sometimes it pays to be wrong

In a recent newsletter, the financial analyst Bob Prechter, makes a great observation about the perils of always relying on statistical probabilities. A given event, or occurrence, may be rare, but that that is no reason not to plan or prepare for it. That 200 year flood or hurricane may be rare, but when they do occur the consequences are disastrous. When the consequences of a given event are huge, it is far better to plan for the worst, even though the chances of dire circumstances occurring anytime soon are slim, rather than do nothing until the inevitable actually does occur which destroys you.

In Bob’s example, he talks about a restaurant which terrorists have attacked several times over the years. Sure, the restaurant patrons might only be killed one out every 500 days, but on that day when the terrorists come, it’s game over. It might be worth while avoiding the restaurant for 50 days of every year that have particularly higher odds of attack (due to special commemorative dates, etc), even though most of those days will wind up seeing no violence at all.

Prechter goes on to explain that economists often fall into this trap of playing the odds. Economic contractions are rare, so it is usually a safer call to predict expansion and growth. However, when contractions do occur they are often severe, and can be utterly devastating to businesses (and investors). What use is an economist who is right 99% of the time (predicting blue skies and growth), if they can’t be relied on to give insights as to when a disastrous economic upheaval may occur? It would be preferable to have an economist err in crying wolf 20% of the time if they manage to advise people correctly about avoiding the next wipe out.

US Treasury as Loan Shark

The financial news almost seems to come straight from bad fiction lately. Who else but an author of pulp fiction could have imagined the US treasury playing the role of a loan shark (although I am sure that anyone who has been on the wrong side of the IRS won't find this too much of a stretch)?

In statements that almost seem impossible to believe, the treasury secretary is now making it clear that banks which received special government bail-outs are NOT even allowed to repay the loans. Not only were many banks forced to accept government funding in 2008, with officials using all manner of threats to cajole reluctant financial institutions to take public money, but now the government refuses to let any of these firms repay the money. It would seem that policy makers see value in forcing companies to remain indebted to them. After all, these loans have given the government unprecedented power to make demands. No bank who's hands are tainted with public bail-outs can ignore ultimatums on executive compensation, or even lending practices.

Anyone considering accepting government funds in the future would do well to remember this. Once you let the government into your business, they will own you. Talk about a deal you can't refuse!

Treasury Secretary Timothy Geithner indicated that the health of individual
banks won't be the sole criterion for whether financial firms will be allowed to
repay bailout funds, a position that might complicate their efforts to give back
the cash.

In an interview, Mr. Geithner laid out some broad
principles, including the need to consider the overall health of the financial
system and the flow of credit in judging whether banks can repay their
government investment.

The Depression You've Never Heard Of -- 1920

The global economy suffered a major contraction in 1920. In a single year US production fell by 21%, US GDP declined 24% and unemployment shot from 4% to 12%. Nevertheless, the economy had begun a significant recovery in 1921, and a long term depression never occurred.

As Tom Wood outlines in this tremendous presentation, the key factor that aided the swift economic rebound was the decision by policy makers to stand aside, and let the economy work out mal-investments by itself. In fact, the President (Warren Harding) embarked on a policy of cutting government spending and advocating deflation. What a complete contrast to the stimulative efforts employed in the 1930s and in 2008 and 2009.

Eerily, it turns out that Japan's response to the 1920 crash was massive stimulus which led to a "lost" decade, and even greater economic ruin in the late 1920s.

I can only shake my head in disbelief to hear the leaders of 2009 argue that the only problem with Japan's failed stimulative efforts of the 1990s was a lack of aggressiveness.

Newer Home Loans Defaulting Faster Than Ever

We are now starting to see evidence that defaults are rising substantially on even the newest vintage of loans. I've long suspected that the worst performing home loans are going to be the most recent ones, as the depression picks up steam. Not only are job losses increasing in the broader economy, but the recently purchased homes are winding up under-water almost immediately (i.e. being worth less than the price of the mortgage) when prices are dropping 3% to 5% in a single month. It is the amount of equity which is the biggest predictor of default, and the newest purchases typically have the least equity.

Troubled borrowers continue to default at high rates even on home loans
that have been modified by lenders, according to a government report issued
today. The report also found that an increasing number of borrowers default on
their loans before making a single payment.

Of the borrowers who had loans modified early last year, for example, about
35 percent had missed at least three payments nine months after their loan was
modified. About 57 percent had missed at least one payment.

The report also found that an increasing number of homeowners, about 1.44
percent during the fourth quarter of 2008, are falling

behind before making a single payment on their mortgages.

http://www.washingtonpost.com/wp-dyn/content/article/2009/04/03/AR2009040300813.html?hpid=topnews

lenders ignoring defaults

Here is further evidence that nothing is really what it seems in the financial system. The statistics we see on defaults (and foreclosures) are becoming increasingly meaningless as lenders simply decide to look the other way, and allow deadbeats to default without any consequences.

I am not saying that creditors are doing the wrong thing by not seizing assets (i.e. there might be little real value left), but this sure messes up the statistics. The phenomena even occurs in residential lending, with many examples of delinquent home-owners who have been in their homes for a year or more without being kicked out. Even once lenders foreclose, some institutions are reluctant to actually sell the assets at current market rates. It is far better to keep unrealistically high valuations on the books, and just sit on a dead property, than to be forced into insolvency by booking severe losses after selling for cut-rate prices.

There is so much rot going un-reported that God only knows how bad things really are…

Under normal circumstances a company with as much past-due debt as General
Growth would have been forced into Chapter 11 bankruptcy protection by now.
Creditors so far have been willing to let deadlines pass because they believe
there is little to be gained and much to be lost through a bankruptcy.

http://globaleconomicanalysis.blogspot.com/2009/04/commercial-real-estate-limbo-lenders.html

Bottom Feeders Beware

The very explosion in the number of buyers looking for great real estate investment opportunities, through foreclosure auctions and short sales, virtually guarantees that we are far away from a recovery. The field is already littered with the corpses of value investors who jumped in too early. Just look at how the big investment funds who bought into financial institutions like Washington Mutual wound up seeing their stakes wiped out.

While savvy investors have long profited from dealing in distressed properties,
the soaring rate of U.S. home foreclosures over the past few years has
attracted mainstream interest and crowds of new bidders.

The experience of all these novice investors jumping into the market is likely to end in tears, as prices keep falling in the years ahead. Those 30% discounts (from peak prices) won't look so good when prices drop another 30% to 60%. There were plenty of people who bought Japanese real-estate in 1994, after it had dropped some 40% from the'89 peak, only to find the prices fall much further over the next decade. There is no reason such a thing can't happen in the US.

When we finally do hit a bottom in real-estate, there will likely be such a level of disgust with the market that few people at all will be interested in purchasing for investments.

O Ye Of Little Imagination

The "Oracle" of Omaha has once again demonstrated that his crystal ball doesn't work so well. According to Warren Buffet, the economic downturn is as bad as he could possibly have predicted. He follows up by saying he doesn't see how things can get any worse.

My response is simple: Warren clearly lacks imagination if he can't conceive that things can get worse (which they will).

Buffett said economic developments have been very "close to the worst case" that he had imagined,

As I've written before, the great business people of the last 60 years are getting their come-uppance now. The principals that have served them well for decades (e.g. "value" investing) just don't work in a protracted depression with crashing asset values.

A bull market at last! Storing crude.

Finally there is a bull market to invest in: storing crude oil. Traders, and producers, are awash in such a surplus of oil that the costs of storing the stuff is going through the roof.

as storage units on land have filled up, the companies that own the tankers have profited. Tanker companies charge an average of $75,000 a day, three times as much as last summer, to hold crude, said Douglas Mavrinac, an analyst with Jefferies & Co.

As I wrote a while back, speculators are betting that crude prices will be higher in a year or so. But with volumes of stored crude rising dramatically, I wonder how well that game will work out.

Meanwhile, oil-producing countries such as Iran have pumped millions of barrels of their own crude into idle tankers, effectively taking crude off the market to halt declining prices that are devastating their economies.

Traders have always played a game of store and sell, bringing oil to market when it can fetch the best price. They say this time is different because of how fast the bottom fell out of the oil market.

“Nobody expected this,” said Antoine Halff, an analyst with Newedge. “The majority of people out there thought the market would keep rising to $200, even $250, a barrel. They were tripping over each other to pick a higher forecast.”
Now the strategy is storage. Anyone who can buy cheap oil and store it might be able to sell it at a premium later, when the global economy ramps up again.

So much for peak oil. Demand for energy is much more elastic than almost anyone realized.

Would you trust this man?

According to the recent financial report from Warren Buffett's holding company, "
Berkshire Hathaway reported today that its net worth fell in 2008 by $11.5 billion, a decline reducing its per-share book value by 9.6%. That was Berkshire's worst result in the 44 years that Chairman Warren Buffett has run the company."

