Who's Paying for the Free Lunch?

No such thing as a free lunch? Try telling that to Easy Al, the mortgage-lenders pal. Of course, today is Monday and the "angriest man in economics" is up in arms…

Richard Duncan, who wrote the book, The Dollar Crisis: Cause, Consequences and Cures has a new essay: Understanding Interest Rates in the Age of Paper Money. In it, he addresses the paradox of the gargantuan borrowing of every financial entity in the United States that should have caused interest rates to increase, since there was such a huge demand for people’s money. Here’s where the paradox lies: The competition for that money would have caused interest rates to rise because the old supply/demand rule says that increased demand should cause prices (in this case, the price of money) to go up. But interest rates did NOT go up. Why?

The answer – you guessed it – because the United States Federal Reserve created so damn much money! So, while there is a big demand for money, and everybody in the United States is issuing debt, the damn Fed and the foreign central banks are creating so damn much money that there is more than enough new money for everybody to get as much as they want! And it’s so cheap that insanely low interest rates are more than enough to turn a profit for the lender, who borrowed the money to make the loan, and is thus merely living off the spread! Therefore, interest rates fall!

Specifically, Mr. Duncan says, "Today, the interest rate on the U.S. 10-year Treasury bond is determined primarily by the relationship between the demand for money from the U.S. federal government and government-sponsored enterprises (like Fannie Mae) and the amount of paper money created by the United States’ trading partners. This, in turn, is generally (but not always) determined by the size of their trade surplus with the United States.

"That’s why interest rates fell. More paper money is currently being created as a result of the rapidly expanding U.S. current account deficit than is needed to fund the budget deficit and the GSE’s demand for credit. This surfeit of money also explains why the interest rate spread on corporate bonds over treasuries is at multi-year lows."

Paper Money Creation: The Price Is Inflation

This is not a free lunch, however many jerk politicians or jerk Federal Reserve people, or jerk American economists flap their lips about it. The price of this monumental mistake, namely printing all this money and credit, will be paid for, as it always is, in inflation. And inflation is the one thing that nobody wants. And the inflation will be measured in Mogambo Misery Units (MMU), which is simply a moving-average of the number of times per day that I look at something and say to myself, "I sure would like to buy that spiffy anti-aircraft cannon to shore up the perimeter defense in the backyard, but the price is now too high!"

And if you want to see the effects that inflation has on people, as measured in MMU’s, ask one of the 50 million Social Security recipients, now equal to a third of the work force and a quarter of adults in the whole country, how their recent piddly 2.7% increase in their monthly benefit is less than how much prices have gone up. Ask them! Ask them how happy they are to have a falling standard of living. As a research project for which I will give extra credit, and so when it comes time to fill out your report card, maybe some of you will have a chance in hell of ever getting out of my class, especially you Democrats who do not believe anything that history says, or anything that textbooks say, or anything the Mogambo says, and most of you could really use this extra credit, so listen up. Ask them to give you a list of things that they had to give up, or are giving up, because they can’t afford them anymore. Then compare that to how they like the prospect of having a similarly falling standard of living for the rest of their freaking lives! And their children, too! And their grandchildren! Go ahead! Ask them!

And even that piddly raise in their Social Security checks is chicken feed, and the recipients of those checks have been experiencing a falling standard of living for quite a while now, as explained by Walter Williams, who writes, "Changes made in CPI methodology during the Clinton administration have understated inflation significantly, and, through a cumulative effect, have reduced current Social Security payments by 30%, from where they would have been otherwise. That means Social Security checks would be 43% higher."

Paper Money Creation: Stupid Old People

So the latest fall in the standard of living for seniors is just a little icing on their cakes, as they are already down by 43%! Hahaha! Stupid old people! They are the ones who always vote en masse, and look who they voted for! The same elected bozos, time after time! And look what these elected officials did to the seniors who elected them! Hahaha! How’s that old saying go? "Getting your just desserts."

"In like manner, anyone involved in commerce, and relies on receiving payments adjusted for the CPI, has been similarly damaged." Well, that is certainly true of the Mogambo, who is usually involved in that part of commerce that says, "Sorry, dude, we didn’t make any money this month, so we can’t pay you, and even if we did make any money we wouldn’t pay you because we don’t like you." And the reason they didn’t make any money is that their costs are all suddenly rising.

