The Exorcism of the United States

The Daily Reckoning PRESENTS:Yes, it’s Monday. And while we’re sure you have more pressing matters to attend to, you won’t want to miss today’s offering from the Mogambo. It has it all: math equations, invaluable comments from an esteemed professor, and – a talking severed head. Now that we have your attention, read on…

THE EXORCISM OF THE UNITED STATES

I am happy to report that the U.S. Federal Reserve is not increasing Total Fed Credit with its usual disregard to the sheer economic insanity of constantly creating more and more debt, money and credit. Being down by $3.5 billion, last week, is nothing to write home about (“Dear Mom and Dad, It’s been a swell week at camp! The Federal Reserve is tightening money by some insignificant little amount, and now, we are going for a canoe ride! Love, Tommy”).

So, I was surprised to discover that the Federal Reserve’s frantic, exponentially increasing of Total Fed Credit since 1997 has apparently paused, as I gather from the cold, cold chart. Looking this up in the Mogambo Economic Book Of Changes (MEBOC), popularly referred to as the Mogambo Ching, it reads, in its entirety, “Prepare to die!” This is a pithy MEBOC way of saying that with our stupid economic system of fiat currency created by debt, it takes ever-increasing amounts of money and credit to keep the whole stupid system from imploding.

In a closely related vein, Thorsten Polleit, a professor at the Business School of Finance & Management in Frankfurt, and author of “Sowing the Seeds of the Next Crisis” at Mises.org, says, “The income velocity of money – that is the relation between nominal output and the stock of money – declined sharply.”

This velocity thing comes from the idea that the total value of goods sold must equal the total amount of money spent on those goods. This translates to the famous equation QP=MV, where Q is the amount of goods sold, and P is the price they were sold at. This must equal M, the total amount of money stock, multiplied by V, the velocity of money (the number of times each dollar is used in a transaction).

OK, then for the equation QP=MV to be true – to balance the equation with a falling velocity (V) – either the money supply (M) increased, the quantity produced (Q) has decreased, prices (P) have decreased, or a little of each.

As for the idea of prices decreasing, don’t make me laugh! Hahaha! Look! I’m laughing, even though I told you not to make me laugh! The reason that I am laughing is because prices are going through the roof! So, jocularity aside, that means that either quantity of goods produced (Q) had to go down or money supply (M) went up. As it turns out, it was mostly the money supply, which increased all those years!

So, what is this actual value of the velocity of money? He says, “Velocity fell from around 1.65 at the end of 1994 to 1.25 at the end of 2005.” Yikes! I’m jumping out of my Freaking Mogambo Skin (FMS) at this! As I stared at those velocity numbers over and over, feverishly jamming them over and over into a calculator, I came to the terrifying realization that velocity went down by 24%! A quarter! Now you know how it is that while prices and the money supply both increased, the economy’s GDP did not increase as much as would be expected. The reason is that velocity went down! Money is not circulating as fast as it did and was, thus, involved in fewer transactions!

Mr. Thorsten remarks, “Taking into account the lessons learned from analyzing monetary matters from the point of view of the Austrian School of Economics, it becomes crystal clear that the very foundations of the monetary system on which economic prosperity of the industrial countries so heavily depends keep deteriorating at a rapid pace.”

Those who majored in Mogambo Economic Studies in colleges and universities know that any massive, sustained increase or decrease of Total Fed Credit is the very thing that consumes whole days in the life of The Mogambo, alternately crying in crybaby fear and screaming in stark, raving horror. It’s very much similar to when Linda Blair’s character in the movie The Exorcist sat up, spun her head completely around in a full circle, and then mockingly asked, with a hideous grin on her horrible green face, “How do you like your little girl, now?” Gaaah! Gaaah!

The reason that I bring this terrifying thing up is that I am trying to be real clever and make the current economic situation analogous to this memorable Linda Blair scene – except that this is real life, and the head that is being twisted around by the Federal Reserve is America’s. Instead of hearing Ms. Blair saying her immortal, blood-chilling line, all you hear is cartilage snapping, bones breaking, and then the head pops off.