Is this the kind of financial performance we expect to see from one of the world's greatest financial minds? According to Buffett's own words, he made a “major mistake” in buying shares when oil and gas prices were near their peak. Worse, Buffett made a bone-headed maneuver in selling derivatives, betting that markets would recover, putting Bershire on the hook for up to $37 billion dollars. And this is the same guy who called exotic financial instruments weapons of mass destruction!

Warren's great trick was buying stocks at the beginning of one of the greatest bull markets in history. Unfortunately, it looks as if the skills that had served so well in past decades are leading him astray in the new world of economic depression, and the prospect for long-term deflation.

Love it or hate it, bank nationalization is inevitable

All the gnashing of teeth of a possible bank nationalization misses the real point- it is inevitable, regardless of whether anyone wants to do it or not. The major US banks (like Citigroup and Bank of America) are technically insolvent, and unless some miracle occurs that turns their non-performing loans back into gold then these institutions are doomed.

Sure, it’s theoretically possible that the government would just stand by and allow a Citigroup to keel over, and wind up being liquidated in a bankruptcy, but policy makers would never allow such a disorderly crash. Show me just one congressman (other than Ron Paul) who would be willing to allow all the depositors in Wells Fargo to lose their savings?

Instead, the government will be forced to step in and supervise an orderly dissolution, much as what occurs with FDIC conservatorships. I find it strange to hear so many critics about nationalization when nary a complaint is uttered when the FDIC seizes lenders and proceeds to find buyers, and disposal of assets. That’s all we’re talking about here. The only difference is that the big banks are of an order of scale larger than anything the FDIC has hitherto dealt with, potentially saddling the government with enormous liabilities as they pick up the pieces.

Of course, I personally favour the hands-off approach, allowing depositors to be completely wiped out (this would definitely stop any moral hazard in its tracks, when everyone realizes they have to take personal responsibility for putting their money in safe institutions), but I know it will never happen.

Sooner or later the federal government will be forced, kicking and screaming, to seize the nation’s big banks. I am sure this is not what Messr Geithner would like to do, but he won’t have any choice. Unfortunately, judging by the collapse in bank share prices it looks like this will happen sooner than later. As we’ve already seen in many other bank failures over the last year, depositors start to withdraw their money when their bank’s stocks are in the sub $5 range, which creates a dynamic that drives the institution into the ground.

We’re all Keynsians now

I just watched a Charlie Rose interview with several well known economists about the new US administration’s bailout efforts and was struck by the absolute unanimity in agreement that such policy efforts are a good thing. In fact, all of Charlie’s guests insisted that even larger bailouts are in order to avoid having a “lost decade” such as Japan saw. I suppose I really shouldn’t be all that surprised considering how this is exactly why people become economists- in order to be technocrats who craft policy. Still, the fact that no one questions the logic of interventions is incredible.

The Frontline documentary on the crash of 2008 also plays right into this general belief that running the economy is all just a matter of good, level-headed, policy making. The documentary infers that the financial crisis could have been stopped in its tracks if only policy makers had used a more comprehensive approach early on, and appeared more confident.

Of course, I can understand the natural desire we all have for hope. We also don’t like to think that events are out of control. It is far more comforting to believe that the only reason bad things happen is because some person’s incompetence, or mistake, than to consider that there was nothing anyone could have done.

But now is not a time to ask such questions. Instead, everyone ought to just be greatfull that our governments care, and are trying to do something to fix the economy. After all, it’s the thought that counts.

Canadian economy bites the dust

So much for the theory that Canada's economy was going to go right on sailing the high seas when the US tanked. Yet another nail in the coffin of the de-coupling theory. If anything, the bubble in Canadian real-estate has been even more spectacularly insane than that of our neighbours to the south.

As I've said for a long time, the economic fall-out from the global credit bubble is going to be far worse in most other nations than in the US.

Economic problems in the U.S. have always been keenly felt in Canada. But
until last fall, Canada looked positioned to weather the storm better than its
southern neighbor. Low corporate and consumer debt levels, no subprime-mortgage
crisis, and surpluses in the federal budget and trade balance placed it on
sounder footing. Economists expected slower growth but no recession.

Last fall, as economic problems multiplied in the U.S. and elsewhere in
Canada, Alberta's oil-and-gas industry briefly remained a bright spot. Then the
bottom dropped out of the oil market, as the global downturn suppressed demand.
Tightening credit compounded the problem. Almost overnight, oil companies
started postponing investment plans.

Rick George, the chief executive of Calgary-based Suncor, which in January
postponed site-expansion work worth C$14 billion, estimates that 35,000
temporary workers employed around the Fort McMurray oil sands will be reduced to
fewer than 10,000 by the end of the year. Given how frenetic the boom was, he
says, "we needed a correction. What we didn't need is a collapse in the banking
system and the world economy to get it."

http://online.wsj.com/article/SB123500580587718267.html

financial bail-outs just add to deflationary pressures

Ironically, the latest attempts to jump start the US credit markets are actually just adding to over-all deflationary pressures by increasing debt. Debt must be repaid, and leads to major economic contractions in downturns as we have seen in 2007 and 2008. All these efforts to create even more debt policy makers are just driving us towards an even deeper decline of asset valuations and an increase in the purchasing power of the dollar.

I guess the new US administration hasn’t heard about the Hippocratic oath.

In the new consumer-lending program, the Treasury provides $100 billion of
capital and the Fed uses that as a cushion against which it could make up to $1
trillion of three-year loans aimed at jump-starting markets and spurring
consumer lending.

http://online.wsj.com/article/SB123440381495875583.html?mod=testMod

Economic Crises Stimulate Community and Interdependence

When times are good, we are quite happy to share in the rewards of prosperity, willingly accepting more in bonuses and pay than they may have actually deserved. We even spend money we don't yet have, based on optimistic valuations of our homes and other assets, not to mention projected future income. We don't need to rely on friends or family or unions because we feel self-assured that we can get another job easily and pay for whatever services we might require without the inconvenience of reciprocating. We somehow feel we can afford to neglect nurturing our relationships to family and neighbours.

As times get worse, we have less money and feel more insecure about the future. New jobs are scarce as many employers layoff workers while others hire new workers at the lower wages of an increasingly competitive labor market. We look for ways of supporting each other by sharing time and resources and helping our neighbours. Suddenly, we can't count on paying for all of our needs with cash and must rely on our relationships with friends, neighbours and relatives. A natural, healthy community spirit becomes essential.

While we draw nearer to our own select communities, we become less tollerant of others that we deem to be outside of our community and who we perceive to be encroaching on our prosperity. We become more nationalistic. We spend more time with our neighbours, but vote for protective tariffs to discourage trade with "others." We criticise immigrants, especially illegals, because they are willing to work harder for less compensation than we are. Instead of recognizing that jobs and wealth are unlimited in the world (if not, then all new entrants to the world since Adam and Eve would be unemployed) and that all humans have equal value, we fall into fallacious economic assumptions about a zero sum game (jobs and wealth are arbitrarily limited and must thus be distributed among us) and actively cultivate categorizations of "us" versus "them."

Many of us are suddenly unwilling to accept the possibility of failure and considerable loss, even though we were quite willing to accept the unreasonable prosperity of recent times. We rejoiced when our investments miraculously rose by 50% over a brief period, but find it somehow intollerable that they should fall by the same amount. We want to savour the benefits of free markets without accepting the associated risks.

Political propositions of security, where the government promises that nobody will be allowed to suffer too much or fall too low become very attractive. During crises, security trumps potential future prosperity and people are willing to trade the latter for the former. Alas, freedom comes with responsibility. Like the farmer, if we want to reap the rewards of his bumper crops we must also accept our lot in times of drought. Voluntary associations can ease the risks, but ultimately, we cannot have freedom without responsibility.

Institutional Instincts Deepen Crises

As we move deeper into the current economic crisis, it is becoming increasingly clear how instinctive responses to the crisis can be counterproductive, both at the national and institutional levels.

At the national level, officials move towards protectionism when their intent is to expand trade and economic activity. Protectionism, including "buy American" policies, reduces trade and production by inducing trading partners to restrict our goods from entering their markets.

Governments also try to encourage easy credit and aggressive consumer spending when those are precisely the reasons for the economic crisis in the first place. The cure for excessive borrowing and spending is saving, but while savings help long term economic growth, they discourage near term consumption.

Individuals and families naturally save more and spend less when they feel that their assets are declining in value or that their sources of income are at risk of decline. The governments are actively discouraging this natural instinct because it means a decline in consumption in the near term which causes declines in perceived economic strength and hence government popularity. Without savings, however, there is less capital available for creating new companies and providing productivity-enhancing capital to workers in the medium to long term.

