Robert Reich's solution: honesty

The crisis on Wall Street right now is less about solvency and about capital than it is about trust. And the real question is, How do you restore trust to a system in which, basically, nobody trusts the numbers that are supplied by big banks on securities?
—Robert Reich, interviewed on Marketplace

That's a great idea, Robert (although America probably is insolvent). We could bring a culture of honesty and fairness to Wall Street. Brilliant. However, since Wall Street has never been honest, nor fair, ever, it might be a difficult idea to implement. But I have an idea for a good way to start: the US government could set an example. The government could instruct the Bureau of Labor Statistics to produce accurate statistics instead of horseshit for a change.

First, how about an honest CPI series, instead of ridiculous fantasy numbers? Even the mainstream media is starting to report the CPI with skepticism and sometimes sarcasm. Then, we could have an honest data series for the gross domestic product! Imagine - numbers that businesses and the American people trust.

Note that none of this would cost billions of dollars. The government could just stop lying.

After that, some pretty simple, common sense finance regulation would avoid all this insane mortgage bond trouble. Twenty percent down payment for a house. No off-balance sheet liabilities for corporations (or the government). Its not that hard.

I realize that admitting we have out of control inflation, negative economic growth, and un-payable debts would send this country into the worst depression ever, but that will happen in any case. We should admit our insolvency, and start building an honest nation.

Walking around Manhattan and seeing.. Lehman Brothers

My girlfriend and I were spending Monday in New York City after attending a wedding, and the only art museum open was the Modern, so that's where we went. I had heard the news about Lehman Brothers in the morning and was following the latest carnage on Wall Street, but I was mainly trying to enjoy a vacation day. After our art-touring, and looking for the mid-town subway stop we pause to gape at the most garishly lit building I've seen yet in Manhattan. It was a massive block of video display. This thing was zipping and flashing. Then I noticed that there were media crews up and down the block, with all cameras pointing to the flashing video building. I realized I was looking at Lehman Brothers!


I was of course thrilled to be looking at the eye of the financial storm. It turns out that Lehman had been in the World Trade Center, but had moved to mid-town after nine-eleven.

News reports were rather odd. NPR interviewed Gordon Steele, author of Empire Of Wealth, an very good economic history of America. Steele compared the Fed allowing Lehman to fail to the the New York banks letting Bank of the United States fail in the 1929. I don't get it. Bank of the United States was the immigrants bank. Lehman is an investment bank that caters to the ultra-rich. The failure of Bank of the United States did set off a chain reaction; a wave of bank failures across America that launched the real Great Depression, because it had far more impact of peoples lives than the more famous stock market crash. Steele wondered is Lehman's failure would set off a similar chain of events.

Other reports described how upset Lehman's employees were at being made into such a spectacle. Most of those interviewed were angry that the Fed had not bailed out Lehman. Wow. They think we should be sympathetic?

I think what is going on today is that the Fed, and the press, and the public, are realizing that bailing out this bank (i.e. Bear Stearns) or that bank is not going to solve anything. We are facing a systemic crisis. The Fed is dealing with this by exchanging credit for just about anything at its many discount windows and TAF facilities. That sure sounds like monetization to me. But it is doing this for the few bank it chooses to save. Bank of America and J.P. Morgan seem to be on the A list. Merrill Lynch and WaMu are on the shit list.

So, what next for the financial crisis? The failure of Washington Mutual is only a few days away, if things keep going at this pace. And, after the elections, we'll have accelerating inflation, probably hyper inflation.

By the way, this financial crisis affects our ability to innovate our way out of the energy crisis. We no longer have an investment banking industry to supply capital to American industry on favorable terms. There is going to be a wave of innovation for alternative energy? Which of the almost-dead banks will finance this project? European banks will prefer to finance Euro companies like Airbus and Siemens over General Electric.

Those bonds we just guaranteed, issued by Fannie and Freddy? We will have to keep making those coupon payments even when the homes they represent are no longer generating income, because the occupants have left. More monetization. Our hapless government will monetize everything they can until our dollars are well and truly worthless.

Fannie and Freddie, ad nauseum

So, the goverment has taken over operation of the America's two giant, government sponsored mortgage brokers, Fannie Mae and Freddie Mac. News reports say ominously that the bailout "could cost taxpayers tens of billions of dollars".

Tens of billions? Who are they kidding? Fannie and Freddie's liabilities were in the trillions (btw, a trillion is a thousand billions). At the rate that American mortgages are defaulting, tens of billions are not going to fix anything. It's hundreds of billions if we're lucky, probably well over a trillion dollars that the government will have to pay. Remember that Fannie Mae was notoriously resistant to audits, and the SEC kept letting them postpone their statements? No one knows the true mass of the black hole at the center of the mortgage galaxy.

