is your health, not mine. It is your healthcare, not mine. These are your expenses, not mine. If you think I’m wrong about all this, I would sure love to hear your reasoning
Try to understand what I’m telling you here. Those people that Obama and the Democrats call “wealthy Americans” are, in very large part, America ‘s small business owners. I’m one of them. You have the evidence, and surely you don’t think that the owner of a bunch of tire stores is anything special. That $534,000 figure on my income tax return puts me squarely in Democrat crosshairs when it comes to tax increases. Let’s be clear about this … crystal clear. Any federal tax increase on me is going to cost you money, not me. Any new taxes on Carrington Automotive will be new taxes that you, or the people I don’t hire to staff the new stores I won’t be building, will be paying. Do you understand what I’m telling you? You’ve heard about things rolling downhill, right? Fine .. then you need to know that taxes, like that other stuff, roll downhill. Now you and I may understand that you are not among those that the Democrats call “wealthy Americans,” but when this “tax the rich” thing comes down you are going to be standing at the bottom of the mud slide, if you get my drift. That’s life in the big city, my friends … where elections have consequences.
You know our economy is very weak right now. I’ve pledged to get us through this without layoffs or cuts in your wages and benefits. It’s too bad the politicians can’t get us through this without attacking our profits. To insure our survival I have to take a substantial portion of that $534,000 and set it aside for unexpected expenses and a worsening economy. Trouble is, the government is eyeing that money too … and they have the guns. If they want it, they can take it.
I don’t want to make this too long. There’s a great lunch waiting for us all. But you need to understand what’s happening here. I’ve worked hard for 23 years to create this business. There were many years where I couldn’t take a penny in income because every dollar was being dedicated to expanding the business. There were tough times when it took every dollar of revenues to replenish our inventory and cover your paychecks. During those times I earned nothing. If you want to see those tax returns, just let me know.
OK … I know I’m repeating myself here. I don’t hire stupid people, and you are probably getting it now. So let me just ramble for a few more minutes. Most Americans don’t realize that when the Democrats talk about raising taxes on people making more than $250 thousand a year, they’re talking about raising taxes on small businesses. The U.S. Treasury Department says that six out of every ten individuals in this country with incomes of more than $280,000 are actually small business owners. About one-half of the income in this country that would be subject to these increased taxes is from small businesses like ours. Depending on how many of these wonderful new taxes the Democrats manage to pass, this company could see its tax burden increase by as much as $60,000. Perhaps more.
I know a lot of you voted for President Obama. A lot of you voted for Democrats across the board. Whether you voted out of support for some specific policies, or because you liked his slogans, you need to learn one very valuable lesson from this election. Elections have consequences. You might have thought it would be cool to have a president who looks like you; or a president who is young, has a buff body, and speaks eloquently when there’s a teleprompter in the neighborhood. Maybe you liked his promises to tax the rich. Maybe you believed his promise not to raise taxes on people earning less than a certain amount. Maybe you actually bought into his promise to cut taxes on millions of Americans who actually don’t pay income taxes in the first place. Whatever the reason .. your vote had consequences; and here they are.
Bottom line? I’m not taking this hit alone. As soon as the Democrats manage to get their tax increases on the books, I’m going to take steps to make sure that my family isn’t affected. When you own the business, that is what you’re allowed to do. I built this business over a period of 23 years, and I’m not going to see my family suffer because we have a president and a congress who think that wealth is distributed rather than earned. Any additional taxes, of whatever description, that President Obama and the Democrats inflict on this business will come straight out of any funds I have set aside for expansion or pay and benefit increases. Any plans I might have had to hire additional employees for new stores will be put aside. Any plans for raises for the people I now have working for me will be shelved. Year-end bonuses might well be eliminated. That may sound rough, but that’s the reality.
You’re going to continue to hear a lot of anti-wealth rhetoric out there from the media and from the left. You can chose to believe what you wish .. .but when it comes to Carrington Automotive you will know the truth. The books are open to any of you at any time. I have nothing to hide. I would hope that other small business owners out there would hold meetings like this one, but I know it won’t happen that often. One of the lessons to be learned here is that taxes … all taxes … and all regulatory costs that are placed on businesses anywhere in this country, will eventually be passed right on down to individuals; individuals such as yourself. This hasn’t been about admonishing anyone and it hasn’t been about issuing threats. This is part! of the education you should have received in the government schools, but didn’t. Class is now dismissed.

Contemporary unchecked finance

Doug Noland of Prudent Bear tackles the flaws in credit and interventionism practiced by our government and concludes: “… it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.” His commentary on the current state of economic thinking and what it will produce appears below.

