The Mogambo Guru pushes his brain to the limits and wonders about the link between Applied Thermodynamics and Economics. The surprising conclusion – Bankers are parasites and Greenspan is causing inflation.
Tom Webber, a reader of the MoGu who foolishly thinks that by sending me things to read I will maybe get an education and hopefully smarten up one of these days, sent an interesting but somewhat lengthy article entitled "Fractional Reserve Banking As Economic Parasitism," by a guy named Vladimir Z. Nuri. The thrust is that the science of physics applies directly to economics, as in "applying statistical and computational modeling techniques to come up with…theories of money flow in…large economies." There is now an emerging body of research actually doing this, and he calls it "econophysics."
(Many of the techniques used in the equation-laden field of thermodynamics, mostly involving the ‘Ideal Gas’ law and Boyle’s law, can be applied to economics – an example of which is the visualization of an increasing money supply as a kind of pressure or the multiplication of money stock by velocity to arrive at volume, etc.)
Thus Vladimir Z. cleverly notes some of these eerie parallels between physics and economics, and how many of their formulas resemble each other, which fascinates me for two reasons…
Firstly, they are both concerned with physical things, like money and gases, and how they operate in the real world, and secondly because the current crop of mainstream economic theorists and THEIR theories and equations have done such a poor job that it apparently amounts to mere hocus-pocus, and we should be on the lookout for something better.
So, getting back to the article, Mr. Nuri wisely instructs us that one can be led to enlightenment by always remembering a Latin phrase, "cui bono?" which translates as "who benefits?" And then he caps that off with "caveat emptor," or "let the buyer beware." This is an adaptation of that other timeless credo, which is "follow the money."
He uses this transcendent insight to ask some (and here you have to imagine that I am slowly stroking my chin in a thoughtful, pensive way and looking into the distance as if lost in thought) very interesting questions, such as concerning "Spending and circulating new dollars…the key question is, who owns those dollars?"
His conclusion, and my conclusion, and your conclusion if you have correctly used your Mogambo Decoder Ring, is that the bankers own the dollars because they are the ones who created the dollars in the first place, and that is why he writes "Whoever has or is given the authority to create credit has the authority to extract wealth from the economy by that same mechanism."
And these people are, as they always are, the bankers. The bankers are, in other words, extracting the wealth of the USA to enrich themselves.
Using this bit of timeless wisdom, he dissects Greenspan’s famous 1967 essay entitled "Gold and Economic Freedom," and notes that Greenspan was correct when he described how, when the supply of money increases, that the "earnings of the productive members of society lose value in terms of goods," but that Greenspan was wrong when he immediately followed that up with, "When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes."
In truth, says Nuri, and the Mogambo leaps to his feet and proclaims "Verily, in truth!" the grubby bankers created the credit, therefore the bankers created the money, therefore the bankers owned the money, and therefore the value went into the pockets of, and I am sure that you have already connected the dots here, the bankers themselves.
What everybody else ends up with is, predictably, pure price inflation, making them all worse off. And this inflation is due to the decreased purchasing power of the previous stock of money that has been diluted by the issuance of the newly created money. See how simple this stuff is? It makes you wonder why Alan Greenspan doesn’t comprehend it.
Nuri also posits the concept of economics as an ecosystem, and, as he says, "building on it, an important additional theme proposed and explored here is that of economic parasitism." I naturally assume that he arrived at this ugly metaphor by talking to my wife, who habitually characterizes me as a blood-sucking parasite that has drained every bit of joy from her life and, even as we speak, her will to live.
But his perspective is that parasites survive by utilizing various techniques to remain unnoticed, they use their anonymity to feed on their hosts, and, in many cases, actually alter the behavior of their hosts toward suicidal actions so that the next phase of their parasitical lifecycles can proceed. Politicians, bankers, overpaid CEO’s and lawyers immediately come to mind, and the term "parasite" is probably a lot more descriptive than "vampires," which is another apt metaphor that is often used to describe these groups of people.