Because individuals cannot be easily discouraged from saving when they sense economic troubles, governments resort to taking the money individuals invest in government bonds and spending it for them. Instead of these savings going into the most productive industries and investments, it is turned into government make-work projects like bailing out poorly run companies and inefficiently building unneeded infrastructure projects. In short, these savings are diverted from achieving their natural role of encouraging long-term economic growth into short-term make-work projects.

The same short-sighted mistakes are made at the institutional level. Rather than simply reducing spending and production, organizations often choose to provide a lower quality product, thus diminishing their reputation and hurting their long-term growth. This is especially true of service organizations like private schools and colleges where it can seem more attractive to accept lower quality applicants who can pay full tuition than it is to offer scholarships or simply lower tuition so as to enable more high quality students to be able to attend. This latter requires some belt tightening, but it ensures that the quality of the product is maintained or even raised. Above all, customers demand value for their investment during crises. Schools and similar service-based organizations need to both reduce their prices and raise their quality.

Whereas the individual instincts to save money and look for better value during crises are very healthy, institutions and governments with short term economic objectives tend to make decisions which seem to be compelling in the short term, but which ultimately diminish the health of the country or organization. The role of crises is to improve value and savings, and resistance these ends will only protract and deepen the economic suffering.

Do No Harm

Lately, it seems that everyone is asking me for my thoughts on what I think the government should do to “fix” the economy. How can we prevent a deeper economic contraction, or (heaven forbid) a depression? The underlying assumption in all these questions is the belief that something can be done.

My standard response to such queries never goes down well. Few people are thrilled to hear my theories on how economic cycles are driven by generational patterns, and that there really isn’t anything that can be done to either ameliorate this current economic contraction, or prevent such things from happening again in the future. I can understand this attitude of defiance. Human beings are resilient creatures at heart, and we have never been willing to accept “no” as an answer. No matter how bad circumstances get, with wars, famine, or disease, we persevere, making the best of things.

Further, it’s in our nature to re-make nature to suit our needs. Why accept the ravages of floods or drought if we can discover how to engineer dams to regulate water flows? Why accept living in the cold when we can build fires, and make warm clothes? If we can create cures for terrible diseases, and put a man on the moon, why can’t we structure the economic system in a way that will ensure no catastrophes will happen ever again? In our modern era, with technology being so endemic in everything from smart phones to home pregnancy tests, why should we put up with chaotic economic cycles?

There are things that man cannot do – things that are best left alone. Yes, we can cure many ailments, but there are still numerous diseases that defy the modern medicine. In fact, there are times where the intervention of man has been found to actually make things worse. Attempts to snuff out every smoldering ember we find in the wilderness can wind up leaving the entire forest more susceptible to catastrophic fires that would otherwise be limited in scope if small fires were allowed to burn on a regular basis. Building levees around rivers, and dredging, to prevent floods can actually prevent the natural replenishment of fertile soils and result in coastal erosion. Dams can kill off fish.

No every attempt of controlling the environment succeed, and some can actually make things worse.

So it is with economies. The attempts to control and manage economies only results in creating bigger messes. It’s quite possible that all the sophisticated economic stewardship by central bankers and finance ministers over the last 50 years has only served to prevent small brush files at the expense of setting the conditions for a cataclysm. Why then should we now be so eager to create new ways to ensure that the economy should never again see a road-bump?

Nevertheless, the rallying cry for economic intervention is deafening. It would be wrong for policy makers to just stand by and allow suffering to run unabated, the masses shout. You must do something! And “something” is exactly what the policy makers are doing. The US government alone has already spent, or pledged to spend, over $14 trillion in all manner of stimulus and bail-outs.

Sadly, even the technocrats, and economists, crafting all this government largesse openly admit they don’t really know what actions (if any) will actually help the economy.

What utter insanity! If they don’t know that the various spending, or stimulus, programs will help, then why do them? Doctors don’t give medicine unless they know it will help (that’s the theory at any rate), so why should governments and central banks behave differently?

No, there is nothing the governments can do to “fix” the economy, nor is there anything that can be done to ensure that depressions never again walk the Earth. Worse, the very attempts to prevent them will merely cause far more grief and hardship.

Deflation 101: the podcast

If you ever wanted to understand deflation, and how it is effecting the economy, I have put together a comprehensive and in-depth lecture on the subject. My "Deflation 101" podcast explores what deflation is, why we are experiencing it, and why it is going to last for years to come.

I have also built a slide deck, with numerous charts, to accompany the podcast.

There is also an episode of the Optimistic Bear internet radio show that offers a primer on deflation. If you want to participate in the community discussion about this subject you can join the Deflation Study Group on LinkedIn.

Growth in speculative stocks of crude destined to keep prices low

This Bloomberg story, about the growing demand for oil tankers to be used as storage by speculators hoping for higher crude prices, illustrates quite graphically why oil prices are set to fall even more. The massive buildup of inventory will eventually have to come back on the market, and will inevitably drive prices even lower.

It speaks volumes that oil prices have continued to decline in recent months EVEN as traders have been squirreling away vast quantities of the black stuff away into the bellies of ships plying the world's ocean lanes to nowhere. If prices are falling even with 50 million barrels taken off the market, then demand destruction must be awesome indeed.

Tech predictions for 2009

Here are my predictions for the technology industry and the economy in 2009.

Almost all of my predictions stem from one thing: 2009 will be the year when the global recession bites hard, and all companies begin to see major sustained impacts from the resulting severe economic slow-down.

• Emerging markets will see an even bigger decrease in electronics/technology consumption than developed ones. (e.g. China and India will each see actual negative economic growth by the 4th quarter, not just a slow-down in over-all growth)
• Mobile phone sales around the world will be very sluggish for the first half the year and actually wind up in contraction by year end, making 2009 the first year in over 20 years with over-all flat sales.
• The fastest (and perhaps only) growth area in mobile phones will be in pre-paid plans, and dirt-cheap handsets lacking any smart-phone features. This will largely occur as consumers try to save money by jettisoning expensive phone and data contracts.
• Apple will report significant contraction in sales (particularly iPhones and iPods) as consumers cut-back in spending, and will see its stock in the $40 range.
• Google growth will continue to slow in the first and second quarters and will report an outright contraction in business by the third quarter as advertising revenue gets hammered. Google stock will be in the $150 range by year end.
• RIMM will see a contraction in revenue, and see its stock in the $20 range.
• Virtually every tech firm there is will see contractions in business in 2009, and almost everyone will have hiring freezes if not actual lay-offs.
• Not one tech firm will go public in 2009. VC funding of start-ups will be 90% lower than in 2008.
• 2009 will be the year of tactical IT spending. Unless there is a provable 6 month ROI, or the existing systems are literally breaking, many companies will opt to conserve cash and forego any kind of up-grades, or long-term efficiency improvements. The products that succeed will be ones that show the customer will realize a benefit very quickly.
• Paradoxically, companies become less efficient when faced with economic business uncertainty. It is only during prosperous times that most organizations are willing to consider significant investments to improve over-all productivity.
• There will be a huge increase in sales of outsourced IT services, which allow customers to pay for usage. Companies will be very eager to control their costs as business changes in an unpredictable economic environment. Instead of hosting e-mail servers internally, just use an outside e-mail service that allows you to easily ramp up, or down, as your needs dictate. Why pay for unneeded capacity if you don’t have any orders next month and need to lay-off half your staff? This is not to say that every software service will succeed, but those that are tailored well (with the right pricing models) will see a big jump-start as more and more companies opt for pay-for-usage pricing models.
• Hardware prices (e.g. memory, displays, storage, PCs) will fall faster than they have in decades, as all tech firms find that they are over-producing when demand slackens dramatically, forcing them to slash prices to unload inventory.
• Investment in hardware R&D spending, and new product introduction will slow substantially. There will be far fewer new hardware standards, or technologies, emerging (e.g. wireless USB has almost stopped, now that most of the start-ups that were its driving force are finished). This will wind up having a knock-on effect of having fewer reasons for people to upgrade to new systems (i.e. because the technology isn’t improving as quickly as in the past).
• The portion of sales of “value” tech products (i.e. products targeted at the lowest price-points) will become a far bigger portion of over-all sales, with a dramatic contraction in “premium” products.
• The US dollar will defy all expectations and appreciate significantly against most other currencies. The Euro will see a significant loss in value as fractures begin to appear amongst EMU member states (e.g. with nations like Greece, Spain, and Italy spending profligately angering Germany and other “rich” nations). Emerging market currencies will be eviscerated, losing 50% of value vs the dollar or more.
• Interest rates will remain extremely low, but it will be hard for businesses to get any credit since the private credit markets will remain frozen and chartered banks will be unable to make up the difference.
• Oil will drop to the $30 dollar a barrel range by year end.
• Global stock markets will close be 40% lower at the end of 2009 than they were at the beginning of the year.
• Global stock markets will see incredible volatility throughout 2009 with rallies and crashes that break records. We will see at least one rally (that lasts more than 1 month) that sees the Dow Jones rise over 30% (only to lose it all again in a big crash).

