“In the event of hyperinflation,” warns Glen Bradley, who has sponsored one such proposal in North Carolina “depression, or other economic calamity related to the breakdown of the Federal Reserve System… the state’s governmental finances and private economy will be thrown into chaos.”

And with that we find ourselves in peculiar territory this morning.

We’re on a train to D.C. to meet with fellow conspirators — gentlemen from the ‘left’ and the ‘right’ — who share in the belief gold must be reintroduced to the global monetary system. It’s become an unintentional hobby of sorts.

The meeting is classified at the moment, so we’ll reserve comments for another time.

But our current mission is only part of what’s making us uneasy.

We begin today by briefly exploring what our line of work is all about. Scientists who’ve studied probabilities and plotted them on a chart typically find a bell-curve distribution — in which the most likely events bunch up in the middle of the curve.

But a funny thing happens out at the ends of the curve, where the rare events are registered.

“Scientists have found small bumps and bulges,” explains Bill Bonner. “Things that were not expected to happen very often actually happened more than they thought.”

“’Hundred-year floods,’ for example, happened every 88 years. ‘One in a million’ shots hit their mark every 700,000 or so. Statisticians refer to these odd bulges on the extremities of bell-shaped curves as ‘fat tails.’ Instead of tailing off as they are supposed to, the rare events seem to swell up where you don’t expect them.”

We are in the business of anticipating fat-tail events — while the “mainstream media” sit in the middle of the bell curve. Click the graph to enlarge and you’ll get the idea:

The problem is that since 2008, “fat-tail events” — like the collapse of the U.S. dollar and the dismembering of the Federal Reserve system — have become harder for us to stake out.

We were once derided as “doom and gloomers.”

Now doom and gloom has become downright fashionable. Heck, we see the National Geographic Channel debuted a show last night visiting survivalists in their bunkers… and here we are carrying on with business as usual in the “belly of the beast.”

With all that in mind, we daresay that declaring the mother of all financial bubbles might be passe. Don’t get us wrong: It’s still inevitable the bubble will pop.

But today we throw in the towel and make a concession: The monetary mandarins will successfully inflate the bubble a few months longer. And the peace we expect to break out once they’re defrocked of their power and prestige will have to wait for another day.

“The Federal Reserve Open Market Committee (FOMC) has made it official,” writes Daily Reckoning regular Charles Kadlec at Forbes: “After its latest two-day meeting, it announced its goal to devalue the dollar by 33% over the next 20 years.”

And that’s if everything goes according to the plan… based on the Fed’s now-formal target of 2% annual inflation.

Likewise, the Federal Reserve’s latest figures on consumer credit jumped in December — to an annualized 9.3% rate, on top of November’s 9.9%.

We’ve seen nothing like it in 10 years — not since the Fed poured gasoline on the fire first ignited by the tech bust in late 2001 made it possible for automakers to offer 0% financing.

Yes, student loans are a big part of the growth, as they’ve been for many months now. But auto loans are up big, and even credit card use is growing again.

The Wall Street Journal talks to a bank president in Colorado who says loan volume is up because more people now qualify and they’re willing to take on more debt.

The paper also profiled a couple in Pennsylvania financing a new SUV. “We had looked at our budget, and it was something we knew we were comfortable affording,” said Heather Davidson. They’re buying a 2012 Nissan Armada for $57,000.

Presumably they got every bell and whistle available, since the manufacturer’s suggested retail for the base model Armada is $40,275. But hey, why not splurge and trick the thing out? It’s easy payments of $650 a month for the next 72 months, the paper says.

Six years? Oy…

Addison Wiggin
for The Daily Reckoning

Of Fat Tails and Fashionable Gloom and Doom originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

But are gold buyers making a big mistake? Is history repeating itself? The New York Times suggests it is:

As it was in 1980, could it be again in 2012?

The 1980 presidential election was fought by a Democratic incumbent weakened by a poor economy amid worries that the United States had lost its ability to compete in the world. Gold prices had risen to unprecedented levels as the election approached, and the Republican nominee hinted he might propose a return to a gold standard.

That Republican, Ronald Reagan, won the election and soon appointed a commission to study the role of gold in monetary systems. To gold bugs, it appeared to be the best chance in decades to move the country toward gold and away from what they like to call “fiat money,” a currency anchored by nothing more than government dictates.

Last month, Newt Gingrich, seeking to widen his support in the days leading up to the South Carolina primary, promised that he would appoint a new gold commission. “Part of our approach ought to be to re-establish something Ronald Reagan did in 1981 and that is to have a commission on gold to look at the whole concept of how do we get back to hard money,” he said in a speech.

No, dear reader, history is not repeating itself. The NYT is wrong…about everything. Well, almost everything. It understands that gold is a threat to its big advertisers…and most of its readers (who don’t own any gold). It is also a threat to most economists — who have built their careers on not understanding how a real economy actually works…and whose income and whose professional status now depend on a gold-free, centrally-planned economy.

So, to prove that gold is a ‘barbarous relic’ and that gold bugs walk on four legs, they merely put the question to economists.

The University of Chicago last month asked a panel of 40 economists, including former advisers to both Democratic and Republican presidents, if they agreed that “price-stability and employment outcomes would be better for the average American” if the dollar’s value were tied to gold. Every one of them disagreed, some with more than a little incredulity that such a question was worthy of discussion.

“Why tie to gold?” asked [the very witty] Richard Thaler, a University of Chicago professor. “Why not 1982 Bordeaux?”

“Eesh,” responded Austan Goolsbee, a Chicago colleague and former adviser to President Obama. “Has it come to this?”

The Times goes on to report that “even economists with some sympathy to gold opposed the idea” of a gold-backed dollar. And Mr. Ben Bernanke, former professor of economics at Princeton, says he doesn’t think gold is money.

Oh yeah, replied Congressman Ron Paul, then why do central banks hold gold…and not things such as ’82 Bordeaux or diamonds?

Mr. Bernanke replied that it was just a matter of “tradition.”

