Effor.com

I ran across this in today’s Daily Reckoning.  It’s a snip from Bill Bonner’s article titled

The Fall of Wall Street: Innocent Frauds and Armed Robberies

It’s good stuff!  Please take a minute to read it because it explains a lot in just a few paragraphs.

gk

From the day of its founding in 1913, the Fed’s assets – the foundation capital of the U.S. banking system – grew, reaching $1 trillion on the 24th of September, 2008. But then, something extraordinary happened. Something breathtaking. And for a classical economist – something incredibly reckless. In the next six weeks, the Fed added another trillion. And the head of the Dallas Branch of the Fed said that he expected to add another trillion before the end of the year.

How does the Fed get these “assets?” Simple. It buys them. Where does it get the money to buy them? Simple again: it creates it. It makes it up. It conjures it out of nothing.

“If it comes from nothing,” you might wonder, “what could it really be worth?” But we’re not going to answer that question. We don’t have time. Besides, it takes us in such a deep metaphysical swamp, we’re afraid we may never slosh our way out…or at least not get out in time for lunch. Instead, we’re going to answer this question:

“If it was that easy, how come the Fed didn’t do it before?”

The answer to that is simple: because when the Fed inflates the money supply it risks inflating consumer prices. People don’t like that. They like it when asset prices go up. But not when gasoline and milk increase.

But now, no one is worried about consumer prices. In fact, the Fed is worried about deflation…about falling prices. Bernanke knows what happens when consumer prices begin to fall. Consumers stop spending – knowing that they will be able to get a better deal in the future. That further depresses the economy…and pretty soon it’s the ‘90s again and you’re back in Tokyo. So the Fed has begun a huge program of monetary inflation, intended to offset Mr. Market’s price-cutting.

And now another question: Isn’t there some risk that the Fed will overdo it?

Oh, dear reader…that’s a puffball of a pitch. If we can’t hit that, you can take our laptop away…you can break our sword…and send us back to the dugout.

Remember what happened in the slump of the early 2000s? Alan Greenspan panicked…cut rates to 1%…and left them there for more than a year. He gave the market the wrong medicine at the wrong time…and then delivered such a horse-sized dose, it set off the biggest bubble in mankind’s whole bubbly history.

Now, it’s a different kind of slump…a credit slump. And once again, the Fed is on the scene, like a quack doctor at the side of a heart-attack victim. This time, he’s giving stronger medicine…not just a 1% lending rate, but actual monetary inflation. Trillions of dollars worth of it.

For the moment, Mr. Market is taking away dollars faster than the Bernanke Fed is replacing them. That could continue…for a few months…or even for several years. But it won’t continue forever.

And here, we affirm our unshakeable faith in the people who lead us. They are trying to cause inflation. Eventually, they will get the hang of it. They may shoot for 2% per year; but they are sure to overshoot. Money printers always do.

This is something I’ve said would happen eventually.  Well, I haven’t said it here, but I’ve said it on a family email list where we discuss lots of weird subjects.  :-)  From todays’ Daily Reckoning Australia newsletter: “Treasuries tumbled after the government’s $9 billion auction of 30-year bonds at the lowest yields ever chased away investors,” reports Sandra Hernandez at Bloomberg. You reap what you sow, Chairman Bernanke. Prepare to reap the whirlwind.

It looks like we’ve reached the point where the Fed is stuck between a rock and a hard place.  They are being forced to lower rates to fight off a recession (which is probably already here) but no one wants our money at these ridiculously low rates.  The dollar isn’t worth much these days, but (although some are calling for the dollar to rebound) I don’t think we’ll see a meaningful correction in exchange rates as long as the fundamental factors which drove it down don’t change.

By fundamental factors, I mean stuff like Americans spending more than they make - personally, in business, and in government - which forces us (collectively) to borrow money from foreigners to keep things running.  What happens when foreigners no longer want to invest in the dollar (via US Treasuries)?  Rates have to rise to entice them to invest.  Although this is the first evidence I’ve seen of it, I think this will become more widespread.  Rates will rise while we go through a recession - or worse.

Play it through to see the end game….  The cost of borrowing goes up so businesses and individuals have to pay more to borrow the same amount.  Mortages cost more, auto loans cost more, credit card rates cost more - and perhaps most importantly - the government has to pay more to pay interest on our huge (thank you Mr Bush!) national debt.   All while the economy is slowing down.  That drives up unemployment, the dollar keeps falling (because we’re still spending more than we earn) and inflation starts to skyrocket. 

Does anyone remember 1979 and 1980?  I think we’re in for a repeat of that at the minimum - and we could potentially be looking at the 1930’s again.  I recommend paying off your debts, piling up cash, and keeping your powder dry.  Picking up some gold or silver on price dips like we’ve seen the past few days wouldn’t hurt either.  That’s good advice at anytime, but especially now with Bernanke dropping cash from helicopters….

That’s right, Bernanke has said he’d do anything to prevent deflation.  Here’s his speech from November 21st, 2002.

In the same speech he said “If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.”

Huh?  Basically Bernanke said that if the government (via the Treasury Dept) printed more money, then the same government (via the Federal Reserve) bought the same amount of treasury bonds, it’s the same thing as the private sector producing something.  To translate this into your personal life, Bernanke is saying that you’re better off if you take out a second mortgage, then use that money to pay yourself to cut the grass.  What the hell is he smoking?

Sorry for the side track rant, the main point of this post is to let people know that today the US Government tried to get anyone to loan them money at 4.41% but no one would give them money at that rate.  The rate on those bonds at the end of the day was 4.51%.  There’s a good story with all the details at Bloomberg.com.  Here’s part of it:

The auction yield on the new long bond was the lowest since regular sales of the security began in 1977, according to Steve Meyerhardt, an official in the Bureau of the Public Debt in Washington.

In today’s auction, indirect bidders, the class of investors that includes foreign central banks, bought 10.7 percent, the lowest on a new 30-year bond since the Treasury resumed sales of the maturity in February 2006 after an almost five-year hiatus. The 20 primary dealers bought 89 percent of the sale, the most since sales resumed.

“Most of it was a dealer auction which meant that customers themselves didn’t put their money where there mouths were,” said James Collins, an interest-rate strategist in Chicago at Citigroup Global Markets Inc., a primary dealer. “The market knows dealers are going to have to sell the issue at a steep discount.”

Regardless of what the Fed does with short term rates, real rates are going up as we become less credit worthy as a nation.  Who will we borrow from in order to keep spending more than we earn tomorrow?

gk

I was aimlously surfing tonight when I found this:

In a credit-based economy, a fall in money supply leads to markedly less lending, with a further sharp fall in money supply (since debt is money), and a consequent sharp fall-off in demand for goods. Demand falls, and with the falling of demand, there is a fall in prices as a supply glut develops. This becomes a deflationary spiral when prices fall below the costs of financing production. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. Banks get assets which have fallen dramatically in value since the (mortgage) loan was made, and if they sell those assets, they further glut supply, which only exacerbates the situation. To slow or halt the deflationary spiral, banks will often withhold collecting on non-performing loans (as in Japan, most recently). This is often no more than a stop-gap measure, because they must then restrict credit, since they do not have money to lend, which further reduces demand, and so on.

Sound familar?  To me it sounds like what’s beginning to happen in the US right now.  The above text is from:

http://en.wikipedia.org/wiki/Deflation_(economics)

Yup, it’s about deflation.  I keep wavering about if we’re heading down the deflationary road, or if we’re setting up for a round of hyper-inflation.  Anyone care to enlighten me?

gk