The Voyages of the Economic Enterprise

This week, The Mogambo leads his intergalactic spaceship and eerily Star Trek-like crew around the economic cosmos. They eventually land on planet ‘Freaking Doom’ where our fearless leader courageously kills off the extras, before inflation has a chance to do it first. What will happen next?

To get a “feel” for how crazy things got, Ambrose Evans-Pritchard at The Telegraph reports that “Bear Stearns had total positions of $13.4 trillion. This is greater than the U.S. national income, or equal to a quarter of world GDP – at least in ‘notional terms.'”

If you are like me, you gulped in horror at the revelation that this one bunch of people had made that kind of a huge, humongous, staggering load of un-imaginable, un-payable commitments! More than the total income of everybody in the country! These are huge commitments, sort of like the kind you find out about, but only AFTER you say “I do” and sign the marriage license, which is when you start to find out that “commitments” in marriage entails getting a job and keeping it! No matter how much you hate it! Which you do, because your bosses and co-workers are all idiots (and don’t get me started on the idiocy of the customers!) then you come home after hours and hours of that boring crap with your stupid, pathetic little paycheck in your hand, and at the end of the month you still have no money left over because your wife spent it on the kids and herself, and then one day, prices have risen so high that you run out of money before payday comes around again, and you discover that you have maxed out all your credit cards, and you have borrowed against all your equity in your house, and you have borrowed money from all of your friends, and now you find it was all for nothing and you have wasted your life with the empty promises of “family, friends, faith and community”, and you want your youth back! I was cheated out of my life!

So you can see how big commitments like this are dangerous, but Mr. Evans-Pritchard ignores me and my penetrating, poignant analogy, and says that the problem at Bear Stearns was that through using “‘swaps’, ‘swaptions’, ‘caps,’ collars,’ and ‘floors'”, they were able to float $13.4 trillion of this weird financial derivatives crap, and that “this heady edifice of newfangled instruments was built on an asset base of $80 billion at best.”

$13,400 billion was what was leveraged on a measly $80 billion? Leveraged 167 times? Bear Stearns had less than 1% in the pot? Hahahaha!

This reminds me of Alan Stang at AlanStang.com, who writes that “Banking is one of the few businesses in which crime is rewarded; and the bigger the crime, the greater the reward. The perpetrators take down millions in bonuses and do not go to prison.”

Perhaps because he knew I was watching and he wanted to get on my good side, he added a nice swipe at Alan Greenspan, whom he describes as “former top Fed swindler,” and then went on about how this little Greenspan creep “more than any other man got us into this mess; now he is telling clients in the Middle East to dump the ‘dollar’ and go to the Euro.”

And speaking of Alan Greenspan and how I hate his guts for what he has done to my country, Bill Fleckenstein of Fleckenstein Capital, author of the new book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve reminds us that “Greenspan bailed out the world’s largest equity bubble with the world’s largest real-estate bubble. That combination easily equates to the biggest orgy of speculation and debt creation the United States (and the world) has ever seen.”

And if you want to see the significance of that, let’s take a little tour through interstellar history! In my best “Captain Kirk of the Starship Enterprise” voice, I say, “Computer on! Computer, research the economic history of the planet Earth and all the planets in this galaxy, and find any instance of a healthy economic boom that started after ‘the biggest orgy of speculation and debt creation’ the planet had ever seen!”

I note for the log book that an eerie silence overtook the bridge. Everyone noticed the complete silence from the computer, which could only mean one thing; there is not one example from anywhere in the whole freaking galaxy where some dirtbag economy escaped collapse after an “orgy of speculation and debt creation.”

I will not ask the computer to look for examples of economies that WERE destroyed by such idiocy as engaging in “orgies of speculation”, because it is, essentially, all of them. In fact, there are so many idiotic economies that experimented with fiat currencies and wild multiplications of debt by the banking system that merely listing them ties up the computer so long that Mr. Spock comes over and tells me, with that damned, dry “logical” voice of his that sets my teeth on edge, that I am hogging all of the computer’s time, and how he needs it to plot some stupid course to slingshot us through a wormhole or something to get us out of the Neutral Zone that I accidentally wandered into because I was distracted by my duties as captain of this starship.