Yes, he’s right…it is a matter of tradition, like marriage…like property rights…like government…like murder…like teenagers who moon adults out of car windows…or like drivers who give each other the finger.

Traditions become traditions because people keep doing them. And they keep doing them for reasons that aren’t likely to go away. Times change. Conditions change. Human nature doesn’t.

But let us go back to the New York Times’ silly notion that we are about to relive the period following ’80. What seems to have triggered the idea was Newt Gingrich’s proposal to study the idea of going back on the gold standard. Every right thinking person in the country — the Times implies — knows the idea is foolish. And the price of the yellow metal is sure to fall, as it did after the Reagan election, when people realize how foolish it is.

But gold didn’t fall after ’80 because the Reagan administration didn’t put it back in the monetary system. It fell because Paul Volcker made it unnecessary. Instead of printing money, Volcker tightened up…taking out some of the money that was already there. And he did it under conditions that were not merely unlike those of today…but almost the exact opposite.

Then, the US was still a creditor to the rest of the world, not a debtor.

Then, the US was still running positive trade balances, not losing money every month.

Then, US stocks were at bargain levels…selling for 5 to 8 times earnings; today, they’re twice as expensive.

Then, US bonds were cheap too…with yields for US Treasury debt as high as 18%, or nearly SIX TIMES as high as today’s long bonds.

Then, US households had debt of only 60% or 70% of their disposable income, not 120% like today.

Then, the Fed was determined to stifle inflation; now it is determined to cause it.

Then, the federal government’s debt was less than 40% of GDP. Now, it’s over 100%.

Then, even in today’s inflation adjusted terms, the US government ran a deficit of $197 billion. Today, the deficit is $1.1 trillion.

Then, stocks had been going down for the previous 14 years; bonds had been going down for at least 31 years. Now, stocks and bonds have been going up, generally, for the last 30 years.

This final point is now just a detail. It’s the heart of the matter. With bonds at a 30-year low, Paul Volcker could squeeze inflation…begin a 3-decade period of rising bonds (with falling interest rates)…and an 18-year bust in the gold market.

Will that happen again? Impossible!

What kind of strange history would it be if it could repeat itself…from totally different initial conditions? Could Napoleon march on Moscow…if he had started out in Chicago rather than Paris? Could Liz Taylor have married Richard Burton twice if she’d died in a traffic accident after her first marriage?

Can gold now repeat its path of ’80-’98, even though today’s situation is almost the opposite in every way?

No, dear reader, history doesn’t repeat itself. It just stutters out the same truths, over and over. G..g..g..g..gold is m…m…m…money. It says.

The N..N…New Y…Y…Y…York Times is full of s..s..s..s…

…error!

Who knows what the future will give us? We don’t. Not here at The Daily Reckoning…

…but we see what could be a bad moon rising. No, we’re not talking about a Great Correction…or even a Depression. Who really cares if GDP goes up or down? You can go broke with honor…with a sense of humor…and with grace and dignity. You can happily go broke.

But you can’t go to Hell with grace and dignity.

In the following article, the FBI notes that 18 people a year have been convicted, mostly of ‘white collar crimes.’ You wouldn’t think this would call for comment. But the FBI says these people are “extremists” who believe they have a right to protect themselves from what they see as an overbearing government. The G-men tell us that these extremists can turn violent “at the drop of a hat.”

How long before they’re rounded up? And maybe they’ll round up “potential domestic terrorists” too, even those who have never committed any crime? And what about gold bugs? They may look harmless, but they give aid and comfort to dangerous elements, don’t they?

Here is the FBI preparing the public for a trip to Hell.

(Reuters) — Anti-government extremists opposed to taxes and regulations pose a growing threat to local law enforcement officers in the United States, the FBI warned on Monday.

These extremists, sometimes known as “sovereign citizens,” believe they can live outside any type of government authority, FBI agents said at a news conference.

The extremists may refuse to pay taxes, defy government environmental regulations and believe the United States went bankrupt by going off the gold standard.

Routine encounters with police can turn violent “at the drop of a hat,” said Stuart McArthur, deputy assistant director in the FBI’s counterterrorism division.

“We thought it was important to increase the visibility of the threat with state and local law enforcement,” he said.

In May 2010, two West Memphis, Arkansas, police officers were shot and killed in an argument that developed after they pulled over a “sovereign citizen” in traffic.

Last year, an extremist in Texas opened fire on a police officer during a traffic stop. The officer was not hit.

Legal convictions of such extremists, mostly for white-collar crimes such as fraud, have increased from 10 in 2009 to 18 each in 2010 and 2011, FBI agents said.

“We are being inundated right now with requests for training from state and local law enforcement on sovereign-related matters,” said Casey Carty, an FBI supervisory special agent.

FBI agents said they do not have a tally of people who consider themselves “sovereign citizens.”

J.J. MacNab, a former tax and insurance expert who is an analyst covering the sovereign movement, has estimated that it has about 100,000 members.

Sovereign members often express particular outrage at tax collection, putting Internal Revenue Service employees at risk.

Regards,

Bill Bonner
for The Daily Reckoning

Why Gold is Money Despite Changing Conditions originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

After reading the article, we concluded that Mr. Davidoff is the most creative financial writer around. As such, Mr. Davidoff may be the perfect apologist for today’s dysfunctional monetary “system.” Certainly, he possesses the cerebral alacrity to dodge whatever cold, hard facts may be standing in the way of a good story.

“I call the Fed a hedge fund,” Davidoff cheerily explains, “because it is operating like one, leveraging its balance sheet to earn huge profits.”

We might have been able to embrace Davidoff’s analysis were it not for one nettlesome fact: the Fed is absolutely nothing like a hedge fund. The Fed is, instead, more like a crime syndicate — a racketeer that relies on coercion, deception and outright larceny.

But before explaining The Daily Reckoning’s official metaphor for the Fed, let’s return to Davidoff’s metaphor and “analysis.” Says Davidoff:

Last year, the central bank turned over $76.9 billion in profit to the federal government, slightly down from $79.3 billion it provided in 2010.

