Cost Free

Mogambo on Monday! Our fearless leader explains how the reckless creation of money engenders both a "fraud" and a "horror" in one fell swoop.

When I see one of the cool new twenty-dollar bills, it is usually in the hand of a stranger, and I always think to myself "Man! I wish I had a bunch of those! Or even one!" But Dan Neel, writing a nice piece entitled "Fancy Greens and Pusherman Blues" at the NY Press, is more advanced in his thinking than that.

"The U.S. is making an incalculable profit on the roll-out of the snazzy new twenties," says Mr. Neel. He figures that the profit comes from the underground economy, who are being roiled by this new regime of currency issuance. "Wholesale drug resellers as close as two tiers above street-level distribution have begun asking buyers to separate older twenties from new ones to more quickly direct the old currency at laundering operations and retail purchases. The result is an accelerated rate of tax revenue for the U.S. government."

Now, I freely admit that my experience with the drug trade is very limited, although I wish I had a big ol’ drug problem so that I could qualify for some of those luscious federal program benefits, with free food and housing and medical care and case workers to handle all my problems for me, and keep people from hassling me because I would be certified as a Person With A Disability And Therefore Possess Powers Beyond Those Of Mortal Men. But the few drug dealers I have run into always wanted cash, and I patiently tell them that I thought the first ones are supposed to be free, and that is how they get me hooked, and it is only AFTER I become an addict that they start charging me and they make all their money on the back end of the service period, but this is just the beginning of the service period, and therefore the drugs are free to me. But that is, alas, only in the movies, and in real life there is only that awkward moment when they are just staring at me in stunned disbelief, and then they tell me to get the hell away from them before they whomp me upside my freaking head, and I do.

Seignorage: Paranoid Seignorage

But getting back to Mr. Neel, he explains that "Such transactions are also the key to a little-recognized form of seignorage. Call it paranoid seignorage: a spike in tax revenue from resurfacing notes when the government refreshes its currency. Think of it as yet another way the government makes money from making money."

In case you are new to the concept of seignorage, he explains: "Seignorage is the difference between the value of money and the cost of its production. In the case of notes, the Fed buys at four cents apiece and sells them to banks at face value." Well, in actuality, the banks sells some T-bonds to the Fed for the money, or the Treasury deposits the money in the banks to use to pay government employees, and therefore the banks don’t spend a dime or even have to do anything other than record the transaction in the books.

But looked at another way, seignorage is also a shining example of glorious government productivity, as two things are accomplished at once, namely, 1) some debt is extinguished and 2) the money supply is enlarged, committing both a fraud (the artificial extinguishment of debt) AND a horror (the precondition for resultant price inflation, as this extra money works its way into prices).

But I regret that Neel really falls short of the mark when he quotes "post-Keynesian economic theorist William Hummel," who has the temerity to write, "For a few cents worth of paper, the [U.S.] notes buy foreign goods and other assets at their face value, and as long as those notes remain overseas, those assets are effectively cost free."

Seignorage: "Cost-Free"

Well post-Keynesian economic theorist or not, if this Hummel fella thinks for one lousy minute that there is no effect on economies because of a large influx of U.S. dollars, or an outflux of U.S. dollars, or large influx of any currency, or a large outflux of any currency, or a medium sized influx or outflux, or even a small influx or outflux of money, influx outflux influx outflux in any country anywhere on the planet, and if he further believes that U.S. nationals burrowing themselves under a mountain of debt so as to finance raw, naked consumption are included in his definition of "cost-free," then I can only surmise that the term "post-Keynesian" means "complete idiot," because I am here to tell you that any movement of even the most insignificant amounts of money has far- reaching repercussions, because it must, and of all the words in the world that I would pick to describe the effects of money piling up anywhere, the very last descriptor on the list, down there at the very, very bottom of the list, is "cost-free." And if you don’t believe me, then watch carefully what happens the next time my wife asks me for ten bucks, and you will note the HUGE effect that it has on me, starting out with the usual "What? Ten dollars? Do you think I’m made out of money or something?"

"Cost-free." Hahahahaha! I love it.