Altruism v. Benevolence

At a Liberty Fund conference this last weekend, the discussion touched upon the role of informal institutions on cultural behaviour and, separately, why there seems to be a decline in honesty among the youth. After some thought, I postulated that the two subjects might be linked.

As our society increasingly emphasizes, both in theory and in practice, that one person's need implies an obligation of others to share. If somebody has less food, we should feel guilty that we have more and donate. If somebody has less money, we should pay higher taxes so that they can have a minimum of comfort. We use euphemisms for our guilt, like "paying it forward," or "giving back to society," when really we simply mean a morally mandatory redistribution of wealth.

Worse yet, we downplay greatness and achievement. Many of our schools, even private ones, offer financial aid on the basis of need alone while even their top students of any given year receive not a farthing in scholarships. Bill Gates, Rockefeller, and Carnegie, rather than being praised for realizing the American Dream by producing incessantly better products that improve the lives of millions at steadily declining prices, we vilify them. Instead, we worship volunteerism and pop stars who ask us to ask our government to help poor Africans.

Among this orgy of selflessness, is it surprising that students have less and less respect for the answers and property of others? If those who have less of anything have almost a right to receive from those who have more, why is copying wrong? Why is stealing wrong? If the government is morally justified in taking from the wealthy and giving to the poor, why shouldn't the private redistribution of wealth be equally justified? What if Johnny has a better brain than Jane, shouldn't Johnny have to share his intellectual wealth with the less endowed?

We have replaced benevolence, the voluntary, discriminate giving by one person to another whom he finds deserving, with a cultural obligation to engage in indiscriminate giving by all who have more to all who have less. Whereas benevolence engenders profound satisfaction on the part of the giver and gratitude on the part of the receiver, institutional altruism engenders resentment in the giver and entitlement in the recipient. Where weakness is rewarded and achievement scorned, we should expect life to once again become nasty, brutish and short.

Commodities tell the story

These charts are some of the best I have seen which illustrate how our current economic contraction compares to past eras. The chart comparing the Dow to commodities is particularly interesting, showing that massive drops in commodity prices have accompanied every major depression since the 1700s. The charts inverting commodity prices are also very intriguing, by illustrating quite graphically that what has really been happening lately is an appreciation of the dollar.

Since the summer of 2008 we have seen one of the most severe crashes in commodity prices ever. These charts show how big price corrections in commodities have an uncanny correlation to downturns in stocks, and the economy.

By the way, Elliott Wave International (the group that put this data together) is my favourite bunch of analysts anywhere. They have been about the only ones out there calling for a deflationary bust, even during the height of the bubble.

the case for deflation - why stimulus spending won't help

At first blush, it would appear as if all the government bailouts and stimulus (to address the financial crisis) will wind up massively increasing inflation. After all, with government putting trillions of new dollars into the economy, how can this do anything other than to cause prices to rise and the US dollar to drop in value?

Unfortunately, this seemingly logically interpretation of government spending is flawed. Rather the causing inflation, government spending will contribute to the exact opposite result. An increase in national debt is DEFLATIONARY. It sucks money out of the rest of the economy, causing asset prices to decline even more (i.e. “deflation”).

The key thing to keep in mind is that debt is deflationary, and is not the same thing as printing money. At some point debt has to be repaid. Sure, increasing debt can also increase the money supply, but it also will lead to a contraction as well (i.e. when the debt is repaid). If the government was actually just “printing” money, instead of borrowing it, then I would agree we might be headed to a period of high inflation. But this is not what is happening.

Also, it is important to keep in mind that all this increased government spending (and the debt to back it) is a drop in the bucket when compared to the amount of debt creation which has VANISHED from the private sector. The global credit markets have been operating in the tens of trillions of dollars range for years ($40 to $60 trillion per annum), and this spigot of debt creation has virtually ceased to exist over the last 10 months. All the increased stimulus/spending of the world’s governments doesn’t come close to making the difference.
Consequently, this leads us towards deflation, since the velocity of money is contracting at a furious rate.

Even the people who are railing on banks to start lending more completely miss the point. As a matter of fact, the world’s banks have INCREASED their lending dramatically this year. The problem, however, is that it just doesn’t make up for the loss of the private credit markets. But this phenomenon is very opaque, and difficult for people to understand.

A given bank may actually be initiating a lower total volume of loans this year, but a FAR higher percentage of those loans are staying on the bank’s books. Over the last 20 years banks have begun to HEAVILY rely on the private credit markets to goose their lending capacity. A bank may lend $10 million to a company wanting to expand it’s manufacturing capacity, and then turn right around and re-sell that loan to mutual funds on the private market. In this way the bank becomes little more than a retailer, making a commission for the initial under-writing and on-going servicing of the loan. The actual loan itself, however, is owned by a 3rd party, and isn’t on the bank’s books at all.

Many companies became reliant on going directly to the private credit markets themselves, and side-stepping banks altogether, to get credit. Many firms became reliant on constantly selling their receivables as asset backed securities, and continuously rolling over that debt with new receivables every month. Unfortunately, this has almost completely ceased to happen over the last year, driving borrowing costs for these firms up enormously as they now have to go directly through banks (which always charged higher rates than the private markets).

In the last year, however, banks have had to place almost all the loans they write on their own books. The total loans the banks have on their books area increasing dramatically, but the actual value of the loans that they issue is down.

This is why we are facing deflation. The global credit markets are MASSIVE, and the virtual disappearance of them is a problem that no amount of stimulus or government spending can replace. The US government could undertake another $5 trillion in stimulus spending and it still won’t help. The Japanese government attempted to spur inflation with massive stimulus during the '90s, but that clearly didn't work either.

It’s possible the world’s governments could “print” money to stoke inflationary fires again, but doing so would pretty much destroy a national currency overnight. The days when governments can print money for months, or years, before the negative impacts are felt are over. Technology ensures that the markets will know when governments start printing and act swiftly.

The printing press (and electronic equivalent) is similar to having an arsenal of nuclear missiles during the cold war. In theory these missiles could be launched in a war, but the reality is that no leader will ever be willing to press the button on global thermonuclear war.

Central Banking Exacerbates Credit Crises

Some of the clearest analyses of banking principles come from the 19th century, when a general awareness of various banking options still existed. Today, with the nationalization of note issues and the ubiquity of fiat currencies and central banking, few remember the alternatives or understand the implications of our current system. A French economist, Charles Coquelin, wrote a number of lucid works, including a comprehensive analysis of credit and banks (in French).

In a shorter article by the same author explaining the role of credit in economic crises, Coquelin explains that only economies that use credit experience periodic crises, and that such crises are acerbated considerably in economies with central banks. While in 1864, the possibility of fiat currency didn't cross his mind, he could still see that the central banks of his day (e.g., Bank of England & Banque de France) distorted credit markets by their privileged status. With specific privileges beyond all other banks, central banks were considered more secure than private banks, and could both borrow and lend at lower rates of interest than their private counterparts as a result. This left largely riskier borrowers for the private banks and led inexorably to de facto national currencies which linked problems with one bank to those of others.

While there will (and should) always be periodic bank failures, as in any other industry, it is important that the full risks and losses of such failures be left with the investors and depositors of such banks so as to avoid taxing healthier banks to support their less healthy neighbours. In a free market, marginal institutions fall first and as their assets liquidated, healthier banks can buy them at discounted prices and shore up their own portfolios. This leaves the healthiest institutions standing at the end of the crises.

Alas, we have adopted the exact opposite policy in the current crisis. The weakest banks that fall first are bailed out by governments, along with every subsequent bank until the government can no longer issue more promises against future tax revenue. At that point, all of the "salvaged" banks fall at once when the government defaults on their debt obligations. Perhaps Coquelin was right in suggesting that the whole process is less painful if left to the free market.

Private Money = Stable Money

The monetary turmoil now underway is, in part, due to the fact that countries have adopted monopoly currencies and then proceed to abuse them without immediate consequences. The euro is about to collapse, as regional manipulation of interest rates and government deficit spending leads to the logical consequence. The solution is the anti-Euro, private, competitive currencies.

National and inter-national currency monopolies lead governments to eventually move to fiat money backed only by their threats against those who refuse to accept it and ability to tax the people to give it value. Currencies founded on intrinsically valuable specie money are always extinguished by central bankers. Once a monopoly fiat currency has been established, central banks proceed to over-produce bills, and entering into excessive debt, sustainable only through continued inflation.

In a private, competitive monetary environment, however, any private mint indulging in debasement of their coin would be punished by the markets. Their currency would trade at a discount, to the degree that it traded at all. Banks issuing banknotes bearing their own bank's name would, likewise, only put the issuing bank at risk for their value. An over-exuberant note-issuer would find their notes quickly discounted by the markets, forcing them to reduce their circulation or face a run.

