Lovable, Moronic Capitalists

Modern economists are more like auto mechanics. They think they can control the economy with a screwdriver. And to some extent they’re right. Which is why the world economy is in such a mess; they turned the wrong screws. Bill Bonner explores…

The first economists – the two Adams, Adam Smith and Adam Ferguson – called themselves "moral philosophers." They were studying the human economy as though it were an anthill — to see how it worked. They figured it must follow rules – just like all other things under Heaven – and tended to see mistakes people made, such as spending too much money, as moral failings.

Modern economists are more like auto mechanics. They think they can control the economy with a screwdriver. And to some extent they’re right. Which is why the world economy is in such a mess; they turned the wrong screws. But it’s why we moral philosophers are having such a good time; finally, we get to laugh and say "I told you so."

In the news last week was word that the Argentines are taking back their national airline – Aerolineas Argentinas. Back in the heyday of privatization – led by economists from the University of Chicago – they sold it to a Spanish group. But now the Iberians can’t seem to make a go of it – not with oil over $130 a barrel – so the Argentines are re-nationalizing it.

What is the likelihood that the heirs to Juan Peron will do a better job of running an airline than a private company? You might put the same basic question to Gordon Brown. What are the odds the Labor Party will run Northern Rock better than private owners? And in the United States of America – almost 30 years after the Reagan Revolution – the federal government is effectively nationalizing the biggest and most important financial institutions in the world, Fannie Mae and Freddie Mac. Between the two of them, Fannie and Freddie hold almost half the entire nation’s mortgages – equal to about a third of the US GDP. It probably won’t be too long before General Motors is nationalized too. Someone is going to have to pay GM’s pension bill. Even if the company isn’t nationalized, its health and pension obligations probably will be. But can America’s Republicans and Democrats do a better job of running a mortgage company or an auto company than card-carrying capitalists?

On the evidence, maybe so.

Milton Friedman warned that if you put government in charge of the Sahara there would soon be a shortage of sand. But the heirs to Friedman have some explaining to do. The smartest of them have crashed airlines, busted banks and wrecked builders. They’ve ruined businesses so simple that even a half-wit could have made a profit. Fannie and Freddie couldn’t win at their business, even though the deck was stacked in their favor from the very beginning. And the Friedmanites’ beloved markets — which are supposed to "look ahead" and anticipate trouble before it happens — must have shut their eyes years ago. They walked out into the blazing desert without a map or a hat; no wonder they’ve been acting strange.

To many of the world’s politicians and opinion mongers, the evidence of the last 12 months has proved what they always suspected – that capitalists are greedy s.o.b.s. But we would have spotted them that…and readily conceded that they are often morons too. Still, a system in which people get what they’ve got coming is infinitely better than a system in which people take only what government gives them. That’s the essential difference between capitalism and socialism: one yields to Armani-clothed fraud; the other to cheap-suit force. Both have their moral failings. But one is wicked; the other is merely dumb.

Want to know who caused Aerolineas Argentina’s bumpy ride…and who’s responsible for bringing down Fannie and Freddie? Follow the money. Before 1971, in the Bretton Woods monetary era, major economies used the dollar as a reference of value. The greenback was a North Star – helping businessmen and investors find their way. The U.S. dollar was reliable because it was tied to gold, which the U.S. Treasury promised to deliver to any country at a rate fixed at $42 an ounce. Then, on August 15, 1971, the U.S. Treasury reneged. Egged on by modern economists, the last link with gold was cut. Governments, investors and businessmen could still look to the dollar as a point of reference, but good luck to them. This disgraceful mischief caused even the stars to wobble.

Since then, the U.S. government could print almost as many dollars as it wanted. Arguably, it printed too many. For something – perhaps it was too much cash and credit in circulation – led American homeowners to think house prices would rise forever. They over borrowed, homebuilders overbuilt, and Fannie and Freddie – even with all their Ph.D. economists on the payroll – over-lent. And something – maybe it was the same thing – caused the price of oil to rocket upwards 400% in the last five years. The airlines hadn’t seen that coming either. So, the big lenders and the high fliers are in trouble.

