Why are stocks rising?

The S&P 500, DJIA, and NASDAQ are all up about 40% from their lows on March 9th.  Why?  Has the economy (and earnings) rebounded that sharply?  Or were the March lows an aberration?  It’s been a while since I talked about the stock market or the larger economic picture, so it’s time to revisit those themes.

First, the economy.  From the data to date, it appears that the broad US economy is shrinking less rapidly than it was just a few months ago – but it’s still shrinking.  The GDP shrank at a 6.3% rate in the 4th quarter of 2008, and it shrank at a 6.1% rate in the 1st quarter of 2009.  These are the revised (as of May 29th) numbers straight from the BEA here.

Passenger: “The GDP is better than it was before Captain – can we start the party?”

Captain: “Ummm, let me think….  The ship is still sinking….  But it’s sinking at a slightly slower rate.  Re-arrange the deck chairs again, maybe that will help.  Party on dude!”

Ok, so the economy isn’t growing – what’s behind the 40% rise in stocks?  Could it be earnings?  Maybe companies have laid off enough workers, and streamlined operations enough so that their profits are 40% higher than last quarter?  Let’s look at the numbers….

With 99.43% of the Q1 2009 earnings reported, the total earnings of the S&P 500 adds up to $7.61.  That’s certainly a lot better than the negative $23.25 the S&P 500 earned during Q4 2008!  Keep in mind that Q4 was the first time ever for “negative earnings” for the S&P 500.   And another word for “negative earnings” is “losses”.  Or “deficit”.  As in “the US Government has $1.85 trillion in negative earnings for fiscal year 2009.”

Anyway, $7.61 in earnings must be a good thing if that has caused the stock market to surge about 40% in the past 3 months right?  According to Standard and Poors latest spreadsheet, no.   Except for last quarter’s losses, As Reported earnings haven’t been this low since Q4 of 2002.  And the Operating Earnings (currently $10.15) haven’t been this low since Q4 of 2001.

Ok, so actual earnings aren’t driving the market higher – what if the earnings are low, but beating the estimated earnings?  In other words, what if company earnings suck, but they suck less than investors expected them to suck?  Sorry Charlie, according to Howard Silverblatt, S&P Senior Index Analyst, “actuals are -24.3% off estimates, and -43.5% behind last year”.

Of course, Howard goes on to say that the “Operating vs As Reported (top down vs bottom up) varriance enormus; out of the woods or the Island has moved.”  I’m not sure what it means when the Senior Index Analyst at Standard and Poors can’t spell “variance” or “enormous”, but it can’t be A Good Thing.

In the same note, Howard also says “189 issues beat est, but only 87 beat last years earnings; 290 missed with 72 beating last years EPS” which translates (seriously) to “189 out of the 500 companies in the S&P 500 beat their earnings estimates.”  189 out of 500 is about 38% – that means that 62% of the S&P 500 MISSED their earnings estimates.  And yet the stock market is 40% higher.

Ok, so maybe the forward PE ratio is finally coming down to reasonable levels?  It was at a record 60 to 1 at the end of Q4, it must be better now….  Or at least when we look at the estimates for the rest of the year….  Right?

Wrong.  The current PE ratio for the S&P 500 is 114.77, another record high.  And it gets even worse when you look ahead.  Here are the current estimated PE ratios for the S&P 500 for the rest of 2009.

• Q1 – 132.22
• Q2 – 3513.31 !
• Q3 – Negative 301.52 (first negative annual PE in history)
• Q4 – 33.46

To sum it up, I see no reason for the current level of stocks.  Zero.  The S&P 500 index (currently at 944.74) is too high relative to earnings – and in the long run, stock prices are based on earnings.  This minibull may continue for awhile, but prices WILL eventually adjust to the low earnings.  And from where I sit, that means stocks will drop back down to at least the March low sometime this year.

The only possible way I can see stocks continue to rise is inflation.  Specifically, inflation caused by the enormous amount of money the Fed is printing out of thin air and injecting into the money supply.  In that case, stocks can – and will – go higher.  But the actual price increase will be close to zero when adjusted for inflation.  And if you want to maintain your purchasing power, gold and silver (in your physical possession, not an ETF!) are, in my humble opinion, much better inflation hedges than stocks.