The Fed made this money in interest on a nearly $3 trillion portfolio of securities. This enormous holding was built up largely in the wake of the financial crisis as the Fed bought these securities through two rounds of quantitative easing.

I call the Fed a hedge fund because it is operating like one, leveraging its balance sheet to earn huge profits. The main difference between a hedge fund and the Fed is that the Fed effectively creates its own money, so it doesn’t have any borrowing costs, meaning yet more profits.

Remarkably, the Fed’s profits are also an afterthought. The Fed is trying to stabilize and increase the United States economy in the wake of the financial crisis, and its profits are a nice byproduct.

Still, these earnings blow away any other hedge fund profits.

Hmmm… where to begin our autopsy of this fatally flawed analysis?

Let’s begin at the end with those earnings that “blow away any other hedge fund profits.”

If Davidoff is referring only to the Fed’s $79.3 billion “earnings,” without any regard for the denominator that produced those earnings, he is absolutely correct. No other hedge fund in the world came close to earning $79.3 billion in 2011, primarily because no other hedge fund in the world runs a $3 trillion portfolio. But obviously, the absolute number tells us nothing about the genius — or lack thereof — behind the Fed’s investment activities.

To get a feel for that, let’s now insert a denominator and calculate a return. Based on the $3 trillion portfolio that Davidoff cites in his column, the Fed produced a 2.6% return. That kind of number would not pop any year-end champagne corks in any hedge fund office in the land. [Editor’s note: In reality, the Fed’s balance sheet averaged about $2.75 trillion during 2011, not $3 trillion. But since $3 trillion is the number Davidoff uses, we’ll use it also].

But maybe Davidoff had a different return calculation in mind when he dubbed the Fed “the most successful hedge fund around.” Maybe he was thinking the denominator ought to be zero instead of $3 trillion, since, as he observes, the Fed “effectively creates its own money.” In this scenario the Fed’s investment activities would have produced a mind-boggling return of “infinity percent.”

Davidoff is absolutely right; no hedge fund can do that.

Or maybe Davidoff was thinking of a denominator somewhere between zero and $3 trillion. Maybe he had $676 million in mind, which is the actual amount of money the Fed spent last year printing new dollar bills. In this scenario, the Fed’s result would have been a spectacular 117.3%. That’s not quite infinity percent, but it’s not bad.

Unfortunately, there’s another problem with Davidoff’s analysis; the numerator is as much a mystery as the denominator. In other words, the Fed’s theoretical $79.3 billion return is a bogus Beardstown Ladies kind of number since it does not account for marking all the Fed’s securities to market. Without marking its vast $3 trillion portfolio to market, the actual results of the Fed’s investment activities are unknowable.

Perhaps the Fed’s hodgepodge of Treasury bonds, mortgage-backed securities, currency swaps and other financial jetsam increased in value during 2011, in which case the total return would have been higher than 2.6%. Or perhaps these holdings decreased in value, in which case the total return would have been lower than 2.6% — maybe even negative.

No one knows. (Or if they know, they aren’t saying).

Net-net, Davidoff’s analysis, expressed as a mathematical equation, would be greater than or equal to idiotic. That said, as a fellow journalist, we sympathize with Mr. Davidoff. We, too, have written things that should never have survived the copy-editing process. But when we have, we have heard about it from readers…just as Mr. Davidoff heard about it from many of the bloggers on Yahoo! Finance who responded to his column:

Kaos from Plainfield, Connecticut wrote:

Anything done by the NY Times is fire starter material.

Greg from Indianapolis wrote:

“The main difference between a hedge fund and the Fed is that the Fed effectively creates its own money, so it doesn’t have any borrowing costs”

Yeah…that is kind of an advantage…

RJ Wrote:

So the Fed made $76.9 billion from interest on US government debt, then turned that over to the Treasury Department?

Wait, what???

JR wrote:

Maybe this year [the Fed] will print a trillion dollars, turn it over to the Treasury, and this writer can say, “Look, a government operation made a trillion dollars while the idiots in the private sector flounder.” The New York Times is a disgrace.

Mark from Tulsa, Oklahoma wrote:

My 6-year old could make money if he could print dollar bills at will.

While we are sympathetic with these critiques, we can’t really be upset with Mr. Davidoff for producing his obsequious homage to the Federal Reserve, anymore than we can be upset with a puppy for peeing on the side of a brand-new flat-screen TV. To the puppy, the TV looks just like a fire hydrant. And to Davidoff, by his own admission, the Fed looks just like a hedge fund.

But it isn’t. The Fed is a crime syndicate that relies on deception, coercion and grand larceny. It is a racketeer.

“Several forms of racket exist,” Wikipedia explains. “The best-known is the protection racket, in which criminals demand money from businesses in exchange for the service of ‘protection’ against crimes that the racketeers themselves instigate. Traditionally, the word racket is used to describe a business (or syndicate)…that it is engaged in the sale of a solution to a problem that the institution itself creates or perpetuates, with the specific intent to engender continual patronage.”

’Nuff said!

Regards,

Eric J. Fry
for The Daily Reckoning

The Federal Reserve and Other Crimes Against Capitalism originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Partly, it is because North America saw mobile phones so early. When other regions finally rolled out mobile phones, infrastructures were more modern. The larger reason, however, is that there is so much at stake.

Right now, there are a limited number of players in the lucrative payment network world. Visa, MasterCard and American Express would like to move to your phone. They fear, however, that enabling electronic wallets in phones would allow aggressive young players onto their turf. PayPal, Amazon and Google are, in fact, financial networks, and they would love to do your banking.

So far, progress has been slow, but the emergence of Android is opening up new possibilities. Work is being done by the Mobile Payments Industry Workgroup that would establish standards. What we know for sure is that the established payment networks will do their best to keep out upstarts. We also know they will fail.

Part of the reason for this is political. Part is cultural.

The politics are that Wall Street and the major banks have never enjoyed lower public regard and support. Consumers sense that the bailout profited rich bankers more than consumers. The customer base is not going to support politicians who continue to put the interests of favored banking institutions above those of consumers.