Those are only two of a long list of today’s troubles that can be traced…directly or indirectly…to the world’s monetary system of the last 37 years. Businessmen, consumers and investors respond to financial signals. If interest rates are set too low, they tend to borrow too much. If the money supply expands too rapidly, they expand too rapidly too. To make a long story short, a bubbly supply of cash and credit led to bubbly markets. The U.S. and major foreign stocks market bubbled up to all-time highs in January 2000; then they headed down. In inflation adjusted terms, most never recovered. Then, in 2003, it was housing’s turn…followed by emerging markets…and lately, oil and commodities.

Sure, the capitalists are greedy. And sure, many of them make mistakes. But with feds rearranging the heavens, it’s a wonder they didn’t wash up more often.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning
July 25, 2008 — Vancouver, Canada

We’re still here, listening to presentations by various financial analysts…trying to make sense out of things…and reporting to you directly from the floor of the Vancouver investing conference.

Up on stage, our old friend Paul van Eeden is explaining why the price of gold may be overpriced.

"Gold is money," says Paul, "and almost only money." So, you can forget supply and demand. To figure out what the price of gold should be, simply look at what it will buy, in comparison to other currencies. The only time gold leaves its "theoretical value" – as measured by what it will buy – is when speculation drives it up or down beyond what it is really worth.

Paul is certainly right. Based on what it will buy, gold should be only about $800. But speculators look ahead…and so do we. And our guess is that gold is going to become a lot more interesting to speculators. It’s above its current "theoretical value" because inflation rates are rising. Investors want to protect themselves. And if inflation rises further, gold will shoot up more.

But, "the real threat you face is located east of one ear and west of the other," says another old friend, Rick Rule. "The subprime economy and the problems it brought us are the result of subprime thinking. A few years ago, there were billboards in Southern California offering to loan people 125% of the value of their houses. Now I ask you, is it a good business to loan more than the collateral is worth to people who can’t pay the money back so they can buy over-priced houses? No, of course not. It was subprime thinking."

Rick says that taking the food and energy out of the consumer price index is also sub-prime thinking.

"The measurement of goods and services that the government uses to describe the growth in the economy, calculate productivity and make inflation-adjustments was a total fraud," says Rick.

"Other shoes are going drop," he continues. "Credit cards, for example. They also lend money to people who often can’t pay it back. Say, a guy wants to buy a big TV set and can’t afford to pay for it. So, he uses his credit card, figuring that it will be easier to pay for it a year later, after paying an additional 18% interest. Then they put millions of these loans together and sell them to a pension fund.

"Or take the loans for leveraged buyouts. It seemed like a great business when sales and profits were rising. But when earnings go down, it becomes hard to service all that debt. In effect, we allowed the Wall Street tycoons to do the same thing as the moron who bought a house he couldn’t afford.

"But there are still bankers out there who know what they’re doing. They’ve got a big advantage now…they’ve got money and others need it. And it’s always a competitive advantage when your competition is brain dead. Now there are opportunities in the financial services sector, but you really have to do some real non-sub-prime thinking to find them…and have the courage to the act upon it."

Meanwhile, back to the financial news. Moody’s Economy.com:

"U.S. household finances are deteriorating rapidly under the strain of increased debt and falling home prices, threatening the health of the U.S. economy, according to a new research from Moody’s Economy.com, a division of Moody’s Analytics.

"Household credit quality is rapidly eroding, and overleveraged households are at the heart of the economy’s problems," said Mark Zandi, Chief Economist for Moody’s Economy.com. "The mounting losses on household debt are straining financial institutions and will keep the economy struggling to grow for the remainder of this year and well into 2009."

But over on Wall Street, the big banks have been staging a major rally, while gold and oil have been falling. Oil was down to $124 the last time we looked. And gold dropped $25 on Wednesday. Wall Street, meanwhile, has come back from the dead – or so it appears.

"Was that the bottom?" Everyone wants to know. Many investors think it was. And they think they can take advantage of it by buying the big banks – run by the same dumbbells who packaged sub-prime loans and sold them to their best customers…and who lost fortunes for their stockholders while paying themselves millions in bonuses.

"More subprime thinking," says Rick.