Monopoly currencies are too tempting for governments to not leverage them as tools of indirect taxation. Once such currencies have been extensively over-leveraged, they collapse in an inflationary spiral. Only healthy currency competition between privately competing currencies in a free market can effectively discourage currency mismanagement.

Savings: Outdated idea?

It is easy to blame greedy bankers and Wall Street for the depth of the current financial turmoil, but the primary source is the encouragement of debt and discouragement of savings by the U.S. government. Inflation of the currency, both by blatent printing and debt expansion, always discourages savings, but the list is not limited to inflation-related incentives:

1. People are taxed on capital gains from their savings and investments, after paying tax on the original principle. If they just spend their money instead of saving it, they might even be able to deduct such purchases as business expenses.

2. "Profits" on long-held investments like homes are not adjusted for inflation, so even if the house lost money in real terms, it could be taxed heavily for capital gains due to inflation.

3. Idle cash must be invested or spent simply to keep up with the inflation rate. Cash balances lose money by default. Often even basic savings rates are lower than inflation rates, encouraging savers to seek higher yield, higher risk investments merely to keep from losing their principal.

4. Mortgage interest is deductable from income tax, encouraging people to borrow money for their home and discouraging renting.

5. There is an unlimited allowance for capital gains and income that is taxable, but only $3,000 in losses may be deducted per year. If you make $1 million one year and lose $1 million the next, the full $1 million will be taxed the first year, but only $3,000 may be deducted from taxes the second year. Even if you save the residual income after taxes from the first year, you cannot cover the loss of the second.

6. The arbitrary nature of breaking the tax year into specific segments. All expenses within a given tax year are deductable, but if profits are saved over a period of years to pay for an expense in cash, those profits are taxed every year before the ultimate purchase. If, however, money is borrowed to pay for an expense up front, its cost can be amortized over many years.

7. Richer people, who have more discretionary income to save, are taxed much more heavily than poorer people. The poor don't have much extra money to save to start with, so if we tax away the would-be savings of the rich, we impoversh our capital supplies.

8. Inheritance taxes encourage the consumption of accumulated wealth during one's lifetime rather than inter-generational savings and investment. If you know that a large portion of your life savings will be taken upon death, why not spend it now?

In short, the government creates considerable incentives to borrow and spend, especially via the various effects of inflation, and thus discourages savings. Any society that neglects savings long enough is sure to ultimately find itself with a lack of real capital, leading to a depression when the credit pile crumbles. A society which values savings is one with slower economic growth, perhaps, but fewer economic surprises.

Another Rate Cut, Another Failure

At last! The Federal Reserve, along with many other central banks around the world, have cut interest rates. This is what the markets have been waiting for, everything will be fine now. After all, the previous rate cuts over the last year have done so well that its obvious that a globally coordinated rate reduction will do wonders.

This is clearly poppycock. Interest rates are already at historic lows but that hasn't helped the economy. Lowering the cost of borrowing further won't do anything to encourage people to borrow more, or prevent a further decline in the value of assets. Japan has been trying to almost GIVE money away for nearly 20 years and that didn't re-ignite their economy, and there is no reason to suppose this recent rate cut is going to help anyone either.

Interestingly, rate cuts are one of the best sell signals an investor can find. Stocks almost always head lower in the weeks, and months, following a rate cut. This only makes sense, of course, since rate cuts are always made when central banks are concerned about the health of the economy. Ironically, the time to buy is when central banks start raising rates.

Actually, raising rates isn't as crazy as it sounds. Low interest rates themselves are a significant contributor to the economic crisis. It is difficult for anyone to make money lending at such ridiculously low rates. Why even bother making a loan at 5% when there is barely enough income to cover your costs, let alone compensate for the risk of default (which is greater today than at any time in the last couple decades)? I vote for a co-ordinated global strategy of raising rates, and ceasing mortgage subsidies (i.e. Fannie, Freddie, FHA, etc).

Such a policy of higher interest rates would absolutely hurt the economy in the short term, but it would help restore health to the financial system by making it profitable to lend once again. Unfortunately, no policy makers seem to be willing to accept any short-term pain, even it it will help reduce the depth of our coming depression.

Oh, and let us not forget that it was abnormally low interest rates which were a major cause of the economic mess we are already in. Central banks did indeed prevent a severe recession in the 2002 by lowering interest rates to historic lows, but wound up contributing to the blowing of asset bubbles all over the place with a crack-up credit boom. Alas, there are no more bubbles left to blow, and there is no one left with a clean enough balance sheet to take on more debt.

The Comfort of Conspiracy

The tin foil hat wearing conspiracy theorists, convinced that dark forces have made secret plans to control events, may not be the paranoid anti-social mal-contents most people assume. In fact, it is quite possible that the belief in (unproven) conspiracies is a perfectly rational response when the world around us feels out of control. It is far preferable to think that the bad, or seemingly unexplainable, events that occur are the result of devious plots by nefarious persons meeting in dark rooms than to accept that terrible things happen all on their own.

It shouldn’t be any surprise, then, that conspiracies tend to be particularly popular amongst the people most alienated or marginalized in society (be it ethnic groups, or just the average social outcast). These people are desperately seeking ways to explain just why it is that life has handed them a raw deal, and a conspiracy is a handy way to explain it.

Most of these conspiracy theories contain the seeds of their own disproof right in their very premise, yet the adherents will swear by them nevertheless. In recent years, for example, there has been a great deal of speculation amongst many gold investors that government intervention was artificially deflating the value of precious metals. But if this were true, why then did gold prices rise so dramatically in the years up to 2008? As soon as gold prices began to decline in 2008 there was a lot of talk (once again) about how this might be due to the collusion of global central bankers. However, if gold prices have been pushed down by a cabal of central banks in 2008, then why did they allow them to rise so breathtakingly fast since 2005?

The same flaw can found in the theories proclaiming that the credit crisis of 2007/2008 was engineered by big Wall Street bankers. Most of those banks actually wound up going bust, and having their shares made into worthless scrip. If there was a conspiracy it would seem to have been a singular failure. It’s particularly telling that most conspiracy theories are designed to explain “bad” things: no one ever considers that the good things that occur were the results of plots.

Of course, conspiracies do sometimes occur. In many cases they aren’t even all that secret, with governments or policy makers openly declaring their intent to manipulate currencies or economies. However, these actions are rarely successful, and most often fail quite spectacularly.

The one thing that remains constant with all good conspiracy theories is the firm belief that it IS possible to control events. By grasping at the belief that somehow things are controllable, we can then feel that at least life could get better if only the “right” people were pulling the strings.

Iceland: The Land That Credit Created

Iceland may be suffering now, as the credit crunch bites deeper than it has almost anywhere else, but in a few years it may prove that the swift decline and massive wave of defaults (as virtually everyone in the nation defaulted on their debts) was the best solution to the calamity. Other nations, with deeper resources (like the US) are delaying the inevitable with massive bailouts, which may ultimately do nothing more than prolong the pain.

The swift decline of Northern Europe’s economic superstar is a graphic illustration of the hollowness of the economic boom the world has seen over the last 20 years. It wasn’t long ago that Iceland was hailed by business magazines as an amazing success, to be emulated by others. The similarities to those Americans buying multi-million dollar McMansions with negative amortization financing, while driving around in SUVs purchased with home equity loan extraction is striking.

The fall from economic grace may be hard on Icelanders, and leave them a much poorer nation with limited economic growth for decades to come, but they may wind up better off than the larger economies that are digging themselves deeper holes in vain attempts to prevent the necessary reckoning from the Great Credit Binge. The irony is that while smaller nations may find their options limited when facing national economic ruin, the fact that they were forced to deal with their problems head on will be to their benefit.

Any who still think that the credit crisis is only an American problem really need to examine what is happening in places like Iceland closely. This is a GLOBAL calamity, that will leave many other nations in even worse shape than the USA before things have run their course.

Will Government Force Banks to Accept Bailout?

One question that has me perplexed by the (latest) government bailout plan is exactly which institutions would want to take the treasury department up on its offer of buying dud assets? My understanding is that in order to tap into the government funding the lenders will have to 1) agree to executive salary restrictions and 2) offer warrants to the government (there is even a provision in the bill that allows the treasury to demand stock in exchange for the financial help, but it isn’t clear if the treasury will exercise this right).

With terms like this, which financial institution would really want to avail itself of government help? Any CEO who accepts this deal will essentially be ending their career and the shareholders likely won’t be too thrilled with the potentially dilutive impacts of the warrants. Logically, it would seem as if most financial firms would rather just hang onto their toxic assets, and hope that the bailout ends the crisis and markets for these dubious goods return (at prices they like). After all, if the government manages to put a floor on prices for shunned credit instruments then why does it matter if they sell them or just keep them on the books, the end result is the same (i.e. they book the same price either way)?

