Tuesday, 7 December 2010

GUEST POST: “The Popular Delusions of Crowds”

Guest post by David Galland from Casey Research, which looks very briefly at how the whole world got here, and where “here” really is.

Dear Readers,

Today is one of those days where the sheer volume of possible topics overwhelms.
    Do we talk about Fed Chairman Ben Bernanke’s appearance on last night’s 60 Minutes in the U.S., during which he confirmed that the Fed’s latest $600 billion Treasury purchase program was unlikely to be the last – that the Fed is unswerving in its decision to debase the dollar “however much it takes” in an attempt to stimulate growth. Just as we have been saying it would for lo these many years. Related to that topic, it’s notable that the dollar actually strengthened on the news – though not against the far sounder monies of gold and silver, both of which are up again today.
    A related story, sent to me by steady correspondent Jack A., might be worth discussing – that the Republican leadership, kowtowing to its friends in high places in the big banks, may try to keep Ron Paul from taking the helm at the congressional subcommittee charged with overseeing the Fed.    Here’s the story.
    Do we talk about the vote in Ireland tomorrow? Will the Irish Parliament approve the deeply unpopular austerity budget the EU is demanding as part of the bailout it crammed down the throats of the country’s equally unpopular government? As that budget was a condition of the rescue plan, if it is rejected, will that put Ireland back in play as the first European nation to default?
    Since we’re in Europe, we could discuss the report out on Friday that Germany’s Chancellor Angela Merkel recently threatened to lead her country out of the eurozone – an act that would leave the experiment in extra-sovereign meddling a gigantic smoking hole in the ground. This is a topic that Bud Conrad spends considerable time on in this month’s edition of The Casey Report, out within the next day or so. (And you can receive it, risk-free.)
    Or perhaps we could talk about the reason for Bernanke’s admission that the gloves are off on monetization – that past and present governments of these United States have led the country into the very dangerous neighborhood shown in this chart. 

    (More charts on a similar theme here.)
    A word or two might also be in order for the massive war games the U.S. is now running off the coast of South Korea, involving 44,000 personnel, 60 war ships, and 400 or so aircraft. With the South Korean defense minister, who resigned over the tepid response to the North’s latest aggression, having been replaced by a hardened and hawkish military commander, the situation has arrived at one of those “interesting” crossroads in history where a miscalculation by the North could lead to a map change.
    Not to be cavalier, but things could get wild if the North so much as pops a cork. Even if nuclear weapons didn’t subsequently come into play, the massive metal-throwing capabilities of the North and the close proximity of those capabilities to South Korea’s heavily populated capital zone (consisting of 23 million souls) could lead to a disaster in the proverbial blink of the eye.
    Or we could talk about lighter topics, for instance a fun and interesting Christmas party I attended over the weekend. At the party, one of the area’s leading architects told me that in his long career, the business has never been this bad. A point of view echoed by a friend in the home furnishings business who told me they are stopping spending money on advertising because it does no good: no one is buying anything, no matter what the offer. I may share some additional observations gained from the party, but not today as I’m running late and am a bit worn down by long hours of wiring and editing The Casey Report over the weekend.
    Instead, I will step back to what the corporate types like to call the “50,000-foot view” and note that the totality of what’s hitting the newswires these days falls almost frighteningly within the scope of the intractable crisis we have been so ardently warning you about.
    As a refresher, or as fresh information for those of you new to these musings, though the storyline of this crisis stretches back many years, it is still pretty straightforward. The kernel of the crisis was planted decades ago when Americans first began to look to the government to solve every problem, large and then even small. 
    As this attitude that government was all-powerful served the interests of the politicians, they took every opportunity to encourage it. For example, while in campaign mode, aspiring politicians energetically position themselves as being the best qualified to solve what ails, then layering on the cream and cherries of new benefits to be dredged from the public trough so that they can be delivered to voters.
    As the election records make clear, the myth of an all-powerful government works even more to the favor of entrenched politicians – with each new year served giving the incumbent added firepower come election time. Not so much because their constituents actually like their representatives – but rather because they have been made to understand that the longer a politician serves, the higher their rank within their party and on the committees that dole out the goodies. It is for this reason that the career politicians invariably build their advertising campaigns about their special ability to deliver the pork, and voters keep returning them to office in order to take advantage of that fact.
    Over time, this attitude of looking first to the government for what might be termed a better life gave rise to any number of fictions. For instance that money could endlessly be created out of thin air as needed to deliver on political promises… but especially in situations that might be considered an “emergency.” 
    The problem is that there’s always an emergency – and ironically, over time, those emergencies have emanated from the past deeds of the politicians themselves. 
    For its part, the government has a range of tools it can bring to bear as problem-solvers – coercion, taxation, regulation, directed spending, monetary policy, drone-fired bombs, cheap loans, and so on, and so forth. When the dot-com bubble began to pop, the tools used by the government included ratcheting interest rates lower and actively encouraging loose credit.
    The flood of cheap money and loose credit set the stage for the housing bubble, which is best seen as part and parcel of a bubble in private debt. Of course, the government was not shy about increasing its own spending… because of the 9/11 emergency, and because there is always another election right around the corner.
    With the prices of housing soaring and everyone feeling like the party could go on indefinitely – mostly because the lower cost of interest allowed them to more easily service a higher level of debt – the total amount of debt in the economy began accelerating.

