Human Freedom Relies On Gold Redeemable Money

I think the title of this post is pretty close to a piece Congressman Howard Buffett wrote in the first half of the 20th century (yes, Warren Buffett's father - they have slightly different political leanings).

In any case, I felt it was an apt title to the below video from Charlie Rose where he discusses gold, inflation, "quantitative easing", and dollar debasement with a few folks including Greenlight Capital's David Einhorn (whom we are a big fan of), Jim Grant (again, we're huge fans), the Chairman of Barrick Gold and John Hathaway of Toqueville Asset Management. Enjoy.

Jim Grant - "gold is money."



HT: TB

Yen:Dollar In Freefall

Wow - the yen's strength is remarkable (or is it the dollar's weakness - pick your poison). Say Sayonara to the Japanese government's budget. Say Ohaiyo Gozaimasu to QE52 in Japan and the ultimate destruction of their currency. As we've discussed several times in the past, this is a "when, not if" scenario.

David Einhorn Complete Ira Sohn Conference Speech

As we discussed here and here, at yesterday's Ira Sohn Conference, David Einhorn gave a speech entitled "Good News for the Grandchildren" about why sovereign debts, huge structural budget deficits, and debt monetization/QE/quantitative easing will matter for our generation and will have to be dealt with well before our grandkids' time.

It was an excellent speech. Below is the unabridged version. Enjoy. Think gold.


David Einhorn - Greenlight Capital - Ira Sohn Conference Speech 2010 - Good News For The Grandchildren

David Einhorn OpEd: NY Times - Easy Money, Hard Truths

TILB friends know that we have followed Greenlight Capital's David Einhorn for years. A year and a half ago, when he first began to publicly disclose his position in gold, we took note.

As we reported from yesterday's Ira Sohn Conference, Einhorn gave a presentation called "Good News for the Grandchildren" (implying that the debt crisis will manifest itself in our generation, not theirs). In today's NY Times, he basically provided them with a slightly modified version of the speech as an OpEd.

Here is the OpEd from the NY Times. Because it's basically the transcript of a speech he gave yesterday, we provide it below in its entirety. Please support the NY Times, one of TILB's favorite newspaper.

Op-Ed Contributor
NY times
Easy Money, Hard Truths
By DAVID EINHORN
Published: May 26, 2010

Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.

According to the Bank for International Settlements, the United States’ structural deficit — the amount of our deficit adjusted for the economic cycle — has increased from 3.1 percent of gross domestic product in 2007 to 9.2 percent in 2010. This does not take into account the very large liabilities the government has taken on by socializing losses in the housing market. We have not seen the bills for bailing out Fannie Mae and Freddie Mac and even more so the Federal Housing Administration, which is issuing government-guaranteed loans to non-creditworthy borrowers on terms easier than anything offered during the housing bubble. Government accounting is done on a cash basis, so promises to pay in the future — whether Social Security benefits or loan guarantees — do not count in the budget until the money goes out the door.

A good percentage of the structural increase in the deficit is because last year’s “stimulus” was not stimulus in the traditional sense. Rather than a one-time injection of spending to replace a cyclical reduction in private demand, the vast majority of the stimulus has been a permanent increase in the base level of government spending — including spending on federal jobs. How different is the government today from what General Motors was a decade ago? Government employees are expensive and difficult to fire. Bloomberg News reported that from the last peak businesses have let go 8.5 million people, or 7.4 percent of the work force, while local governments have cut only 141,000 workers, or less than 1 percent.

Public sector jobs used to offer greater job security but lower pay. Not anymore. In 2008, according to the Cato Institute, the average federal civilian salary with benefits was $119,982, compared with $59,909 for the average private sector worker; the disparity has grown enormously over the last decade.

The question we need to ask is this: If we don’t change direction, how long can we travel down this path without having a crisis? The answer lies in two critical issues. First, how long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms? And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts — that is, by the printing of money?

The recent United States credit crisis was attributable in large measure to capital requirements and risk models that incorrectly assumed AAA-rated securities were exempt from default risk. We learned the hard way that when the market ignores credit risk, the behavior of borrowers and lenders becomes distorted.

It was once unthinkable that “risk-free” institutions could fail — so unthinkable that the chief executives of the companies that recently did fail probably didn’t realize when they crossed the line from highly creditworthy to eventually insolvent. Surely, had they seen the line, they would, to a man, have stopped on the solvent side.

Our government leaders are faced with the same risk today. At what level of government debt and future commitments does government default go from being unthinkable to inevitable, and how does our government think about that risk?

I recently posed this question to one of the president’s senior economic advisers. He answered that the government is different from financial institutions because it can print money, and statistically the United States is not as bad off as some other countries. For an investor, these responses do not inspire confidence.

He went on to say that the government needs to focus on jobs now, because without an economic recovery, the rest does not matter. It’s a valid point, but an insufficient excuse for holding off on addressing the long-term structural deficit. If we are going to spend more now, it is imperative that we lay out a credible plan to avoid falling into a debt trap. Even using the administration’s optimistic 10-year forecast, it is clear that we will have problematic deficits for the next decade, which ends just as our commitments to baby boomers accelerate.

Modern Keynesianism works great until it doesn’t. No one really knows where the line is. One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence and, worse, are pro-cyclical, aggravating slowdowns and inflating booms. Congress has a rare opportunity in the current regulatory reform effort to eliminate the rating system. For now, it does not appear interested in taking sufficiently aggressive action. The big banks and bond buyers have told Congress they want to continue the current system.

As William Gross, the managing director of the bond management company Pimco, put it in his last newsletter, “Firms such as Pimco with large credit staffs of their own can bypass, anticipate and front run all three [rating agencies], benefiting from their timidity and lack of common sense.”

Given how sophisticated bond buyers use the credit rating system to take advantage of more passive market participants, it is no wonder they stress the continued need to preserve the status quo.

It would be better to have each investor individually assess credit-seeking entities. Certainly, the creditworthiness of governments should not be determined by a couple of rating agency committees.

Consider this: When Treasury Secretary Timothy Geithner promises that the United States will never lose its AAA rating, he chooses to become dependent on the whims of the Standard & Poor’s ratings committee rather than the diverse views of the many participants in the capital markets. It is not hard to imagine a crisis where just as the Treasury secretary seeks buyers of government debt in the face of deteriorating market confidence, a rating agency issues an untimely downgrade, setting off a rush of sales by existing bondholders. This has been the experience of many troubled corporations, where downgrades served as the coup de grâce.

