The beginning of the end

Make note of this date – March 18th, 2009.   100 years from now, historians will point to it as the day the United States of America sealed its’ fate.

Today the United States shifted from a long slow decline into high gear – and nailed the accelerator pedal to the floor.  There are several other dates which may be picked as well, such as the AIG bailout on September 16th, 2008, or even the Bear Stearns bailout on March 14th, 2008, but today is the one that should be remembered.

It should be remembered as the beginning of the end, because today, for the first time, the Federal Reserve announced that it is going to directly purchase US Treasuries.  $300 billion worth – and that’s in addition to $1 trillion in mortgages.  The full text of the Fed announcement is here.

Here’s an important part:  To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. [Emphasis mine]

The term “increase the size of the Federal Reserve’s balance sheet” is a euphemism for “create money of out thin air” – or as it’s more commonly known – printing money.

It’s time for a refresher in basic economics – although this isn’t in Econ 101 – but it should be.  In the past, the Federal Reserve served simply as a clearing house for banks.  They would lend money to banks, but they effectively “held the mortgage” on whatever collateral the banks put up.  The collateral was commonly US Treasuries, although it could be almost any asset.  So the Federal Reserve might do something like take $100 million in US Treasuries from Bank of America and in return the Federal Reserve would give the Bank of America $100 million in US dollars. (Hypothetical situation)

They printed up $100 million to loan out, but they received $100 million in assets, so the net effect on the balance sheet of the Federal Reserve was zero.  This is important – please re-read that if you don’t understand the process.  No money was created that didn’t already exist.  In the hypothetical example above, the Bank of America gave the Federal Reserve $100 million in the form of US Treasury bills, and the Federal Reserve gave them $100 million in cash in return.  The Bank of America can now loan out that $100 million to others – something they couldn’t do with a Treasury note.

But the net effect on the balance sheet is zero.  No new money was created.  It all existed in some form before the transaction, so the net effect is zero.  You can’t give the local grocer a US Treasury bill for a loaf of bread – you can give him dollars.  That’s what the Federal Reserve effectively did – they provided a liquid form of money (dollars) in exchange for illiquid money in the form of Treasury notes.

Got it?  Ok, read on….

Another part of the announcement says Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

You really need to understand that the Federal Reserve doesn’t actually have any money, so when they “purchase” something – as opposed to normal lending – with what do they  purchase it?  The answer is really simple – they make up money.  They create it out of thin air.  Unlike the example above, this money isn’t backed by anything.  Nodda.  Zilch. Zip.

They simply make a few keystrokes and “create” more US dollars.  This is the electronic way to debase the currency.  The Romans did this by alloying other metals such as lead into their gold coins.  The end result is the same.  Inflation.

When you make each coin (or dollar) worth less, you are expanding the supply of money.  The amount of goods in the economy hasn’t changed at all.  If you read through an earlier post of mine, you’ll see that money is simply a way to facilitate transactions – but all money needs to represent actual goods produced that have not yet been consumed.

When the Federal Reserve buys US Treasuries, they are doing the same thing that the Romans did – causing inflation by debasing the currency.  It’s the law of supply and demand.  The Federal Reserve announcement today directly expanded the money supply by $300 billion.  That’s why gold soared today at the exact time of the announcement.

US Treasuries also soared on the news, but that will prove to be short lived.  It will be short lived because traders will realize Treasuries soared because the Chinese have dramatically slowed down their purchases of US debt – and their initial joy that someone is going to purchase the treasuries will fade when they realize that the purchases are being made with funny money.  The Chinese have made it clear that they won’t sit by idly and watch the value of their investments be debased by US policy.

Here’s a link to a NY Times article with a few different takes on the news.  It’s good, read it.  A few choice quotes are copied here:

• Although the notion of quantitative easing has been much discussed in the past few months, the policy clearly took effect today. Many thought it would never come to pass. In many ways this is a tragedy that could have been avoided. (Joseph Brusuelas, Moody’s Economy.com)
• Today’s announcement that the Fed is committed to purchase more than $1 trillion in Treasury and agency debt is great news for current holders of those instruments looking to bail out, but horrific news for just about everyone else, particularly long-term holders of U.S. dollars-based assets. (Peter Schiff, Euro Pacific Capital)
• But by being the buyer, not just the lender, of last resort, the Fed has laid in a course that can only lead to ruin for the U.S. dollar. (Peter Schiff, Euro Pacific Capital)
• Adding up these programs puts the Fed’s balance sheet somewhere around $4½ trillion before the end of this year… We think the Treasury rally will be short lived and see these purchases as negative for the dollar against foreign currencies and gold. (John Ryding and Conrad DeQuadros, RDQ Economics)

If you’ve read this far I congratulate you.  If you read through this looking for advice on what to do with your money, or what the stock market will do, here’s my take.  This advice is free and worth every newly debased penny.  Go long on anything that’s sold in dollars, because as each dollar becomes worth less and less, the value of those items is more and more when measured in dollars.