    Unfortunately, the party ended with the crisis that began unfolding in 2007, after which the availability of credit dried up and the housing bubble began to unwind. Thanks to derivatives and other modern financial innovations that allowed leverage, it quickly became apparent that the problems were not just bad but acute.
    Naturally, because it’s what we Americans now know, the populace turned to the government to fix the broken machine of the economy. With barely a moment’s hesitation, all of the king’s horses (asses) and all the king’s men set to the task. The scale of the problems was so big, however, that so had to be the government’s response.
    Viewed even from 50,000 feet, what then followed beggars the imagination. From the Fed lending out $3 trillion or so to pretty much anyone who raised a hand – foreign banks and private corporations included – to the government takeover of entire industries... to sending checks to hundreds of thousands of individuals… to guaranteeing bad loans by the boat load… to allowing the banks to transfer hundreds of billions of dollars in toxic real estate loans onto the balance sheet of the Fed… to dropping interest rates to zero… to providing cash incentives for car buying or installing alternative energy equipment (among others)... to extending unemployment benefits to two years… and on, and on, and on.
    While the consequences of these extraordinary actions are many, with many more to come, the most obvious result has been an annual government spending deficit in excess of $1.4 trillion – with no clear way to reduce that deficit in the years ahead. In fact, with the increasing takeover of the medical system just ahead of the first waves of retiring baby boomers, the deficits are likely to stay at these elevated levels, or even worsen, in the years just ahead. Especially given that the interest rates being paid out on all the debt are at historic lows. Meaning they are an anomaly that can’t last long. And once they start to rise, the deficits will begin to run out of control and the endgame will begin in earnest.
    While woefully inadequate, that’s the big-picture look of how we got here – now a quick look at where we’re headed next.
    And that, as our own Bud Conrad has steadily pointed out, is to a sovereign debt crisis, which in turn leads to a currency crisis.
    What’s going on in Europe, which very much followed the U.S.’s lead in trying to fix everything – versus letting all the malinvestment follow the natural path that a free market would have dictated – is just a preview of what’s going to happen here in the U.S.
    And this is where it gets interesting. You see, when the eurozone was established, there were certain controls put into place to avoid a willy-nilly printing up of new money by the central banks of its constituent economies. Thus, when faced with demands to repay its debt, Ireland can’t just whip up the tens of billions it needs… but rather must accept a bailout from the EU, along with all the attached strings.
    As Bud Conrad explains in his article in this month’s edition of The Casey Report, the eurozone’s problems now revolve around debt that is simply too big to cover. And so, for the reasons you’ll read, the odds are high that the euro will blow up. After which the Irish, the Italians, and the Spanish can get back to the serious business of printing up tons and tons of their own local currencies to meet their oversized obligations.
    In other words, the unbacked fiat currency of the euro will be annihilated and replaced by the unbacked fiat money of a bunch of countries, and the race to the bottom will begin in earnest.
    Meanwhile, back here in the U.S. where there are no restrictions on how much money the Fed can create, Bernanke and friends are already leaning heavily on the monetary levers. Because they can. And, as Ben’s 60 Minutes appearance makes clear, they’ll continue to lean on those levers until Congress decides enough is enough (Ron Paul not being named to head the oversight committee would be a step in the wrong direction) or, more likely, the lever breaks.
    Which is to say, when each new wave in money printing is met by a demand for higher and higher interest rates from prospective buyers of U.S. Treasury instruments. Around the same time, we’ll begin feeling the impact of increasing prices that must follow from the Fed’s monetary inflation.
    At which point the U.S. dollar as currently constituted will follow the euro into the trash bin of history.
    There is, of course, much more to it than that – for instance, the widely accepted notion that the “big countries” of Europe, the United States, Japan, and maybe China are too big to default on their debt will be proven false. That’s because ultimately, the fiction rubs up against the reality that the debt that is a hallmark of this crisis not only hasn’t been resolved, it’s been made worse by all the bailouts. For example, the solution being foisted on woefully indebted Ireland is to layer on another $100 billion or so of debt.
    I guess when you get right down to it, this crisis had it seeds in the madness and popular delusion of crowds. But it’s going to end up on the rocks of the reality that real money doesn’t come from nothing, and that there’s no such thing as a free lunch. Sooner or later the tab comes due.
    The tab is now sitting on the table in front of us all. While the bankrupt governments of the world will continue to pretend they are good for it… it’s becoming increasingly clear to just about everyone that they are not.
    (Where does North Korea fit into this construct? Only as a reminder that Black Swans, while rare, are also real. While we can’t know where the next surprise is going to come from, the way things are lining up, the odds are that it won’t be a pleasant surprise when it comes.)
    And it’s not just the federal governments in trouble… it’s pretty much everyone…

David Galland
Managing Director
Casey Research

Reposted by permission from Casey Research.
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