The current upset in the European sovereign debt market is a prequel to what might happen here. Banks can hold government debt with a so-called zero-risk weighting, which means zero capital requirements. As a result, European banks stocked up on Greek debt, and sold sovereign credit default swaps, and now need to be bailed out to avoid another banking crisis.

As we saw first in Dubai and now in Greece, it appears that governments’ response to the failure of Lehman Brothers is to use any means necessary to avoid another Lehman-like event. This policy transfers risk from the weak to the strong — or at least the less weak — setting up the possibility of the crisis ultimately spreading from the “too small to fails,” like Greece, to “too big to bails,” like members of the Group of 7 industrialized nations.

We should have learned by now that each credit — no matter how unthinkable its failure would be — has risk and requires capital. Just as trivial capital charges encouraged lenders and borrowers to overdo it with AAA-rated collateral debt obligations, the same flawed structure in the government debt market encourages and therefore practically ensures a repeat of this behavior — leading to an even larger crisis.

I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.

Some believe this could be avoided by printing money. Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.

That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.

Government statistics are about the last place one should look to find inflation, as they are designed to not show much. Over the last 35 years the government has changed the way it calculates inflation several times. According to the Web site Shadow Government Statistics, using the pre-1980 method, the Consumer Price Index would be over 9 percent, compared with about 2 percent in the official statistics today.

While the truth probably lies somewhere in the middle, this doesn’t even take into account inflation we ignore by using a basket of goods that don’t match the real-world cost of living. (For example, health care costs are one-sixth of G.D.P. but only one-sixteenth of the price index, and rising income and payroll taxes do not count as inflation at all.)

Why does the government understate rising costs? Low official inflation benefits the government by reducing inflation-indexed payments, including Social Security. Lower official inflation means higher reported real G.D.P., higher reported real income and higher reported productivity.

Subdued reported inflation also enables the Fed to rationalize easy money. The Fed wants to have low interest rates to fight unemployment, which, in a new version of the trickle-down theory, it believes can be addressed through higher stock prices. The Fed hopes that by denying savers an adequate return in risk-free assets like savings deposits, it will force them to speculate in stocks and other “risky assets.” This speculation drives stock prices higher, which creates a “wealth effect” when the lucky speculators spend some of their gains on goods and services. The purchases increase aggregate demand and lead to job creation.

Easy money also aids the banks, helping them earn back their still unacknowledged losses. This has the perverse effect of discouraging banks from making new loans. If banks can lend to the government, with no capital charge and no perceived risk and earn an adequate spread, then they have little incentive to lend to small businesses or consumers. (For this reason, higher short-term rates could very well stimulate additional lending to the private sector.)

Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers, including the government, to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise.

While one can debate where we are in the recovery, one thing is clear — the worst of the last crisis has passed. Nominal G.D.P. growth is running in the mid-single digits. The emergency has passed and yet the Fed continues with an emergency zero-interest rate policy. Perhaps easy money is still appropriate — but a zero-rate policy creates enormous distortions in incentives and increases the likelihood of a significant crisis later. It was not lost on the market that during this month’s sell-off, with rates around zero, there is no room for further cuts should the economy roll over.

EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.

The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting.

Though we don’t know what’s going to happen next, the good news for our grandchildren is that we will have to face our own debts. If we realize that our own future is at risk, we might be more serious about changing course. If we don’t, Mr. Geithner and others might regret having never said never about America’s rating.

David Einhorn is the president of Greenlight Capital, a hedge fund, and the author of “Fooling Some of the People All of the Time.” Investment accounts managed by Greenlight may have a position (long or short) in the securities discussed in this article.

A version of this op-ed appeared in print on May 27, 2010, on page A35 of the New York edition

Inflation Nation - Prepare For The Coming Hyperinflationary Dollar Collapse

Dammit.

TILB has been trying to post less frequently and to have those infrequent posts avoid frustrating topics such as the destruction of our economic and social future. You can understand that.

I've established many times over that nobody cares, so why even keep banging the gong...particularly when it seems I'm banging it with my forehead instead of a mallet?

As an aside, friend of TILB and thief (before I invented it) of the phrase Tooth Fairy Economics Tom Woods makes several appearances in this video as do several other TILB mancrushes like Ron Paul, Peter Schiff, Mark Faber, and Uncle Jimmy Rogers.

This is the best video I've seen since Chris Martenson's Crash Course collection (someday I'll post about that video collection - if you haven't watched it yet, you must stop everything you're doing and spend a few hours watching immediately - link here).

I've been meaning to sit down and write more about the value of money, why price deflation is the natural course of the world (a good thing, btw!), and why not all GDP is created equal, but honestly, it's an emotional drain to reflect on and write about these ideas and it requires more of my head banging the gong. But I'll get to it, because while I'm sure nobody reads this, much less cares, I find the anguish and process of putting myself through it strangely beneficial.

In any case, watch this video and watch the Crash Course. As the great Cypress Hill has warned us so many times, "when the shit goes down, you better be ready...YOU BETTER BE READY!!" Indeed



PS: Please do me a favor and buy some actual, physical gold. It's for your own good.

Hayman Advisor's Kyle Bass: The Pattern Is Set

As we've said many times, we hate us some dollar and we hate us some yen even more than the dollar. The euro is an enigma. Other fiat currencies are subject - long-term - to the same issues. That leaves us with gold. Apparently Hayman's Kyle Bass agrees with us. This should come as no surprise to long-time TILB readers as we've highlighted Kyle's work/talks several times.

Below is the text of Hayman's most recent letter to its clients following the European debacle this weekend. TILB's immediate reaction was "holy shit, I don't want to own the euro", in spite of most Wall Street participants claiming this was a great showing of support for the euro. Our view was this "show of support" was more akin to a roadmap for self destruction. The euro's rally than recent retrenchment seems to support our initial take.

We lifted the below text it from First Adaptor's blog (click here for First Adaptor). Make sure to follow First Adaptor on Twitter.

