A Financial Fiasco

The voices in the Mighty Mogambo’s head are getting louder…so loud, in fact, that he needs to share with us what exactly they are screaming about. And yes, you guessed right, it does have to do with the Federal Reserve.

The fact that the stock market is going up at the same time as the dollar going down, along with all the other economic headaches both domestic and foreign, is just too, too weird for me, and I thank my lucky stars for the calming effect of modern pharmaceuticals, doctors who are not squeamish about keeping me overly-sedated and a wife who prefers it that way. Otherwise, I would be in Pure Mogambo Panic Mode (PMPM), and remember that I am the guy who invented the concept of hooking a machine gun to a motion detector just because I was merely "anxious" about something, probably about those Girl Scouts and their cookies and how it may NOT be just a coincidence that our whole bankrupting mess started about the same time as they started peddling their delicious treats door to door. So it was with trepidation, which I define as "Hoping that my heart doesn’t explode from the shock" that I meandered through the Market Laboratory section in Barron’s.

I see that a lot of the money for the recent spike in the stock averages came from total Fed credit going up $1.4 billion, and the Fed continued that blatant monetary fraud known as U.S. Government Securities Bought Outright, and it was up another $1.8 billion. So if we add these two numbers together we get, wait a minute here while I get my calculator out, $3.2 billion dollars. If this number looks familiar to you, perhaps it was due to a recent newspaper headline that you probably saw, "Armed Lunatic Screaming About $3.2 Freaking Billions of Freaking Dollars in One Freaking Week!"

And then we cruise on over to the actual banking side of the system and note that they ALSO bought up a lot of government debt last week, if you are the kind of person who thinks that $5.1 billion is a lot. I am, personally, one of those old-fashioned guys who still thinks that 5.1 billion of anything is a lot, and especially if that 5.1 billion of anything is accumulated in one crummy week.

And while we are still snooping around in the banks, I notice that Required Reserves never seem to go up, although every time I get out a book on economics I am always reminded that 1) I am an idiot and that I don’t seem to understand any of this stuff, and 2) I am always reading things like how banks set aside reserves as some big percentage of liabilities, and the starting place for every example is that we are asked to assume that reserves are 10% of liabilities.

Economic Disasters: 400% of GDP

Keeping this classical 10% figure in mind, I look around at the banks and I am surprised to note that Required Reserves are always essentially unchanged, especially since the banks’ assets and liabilities have both been increasing like gangbusters all this time, all these years, right along with the growth in M3, and right along with the growth in total debt extant throughout the whole freaking country until, and I think I read this somewhere but I know it is about right, the total debt (personal, business, local, state and federal governments) is now over 400% of GDP. 400%! My knees buckle at the very thought of owing four times as much as everything this whole freaking country produces in goods and services in a whole year. And this is right along with the growth in house prices, and right along with the growth in the price of every damn thing you can name that can be measured in money, and especially those things that can be measured in terms of MY money.

But Required Reserves are still hovering around some piddly $45 billion, while Liabilities are north of $4.5 trillion, which makes Required Reserves a nice, round 1%. One percent! Now you know why almost all economic disasters start in the damn banks.

It is spooky. In fact, every time the wife and I are on our way somewhere in the car, she productively uses the time and opportunity to list a few hundred of my most recent faults that have come to her attention. And then it predictably gets into that crap about how I don’t pay any attention to her, and things would better if I would only listen to her once in awhile, and blah blah blah, and pretty soon my mind is wandering, and I start thinking about economics, because all I ever do is think about economics, and this is because, and you might want to write this down because it is THAT important, everything is always about the money. To repeat myself, and it bears repeating: Everything is about the money.

But after awhile, while my wife is winding up her remarks about my more glaring personal faults, I look forlornly out of the window of the car, gazing at the passing cars, and I see the people driving those cars, and I think to myself, "All this debt misery I write about, and am fearful about, and am getting more and more nervous about, and now that I am talking about it I can hear those voices in my head getting louder and louder, is being borne by you. And you. And you." And as each car goes by, I think of their dire financial situations that are at the root of the total debt in the American and other economies of the world, and my heart goes out to them.