I could go on and on about how Geithner, Helicopter Ben Bernanke, a willing Congress anxious to be seen as “doing something”, and Obama are making the mess worse – just as Greenspan, Bernanke, Bush, and a willing Congress created the problem – but that’s another story for another day.

gk

Is Geithner really that dumb?

Timothy Geithner is either really stupid or he’s simply lying to buy time.  I left work early today and I heard this quote from Rush Limbaugh on the way home (I used to listen to him regularly, but his shtick is getting old – how long can he blame everything on the Democrats and Clinton?  Bush had power for 8 years, and borrowed as much money as ALL previous presidents combined – I didn’t hear Rush bitching about spending then.)  so I had to look it up.

Rush is right on this one – here’s a quote from a Bloomberg news story: “It will be helpful if Geithner can show us some arithmetic,” he said.

“He” is Yu Yongding, a senior researcher at the government-backed Chinese Academy of Social Sciences and a former central bank adviser. “The Chinese public is worried about the safety of its foreign- exchange reserves,” Yu said in an e-mail.

Yup, that would sure be “helpful”.  I’m still trying to figure out how we (the US) can borrow as much as we collect in taxes this year and next year and still Geithner can state “No one is going to be more concerned about future deficits than we are”. I’d like to see the math on that.

To put it bluntly, Geithner is either really, really dumb, or he’s simply lying. I think he’s lying.

According to a Reuters story about the visit A major goal of Geithner’s maiden visit to China as Treasury chief is to allay concerns that Washington’s bulging budget deficit and ultra-loose monetary policy will fan inflation, undermining both the dollar and U.S. bonds.

That sounds good – I too would like to be reassured that my savings aren’t going to be worthless because of the incredible amount of money being printed.  But guess what?  Words mean nothing – it’s what they actually do that counts.  And what the Obama administration is doing is driving the final nails into the coffin that is the US economy.  Bush dug the hole, and Obama is pushing us into it.

The really sad part of Geithner’s statements is that even the Chinese know that he’s lying.  According to the same Reuters story when Geithner said “Chinese assets are very safe,” it  drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.

Towards the end of the Bloomberg story, it says “I will, of course, make it clear that we are committed to a strong dollar, that we are committed to bringing our fiscal deficits down over the medium term to a sustainable place, to a sustainable level,” Geithner said in the briefing May 27. “We believe in a strong dollar. A strong dollar is in the U.S. interest.”

That’s pure bullshit and I think Geithner knows it.  He can’t really be that stupid.  No deficit is “sustainable” over the long run – every year simply puts you further and further behind.  At some point you must pay the debt off.  And in order to pay ANY debt off you must have a surplus.  That’s simply not in the cards for the US.  Medicare and Social Security are soon to run huge deficits – and where will we get the money to pay that?

gk

A discussion continues

This will be a different type of post.  Over the past few days, I have had an exchange of comments on MarketWatch.com, and the format there doesn’t lend itself to that type of discussion, so I’m going to continue it here.

I have no idea if “Marsden” will reply or not, but I hope so, because he seems to be different from my normal antagonists on that site, mainly because he is making an attempt to use facts to support his opinions.

I strongly disagree with some of his opinions, and the disagreement stems from my post a few days ago (A deficit dummy) where I took Robert Frank to task because of numerous errors and half truths in a NY Times article.

Marsden started his reply with “Robert Frank is brilliant and so was his essay.”  So of course I couldn’t leave it alone.  🙂  The rest of his reply was actually thoughtful, and I actually agree with most of it.

Here’s part of his reply: People trade time for things. Precious, irreplaceable time, for useless cr@p which makes them feel better for only a short while. Then, to get even more, they leverage, borrowing from their own (and their children’s) future. This needs to be shouted from the mountaintops imho. Meanwhile we tax production instead of consumption, getting it exactly backwards.

I don’t have any disagreement with that at all – it’s common sense – and if more people thought that way we wouldn’t be in this mess.