The Pattern is Set - Betting the Bank on a Keynesian Free Lunch by Kyle Bass

--------------------------------------------------------------------------------

Dear Investors:

With the avalanche of announcements over the weekend out of Europe and the IMF (and even the US Federal Reserve), I think it is important to communicate our views. The Lisbon Treaty explicitly prohibits direct monetization of fiscal deficits (i.e. printing money out of thin air in order to perpetuate deficit spending) because central bankers are (or I guess at least "were") aware it is the path to severe inflation or even hyperinflation. Just as the Romans did time and time again, the EU has now decided to change from the rule of law to the rule of man when it suits them. With none of the sixteen members of the currency union forecasted to be in compliance with the Maastricht Treaty (the foundation on which the EMU is built) in 2010, today's actions further attempt to eliminate the natural policing role that markets play with respect to egregious economic behavior. It looks like there will be no consequences for fiscal profligacy... no negative implications for continuing to spend far beyond one’s means... there will be nothing but moral hazard for running massive deficits as member countries can now hold hostage the entire EU (as Greece has done).

The ECB’s monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to "solve" a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more "bail-outs" and debt financed spending. This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future.

Germany weakened itself as it has now abandoned the core bargain of the Euro (which was that they would never be responsible for another country’s debt) by opting to be the largest guarantor of a new loan program that essentially makes European countries joint and severally liable for emergency funds for the worst fiscal offenders in the EU. It has begun a process of ceding its fiscal sovereignty to the over-indulgent countries. I still cannot believe Germany has done this. No wonder Merkel’s government is so unpopular. Meanwhile, I guess that Trichet must have decided on the lesser of two disastrous outcomes for fear that the very existence of their European Union was being called into question. He must have believed this to be the case as it would be the only rational reason to agree to such drastic measures – despite his blanket opposition to such policies just days ago and against the explicit wishes of the Bundesbank, Germany’s central bank.

We believe that there is a “Keynesian End” to the policy du jour that governments can solve all their fiscal and economic problems with more debt and more cross guarantees (aided and abetted by desperate central bankers). We at Hayman believe this theoretical endpoint is reached when debt service exceeds government revenues. Of course, any particular country has certain fixed expenses beyond debt service; therefore, the real endpoint occurs significantly in front of our definition. Outside of Greece and “Club Med” countries, Japan will begin to grace the front pages of newspapers very shortly. Japan has already reached a point where its central government tax revenues are eclipsed by debt service and social security payments alone. Coupled with its debt and demography problems, the world's second largest economy is about to enter a real bond crisis.

Attached is a Bank of International Settlements working paper that I highly suggest you read [TILB - link to referenced working paper here]. Please pay particular attention to the chart on the top of page 11 and remember the numbers you are seeing are as a percentage of GDP and NOT government revenue. This paper takes a very conservative view of interest rates (it essentially assumes they stay flat from the low levels of a few months ago – regardless of changes to debt levels or savings rates) and extrapolates current fiscal projections and even assumes pretty robust global growth. Even in this somewhat utopian scenario, the Keynesian End arrives in many of the world's countries much sooner than is popularly believed.

The competitive devaluation will begin in full force with Japan needing a weaker Yen to grow exports, the US needing a weaker dollar in order to double our exports (under the current Obama plan), and the EU really needing a weaker euro in order to grow their own exports. It is no wonder that Bretton Woods failed so miserably in prohibiting “cheating” via currency weakening. It is also no wonder that the IMF and World Bank were created at that very same meeting in 1944.

We have also attached a chart showing total IMF commitments to member countries as a percentage of each respective country’s IMF quota. The magnitude of the initial EUR 30 billion commitment to Greece trumps all other commitments made throughout this crisis by multiples. This does not even include the EUR 250 billion announced for the broader Eurozone this weekend. By granting Greece more than 30x their quota, they are making a mockery of their own rulebook.

This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors. In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a “sea change” in public opinion towards government spending and deficits. We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well.

Sincerely,

J. Kyle Bass
Managing Partner

Kyle is clearly cut from the Austrian cloth.

Liberty Quote Of The Day: Jens O. Parsson

Jens Parsson discusses how the persistent debasement of money kills society in his 1974 book "Dying of Money: Lessons of the Great German and American Inflations". The below quote is reminiscent of Murray Rothbard's description of the early "fun" portions of an inflation as a "heady wine" (click here for Rothbard's in-depth essay on German hyper inflation).

In any case, Parsson makes the point that monetary inflation always ends in a trail of tears, because it is addictive and requires an increasing volume of inflated money in order to keep the party going. As soon as the spigot is turned off, pain comes, so the spigot is never turned off. In fact, it is provides a constantly accelerating flow and ultimately either tragically deluges society in an out of control hyperinflation or, if discipline is somehow re-instituted, ends in a painful deflationary liquidation. Read on for Parsson's quote:

"Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and an ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation."

- Jens O. Parsson, Dying of Money: Lessons of the Great German and American Inflations (1974)

[HT: LB]

The Singularity

We believe the world is walking a tight rope of low rates driven perceived safety. Reality is something uglier. Click here for our definitive take on The Singularity risk.

David Rosenberg Calls For Gold $2600

To the moon.

Enjoy.

Ben Bernanke Defends The Indefensible: The Fed

As we occasionally do with OpEd's intended for broad public distribution, we provide below the complete version of Bernanke's ridiculous defense of the Fed's ability to hide its actions from Congress and his table pounding support for the Fed's place as a regulator.

These ideas are of course ridiculous on their face, as the power to destroy our currency and thus our country should be watched closely (it should never be granted in the first place, but certainly we should have a right to understand what they are doing and who benefits). Further, The Fed has obviously been an abject failure as a regulator (a cursed job to begin with, admittedly).

Anyway, from The Washington Post.

The right reform for the Fed

By Ben Bernanke
Sunday, November 29, 2009

For many Americans, the financial crisis, and the recession it spawned, have been devastating -- jobs, homes, savings lost. Understandably, many people are calling for change. Yet change needs to be about creating a system that works better, not just differently. As a nation, our challenge is to design a system of financial oversight that will embody the lessons of the past two years and provide a robust framework for preventing future crises and the economic damage they cause.

These matters are complex, and Congress is still in the midst of considering how best to reform financial regulation. I am concerned, however, that a number of the legislative proposals being circulated would significantly reduce the capacity of the Federal Reserve to perform its core functions. Notably, some leading proposals in the Senate would strip the Fed of all its bank regulatory powers. And a House committee recently voted to repeal a 1978 provision that was intended to protect monetary policy from short-term political influence. These measures are very much out of step with the global consensus on the appropriate role of central banks, and they would seriously impair the prospects for economic and financial stability in the United States. The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution's ability to foster financial stability and to promote economic recovery without inflation.