I will not take you farther down this ugly path because I am disgusted by the whole parasite concept, nor down the path of math and formulas because I am confused by that whole concept, too, and I spend more than enough time being disgusted and confused as it is, thank you very much. But I will take you gently by the hand and lead you directly to some of the conclusions, and then show you how to make some money on the deal, so that maybe we’ll all go out for a beer.
The short executive summary (SES) is that Mr. Nuri validates, through rigorous mathematical process, everything that the Austrian school of economics has been saying all this time, and everything that I have been saying all this time, too, although they say it with class, wit and erudition, which you can verify by going to the Mises.com website, while I spew what appears to be blubbering gibberish, which you can verify by reading anything I have ever written.
And the mathematical conclusion shows that deflation is actually a good thing! Nuri says "deflation can be a natural and beneficial redistribution of increased GDP or efficiency," although the horrid Alan Greenspan thinks otherwise, and that is why he is trying to kill us all with inflation. I, and a lot of other people, think that deflation is a good thing, too, because it is 1) the mark of a truly healthy economy, and 2) it is intuitively obvious that lower prices mean that a paycheck can buy more things, and buying more things is the favorite pastime of homo Americana as well as being at the very heart of increasing standards of living, which is the goal of economics and its application.
The obvious way to make money on the deal is to buy a bank. If you can’t get one of them, then buy gold, because all bank multiplications of the money supply in excess of the growth of GDP lead directly to inflation. In fact, the main conclusion is that, like the Austrian school, expanding the money supply automatically produces inflation, as when Nuri says "Price inflation is a precise, mathematical measure of the macroscopic energy dynamics of a system which adheres to physical laws." And where does this energy come from? Exactly where you thought it comes from: fractional reserve banking. It is one of the world’s greater evils, my grasshopper, and if you don’t watch out, Mr. Greenspan and his banker cronies will use it to steal the value of your money from under your very nose.
The Mogambo Guru
for The Daily Reckoning
May 3, 2004
Editor’s note: 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. If you’re inclined to read more, you’ll find the whole Mogambo here:
The Handwriting Is On The Wall
America used to subsidize the rest of the world. It produced a lot and consumed little. Since the mid-’80s, it has done the opposite: it consumes a lot and produces little, relatively.
Someone must produce what America consumes. There are many nations that run positive trade balances, but the most important is China. The Chinese produce a lot and consume little. The difference, or at least much of it, is sent to America.
We pause, briefly, to enjoy the irony: The world’s richest capitalist nation is being subsidized by the world’s largest and poorest communist country.
But today, it is not irony that interests us, but fraud. American central bankers stimulate demand – with artificially low interest rates, for example – in order to give the U.S. economy a boost. The increased demand is supposed to stimulate production and employment. It does, but mostly in China as opposed to America. Chinese-made goods end up providing Americans with ‘Everyday Low Prices’ at Wal-Mart. It is the Chinese who come home with sore fingers; they have stitched the hems that America wears. They have turned the little screws that hold their gameboys together. They have glued the soles onto the shoes Americans wear when they walk to the mall to buy more Chinese-made gadgets.
It is Chinese fingers, too, that count the money sent to them by Americans who have mortgaged their homes to get it.
Both Americans and Chinese believe their economies are enriched by this commercial intercourse. But only one is.
Wages in America have been stagnant – in real terms – for the last thirty years. In China, they have gone up 25 times. You increase your wealth, after all, not by consuming, but by producing.
Last week we wondered how an increase in house prices made anyone richer. What additional value has been produced? True, a man can borrow more against a million-dollar house than against a trailer, even a double-wide one. But the ability to go into debt is not the same as real spending power. Unlike earnings, debt needs to be paid back. Real spending power does not. If a man earns an additional $100, he can spend an extra $100. But a man can borrow a million and his real net increase in spendable money, over time, is still zero – because he has to pay it back.
A merchant cannot tell a borrowed dollar from a real one – and usually doesn’t care. He takes one as he takes the other – as evidence that someone has money to spend. The Chinese thought Americans had money to spend. Racing to keep up with demand, the Chinese have set new records in the history of industrialization.
