One Big Ugly Thing

In an economy that reaches for prosperity by printing and spending more and more money, a certain side effect will inevitably throw a wrench in the works…

"Fed governor Bernanke believes that it is the low interest rate policy of the Fed that has laid the foundation for a sustainable economic expansion," writes Frank Shostak, one of the big-brained guys with an Austrian-school bent who often shows up on the Mises.com website. "The governor argues that the low interest rate policy has been instrumental in revitalizing household and business balance sheets."

Now, if you are like me, and I can only pity you if you are, then you automatically disagree with anything that Ben Bernanke says, does, or thinks, and if I could get some full-length shots of him perhaps I could muster up a little criticism of his wardrobe, maybe his posture, and if his nose was too big perhaps I could get in a few shots about that, too. As concerns macroeconomic policy, especially monetary policy, then in the majority of cases you have a duty, as a thinking human being who can read, to criticize him without pause, and you would be absolutely right to have done so.

This is one of those times. How in the hell can Bernanke – and I find that I am beginning to say this man’s name with a hollow monotone that signifies cold hatred and loathing – possibly believe that balance sheets are "revitalized" by these low interest rates? Only a crazy person could POSSIBLY believe that "revitalized" is defined to mean "Being saved at the last minute from imminent destruction, by merely postponing and intensifying the destruction."

Mr. Shostak seems to agree with me, in his own fashion, and continues, "But how is this possible given the massive load of debt relative to income? Moreover, how is it possible that a sustained economic expansion can commence while savings have almost disappeared? The so-called recovery that we are currently observing is nothing more than a reshuffling process of real funding from wealth-generating activities towards wealth-consuming activities." Now, I go far, far, farrrrrr beyond that, and say that this "so- called recovery that we are currently observing" is nothing more than raw government spending.

Deficit Spending: Hedonic Measurements

To prove my loudmouth assertion, Fred Hickey, editor of The High Tech Strategist says, "Over the past couple of weeks, I’ve listened to scores of tech company conference calls. In nearly every case, from Cisco to Foundry to Motorola to CDW, the story was the same – their best customer was the U.S. government."

It has already been shown [often by Dr. Kurt Richebächer himself in these pages] how the government uses hedonic measurements, so that each of those dollars of sales of technology is actually multiplied by about six times, as I recall, so as to account for the increase in power per dollar. So, and I love this stuff, their "best customers," i.e. the government, are actually SIX new "best customers," since each of those dollars in sales is multiplied by six. And there was no, none, zero, zip effort, or money spent, or time consumed, or raw materials transformed! Therefore, the astonishing 7.2 increase in productivity pales before the gigantic GDP gain of these technology sales to the U.S. government, being, as they are, mere hedonic measurements, and therefore are completely bogus. And don’t "bogus" and "Federal Reserve" seem to cleave so naturally together?

And as much as I loath Keynes and everything he stood for, I gotta grudgingly admit that he was right about one thing: it is NOT okay to run deficits forever. And deficits ARE good for stimulating the economy during downturns. The point of disagreement I have with him here is not whether deficit spending can stimulate the economy, but whether or not the stimulating is a good thing. I say it is not, in general, a good thing.

For instance, the government spending borrowed money so as to buy guns and tanks will certainly stimulate the defense industry, and there will be the inevitable spillover effects into the general economy that will generate some macro-economic benefits in the aggregate, as the employees of the defense industries cash their paychecks and buy things and services. And the defense industry will borrow and expand, and ramp up production, and consume goods and services, and everybody will have a wonderful time making money, and the economy will be permanently altered. Then, one day, the powers-that-be will decide that they don’t need any more guns or tanks, and then the party is over, and then what in the hell does everybody do? The whole economy depends on making guns and tanks!

Deficit Spending: Why I Hate Deficit Spending

And that, in a nutshell, is the reason why I hate deficit spending, and much prefer that the powers-that-be just let the country sink into a cleansing recession, so that the waste and stupidities are washed out, including the elected yahoos that got us into the mess to start with, the resources are put to uses that correspond to real demand by real people who have real money to spend, the morons who invested in the stupidities and mal-investments are wiped out, and everybody learns a little lesson from watching those guys standing in the welfare lines because they speculated on such superfluous gee-gaws and gimcracks, and lost everything for their stupidity.