The proposed measures are at least in part the product of public anger over the financial crisis and the government's response, particularly the rescues of some individual financial firms. The government's actions to avoid financial collapse last fall -- as distasteful and unfair as some undoubtedly were -- were unfortunately necessary to prevent a global economic catastrophe that could have rivaled the Great Depression in length and severity, with profound consequences for our economy and society. (I know something about this, having spent my career prior to public service studying these issues.) My colleagues at the Federal Reserve and I were determined not to allow that to happen.

Moreover, looking to the future, we strongly support measures -- including the development of a special bankruptcy regime for financial firms whose disorderly failure would threaten the integrity of the financial system -- to ensure that ad hoc interventions of the type we were forced to use last fall never happen again. Adopting such a resolution regime, together with tougher oversight of large, complex financial firms, would make clear that no institution is "too big to fail" -- while ensuring that the costs of failure are borne by owners, managers, creditors and the financial services industry, not by taxpayers.

The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis. We have extensively reviewed our performance and moved aggressively to fix the problems.

Working with other agencies, we have toughened our rules and oversight. We will be requiring banks to hold more capital and liquidity and to structure compensation packages in ways that limit excessive risk-taking. We are taking more explicit account of risks to the financial system as a whole.

We are also supplementing bank examination staffs with teams of economists, financial market specialists and other experts. This combination of expertise, a unique strength of the Fed, helped bring credibility and clarity to the "stress tests" of the banking system conducted in the spring. These tests were led by the Fed and marked a turning point in public confidence in the banking system.

There is a strong case for a continued role for the Federal Reserve in bank supervision. Because of our role in making monetary policy, the Fed brings unparalleled economic and financial expertise to its oversight of banks, as demonstrated by the success of the stress tests.

This expertise is essential for supervising highly complex financial firms and for analyzing the interactions among key firms and markets. Our supervision is also informed by the grass-roots perspective derived from the Fed's unique regional structure and our experience in supervising community banks. At the same time, our ability to make effective monetary policy and to promote financial stability depends vitally on the information, expertise and authorities we gain as bank supervisors, as demonstrated in episodes such as the 1987 stock market crash and the financial disruptions of Sept. 11, 2001, as well as by the crisis of the past two years.

Of course, the ultimate goal of all our efforts is to restore and sustain economic prosperity. To support economic growth, the Fed has cut interest rates aggressively and provided further stimulus through lending and asset-purchase programs. Our ability to take such actions without engendering sharp increases in inflation depends heavily on our credibility and independence from short-term political pressures. Many studies have shown that countries whose central banks make monetary policy independently of such political influence have better economic performance, including lower inflation and interest rates.

Independent does not mean unaccountable. In its making of monetary policy, the Fed is highly transparent, providing detailed minutes of policy meetings and regular testimony before Congress, among other information. Our financial statements are public and audited by an outside accounting firm; we publish our balance sheet weekly; and we provide monthly reports with extensive information on all the temporary lending facilities developed during the crisis. Congress, through the Government Accountability Office, can and does audit all parts of our operations except for the monetary policy deliberations and actions covered by the 1978 exemption. The general repeal of that exemption would serve only to increase the perceived influence of Congress on monetary policy decisions, which would undermine the confidence the public and the markets have in the Fed to act in the long-term economic interest of the nation.

We have come a long way in our battle against the financial and economic crisis, but there is a long way to go. Now more than ever, America needs a strong, nonpolitical and independent central bank with the tools to promote financial stability and to help steer our economy to recovery without inflation.

The writer is chairman of the Federal Reserve Board of Governors.

End The Fed.

President Richard Nixon Ends The Bretton Woods Agreement

God bless YouTube - TILB had never seen this before.

To think that our non-existent respect for Nixon could go lower would have been a challenge, but listening to him help lay the groundwork for the dollar's destruction makes us sick to our core. The below is video of his infamous decision to end the dollar's convertibility. The talk resonates particularly powerfully today as the media celebrates Helicopter Ben's "stabilizating" debasement efforts.

Beware what you wish for.

The Singularity: A World Walking The Tight Rope Of Low Interest Rates

[What follows is a thought piece I spent two weeks writing and sent around to some colleagues on Sunday October 18th. It has been modified slightly to take some associate's names out. TILB believes the outcome of rising rates would be unusually horrible for risk assets and, frankly, our society in general.]

“Are you getting it? Armageddon it! Ooh, really getting it? Yes, Armageddon
it!”

- Def Leppard

We have spent a great deal of time reflecting on the lessons learned over the past two years. As I've contemplated those lessons and considered Hatch's recent point that after this recent risk-rally, it appears that market participants' behavior is seemingly unchanged, I began thinking about what we should do to prepare/adjust for the risks that remain in the world (assuming any do). I have many views about this but want to address one in particular.

Humans have a fairly well defined collective “nature” and we are all challenged to deal with our own tendencies within our nature. We have a tendency to self deceive – particularly in situations where we’ve already put ourselves out to the world as having taken a view. Among other things, we have a desire to be right, a desire to be liked, we anchor to the past – especially the recent past – and we act emotionally and generally as a herd. I suffer from all of these, especially self deception.

It's part of life.

Hopefully I have some advantage in dealing with my own tendencies simply by acknowledging them, being aware of them, and realizing that self-deception doesn’t help with my even greater desire to be right. When I frame something through those combined lenses, it helps me stop deceiving so that I can get on the side of “right”.

That’s me. But collectively it’s not possible for man to suppress its aggregate nature and so we muddle along doomed to commit the same mistakes over and over again. The mistakes may not be identical on the surface but they’re identical at their core. This reality was reinforced by Seth Klarman at a conference I saw him speak at back in 2004 or 2005 when he fielded the question (paraphrasing), "do you worry that with the rise of hedge funds and everyone looking for inefficiencies that you're not going to find fat pitches anymore; that the market has become more efficient?" with the following response, "I'm not worried that human nature has changed."

Exactly.

So what is it about human nature pre-2007 that led to the “crisis”. This doesn’t need to address the true “core” problems that I see of fiat money, fractional reserve banking, and unintended consequences of certain policy and regulatory actions. Instead, let’s look at the nature of the foundation those skewed incentives created and how those building blocks were set to crumble in the first place.