This all assumes that the treasury was even willing to offer near full value prices for these assets in the first place. If the government somehow tries to offer a significant discount from face value (albeit still above actual market prices) then virtually no one would be interested in the bailout. For most institutions accepting any kind off significant price cut would render them immediately insolvent.

It all boils down to this: accept the bailout and lose your job and accept the potential of wiping out shareholders or hang on hoping that somehow markets recover. This really doesn’t seem like much of a choice. What manager would take the altruistic stance that it was ultimately in the best interests of the economy to restore the company to health even if to do so would hurt themselves (and existing shareholders)?

So what’s the government to do? Are they going to have to resort to forcing struggling financial institutions to accept the bailout?

Of course, even if the demand for access to bailout money is substantial, we have no guarantees that the credit markets will unfreeze. No bailout will change the fact that tens of millions of Americans can’t afford their debt payments and that default rates will continue to increase. Until all those defaults have run their course the underlying asset prices (e.g. mortgages, credit card and auto loan receivable securities, etc) will continue to fall, which will force lenders to continue ratcheting up lending criterion and terms. Why accept 10% down for a mortgage when there is a good chance the home will drop another 10% in the next year?

Original Sin

In all the rush to crucify the "greedy" Wall Street bankers and lax regulators for the current financial crisis the actual offender is going unnoticed.

It doesn't take a Nobel Prize winner to identify the underlying cause of the credit crunch as stemming from over-investments, which has left a glut of unproductive assets (e.g. real-estate around the world, factories in China, etc) that are dragging down the global economies. This mal-investment binge is so obvious that some pundits have even suggested a whole-scale demolishion of homes as a strategy for fixing the economy.

But what caused this horrendous buying (and construction) binge to begin with? Fortunately, we don't have to go far to find the underlying disease.

It is no cooincidence that real-estate prices have been appreciating at an historically abnormal rate after the Great Depression and World War II. The big changes that made this resurgence of real-estate possible are obvious: mortgage tax deductions and government subsidized mortgages (i.e. Fannie Mae, Freddie Mac, FHA, etc). Prior to the 1930s these government programs to foster home-ownership didn't exist.

It is these

Absolution

Any last hopes that the latest government financial bailout would stave off the economic downturn and cheer investors was put to rest when the stock markets tanked immediately after the bill was signed into law. This bailout can't possibly succeed, and will fail just as all the others have over the last year, but that hardly matters. The real goal of this bailout is to absolve the government of responsibility for the real troubles that lie ahead, and at this it succeeds in spades.

Had the policy makers not enacted a major intervention then they would have nothing to say for themselves months from now, as the economy continues to crumble and increasing masses of people lose their jobs. Instead, the nation's leaders have now absolved themselves of any responsibility for the disaster in the offing. When the Dow is below 8000, and home prices have dropped another 30% the US leadership can say, with a straight face, that they did their best to stop it. After all, the government spent $800 billion of tax-payer money in a valiant effort to stop the bleeding. Is it their fault that the bailout didn't work?

To be fair, I am sure that many policy makers actually doing what they thought would help, but for many others the cover this legislation gives them is well worth the tax-payer money they are spending, and more.

Of course, its not as if the government can do anything to stop the depression, but that won't stop the world's leaders from spending as much of their fellow-citizen's money as they can to make it look like they are trying.

Blame The Little People

While its certainly true that Wall Street bankers (and their colleagues in London, Tokyo, Shanghai and elsewhere) bear some of the blame for the financial mess the world is currently in, the average consumer bears a huge portion of responsibility as well. After all, it was individuals who were agreeing to buy homes and all manner of goods for loans that far exceeded their earning capacity.

I have little sympathy for the vast majority of people who are losing their homes on the coast of Spain, Northern Ireland, or California when it was their irresponsible borrowing that led them to this sorry state to begin with. Sure, the bankers never should have given such large mortgages that couldn't be justified by incomes, but that still doesn't excuse the individuals from digging themselves into a hole.

The credit bubble that created this economic crisis required collusion by all parties: the central banks who kept interest rates too low, lenders who just wanted to pump out loans for commission, ratings agencies who threw common sense to the wind, and the investment banks that packaged mortgages into securities for investors hell-bent on chasing yield regardless of risk.

To now blame the whole mess on "Wall Street" not only over-simplifies what happened, but it also avoids taking responsibility for our own actions and connivance. Let's not lose tears for those "greedy" mortgage holders who gambled on appreciation to bail them out (and make them rich).

the banking business model is dead

In the upside-down economic universe America finds itself in these days, banks can no longer be viable businesses. Due to the government intervention in mortgage finance (e.g. ownership of the Governmental Special Entities like Fannie/Freddie/FHA) it has become impossible for private finance to compete with the artificially low interest rates that the government has on offer. Who would want to get a mortgage from a private bank for 8% when they would qualify for a government backed loan at 5%?

Banks simply don't have access to capital as cheaply as the government, and are therefore unable to lend at a profitable rate. The only market left to banks is lending to those who wouldn't qualify for a government loan, which pretty much means people who are virtually certain to default (i.e. even people with 620 credit scores can get 3% down FHA backed loans).

Sure, US banks are still making loans, but if you look closely the vast majority of those loans are government backed, in one way or another (GSE/FHA). Banks have simply stopped putting their own money at risk. Why should they, since they can't possibly get the rates they need that is commensurate with the true risk? This leaves banks with nothing much more than a transaction fee.

It is hard to see how any banks can possibly heal themselves, restoring their balance sheets, as long as the government continues to subsidize lending.

Ironically, the more the government bails out, or seizes, struggling financial instutions, the more difficult it becomes for the banking industry make money and establish a firm footing.

The Hunger That Never Ends

The Paulson plan to relieve hundreds of billions in seriously de-valued assets from the financial industry can’t possibly succeed. The more successful the government is in purchasing “toxic” assets, the more they will be squeezing private money out of the global economy and preventing the natural discovery of market prices and the re-allocation of resources to where they will be productive.

Instead of stopping the collapse in house and debt instrument prices, this massive bail-out will instead speed up the deflationary process by hovering up whatever capital still remains. For every dollar the US government raises by auctioning off a treasury bond for the bail-out that is one less dollar available for raising capital and purchasing assets in the private market. Banks will find it even harder to raise additional capital (which would enable them to lend more freely) than it already was since the US government is sucking all the capital out of the system. Which pension fund, sovereign wealth fund, or central bank, will want to participate in a CitiGroup share issue in such an uncertain economic environment when they can buy safe t-bills?

Of course, this assumes that this super-sized bail out will even succeed in acquiring the troubled assets it is designed to consume. It is far from clear that this bail-out entity will be willing to offer sufficiently high (above market) prices that the lenders need. There is no way financial institutions will sell their defunct assets at anything close to market prices since doing so will render them immediately bankrupt. It’s possible the government might be willing to pay the high prices these institutions demand, but that is far from clear right now, and we won’t know until the final details emerge.

Worse, even assuming that the bail-out entity does buy derelict assets at inflated prices, the government will further be forced to hang onto foreclosed properties in its portfolio indefinitely, keeping masses of vacant properties looming over the market. Selling these millions of homes at the actual market clearing rates will further drive down prices even more, causing greater financial disruptions (requiring the bail-out entity buy even more over-priced assets), and cause political problems when it becomes apparent that tax-payers will be taking a bath on their investment after-all.

And none of this is even mentioning the difficulties with other forms of toxic debt assets beyond the scope of real-estate. Will the US government also be purchasing GM and Chrysler bonds that have dropped in value?

The more the government buys, the more prices will drop forcing the government to buy even more assets, which keeps the cycle going. At some point the whole bail-out concept will come to an ignominious end.

Competition: The Key to Restaining Government Power

The famed balance of power between the three branches of the federal United States government is often credited with the success of the American government experiment. While this healthy competition between government powers certainly has some restraining powers, it constitutes only one of the many levels of competition which have slowed the usurpation of power by the government.

At the highest level between governments of countries. A government with poor policies encourages its citizens to emigrate. A sure sign of poor leadership comes in the form of restrictions on emigration. This constraint on poor government is only as effective as the quality of foreign countries willing to accept immigrants. It is also constrained by the natural inclination of citizens to "suffer, while evils are sufferable." Abandoning family and community is not something undertaken lightly.

Competition between government jurisdictions does not always require families to move. Businesses can take some of their operations, like the manufacturing and call centers, abroad without necessarily taking their employees. Such outsourcing is quite simply the result of foreign governments outcompeting ours to attract business. The solution is not laws forbidding such competition between countries, but rather to create a more competitive business environment at home. Government regulation against businesses moving operations abroad, like communist laws against emigration, indicate an unwillingness to accept the hard fact that jobs are leaving because the domestic environment is uncompetitive.