Meanwhile, back in economics land, foreigners decided that they would hold their noses, bite the bullet, and buy another $5.1 billion of U.S. debt and store it at the Fed. If you go to the Mogambo Dictionary, you will find that when I say "foreigners" in this context, I mean foreign central banks. And the reason that these foreign central banks started buying our debt again is that these selfsame foreign central banks are reeling from the pain of listening to people, powerful people, with money invested in U.S. debt, who are screaming on the phone, everybody wanting somebody to get up off their big butts and make us Americans do something about our financial problems because they are losing money on their portfolios. Now, if you are like me, you assume that all foreigners are backwards idiots who dress funny and stuff their portfolios with cheese and the icky parts of dead animals. In reality, it turns out; their portfolios are crammed with, along with the aforementioned cheese and animal pieces, U.S. debt and equities. The downside is that after a while, the cheese starts to stink, the meat products go rancid, and, once their dollar holdings are exchanged/translated back into their local currency, they are finding that the whole portfolio stinks.


The Mogambo Guru
for The Daily Reckoning
November 22, 2004

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 the better to heap disrespect on those who desperately deserve it.

If anyone loses money on the falling dollar, it won’t be our fault. We have warned readers for years.

Now, says Alan Greenspan, it won’t be his fault either.

With the elections behind them, the Feds see no further need to deceive voters. The voted have been counted; the dollar be damned.

The dollar is going to fall, Mr. Greenspan told the world last week.

And we’re not going to lift a finger to stop it, added Treasury Secretary Snow.

On the news, the dollar fell to 1.3/euro. When it will stop falling, no one knows.

Why have the Feds abandoned their own money?

The answer to that question, says our old friend Kurt Richebächer, can be found by studying a chart of U.S. corporate profits since 1991. Profits, he reminds us, are the result of capital investment. In order to make a profit, you have to buy new machinery, train new workers, and create new products. When you stop making capital investments, profits disappear.

Profits hit $508.4 billion in 1997. Six years later, based on annualized figures from the 2nd quarter of 2004, they are $448.8 billion.

Something went wrong.

Actually, a number of things went wrong. But they all center around the U.S. trade deficit. Instead of making capital investments in America, the new factories and new products were created in China and other parts of Asia. Profits that might have been earned by American companies were instead earned by foreign companies, and then recycled back into the U.S. financial markets. That is why this "recovery" is so odd; it is not only jobless, but low on profits and income growth too.

The way to fix the problem, in the view of nearly all economists, is to let the dollar fall…and pray that it does not fall too much, too fast.

A lower dollar would show up on Wal-Mart shelves almost immediately. Everyday Low Prices wouldn’t be quite as low as consumers had come to expect. Other things being equal, Americans would spend less on foreign products and more on homegrown ones. Profits, employment, and American GDP would all rise.

But, of course, other things never do remain as they were for very long. When the Greenspan-Snow team announced a falling dollar, speculators’ ears bent towards them. Now, these same speculators "have very little downside risk," says the Financial Times, when they short the dollar. But what of large dollar holders – such as Japanese and Chinese central bankers? Were their TVs turned off when Greenspan spoke? Had their newspaper subscriptions been cancelled? Had their brains gone dull from too much sushi and rice wine? Had they no way to take part in this great bonanza of risk-free gains Greenspan and Snow have given speculators? Or, had they no way to escape?

It was as if the two Fed honchos had revealed their battle plans to the entire world: We will come around from behind and attack, they said. This will be great, said the news headlines; we will catch them unawares…and shoot them in the back.

No one seemed to imagine that the people who hold trillions worth of dollar assets might read the papers and turn around!

And so it is that we enter a new phase of the Great Comedy. The dollar is going down. Everyone knows it. Will no one do anything about it?

We wait to find out.

Meanwhile, gold rose $4.10 on Friday. At least a few people are taking precautions.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street…

"We Americans can never really know when our foreign creditors will say, ‘Enough!’ But we can surmise that any financial trend that appears to be unsustainable, most likely is unsustainable."