Buy gold.  Buy silver.  Buy oil. Buy the Euro, the Brazilian Real, the Chinese Yuan – and short the dollar.  The dollar is officially toast.

I’ll end with a note that I REALLY hope I’m wrong.  I hope that the US isn’t headed down the path to inflationary ruin.  But that’s just hope.  My head says that this is the beginning of the end of this brief experiment, and that the United States as we know it will cease to exist at some point in the next 10 to 20 years.  Damn I hope I’m wrong….

gk

The real reason we bailed out AIG

In reading through the news over the past few days, it’s apparent that many people are upset with the multiple AIG bailouts.  Some are upset that executives are getting bonuses (I am too) but I think the real reason for the bailouts in the first place is far worse than a few boneheaded executives paying themselves with our money – or as Bernanke says, we paid them by “printing money”.

The real reason is so billions in bailouts could be funneled to other financial firms without having to disclose it.

For example, the Washington Post reports The funds were paid from the government’s initial $85 billion emergency loan in September and included major firms such as Goldman Sachs, Societe Generale, Deutsche Bank, Merrill Lynch, Morgan Stanley, Bank of America and Barclays.

The government has already publicly bailed out Goldman Sachs, Morgan Stanley, and Bank of America  with hundreds of billions of dollars – and I think this is simply an underhanded way to funnel billions more to them to avoid bailing them out again.

The money AIG talked about in this report was from the original $85 billion bailout last year, and doesn’t include anything from the 2 subsequent bailouts.

TIME says AIG, under pressure from Congress and the press, also released the number of the counterparties to many of its credit default swaps. AIG had decided to insure the value of certain paper owned by the likes of Goldman Sachs (GS), Morgan Stanly (MS), and Deustsche Bank (DB). When the value of that paper fell, AIG was on the hook to pay off the “insurance” which kept the likes of Goldman from having to book large write downs. Those write downs might have pushed Goldman into a difficult financial situation.

And by “difficult financial situation” they mean bankrupt, broke, out business Bear Stearns/Lehmann Brothers broke.  That’s the real reason for the AIG bailouts.  Paulson and Bernanke didn’t have to publicly give their old buddies more money – they could pass billions to them through the guise of AIG bailouts.

On the subject of bonuses, The Street.com says Another issue on the table is that AIG and government officials have created a human-resources Catch-22. The firm plans to dole out $165 million in bonuses to keep the employees who created the very derivative products that ultimately destroyed AIG as a private, independent entity. The firm says it is contractually obligated to pay those bonuses, and that the employees have critical knowledge about valuing and winding down its toxic assets.

Really?  Critical knowledge about valuing and winding down the toxic crap on their books?  I’m not too bright, but I think that if your company lost $61 billion in the last quarter alone, there ain’t no one with critical knowledge at your company!

“Maybe [regulators] should have asserted more control at the start, back in the fall,” says David Steuber, co-chair of the insurance-recovery practice at Howrey LLP. “But now they’ve made some of these people indispensable, and those people are going to need to be compensated at or about the market rate.”

Oh come on!  these people are “indispensable?”  Maybe so, because there aren’t a hell of a lot of people capable of screwing up a company this badly.  Dudes, you freaking lost $61 BILLION in the 4th quarter alone – how “indispensable” can you be?!?

Are you “indespensable” because the average wino off the street might have only lost $1 billion?  Get a life assholes – you would not have a building to go to work in today if taxpayers hadn’t given you over $170 billion.  And you think you deserve a freaking bonus?!?  WTF have you been smoking, snorting, or shooting?

Idiots.  Kick their asses out on the street and stop giving them our money to blow and pass on to their buddies.  Let the comapnies who made bad bets on derivatives suffer the consequences and go broke.

gk

Bernanke's Interview

Like many of you, I just watched Helicopter Ben’s interview in 60 Minutes.  Here’s a quote from the transcript on 60Minutes.com that struck me:

Asked if it’s tax money the Fed is spending, Bernanke said, “It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It’s much more akin to printing money than it is to borrowing.”