And, as the severed head sits there on the ground, the camera pans in for a close up. You note with horror that the head is still alive! Its mouth is saying, “Ouch! That hurts!” Panning in for a closer shot, the talking head goes on to say, “And what hurts even more is that the loudmouth idiot Mogambo was right! We’re freaking doomed!”

The eyes in the head start to glaze, and yet, with a Herculean effort, the severed head startlingly continues, “Beware! Beware of a massive and massively expensive government, paid for by debt, financed by the Federal Reserve and the banks creating all that new credit so that someone could borrow it and use the money to buy government bonds, stocks and houses, and leveraging to borrow every scrap of equity that ever appeared in anything, including houses, stocks, bonds, receivables. God knows what else.”

And then, the drying, dying lips were barely moving now, “it was all securitized and sold back to us; we hold our own debt!”

With a final dying exhalation of breath, the eyes closed and the lips stopped moving. America was dead. Next, a dog walked up, lifted its leg, and peed on the lifeless head, which was both a nice touch of comic relief, and highly symbolic, given the subject matter.

The bigger news, and probably the cause of all the alarm bells in the Mogambo Bunker Of Wailing In Fear (MBOWIF) clanging, bonging, ringing and buzzing, is that the dollar fell in value. This may not mean much to you, right this very nanosecond, but it will mean a lot to you very soon.

But at least you are not Japanese, Chinese or European; they hold a lot of U.S. debt and equities. Now all have sudden, they have huge paper losses on their holdings in terms of their own currencies! Hahaha! Chumps! OK, in nominal terms, it wasn’t that much, but when you consider the leverage that is being used, suddenly this is a huge chunk of money!

And puh-leeze, don’t tell me how the brilliant use of derivatives is some kind of savior here. The total amount of money lost is the same either way. The only difference is that instead of a few guys getting slaughtered for being so stupid, the use of derivatives means that everybody took a tiny loss.

Until next week,

The Mogambo Guru
for The Daily Reckoning
May 8, 2006

Mogambo sez: If you are not buying gold, silver and oil, then don’t come crying to me in the coming years. And if you are buying gold and silver and oil, then you will be rich, and I will soon be calling you up to ask to borrow some money. You only have to decide which is worse.

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

Yesterday, driving back from a horse show in Bath, we stopped for gas. Britain has gone metric in order to stay in harmony with her European trading partners, but she still lists distances in miles. Gasoline is measured out in liters, just as it is in France, but it is priced in pounds.The price for a liter of diesel fuel was 99.9 pounds. If we did the math right, this is equivalent to about $6.50 per gallon.

By comparison, we read today that the average price per gallon in America is $2.92. Gasoline is so cheap in the U.S. that Canadians are flocking across the border to fill up their tanks.

If the British are confused about how their gas is priced, the Yanks are certain they know where it should be – at rock bottom. The U.S. economy is set up for much cheaper gasoline. People have organized their lives and habits around the expectation of cheap fuel and cheap credit. They’re understandably disappointed to see prices rise.

But now, prices are rising; the dollar is falling; inflation is increasing. And we begin to see how the great Credit Bubble Boat ends, don’t we? It runs into the iceberg of inflation.

It seems obvious.

College tuition, health care, commodities – all seem to be going up quickly. Last week brought news that even salaries are going up. Pay levels are said to be 3.8% above those of a year ago, despite very sluggish job growth. Why would salaries go up when there is no apparent pressure to recruit new employees or hold onto old ones? The answer is simple: salaries are responding to inflation, not to job market. And on Friday, even stocks went up. The Dow rose 138 points. Are business conditions suddenly much better? No? Maybe it is just inflation.

Way up high, in the staterooms and luxury suites of this Titanic, the price increases are even more dramatic. One painting by Picasso sold for $95 million. Another sold for $34 million and still another sold for $18 million. That’s a lot of money to pay for crude paintings of people with their noses in the wrong place.