Supposedly the holders of GSE debt (collateralized debt obligations, mortgage backed securities, etc) are relieved that the US Treasury will guarantee the monthly interest payments on this debt. Not to worry, the freshly printed notes will keep arriving in the mailbox on schedule.. but something is different here. Think of what those bonds used to represent. All those people going to their jobs, bringing in paychecks, making mortgage payments to banks.. that was a lot of economic activity. That was the process of wealth creation. Now that those homes have foreclosed (not all of them of course, but a lot of them) and mortgages defaulted, the treasury will simple write out a check to cover the mortgage - even though the people who originally borrowed the money no longer even own the home! What economic activity does that represent? Not a lot. No equity is being accumulated, no wealth is created, or value added. The government simply prints the money. The government could try to cover the cost with increased taxes, but that would only suppress economic activity even more (not to mention cause riots). These bailouts are simply the next stepping stone to hyper-inflation.

In the end, who owns all those homes? Bond fund PIMCO does, and the government of China, which are both huge holders of Fannie and Freddie debt. These are the owners of American homes, along with many others. And if those homes go into foreclosure, the mortgages will still be paid by the USA. In soon-to-be-worthless American dollars.

The Terrible Silver Plunge

For all the people like me, who believe silver and gold are real shit, as opposed to fiat currency, the recent plunge in the futures price of silver and gold, was a crime against humanity.. well not really. But this is a prevailing view of many good and smart precious metals analysts. Heck, I don't see it. I think the major banks and nations that are aligned with the U.S. dollar have a very strong interest in not seeing the precious metals soar in price. So, they try to manage the price down. No conspiracy needed other than the usual corrupt shenanigans on Wall Street. Is anything new here?


Silver is still within it's recent uptrend, and may in fact be a spectacular bargain right now.

Silver was driven down very hard and fast by two New York investment banks. Almost certainly JP Morgan was one of them. Shorting silver is one of their lines of business. They probably had help from a variety of self interested parties: central banks, hedge funds. This is how hot commodities go: up and down. However there are repercussions to such savage price manipulation. Silver miners will find it impossible to continue operating. If not forced to shut down, because they'd be running at a loss, they might chooses to inventory their production. Artificially suppressed prices are a guaranteed way to create shortages, and shortages can then persist for some time. Even the arrogant JP Morgan, flush with their vanquishment and consumption of Bear Strearns, knows that they cannot control silver for long. Instead they will reverse their position and ride the precious metals upward, as the dollar renews its own fall into oblivion. If Bernanke is thinking the New York investment bankers are his friend this month for helping drive down commodities and prop up the dollar, he is crazy. Those guys are both ruthless and desperate.

War with Iran? I don't believe it.

The press seems to assume war with Iran is more and more certain. At least the western press. My father, who travels widely, tells me that virtually all Israelis now believe war with Iran is now inevitable. The prevailing assumptions are outlined in this gloomy op-ed for the New York Times:

Israel will almost surely attack Iran’s nuclear sites in the next four to seven months — and the leaders in Washington and even Tehran should hope that the attack will be successful enough to cause at least a significant delay in the Iranian production schedule, if not complete destruction, of that country’s nuclear program. Because if the attack fails, the Middle East will almost certainly face a nuclear war — either through a subsequent pre-emptive Israeli nuclear strike or a nuclear exchange shortly after Iran gets the bomb.
—Benny Morris

I guess this puts me in the optimist camp for a change. I think Morris is missing something (maybe everything would be more accurate). Israel can not hope to achieve anything by launching a unilateral war against Iran. This is because Iran is now backed by both China and Russia (and, discretely, by Japan). China and Japan depend on Iran for energy supplies. Russia is building much of Iran's new infrastructure, including military, and has many billions of rubles worth of business deals there. Iran is to Russia as Iraq is to America: Russia is fortifying Iran to secure their oil and gas supplies, much as America installed massive military bases in Iraq to secure their oil and gas. Russia has supplied Iran with Sunburn cruise missiles, which are a generation more advanced than US and Israeli cruise missiles, giving them tactical superiority. They are capable of evasive maneuvers, making them hard to defend against. These missile installations look down on the straits of Hormuz, bottleneck to the Persian Gulf oil shipments.

Of course, Iran can't win on the basis of better missiles. Over all, the Israeli and American military is far superior to Iran's. The real issue is not tactical, but strategic. Israel is backed by the USA and England, and Iran is backed by Russia and China. If a conflict starts, unless it turns into a short and quick victory for one side (unlikely), the side that will prevail will be the side with access to the most energy and capital. I'm not saying that Russia or China would attack the USA or England. Rather that those powers would employ geopolitical leverage to prevent Israel from destroying Iran, and vital Russian interests there, i.e. the oil and gas fields.

The USA and England are both on the brink of outright insolvency, and the USA is also dependent on imported energy. They are in no position to back Israel in a war. Wars are insanely expensive. England is now a net importer of energy, and their domestic supplies are in rapid depletion. Israel purchases its oil imports on the London and Russian markets. They depend on American and UK lines of credit.

Russia is not only self sufficient in energy, but can, and has demonstrated its willingness, to cut off energy from its export markets. China can do the same with capital, by simply selling part of its war chest of US Treasury bonds. China and Russia's superiority is so overwhelming that they can prevent a war from happening.

And that, I believe, is optimistic. If Iran had the bomb, I don't think Iran would nuke Israel and assume a retaliatory strike. In fact I think it is astonishing that Israel is threatening exactly that. Don't tell me that Iran is more crazy than Israel. They are both crazy. I think saner heads, i.e. Russian and Chinese, will prevail.