But here we are with Alan Greenspan, Ben Bernanke and all the rest of those pompous jackasses who call themselves "economists" – and I laugh – Hahaha! – in mirthless glee at the sheer gall it takes for them to do that – who work at the Federal Reserve, and who all think THEY have found a way to make this scheme work. So, apparently it CAN be done, even though it has never, ever worked before.

Unfortunately, all that extra money and credit will work its way into prices, because that is where the money always goes, as has been proved by unanimous historical precedent. Sometimes the bulk of it goes into the prices of assets, like now, where we witness the rise in stock prices far beyond anything that has been seen before, or into loaning deadbeats money to go farther into debt than they have ever gone before, where we also witness the rise in bond prices far beyond anything that has been seen before, or into real estate, and we witness the rise in housing prices far beyond anything that has ever been seen before, or into the expansion of government and government programs, where we witness a government that is larger than anything that has ever been seen before, and with its attendant wealth- redistributing programs, more and more of them, overlapping and contradicting one another, all competing for a larger and larger share of the economy, the ones that doom us as a nation, that are larger and more epidemic than anything that has ever been seen before.

Deficit Spending: The Economy Is Being Destroyed by the Fed

You will probably notice by the way my voice has raised to a high-decibel, piercing squeal that I am getting so angry that I am on the verge of ripping this awful straightjacket right off and going absolutely berserk. And the reason is that it is this rise in prices that is always the thing, the one thing, the big thing, the One Big Ugly Thing that ultimately destroys the economy, any economy, that tries to print and spend money. Ergo, the economy of the United States IS being destroyed by the Fed, and WILL be destroyed by the Fed and their coterie of ignorant, self-important morons, as exemplified by the aforementioned Ben Bernanke. Like I said, it is as simple as that.

As Exhibit A in defense of my argument, I present Jeffrey Tucker, who reports that "Federal discretionary spending expanded by 12.5 percent in the fiscal year that ended Sept. 30, capping a two-year bulge that saw the government grow by more than 27 percent."

As Exhibit B, I say take a look at the labor strikes, the calls for higher minimum wage, the demand for prescription drug benefits, etc. as what they are at root: Demands for relief from prices that are always rising faster than incomes, and has now made so many things unaffordable.

This is always the result of excess money and credit. Get used to it, because it gets worse, a lot worse, from here on out.

Kind regards,
The Mogambo Guru for the Daily Reckoning

November 24, 2003

P.S. And in the end, what will happen, because it has to happen, is that prices will rise and rise, and the poor will end up in worse shape than they are now. And the more extreme the level of government mandates, the more extreme the level of misery that will be inflicted on the most vulnerable of the society; the poor, the sick, the old, the retired, the retarded, and the children. And it will get worse and worse and worse, and then one day it all boils over.

—Mogambo Sez: If you want a real good piece of investment advice, take it from me, the Mogambo, and buy things that are going to be a hell of a lot higher in price in the future. Like gold. And unlike near anything else you can name.

Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it. The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications.

We first mistook the magazine in our hands for TIME. Its cover story, "Life on Credit," seemed to describe America’s consumer economy.

Looking closer, we discovered that the magazine is INDIA TODAY, published not in New York, but in New Delhi. Its feature article describes the state of consumerism on the subcontinent, not in the 50 states.

"Indians have never had it so good," begins the article. "Low interest rates and easy access to cheap loans afford them the chance to upgrade their homes, cars and lifestyle, including that Caribbean cruise they always longed for. And they are going for it."

They are going for it all over the world, dear reader. And we know why.

"How did we get so lucky?" asks India Today.

"A lot of jobs are coming to India – because of the rush of outsourcing, experts and the growth in the domestic economy. This is creating a flow of income in the hands of people, and people are now more willing than ever before to borrow on the strength of income flows."

We have no study of the Indian economy. Our ignorance is near total. But what we lack in information we are more than ready to make up with theory. Our guess is that India is merely another of the many nations to be touched by the magic wand of the International Dollar Standard System.

You will recall, dear reader, that in 1971, Richard Nixon made a daring and desperate move. After nearly two centuries of happy marriage to a gold standard…interrupted only briefly and regrettably, in time of war…the president turned his back on the nation’s faithful companion and ran off with paper money. Since then, it’s been whee! and whoopee! all over the planet. Dollars – not gold – have fluffed out banker’s vaults all the world over. Unlike gold, the quantity of dollars has no practical upper limit. All a nation has to do is to sell products to the U.S., and it will soon find itself with a multitude of them.