Eventually, market forces always win. Currently, retailers are capable of dealing with only a few credit and debit card companies. This limits competition and keeps prices higher than they would otherwise be. A sophisticated mobile payments infrastructure, which is inevitable now that the Android has broken free, will arise. In fact, it will arise before most people know it’s happened.

The cultural factor I referred to is the difference between the old-school financial institutions and the new electronic services. I have little confidence that Visa or MasterCard is going to do what’s necessary to exploit the convergence. They’re too habituated and institutionalized.

PayPal, Amazon and Google, however, are populated by people who want to transform the financial world. They will find a way to force themselves into an industry that has lost serious credibility and clout due to its participation in the ongoing subprime mortgage fiasco.

Fortunes will be made by financially sophisticated app developers.

Finally, I’d like to get a little speculative and tell you what I think the real long-term consequences of the Linux/Android revolution will be.

It’s not well known, but Peter Thiel, one of the founders of PayPal, was motivated by quite subversive goals. His initial purpose was to create a mechanism for financial transaction outside the reach of governments. He has written:

As an entrepreneur and investor, I have focused my efforts on the Internet. In the late 1990s, the founding vision of PayPal centered on the creation of a new world currency, free from all government control and dilution — the end of monetary sovereignty, as it were.

Obviously, he has not succeeded. Nor do I think we’re going to see such a purely private system in the near future. However, we are moving very rapidly toward developing an electronic infrastructure that would enable brand-new forms of banking. Given our recent experience with the federally controlled financial system, the need is clear.

I won’t detail here how I think this new banking will function. For now, however, I’d just like to warn you that you shouldn’t be too surprised to see completely transformed financial institutions arise from the current rubble. Who knows? Maybe Thiel will be proved right. For extra credit, you can read F.A. Hayek’s Denationalisation of Money: The Argument Refined online here.

Regards,

Patrick Cox
for The Daily Reckoning

Banking on Your Phone originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Overnight, it’s been a roller coaster ride, with the euro (EUR) being sold ahead of the French bond auction, and then recovering after the auction results, which were not bad results, as yields on their bonds fell… The same result in Spain this morning, too… More baby steps of stabilization… However, Greece continues to weigh heavily on the euro, and all other currencies as far as that goes. The ECB remains on the sidelines, and I think they’ll remain there for some time, waiting until the last minute. This is worrisome for the markets, and I think a statement by the ECB that they remain the lender of last resort would go a long way here…

The other day, I told you that German Chancellor Angela Merkel was going to China, not to bash the Chinese for their currency policy, but to gain China’s confidence in the eurozone. In Merkel’s meeting today with Chinese Premier Wen Jiabao, Wen stated, “China is still researching the best way to participate in the European Financial Stability Facility (EFSF).” That’s a good sign…

As I’ve said for over a year now, China knows the steps it needs to take to become a world leader, and push the renminbi (CNY) to the front of the class for reserve currency status. And one of those steps is becoming the world’s financier, like the U.S. did after World War II. China already performs this function here in the U.S. and has taken the back road into Europe, but I think the country will increase its financing of eurozone debt as it wrests the title of world’s financier away from the U.S.

Gaining a wide distribution of the renminbi is another step that China has begun, as I’ve reported here. This whole change for China isn’t going to happen anytime soon, but it will happen at some point in the future… I’m thinking 2020, but could be as soon as 2017…

Yesterday, I told you how manufacturing reports in Germany, China and Australia were all stronger than expected. The U.S. version of this report was strengthened from December, but was not as strong as forecast. But the U.S. version has a good grip on expansion at this point. The weak dollar helps, and I know you’re going to say, “But Chuck, the dollar has been stronger recently…” Yes, it has… but it’s still weak!

Moving on… I found this to be a case of the kettle calling the pot black… Japanese Finance Minister Jun Azumi took a shot at the U.S. Fed and their interest rate policy last night. First, Azumi was warning the markets about the yen’s (JPY) strength, and how he was in a position to do something about it (intervene by selling yen). And then he said, “Speculative moves are increasing in the market, and we can’t overlook them. Against the backdrop of the Fed’s plan to keep interest rates exceptionally low until 2014, short-term speculative buying has increased, contributing to the yen’s gain.”

Speaking of the Fed… They sure have had a pile of junk thrown at them and will continue to have it thrown at them… You see, government spending has been a HUGE part of economic growth measured by GDP. Now, everyone would love to see the government out of the deficit spending deadly cycle they’ve been on for some time… And they will attempt to do so, starting next year. But what becomes of the economy, if the piece that the government spending was taking up isn’t taken over by something else? Ahhh, grasshopper, you have become so smart! Yes, the economy circles the bowl…

There were a couple of reports done recently that outline the hit that the economy will take in 2013 and beyond as the government withdraws their support of the economy… JPMorgan Chase’s guy thinks that 1% of GDP will be lost in 2013, as $500 billion in spending cuts come on board in January 2013. And then another $250 billion gets taken out by allowing the Bush tax cuts to expire. Bank of America’s guy thinks the hit will be worse… He believes that the first hit will be $586 billion at the end of this year. And then $100 billion per year gets taken out, as required by the agreement when lawmakers couldn’t agree on spending cuts.

I’m all about less government and less government deficit spending. And if we have to suffer through withdrawal pains, then that’s what we need to do. We have to break this addiction to government deficit spending.

Let’s talk about something else. The other day I told you that the Aussie dollar (AUD) had climbed back above $1.06, and the next line of resistance wasn’t until $1.0770, so it had “room to run.” The A$ has climbed above $1.07 now, so the “room to run” is growing smaller. But that’s just a line of resistance. There’s not a “hard stop.” The A$ reached $1.10 and change last year, so it does have that ability. The one thing that concerns me is how quickly this move higher has happened. Let’s not get ahead of ourselves here, A$ traders.

I read this morning that the Canada Pension Plan Investment Board, which manages about $155 billion, plans to increase its longer-dated investments in Australia to boost returns. The pension board already has about $10 billion allocated in Australia and the A$. Pretty interesting stuff here.