When push come to shove among bankers

Since it is increasingly clear, reading between the lines of the business press, that there are going to be bank runs in America and other western nations, it seems prudent to wonder just how and they will occur. Bernanke himself said in February that

"There probably will be some bank failures," he said, though they are likely to be among smaller regional banks that are particularly exposed to falling property markets.

So, Bernanke expects smaller banks to fail? Aren't some of the largest investment banks heavily exposed to mortgage bond losses? I think he is suggesting some consolidation will be happening. What might occur is larger banks preying on smaller banks in cannibalistic fashion. If all banks are finding it hard to make any money and can't borrow, the larger ones, especially those with access to the Fed's "discount window" and "term auction facility", could take over pretty much any bank they want. They will of course choose the most solvent ones, which have capital on deposit. They will use that money to pay off their bad loans! Any bad loans on the consumed bank's books will not be absorbed, rather it will be disposed of by being passed off to "garbage can" banks. Jim Willie has written extensively about how JP Morgan functions as the Fed's depository of debt that must never see the light of day

Continuing in this extrapolating manner, of positing free ranging thought experiments, I'll point out another thing. This process might continue up the food chain. The big New York banks and investment houses have always assumed that the Fed has their back and wouldn't let anything truly bad happen to them. Such assumptions are true to a point. The Fed is just one more bank, albeit the biggest. The Fed is having problems of it's own. It has blown almost its whole stash of capital trying to stabilize the credit crisis, and it has failed. It can neither raise nor lower interest rates. It can only create more "dollars", of uncertain worth, but they hemorrhage out of the financial system faster than the Fed can create them. I don't think Wall Street can be too confident that the Fed has their back for ever. At some point, after much bank-failing and insolvencies have come to light, and when the Citibanks and Goldman Sachs are still struggling to survive, they might realize that the Fed is now looking at them with a hungry eye, and inventorying their balance sheets for morsels.

OK, one more thing, on banks. Suppose you are a bank with a lot of unsalvageable mortgage debt. You have no morsels of good loans, and little capital to attract predators (i.e. investors). There is no market for your shit, and you know, deep in your heart, that there never will be, and you can't raise capital from any friendly Saudi Princes. Bankruptcy is inevitable. About the only thing you can do is control the timing. Maybe you can choose a favorable moment to go out? A good time might be when a lot of other banks go down. Or when there is an international crisis. Perhaps a currency crisis! Then you will be less exposed to liability. You might even get to claim a force majeure. Corporations always think of their liability first. Will they consider their depositors in this calculus? No way. Only liability.

Schumer tells the Saudis.. something he'll apologize for

Senator Charles Schumer is trying to threaten OPEC, and Saudi Arabia in particular, to get them to sell America cheaper oil.

“The Saudis have to understand this is a two-way street. We provide them weapons, our troops provide them protection, and then they rake us over the coals when it comes to oil.”— Schumer

Wow. Schumer is threatening the Arabian oil producers. The whole thing about protecting them with our weapons and troops sounds just like a mafia shakedown, with the thing about our troops being already there. Amazing. Doesn't he know that most Saudis hate the fact that US military “protects” them? Does it occur to him that Saudi Arabia could trade American protection for Chinese and Russian protection?

Doesn't he know who recently bailed out America's investment banking system? Among the participants of Citicorp's private offering of convertible preferred securities are the Kuwait Investment Authority, and His Royal Highness Prince Al-Waleed bin Talal bin Abdul Aziz Al Saud (see Citi's own press release). Mr. Al-Waleed bin Talal is a member of the Saudi royal family, and one of the world's most successful investors.

The senator from New York, of all people, should know what's going on on wall street. He should know who now controls the huge money center banks. The large investment banks' recent preferred stock offerings were no ordinary stock offerings. These were last ditch efforts to re-capitalize America's banking infrastructure. If these offerings failed there would have been a global financial collapse. So, know that the rescue money from the Arabs did not come without conditions, far on top of the 7% coupon the preferred shares pay. The first condition would be “we control the oil now”.

An article that expands on Schumer's assumption that America can still prevail as a superpower, and gives a somewhat more logical and reasoned framework, was published last week by Chile based market analyst Clive Maund: Powerful Bullmarket In Us Stocks Looms As The Us Prepares For Global Hegemony.... Maund basically says that America now has control of Iraqi oil (because of it's permanent military installations), and, in addition, will soon secure Iran:

“The oil reserves contained within Iraq are gigantic, and thus its acquisition was a major economic and security leap forward for the United States. In addition its central position within the region and the earlier acquisition of Afghanistan make the eventual appropriation of oil-rich Iran an almost foregone conclusion... At present the US is only militarily the greatest power on earth, but in a few years it looks set to assume comprehensive hegemony of the planet, as the massive oil revenues from the spoils of the Mid-East campaigns flow in and correct the careening deficits. China will then comply with US demands or the oil tap will be swiveled in the off direction. Russia, currently blessed by an abundant supply of oil and other natural resources, should do well, but will be surrounded and eventually forced into compliance as its resources dwindle and it becomes increasingly isolated. Britain, as the 1st officer of the US in its wars of acquisition, will enjoy a privileged place at the table in an increasingly resource starved world. Israel will look on with quiet satisfaction at all of this.”