"Under the current system," writes Robert Blumen in a little essay called "The Dollar Crisis" on the incomparable site, "the United States year after year imports goods from the rest of the world for consumption and pays for them with dollars. The dollars are then used by foreign central banks to purchase debt instruments from either the Fed or the private sector, in addition to U.S. stocks and real estate."

Now note what Blumen says here, leading to the point that assets we buy from foreigners are definitely not "cost- free": "Where these are Treasury securities, they are created out of nothing, requiring no savings by any American consumer. Under this arrangement, Americans are now freed from the ponderous burden of saving and the onerous requirement of first producing in order to later consume. Their consumption is offset by a growing indebtedness of the private sector and the Fed to foreigners. This state of affairs is unsustainable, and will come to an end with a deep fall in the exchange value of the dollar relative to other currencies." As we are now seeing, if you pay any attention at all to the fate of the dollar, every day.

Blumen draws extensively from a new book by Richard Duncan, "The Dollar Crisis: Causes, Consequences, Cure."

Seignorage: The US No Longer Creditworthy

Mr. Duncan writes, "How much longer will the rest of the world be willing to accept debt instruments from the United States in exchange for real goods and services? It is only a matter of time before the United States will no longer be considered creditworthy. It is only a matter of time before the United States will not be creditworthy." If it was me writing that, I would have capitalized that last sentence to read "It is only a matter of time before the United States will not BE creditworthy."

The dollar must collapse, forecasts Mr. Duncan, because it will become impossible for the U.S. to continue to sell one-half trillion dollars worth of debt securities each year (the amount required to offset the trade deficit) for very much longer, because foreigners, who are obviously a real stupid bunch of people, are not so stupid that they will never get smart enough to stop doing it.

Now this is the place where I take exception to that, as the great advantage of a fiat currency is that we don’t have to sell nuthin’ to nobody, much less a bunch of debt. We can print up all the money we want, anytime we want. We can have so much money floating around that we can retire the entire national debt in one stroke if we want. However, the resultant monetary inflation will, of course, filter through to inflation in prices, and then all the poor people start starving to death and getting uppity, and commerce falls to zero as everyone is afraid to go to the mall and have to wade through mobs of angry, homicidal people.

Seignorage: It’s Not Okay

But Mr. Duncan anticipates that very objection when he says, "The more familiar effect of inflation, consumer price inflation, is the bidding up of the money prices of consumption goods as the money supply expands. However, inflation does not always take this route: asset price inflation occurs when credit money creation flows into financial assets." Namely, stocks and bonds and houses. Which is what we are seeing nowadays, as if that is okay somehow. It is not, in case you were wondering.

But back to the Blumen essay, in which Blumen goes on to say, "Bubbles are followed by busts, which usually result in banking crises, and then fiscal crises generated by the ensuing costly bailout of the banking system by the government."

Not to mention, of course, the inevitable bailout of every dirtbag country and THEIR banking systems that have fallen victim to the IMF’s ministrations, which is the exact same thing on an international scale. And not to mention the bailout, in this case "debt-forgiveness" of Iraq and Afghanistan, since we decided to invade them and destroy their economies, which means that we taxpayers eat another huge cost.

And still, insists the aforementioned Mr. Neel, the U.S. consumer’s profligacy is, of course, "cost-free." Hahahahaha! I love it.


The Mogambo Guru
for the Daily Reckoning

December 29, 2003

— Mogambo Sez: It is almost over. You spent the whole year being good. Let’s hope it pays off better than it has in years past.

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 have been taking advantage of this lull in the markets to think about THINGS.

Our consumer economy depends on people buying more things. But every major religion tells us that the more ‘enlightened’ we become, the more we realize how unimportant things really are. What things did Jesus have? We don’t recall any mention of them.

On the contrary, Jesus sermonized more than once against letting yourself get distracted by wealth and worldly things. It is easier for a camel to pass through the eye of the needle than for a rich man to enter heaven, he warned. It now looks as though our entire economy has gotten trapped…stuck like a fat camel in the eye of the needle on its way to paradise…so blubbered up with things bought on credit – it cannot get through.

When we are interviewed on the radio, we are frequently asked, "Well, what should George Bush do…what should Greenspan do…to avoid the grim scenario you see coming."