Anyway, I replied to the Frank is brilliant part, saying: You may think he’s brilliant, but his editorial is factually wrong. Since he’s an economist and presumably should know economic history, I have to assume that he intentionally lied in order to make his points.  That’s not my concept of “brilliant.”

Marsden replied: All you have done is to repeat your assertions (“wrong!” “lies!” etc). If you want to make a point, feel free to do so. But it will take something concrete by way of example, particularly if you expect to convince anyone.

I assumed (mistakenly) that he was referring to my “deficit dummy” post on here, which I had taken care to document all my opinions with facts.  Plain facts, straight from the source, no news stories or opinion pieces.  So I went a bit overboard in my reply.  I said….

Did you bother to read the link I provided? My “assertions” are documented, complete with source data that documents the facts to show that Robert Frank has his facts wrong. I fail to understand how “brilliant” people think they can base policy positions and decisions on incorrect data, then blame others when their decisions turn out to be wrong.

(I inserted the chart of Hoover’s increased spending here)

Claiming that Hoover cut spending while the facts are that Hoover increased spending by 63% in 4 years is a “concrete” example of my “assertion” that Robert Frank lies as needed to make a point.

I freely admit that this was a bit over the top for a comment on MarketWatch – the misunderstanding will become clear in a moment.

Marsden replied with a lengthy comment that I will respond to here.  I’ll break it up and respond to each area of disagreement.  Hopefully this will make the multiple points of contention more clear.

Marsden starts with I not only didn’t read your link, I didn’t even see it. Definitely my mistake! That explains my over the top response to his comment – we were talking about different things, so of course we disagreed.

He continues About Hoover however, everywhere I turn I see the contention that he cut spending as a mistaken response to the financial collapse. So is this some nefarious plot by Democrats in your view, to misrepresent history?

No, I don’t think it’s a plot by Democrats, and nowhere did I mention political parties.  I do think that it’s a common misconception – reinforced by ignorant economists and journalists such as Mr. Frank so that you see it everywhere you turn – that Hoover cut spending and FDR’s New Deal reversed that and brought us out of the Great Depression.  I merely stated the facts.

Marsden then quotes an Encarta article that simply repeats the lie about Hoover cutting spending – as if by quoting another source which was also mistaken, it wiped out the facts about Hoover’s spending that I had presented.

He continues Meanwhile, do you really think that cutting spending is the proper move when private investment has collapsed?

No I don’t – as long as you have money to spend.  But when the US has to borrow from China, and even resort to printing money (as happened this week when they purchased $7.5 billion of debt on Wednesday, and another $7.5 billion today)  we don’t have money to spend.

I believe that too much debt – public and private – is what caused this crisis.  Borrowing more money and going deeper into debt isn’t going to solve it.  If more government deficit spending actually stimulated the economy, why didn’t the Bush 66.5% spending increase (from $1.79 trillion in 2000 to $2.98 trillion in 2008) prevent the problem in the first place? (Source is CBO, link will open an Excel spreadsheet, and doesn’t include Bush’s 2009 spending.)

Marsden continues Please note, btw, that I am generally violently opposed to deficit spending of any kind, and particularly the kind we’ve engaged in for the past eight years. Also note that I am not one of the people who believe that FDR rescued this nation from the Great Depression. In a way, Hitler did, but in a different way from the way in which he rescued his own nation years before.

I agree with him on that.

Here’s where we start disagreeing. There’s a lot to argue in that link. Is it your writing? For example, the author declares that the budget has never been balanced in his lifetime.
Yes, it’s mine.   And you’re disagreeing with something I never said.  I never said the “budget has never been balanced in my lifetime.”  I said “Politicians and economists have been saying that they’ll balance the budget and start paying down the debt for as long as I can remember – and I’m 47.  It has not happened in my lifetime.  Not once.

Read on, I’ll provide the actual numbers to prove this further down.

But there’s this: http://archives.cnn.com/2000/ALLPOLITICS/stories/09/27/clinton.surplus/ (from the year 2000)

“President Clinton announced Wednesday that the federal budget surplus for fiscal year 2000 amounted to at least $230 billion, making it the largest in U.S. history and topping last year’s record surplus of $122.7 billion.”