This is a fascinating thesis, and one that I disagree with. America had global hegemony. That ended last year when it became apparent that the USA is essentially insolvent. We simply don't have the time to get out of this: a domestic shitstorm of housing collapse, energy shortage and capital crises are slamming us concurrently. Far from expanding our influence in the Persian Gulf, I think we'll be forced to withdraw. Jim Willie has made a prediction on how the showdown would occur: a demonstration of Iranian firepower via a Russian Sunburn cruise missile.

“The Iran wild card cannot be dismissed. A casual observer might believe the United States Military eagerly desires an incident, even with loss of US soldier lives, provided a cause for war is achieved with Iran, for some greater good not easily understood. So far Tehran has not bitten the bait. In the wings is Russia, quietly in control of European energy supply and eyeing its odd bedfellows among the ruling mullahs. Hidden in the hills and along the shore of the Persian Gulf are oodles of Sunburn missiles, supplied by Russia, installed by Iran, aimed at US warships. The Sunburn is one generation ahead of the Tomahawk Cruise missile in the US arsenal, capable of evasive maneuvers. ”

A sunk aircraft carrier would be a convincing demonstration of power. Naturally such a blow would not go unanswered. Iran would suffer some terrible attack with probably far more loss of life. But the American generals know, as do the Iranian, Russian, and Chinese generals, that America can not prevail. With a depleted military, and without the capital to re-fit and re-build, America can no longer use its military to seize the remaining great oil prizes. Weapons and ideology can start wars, but only fuel and capital can win them.

Fortunately it need not come to warfare. The Chinese could use discreet diplomatic and financial threats to steer us away from the path of global hegemony, even though that is America's natural default stance. We'll just have to spend the money on something boring, like building public transportation. We should mention it to Schumer one of these days. And next time New York needs a little cash he might be saying “sorry!” to His Royal Highness Prince Al-Waleed bin Talal bin Abdul Aziz Al Saud.

Lessons of the Russian Ponzi scheme

This is how Wikipedia describes the Russian financial crisis of 1998:

“Prior to the culmination of the economic crisis, the GKO bonds (Russian treasury bonds) issuance policy was similar to a pyramid, or Ponzi scheme”.

A Ponzi scheme! How America gloated in 1998 at the victorious end of the cold war. We were flush with pride over the beautiful new internet, and the stock market was soaring. But America, having gone a little overboard on internet frenzy, and hoping to pull off something bigger and better, soon built the most spectacular Ponzi scheme the world had ever seen: the housing and mortgage bond Ponzi. A Ponzi to end all Ponzis.

The thing that finally drove Russia into insolvency was a peculiar problem: oil was selling too cheap. It was essential to government revenues. Now people want Russia to increase oil production for the convenience of American drivers. If Russia (or the Arabian nations) increased production, the price of oil will go down. Why would they do that? Earth to America: nobody owes you any favors. It is America that owes.

A few weeks ago I wrote that when the treasury bill market finally softens, it will be “game over” for the Fed. A strong treasury market is the only thing that is maintaining the illusion of American solvency right now. I was thinking the treasury might start to turn over in November or December (08). But almost as soon as I wrote it, the treasury chart started to look a little softer:


Well a little softness in the very strong treasury is not going to crash the dollar — yet. But what would happen if it decisively broke down out of its up-trending channel? Suppose it went into a secular bear trend, chasing the dollar to the bottom? There would be a stampede out of treasuries, that's what. We'd blame the Chinese, naturally. “Economic Warfare”, we'd shout (although American hedge funds would be selling too). The Persian Gulf states would finally give up on us. They would try to separate their economies from ours. The only question is what sellers of treasuries would buy? Euros? Rubles? Gold? All three, probably.

Don't forget that the yield on a bond moves inversely to the price. A falling price makes the yield on a bond rise. And how would an insolvent USA pay the increasing interest on its debt? Simple: not for very long. The point will come, maybe within a year, when America defaults on its debt. Just as Russia did in 1998, as a result of its own top heavy financial system, America will default. That will be the final, ignominious end of a spectacularly successful era of American history, and it's sudden collapse. Maybe it will also be a beginning? I hope so.

And now for copper's turn

I don't know if other people find commodity prices as fascinating as I do, but that's why I blog after all. This chart of copper is very interesting:
Copper seems to be trying to break out to the upside. Now, when the US economy is just entering recession? There are three explanations that come to mind:

• The United States' economy is no longer the world's economy. The four largest growing economies are the BRIC nations: Brazil, Russia, India and China. They accounted for 40% of global growth in 2007, and they don't need America for much these days. BRIC nation exports to the US have become relatively small portions of their economies. Brazil only 3%, Russia only 1%, India only 4%, and China only 8%. 95% of Chinese economic growth came from internal domestic demand, as wealth has grown from actual work in factories (source: Hat Trick Letter).
• Copper smells hyper inflation coming. Copper is not be a precious metal, but it is priced in dollars. If you need copper to do your job or produce something, you might want to stock up. The problem that all global commodity markets are priced in dollars. Does anyone really know what the dollar is worth today (and what it will be worth next month)? And if it is hard to value the dollar, how would you ever be able to correctly price copper?
• Copper production might have peaked. This is part of the “Peak Everything” theory. I don't know if this is true, actually. Copper was predicted by some to peak in 08, but the latest numbers don't bear that out, so we'll see. I still think all commodity production is ultimately linked to the availability of energy.