"Nothing," we reply. "There is no easy way out. We are stuck."

And there is no escape. Going forward means getting deeper into debt – which will cause even greater problems in the future. Backing up, by curtailing spending and borrowing, would mean recession, joblessness, and lower standards of living – now. It would also mean that George W. Bush would serve only a single term.

But we are thinking about other things, too. It is nearing the end of 2003. So far, we have little cause for complaint; the 3rd millenium has seemed about as agreeably mad as the 2nd.

In last week’s paper, the Wall Street Journal noted that IBM had announced moving nearly 5,000 well-paid jobs offshore.

"Most of the millions of white-collar workers who could be affected by this phenomenon over the next several years are clueless as to what they can do about it," writes Bob Herbert in the New York Times.

Mr. Herbert was thinking in terms of labor unions…and how they might pressure either IBM or Congress to prevent the loss of jobs. No one asked us, but we would have given the same response we give to the radio: nothing.

"These families have little protection against the powerful forces of the global economy," Herbert concludes.

Americans are trapped in more ways than one. Not only has their spending wiped out their savings and laden them with debt…it has also destroyed their industries and their ability to pay. Each dollar of excess purchasing power in America brought forth a dollar and fifty cents worth of extra effort overseas. Gradually, foreigners – with almost inexhaustible supplies of cheap labor, abundant capital, and an apparently unquenchable demand for new THINGS from American consumers – built the factories that might otherwise have been built in America…and took the jobs that might otherwise have been given to American workers.

We have not quite seen the proof of it yet. Only the hints and soupçons – a falling dollar, rising gold, a strange ‘jobless’ recovery. But we believe we are entering a different world, a different epoch. Globalization, derivativization, consumerism, dollarization…all have turned the tables on Americans. The huge advantage that the average American enjoyed – merely by being born into a rich, high-wage society – is giving way. Capital is available worldwide now. Except for the curious marvel of the Dollar Standard System, Americans have no special access to it.

In fact, with national savings rates near zero…they are forced to rely on Chinese communists for their spending money. And now the Dollar Standard System is giving way, too. It seems inevitable that wages in America will fall, compared to the rest of the world. Living standards will rise in other countries…and stabilize or even collapse in the U.S. Somehow, we suspect, Americans must go through a veil of tears – paying down their debt, building their savings, turning their backs on runaway consumerism, buying gold, and adjusting to a new and less accomodating world.

In the meantime, here’s more news from Eric:

Eric Fry from the belly of the beast…

– Wall Street’s losing streak is finally over…(unless the stock market crashes 20% before Thursday). This year’s double-digit gains will bring an end to three years of falling share prices, while also bringing an end to Abby Joseph Cohen’s three-year forecasting slump. The Dow added seven points last week to 10,324 – giving the blue-chip index a plump 24% gain for the year. The S&P 500 is up a similar amount, while the Nasdaq Composite has surged nearly twice as much.

– Abby Joseph Cohen – for one – is delighted that her perennially bullish prediction for the stock market came to pass in 2003, unlike the perennially bullish forecasts she issued for 2000, 2001 and 2002. If memory serves, Ms. Cohen issued a succession of overly optimistic stock market forecasts for share prices, beginning with the prediction that the S&P 500 would hit 1,755 by the end of 2000. Instead, the index fell to 1,320 – 25% below her forecast.

– Undaunted, she called for the S&P to hit 1,650 by year- end 2001. Instead, the index fell to 1,148. She came roaring back in 2002 with a guess that the S&P would recover to 1,425 by the end of that year. Oops again! The S&P ended the year a whopping 38% below her forecast, at 880. Mercifully, 2003 brought a bit of much-needed redemption to Ms. Cohen. This year, her forecast was off by less than 5%. The S&P currently sits at 1095, only 55 points shy of her year-end price target.

– Abby Cohen’s experience demonstrates just how tricky it is to outguess Mr. Market. We are sure we know what he should do, but we are never sure what he could do. That’s why we here at the Daily Reckoning have a perfect forecasting record; we never offer a forecast.

