Odious, Market-Manipulating Remedies

As we expected, the conspiracy theory the Mogambo has about evil people destroying the world with inflation, is true. We know, it’s hard to believe anyone who screams these theories late at night from his roof, wearing only his underwear and a cape…

"America has become more of a debt ‘junkie’ than ever before with total debt of $40 trillion, or $136,479 per man, woman and child. 66% ($27 trillion) of this debt was created since 1990, a period primarily driven by debt instead of by productive activity," says Michael Hodges of the Grandfather Report, and I note with a shudder that Alan Greenspan took over the Federal Reserve in 1997, just three years earlier.

He identified this debt load as representing "All U.S. debt," which is the "sum debt of federal and state & local governments, international, and private debt, incl. households, business and financial sector debts, and federal debt to trust funds."

And then when you divide this $40 trillion cumulative debt by the 70 million people whose jobs are not government jobs or are paid with government money, then those poor 70 million private-sector workers have to work to pay off $571,428 apiece! Hahahaha! Whose idiotic idea IS this? Hahahaha!

Antal Fekete: "Burning Bridges and Halfway Houses"

Anyway, I get to thinking about these things, and I wonder how in the hell we got where we are, which is one of the downsides of being stupid, as I am always confused as to how I got where I am. Then I receive a forward from my old budderoo, Phil Spicer, who thought I would be interested in reading an article, "Burning Bridges and Halfway Houses," by Antal E. Fekete, who is the Professor Emeritus at Memorial University of Newfoundland, dated March 21, 2005.

Prof. Fekete writes about the idea of the liquidity trap. "The term originated with Keynes himself," says the professor, "who, in the second half of the 1930’s, noted that his contra-cyclical prescription to inject new money in the economy through central-bank purchases of bonds in order to combat falling prices wasn’t working. In fact, it produced just the opposite effect of what he had hoped. Deflation got worse, not better."

Bummer, huh? Keynes and his stupid little economic theory are a dismal failure, and now everybody looks like a bunch of idiots.

What’s the problem? Well, Prof. Fekete goes on to write, "As the ownership of monetary gold was made illegal in 1933, the only competitor to government bonds was removed from the arena. Owners of monetary gold were forced by the strong arm of the government to invest in government bonds – not a very pretty sight in itself, even if the matter ended there. But the matter did not end there. As holders of gold were competing for the limited supply of government bonds, which rightly or wrongly they considered as the safest thing to have second only to gold, bond prices were driven to unprecedented heights and interest rates were plunged to unprecedented depths."

Again, just like today! People today are actually buying bonds, and long-term debt to lock in yields that are less than the rate of inflation! Which is rising! And it is rising at the same time as the Federal Reserve guarantees general interest rates; to keep rising from these historically aberrant lows! Everybody is piling into bonds as the government is issuing oceans of new bonds, and the Federal Reserve is creating the credit that will be turned into money by everybody borrowing money to buy the bonds, thus creating a supply-demand imbalance that drives up prices, which drives down interest rates, which hands a tidy profit to all the people who borrowed money to buy the bonds, which makes a bunch of OTHER guys say, "Hey! Maybe we ought to borrow some money to buy some bonds, too, so that we can make this easy money!" And so they do! And that worsens the supply-demand imbalance, which makes prices go up more, which makes interest rates go down more, and everybody is making scads and scads of money on this scheme! Weird!

Prof. Fekete says, "Deflation is present in the economy in the first place, in which case it is made worse than it need be by prompting speculators to buy bonds in tandem with the central bank. Interest rates fall and through the mechanism of linkage prices fall, too, as the flow of money from commodities to bonds accelerates. In the worst-case scenario a vicious circle is activated and the economy plunges into depression."

Of course, a sane person would have started a large ceremonial fire in the front yard and danced and chanted, "The Mogambo was right! This is stupid! We MUST go back to gold as money!" But noooOOOoooo! What did they do instead? Well, they kept that silly philosophical crap up the whole time, trying and trying and trying until it was made to work, until now we have, as he explains, "The world center for liquidity-trap studies and for the inflation-targeting cabal is the Woodrow Wilson School at Princeton University in New Jersey. Under the leadership of department head Ben Bernanke a team consisting of Paul Krugman, Lars Svensson, and Mike Woodford has been busy investigating the liquidity trap and finding ways to unplug it through inflation-targeting should it get clogged again."

These evil people are the ones who want to destroy you with inflation as a remedy for the mess made by this very stupidity! Gaaahhhh!

Antal Fekete: "Can Deflation Be Prevented?"

Then Mr. Fekete links this all to an infamous essay, "Can Deflation Be Prevented?" by Paul Krugman, and written in February, 1999. Mr. Krugman explains their weirdness like it is the most natural thing in the world. "Yet here we are, with deflation turning out to be a serious problem after all – and with policymakers finding that it is not as easy either to prevent or to reverse as we all thought. The point is that deflation should – or so we thought – be easy to prevent: just print more money. How can we get finance ministers and central bankers, who have spent their whole careers preaching the evils of inflation and the virtues of price stability, to accept the idea that price stability may not be an available option?"

How do you get people to get over the silly notion that shooting a bullet into your own brain is a bad idea? Is that what Mr. Krugman wants to know? How do you get a person to do something that is irrational and stupid, when every relevant source, in-freaking-cluding all of history, the Bible, and common sense, all say it is irrational and stupid?