Then, something funny happens. The dollars act as ‘high powered currency’…the foreign nation’s banks put them in reserve and lend against them….as though they were real money. All of a sudden, the lucky country enjoys a boom. Factories are built, wages rise, interest rates fall, capital assets boom – it is almost too wonderful. That is the story of the Japanese boom…and bubble. Malaysia, Taiwan…China…India…each has its turn.

"In layman’s language, it means people are getting richer," says India Today.

Whether they are getting richer or not, we don’t know. But when a boom begins, people begin to think they are getting richer. They typically stop worrying about the future; they are sure it will be bright and sunny forever.

"Good times are here to stay," adds another headline, no tongue in cheek.

"Why shouldn’t I have the small comforts of life when banks are willing to lend?" asks Maju Sukumaran.

Wages don’t often rise as fast as desire. The gap is plugged with credit and cash flow. Instead of asking the price of a big-ticket item, the new consumers only want to know how much it will cost them per month. Indian retailers have translated this to a simple figure known as EMI or ‘equated monthly installments.’ A new Scorpio SUV, for example, is only 19,712 rupees per month…a Honda Hero motorcycle is only 1,185 rupees each month…a new set of disposable soft contact lenses is only 525 rupees per month…and a Sony Wega Theatre can be yours for only 18,531 rupees each month for a year.

What a marvelous boom! What luck! If India is really lucky…it may even survive…

Over to Eric for more news…

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Eric Fry, in an even ‘luckier’ corner of the world…

– Wall Street’s stock market stumbled for the second straight week, as the Dow Jones Industrial Average dropped 140 points to 9,629 and the Nasdaq Composite fell 2% to 1,894. The dollar also stumbled for the second straight week, slipping more than 1% against the euro to $1.191.

– The gold market – like a patient vulture – observes the dollar’s struggles and awaits an opportunity to feed on its bloodied carcass. Gold dipped $2.00 for the week to $396.00 an ounce, after briefly nosing above $400 an ounce for the first time in more than seven years.

– The yellow metal picked up an extra boost Friday, after Barrick Gold announced it would initiate no new forward sales of gold (a.k.a. "hedges") over the next decade. Chairman Peter Munk, addressing a gold conference in London, called his company’s hedge book, "too large in the current environment." That’s why Barrick has already reduced its forward sales of gold to 16 million ounces from 24 million a year and a half ago…Barrick’s conversion to a non-hedger may be one more bullish indicator for the gold price.

– Meanwhile, the schizophrenic U.S. economy continued displaying its split personality last week. As "Mr. Recovery," the economy produced an 18-year high in housing starts during the month of October. But as "Mr. Slowdown," some of the economy’s largest employers announced some very large layoffs. AT&T Wireless, for example, announced plans to lay off more than 10 percent of its 30,000 workers over the next year.

– The telecom giant plans to export many of its jobs to India. General Motors and Ford also announced similar intentions this week. The two automakers hope to trim costs by shifting many local jobs to workers in India and China. As U.S. jobs paddle oversees like Cuban refugees in reverse, what sorts of jobs will remain here at home? And as U.S. employers shift their operations to lower-cost foreign locales, which companies will remain to employ the next generation of American home-buyers?

– The robust housing starts data encouraged Wall Street’s perma-bulls to remain as perma-bullish as ever. Single- family housing starts in October were the highest on record. Meanwhile, building permits in October surged 5.2% over the September tally, to the highest number since 1984…But again, who will buy the ever-increasing stock of new and existing homes?

– "Builders have been enormously confident about home sales, and it’s hard to find anything out there that points to a significant slowdown," one Wall Street economist gleefully remarked. We do not share this glee. That’s because we understand that a house started is not a house sold.

– A confident builder, like a confident gambler, cannot achieve success merely by wishing for it. Builders can exhibit as much confidence as they like. But unless buyers continue buying, the confidence merely sows the seeds of the housing market’s undoing. In other words, confident builders build lots of houses, thereby helping to depress housing prices overall.

– What a week it was for the dollar and the gold market. As the dollar swooned toward $1.20 per euro, the gold price kissed $400 an ounce for the first time since 1996.

– "Here’s some big news," Addison reported mid-week. "Foreign investors and central banks who have been propping up America’s credit-bubble…have begun to lose faith. Figures released by the U.S. Treasury show net capital inflows to the U.S. fell more than 91% in September, from $50bn in August to $4.2bn.