In summary, we had a lack of respect for risk, perhaps engrained from 25 years of a generally painless experience for capital (recency bias) where the speedbumps that were approached seemed to be flattened out by the all-seeing, all-knowing Federal Reserve. Howard Marks said that, "the fear of loss is to capitalism as fear of hell is to Catholicism." Collectively, our balance between fear and greed was eroded by this apparent government-gilded safety net and the scales tipped out of whack. This manifested itself in a variety of ways including too much leverage, too little diligence, too much faith in government, too much moral hazard, prices that appreciated too far above the associated intrinsic worth of the assets they represented, too much illiquidity, etc.

I think back on 2006 and remember having conversations over and over where smart investment managers told us that “spreads were too narrow” in the credit world. In fact, despite our repeated asking, we could find almost nobody who would admit to buying at then prevailing prices. This lack of opportunity caused these managers to hold cash or, more often, drift out of their competency in credit analysis into other areas like public equities, LBOs, etc. We spent a little time trying to figure out who was actually buying these assets but frankly did not do a thorough job. What bothered me about this was that I felt like this was a consensus view and my strong preference is to be contrarian.

I have been noodling on the paradox of what it means for me to agree with the consensus - perhaps it is possible that a consensus view point can actually be contrarian? My conclusion is it can. When very large unnatural forces impact the market, an artificial, "unseen" consensus may be created that opposes the traditional "seen" consensus, allowing the seen consensus to actually be contrarian.

I refer to the unnatural forces creating the artificial, unseen consensus as "dumb money". It is dumb in the sense that is not invested with risk-adjusted return generation as its north star; it serves some master other than unfettered economics, be it regulatory or political. In that regard, it is mindless and dumb.

As I mentioned, the view that credit spreads were too tight was a consensus view. However, a thorough research job would have shown us that there was, in effect, an enormous regulatory bid. It was a bid from ABS in the form of CDOs, CMBS, CLOs, RMBS, etc. This was and remains purely a regulatory game where assets that do not have the most attractive properties from a regulatory capital standpoint (e.g., sub-prime no doc mortgages, 2nd lien small cap bank lending to an LBO company, BBB tranches of other ABS) are pooled and re-crafted to rate very well from a regulatory standpoint. Generally 75-85% of these pools of unattractive regulatory assets receive an attractive regulatory treatment (A rated or better) and the balance of the assets are held by unregulated owners that are willing to take low- or un-rated risk.

When you think about this, it is a fascinating reality: buyers had all kinds of incentives that had little to do with the quality or price of what they were buying and a lot to do with interference in markets by regulators and government that drove buyers toward assets for unnatural reasons. In essence, they were price insensitive and it led to unsustainable outcomes.

So we learned a lesson: Follow the Dumb Money. It leads you to the excess (and perhaps to opportunities for shorting).

So Where is the Dumb Money Today?
All of the above was a preamble to establish the case that human nature is fundamental, it causes recurring problems, and the problems are identifiable if we’re willing to hunt down the Dumb Money’s most recent activities. We saw in the recent credit bubble a regulatory Incentive Caused Bias that led buyers to overpay for high ratings and over-trust ratings agencies. Where is Dumb Money today?

It has bothered me for some time that the "seen" consensus view point seems to believe higher rates and more inflation are inevitable. It bothers me because I completely agree with it. I operate more comfortably in a contrarian circle and yet here I find myself rubbing shoulders with the masses. Perhaps it's simply another form of self-deception but I believe we are witnessing a volume of Dumb Money buying ("unseen" consensus) that registers near the right tail on an all time scale. And the Dumb Money ring master is us - the US taxpayer - via our body politic and our printing press operations at the Federal Reserve.

One of the causes of truly great inflations is that in the early stages of rapid money-printing, the price of a typical consumer's basket of goods doesn't immediately respond one for one with monetary creation. The economist Murray Rothbard was a student of past inflations. He refers to that phase of apparent central bank induced nirvana of rapid money-printing and stable prices as a "heady wine" for those operating the printing presses*. It reinforces the logic and encourages a continuation of the practice and, by the time the inevitable result is obvious, it is too late and often too politically difficult to cease, much less unwind. Today we have a Chairman of the Fed that has all but promised to continue debasing the currency by interfering with the Treasury and Agency markets ("quantitative easing" or QE) and is in the process of fulfilling a nearly $2 trillion execution of his QE thesis. Two. Trillion. And I doubt he'll be able to stop there.

Today, I believe the Dumb Money is in sovereign debt, specifically US Treasury Bonds.

Similar to when AAA CLO tranches were issued at par paying 20 bps over LIBOR, Ten Year U.S. Treasuries today are priced to yield 3.3% - not exactly a glorious return, even if inflation is subdued. A while back, Jim Grant coined the term “return free risk” to describe Treasuries at these levels. I believe that return free risk extends well beyond simple Treasury Bonds but before we get to that, let’s talk about why these are the home for today’s Dumb Money buyers.

In a world of global trade imbalances, a dollar-based reserve currency, deleveraging and defaults, Treasuries hold a special place. Combined with unusually favorable capital treatment at regulated institutions, the artificially steep yield curve created by the Fed has given banks a taxpayer gift to put a bid on longer bonds. Near term deflationary fears have a foot on the head of the short end. Foreign central banks – flush with IOUs from the Fed (“dollars” exported by our trade imbalance) – have to buy Treasuries or other dollar denominated assets every single day. Capital raised by banks must find a home and when those banks either lack quality borrowers or are uncomfortable lending precious capital out (or both) they buy Treasuries. Scared by the run on commercial paper last year, money market funds have shifted toward Treasuries. Capital market participants have shifted away from risk assets and toward Treasuries. Etc., etc., ad nauseum. Most importantly, the Fed itself has announced that it will purchase hundreds of billions of Treasuries and even more of Agencies (the sellers of which then take the newly printed dollars from the Fed and themselves buy Treasuries).

In summary, there are a slew of buyers for U.S. government issued debt (including, confusingly, the government itself) and in the current environment of fear of “risk” assets, “risk free” assets have caught a hell of a bid. Most of these buyers are buying for reasons that have nothing to do with absolute value. They are mindless, Dumb Money buyers.