But all is not lost! For every winner there has to be a loser, so that the cosmic yin-yang works out, and Williams says, "On the other side, if your are making payments based on the CPI (i.e., the federal government), you are making out like a bandit." See? Don’t you just love how this whole balancing of karma keeps things in neutral? Now you see the cold, hard logic of it all. And Alan Greenspan and Congress are in the heart of it.


The Mogambo Guru
for The Daily Reckoning
November 1, 2004

The consumer continues to dig his own grave.

The economy grew at a 3.7% rate in the 3rd quarter. The number was a disappointment. Economists had hoped for more.

Most of the increase came from "accelerated consumer spending," which grew at a 4.6% rate. Consumer spending is about 70% of the total GDP.

What to make of it?

The typical economist looks at the number and says, "All is well. Consumers are spending. Greenspan is at the head of the Fed. And God is somewhere in Heaven."

But while consumers spending rose, their income remained about even with inflation. Where does the extra money come from?

Oh yes, their houses are going up in price.

Among the many mysteries of modern life, one is how houses can go up faster than the incomes of the people who live in them. In fact, the money they have available for housing is actually going down.

Among other things, energy costs are rising. The average household paid about $6,000 for energy in 2000. This year, it is expected to cost them between $8,000-$9,000.

Part of the reason for this increase is that they are using more energy. In the last few years – largely due to the Fed’s extra-EZ credit – consumers have bought new, bigger cars…and new, bigger houses. In 1970, the average house measured 1500 square feet. Today, it is 2,230.

And today’s house has many more electric devices. Computers. Alarm systems. Microwaves. Televisions.

Meanwhile the price of energy itself is on the rise.

"I wouldn’t be surprised to see $100 or $200 for a barrel of oil in the next five to ten years," says Marc Faber. "It’s not a projection. It’s that I wouldn’t be surprised."

Faber lives in Asia. He looks out his window and sees a huge uptake in the use of fossil fuels. He says, "We [in China] have a per capita consumption of oil of 1.7 barrels. In America it’s 28 barrels, in South Korea 17 barrels, Japan 17 barrels, in India 0.7 barrels. In Vietnam it’s probably also less than one barrel. So, in Asia with the population of 3.6 billion people, we consume less oil than the United States, with a population of 295 million.

"I would imagine that in Asia the demand will certainly double by comparison. Say Mexico has a per capita consumption of 7 barrels, Latin America 4.4 barrels. In Asia, as I said, it’s anywhere around 1.5 barrels."

Asia is where the majority of the world’s people live. It is also the region that has benefited most from Alan Greenspan’s very stimulating credit policies. Making things for people who can’t really pay for them is not a long-term success strategy. But in the short-run, it has caused a huge boom in Asian industry and put trillions of dollars in Asian hands. As long as oil is priced in dollars, Asians can buy a lot of it.

Like gold, oil took billions of years for the earth to make. Nor is it an easy matter to get the earth’s oil into barrels. And unlike gold, the oil that comes to the surface is used up quickly. When it is gone, it is gone for good.

Dollars, on the other hand, are neither mined nor pumped. They are printed. Sometimes, they are merely noted – electronically. Add a zero, at virtually no cost, and you have increased the number of dollars ten times. As time goes by, the consumer will need more oil and want more gold. What he will probably have – and have in abundance – is more dollars.

As Ray Dalio puts it: "An abundance of dollars and a shortage of oil is a dangerous combination."

Here’s more news from our currency counselor :


Chuck Butler, reporting from the Everbank trading desk in St. Louis…

"Friday, we saw GDP disappoint, U of Michigan confidence improve, and the Chicago PM soar! It was six of one and a half-dozen of another, with regard to positive signs for the economy. So, the dollar gave back more of the gains made earlier in the week. In fact, I stayed at my desk on Friday until I saw the 1.28 figure in dollar/ euro!"


Bill Bonner, back in France :

*** Today is a holiday in France – Toussaint, or All Saints Day. It also marks the 50th anniversary of the beginning of France’s war against terror in Algeria. On this day in 1954, terrorist groups attacked 70 targets throughout Algeria. (More on this tomorrow…)

But here at the Daily Reckoning the beat goes on. Our beat is the markets. But what moves the markets? Is it not the people who buy and sell? What moves them to do so? Is it the brain or the heart? One day they are willing to pay $20 for one dollar’s worth of earnings. Six months later, they think $10 is a little pricey – for the very same company.