It could have happened to anybody! And it has nothing to do with the fact that I had ordered all the “good-looking chicks in the quartermaster section to report to the bridge”, and now Mr. Spock is acting like our predicament is all my fault, and I am really, really getting so sick of his snotty Vulcan attitude and his stupid reports to Starfleet Command.

The point is we are indeed screwed because we engaged in what Mr. Fleckenstein calls an “orgy of speculation and debt creation” of world-record proportions, and since the pain is usually proportional to the gain, get ready to say “ouch!” in a really, really loud voice to give Mr. Spock’s stupid big ears something to listen to!

Until next time,

The Mogambo Guru
for The Daily Reckoning
March 31, 2008

The Mogambo Sez: For this week’s pep rally, the cheerleaders will leap about and chant “Gold and silver, that’s for us! Everything else is a big fat bust!” Since everyone has their eyes glued on the cheerleaders prancing about in their tiny little costumes, there is no point in my saying anything more. You got an important message and a nice show, which is more than you usually get from a Broadway play!

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.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

Few things in life are more satisfying than shooting teenagers…watching them yelp in pain and fall down in a heap…defeating youthful energy with age and treachery. More about that below…but first, the financial situation:

The weekend gave people time to think. Too bad. Thoughts lead to action, which leads to trouble.

What the commentators, pundits, and policymakers are thinking about is how to ‘fix’ problems in the capital markets. Most of them couldn’t fix a flat tire, of course. But that doesn’t stop them. They imagine that they can find the hole in the world’s money system…and patch it.

“U.S. readies overhaul of financial regulation,” is today’s big headline in European version of the Wall Street Journal. The article goes on to tell us that a whole group of changes are coming our way. As near as we can tell, these changes mean nothing – they are simply rearranging the bureaucrats’ desks. This is the plan put forward by Hank Paulson, former Goldman chief executive and now head man at the Treasury.

Critics charge that it doesn’t go far enough…that it is really an extension of the deregulation trend that got us into trouble in the first place. A whole chorus of whiners is now calling for re-regulation of the financial institutions – with heavy emphasis on mortgage lending.

“Free market thinking takes hit from U.S. economic crisis,” reports an AFP story. “Bush mortgage bailout in the works,” adds the New York Post.

Alas, ‘improvements’ seem unavoidable.

March 14th, 2008, was the ‘day the dream died,’ according to Martin Wolf in the Financial Times. The dream was the dream of “global, free-market capitalism,” says the report. The world’s wake-up call came, it continues, when the Fed decided to bailout Bear Stearns.

The ‘dream’ was more like a hallucination, in our opinion. We can imagine that we live in a free market world. But the world’s central banks have been fixing the price of credit, fudging the numbers on inflation, and printing money all along. Now that we have a crisis on our hands – embellished and exaggerated by central bank planning – the long knives are out for ‘free enterprise.’

The ‘Anglo-Saxon’ model – as full of illusions, conceits and absurdities as it is – is still the best model, because it allows fools and their money to part company relatively quickly. Every other model merely slows it down…gumming up the gears with special privileges, protections, and government-granted larceny. The real problem in today’s capital markets is not that the machinery of capitalism is broken, but that it’s working. And that is what the reformers aim to stop. They want to ‘fix’ the markets… like you would ‘fix’ a stray cat – so it couldn’t have kittens. What they really want is to neuter the market…spay it, so it is a cuddly pet, but one that doesn’t give you any trouble.

So far, U.S. homeowners have lost probably about 12% of the wealth they thought they had in their houses. The total capital value of the residential housing market is about $20 trillion. So, a 12% loss is equal to about $2.4 trillion. A few foreign housing markets have been hit harder – Ireland, Spain and Iceland, for example.

The equity markets have been hit by similar losses. Equity funds alone have seen $100 billion of cash pulled out by nervous investors. But here – something curious – “In an ugly global crisis, U.S. markets not so bad,” another WSJ headline.

In 2008, the Dow is down 7.9%. But foreign markets are down more. France has lost twice that amount. Germany has dropped even more – 18.7%. But the biggest losses are in the go-go markets of the East. Indian stocks have lost nearly 20% of their value. The Shanghai stock market has fallen 32%.