But now, some fellow in China has figured out how to create his own gimmick. He’s picked up the advertising cartoon, Joe Camel, and turned him into an art-world icon. Look, he explains, this modern art is simple; anyone can do it. In fact, you don’t even have to do it yourself. He pays others to do the actual work. He just comes up with the idea.

You’d think the art world would be annoyed at the chutzpah; the Chinese hustler is clearly pulling someone’s leg. But it doesn’t seem to matter. Aficionados are either too dumb to notice or too rich to care. They’re buying up the paintings of Joe Camel and hoping to score as big a coup as people who bought Picassos.

While prices rise, the dollar falls. Against yen, it dropped to a seven-month low on Friday. Against the euro, it fell again, last week – to $1.27 per euro. And against gold, the dollar plummeted. June contracts for gold sold over $684 on Friday. Overall, the dollar has lost 4.5% of its value in the last three weeks.

There is no question that prices are increasing. Nor is there doubt as to why. Central banks are desperate to keep up with the expanding supply of dollars. Remember, they can control either the quantity of their currencies, or the quality of it, not both at the same time. As the United States emits billions and billions more dollars, the foreign central banks have to produce more of their own currencies. Otherwise, the falling quality of the U.S. dollar will make the foreign currencies go up in price. This will put their export industries at a disadvantage.

All over the world, central banks are favoring quantity over quality. They are inflating their currencies. Consumer price inflation is sure to follow.

There might be more to the story. Yes, all central banks favor inflation. And yes, Americans would vote for inflation, if they could; they are deep in debt and would welcome inflation as a way out.

But for every debtor, there’s a creditor. And for every fool who borrowed money to buy something he couldn’t afford and didn’t need, there’s a lender who lent to someone who might not be able to pay him back. The big question is: who will turn out to be dumber – the lenders or the borrowers? We don’t know the answer, but we suspect there is enough dumbness to go around. When the ship goes down, there will be plenty of losses for everyone.

Over to the latest news from our currency counselor…

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Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis:

“Since November 28th, 2005, the euro has gained a total of 8.2% versus the dollar. I’d have to say the ‘wave’ has gotten everyone’s attention.”

For the rest of this story, and for more insights into the currency markets, see today’s issue of The Daily Pfennig

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More thoughts from Bill Bonner…

*** For all of you insomniacs…or (really) early-risers…or those of you with TiVo…Addison will be appearing on ABC’s World News This Morning at 4:40 a.m. (EST) on Tuesday. Be sure to check it out – and let us know how it went. We need our beauty sleep.

*** As the public realizes that gas prices aren’t going to go down anytime in the near future, many are turning to hybrid cars as their salvation. These cars are the most environmentally friendly – and supposedly fuel efficient – option for those who can’t give up their vehicle and ride their 10-speed to work.

The Guardian tells us that a new report by Which?, a U.K. consumer magazine, shows that these cars aren’t all they claim to be:

“The recently launched Honda Civic hybrid only managed between 28mpg and 34mpg on its test, well below the most fuel efficient petrol and diesel cars and nowhere near the 54mpg being claimed in Honda’s literature. Tory leader David Cameron’s new hybrid car, the Toyota Lexus RX400, recorded 25-34mpg during testing and consumed around twice as much fuel as the most fuel-efficient diesel car.

“The consumer body noted that its greenhouse gas emissions were 27% lower than a petrol Lexus, but said it was no less harmful to the environment than a standard family estate car.”

So, if hybrids aren’t going to save the world from high gas prices, what will? Outstanding Investments’ Justice Litle argues that there is an oft-overlooked contender for the Car of the Future: the humble old diesel engine.

“When most people think about diesels, they think ‘loud, dirty and smelly’ – a pollution nightmare. Except – surprise – those diesels you hear and smell are antiques. Thanks to new technology, diesels aren’t so dirty anymore and the gas mileage is better than ever!