Greenspan begs and pleads

Is there a decent way to get Alan Greenspan to shut up? The guy is out there, trying to defend his reputation, sounding increasingly desperate, pleading. A recent Financial Times editorial by Greenspan is simply embarassing: The Fed is blameless on the property bubble.

Greenspan asserts repeatedly that stronger banking regulation and oversight would not have prevented a property bubble, that it is not his fault, and that he is surprised at how bad things have become so fast, and that no Fed policy would have prevented it. Here are some pullquotes:

“Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators.”

“Aside from far greater efforts to ferret out fraud (a long-time concern of mine), would a material tightening of regulation improve financial performance?”

What did Greenspan ever do to ‘ferret out fraud’? His whole carrer he was enthralled with innovation and productivity. He never saw any financial fraud of any kind.

“The core of the subprime problem lies with the misjudgments of the investment community.”

Not my fault, not my fault!

“I have been surprised by the fierceness of investors in retrenching from risk since August.”

Alan, you're not needed any longer. Just shut up and try not to do any more damage. You are a Knight of the British Empire, you are rich. Go away and save your dignity. You have, all your life, stood for what your believed and you prevailed. Few can say as much. Now history will provide your reputation, not squirming editorials.

what do brokerages really do with your money?

We will never know the whole story of the Bear Stearns fire-sale to Morgan Stanley. There is not a lot of transparency in these things. But I have a different perspective. I think Bear Stearns was no bailout. It was a cover up.

Some indication of what might have happened if Bear had been allowed to fail was given last week when Australian brokerage Opes Prime went bankrupt. Opes Prime's laundry is seeing the light of day.

What was Opes Prime doing that resulted in their bankrupcy? It seems that some of their best customers, either hedge funds or “high net worth individuals”, were getting in trouble with their leveraged positions. They were getting shredded. Normally this would result in a simple margin call, the fund would liquidate its losing position and settle up. Things would be fine. But there might be a problem if the client's loss was very large. The worst thing that could happen is that the client would declare bankruptcy and not pay.

This is a problem because of the way modern brokerages work. All investments in brokerages these days are held in street name. None are registered to the account holder. The brokerage is the real owner of the investment. This is true for shares, contracts, derivatives, bonds, everything. This is what allows quick discount trading. The broker takes advantage of the situation to keep the securities on their books as assets. All the account holder has is a claim on those assets. On the other hand, every asset is also a liability. Just in the way a bank can be “too big to fail” for the Fed, a customer can be too big to fail for a brokerage. A large and heavily leveraged investor can take down a brokerage. If the client goes bankrupt, its liabilities become the brokerage's liabilities.

So what happened to Opes' customers? They lost everything. Not just the ones with losing positions, but any customer with a margin loan of any size, even if they were well in the black. This is because Opes pledged clients' shares as collateral for capital loans from another bank. They needed cash to keep their biggest clients solvent.

Was Opes the only brokerage in this age of widespread greed and fraud to play fast and loose with its customer's money? And, even more importantly, how would we ever know? Wall street is one of those magical self-regulating industries that needs only token oversight. Do you think the SEC cares about you or your account? I think you should assume your brokerage has pledged your shares and mutual funds as collateral for it's own needs. There is a prevalent attitude on wall street that anything goes as long as it makes money and doesn't show up in the news. But bad news is now coming out daily.

You are hanging on the end of a chain that has a series of weak links. It doesn't matter if you have a large account, small account, IRA account, mutual fund, margin or cash, or whatever. It is all registered in street name, and you are last to get paid if things go badly. If any one of various counter-parties to your brokerages' own positions defaults, your brokerage can be wiped out very fast. Or if one or more big clients turns turtle, either funds or individuals, your chain breaks. Your account can go from anything to zero overnight, not because your stocks went down but because you no longer own your shares. All you can do is take them to court. (who do your think will have the more effective legal team?) Sure you might have a strong case and a good claim. But just because someone else commited a crime, and you didn't, doesn't mean you will get your money back. In the end, if your brokerage goes down, you will be lucky to see pennies for dollars.

the price of gasoline

This is a weekly chart of wholesale gasoline. Gas is currently at $2.75 a gallon (lower than the retail price by about a dollar).

Gasoline is painting itself into a corner. A quickly approaching point will cause the price to break out of this triangle. A wedge like this predicts a dramatic change. It is unlikely to hold the current price. And when it breaks out it will either go up or down. Given the scale of the chart (rather long term) it could move quite far.

This looks like a bearish rising wedge, meaning the price should break downwards, and send retail gas down well below $3.00, maybe to $2.50. That would no doubt give much needed relief to recession-strapped Americans, truckers, taxi drivers, and the whole American economy in general. But this wedge can also break upwards. Gasoline could spike to $5.00. This would be the devastating blow that crushes all hope of any quick recovery from the current recession. Even mainstream economists would start uttering the anathematic word hyper-inflation.