Bill Bonner, back in Paris…

*** *** This morning, the venerable CBS Market Watch quoted our very own commodities trader, Kevin Kerr.  He remarked on December crude’s 24-cent falloff after an overnight climb to $49.55.  Interestingly enough, Kevin saw 119% gains from crude calls in late August.  He’ll often go long and short on the same commodity…it just depends on where he thinks the underlying resource will go.  8 of his last 9 trades have been winners, and to see how you may be able to profit from Mr. Kerr’s insights.

*** We went to Munich over the weekend. Our book has come out in German. We were there to give it a little boost. But speaking to a conference of investors, we probably dampened sales rather than lit them up.

"What price will gold hit?" questioners wanted to know. "How will the dollar’s fall affect the euro?" "Do you have an opinion on the German economy?"

We had no helpful advice or insights. Instead, we rambled about the Great Crusades.

"If something is called "Great" by historians, it was invariably a disaster. The Great Plague, the Great War, the Great Crash, the Great Depression… And all we can learn from the Crusades – aside from the amusing Public Spectacle of it all – is that the Holy Land was not a good place to be in the 11th and 12th centuries. If the Christians didn’t massacre you, you’d probably be massacred by the Muslims…or later Mongols.

"All we can really tell you, is that U.S. dollar assets will probably be a dangerous place for your money in the years ahead. We now face what Alan Greenspan calls a ‘debt maelstrom.’ We don’t know how it will turn out, but we fear that it will eventually be preceded by the word ‘Great,’ with a capital G."

*** We always feel very comfortable and at ease in Germany. Perhaps the German mentality is closer to Middle America than the French…or even the English. At the end of WWI, we recall that General Pershing remarked that his erstwhile German enemies were easier to deal with than his French and British allies.

*** Back in Paris, we went immediately to a "rally" organized, in part, for our son Jules. "Rally" is the word given to a series of outings for young people, organized by their parents. They are way of trying to control how and with whom adolescents socialize. The young people are expected to learn how to conduct themselves in polite society…and, it is hoped, how to fall in with the "right" crowd. To this end, parents work very hard to cull the invitation list of anyone whom they believe might not "fit in" and spend thousands of dollars to host the events.

We are skeptical of the whole project, but generally willing to go along with anything. As a parent, your editor was expected to attend and was promised an open bar.

He arrived at 9pm. The nightclub that had been reserved for the occasion was nearly empty.

"Don’t worry. The kids don’t come until 10 or 10:30. It’s considered hopelessly out-of-style to show up before then," explained another parent.

By 10pm, though, they were coming in steadily and the dance floor was filling up. Generally, the invitees – kids between the ages of 16 and 20 – were very well brought up. They wore long dresses…or coats and ties, for the boys. Most stopped by to introduce themselves to the hosting parents, who had formed a disordered receiving line.

The boys looked like boys – awkward, gawky, generally unsure of themselves. The girls, on the other hand, many of them, looked like young women.

What would have been unusual and illegal in America was that the parents provided an open bar, not just for your editor, but for the kids too.

"It’s just a punch with a very low alcohol content. And some wine," a mother told me.

But, the loud music and dancing continued. And the bar stayed open. By 2 AM, we noticed a relaxed tone had set in. Coats had come off. Ties were loosened. Those rosy cheeks of youth had turned scarlet.

We report these things for no apparent reason. We just thought you might be interested.

And so the music blared, too loud for anyone to talk. How this helped the kids learn to interact socially, we don’t know.

Jules and his friends danced. It was not clear who was dancing with whom. It didn’t seem to matter. But later, we found Jules with his arms around a young woman. And then, he kissed her!

"You’d better put a stop to that."

Elizabeth had turned to us, urging action. That is what the fathers were there for, after all – to make sure the young persons conducted themselves properly. And here was your editor’s own son, getting fresh in public!

Trying not to make a scene, we wandered over towards the couple, so engaged with each other they did not notice us coming. Even standing next to them, they paid no attention.

Your editor stuck out his elbow to give his son a nudge:

"Straighten up," he said in English.

The message was taken in good grace. And the party continued.

It did not end until after 3AM.

"Well, I think it went very well," said one of the parents. "But I’m glad it’s over. Now we can go home and go to bed."

Ditto that, thought your editor.