Below the federal level, there is competition between local city and state governments. A poorly run city government is easily evaded by moving outside the jurisdiction of the offending city. The same is true at the state level, albeit a little more inconvenient to move between states than cities. At an even more local level, there is competition between public schools, as families vie to find homes associated with quality schools. Companies shop around as well, looking for the most favorable environment for both the company and its employees.

By removing their ability to create money, the Constitution forces local governments to pay for their decisions through explicit tax revenues, be they immediate or delayed through bond issues. Cities with favorable trade and tax policies, like those of Hong Kong and Singapore, prosper as a result, without any substantial natural resources. Competition between cities, like the competition for Boeing's new headquarters in the early years of the 21st century, is healthy.

The most local level of government, the individual, is perhaps less controversial. That individuals should be judged by those with whom they interact based on how they govern themselves is fairly well accepted. If individuals can't find jobs or spouses, they need to work on themselves, to become more competitive rather than blaming others.

The sharing of power in the United States between the federal and local governments (all the way down to the individual) is a vital competition that has long kept the federal government from expanding as rapidly as it might have liked. Alas, this competition has been breaking down since the Civil War, when the federal government made it clear that secession, another form of peaceful government competition, is not allowed. Instead, the federal government extensively expanded its powers, beyond the intended limits, to include national railroads, national bank charters, fiat paper money, and conscription. In more recent times, the federal government has further eroded competition by increasingly adding social programs and getting involved with traditionally local issues like K-12 education.

Freedom, by definition, is the retention of decision-making power as locally as possible. In the upcoming U.S. Presidential election, it is important for voters to remain vigilant in not only seeking candidates who have noble intentions, but who want issues to be dealt with at right jurisdictional level. May we vote to localize power and maintain domestic competition between jurisdictions. May we vote for freedom.

Fascism: A Cure-all?

As diverse as the dissatisfaction with the economic, environmental, government status quo might be, there seems to be general agreement in the continued strengthening of central governments. The only disagreement lies in whose desires this power should obey. Virtually nobody suggests that strong central power will always attract a variety of powerful interests willing to pay to access that influence.

The environmentalists rejoice at the idea of using this power to force environmental legislation more universally upon the populous. They dream of invisible wind farms forests, and solar panel lakes, funded by government grants and subsidies, which are then funded by suffocating taxes on conventional nuclear and carbon-based power generation. Were such changes economical, they might happen in a free market, so implicit in these desires is the fact that they will reduce our quality of life, and must thus be achieved through via an enlightened, powerful government.

Likewise, a wide variety of conspiracy theorists, ranging from gold bugs to Lyndon LaRouche believe that big business interests control our current regime, but their solution is not to reduce government power, but to centralize it even further and put it in their enlightened hands.

The status quo major political parties also want more centralized power. Fascism, with a powerful central government exerting extensive control over private citizens and companies is the undisputed mainstream government of choice. The dominant parties differ only in how they propose to use that power and how enlightened a despot each leader claims to be. Though they may not have a complete plan for recreating utopia, they generally favor of bigger government, regulating more of our lives in everything from investment banking to education and health care. The resulting potpourri of policies are concocted with the intent of trying to please a wide variety of interest groups. A dollop of environmental legislation, a pinch of business deregulation, and a spoonful of income tax mollification.

Rather than continuing to dream that centralized power can avoid attracting power-mongers of all colors, perhaps we should consider allowing the markets to function. We can count on governments doing nothing efficiently and selling their influence to the highest bidder, so let us return government to its proper role defined in the Declaration of Independence. Alas, governments seldom willingly relinquish power. Any cure to encroaching fascism will likely involve war, revolution and depression. Let us hope, against most historical precedents, that the governments which follow such upheavals will protect our natural rights and freedoms, leaving market competition to bring sustainable prosperity to ourselves and our posterity.

Reining in Government: Sound Money

The United States Constitution is a marvel to behold for its clarity, brevity and limitations on government power. Some of its unfortunate compromises, like the protection of slavery, are understandable given the context in which it was written, but others are perhaps less comprehensible. In the case of money, the founders understood intimately the dangers of issuing paper money, stating that, "No State shall...emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts." Such restrictions were unfortunately not placed on the federal government, allowing the Congress the vague rights to "To coin Money, regulate the Value thereof, and of foreign Coin," which have become (mis)interpreted in conjunction with the elastic "necessary and proper" clause to allow for the creation of fiat paper money.
While it is understandable that the founders were frustrated with Britain's restrictions on coinage in the new world and the general shortage of coin that resulted, they neglected the market alternative of allowing private mints to competitively create coinage. In a competitive currency environment where merchants have the freedom to accept or reject any form of currency, there is a natural incentive for mints/banks to create reliable, quality currency so as to not have their currency rejected.

In any monopolistic currency regime, the temptation to use the monopoly to tax users of the currency via inflation and debasement of the money supply is irresistible for the monopoly issuer. The main restrictions on such inflation, revolution, emigration and foreign currency competition, have delayed and muted effects proportional to the size of the domestic economy. Large economies, like that of the United States, can force domestic acceptance of the national currency, thereby taxing the substantial domestic wealth. Debtors, who benefit from inflationary monetary policy, then provide democratic support for the perpetuation of such policies, along with the largest debtor of all, the government.

Sound money favors prudence and saving, punishing excessive risk-taking and debt with bankruptcy and failure. While sound money does allow for periodic fluctuations in the value of currency, be it through changes to the supply of precious metals, wars or other exogenous events, such fluctuations are minor in comparison with the rampant inflation caused by fiat money. Small fluctuations are even healthy because they can be both inflationary and deflationary, rewarding the prudent and punishing the over-extended.

Without access to the ability to monetize debt, governments are unable to bail out industries as the U.S. government recently did with Fannie Mae, Freddie Mac, AIG and the bad debt purchases. Indeed, such industries would never have been allowed to become so insolvent without the rampant encouragement of debt possible in a fiat monetary system.

Unfortunately, rather than calls to return to private, competitive money, the general cry is for more government inflationary and regulatory intervention. Regardless of the outcome of the upcoming U.S. elections, the resulting regime will surely comply, inhibiting market forces in the financial markets until such time that the necessary re-alignments lead to depression and revolution. Is there an alternative route?

Capitol Hill beats physicists to create black hole

The more I hear about the US government plans to accumulate bad loans and "toxic" assets from financial institutions the more it sounds like an astronomical phenomena: a black hole.

Not only is this new bail-out entity supposed to suck any tainted assets within its gravitational pull, but these assets will somehow be placed into an alternate universe, permanently removed from human contact. It is not enough to just buy these assets at above market prices to prop up the financial system, but it is also critical that the underlying assets (e.g. foreclosed homes, etc) never come on the market to be sold at cut-rate prices. Doing so would drive down other asset values which would in turn make even more assets insolvent (continuing to undermine the health of the financial system).

This is NOT a Resolution Trust Corporation 2.0. The intent of RTC 1.0 was to quickly dispose of seized assets in an orderly fashion. The purpose of this bail-out is to magically transmogrify vacant real-estate into nothingness.

This sounds very much like a black hole to me. Perhaps the $700 billion going towards the bail-out will result in the creation of the biggest under ground super-collider ever seen, running from Maryland and Pennsylvania to DC and Virginia. Who would have thought our politicians would beat all the world's physicists in creating a black hole?

it's official: depression just ahead...

The US government’s decision to step in and acquire hundreds of billions of dollars worth of bad loans at above market prices pretty much guarantees that what was already looking like a dismal economic future will be an out and out disaster. I do not use the word lightly, when I describe the virtually certain outcome as a depression.

As much as policy makers have attempted to avoid repeating the mistakes of the past (e.g. Messr Bernanke is an expert on the ‘30s depression) they have wound up following the script of past catastrophes to a T. Just as Hoover and FDR fell over themselves to attempt to bail-out the economy as dark clouds mounted, the global governments are doing the same thing today. In the feverish effort to stop the immediate pain, we are actually making it increasingly harder to come out the other side.

Not only have we not learned the lessons from the Great Depression, but we haven’t even learned the lessons from the .com bust of 2001/2002. Recall that in order to avoid a significant recession the Federal Reserve dropped interest rates to historic lows, and pumped masses of short-term liquidity into the financial system. The policy makers succeeded in preventing any serious economic contraction but wound up blowing another bubble into the real-estate and M&A sector --the mess of which we are dealing with now. What Bernanke et all failed to realize in their studies of the past is that when the apocalypse is staring you in the face, policy makers will always cave-in and try and attempt to bail things out. The only real choices occur in the decades before the crisis hits.

The irony is that every bail-out and intervention merely drives more good money out of the system, ensuring that more bail-outs will be needed. Every government subsidy, or bail-out, makes it that much harder for the private sector to be profitable on its own. Who would want to get a 30 year fixed mortgage from the private sector at 12% when they can get a government guaranteed loan for 5.5%?