Speaking of Canada, Canadian manufacturing wasn’t on par with the reports from Germany, China and the U.S. yesterday, as it slipped a bit in January. The stronger Canadian dollar/loonie (CAD) can be blamed for that. I’m not concerned here. Canada has the “stuff” other countries want, and will continue to attract investment.

Gold is eking out another small gain this morning, after adding about $5 to its value yesterday, it’s up $4 this morning. I would rather see these small moves that fly under the radar than the wild swings we’ve seen in recent years.

A little game today of “who said this?” I’ll give you this quote and you guess you said it. The answer is at the end: “Gold, unlike all other commodities, is a currency. And the major thrust in the demand for gold is not for jewelry. It’s not for anything other than an escape from what is perceived to be a fiat money system, paper money, that seems to be deteriorating.”

Remember yesterday when I told you that the Congressional Budget Office had forecast that the U.S. will print a trillion-dollar budget deficit for the fourth-consecutive year in 2012? I completely forgot to mention the most important thought on this forecast. The CBO has also forecast that the budget deficit in 2013 will narrow and in future years will continue to narrow. Just how did the CBO come to that conclusion?

First we have the reduction of deficit spending that we talked about above. And then the real reduction comes from an increase in government revenue for future years. You know what government revenue is, don’t you? Taxes! In fact, the CBO believes that taxes will increase by 30% in the next two years!

There are still people out there that think having debts are OK. When taxes to the public have to rise 30% to help pay for them they are not! And that’s just the tip of the iceberg. As each year comes from here on out, large numbers of baby boomers are going to hit the retirement age. And those unfunded liabilities I told you about last week? I guess we’ll solve that problem when we get there, eh?

To recap, the New York traders didn’t reverse the currencies’ overnight gains yesterday, and the currencies and metals were allowed to add to their gains all day! The gains were small, but still gains. China is mulling over how to participate in the EFSF. It’s easy: Write a check! U.S. manufacturing was up nicely in January, and Canada’s was down slightly. And the CBO’s bomb they threw at us is a doozy!

Oh, and the answer to our game of “who said this?” is… Alan Greenspan!

Chuck Butler
for The Daily Reckoning

Who’s Still OK With Deficit Spending Now? originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Okay, so the insiders didn’t exactly say their stock is a “sell,” but they didn’t need to. Their feet did all the talking. Last week, nine Goldman insiders scurried away from their stock as fast as the law would let them.

They cashed out $20 million worth of stock at an average price of $107.44. This is the very same stock (NYSE:GS) that Goldman — on behalf of its shareholders — spent $21 billion buying over the last five years. The average price of those purchases was about $171 per share.

Here’s our question: Why is Goldman’s stock a “Buy” for shareholders at $171 a share, but a “Sell” for insiders at $107 per share?

Something’s wrong with this picture. Or, to change metaphors, something’s rotten with this onion. Let’s peel it back until we find the source of the stench.

First data point: Goldman’s revenues and earnings are falling even faster than its reputation. Two weeks ago, the company reported a whopping 58% drop in fourth quarter earnings, compared to 2010.

This latest quarterly report punctuates a troubling three-year trend. Goldman’s full-year net income hit a record $13.4 billion in 2009, then slipped to $8.4 billion in 2010 before tumbling to $4.4 billion last year.

Reflecting this downward earnings trend, Goldman’s share price has plummeted from its 2009 high of $192 to the current quote of $111. Perhaps the stock has now reached “deep value” territory. Then again, cheap stocks have a way of becoming even cheaper when a company’s core operations are in “deep trouble” territory. Goldman’s core operations may not yet be in deep trouble, but they seem to be wading into shallow trouble, at least.

Strangely, the worse Goldman’s operations perform, the more aggressively the company repurchases its own shares. During 2009 and 2010, Goldman spent 71% of its net income buying back its stock. But last year, the company spent a whopping 264% of net income buying its stock. Even after excluding the repurchase of preferred stock from Warren Buffet, Goldman still spent a hefty 140% of its net income buying its own shares last year — double the rate of 2009-10.

Furthermore, Goldman did not buy back its stock very opportunistically. In other words, Goldman did not “buy low.” The company paid an average of $128.33 for the shares it acquired in 2011, compared to a low tick for the year of $84.27 and a current quote of $111. Is it not a little strange that the same Wall Street firm that is supposed to be packed to the ceiling with genius traitors couldn’t trade its own stock any better than a raw amateur?

When stewards of the company are trying to build shareholder value through a share-repurchase strategy, they usually try to buy their stock on weakness…and only on weakness. By contrast, when the stewards are trying to build personal checking account value, they buy their stock aggressively, no matter the price.

Just maybe, Goldman’s “investment” in its own stock was executed so carelessly and unprofitably (so far) because it had nothing to do with investing, but everything to do with lifting the stock to levels that would reward Goldman’s stock-laden partners.

Last week, the top brass at Goldman cashed in $20 million worth of stock that had been “locked up” for the last three years. (The nine privileged recipients also received another $27 million in stock that they did not sell immediately). “Starting in 2009,” Reuters explains, “Wall Street banks began shifting more of their bonus awards into stock that executives are required to hold for multi-year periods in an effort to align incentives with long-term performance.”

But as it turns out, “aligning incentives” is trickier than it sounds, especially if management is repulsed by the idea of aligning its incentives with the common shareholder. Under the new and improved “aligned incentives” era at Goldman, for example, the top insiders still found a way to enrich themselves at the shareholders’ expense. The only shareholders to enjoy an alignment of incentives were the ones in the mirror.

As noted above, Goldman’s management spent $21 billion of the shareholders’ capital buying GS stock in the open market at an average price of $171 a share. Today, the stock sells for $111. On a mark-to-market basis, therefore, Goldman’s stock buy-back “investment” has produced a loss of about $7.3 billion for shareholders — or more than the company’s total net income during the last five quarters! That’s the bad news. The good news is that these share purchases helped support the share price so that the top nine guys at Goldman could sell their stock for $20 million.

I think we just found the source of that stench.

Just maybe, the company could have identified a better investment opportunity during the last three years than its own stock…like a Treasury bond or an S&P 500 Index fund — both of which have been rising while Goldman’s stock has been sinking.