“You see, diesel gets about 30 percent more miles to the gallon than gasoline, and those savings are real, in any kind of driving conditions. What’s more, people who worry about global warming prefer diesel because it emits up to 20 percent less carbon dioxide.

“This is all well and good, but the kicker is this: you don’t need crude oil to make diesel fuel.”

*** Last week, Barron’s cover told us the Dow was going to 12,000. By Friday, the index did appear to want to go in that direction.

But if it’s going, it will have to go without us. We see little profit in trying to squeeze a few more points out of the Dow – and much potential for loss.

This week’s Barron’s cover headline is: “Paying Up! Strapped for cash, U.S. states and cities are selling toll roads to foreign companies willing to pay rich prices.”

The money leaves home a servant; it comes back a master. We buy flat-screen TVs and Chinese tea. The money does our bidding. But then, the overseas suppliers end up with a net trade surplus over $800 billion a year. What do they do with the money? It comes back to us. They buy our factories, our T-bonds…and now, our roadways. Now, we are their servants – their clients, their customers, their employees, their debtors, their lackeys, their proles, and their lumpen.

*** We drove out to the city of Bath this weekend to attend a big horse event at Badminton.

Bath is a city made beautiful by its golden stone and the work of a handful of 18th century architects. It was almost fully built as a resort under various Georges, giving the city its harmonious, elegant look. The historic buildings are often rented out to tourists by Britain’s Landmark Trust – which holds properties all over the island – to help pay the expense of maintaining them. One of these is an apartment facing the old Bath Abbey and the Roman baths. We took it for the weekend.

We discovered that Bath would be even prettier to look at if it had not fallen under the spell of urban renewal in the ’60s and ’70s. There were sure things in need of improvement in the city during that period, but the architecture of the place was not one of them. Still, in came the wrecking balls and front-end loaders, and out went tons of gracefully carved stone. In its place, buildings were thrown up with all the charm and appeal of a Soviet-era YMCA. The Hilton hotel, for example, is an abomination; its front door looks so much like the emergency entrance to a public hospital, we expected an ambulance to drive up at any moment.

Still, most of Georgian Bath is intact, and still worth visiting, including of course the baths themselves, which are remarkably well preserved and extensive.

We did not stay in the city long, however. Our rendezvous was fixed for early on the morrow at Badminton, where one of the world’s premier horse riding events was to took place over the weekend. We are not especially interested in horses, but Elizabeth is a serious rider. So off we went.

While Elizabeth followed the horses around the track, we followed the people who followed the horses around the track. There were thousands of them. Young, old, fat, slim – we even ran into a blind man. We wondered what the attraction was…to someone who couldn’t see. As far as we could tell, the weather was miserably cold and wet. The horses ran around the track one by one, so there was no great sense of rivalry or the thrill of a tight race. It was so crowded that we could barely make any headway or see over the heads of other spectators anyway.

“And now, beginning over in the main stadium,” said the loudspeaker, “the Riding for the Disabled Association, is putting on a special display.”

We rushed over, out of curiosity.

There were about a dozen riders, some with obvious infirmities, others with merely a glazed look. Over the speakers came a loud version of “Hot, Hot, Hot,” whereupon the monitors and teachers – two of them per horse – led the disabled riders around the ring. There was nothing “Hot” about any of it. In fact, the whole thing seemed exceptionally cold and restrained.

The people with handicaps and Downs Syndrome were appropriately puzzled. They must have wondered what the point was. Others, good-naturedly went along with the charade. We could practically hear them saying to themselves, “Well, this is silly…but if it makes them happy…”

The teachers were not only happy, they all had such big, cretinous grins of satisfaction on their faces, we were tempted to ask for a drug test. What were they so damned happy about, we wondered?

Maybe they were genuinely content to be doing what they thought was such a good thing – helping the handicapped. Or, maybe they were just pleased with themselves. After all, hadn’t they managed to turn a horse hobby into a career? All they had to do was smile like a half-wit from time to time, and use the poor handicapped kids as props.