Saturday, February 27, 2010

The Dark Ages for Economics

The economics profession is in a bear market. The practitioners of the dismal science, with their economic theories that do NOT work, seem determined to push their profession into a death spiral from which it will never recover.

For example - with modern-day economists, if something doesn't show up in the economic data, it doesn't exist.

The prime example of this is the housing bubble. According to most mainstream economists, it did not exist. That is until it burst and nearly brought down the entire financial system.

And their 'prescription' for getting out of the economic mess (that they did not see coming) is for the United States to accumulate trillions and trillions more dollars of debt.

Their 'prescription' to cure a debt problem with more debt does not make sense. But then who said economists had any sense.

Think of it this way - a person has lung cancer due to his pack-a-day cigarette habit. The economists 'cure' would be like a doctor telling that person that to cure his lung cancer, he must now smoke 4 packs of cigarettes a day!

And just look at the 'cure' prescribed by economists for our ailing banking system.

They opted for the 'Japanese' model of trying to save our banks, even though it has NOT worked. Japan has been mired in a recession for two decades and their financial system is still shaky.

Economists should have opted instead for the 'Swedish' model from the early 1990s which Sweden used to save their banking system.

The Swedish model forces insolvent financial institutions into receivership, senior management is fired, the shareholders wiped out and the debt written down to zero. The assets get sold off or spun out as a new public entity with the government helping to recapitalize the banking system. This would allow the financial system to start lending again.

What we would have gotten for our trillions of taxpayer dollars was a well capitalized, low leveraged, low debt financial sector, capable of making loans and driving the economy forward.

Instead what we have are self-interested financial institutions (with the same management in place) who are not lending and not writing down debt (due to the government allowing them to use 'fantasy' accounting) and capturing the lion's share of any wealth that is left as bonuses.

Why didn't the economists chose the Swedish model? Probably because in that model both shareholders and bondholders are wiped out, which is how capitalism is supposed to work - you have winners and losers.

But the losers would have been Wall Street bankers and since so much of modern economic thought comes from Wall Street, 'punishment' for Wall Street was not even considered. So the 'socialist' bankers and their economists decided to save the banks and their own asses, rather than the banking system.

I believe history will not look kindly on the modern-day economics profession. They will be lumped together with physicians of the Dark Ages whose cure-all for diseases was to use leeches. Just substitute debt for leeches and you have the cure-all prescribed by economists today.

Now that I think about it, the term leeches is more appropriate than I originally thought.

Saturday, February 20, 2010

Much Ado About Nothing

I usually don't start an article about the financial markets with a quote from Shakespeare, but I will this week. It's from Macbeth's soliloquy in Act 5, Scene 5:

"It is a tale told by an idiot, full of sound and fury, signifying nothing."

This quote pretty much sums up my thoughts about the news late Thursday that the Federal Reserve was raising their 'discount rate' by a quarter-percent to 0.75 per cent and the breathless coverage by the financial media.

The Federal Reserve's 'discount rate' is the rate that the Fed charges banks on emergency loans. In other words, it is meaningless.

The key rate to keep an eye on is the 'federal funds rate'. This rate, also set by the Federal Reserve, is the rate from which both consumer and business loans are based.

So why did the Federal Reserve even bother raising the discount rate?

Because the Fed and its chairman, Ben Bernake, are trying to fool people. They want people to think that they will soon stop their policy of trillion-dollar giveways to Wall Street and actually protect the value of the US dollar.

The Fed wants people to believe that they will quit printing money and perhaps even give savers a break and raise interest rates.

I doubt very much that will happen. Look at the Fed's recent history.....

In the last year, the Federal Reserve bought roughly a trillion and half dollars worth of Treasury securities, financing almost ALL of the Federal deficit!

The Fed also bought a trillion dollars worth of mortgage-backed securities. And all of this was paid with "phony" dollars that the Federal Reserve printed out of thin air.

Is it any wonder that the US dollar continues on its downward slope?

Or that the Chinese are no longer the biggest holder of US Treasuries? In December, they sold over $34 billion worth of Treasury securities. They can't get of the US dollar fast enough to suit them.

The Chinese and the rest of the globe can see that every time the US economy gets into trouble, the Federal Reserve's solution under both Greenspan and Bernanke is to print up a ton of money and give it to Wall Street.

That "solution" solves serves only to enrich a select few.

So Ben Bernanke isn't fooling anyone with his little 1/4% hike in a meaningless rate...except maybe the financial media.....

And anyone who buys the snake oil they're selling about how "prudent" the Fed is being, what a "smart" move it is, etc.

Saturday, February 13, 2010

Wall Street and Greece

The gamblers on Wall Street continue running wild, causing havoc all over the globe.