Maybe the truckers want to strike?

There are rumors of a truckers' strike in the USA. Prominent blogger Mish writes a condescending post telling truckers to stop asking for hand outs because no one owes them a living. Well I think any working person who thinks they can improve their situation by the somewhat risky strategy of striking should go for it. Anyone who thinks they should take it on the chin for the good of Team America is crazy. But if the truckers think they can prevail in a strike they are also crazy. The economy is slowing, and transportation, especially hauling, will slow down dramatically. We have way too much trucking capacity. We need to, and will be, switching to rail and barge for everything that we can ship, except for the last few miles of delivery. BTW, cab drivers are facing similar problems:


This cab driver is so frustrated with King County (Seattle) that he is angrily calling for a strike. The strike never happened. But I think those guys have every right to do so.

A new conundrum: why would Bernanke destroy the dollar?

The breathtaking speed and force of the US dollar's ongoing disintegration amazes me, even though I saw it coming years ago. But there is one thing I got utterly wrong. I wrote a post in June, 2006, in which I postulated that the Fed, then led by newly appointed Ben Bernanke, would sacrifice the equity markets in an attempt to save the dollar. I thought they'd put up more of a fight, and that the dollar would crumble over the span of several years, not the nine months since the credit crisis started last summer. I concluded my analysis with this thought:

In the end the Fed will have to try defend the dollar to support the all important treasury bond market. This is what keeps the government solvent. And if things play out this way, I wonder how how much independance our Federal Reserve will really have anyway. I wonder if China's central bank Governor Zhou Xiaochuan, and Russian central bank chairman Sergei Ignatiev are now discrete and unofficial members of the Federal Reserve, and if they will be the ones who really set monetary policy.

Clearly, things have gone differently. In the first place, the Fed has no need to defend the treasury bond market right now. With all other kinds of fixed income paper looking like poison (i.e. toxic waste CDOs, etc), the only bond that has any attraction is the T-bill. That single bright spot in the Fed's universe will not last long. Next year, or this fall, when the T-bond market turns over, then the Fed will truly be out of options. Game over.

Most amazingly, the Fed has not made the slightest effort to save the dollar as it dropped like a stone. The dollar has fallen nearly 22% since December 2005, and is currently enduring an unprecedented and very possibly ruinous breakdown.

But instead of fighting to save the dollar, the Fed is fighting with all they've got to save wall street, and it's bond and stock markets.

The dollar's problem, denied against all reason by Bernanke, is inflation. We are clearly, indisputably, in double digit inflation right now. That is consumer price inflation. And cost inflation, felt by businesses, is rising very fast, with the price of oil. The United States of America is heading down the path of the Weimar Republic, if not Zimbabwe. Could we launch into hyper-inflation any faster? I don't think so. The Fed is desperately trying to prop up real estate prices, and monetizing the bond market. They are allowing the banks not to admit their insolvency. The Fed is spraying cash at the credit problem through high pressure hoses, but the money is going directly into commodities, not into the frozen bond markets.

Are the stock and bond markets really more important than the dollar? There has never been a worldwide currency collapse, so it is hard to predict the consequences. But there have been many stock market crashes and it seems that they are survivable. Ultimately, the dollar is far more important than the stock market. It is the uber-stock, the shares in the nation itself. A nation's currency represents citizens' belief in their country. It is significant that our bills have our founding fathers' portraits. And why would the Fed destroy the only thing that they have? Their only reason for existence is to regulate dollars. If the dollar is worthless and irrelevant, so is the Fed itself.

Jim Puplava has a theory that the Fed will succeed in re-inflating markets, at enormous cost, but that will only be a very short term solution. He calls it his oreo theory:

And the best way to describe what we see happening this year – and I was trying to think of an analogy, and here it is: An Oreo cookie. Dark on the outside and a creamy filling in the inside. And what I mean by that is the first quarter is we're going to see a lot of volatility, we're going to see a lot of roughness in the market, kind of what we're seeing right now with the major average is down anywhere from 3 to 5%. We may see a 10% to 15% correction in the markets. And then we're going to see monetary reflation kick in with a vengeance.

We're probably going to see fiscal stimulus. So by the second and third quarter I call that the filling. You're going to see the positive sides of monetary reflation and that's going to be higher asset prices. And then, however, by the time we get to the fourth quarter of the year, you're going to see inflation come back with a vengeance and you're going to see higher bond yields, higher inflation rates so that, John, when we get into the year 2009, central banks will be back into the rate-raising mode. And by 2010 – and hold onto your seat, get your Maalox, by 2010, if things unfold the way we think, the US will experience a depression.

Puplava knows a lot more about financial markets than I do. Maybe he is right, and the global economy won't collapse this year. Right, it will collapse in 2010. That's a relief. And maybe it explains what Bernanke is doing with his hyper-inflation game. He is doing what everyone does when they get into a financial tight spot: he is desperately trying to buy some time, and hoping for a miracle. It is not working so far. But when you are desperate, hope is always free. As is printing dollars.

Eco-terrorists?