Goldman’s CFO, David Viniar begs to differ. Two weeks ago, when discussing Goldman’s share re-purchases in 2011, he said he felt “relatively certain that at some point we’re going to wish we bought back more.”

No doubt! Viniar still holds more than one million shares of GS! CEO Blankfein holds more than two million shares. “Aha!” the Goldman apologists might say, “You see, their incentives are aligned with shareholders.”

“Think again,” we would reply, “If this particular crew of insiders did not hold so much Goldman stock, they probably would not be blowing so much of their shareholders’ capital buying it. But these particular insiders have demonstrated repeatedly that they will squander shareholder capital to pay almost any price for GS, while they, for their own accounts, will unload GS at almost any price.”

If incentives were truly aligned, you would never observe a gaping spread between what the shareholder pays for his stock and what the insider is willing to receive for his stock. If the stock is a “Buy” for shareholders at $171 a share, then it is also a “Buy” for Lloyd Blankfein and David Viniar at the same price, or any price below that level. But the last three times these guys unloaded large chunks of stock — August 11, 2010, January 25, 2011 and last week — they realized average prices per share of $150, $162 and $107.

On the other hand, if the stock is a “Sell” at $107 for insiders, why did the company spend $6 billion in 2011 to pay $128 per share for the stock?

One final curiosity about Goldman’s hefty share repurchases in 2012: They took place in the midst of a period of high market volatility and uncertainty — a period during which the Federal Reserve was mandating all banks to bolster their balance sheets.

“Under the Fed’s Comprehensive Capital Analysis and Review, or CCAR,” Bloomberg News explains, “US lenders must prove they have enough capital to withstand a ‘severe’ US recession before they can increase dividends or repurchase shares.”

Despite this mandate, however, Goldman continued churning through its precious capital to re-purchase its own shares. This process has contributed to a steady erosion of its Tier 1 Capital ratios since early 2010.

Although Goldman’s Tier 1 capital still remains relatively healthy, it is moving in the wrong direction. During the last two years, most major financial institutions have been ramping up their Tier 1 capital — i.e. strengthening their balance sheets. But not Goldman. In fact, as of year-end 2011, Goldman’s Tier 1 capital — at 13.8% — had dropped to within a whisker of Citigroup’s — at 13.6%.

A 13.8% capital ratio may be just fine in most market environments, but it is hardly disaster-proof. For perspective, Goldman’s Tier 1 ratio was 11.6% on the eve of the 2008 credit crisis. That “conservative” capital buffer would have sent Goldman into bankruptcy during the crisis, were it not for the infinite Tier 1 capital of the US Treasury.

“We put in what we want to do and the Fed tells us yes or no,” David Viniar, Goldman’s Chief Financial Officer, told analysts when asked how the bank was able to spend so much more on buybacks than it earned.

From all outward appearances, this process has always operated in reverse: The Fed tells Goldman what it wants to do and then Goldman says “yes” or “no”… but usually “yes”… as long as Goldman’s trading desk is properly positioned.

The US stock market may be a “Buy,” just as O’Neill predicts. But Goldman is a “Sell”…until the day it disappears completely.

Regards,

Eric J. Fry,
for The Daily Reckoning

Goldman Sachs is a “Sell” originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The Great Correction seems to be going along just as you’d expect. Or, just as we’d expect.

Here’s the latest from Reuters:

Home prices fell more steeply than expected in November, and consumers turned less optimistic in January, highlighting the hurdles still facing the bumpy economic recovery.

The S&P/Case-Shiller composite index of single-family home prices in 20 metropolitan areas, released on Tuesday, declined 0.7 percent on a seasonally adjusted basis, a bigger drop than the 0.5 percent economists expected.

Separately, an index of consumer attitudes fell to 61.1 in January from 64.8 the month before, as Americans turned gloomy about the job market and income prospects, said the Conference Board, representing private companies.

Some improving housing data in late 2011 had raised hopes the recovery was finding its footing. But weaker numbers this month have underscored how lengthy the healing process will be.

US housing prices have plunged by about a third from their peak before the financial crisis, and a combination of high unemployment, tight mortgage lending conditions and more foreclosures in the pipeline are holding back a recovery.

A report released on Monday showed spending was flat in December as Americans focused more on saving.

Once a key pillar of the US economy, Americans have taken a more frugal tack as many struggle with hefty debt burdens.

And guess what? The Great Correction is having the same effect in Europe. Here’s The Wall Street Journal:

LONDON — UK households made a record repayment of personal loans and credit card bills in December, Bank of England data showed Tuesday, underscoring households’ limited appetite for spending and heightening fears the UK may slip back into recession.

BOE figures showed UK consumers made a net repayment on unsecured loans of £377 million ($592.3 million) in December, the highest figure since records began in 1993. It was also the first time since last January that repayments exceeded new borrowings…

In some ways the situation in Europe is worse than in the US, depending on where you are. Youth unemployment is up as high as 50% in some areas. Even in supposedly strong economies it is around 20%.

And, oh yes, you want yield? How about a 10-year note from Portugal? It comes with a yield of 17%.

Portugal’s economy is shrinking at a 5% annual rate. Italy, Spain, Greece and Ireland are not in much better shape.

So what do the euro-crats do? Same thing as the US-crats. They give the banks money, hoping the nice bankers will spread it around.

Last month, the European Central Bank provided 489 billion euros in 3-year loans. “Super Mario” Draghi — formerly head of the bank of Italy, now head of the ECB — keeps the banks from going bust…and begs them to keep the governments from going bust.

The banks needed about 230 billion to refinance loans coming due in the first quarter of this year. They got the money from the ECB.

What a show! Draghi, Monti, Papademos and all the other ‘technocrats’ now managing the crisis are the very same guys who created the crisis. They worked for Goldman, ran central banks, and helped organizations such as the IMF and the World Bank make a mess of the world’s financial system.

Now, they’re solving the crisis the same way they caused it — by creating more debt. The banks can’t pay their bills so the central bank lends them money. Governments can’t pay their bills either, so the central bank lends them money so they can lend it to the government.