And even more to the point (same link): “Instead, the president explained, the $5.7 trillion national debt has been reduced by $360 billion in the last three years — $223 billion this year alone.

This represents, Clinton said, “the largest one-year debt reduction in the history of the United States.”

Since the author says he’s 47 years old, he ought to be aware of that. Or is it more “lies”?

Then he declares: “The last time the US reduced the national debt was 1957. (Source is the US Treasury.)”
The author then provides a link which includes the years up to 1999, but not 2000. How convenient. You should call that a “lie” shouldn’t you?

To be blunt, yes, it’s more lies.  Here are the facts straight from the US Treasury here and here.  (Sorry, they split the data between 1999 and 2000, so I have to use two links.  I should have provided that in my original post so you wouldn’t have wasted your time thinking that I left out a debt reduction year in 2000.)

Year	National Debt
9/30/2001	5,807,463,412,200.06
9/30/2000	5,674,178,209,886.86
9/30/1999	5,656,270,901,615.43
9/30/1998	5,526,193,008,897.62
9/30/1997	5,413,146,011,397.34
9/30/1996	5,224,810,939,135.73
9/29/1995	4,973,982,900,709.39
9/30/1994	4,692,749,910,013.32
9/30/1993	4,411,488,883,139.38
9/30/1992	4,064,620,655,521.66

So when CNN says  “Instead, the president explained, the $5.7 trillion national debt has been reduced by $360 billion in the last three years — $223 billion this year alone.” and This represents, Clinton said, “the largest one-year debt reduction in the history of the United States.” they are lying.  Look at the freaking numbers!

The facts are that the national debt increased each and every year of the Clinton administration. Show me where the debt was reduced by even $1 during Clinton’s 8 years.  You can’t because it simply did not happen. 

Look at the facts! Clinton – and CNN – simply lied.  What else can you call it?  What they said and the actual facts -straight from the government, no editing – are simply not compatible.  I call it lying, you may have a more pleasant euphemism, but it’s certainly not the truth.

As to my statement that the national debt has not been reduced during my lifetime, I stand by it.  Again, look at the facts.  Go to the Treasury site and actually look at the numbers. 1950 – 1999 are here.  2000 – 2008 are here. Find the last year in which the actual debt was lower than the previous year.

You’ll see that until you get back to 1957, each and every year the debt was larger than the year before.  In 1957, the national debt was $270,527,171,896.43,  down from $272,750,813,649.32  in 1956.

I was born in 1962.  That’s after 1957, so I stand by my statement.

One last point to make.  Marsden says Finally, with respect to your major point, Frank was careful not to say explicitly that Hoover cut spending. He said:   “In 1929, President Herbert Hoover thought that the best response to a collapsing economy was to balance the federal budget. With incomes and tax receipts falling sharply, that meant cutting federal spending. But as almost all economists now recognize, President Hoover was profoundly mistaken.”

And there are no errors there, much less “lies”, unless you contend that one may balance the budget by cutting taxes and increasing spending. Oh where have we heard THAT before?!

I actually answered that in my original post.  You are correct in that Mr. Frank did not EXPLICITLY say that Hoover cut spending, but I ask you that if he wasn’t saying that, WTF was he saying?  How was Hoover “profoundly mistaken” if he didn’t reduce spending?

Since Hoover actually increased spending, was that his profound mistake?  I don’t think that’s what Mr. Frank was trying to say, and I don’t think you believe that either.  Otherwise you wouldn’t have quoted the Encarta article that states “Hoover sought to cut government spending and raise taxes”.

I have never stated, implied, or otherwise insinuated that you can cut taxes and increase spending and balance the budget.  That’s a straw-man argument that I won’t bother to refute.

Marsden – I appreciate your considered response to my comments on MarketWatch.  Feel free to respond here by posting a comment.  I’ll reply in a like manner and we can discuss anything else you’d like.

I think we pretty much agree on everything except our opinion of Robert Frank.  Once you see the facts I’ve presented about, there will be no disagreement about the debt.