– "The government took a hit, too, as foreigners bought just $5.6bn in Treasuries, down from $25.1bn the previous month. Drew Matus, an economist with Lehman, states the obvious in the FT: ‘It appears foreigners may have tired of U.S. treasuries.’

– "The current account deficit that the U.S. sports with the rest of the world requires foreigners to sink $1.5 billion into the homeland every day. What happens when foreigners decide not to sign the checks? Well…the dollar falls. Fast. Hard."

– And gold would rally. Fast. Hard.

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Meanwhile…Bill Bonner, back in Paris…

***Alan Greenspan says trade deficits haven’t hurt the U.S. economy. He doesn’t mention it, but they seem to have done wonders for the Chinese economy…and now the Indian economy, too. Yes, trade deficits are the evidence that the residents of Squanderville are squandering their wealth. But as long as there is something left to squander, the nation’s top banker sees no problem. Stephen Roach warns that the trade deficit may rise to $3 billion every working day, by the end of 2004. [More on trade deficits below, from the Mighty Mogambo…]

*** "UK consumers flock to the shops," says the BBC. All over the world – especially the Anglo-Saxon world – the Dollar Standard System encourages people to spend, spend, spend.

*** China, by contrast, has reacted differently. In Asia, generally, people prefer to produce, produce, produce… The Chinese economy has become so overheated that the government has begun to lie about it. It reports 8% growth; independent observers think GDP is growing at a 13% or 14% rate.

*** Gold rose on Friday, but is still trading below $400. Should you buy now and feel like an idiot for not buying at $350? Or not buy now, and feel like an idiot when it goes over $500? Our guess is that you will feel like slightly less of an idiot by buying now. The bull market in gold is still very young. If it follows previous patterns, in a few years…you will feel like a genius. That will be a good time to sell.

*** Reader Byron King calls our attention to a letter from tech stock maven Michael Murphy:

"Last year – in my November issue of Technology Investing – I addressed the concerns of a new subscriber who had lost 89% of his retirement funds in the NASDAQ crash…and felt, at the age of 58, he would never, ever recover.

"I pointed out that three straight doubles would get him back to 88% of his capital. And just one more would take him to 176%. With stock prices so depressed, I thought he’d be likely to squeeze at least the first three doubles into the seven years he had left before retirement."

"In essence," King explains, "if you lost a bundle in techs in the 2000-2001 crash, you can make it all back with…techs in the coming tech boom. And all you have to do is buy tech-stock options that will continuously double your money. Just do that a couple times in a row, and you will be one rich hombre. Hey, I think that the Murph’ is onto something. If you keep doubling your money, you can become fantastically rich. Follow this "perpetual options strategy" for a while, and you will have so much money that you will never be able to fold it all. Has Dr. Greenspan heard of this technique? Adios, national debt. But, shoot…I need some green-buck cash to fund this neat new trick. Hey, wanna buy some gold?"

*** Poor little Edward. He has a young woman who comes over in the afternoons to help him with his homework…and another woman who comes in the evening to check it. After a meeting with the headmaster, his mother is taking no chances. She wants to be sure he does not fall behind while she is traveling in America.

"How the Elite Educate Their Children," is a popular book in France. It was intended as an attack on the educational system and the attitudes of the upper classes, who push their children to do schoolwork night and day in order to get them into the best schools.

But for many ambitious parents, including this writer’s own wife, the book is a useful handbook. Forget the criticism; they just want to know how to do it.

So much of what we know is not worth knowing. Among the things not-worth-knowing is that France is a socialist country. Education, in America, is "free" and very expensive. Typically, the rich pay much more to educate their children than the poor. Our son’s 4 years at St. John’s College, for example, cost about $150,000 in pre-tax earnings. Too rich to need "aid" and too dumb to lie about it…we paid cash.

A reader may get an idea of the desperate state of this author’s finances by realizing that he has 5 more children to put through college. In the Land of the Free, it will cost us about three-quarters of a million dollars, pre-tax. But in France, it would cost us very little; all we would have to do is have children who get good grades. Then, they would have the doors of the best schools in France open to them…at practically no cost.

Since it is the children of the rich – those whose mothers are at home, pushing them to do their homework – who typically get the best grades, it is also the children of the rich who go to the best schools and spend the most time in them. Thus do the taxes of the middle classes subsidize the educational system…and the children of the wealthy.