While the inflationary 1970s taught investors that fixed income securities could be “certificates of confiscation”, Greenspan and Bernanke’s Great Moderation brought us a slightly different lesson: From Oct. 1, 1982 through Sept. 30, 2009 (which is three generations, in Wall Street measurements), the Merrill Lynch 7-10 Year U.S. Treasury Bond Index returned 10.0% p.a. Over the last 1, 5 and 10 year periods, it earned 8.0%, 5.7% p.a. and 6.8% p.a., respectively. Stocks as measured by the S&P 500 did not manage to differentiate themselves, besting bonds over the 28 year period by just over 1% per annum, but trailing massively over the 1, 5 and 10 year timeframes.

As such, we have generations of Wall Streeters that have grown to appreciate and believe in the risk free return of U.S. Treasury Bonds, adding stickiness to their bid and reinforcing the mantra of “risk free” (another recent mantra, “home prices never decline nationally”). We have trade partners that are addicted to American IOUs ("dollars"), we have banks and insurance companies that are junkies for any regulatorily blessed capital rebuilding efforts and are now riding the yield curve dragon hoping to catch that old high, we have scared Boomers trying to preserve their precious retirement, we have a Fed that is encouraging the buying of Treasuries and that has itself become the global marginal buyer of Treasuries and Agencies. For the time being, the freshly printed money that is funding the Fed's purchases has not multiplied and filtered out to society, at least on a scale that has frightened the average American. We are in Rothbard's "heady wine" phase and so the process continues. As the merry-go-round spins, non-value oriented buying pressure is unnaturally manipulating prices, keeping them artificially high and yields artificially low.

The Dumb Money is in U.S. Treasury Bonds. They provide virtually no return and a ton of risk. They are, indeed, return free risk.

But, by definition, either this buying cycle will end voluntarily or a special dose of inflation will take hold. And when either of those occurs, what happens to rates?

Unlike other asset classes, U.S. Treasury Bonds denominated in dollars hold a special place in the world. They are considered the global Risk Free Return and are the benchmark for virtually every other asset class on Earth. Even to this day, despite the debacle of the past few years, homebuyers make their purchase decisions not on the economic return a house can generate, but on monthly payment affordability. That affordability is directly tied to Treasury yields and thus, homeowners are effectively short rates (or long long-duration bonds). Commercial real estate, when cap rates are in the 6-8% range as they are today, are attractive only if Treasury yields stay low. Today's price to earnings multiples of 17x or 18x (vs. historical averages of 15x) are implicit bets on low rates, all else being equal. Discount rates and WACC calculations for most people actually embed the 10 Year U.S. Treasury Bond into their calculation. Yield curve junkies are betting on stable or flattening curve-structure. How would floating rate borrowers perform in a rising rate environment, many of whom are skirting bankruptcy now on the backs of a sub 1.0% LIBOR?

And what about the U.S. Federal Budget? The average maturity on the Treasury’s debt is 50 months or so, meaning that the bulk of our issued debt has a four and a quarter year maturity or less, reflecting the U.S. Treasury’s attempt to take advantage of the most attractive end of the yield curve. Despite lower average rates, for the fiscal year-to-date through August (a September FYE), interest expense for the Treasury was $367 billion, eating up 20% of receipts.

We have built an entire world around the foundation of low rates. This is the thread that ties. The Singularity. This is the risk that could cause every asset in our portfolio to get face-punched, as diversity vanishes into the ether and the singularity saddles up.

If debasement activities continue much longer, inflationary expectations will take hold and rates will rise. They must to offset the losses created by monetary inflation, otherwise lenders will not lend and the government will not be able to finance itself. So rates will rise. Perhaps by a lot.

Imagine yourself in a world where instead of a 2s/10s yield curve of 0.9%/3.3%, we were in a world of 3%/6% or 6%/10%. What does that world look like? I’ll take a crack:

- Corporate profits suffer as financing costs skyrocket and customers pull back;
- P/Es contract massively and stocks get re-rated downward;
- Spreads widen on credit securities and absolute rates obviously back-up, leading to a severe decline in the value of credit securities;
- Homeowners get obliterated;
- Corporate borrowers get obliterated;
- Commercial real estate gets obliterated;
- This leads to giant holes in bank balance sheets;
- The annual Federal deficit gaps wider by nearly two-thirds of $1 trillion on U.S. Treasury interest alone (5% of GDP). That incremental deficit is the size of the entire deficit we suffered under Bush2 when we already thought the deficit size was unsustainable. Interest expense alone could theoretically consume nearly half of all Federal tax receipts. How do you ever recover from that?

As such, the Federal Reserve faces a Faustian bargain with a choice between letting nature take its course and walking away (allowing the deflation and liquidation phase of the cycle that the market demands) or to monetize aggressively. What do you think the Fed will do in that scenario? Abandon the Treasury and allow her to default? Monetizing is the Occam’s Razor outcome, despite the problematic result of reinforcing the higher rate regime. Bernanke has said again and again that he will not late the “mistakes” of the past recur. He has already and will continue to use freshly printed money to fill the money supply vacuum left by damaged, deleveraging banks. The government may struggle to find enough buyers to take on the new supply of debt the deficit would demand, forcing Bernanke to either let the Treasury deal with its own problems or to monetize the debt.

He will monetize.

As dollar holders rationally begin to question the value of their currency and the sustainability of its purchasing power, commodity prices will rise to reflect a weak dollar and the velocity of money will accelerate as demand for money diminishes**. Interest rates will rip, financial assets will face valuation headwinds, levered entities that need to refinance, sell or deal with floating rate obligations will spiral toward bankruptcy. The singular thread that ties virtually all asset classes is low rates. We need to be prepared for the pain that will occur when higher rates aggressively yank that thread and unravel the world.

Worst of all, this is a self feeding cycle that will persist as long as deficits grow as a percentage of output or the government continues to monetize debt. If nobody steps in to break the cycle (e.g., Volker), at some point utter devastation results.

I will go out on a limb and state that if rates rise too much and the monetization cycle loses control, a number of non-investment risks that can be difficult to mitigate may arise. These include the erosion of the dollar’s reserve currency status, cessation of tax-exempt status for not-for-profits, overtly confiscatory behavior by governments, much higher tax rates, a challenged system of fractional reserve banking, and the potential for civil unrest. Some of these are unavoidable and difficult to mitigate. But we should try.