– "The annual parade of strategists’ predictions has devolved into a mock-heroic farce," we observed one year ago in this column. "The strategists play their part by taking their predictions – and themselves – very seriously, which enhances the comedic effect of the farce. However, the effect is much less comedic for those gullible souls who, over the last three years, may have trusted in the strategists’ woefully errant forecasts. Recall that at the very start of 2002, Abby Cohen urged investors into the stock market with her confident assurances that share prices would rise briskly. Heeding the call, many bullish investors, armed only with their naïve enthusiasm, rushed into the fray and went head-to-head with bearish financial market trends…The outcome wasn’t pretty."

– But this New Year’s Eve, let’s let bygones be bygones and raise a glass to Abby Cohen’s "clairvoyance." Let’s toast the occasional success of robotic bullishness and let’s hope that Abby is "right" again in 2004. Ms. Cohen is expecting the stock market to advance again next year. Not surprisingly, she holds the highest Dow forecast for 2004 of any Wall Street strategist. She expects the blue-chip index to hit 11,800 by year-end, and expects the S&P to reach 1250…Here’s to Abby! As the new year dawns, Ms. Cohen’s bullish outlook is hardly a contrary opinion. Everyone, it seems, is bullish – professional strategists as well as amateur investors.

– "A thorough, if not exhaustive, review of the formal year-end outlook dispatches produced by every Wall Street strategist and buy-side chief investment officer reveals a kind of harmonious, upbeat perspective," observes Barron’s Michael Santoli. "Here are the beliefs espoused broadly as the year turns: The bear market ended in October 2002. Stocks will continue higher, though at a more moderate pace…The cyclical upturn in the economy is strong and probably sustainable…Business spending will grab the baton flawlessly from consumer spending, which will slow…Treasury yields are headed higher – but that’s okay for stocks because it means the economic improvement is real. The dollar will continue trending lower – but that’s no problem for stocks because it helps multinational earnings and will cut into the trade deficit. Profit and gross domestic product growth will decelerate – but stocks can still log gains in a moderating growth climate."

– Sounds good to us…Maybe too good.

– Wall Street’s happy scenario reminds us of a child’s lie – as entertaining as it is unbelievable. To be sure, some things will go right in 2004. But the happy scenario assumes that nothing will go wrong…We have our doubts.

Bill Bonner, back in France…

*** The papers report an un-encouraging Christmas shopping season. Wal-Mart said its sales were near the low end of the forecasts.

*** "Small business hiring on hold," reports the Arizona Republic.

*** But hey, who’s complaining. Stocks are up! "Best results in 17 years," says the Financial Times. Worldwide, investors averaged a 29% return this year…with emerging markets up 64% in dollar terms.

The Dow is up 21%…also in dollar terms. Adjusted to real money – gold – or better phony money – euros – U.S. stocks gained little during the year.

*** "Things mean more to women than they do to men," Elizabeth volunteered. "Status is more important. At least for women who don’t work; they get their status from having fine things. And successful children. They have few other ways to show off."

The conversation began about spending money. It took a curious turn.

No serious man gains status by spending money, your editor explained. The man who buys a fancy sports car or a expensive suit of clothes – or who dumps his long-suffering wife in favor of a trophy bride…is regarded by other men as a fool. They know he is just giving himself handicaps.

A man gains status – at least among other men – by being able to do things. A man who knows how to fix a car…mix a good drink…cure a ham…or track an elk is a hero to all who know him. But women cannot appreciate him. They prefer the big-spending nincompoop. And maybe they are right.

A fur coat is more than just a way of proving you are successful, Elizabeth replied. It is success itself. It is all very well for a man to feel like a success just because he has been able to make some money. But what good is it? It is merely an abstraction…something he can look at on a report from his stockbroker…or put in his will. But a fur coat is something that you can enjoy. It is real. It feels good and it makes you feel good about yourself…knowing that life’s good things are available to you.

"I don’t like wasting money," she went on. "But I don’t mind spending it either. Otherwise, it has no value. No point. The miser who lives a Scrooge-like life…and saves all his money in gold coins is always a pathetic figure in literature. And there’s a reason for it. He is a pathetic creature in life. Money is meant to be used, enjoyed.

"Now, sweetheart…about that fur coat…"

The Daily Reckoning