This time the same gamblers who used leverage and exotic financial instruments such as credit default swaps (CDS) to bring our financial system nearly to its knees have set their sights on Europe. Wall Street traders have bet a record amount against the European currency – the Euro – betting that it would fall.

The Wall Street gamblers have attacked Europe's peripheral economies which include Greece, Spain, Portugal, Ireland and Italy. In particular, they have attacked effect, turning the country into a pinata. But instead of sweets, the Wall Street version is stuffed with money for the bankers to scoop up with both hands.

Wall Street has jumped on the notion that Greece and these other nations have too much sovereign debt on their books that they will not be able to pay back. And there is no denying that it is a serious problem. For instance, Greece must pay back about $70 billion in maturing debt this year.

But it is a manageable problem with probably the richer European countries such as Germany helping their poorer neighbors. Also do not be surprised if China becomes a 'sugar daddy' to many of these European nations.

China probably senses an opportunity for political advantage and good PR, especially in light of the many anti-American protests – really anti-Wall Street protests – in these countries (which are not being covered by American media).

My question is whether by the time Wall Street is done pillaging the globe, will America have any friends left?

Owe Say Can You See

Perhaps Wall Street should pay closer attention to the massive debts piling up here in the United States and the future of the US dollar, not the Euro.

The budgetary strains in America's 50 states (only North Dakota is in good shape) and 52,000 municipalities gets far too little attention.

There are seven large US states which are in much bigger trouble than the smaller European countries. In addition, these states are a much larger portion of the US economy than the small European countries are of the total European economy.

These states are: California, Florida, Illinois, Ohio, Michigan, North Carolina and New Jersey. Of course, there are other states teetering on the brink like New York for instance. And let's not forget about all the many cities and municipalities across the country which are considering filing for Chapter 9 bankruptcy.

Why all the problems? Because US states and the politicians running them spent freely before the recession hit. In the 30 years to 2008, spending in US states grew at a compound annual rate of 6.7%, well above the inflation rate.

And the problems are actually worse than they appear on the surface. Actuaries have identified state pension deficits as high as $3 trillion! This is double all annual state spending.

As I discussed in a previous article, pensioners are just going to have to be told to expect much less than was promised...or there will be bankruptcy after bankruptcy.

It is not a pretty picture for most states. But don't tell Wall Street that...they are too busy scooping up billions of dollars from 'pinatas'.

Saturday, February 6, 2010

The Government Wants Your Retirement Money

It's bad enough that middle-class Americans have been forced to bail out the greedy ingrates on Wall Street. But now Uncle Sam is hatching plans to raid Americans' retirement savings too.

According to media reports, both the US Treasury Department and the Department of Labor plan to stage a public comment period before implementing regulations that would require US savers to invest large portions of their 401k savings plans and Individual Retirement Accounts (IRAs) into annuities or other "steady" payment streams backed by long-term US government bonds.

There is only one reason why the US government is contemplating such a move. That reason is that the nation's creditors - foreign nations in Asia, Europe and the Middle East - think that long-term US government bonds are a bad bet and don't want to buy them anymore. There have been some recent Treasury bond auctions where foreign interest has been practically nil.

This is very serious since the US government is facing at least a $14 trillion fiscal hangover and the government needs to sell Treasury bonds, without raising interest rates, to keep the country running.

So like a grifter who is down to his last dollar, the government is hoping to get its greedy hands on the hard-earned savings of the American people before they realize that they've had the wool pulled over their eyes...again.

It makes sense if you're the US government. Facing increasingly skeptical overseas buyers, the government is changing tactics and targeting the biggest pile of money available, as a means of dealing with its fiscal follies - the $3.6 trillion sitting in US retirement plans.

The US government can see the financial train wreck that will occur if nothing is done. But instead of taking responsible actions, the government is rushing to crack open the safe that holds Americans' retirement money before anyone realizes that they have been robbed.

The government is betting that the American people will be too stupid to realize that purchasing long-term US government bonds right now is financial suicide for anyone who does so.

With interest rates being held down around zero per cent thanks to the incompetence of the Federal Reserve, there is only one way interest rates can go from here - up. And if interest rates go up, that means the value of long-term bonds goes down and down a lot. Poof - there goes most Americans' retirement savings.

Nassim Nicholas Taleb, author of "The Black Swan", said that "every single human being" should bet that US Treasury bonds will decline in price. He cited government policies and in particular the policies of Fed chairman, Ben Bernanke. I firmly believe that Mr. Taleb is correct.

I hate to keep harping on the same subject, but the absolute worst possible thing investors can do now is to own long-term US government bonds. I urge everyone to contact their Congressperson and stop this outrage before the government cracks open the safe containing everyone's retirement savings.