Hey Ben, why not simply “mark up” the size of every one’s accounts?  What’s that you say?  You can’t do that because it would cause the value of the dollar to drop immediately?  And by creating (printing) money just for the banks, you slow down that process? But guess what – you’re simply delaying the inevitable.

The interview continues…

“You’ve been printing money?” Pelley asked.

“Well, effectively,” Bernanke said. “And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.”

They’ve been printing money (as I’ve said all along) and they plan to stop printing when the economy recovers.  Anyone want to bet on that?  Have anyone – ever – seen a government bureaucracy do something right?

Yeah, that’s a rhetorical question.  I may have more to say about the interview later, but this part really struck me because it’s so stupid.

Just let the bad banks go broke.  The few good ones left will buy up the good assets cheap, and the bad investments (and those who made them) will be gone.  Problem solved.

gk

Mr. President

Saw this article and had to get a link to it here.  It says – much better than I could – what I’ve been trying to say about President Obama’s spending.

Here’s a snip to give you the flavor of the article.

With all due respect Mr. President, Tim Geithner and Ben Bernanke are offering the same policies as President Bush and Secretary Paulson. Those policies are to bail out banks regardless of cost to taxpayers. Mr. President, it’s hard enough to overlook Geithner’s tax indiscretions. Mr. President, it is harder still. if not impossible, to ignore the fact that neither Geithner nor Bernanke saw this coming. Yet amazingly they are both cock sure of the solution. Even more amazing is the fact that solution changes every day.

With all due respect Mr. President, Geithner and Bernanke are a huge part of the problem, and no part of the solution and the sooner you realize that the better off this nation will be.

With all due respect Mr. President, your budget proposal is the same big government spending as we saw under President Bush. The only difference is you promised more spending and bigger government, while President Bush promised less government and less spending and failed to deliver on either count.

With all due respect Mr. President, it is impossible to spend one’s way out of a problem, when the problem is reckless spending.

I haven’t previous read anything from Mike “Mish” Shedlock, but I’ll have to check out more of his site later.  If the rest of it is anything like this post, it would be a great addition to my blogroll.  Good stuff!

gk

How's that working for you?

Back in January, I posted a short article basically saying that it was way too early to call a bottom in financial stocks.  I had been reading an article on TheStreet.com by Doug Kass where he made the case that it was time to buy the financial sector, via XLF.  

While I agreed with much of his analysis, I didn’t think the financials were anywhere near a bottom – most banks and brokerages simply hadn’t taken into account the full impact of the sub-prime mortgage debacle.  Those relatively few bad mortgages were so highly leveraged that just a few percent failure rate is enough to make the whole house come tumbling down.

Despite the best efforts of the Fed, Bear Stearns has disappeared.  It took a $30 billion taxpayer backed guarantee to do it, and I think the buyout simply swept the underlying problems under the rug and out of sight – for a few months.

The last few months are looking more and more like a rehash of the Internet bubble and the resulting bear market from 2001 through 2003.  during that time, I lost count of how many times I heard things like “buy and hold”, “stay the course”, “this is a great buying opportunity”, etc. 

The people who listened “to the experts” back then STILL aren’t back to even on their investments, while those who got out and waited for the smoke to clear are way ahead.  Those of us who are conservative investors, who follow broad trends and don’t move in and out of the market very often know that this isn’t the time to buy back in.

Could this be the bottom?  Sure – but I don’t think so.   I move in and out of the market in my 401K based on the crossover of the 75 day EMA and the 200 day EMA.  I usually go with an S&P 500 index fund, and here’s what the chart looks like today.

The 75 and 200 day EMA’s are nowhere near signaling the start of another bull market, so my retirement money is 80% in cash and 20% in overseas funds.  I’m down about 4% for the year – how’s your 401K YTD? 

If you’re still fully invested (like the “pro’s” tell you to be) you’re down over 12% YTD, and you’re right back where you where in July of 2006.  If you’re retired and you’ve been fully invested for the last decade, you’re right back where you were in March of 1999. 

9 plus years and zero return – how’s that “buy and hold” strategy working for you?

Anyway, it’s time for a check on Mr. Kass’s buy call on XLF.  I normally don’t make a big deal about stuff like this – after all, analysts make bad calls everyday – but he titled his original analysis “Buy the Financials. Yes, Buy” to emphasize what a great opportunity it was.  So, let’s see how XLF is doing since Jan 14th.

XLF closed at $27.88 on Jan 14th.  It closed today at $20.57.  That’s down $7.31 – or about 26% in about 6 months. 