Overall, non-U.S. and Canadian markets are down about 15% – meaning, that the world’s equities have taken a loss of about $4.5 trillion in local currency terms…or about $3 trillion when measured in dollars. (The dollar has gone down so that dollar-based investors have lost less on foreign markets than local investors.)

We have been pointing out that these huge reductions in the implied wealth of the world’s investors weigh heavily on the deflation side of the scales. The money people thought they had is disappearing. To a hedge fund investor, the vanished money may mean nothing more than a missing digit on his portfolio report. But to a marginal homeowner, the losses force him to change his standard of living – cutting back on expenses so as to balance his family budget. For not only does he have less money, his costs keep going up. Every three months the American Farm Bureau buys a typical bag of groceries. This quarter, the price was up 8.9% over a year ago. And gasoline? It’s up 64 cents a gallon over the last 12 months.

“Economic downturn worsens in March,” says Money Watch.

A good part of the world economy seems to be drifting into a slump – despite the efforts of the feds to keep the money flowing.

“Capital shortage lingers despite Fed’s latest steps,” reports the WSJ. The banks are rebuilding their balance sheets; they’re not taking on more risky credits.

Analysts will take aid and comfort from the performance of the U.S. market so far this year; they will see it as a sign of strength that American equities have sunk less than others. But it is really a sign of weakness. While foreign markets soared over the last 10 years, U.S. stocks went nowhere. Having not gone up, now they’re not going down. And while they are not going anywhere, the value of the dollar continues to fall – wiping out stockholders’ real wealth. In terms of what they can buy on world markets, U.S. stock market investors have lost 25% to 30% of their purchasing power over the last decade. They’ll probably lose another 30% over the decade ahead.

And so, we turn our weary eyes back to Japan. The sun set on the land of the rising sun 18 years ago – when the air went out of Japan’s bubble and the Nikkei crashed.

Japanese authorities have been pumping ever since – but the air leaks out about as fast as it goes in. This year alone, the Nikkei has lost 16% of its value, bringing it down to a level that is less than one-third its peak in 1989.

In real terms, we suspect that that is where U.S. stocks will end up too – maybe five years from now…maybe ten years.

But – not without a fight!

“Japan’s ‘lost decade’ offers dire pointers for the Fed,” says a headline in the Financial Times today. The pointer is that the Fed should act fast and aggressively to bailout the banks and homeowners. According to legend, Japanese officials dithered. They failed to react quickly enough so that by the time they finally got moving, it was too late…a deflationary slump was already underway and impossible to reverse.

Ben Bernanke went over to Japan years ago to offer advice on how to get out of the deflationary trap. Now, he has a chance to show the world how it’s done. Will he succeed? We doubt it.

*** On 321gold.com today, economist Antal Fekete reminds us that this is the 75th anniversary of the seizure of U.S. gold stocks by the presidential diktat of a certain Franklin Delano Roosevelt.

“I remember my grandmother telling me about her sentiments as she was faced with the decision of whether or not to turn in the family gold coins,” Byron King tells us.

“Back in 1933, my grandmother was a young widow raising four children during the depths of the Great Depression. She taught school in Pittsburgh and supplemented her living with private tutoring. She had some of her savings in a local bank, and some of the rest in gold coins that she had accumulated over time. Her ‘gold’ savings added up to about $2,000 – about 50 gold $20 pieces, and various other gold coins of lower denomination – which was a lot of money back then. If something had happened to my grandmother, the gold was all that would keep the children out of some orphanage.

“Within a few days of FDR being inaugurated in March 1933, he issued a Executive Order requiring that all citizens and others subject to the jurisdiction of the United States turn in and redeem their gold coins in exchange for an equivalent value of U.S. currency.

“So my grandmother went to the bank and asked the bank manager what he thought she should do. He became very serious, and pulled out a piece of paper. He started reading to my grandmother the possible penalties that she could suffer if she failed to turn in her gold coins. The penalties included prosecution, fines and even imprisonment. So my grandmother – suitably intimidated – took the gold coins out of hiding, and turned them into the bank. The U.S. government eventually melted down the coins, into what are called ‘gold melt’ bars. The paper currency immediately began its long period of depreciation due to inflation.”