The ECB says it will give away more money on February 28th. Goldman Sachs is advising other banks to take the loot. As much as $1 trillion could be given out.

Let’s see, how does this work? You are deeply in debt. So, the bankers lend you money so you can continue making payments. You go even deeper in debt…and the bankers lend you more money so you can keep making payments…

…and so on…

Where does this end? We don’t know.

Whee!

Bill Bonner
for The Daily Reckoning

Creating More Debt to Solve the Crisis originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The specific O’Neill that Taibbi mocks is Jim O’Neill, head of Goldman’s Asset Management department. “It seems,” Taibbi observes, “that O’Neill is predicting that the United States stock market may go up ‘15 to 20 percent [in 2012].’”

On its face, this prediction seems pretty tame…and harmless. But Taibbi — like many other cynical financial market observers — has learned to regard every pronouncement from Goldman Sachs with suspicion. Recent experience has demonstrated that “tame” and “harmless” are attributes that rarely operate within the Goldman Sachs business model. “Conniving” and “conspiratorial” seem much closer to the mark.

According to Goldman’s critics, the investment bank’s “recommendations” often advance a self-serving agenda. A “strong buy” recommendation from Goldman, for example, could mean the Goldman trading desk already owns the recommended security and is looking to unload its position into a rising market.

“The folks at Zero Hedge long ago caught on to Goldman’s pump-and-dump vibe,” Taibbi reports. “Here’s what they said when Goldman upgraded European bank stocks a few weeks ago:

Goldman has just started selling European bank stocks to its clients, whom it is telling to buy European bank stocks…Translation: run from European bank exposure.

Sure enough, Euro bank stocks plummeted a few days after that Zero Hedge post.

As a result of Goldman’s alleged — albeit unproven — “pump-and-dump vibe,” its recommendations often seem very poorly timed (from the standpoint of its clients), which, of course, would make them very well-timed from the perspective of Goldman’s trading desk.

“Goldman is building an impressive résumé of sweepingly bullish predictions that later on, in retrospect, look more like signals to investors that they should have run screaming in the opposite direction,” Taibbi remarks. “A good example might be May of 2008, when Goldman boldly predicted that oil would go to $200 a barrel; oil would go on to peak at $147 less than two months later and crash to the floor soon after… Anyway, every time I read one of these rah-rah predictions, I get this feeling that I’ve seen this movie before.”

Concerning Goldman’s bullish outlook on US stocks, Taibbi remarks, “O’Neill apparently believes Ben Bernanke and the Federal Reserve will resort to another round of money-printing, and finally green-light the long-awaited ‘QE3,’ or third round of ‘Quantitative Easing.’

“The QE programs,” Taibbi continues, “involve the Fed printing hundreds of billions of dollars and pumping them into the marketplace, where they ostensibly stimulate the economy (although recent experience tells us that the money mostly ends up being swallowed by the financial services industry — but that’s another subject for another time). Anyway, Bernanke declined to go ahead with a third QE program in late 2011, but O’Neill apparently thinks we’ll get it in 2012.”

O’Neill is hardly the only Wall Street bigwig to predict rising share prices in 2012. And a 15% to 20% gain for the S&P 500 is hardly an outrageous forecast. So why does Taibbi make a big deal out of it?

Probably because of that old expression, “Fool me once, shame on you. Fool me twice, shame on me.” Goldman’s high-stakes hijinks are infamous. Remember, this was the firm that continuously packaged and sold mortgage-backed securities (MBS) to its clients, while simultaneously building a meaningful short position in the identical (or very similar) mortgage-backed securities. This practice was perfectly legal, but it was also perfectly scummy.

It was a little like selling tickets for an ocean cruise, then buying a disaster insurance on that particular cruise because you had some knowledge that the ship was barely seaworthy. Hey, you didn’t force anyone to buy a ticket for the cruise; you simply designed the cruise, then marketed it and sold tickets.

So if Goldman devoted itself to a series of perfectly legal — but morally bankrupt — business practices during the go-go years of 2005 to 2008, would it not be tempted to do even more of the same during the grim conditions of 2011-12?

Likely…which is just one reason why Goldman Sachs is probably not a “Buy.” Tomorrow we’ll share one reason why it probably is a “Sell.”

Regards,

Eric J. Fry
for The Daily Reckoning

Goldman Sachs is Probably Not a “Buy” originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

We begin another week pulled in two directions: In one direction lie unresolved failures in policy… and the mayhem it has wrought in the financial system. In the other lie breakthroughs in energy and biotechnology.

There’s no real point in wagering on which of these trends will ultimately “win out.” It’s entirely possible the system can fly apart even as scientists and entrepreneurs stick to their knitting and achieve great new things.

The stress we alluded to last week is borne of the fear that the former — i.e., Hellish Financial Crisis Is on Its Way — will prevent the benefits of the latter from ever seeing the light of day.

If that happens, well… then… in the immortal words of the Mogambo Guru: “We’re all freakin’ doomed!”

Until such an event, however, we’re left to our own devices. We’ll continue to do what we do each day. We’ll follow the breadcrumbs. Let’s get started and see where they lead today…

“TARP is not over,” Christy Romero, acting inspector general of the Troubled Asset Relief Program, reminds folks of the program through which she derives her own power, prestige and paycheck (PPP).

Congress authorized $700 billion. $413.4 billion was paid out. Only $318 billion’s been paid back, according to a new report from Ms. Romero.

So much for the shrill lecture delivered last fall by CNN’s Erin Burnett to an Occupy Wall Street protester: “Taxpayers actually made money on the Wall Street bailout.” But what would you expect from someone engaged to an executive at Citigroup?

Getting the rest back will be no easy task: For starters, General Motors stock would have to more than double from $24.28 to $53.98.

Another trend that’s “not over,” we note, is bank shutdowns. The FDIC swooped in and closed four banks Friday night. (Yes, it’s the return of our own watch list for failed banks and the feds’ attempts to save them…)

Two of Friday’s victims are in Tennessee, where the last bank failure took place in 2002. The others are in Florida and Minnesota.