The media is reporting with a very straight face the latest act of eco-terrorism. The Earth Liberation Front supposedly fire bombed a development of McMansions in Seattle suburb Woodinville. Pardon my skepticism. In the first place, the ELF is probably heavily seeded with undercover agents (which means that if they did fire-bomb Street Of Dreams we'll be seeing indictments within hours).

I hope at least that the police and FBI are not quite so credulous as the media. This developer is probably benefitting from this fire-bombing in a big way. Developers need eco terrorists right now just as much as banks need rogue traders. Maybe we'll see more of both this year?

BTW, what is the difference between arson and terrorism? It is terrorism if an activist sets a fire and arson if a developer sets a fire?

Who ever heard of monolines?

The financial news has been reporting on the hard times of the monolines, or bond-insurance companies lately. Ambac and MBIA are the two biggest ones. But it is not like bond insurance has become the latest sexy business sector.

Bond insurance is like your home's foundation. If you have to think about it, it probably isn't good news.
It is not good news. The core of the monolines' business has been insuring municipal bonds. Originally this was all they did and thus the odd name (which I had never heard of, like everyone else, until recently). Like many sensible businesses that worked perfectly well, they got bored of the municipal bond insurance trade. Maybe it didn't generate 20% return on capital or some other obscene profit target? In any case they wanted a little more action, and they got it — by expanding into mortgage-security insurance. They were probably crowing about innovation..

Now they are in trouble. The problem with any insurance company is that they would be fine if a few of their policies filed claims. But suppose a whole lot of mortgage-backed securities (which are a form of bond) defaulted at the same time? There is no way they can pay all those hundreds of billions of defaulting mortgages. Of course we all know that the sub-prime mortgages are toast, and that the alt-A and prime mortgages will soon follow. But the real problem is how insolvent monolines will affect municipal bonds.

Cities and towns assume that they will be able to get cash when they need it to build schools and transportation and other infrastructure. And typically they would issue a bond, which has to be insured for it to trade in public markets. On the one hand, paying premiums to a likely insolvent insurance company seems rather stupid. On the the other hand buying a bond insured by an insolvent company seems also stupid. So, right now, simply on the suspicion that the bond-insurers are insolvent, they are probably experiencing a devastating cash flow shortfall. Business on both ends of their model will fall off very sharply if they can't inspire confidence.

The upshot is that it will be much harder for municipalities to raise cash this year, or at least until credibility can be brought back into the insurance business. This is the sort of thing that makes a recession painful and last a long time. It is a much bigger problem for most Americans than the stock market. We might see construction projects halted suddenly, bus drivers not getting paid.

Give the Ford 150 a rest, please..

The North American International Auto Show is this week in Detroit. It seems that the most exciting cars that Detroit has to offer us are new versions of their flagship pickup trucks, The Dodge Ram and Ford F-150 with a herd of longhorn cattle as a selling stunt. This is stupid. The American fetish of the pickup truck is getting old. We don't need to drive all these trucks, or their cousins, the SUVs, which are cars built on truck chassis. Sure, ranchers need pickups. But Detroit is not selling that many trucks to ranchers, they are selling the image of ranching to suburban wannabes and weekend warriors.

I was actually thinking just last week that the Detroit carmakers could help us out a bit in the next few years. I hear a lot about how American innovation will save our butts in the coming recession and energy crisis. I am wondering when the innovation starts? I think a new line of fuel efficient cars would be innovative.

With the dollar lower, tight cash, and gas prices practically certain to hit $5 this year, a lot of Americans will be planning to trade down in cars. Suddenly, Priuses and diesel VWs will be lot more expensive. Ford, Chrysler and GM could sell a lot of cars if they had some that got 40 mpg. A lot of Americans could get work making such cars. We might even sell them overseas, with our cheap currency. So come on, Detroit, you can do better than the "next generation pickup".

globalization, the end game

In the 1990s, the era of permanent global “free trade”, so called, or globalization, was ushered in. Local production workers everywhere, that is in America and abroad, hated it, and protested. Economists loved it because it was more “efficient”. Global trade's most charismatic promoter was probably Bill Clinton. I don't know where, but I think I read some theorist saying that globalization was a permanent beneficial change to the world's economic system. Maybe it was the same train of logic that led philosopher Francis Fukuyama to declare permanent prosperity and peace for the globe in the form of the “end of history”. History, it turns out, is now proceeding to change things at an accelerating rate. And the era of globalization will end a lot sooner than those ideolouges thought. Three powerful trends will seem to conspire to break up the world trade routes (despite the fact that a lot of wealth is created for a few powerful rich magnates and they will try to preserve this system at all costs):

• Nationalization of Resources
• Protectionism
• Capital Controls

In the first place, we are witnessing an era of resource nationalization. Globalization was predicated on the assumption of efficient worldwide commodity markets, and such markets only function with a relative abundance of commodities. One of the curious and most exploitive of the tenants of the GATT talks (so viscously protested in Seattle in 1999) was the idea that all signatory nations had to agree to produce, and sell in open markets, any natural resources they possessed. Efficient production usually occured alongside the environmental degradation of the less wealthy nation. But that is now changing. Nations such as Bolivia, Russia, etc, are finding that they do have to power to regulate and nationalize oil, gas, and mining production.