The Governator and the Market Operator I’ll begin with an excerpt from Bill Gross’s latest Investment Outlook: “But California’s problems, while somewhat unique and self-inflicted, are really America’s problems, and not just because the California economy is 15% of national GDP. While California’s $26 billion deficit is not directly comparable to the federal gap of $1 trillion-plus, they both reflect a lack of discipline and indeed vision to perceive that the strong growth in revenues was driven by the same excess leverage and same delusionary asset appreciation that was bound to approach cliff’s edge.” It’s contagious. Both at the state and local level and in Washington, policymakers “lack discipline and indeed vision…” It is said that “bull markets create genius.” I’ll suggest that the downside of the Credit cycle fashions lousy policymaking. I feel for the “Governator” and the California legislature, and I feel for our new President and members of Congress. They confront the harsh post-Bubble reality of no win circumstances – wearing big bullseyes on their backs in an age of slings and arrows. As much as I respect Bill Gross – and can’t take strong exception with much of what he has been saying and writing of late – I just can’t find it within myself to move on. Newer readers might be unfamiliar with my long-standing – and one-way debate – with the McCulley/Gross view of the financial world. They have over the years been leading proponents for the popular consensus ideology that I have labeled “inflationism.” It is a basic tenet of Credit Bubble theory that if the system inflates the quantity of Credit it will be spent. Credit Bubbles are fundamentally about a lack of discipline – one could say a confluence of undisciplined behavior. Credit Bubbles evolve specifically because of undisciplined monetary system management, undisciplined lending, undisciplined borrowing, undisciplined investment, undisciplined speculation and, at the end of the day, undisciplined spending throughout. And there are some absolutes: Inflated mortgage Credit, home price gains, and elevated incomes will absolutely inflate the propensity for undisciplined consumption. Inflated tax receipts will absolutely inflate government expenditures – in California, Washington D.C., and all across the country. The discipline problem goes way back but commenced within the bowels of the Credit system. Mr. McCulley, in particular, was a vocal proponent for post-technology Bubble reflation. This reflation doubled total mortgage Credit in about six years and unleashed Monetary Disorder all over the world. In the process, this historic Credit inflation inflated asset prices, incomes, corporate profits, and government receipts. The state of California was at the epicenter of this massive inflation. Going back to fiscal year 2002-2003, California general fund revenues were about $71 billion. By the beginning of the 2007-2008 year, the state was budgeting for general revenues of $101 billion. In percentage terms, state revenues inflated about 40% during the five-year boom. And with receipts rising each year, of course legislators were going to extrapolate and increasingly inflate state spending. There’s no mystery here. Keep in mind that in typical Bubble economy form, much of the rising expenditure was the result of rising costs all along the chain of state services. Those campaigning earlier this decade for aggressive monetary ease to fight deflation got, not surprisingly, more than they bargained for. In hindsight, it is amazing to contemplate the complete and utter lack of vision that afflicted policymakers throughout the golden state and all across the country. How could they not perceive that sophisticated Wall Street financial leveraging and resulting asset Bubbles were only temporarily inflating their coffers? When seemingly everyone bought into the notion of endless prosperity, why couldn’t they have kept their heads? Just because everyone believed the enlightened Federal Reserve had forever mastered the business cycle, why couldn’t they have been more skeptical? And that the economic community, the regulator community, the Federal Reserve and the marketplace all missed this Credit Bubble dynamic is, apparently, no excuse. As I have often written, I sympathize with post-Bubble policymakers. It is a tenet of Credit Bubble theory that politicians – given the opportunity – will inflate. There is ample history illuminating the dangerous propensity to run the government printing press. Contemporary analysis gets more complex because of the nature of private-sector Credit and the penchant for government (explicit and implicit) guarantees. During the boom, “money” was burning a hole in policymakers’ pockets, but it was Wall Street and the GSEs commanding the electronic printing press 24/7. By far the most precarious absence of discipline and vision belonged to those Operating in and accommodating this historic private-sector Credit Bubble. I disagree with the policy of massive deficits. Yet the California and U.S. budget quagmires are the direct consequences of the bursting of the Wall Street/mortgage finance Bubble. And as much as greed and leverage have provided easy scapegoats, responsibility lies first and foremost with the nature of contemporary unchecked finance and flawed “activist” monetary management (trumpeted, not coincidently, by our era’s preeminent market Operators). And as much as the consensus view believes that previous financial maladies have been largely rectified, I see a continuation of the same malignant Credit system dynamics. In short, massive government intrusion into the market pricing of Credit continues to fuel economic maladjustment and Bubble dynamics. Why did Wall Street issue Trillions of ABS, auction-rates securities, CDOs, and private-label MBS? Because they could. Why did the hedge funds and others leverage so egregiously? Because they were making a bloody fortune and the marketplace was more than ok with it. Why did the GSEs increase their MBS guarantees by $400 billion over the past year, and why did the Treasury issue $1.9 Trillion of Treasuries the past twelve months – and will likely do only somewhat less over the next year? And why are cash-strapped state and local governments borrowing so aggressively these days? It’s because the marketplace continues to readily accommodate Credit excess. Who is demonstrating a lack of discipline and vision – the borrower or the lender? The “Governator” or the market Operator? Is this the way the market pricing system is supposed to function? Why is the marketplace inherently incapable of disciplining the egregious borrower – whether mortgage debt during that Bubble or government debt today? First, there are no inherent system restraints on Credit creation. Recalling the mortgage finance Bubble, recent massive increases in the supply of government debt have been met with a collapse in borrowing costs. Second, the marketplace perceived that fiscal and monetary policymakers were backstopping mortgage Credit during the boom. Today, the market is confident that policymakers are firmly behind the Treasury and agency securities markets. Borrowers are undisciplined for one reason: the distorted market mechanism not only fails to discipline them – it accomplishes the exact opposite. I could ramble on for pages on the myriad costs associated with unchecked, undisciplined and mispriced finance. Mr. Gross touched upon a key cost, noting today’s uncompetitive California and U.S. economies. This is a key aspect of Bubble economy distortions. The dangerous flaw in inflationism dogma is that the Federal Reserve and policymakers can manipulate the cost and quantity of Credit with positive systemic results. In reality, the consequence of increasingly bold policy activism over time include a more distorted and unbalanced economic structure, as witnessed today. And it is my view that a flawed Credit apparatus, ill-advised government intervention, and dysfunctional market dynamics ensure economic maladjustment gets worse before it gets better.