How Can We Prepare?
As we consider preparing for the more pure investment ramifications of this outcome, the vast majority of preparations should not be around profiting, but instead should be built around preservation of purchasing power and asset protection/defense. From a macro standpoint, printing new money shifts a portion of every existing dollar's purchasing power to the hands of the person holding the newly printed dollar (the government and banks). This means the government will likely steal more and more of society's purchasing power through this particularly unconstitutional tax. Simply treading water from a purchasing power standpoint will take yeoman's work because we'll be fighting this backdoor wealth confiscation headwind. What are some steps we can take?
- Aggressively shift our equity exposure into high quality, unlevered, low capex businesses. Businesses with global or purely foreign operations may be preferred
- Immediately diversify a meaningful portion to non-U.S. domiciled custody, outside the grasp of our government if true tail risk arises (the new country’s stability must be considered as well). This is low cost, super high value insurance for a magnitude 10 Earthquake on the Richter scale. Seems like a no-brainer.
- On the margin, move our asset allocation toward cash and move “cash” toward select commodities and select foreign currencies as our "new cash". Don't be tricked into believing that just because our "new cash" seems to move everyday relative to the dollar means they have a special risk. Prices constantly move relative to the dollar for everything which means the dollar intrinsically holds the same risk. It just so happens that oil is quoted in dollars rather than dollars being quoted in oil. But the fundamental relative risk is the same, particularly if the dollar’s reserve currency status dissipates. Within commodities, focus on fixed or diminishing resources such as precious metals and energy resources, (maybe agricultural land).
- Avoid all Treasuries and, if we must hold some, keep it all in TIPS even beyond implied inflation levels where we might normally sell (recognizing that we are reliant on the CPI calculation, which is dangerous).
- Prepare for a distressed cycle - huge opportunity.
- Short long-duration Treasuries, perhaps through long-dated, well out of the money puts. Do it in a size that moves the needle and is perhaps surprisingly far out of the money. Long-dated is key. The issue is they are expensive today.
- Short a basket of credit spreads that are too tight, perhaps some sovereigns too - the U.S. isn't the only country going down this road.
- Economic unions like the Euro bloc could be blasted apart as different countries desire massively different monetary and fiscal policy actions.
- Raise the cost of our money yet further - we should be increasingly selective with investing "new cash". The implication of this is that perhaps we need to prune our portfolio and exposure even further and build our new cash exposure.

Where Are We Now?
It is impossible to assess exactly where we are now and when this interest rate/inflation risk might manifest itself. We can’t know with certainty that rates will rise – Japan has defied this experience for twenty years (as an aside, Japan faces this risk as well, perhaps moreso). I have been saying for some time that I think Japan is the U.S.’s upside scenario. In any case, Japan has two advantages on us: 1) they began with a lower level of government debt as a percentage of GDP; and 2) they began with a much higher personal savings rate with which to internally finance newly issued debt (they also had a bigger bubble which meant the deflationary headwinds were bigger to begin with).

I think the U.S.’s peculiar situation is that, because we’ve acted much more aggressively faster, we have already begun to scare off the marginal central bank buyer. The Chinese have aggressively curtailed Treasury purchases. For instance, for the four months through July 2009, China only purchased $33.6 billion of Treasuries (and actually was a net seller during the months of June and July). The oil exporting nations have only added $3 billion to their aggregate $189 billion Treasury portfolios through July.

Stepping into their shoes has been the U.S. Federal Reserve. The left pocket (the U.S. Treasury) is issuing bonds and the right pocket (The U.S. Federal Reserve) is buying bonds with newly printed money. In March, the Fed authorized $300 billion of Treasury purchases, $200 billion of agency debt (Fan and Fred) and $1.25 trillion of agency MBS. In the last week of September alone, the Fed reported buying $5 billion of Treasuries, $3 billion of agency debt, and $39 billion of agency MBS. Its 29 week average for these purchases has been $35 billion per week. Since the late March authorization was put in place, the Fed has bought $291 billion of Treasuries (out of $300b authorized), $700 billion in MBS ($1.25T authorized), and $130 billion of agency debt ($200b authorized). This totals $1.1 trillion and the Treasury bond specific buying authorization is basically used up, though the agency capacity is still ample to last another several months. Of course, the Fed can expand its authority at any time.

The point is, we’ve had $1.1 trillion of money brought forth by the Fed and put into the world over the last six months. The run-rate of the Federal deficit is not shrinking – so how can the Fed stop? Who will step into their shoes?

Imagine what the world would look like if that $1.1 trillion did not exist today.

And so we watch.

But one thing we know is this rate of monetization cannot continue indefinitely without being hugely inflationary, which leads to rising rates. We also know that if the Fed were to suddenly stop, marginal buyers that can step into the Fed's shoes do not seem to exist at today's yields. So a cessation would also lead to rising rates. The Fed’s obvious hope is that they can restart the economy (despite worsening employment and default trends) so that someone can replace their buying or so that the government can cut spending / raise tax receipts and bring the deficit back to more manageable levels. They would then theoretically slowly but steadily unwind their QE, somehow without tipping the economy back into crisis mind you, and take the inflationary risk out of the room. I suppose anything is possible, but I am skeptical.

Further, it is quite possible that we actually suffer from continued deflation, which would seem to justify low nominal rates. The issue, of course, is that a) this is bad for risk assets in general in a society as levered as ours; and b) if we suffer continued deflation, the ensuing inflation will be even worse because it will provide Bernanke cover for even more aggressive debasement tactics. He's playing with fire in a dry forest, but he obviously believes nothing major will come of it.

When this heady wine phase passes and the hangover comes, I hope we are prepared. We have no excuse not to be. It is the most obvious risk in the world, but we have been numbed to it by three decades of apparent stability. The Dumb Money is trying as hard as it can to keep the music on and the party going. However, the more drinks we have, the less fun tomorrow morning will be.

It is time to prepare.

* Rothbard's more full quote is from his book The Mystery of Banking and it reads as follows: "Unfortunately, the relatively small price rise often acts as heady wine to government. Suddenly, the government officials see a new Santa Claus, a cornucopia, a magic elixir. They can increase the money supply to a fare-thee-well, finance their deficits and subsidize favored political groups with cheap credit, and prices will rise only by a little bit!

"It is human nature that when you see something work well, you do more of it. If, in its ceaseless quest for revenue, government sees a seemingly harmless method of raising funds without causing much inflation, it will grab on to it. It will continue to pump new money into the system, and, given a high or increasing demand for money, prices, at first, might rise by only a little."