Since you made a reasoned response on MarketWatch, I have high hopes that you’ll agree with me once you see the actual facts, and not some CNN/FoxNews/NY Times/etc distortion of the facts.  Check out a few of the site on my blogroll (especially mises.org) to understand why “almost all economists” are almost always wrong.

Keynesian economic theory simply doesn’t work, yet “almost all economists” – including Mr. Frank – persist in trying to make it work.  They are failing, and I fear they are taking us all down with them.  Read a few other posts here to understand why I feel they are wrong.

Thank you,

gk

Who will give us money?

I was reading through The Daily Capitalist blog tonight, and I read a post entitled “The Chinese Aren’t As Dumb As the Fed Thought” that reminded me of a news blurb I saw today.  It seems that there was much less interest in today’s Treasury auction of 5 year notes than was expected.

According to MarketWatch, The Treasury Department sold $34 billion in five-year notes to yield 1.849%, higher than traders had expected before the results were announced.

Bidders offered $2.02 for every dollar sold, compared to an average of $2.17 at the last four auctions.

Indirect bidders, a closely watched metric because it includes buying by foreign central banks, bought 30% of the monthly auction, the lowest since December.

I could have sworn that I saw that they were auctioning off $40 billion today, but I must have been wrong because I can’t find it anywhere.  The Treasury press release dated March 19th also says $34 billion.

Anyway, it appears that there’s just not as much interest in loaning the US money as there was a few months ago.  This can be taken in one of two ways:

1. The economy is recovering and people think they’ll get better returns in the stock market.
2. The US dollar is toast and everyone knows it, so fewer people want to invest in US government debt.

I don’t think #1 is the reason.  #2 is much more likely because the Federal Reserve is now directly printing money (buying treasuries with funny money) and what’s the use of buying US debt if it’s soon going to be worth less?  Or worthless?

As I’ve mentioned before, the Chinese aren’t stupid (that’s what The Daily Capitalist post above reminded me of) and they appear to be loaning us less money as well.

Speaking of The Daily Capitalist, the post I linked to above makes some good points regarding the Chinese hinting at a new reserve currency:

I see this as a crack in the dyke so to speak. When a power like China says these things, it’s serious. Things aren’t going to change overnight because of the complications of international trade and the role of currencies. But I see a trend. Last week’s announcement by the Treasury and the Fed that they were going to print a trillion dollars helped the discussion along. The whole world knows that eventually we’ll see inflation and the further devaluation of the dollar.

The consequences to us as a result of being replaced as the world’s reserve currency will be a further depreciated dollar. It will also make our taxes go up to pay the increased interest costs on our national debt as the Treasury finds it needs to make the rates on Treasuries more attractive to foreign investors.

What could replace the dollar? The Chinese and others suggest the IMF issue bonds backed by a basket of currencies—special drawing rights (SDRs). This would in essence, try to replace the dollar as a reserve currency and sort of create a supranational central bank. This is the worst thing that could happen to us. We’d have a group of Keynesian econometricians who are worse than our Keynesian econometricians controlling the world’s currencies and international trade. Trust me when I say we would get the short end of that stick.

What about gold? It worked pretty well for the last 6,000 years of human history. It is valued by everyone, it is seen as a monetary metal, it would create a stable medium of exchange, there is plenty to go around, and it takes away the power of the central banks to inflate. I believe, as do most free market economists, that it would serve us well. We’ve heard all the arguments against it and have some pretty good answers. This is not the time for me to expound on gold; I will do that at another time.

Another government engaged in the “quantitative easing” strategy is Britain.  Quantitative easing is the euphemism Keynesian economists like to use instead of “cranking up the printing presses” or “printing money” or “making funny money” or “lets send the whole country to hell in a hand basket – fast!”  I guess they think people won’t understand what they really mean, so they can get away with it.

According to MarketWatch, the British had a failed auction today.  A failed auction is where there aren’t enough buyers for the amount of debt you’re selling.  In the British case, they were trying to borrow a measly 1.75 billion pounds (about $2.6 billion) and they only received 1.63 billion pounds ($2.3 billion) of bids.