Investment in fixed assets rose by an amazing 27% last year. In the first two months of this year, it was increasing at a staggering 53% pace. Visitors report that they have never seen anything like it. Construction cranes stick up like pins in a pincushion. Everywhere you go you hear the thump and bang of building…and see the dust of rapid growth.
This year, China is expected to gobble up 7% of the world’s oil, 30% of its coal and coke, 27% of its steel, and 40% of its cement. So great is the urgency…so large is the task…so high are the stakes – the whole nation bends its back to the job…the whole economy (the 4th largest in terms of what it buys and sells on the world market) is geared to it…depends on it…
What happens when it discovers that the demand is as counterfeit as the currency in which it is quoted?
We don’t know…but every day we are closer to finding out.
Here’s Addison with more news:
Addison Wiggin, from the city that ‘breeds’…
– "With the U.S. economy surging at a 5.5% average annual rate in the three quarters ending in the first quarter of 2004, a 1% federal funds rate is a joke," says Steven Roach, Morgan Stanley’s highly acclaimed pessimist.
– "A year ago, the Fed implemented an ’emergency’ policy stance in response to a full-blown deflation scare – a scare that I was very sympathetic to. That was the right thing to do at the time. But now the emergency is over – suggesting it’s high time to abandon the emergency policy prescription."
– Despite misreading the tea leaves throughout the bear market (more below), the Fed’s persistent market dalliance appears to have warped the global financial balance. Here at the Daily Reckoning, we have often wondered how more debt, more consumption and less saving can be the solution to…um…more debt, more consumption and less saving. But then we just assumed we had quaffed many more vintages than the geniuses in Washington, and were too fuzzy-headed to comprehend.
– Lately, however, we’ve begun to wonder about a whole new basket of problems: Not only are the "central planners" trying to manage a reflated stock bubble…but now they appear ready to address a rapidly expanding commodity bubble by pricking the housing bubble.
– Alas, bubbles are nothing new, even to Alan Greenspan…claim as he might a certain myopia when it comes to identifying them. What is new is the breadth and scale of our current bubble – it is unprecedented. And chosen to lead us across this perilous uncharted territory: a team of boobs, stumbling around in the dark, pursuing short-sighted, temporary policies bodged together without any room for error, human or otherwise. Man is at his weakest when he thinks he knows what he is doing.- To see theory in action, dear reader, simply listen to Greenspan’s announcement following the FOMC meeting on Tuesday.
– The Fed thinks it can use short-term interest rates to control GDP, the dollar, employment and the various speculative bubbles it encounters along the way – all at the same time. What gives them the arrogance to undertake such folly? A 20-year bull market in hubris…
– And of even greater concern, it seems that the Fed might have been misinterpreting the data when they started to worry about deflation in the first place, chopping rates: "…much of the drop in inflation between 2001 and 2003 was due to unusual behavior in residential rents and used-car prices indirectly caused by low interest rates," claims the Wall Street Journal. If that’s so, suggests a Fed Reserve Bank of Atlanta study, then: "The Fed may have been responding to a false alarm last year when it cut interest rates to four-decade lows and held them there over fears of deflation."
– If the Atlanta Fed study is correct in its assessment that the threat of deflation was over-estimated, the implications – apart from proving that central bankers are clueless and have no business manipulating the price of money – are deadly serious. The inflation rate could actually be much higher than the CPI would have us believe…or maybe not. How can we know? But when the Fed begins to raise rates again, the odd behavior in the used-car and rent markets could be reversed, pushing measured inflation rates even higher still…
– "I think we’re starting to see (inflation) heat up in this country," Warren Buffett chimed in on Saturday, speaking at the annual shareholder meeting for Berkshire Hathaway. "Inflation is the enemy of the investor in real terms." But inflation was only one of Buffett’s concerns this weekend. Turning his attention to Wall Street, Buffett was "especially critical of those who advise some sort of specified 60-40 percent split between stocks and bonds," calling such a strategy "nonsense." Instead, Mr. Buffett advised the audience to seek out bargains no matter what type of investments they are.