** "Demand for money declining" may seem non-intuitive, but what we are really saying is that people who sell things demand more money for the same good or service or, described from the inverse, that consumers will prefer goods and services that can be purchased today to the risk of holding dollars for more expensive goods and services tomorrow.

Jim Rogers Gives An Extended Interview To The F.T.

"At the moment, I'm terribly pessimistic for the foreseeable decade or two..."
- Jim Rogers

"...and I do expect a currency crisis or semi-crisis in the next year or two...If you were Icelandic, you'd know what a currency crisis was. Some currencies will just totally lose value. This time it may be the U.K., it may be the U.S."
- Jim Rogers

We cannot seem to find a simple way to embed the video, so here's a link to the interview.

Great stuff.

[HT: Max Headroom]

Inflation Vs. Deflation And The Race To Debase The Dollar

Wall Street boutique dealer, BTIG, circulated the following story from China yesterday a.m.:

Neptune Orient Lines Ltd., China Cosco Holdings Co. and 12 other container lines agreed to raise rates on Asia-U.S. routes, seeking to end a price war caused by slumping demand, overcapacity and "panic." The lines decided on a $500 increase for carrying a 40-foot box from Aug. 10 as a "voluntary guideline," the Transpacific Stabilization Agreement said in an e-mailed statement yesterday. The companies will also raise fuel levies and may add peak season surcharges, the group said. Container lines will try to raise rates again after an April increase collapsed amid rising competition and a 20 percent drop in demand, the TSA said. Spot market Hong Kong-Los Angeles rates have slumped to as low as $900, according to Lloyd's List, as U.S. retailers pare orders for Asian-made furniture and toys on weak consumer -spending. - Bberg

Today, the same dealer friend at BTIG circulated the following:

TOKYO (Nikkei)--Amid still-faltering exports, rates on container ships from Asia to North America have been dropped for the first time in three years, reaching six-year lows.

In just-ended negotiations with businesses, shippers -- including Japanese firms Nippon Yusen KK (9101), Mitsui O.S.K. Lines Ltd. (9104) and Kawasaki Kisen Kaisha Ltd. (9107) -- agreed to reduce rates by 20-40% for the fiscal year ending May 2010. The major reason is sluggish exports of automobiles and housing-related products from Asia to the U.S. in the wake of the economic recession.

The new rate on service to the U.S. west coast, such as Los Angeles, is 1,000 dollars to 1,500 dollars per 40 feet container. It is 2,300 dollars to 2,800 dollars for the Midwest region, such as Chicago, and 2,000 dollars to 3,000 dollars for the east coast, including New York.

Marine transport from Asia to North America started plunging around November last year and continued its double-digit year-on-year losing streak until April. Even though shippers have revamped routes and reduced services, there are still more vessels available than needed.

Major Japanese and overseas shippers bled huge red ink in the January-March quarter because of the harsh business environment for container ship operations. They intend to seek a rate hike if demand recovers for shipments to North America. A clause included in many contracts allows renegotiation for higher rates in the second half of fiscal 2009.
(The Nikkei July 10 morning edition)

These stories are directly in conflict with each other (or, perhaps, they are perfectly in sync with each other since there is little chance the cartel manages to keep all the participants in line). TILB forwarded those BTIG emails and posed the following question to a handful of friends: "Deflation or Inflation?"

TILB friend and Fed watcher extraordinaire, J-Thrill, responded as follows [bracketed statements are from TILB]:

The main thing holding back inflation now is low velocity/Money multiplier [i.e., banks are not lending/demand by quality borrowers is low]. If V/MM comes back with low interest rates = we’ll get 70’s inflation or worse. The Fed has expanded their balance sheet at an unprecedented rate and to the extent the debt they guarantee goes bad, it’s pure inflation. I think that money creation number is probably going to be 2 Trillion from loan losses.

In the early 80's, there was a similar capacity utilization deficit, but inflation persisted until Volcker stamped out inflation with higher rates and restrained M3. I think the low inflation during the 90’s was due to China’s massive low cost import increase to the U.S. and was a free gift to Greenspan (he concedes this). If (when) China’s [currency] strengthens and they continue to make better stuff over time, it will cause inflation for us, but a weak dollar should help our exports. The question is, do we really want to regain the position of the lowest cost tube sock manufacturer to “gain” jobs by killing our currency? I do not. When we start exporting cars to China, you should go long the dollar.

Please pardon a brief digression. As TILB has been known to say in real life (as opposed to the blogosphere), Americans worried about having lost jobs to China need not worry. What we have "lost" are the lowest returning, worst parts of the worst businesses to China, et al. We agree with J-Thrill: we do not want those "jobs" back; government edicts be damned. TILB much prefers our scarce resources be directed at higher value industries by the collective actions of the many rather than commanded toward lower value industries by the whims of a ruling elite.

Our government does not get it (nor do most governments). They think jobs can be saved by "protecting" our manufacturing base. Long run, this will kill jobs from a macro standpoint and lead to malinvestment of scarce resources (directed away from a natural, likely to be more productive use and toward an unnatural, likely to be less productive use). The jobs "saved" will be an illusion since it will cost other better jobs elsewhere (That Which Is Not Seen) leading to a less dynamic economy.

In any case, back to "Inflation or Deflation?" J-Thrill included the following fun graphs that layout the inflation/deflation back and forth quite well.

First, we have measured and reported Urban CPI actually hitting a negative number. - (deflation):



Here, we have capacity utilization at historic lows. - (deflation):



Here, we show the St. Louis Fed's report on the monetary base, which after growing slowly and steadily for decades has more than doubled in the past year (or, as we are wont to say, "it took 100 years to print the first trillion dollars and then it took a few months to print the next trillion; don't worry though, things are fine"). - (inflation)



This final graph shows that net exports have been very negative since the end of the early 90s recession but has corrected a huge amount in the last year (though still very negative). The graph does not clearly lead to a conclusion on inflation vs. deflation. However, it hints. You can extrapolate quickly that we have been sending hundreds of billions of dollars annually to foreign countries for years and years. Those foreign nations have been kind enough to provide epic amounts of low interest seller financing. Perhaps we'll pay them back with newly debased dollars? - (inflation) Further, it indicates that domestic demand for imported goods has fallen off a cliff (that's the reason for the recent inflexion rather than a burst of exports). - (deflation)