The failure significantly limits the scope for further stimulus borrowing, said Nick Stamenkovic, an economist at RIA Capital in Edinburgh. “It’s a warning shot about the fiscal position … It would suggest that the government’s scope for further fiscal easing is extremely limited,” Stamenkovic said. (Fiscal easing is just Stamenkovic’s euphemism for printing money out of thin air and expecting it to actually be worth something.)

Printing money comes eventually dooms every government that’s ever tried it.  History is full of examples like Rome, France, Germany, Argentina, and Zimbabwe.  I wish it were not that way, but we seem to be racing towards that same end as fast as possible.

But a review of expansive monetary practices and the effect on the governments who tried it will have to wait for a later date.  I also need to write about how the Keynesian policies have never worked (that I’ve found), and about how the debt of 1929 compares to day – and the results of a debt bubble.  And about 5000 other things….

gk

Capitalist Blog Revolution (IV) : Another nail in the coffin

As usual, good news are scarce in todays economic climate – most of us can only sit and wait for what government policies will bring.  The only good news I have run across lately is that ECB, lead by Claude Trichet, is not planning any quantitative easing. He also defends the fact that Europe has not spent more than half what the US has in “stimulus”. One could wish he would say : “we do not engage in destructive policies”, but at least it’s better than Obamanomics. The general media attitude towards the US stimulus package is starting to turn around, probably because someone finally took the time to calculate how much money the US deficit actually is. For those of you wondering what a trillion actually is, I will repost this link.

As for the bad news, its hard to know where to even begin. The US Federal Reserve will engage in quantative easing to the tune of another trillion. It seems that everytime I manage to tell myself that there is a 1/trillion change that things won’t go straight to hell, someone comes up with something new to worsen the prognosis. And you know what the worst part is? We could be seeing the light at the end of the tunnel already (and it wouldn’t be a train). Anyways, here is a round of posts I liked in particular from the last two weeks :

The Last Capitalist:Another dailyish Ayn Rand quote
Silverwolf: Respect for Iran?
Effor : A deficit dummy
DailyCapitalist : Professor Krugman and Professor Keynes
SaveCapitalism: The Chinese Bear Trap

And as always, the neverending stream of knowledge from The Mises Institute comes heavily recommended – they actually offer complete books for download – and lots of them! For those of you who haven’t checked out the blogroll yet – I strongly recommend EconomicPolicyJournal because a lot of interesting stuff seems to be leaking out of there constantly.

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

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

China disagrees with US stimulus

Here’s a bit of an update on the G20 meeting.  It appears that China is getting serious about the US economy, because they want to eventually get the money back that they’ve loaned us.

According to a story on KnoxNews.com

Chinese Premier Wen Jiabao called on the United States to remain “a credible nation” and not weaken the U.S. dollar with endless government spending on bailouts and stimulus packages.

China gets it.  The US doesn’t.  Government spending – when the government doesn’t have money to spend – causes the currency to weaken relative to other currencies.  (Side note – it doesn’t not cause inflation.  Only increases in the money supply can do that.  But of course we’re doing that too…)

Here’s what Wen said:  “Of course, we are concerned about the safety of our assets. To be honest, I’m a little bit worried,” Wen said at a news conference Friday after the closing of China’s annual legislative session.

The story goes on to give a little background by saying Chinese investment in U.S. Treasuries for years has helped finance U.S. budget deficits, keep interest rates low and buoy the dollar. It is all the more important as the U.S. takes on a deficit in excess of $1 trillion to fight its recession.

As I’ve said many times before, if China doesn’t loan us money, the US is quickly screwed.  Of course if China does loan us money, we’re still screwed – but the ultimate collapse will be delayed.

China appears to fear that overspending on stimulus by the United States could ignite inflation and send interest rates climbing.

It doesn’t look like Chinese Premier Wen believes in Keynesian policies.  At least one member of the G20 is not lacking in common sense.  Isn’t it ironic that a communist country understands economics better than we do?

gk

Obama to China – give us money!