stock and bond markets

To paraphrase Houston Command Central: America, The Ego Has Landed. And not smoothly.

Today’s Copenhagen announcement was a political disaster heard around the world. It further raises issues concerning the  image and competency of the President. Regardless of one’s politics, another failed Presidency is not good. Given the current geopolitical and economic situation, it might be especially dangerous as discussed earlier. Unfortunately the  Copenhagen fiasco along with the disastrous job report today enhance the perception and probability of a failing Presidency.
One wonders at the level of stock and bond markets. How much longer can Alice-in-Wonderland financial markets continue in light of continuing deterioration in economic and political fundamentals? The Ego landing does not make it easier for markets to continue to levitate.
A harsh political evaluation was offered today by the American Thinker (a conservative website):

Thomas Lifson
Dude, where’s my charisma?
In a huge slap in the face for Barack, Michelle, and the Oprah, Chicago was the first city eliminated from Olympic consideration.
It turns out the world is getting sick of Mr. Know It All. The President of France openly mocks him, and now the Olympic Committee is unimpressed with his wonderfulness.
He is having even a worse day than David Letterman. He made it all about himself.  Ben Smith of Politico wrote before the decision:
Obama’s pitch to the International Olympic Committee this morning is very much about his and America’s identity, and not the IOC’s sometimes transactional politics, raising the stakes for the decision:

We stand at a moment in history when the fate of each nation is inextricably linked to the fate of all nations — a time of common challenges that require common effort. And I ran for President because I believed deeply that at this defining moment, the United States of America has a responsibility to help in that effort, to forge new partnerships with the nations and the peoples of the world….

Richard Baehr adds:
It would be hard to exaggerate how humiliating is the IOC vote with Chicago going out in the first round, with  the lowest score of the 4 cites. So much for the theory that the world loves America more under Obama.This is a huge embarrassment  for Obama, given he shoed up for the presentation. Obviously, he neither can count, or control votes on the IOC, the way he may in the Congress. This will not help him with any part of his domestic agenda.  A key part of his message has been that he is not Bush, and presents a different America to the world. Andrew Young won the 1996 games for Atlanta during the first Bush presidency. Obama could not do it for Chicago.
Ed Lasky adds:
He has done zero since elected — except cause some damage internationally.
Stimulus bill was cooked by Congress, not him. Health Care: stalled; Card Check: stalled; Cap and Trade: stalled.
He has empowered unions and the left wing-which is causing businesses to postpone investment and hiring. I have a radiologist friend who told me his practice and the hospital re postponing purchase of equipment because they have no idea how much they will earn in the future.
How is that for health care “reform”?