That makes seven banks for the month of January — an annual pace of 84. Close to last year’s total of 92, but lagging 2010’s peak of 157. (Who knows, maybe things will pick up in the spring!)

There is one notable increase: the FDIC’s “loss ratio.”

Of the 92 bank failures last year, FDIC losses totaled 20% of the failed banks’ assets. So far this year, it’s 32.9%… nearing TARP territory.

The deleveraging of the U.S. consumer is “not over” either.

The monthly “income-and-spend” figures from the Commerce Department reveal consumer spending was ruler-flat between November and December. Consumers, indeed, got their shopping done early.

Personal income, on the other hand, grew 0.5%. Gee, what a bunch of tightwads Americans have become.

“The capacity for households to carry on to be the engine of growth that they have been in past recoveries is simply not there,” says economist Carmen Reinhart of the Peterson Institute.

She points to figures showing that in the third quarter of last year, household debt totaled 86% of GDP. That compares with 47% as Americans climbed out of the “double dip” recessions in the early ’80s.

By the way, that same Commerce Department report features the “core personal consumption expenditures,” the Fed’s favorite measure of inflation.

Last week, you may recall, the 2% “inflation target” ceased being an “unspoken agreement” and became “official policy.” According to the numbers, the year-over-year increase in December was 1.8%. So in the estimation of the monetary mandarins, there’s still not enough inflation in the system.

Addison Wiggin
for The Daily Reckoning

Trends that Won’t End originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Dow up by 80-something points. A barrel of the world’s currently-preferred energy sits pretty at $100, on the nose. Nothing much, in other words.

Ooh…but here’s something: “Gold extends post-Fed rally to 6-week high.” MarketWatch has the story…

Gold prices climbed Thursday to levels last seen in early December, extending a rally triggered as the Federal Reserve pledged to hold US interest rates near zero until the end of 2014.

Gold for February delivery, having risen almost $25 yesterday on the news, now fetches $1,725 an ounce. And this, just when investors had begun to abandon the barbarous relic, to question its motives. But that was their mistake. Gold may go up. It may go down. But it has no motives. It is no man’s liability. Instead, it simply holds a mirror up to its government-issued competition. It is, itself, just a dumb lump of metal. But even so…it frequently appears the brighter, smarter choice — in relative terms — to the buffoons in the mirror.

Should we be surprised?

So Mr. Bernanke is fiddling the levers again, promising to keep rates lower than a sea snake’s belly until 2014. He might have just taken out an ad in the front page of the paper:

“Fed to Savers: Go to Hell!”

America’s #1 central banker may well be highly intelligent…but that does not preclude him from also being a dunce. Probably, it depends on the subject at hand. Maybe he’s a talented cowboy, for example. Or perhaps he is a whizz at the Times’ crossword. Either way, we wish he’d dedicate more of his time to words and herds because, as a central banker, he’s either a fool, a knave…or both.

This is a man, let us not forget, who proclaimed…

• In 2005, on the question of a speculative bubble building in housing as a result of cheap credit, that “these price increases largely reflect strong economic fundamentals.”

• In 2007, as the market started to turn, “we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

• In January of 2008, two months before the nationalization of GSEs Fannie Mae and Freddie Mac, “They will make it through the storm.”

• And in June of 2009 that, “The Federal Reserve will not monetize the debt.”

And now, despite all evidence to the contrary, Mr. Bernanke thinks he can pull the economy out of the very mess into which he helped to steer it. He thinks he can deliver prosperity to a nation by punishing savers and inducing malinvestment — gross capital misallocation — on a scale so grand that die-hard proponents of Social (In)Security must be starting to blush.

Bernanke’s commitment to holding interest rates “exceptionally low” for an “extended period,” reeks of exactly the kind of insanity required to double down on a bad bet, of repeating the same experiment and expecting a different result. Combined with his “relapse into QE3, Euro-style,” which Eric Fry highlighted in yesterday’s issue “Gentlemen, Start Your Printing Presses!”, dollar-holders (and metal holders) ought to expect more of the same.

Critics, amazingly enough, still wonder when the man will ever learn. Never, is our guess. For one thing, his incentive for denial is simply too great. What do we mean by that? Glad you asked…

Imagine someone’s whole existence, his entire life’s work, is somehow built on a false grasp of reality, a radically skewed first principle. Imagine, for example, he is an internationally respected professor of alchemy. Or a world renowned proponent of the “stalk theory” of conception. Or…a central banker who believes he can know the impossible…the minds, the desires and the needs, of the millions who make up the market over which he imagines himself to lord.

For a while, luck, coincidence and the arc of history appear to be on his side. As his life goes along, our hapless hero is awarded greater and greater accolades for his misbegotten theories and crackpot ideas. He is gifted the highest seat in the land. The adoration of friends and peers. TIME Magazine’s “Man of the Year.” Eventually, he comes to believe in the delusion he has created. It becomes his reason for being, his raison d’etre. Deeper and deeper he becomes convinced in his own ability to perform the impossible.

One can see that our hero, sadly mistaken as he is, has every incentive to deny reality when (especially when) it is presented to him facts and all. Tell the alchemist he cannot alter the properties of led and his world, as he knows it, as it comforts him at night, begins to crumble. Likewise for our birdbrained OBGYN.

So let the evidence against Mr. Bernanke’s understanding of reality mount. As it will continue to do. We don’t imagine this man, whose entire reputation, whose entire career, rests on a false reality, is going to suddenly about-face anytime soon. He has every incentive to deny the facts, to look the other way.

Of course, it’s easy to deny reality. Not so easy, as Ayn Rand once quipped, to deny the consequences of denying reality. They will come due soon enough, Fellow Reckoner…and then, as Bill Bonner likes to say, all the Fed’s horses and all Obama’s men won’t be able to put Mr. Bernanke’s economy back together…ever again.

Joel Bowman
for The Daily Reckoning

How Ben Bernanke Rationalizes “Exceptionally Low” Interest Rates originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.