I mentioned this a couple of times before, here, and here, but it’s escalated a bit this week.  Bloomberg (and a bunch of other places) has a story on it today.  According to Bloomberg, The US is pretty much reduced to pleading with China to keep us afloat.

“There’s no safer investment in the world than in the United States,” White House Press Secretary Robert Gibbs said yesterday at a briefing in Washington.

Gibbs was responding to comments from Wen that China, the U.S. government’s largest creditor, is “worried” about its holdings of Treasuries and wants assurances that the investment is safe. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets,” Wen said at a press briefing in Beijing.

“Of course we are concerned about the safety of our assets,” Wen said after an annual meeting of the legislature. “To be honest, I am a little bit worried.”

China is right to be worried.  And Obama is right to be worried that China won’t keep giving us their money.  The US will have to resort to printing even more money if China won’t loan it to us.

President Barack Obama is relying on China to sustain buying of Treasuries amid record amounts of U.S. debt sales to fund a $787 billion stimulus package and a deficit this year forecast to reach $1.5 trillion. Investors abroad own almost half of all U.S. debt outstanding, and China last year overtook Japan as the biggest foreign buyer.

The US seems to be counting on this: “China won’t sell the U.S. debt now as that will only drive down Treasury prices, hurting not only the U.S. but also the value of its own investments,” said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp.

But look at it from the Chinese point of view – why should they throw good money after bad?  To them, the US is becoming a bad investment, and at some point every investor has to cut their losses and salvage whatever they can from a bad investment.  Think Bear Stearns and Lehman Brothers.  Or Citi and Bank of America.  Or AIG or GM.  The list is long.

I doubt that the Chinese will simply dump their current holdings, but what if they simply stop buying more bonds?  Without their deep pockets buying up the US debt (loaning us money) the price of treasuries will drop, causing interest rates to surge.  Which only increases the need to borrow more money simply to pay the increased interest on the debt.

The US effectively has an “option ARM” from the Chinese right now.  We’re not making enough to pay the interest – much less reduce the principal.  So the amount we owe goes up every day.  When it becomes clear that we’ll never pay that debt, the Chinese will stop making our interest payments.  When that day comes – and it will come someday –  look out, inflation will soar.

Buy gold.  I don’t see anything else that will protect you from hyper inflation.  Maybe the Yaun.  🙂

gk

$11 Trillion in debt

At the current rate, at some point withing the next 24 to 48 hours, the US Government debt is going to hit $11 trillion.  According to the US Treasury website “Debt to the Penny” as of right now (8:45pm EDT) we owe $10,951,578,308,859.02. Look at the Debt Clock at the top of this page for the current number.

That’s the US government debt only – there aren’t any firm numbers on the total state and local debt, but historically it’s about the same as the national debt.

That’s $22 trillion you and I owe to others.  And that doesn’t include any credit cards, car loans, mortgages, consumer debt, etc that you may personally owe.

There are about 306 million Americans according to the US Census Bureau, so that comes out to $35,947.71 for every man, woman, and child in the US.  That’s your share of the public debt.

That debt will never be paid.  The US has 2 choices:

1. Inflate the dollar so the massive debt can be paid back with cheaper dollars in the future.
2. Default on debt payments.

Since the US government alone has the ability to print dollars, a true default will not happen.  They’ll just crank up the printing press in order to create money (out of thin air) to pay the bills.  And when you print money, it’s worth exactly what it’s printed on.

Supply and demand doesn’t disappear because of a government rule or law.  When you print more dollars out of thin air, each dollar is worth less.  Eventually, each dollar is worthless.

You don’t need to look very hard to find out what happens next.  Look at Rome, Germany in the 1920’s, Argentina in the 1980’s, or Zimbabwe now.   Dictatorship ALWAYS follows the anarchy which is brought about by hyper inflation.

No, I’m not optimistic that we’ll be the first country ever to break that cycle.  I don’t know the time frame (1, 2, 10, 20, or 50 years) but it will happen here if we don’t stop printing and spending.  Now.  It’s not even tax and spend anymore, the US government has gone straight to print and spend.

Pretty gloomy huh?

gk