There are so many bail-outs and interventions under way that I don’t even know where to start, and I am sure this is only the beginning. To take just one bone-headed idea, let’s look at the decision to ban short sales of financial stocks. This is tantamount to killing all the “repulsive” carrion beasts to prevent them from dis-respecting the deceased. Unfortunately, the dead animals are still with us and will just take MUCH longer to finally rot away. This is just another superb example of how the desire to stop short-term pain only makes things more dire.

Perhaps the most maddening thing of all this is how utterly ambivalent the public is to all of this. Hardly any voices are raised in protest. Expert after expert chimes in with agreement that all these interventions are simply “necessary”, albeit regrettable. Does no one realize that all of these interventions come at the price of shackling the global economy in even more red-tape and regulation? The politicians will want their pound of flesh in return for their help, in the form of extensive (and muscular) new regulatory regimes that will hold back economic growth for decades. Even the Wall Street financiers who ought to know better are begging for government help in their hour of need.

It’s like some medieval village that begs a Knight to defend them from a barbarian horde headed towards their town. The knight and his pals may well defend the town, preventing mass rape, looting, and death. The price, however, is that the goodly Knight will henceforth treat the villagers as his chattel, forever taking away their freedom. Sometimes rape and pillage is preferable to the cost of temporary salvation.

Yes, the governments of the world might succeed in delaying the onset of severe economic distress through their interventions, but they will ultimately push us even deeper into a long, dark, abyss. It would be far better to allow the real pain to be felt through the economy now, thereby allowing it to start recovering quickly thereafter.

Government Bailouts Reinforce Irresponsibility

The recent bailouts of Fannie Mae and Freddie Mac, not to mention AIG, are indicative of a government determined to keep foolish investers from learning the necessary lesson about the risks they took when the bought into these companies. In fact, the bailouts rescue the most foolish of the investors, the ones who didn't get out earlier when it was clear that there were problems.

While it is not new for the U.S. government to use taxpayer money to bailout the creditors of failing companies, it is a trend that needs to stop if we don't want to strengthen the existing moral hazard. No company is too big to let fail and there is no "optimal" moment in the economy to let companies fail.

It is understandable that the government wants to avoid letting big financial institutions fail in the hopes of stemming a trend, in order to bail out foreign investors (especially foreign government investors), and in order to avoid letting the derivitives on the books of some of those institutions establish the new market price by which comparable derivitives on the books of other institutions must be measured. All of these reasons are short-term delays in the inevitable purging of over-extended companies and poor investments. Such interventions serve the political imperitive to postpone the inevitable pain of foolish investments, but may well make it worse and more prolonged in the process by deepening the moral hazard.

The standard response in times of crises of "we need more regulation" doesn't address the more fundamental problem of not letting investors bear the full risk of their investments. No matter how much regulation there is, if investors can count on being bailed out by the government when things get bad, they will make risky decisions assuming that the government will never force them to bear the full risk of their investments. There is only one clean remedy, let poor investments be liquidated automatically by the market.

Consumer Report: Socialized Medicine

Growing up in Canada, I was oblivious to the fact that there were alternatives to many of the government programs that were an integral part of life. Government medical care was one such service. As I child I had little need for medical care, except when I broke bones or such similar childhood mishaps, which wasn't often. Such minor problems were quickly and cheerfully treated. As I grew older and more aware, I witnessed friends receive contaminated blood because the Canadian government had decided to save money by not testing for HIV and Hepatitis long after blood screening was systematic. Later, I visited Cuba to discover first hand that many basic ailments - including broken limbs - sometimes involve weeks of waiting lists to receive treatment, often without painkillers. Here in the UK, I had multiple first- and second-hand experiences where basic care was appalling. On one occasion, for example, the admitting nurse in the emergency ward perfunctorily asked me to wait while she sat and ate a sandwich for half an hour while I writhed in pain before her - before admitting me or even asking me why I had come to the emergency room. In the UK, it is not uncommon to wait for months, even years to receive an MRI and subsequent surgury or treatment. In the US, such waiting lists would be considered inhumane.

For those who consciously choose to live under socialized medicine, I can respect the trade-offs that they implicitly accept with that decision. If every one is to receive free care, then it must be rationed as there are limited resources. They are effectively accepting mediocre universal health insurance with premiums paid indirectly and disproportionately through taxation instead of having the option of choosing their own insurance provider. My concern lies rather with those who criticize private medical systems, even ones that are becomingly increasingly socialized and regulated like that of the USA. For all of its imperfections, I have received more prompt, friendly and effective service in the US under private insurance than I have experienced under various socialized systems.

True Poverty = Starvation

There is some confusion regarding definitions used in discussing poverty in industrialized countries. Proponents of minimum wage laws and welfare refer to the number of people considered to be "in poverty" based on some arbitrary definition of a poverty line. Aside from discussing whether their proposed policies help or hinder "the poor" - usually, legislation to help the poor has quite the opposite effect of its intent - I take issue with the basic definition of poverty.

Poverty is fundamentally a question of basic human needs. Truly poor people are not obese, they're under-nourished. In America, like most industrialized country, there are relatively few who are truly poor. The very fact that there are so few truly poor people in countries which have better-defined property rights and more capitalism is itself a strong hint as to the true solution to poverty (http://fte.org/capitalism/introduction/). While it is not uncommon to hear disparaging comments about the alarming degree of poverty in America - including rising obesity - I would entreat such commentators to remember that the poor do not include the fat.

another lost cause: Canada in Afghanistan

The Canadian government has just decided to keep throwing good money (and people) into the growing sink-hole that is Afghanistan. It’s all well and good to want to help other countries (as Canada prides itself in doing with peace-keeping), but there is no point in expending precious resources when the effort has no realistic prospect of success.

It’s been 4 years since the over-throw of the Taliban, but Afghanistan has little to show for it. The national armed forces are still useless, the government is rife with corruption, and reliant on war-lords. All the while opium production, and the narco-economy, has become ever more firmly entrenched. Oh, and let’s not forget that the Taliban is actually posing a bigger threat today than it did when they were originally deposed in 2002.

The die is already cast: the central Afghan regime is growing increasingly weaker, as war-lords and the Taliban seize tighter control of the regions. The Afghan military and policy are degenerating even further (hence the reliance on regional thugs). Reconstruction efforts are continuing to shrink as the security situation deteriorates.

So remind me, please, just what Canada hopes to accomplish by continuing to have its soldier’s killed in Afghanistan with car bombings and sniper attacks? Is it to build Canadian prestige abroad, by demonstrating the nation’s ability to project force? Maybe this is just a way to get the US off Canada’s back for its refusal to get involved in Iraq (another futile foreign imbroglio).

Unfortunately, Canada has a long history of involving itself in foreign conflicts for all the wrong reasons. Canadadian politicians viewed the Boer, and both world wars, as great opportunities to burner world prestige, and gain greater independence from the motherland (i.e. the United Kingdom). I am sure that made all those mothers who lost their sons at the Somme just thrilled that they were able to contribute to Canadian independence.

At the very least, Canadian policy makers should be asking themselves the very realistic question as to what criteria they are looking for to convince them that a withdrawal from Afghanistan is necessary. Would Canada withdraw after 8 years of peace-keeping if the country isn't any better off? What about increasingly higher Canadian casualty rates over a couple years?

Whatever the reasons for Canada being in Afghanistan, it will all be for not when the Canadian forces eventually withdraw, their tails between their legs, letting Afghanistan tear itself even further apart. But I won’t blame the lowly Canadian military, they are just dealing with an impossible task foisted on them by timid leaders who don’t know how to say “no”. Clearly there must be some point at which Canada's leaders would decide to cut their losses and bring the troops home. Let's just hope it is sooner rather than later.

don't punish the soldiers

The US administration is at it again, punishing the lowly soldier for war crimes that were the inevitable result of the precarious situation these patriotic warriors were placed in. The prosecution of marines for a civilian massacre in Haditha (Iraq), will result in the same hollow justice found in the aftermath of the Abu Ghraib prisoner abuse.

Don't blame the soliders. They have been placed in an impossible position, fighting for their lives in a hostile country where everyone is a possible enemy. It only makes sense that there will be over-reactions, now and again, with the tragic loss of innocent life. The people who deserve the real responsibility are the leaders who put these soldiers in a no-win war, that destroys the psyche.

No matter. The US administration will get it's mug-shots of disgraced marines to parade in the media, allowing it to demonstrate it's commitment to justice for the Iraqi people.

Of course, no one will ever comment that the real solution to avoid future such civilian massacres by US troops is to get the hell-out-of Dodge, and leave Iraq to it's own devices. Sure, Iraq will descend into messy civil war, and cause great instability (and possibly terrorism) if the US withdraws, but the presence of US forces isn't making things better and only delays the inevitable.