If the high price of gold makes you a bit wary of investing in the precious metal, fear not. Byron has found a way for you to pad your portfolio with gold…for a penny per ounce.

*** Pow…pow…pow, pow, pow.

We had snuck around the side of a burned out truck. The enemy soldier was shooting at our men over on the right. He didn’t see us until it was too late.

Pow…pow…pow. The bullets flew like tracers. One hit him in the head…another hit him in the thigh. He squirmed around and threw up his hands.

Ah…another teenager down.

It was Edward’s birthday present…delayed for several months…a chance to wage a paintball battle with eight of his friends. The Paintball Company, about 30 minutes outside of Paris, required one adult with the group. We were drafted.

But once suited out and with a rifle in our hands, we felt a sense of strange calm. It was as if a part of our brain – rarely engaged – suddenly lit up. Of course, it had been there all along, an instinct for fighting; but how often do we get the chance to kill someone – even a mock killing in a mock battle? The human race would probably be better off if it could be surgically removed. But on Saturday, it came in handy.

The battle raged in an area called “Stalingrad” – full of bunkers, rusty trucks, foxholes, fences and sniper nests. One team of five attempted to kill the other team; it was very simple.

At first, we kept quiet, merely going along with the game. But gradually, we began to pull rank. Our side was making too many tactical errors, too many strategic plunders…taking too many casualties. We tried to impose order on our troops…

“You two…go over to that hill and cover our left flank,” we ordered. “You other two…stay here and shoot anything that moves.”

It was a basic battle order. But these were untrained teenaged recruits. One of them, for example, held back – hiding behind a upturned shipping pallet while the rest of us got pelted with ‘bullets.’

We’d have to impose some discipline or we were going to lose every fight, we realized. When it came time to reload, we hauled the kid out from behind the pallet and made an example of him. He was duly court-martialed and executed by firing squad. We would have imposed the old Roman tradition of “decimation,” shooting every 10th soldier. But we only have four of them; we’d have to keep it simple.

When we were all fully locked and loaded, the shooting started again. By this time our unit was performing better. The kids had gotten the hang of the weapons and were no longer afraid of the bullets. Most of them were covered in orange blotches and were now used to the sting of a hit. They were supposed to leave the field after they had been hit twice, but it looked like there were a lot more hits than dead teenagers; they must have been cheating, we concluded.

Our unit had taken the high ground – a good move tactically. We were dug in. We had learned that the best offense was a good defense – ‘stay down and shoot them whenever they come out,’ was our strategy.

It seemed like a good plan. But one member of our squad had to leave suddenly – his mother showed up and took him off to a family wedding. We saluted him as if he, too, had been sent to face a firing squad. Then, another private ran out of ammunition. Now, there were only three of us left…and the incoming was hot and heavy. Bullets splattered on the ramparts…nipped up bits of dirt around the parapets…and rained down on us. We didn’t know exactly how the other side was getting so much firepower…but we could scarcely get off a shot without three or four rifles answering us immediately.

“Hold your positions,” we yelled, “and watch out on the right…there’s an enemy trying to outflank you.”

The firing went on as we tried to sink lower into the mud. Though we thought we had a good position, the bullets kept coming in and getting closer. One hit us in the leg.

“Ouch…”

Just a flesh wound, we said to ourselves. Another grazed our shoulder.

‘Not even a scratch…’ we decided it didn’t even count.

Then, we noticed that the boy on our right was out of action. The two shooters on the opposite hill had gotten him. And what happened to the fellow who was protecting our right flank?

Damn. He was gone.

“Hey…you down on the right,” we called. No answer. We were the last man standing. Only, we weren’t standing at all. We were lying in the mud, with a wounded leg and a torn trouser. Bullets were flying all over. The enemy realized that there was only one person left ‘alive’ on the hill. They were closing in.

“Rendez vos arms!” said a voice from the other team…demanding a surrender.

“Don’t surrender,” said the boys who had been on our team but who were now “hors de combat.”

“Come and get me, &@$****,” we replied, with a Pattonesque air, determined to fight to the end.

At almost that very moment, we felt a sharp sting from the derriere. An enemy soldier was standing up, barely five yards behind us, and shooting us squarely in the backside.

Until tomorrow,

Bill Bonner
The Daily Reckoning