There have been no shortages of commodities to slow down global economies for a long time, and some economists seem to think shortages are so obsolete they it couldn't possibly occur in the 21st Century. But the trend is for commodities of all kinds to rise in price and value. Scarcity of resources is the coming dynamic and free markets do not love scarcity. This will not just slow down the global trade in the resources themselves, but also affect trade in such manufactured goods which require non-local resources. China, for example, will be limited in its manufacturing by how much energy and copper it can import, now that it is no longer self sufficient. In time even American precious metal mining and energy production will need to be nationalized, if only to keep them out of the control of our creditors.

The second anti-global-trade factor is a slowly building force in the USA. It is simply the demand by citizens to support their domestic production. Protectionism. Now that the the American economy is obviously stumbling and there will be layoffs, and people losing their homes due to mortgage defaults, the government will need to do everything it can to try and keep as many people employed as possible. Even if it is not economically efficient. Social unrest will be a bigger threat than loss of cheap imports. This is the same force that was protesting against globalization in Seattle, but now they will have a much more sympathetic ear from congress. We will very likely see import quotas, tariffs and other abrogations of our trade treaty obligations.

The third trend will hit the global economy with terrible shock waves in the next two years: capital controls. Why economists assume that currency will remain freely exchangeable is baffling to me. The world now runs on fiat currency managed by central banks. This system was created to finance the gigantic economic expansions of the past half century. It is now teetering on the brink of collapse. The huge structure of artifice convinced people that paper money was as good as gold, and it was very effective in the times of plenty that the world has seen. Now that almost all central banks (Switzerland is the sole exception) are inflating their money supply at double digit rates, and the US dollar is in a death spiral, the system is doomed. The plunging dollar has created a global state of emergency: pretty much everything traded internationally is priced in dollars. If no one knows what, if anything, a dollar is worth, how do they know what anything else is worth?

Nations holding US treasury bills will be forced to sell their dollars and no county, including America, will be happy to take them in. Like destitute refugees, no nation will want to give the dollar a home. I have heard people say that because the dollar is the world's reserve currency, and no other currency will serve, it has to stay. I don't buy it. Within a very few years all fiat currency (unbacked by gold or other assets) will not be welcome in international trade. The euro can not save fiat currency either: the European Central Bank is racing America's Fed to inflate concurrently with the dollar. BTW, If you think you will always be able to own stock in that Australian mining corporation.. well I'm saying maybe not, unless you are in Australia. Soon, capital will have to stay closer to home.

This is not to say Saudi Arabia, China and other exporting nations will no longer export oil or goods. They can't do much else after all. Trade will be negotiated between nations under secret terms in guilded state department halls and embassies instead of open electronic trading bourses. Agreements will be made with armies and navies in the background, always the subtle threat of war (historically, most wars have been fought for control of resources and trade routes). Terms of trade will consist of exchanges of hard assets, military services, manufactured goods, or precious metal bullion. Barter between nations is the future of trade, and will be made to secure strategic advantage, not the best price. No nation will want to trade with its strategic rival, except under threat of war or other coercion.

a $700 trillion volcano

This is a fascinating essay by Mike Whitney, published at Rense.com. Whitney explains several key items, the most important of which is how "the markets have been transformed by 'structured finance'."

What's so destructive about structured finance is that it allows the banks to create credit "out of thin air", stripping the Fed of its role as controller of the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:

The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)

The banks have been creating trillions of dollars of credit (by originating mortgage-backed securities, collateralized debt obligations and asset-backed commercial paper) without maintaining the proportional capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital. It was, quite literally, money for nothing.

Right, money for nothing. Structured finance explains the $681 trillion value of outstanding financial derivatives out there, according to the Bank of International Settlements. Whitney's key point here is that all of this money creation is out of the Fed's control. Adjusting interest rates won't fix the problem. The Fed certainly doesn't want to try to take control of monstrous toxic pile of money either, because then it would surely blow up, not just immediately, but also in their own hands.

If some unscrupulous financiers can come up with a way to generate money out of thin air, they are probably going to choose to generate a whole lot of it, not just a little money. Especially if it is hidden from all oversight and regulation. And in theory this money is risk free. It is insured (via credit default swaps). No doubt. Those insurers will surely pay off, now that the shit is officially hitting the fan. It's not like we have a $700 trillion volcano about to explode or anything..

About time for indictments

I just want to make one simple point, and it is not that complicated. I don't think anything the Federal Reserve Bank can do, this year or in the next six months anyway, can help free up the frozen credit markets. It simply has nothing to do with interest rates.

There is one thing the U.S. Justice Department could do though: a few indictments of fraud would help a lot. I know that white collar criminal cases are never quick to file or prosecute. It took years to bust the Enron executives. I certainly hope we get some soon. Angelo Mozilo of Countrywide Financial would be one good place to start. Definitely the Citibank perpetrators of the sale of the CDOs sold to the three Norwegian townships. That got a lot of press - they should be indicted. There are no doubt hundreds of people who participated in all this fraud. They should do the time. That would restore confidence in credit markets.