Great timing on the “Buy the Financials.  Yes, Buy” call Mr. Kass!  I hope you haven’t screwed over too many investors with your advice.

In my original post, I made this prediction: “In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.”

Since I recomended investing in commodities instead of stocks, let’s see how my pick (gold) is doing.  Gold closed at $903.40 on Jan 14th, and it closed today at $931.30.  That’s up $27.90 – or about 3% in 6 months.

Yup, gold is up just a tad, and it’s actually off the highs of a few months ago.  It’s also just come back up over $900 after being stuck in the $860 to $890 range for a while – I mention that because it just came back up this week, and I don’t want to appear to be trying to hide that it’s been lower.

But as long as the Fed keeps printing extra money (inflating the supply) the dollar will keep falling, so gold will continue to hold its’ value for now. 

Only if Bernanke gets serious about fighting inflation and ensuring a stable dollar (which is the Fed’s primary purpose – read the Fed website if you don’t believe me) will the dollar rebound and gold fall.  And “Helicopter Ben” isn’t Paul Volker, so it ain’t gonna happen anytime soon.

For you too young to remember the late 70’s, inflation was high and the economy was stagnant – the term “stagflation” was coined to describe it.   We’re in the early stages of it now, and unless we get the Fed to grow a pair of brass balls, it’ll be 1980 all over again.

Raising rates and restricting money supply killed the stagflation, but it also caused a deep recession.  But that recession led to one of the greatest bursts of prosperity this country has ever seen.   We can do it again – if the Fed would administer the medicine.

As is stands, Bernanke is simply trying to keep a sinking ship afloat.  He doesn’t want a deep recession (or worse) to mar his tenure.  After all, he is an “expert” on the Great Depression, and he know’s what he’s doing.  Just like the experts calling repeated bottoms in the stock market.

I didn’t come up with any of this on my own.  Read  Warren Buffett’s annual letters to shareholders.  Read Phil Town’s “Rule #1”.  Read damn near anything by anyone who isn’t a Wall Street “expert”.  Their jobs are going away as the companies they work for are revealed to be a highly leveraged house of cards.  They’re running scared and are trying anything to keep up the pretense of the 80’s and dot com years.

What about the next 6 months?  I don’t see the financials (banks and brokerage houses) coming clean with their books yet – many are still pretending that their “level 3” securities are still worth a lot of money.  Until they ‘fess up and take the losses they’ll just be on a long slow bleedout. 

This part is simply a guess, but I think Goldman Sachs is priced way too high.   At some point I think they’ll come down to earth just like the rest of the investment banks.  This might sound “out there” but I would not be suprised to see GS lose 50% (or more) of their value over the next 2 years.   Maybe sooner.  Something is fishy in their financial statements, but I can’t put my finger on what.  Just doesn’t smell right….

Back to the “hard vs soft stuff” that started this.  Don’t take my word for it – read and look at the situation for yourself.  Decide where to put your money because YOU want to put it there – not because some so-called “expert” on TV or the Internet said “Buy the Financials.  Yes, Buy”.

gk

The dollar is done

I read an article on Business Week saying that the dollar may be at a bottom.  Huh? 

I read the entire article, but I don’t see anything that suggests we’re going to quit borrowing $1.45 billion per day – and that’s at the national level alone.  Coupled with the American consumers’ ability to live beyond their means, and we continue to spend more than we produce.  Individually, and at the city, county, state, and national levels.

 Why’s that bad?  Because someone is forking over money when you charge something on your Visa card, someone is paying when you take out a second mortgage, someone is paying when you do a no money down deal on a new car….  Where is the money coming from?

Overseas.  We (Americans) are flooding the world markets with debt instruments.  It doesn’t matter if it’s  bonds sold by the US Government, or bonds sold by Citigroup, or bonds sold by AMBAC, someone has to have the money to lend – and that someone is overseas investors.

As long as “helicopter Ben” keeps printing money, and as long as Americans overall refuse to live within their means, the dollar will continue a downward spiral.  There will be days and weeks (like the last couple of weeks) in which the dollar rises, but nothing has changed regarding the long term fundamentals.

These articles where pundits are calling a bottom in the dollar remind me of the financials since last fall.  How many times have we heard that “this is a kitchen sink” quarter?  “All the bad news is out there now” and “this is the end of the writedowns” has been said countless times by the financial press.

Here’s the bottom line:  The financials ain’t done writing off losses, and the dollar ain’t done falling. 

gk

 

Here comes stagflation

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