*** "China is the next great country," says our old friend Jim Rogers to the Agora Financial Investment Symposium crowd. "Of course, there will be setbacks, just as there were in the growth the United States. We had crashes on Wall Street and even a Civil War. But you still could have made a lot of money by investing in the United States. There will probably be real estate speculators going broke. Who knows what will happen? But the growth of China will be the single most important event of this century.

"And the best thing you can do for your children is to teach them Chinese. And make sure their money is not in dollars. The U.S. is now the largest debtor ever. We owe the rest of the world $13 trillion…rising at the rate of $1 trillion every 15 months. And even our friends are starting to think there is something wrong in the United States. Of course there is something wrong. And the few people who know what is going on don’t seem to care… the head of the central bank is on record saying that he will drop money from helicopters if that is what it takes. He doesn’t know much about economics. But he knows about printing money. He controls the printing presses…and he’ll run them as fast as necessary to keep the economy running. You better take him at his word.

"My little girls do not have American bank accounts, they have Swiss bank accounts. In 2003 bond market made its top…a big top…bonds are now a terrible place to have your money invested. I’m short bonds…

"And U.S. stocks have gone sideways for the last 10 years. You’re not going to make any money in stocks, in my opinion. We’ve had many periods when stocks go nowhere. We’re in one of those periods now… And sure, if you’re a good stock-picker, you can make a lot of money. But most people need a secular bull market to make any money.

"And we have a secular bull market – but it’s not in stocks; it’s in commodities. There are long bull markets in stocks…and then long bull markets in commodities. And these can last a long time. The shortest bull market in commodities lasted 15 years…but it could last much longer. This one will probably be around until 2020 and I’ll come back here and tell you to sell your commodities. And when I do, you’re going to say: "What…you old fool, don’t you know commodities already went up?"

"Whenever stocks have done well, commodities have done badly. Stocks did well in ’80s and ’90s…now it’s commodities that are doing well. Rogers International Commodity Index is up 471% since August ’98. There will be more setbacks of course, but commodities will keep going up. Commodities have done 15 times better than stocks in the past10 years…and they’ll continue to do better."

"Which commodities would you buy now?" asked a listener.

"I’m buying agricultural commodities…they’re still way below their all-time highs," was the reply. "Sugar, for example, is down 80% …and that’s not even inflation adjusted… That’s in nominal dollars. If you adjusted for inflation it would be down a lot more. You should pick up some of these little packs of sugar that they give you with your coffee. Put them in your pocket. Take them home."

*** Maybe James Kunstler is right; maybe the whole "cartoon" period is over. Kunstler argues that the suburbs produced houses that were only parodies of the real thing. The porches were only meant to look like porches – from a distance. There were picture windows, but no pictures worth looking at – just another cartoon house across the road. And the shutters were not real shutters – but mock shutters you couldn’t close.

What occurs to us is that his critique of modern suburban architecture applies to the whole economic period, beginning in the early 70s…and lasting right up until the present. The GDP grew, but it was mock growth, not the real thing. People spent money they didn’t have buying things they didn’t need. People felt richer, but it was ersatz wealth – a misleading sensation caused by inflation of their house prices, credit cards, cheap products at Wal-Mart and home equity lines.

The whole economic model was a scam. You can’t really get rich by spending more money. It’s saving money…and investing it in productive enterprises…that makes you rich. Yet, for the last 30 years, the feds have been encouraging consumer spending as a way to boost the economy. Wall Street turned over trillions of dollars – pretending to "add value" by better allocating capital and credit. What it really did was to pay itself huge fees for loading down the whole society with debt.

And even the wealth supposedly created in the stock market turned out to be phony. Compared to increases in the price of gasoline, the Dow went nowhere for the last 40 years.

*** At dinner, an old friend – who happens to be in the coin business – explained how customers used rare coins as an informal way of estate planning.

"These old fellows are pretty shrewd. They come in and buy coins. Sometimes millions of dollars’ worth. Then, they put them in storage somewhere and leave a note to their children about where to find them after they die. Often, the kids don’t know anything about coins. So they come into the shop with bags of these coins, asking me what they’re worth. One guy came in the other day. I looked at the coins and told him he had about $350,000 worth of coins in his hand. He practically fell over. Then, he told me he had another 14 bags at home."

The Daily Reckoning