– And where might those bargains be? For regular readers, the answer will seem as familiar as an old pair of jeans…Mr. Buffet has been buying foreign currencies and increasing his bet against the dollar by "more than a little bit," Chuck Butler of Everbank tells us. Last week, the lumps seemed to have difficulty finding bargains in the U.S., too. The Nasdaq declined on each of the five trading days, losing 132 points or 6.4%. Likewise, bonds, commodities, gold, silver and the Dollar all finished the week lower.
– Further, Buffett warned that "sometime in the next 10 years you will have a huge problem that will either be caused by or accentuated by people’s activities in derivatives." Who should he cite? None other than one of the central characters in the unfolding drama of the housing bubble: Freddie Mac.
– The ‘sage’ used our friend Freddie as an example of an organization unable to get a hold on the complexity of these financial instruments. You thought Enron was a mess…wait ’til the trillion-dollar mortgage market gets whacked by rising interest rates and Fannie and Freddie take it on the chin.[Ed note: In fact, if the Fed happens to raise rates when they meet…tomorrow…drumroll…it could spell:
Doom For The U.S. Housing Market!]
Bill Bonner, back in London
*** Kurt Richebächer stopped by the office on Friday.
We had been wondering if the coming financial crisis in America would be as bad as we had been imagining it could be. Kurt answered our question directly:
"It will be much worse.
"The thing is nobody knows exactly what will happen. We have never seen a situation like this where the excesses have been so extreme. We don’t know exactly how it will resolve itself. But what makes me worry is that when you get excesses this bad, you get results you can’t expect."
The excesses Kurt referred to are many. They find expression in the curious phenomena we discuss here in the Daily Reckoning. Trillions in mortgage refinancing…debt at record levels…the carry trade (taking advantage of the Fed’s artificially low rates by borrowing short and lending long)…Japanese support for the Treasury market (in order to hold the yen down)…There are so many absurd elements, it’s hard to decide what to laugh at first.
"The whole consumer economy in America now depends on having mortgage rates on new mortgages lower than those on old mortgages. People need a reason to refinance. But how long can new rates be lower than old rates? As time goes by, today’s new rates become tomorrow’s old rates.
"I think the whole economy could be headed towards a liquidity crisis, like the crisis that hit LTCM [Long Term Capital Management…a hedge fund that got caught on the wrong side of rising yields in the 1990s]. If long rates continue to rise, people will not be able to refinance. All of a sudden, they will have to reduce their standards of living…and they will be desperate for cash to pay their bills. How will they get it? They will have to sell assets – stocks, bonds, houses – everything.
"I don’t really follow gold, but that’s what worries me. When people need cash they will sell everything – even gold.
"And when I say ‘people,’ I mean financial institutions, too. Like LTCM, they have trillions of dollars’ worth of exposure to various derivative positions…many of them leveraged on low interest rates…with little real capital behind them. When rates go up, the capital will be quickly wiped out. They’ll be forced to sell to raise cash.
"It will be worse that people expect. Much worse."
And with that, Dr. Richebächer raised his silver-handled cane in a gesture we didn’t know how to interpret, and smiled.
*** J.P. Morgan, we note in passing, may be LTCM reincarnate. According to Grant’s, it has "$36.8 trillion in notional value of derivatives contracts and 1.5 million separate and distinct securities positions with 240,000 different pricing series…"
*** "You know, this is a funny business," said a Dutch woman selling plants at the annual garden show at the Château de Beauregard yesterday. "I’ve seen rich people – I mean really rich people – come in their private jets just to buy a special tulip bulb or some other plant. People get very excited about rare plants. Especially in springtime.
"But the really rich people are very nice. Very modest…they act like ordinary people.
"It’s the people who are not-quite-rich who are a pain in the neck. They feel they have to pretend to be important. So they treat you badly, as if bad manners were a mark of distinction. It is really absurd and sad."