An ounce of gold may be worth $800 one year. Twenty years later, people pay no more than $400. Has the gold been turned to base metal? Is the world a different place? Has the dollar, in which gold is measured, really worth twice as much?

People move markets. Here at the Daily Reckoning we wonder what moves people. We especially wonder what moves groups of people. Because the markets are not lonely, individual pursuits, and investors are not like Michelangelo lying on his back painting a ceiling. Instead, they are more like infantrymen marching along as part of a great army…or voters on their way to the polls after soaking up weeks of party propaganda…or members of a lynch mob after soaking up hours of whiskey.

A man on his own is a tolerable fellow. He usually does his work passably well, knows right from wrong, says hello to his neighbors, and has his moments of triumph and courage.

Yet, the same man – jacked up by politics or CNBC – will put his hand on the Bible and swear to the most preposterous things.

*** We have never met Rod Martin; we presume he is an honest and decent man. Yet in his ode to Ronald Reagan and George W. Bush, that takes the form of a book called Thank You, President Bush, the man seems to have taken leave of his senses all together. Freedom, he says, making no attempt to explain what he means by the word, is the key to peace and prosperity. This insight, he maintains, is what made both Reagan and Bush such great presidents; they "got it."

And yet, the insight is absurd. America’s most costly war – the war between the states – was fought between two groups of people, both of whom were far freer than Americans today. Freedom didn’t stop them from killing each other.

At the Daily Reckoning headquarters, it’s not that we don’t care about freedom. We just don’t like anyone telling us what to do…and we’re partial to not being killed.

*** The trouble with trying to work in rural France is that there are too many interruptions. Yesterday, a neighbor came to the door, with two bottles of "pineau" – a local aperitif – that he had made himself. It is amazing anything gets done in autumn. The grapes have been pressed. The wines, and various derivative drinks, have been bottled. Now it is time to uncork them.

Serge is a farmer…and a good, hearty chap. He was dressed in a pair of corduroy pants, a wool cap, and a hunting jacket, with torn pockets. He was also dripping wet; it was raining outside, but the local men hardly notice; they go about their business rain or shine.

Like so many men who work the soil, conversation does not come easily to Serge. He always seems to be on the verge of saying something. But the words never quite get out. He begins to purse his lips as though to form a word. Then, we have to guess what it is he wants to say.

"The hypotenuse of a triangle is equal to…" we were about to suggest…when, suddenly and unexpectedly…

"Let’s have a drink," he said.

One led to two…even though the conversation barely budged an inch…and by the time he left we were incapacitated.

The next day, another neighbor came over. He too, had brought drinkables…

"Here is some wine I made," said Clement…"It’s called ‘gray wine.’"

"What’s gray about it? It looks red."

"Well, I don’t know…they just call it gray wine… would you like to try some?"

How could we refuse?

The first drinks made us think of a word: rotgut. We could barely gulp it down; it was like medicine.

"Hmm…a very interesting taste," we said diplomatically. "Not like any wine we’ve ever tasted."

"Glad you like it," came the reply. "Here have another drink."

By the time this session was over, the wine didn’t take so bad. We were afraid we were acquiring a taste for it…which would prejudice us against every bottle of decent wine we drink from now ’til our drinking days are over.

"Not bad…" We finally rendered judgment…after several glasses.

"Great… I made 635 bottles this year. I’ll bring you a few dozen."

"Thanks, that’s great…"

Hardly had our head cleared than another friend appeared in his hunting outfit. Good old Francois. He used to work on the farm, taking care of the cattle. Since he has been retired he still comes over to hunt. But he needs a written authorization from the owner…which we gladly supply. In return, he gives us wild game…and…

"Here," he began, carrying what looked like a 10-gallon jerry can. "We had good grape harvest this year. So I made you some pineau. If you’ll get out some glasses…we’ll try it."

Dear reader, we don’t what lies ahead for the world economy. But whatever it is, it is a great relief to know that we will not have to bear it sober.