Well, Hans Sennholz, famous Austrian economist that he is, says that it may be a hard sell, because, like me, he sees it again and again all the way through history. "The popular notion that an increase in the stock of money is socially and economically beneficial and desirable is one of the great fallacies of our time. It has lived on throughout the centuries, embraced by kings and presidents, politicians and businessmen. It has shattered numerous currencies, inflicted incalculable harm, and caused social and political upheavals. It springs forth, again and again, no matter how often economists may refute it."

While Dr. Sennholz does not mention the Princeton group by name, he obliquely refers to, "American statisticians and economists want to make us believe that America is a new-paradigm exception in this respect, being miraculously able to generate unprecedented productivity growth with zero savings and record-low fixed business investment. The consensus readily believes it. For us, this is macroeconomic rubbish."

Antal Fekete: Inflation-Targeting

Mr. Fekete goes on to lie out more bad news: "Without any hesitation they took the advice of Krugman, abandoned policies ‘conventionally regarded as responsible,’ unilaterally betrayed their mandate, burnt the halfway house of price stability, and hit the warpath of inflation, euphemistically calling it ‘inflation-targeting’."

I leap to my feet, and shout, "Yes! Yes!" That is EXACTLY what makes the poor old Mogambo go berserk and is what he has been screeching about at the top of his voice all these years, and now this Fekete character does such a good job of explaining it without even raising his voice, and now I feel my life is wasted, and nobody loves me and boo hoo hoo.

But I was going to try and save a little of my tattered career as a lovable lunatic by talking about how serious this was, but before I could even open my damn mouth, Mister Know-It-All Fekete was already talking about it, so I sat back down in a petulant huff and started feeling sorry for myself again, and I could hear him say, "The seriousness of the problem cannot be overstated. A steep rise in interest rates at this juncture would be the horror of horrors. Normally higher interest rates would strengthen the value of the currency as they attracted foreign investors. Not this time. Apart from the problem of pricking all the bubbles in the economy starting with the housing bubble, and ballooning the budget deficit into outer space, there is an even larger and more immediate problem. And that is the effect that steeply rising interest rates have on the value of bonds, widely held at home and abroad. The effect is inevitable and instantaneous. Higher interest rates make bond values collapse."

Now if we have a gazillion dollar’s worth of bonds out there, which we do, and there are owners of those bonds, then what is the economic effect of a gazillion dollar’s worth of bonds collapsing to those guys? Hahahaha!

The only thing left for me to do, to try and grab a little of this elusive limelight, is to insult the Fed and Krugman and Bernanke and all the rest of these crumb-bum losers, but even HERE this Fekete dude is busting my chops!

He goes on to say, "Krugman has convinced us that the money-managers at the Fed have got rid of their last scruples, if they ever had any. Paraphrasing him, if you really believe that runaway inflation is now a global threat, you should also believe that only policies lying outside of the realm what is conventionally regarded as responsible will contain that threat. One irresponsible monetary policy deserves another. The contingency plan to prevent a steep rise in interest rates will have to involve a conspiracy between the Fed and the Bank of Japan to punish speculators short-selling the dollar and dollar bonds. There is nothing else left in the Fed’s bag of tricks but the check-kiting scheme with the Bank of Japan that could hold back the forces of monetary destruction waiting in the wings."

Then he sums it up in particularly poetic form. "Never mind that it is ‘conventionally regarded’ as irresponsible. Never mind that it is illegal. Never mind that it is criminal. Nothing else will defer the day of reckoning."

I guess the lesson is that there may be life left in the stock and bond markets yet, as the Fed is now reduced to these odious, market-manipulating remedies.


The Mogambo Guru
for The Daily Reckoning
March 28, 2005

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.

"A lot of people don’t like my book," said Nassim Nicholas Taleb, author of Fooled by Randomness, over lunch on Friday. "There are two groups who don’t like it. One group doesn’t like it because they think it undermines their success. My book explains that, most likely, they’re just lucky. There’s just so much in the financial markets. People do well and they think they’re smart…but it’s usually just luck…or mostly luck.

"The other group that hates my book are the professional analysts because I point out that most of what they are doing is a scam. They have programs that are supposed to analyze the pattern of past events and give you a probability that a certain thing will happen again. And so based on that analysis, a fund takes a position. But what they’re analyzing are only what they can see, not what they can’t see. They only model what has happened, not what might happen.

"But if they could imagine it happening…it’s probably already happened…and already discounted in present prices. Where you make money – or lose it – is on what is not expected, because it’s not in the model.

"I’ll give you an example, I was invited to the Pentagon to give an address on my subject – fat tails. ‘Fat tails’ are statistical outliers on the far edges of bell curves. They’re the things are never supposed to happen, but actually happen rather frequently. But because they’re not supposed to happen, they are priced incorrectly. For example, you can buy insurance against an asteroid hitting your house fairly cheaply…because it never happens. The insurance companies figure they’ll never have to pay off. But all the models treat events as if they were purely random, known events…such as you might get at Las Vegas.

"When you flip a coin you get heads or tails. You don’t know what you’ll get…but you know it will be either heads or tails so you can build a model with 50/50 probability that you’ll get either heads of tails. But in real life the possible outcomes are unknown and completely unpredictable. And those that are both most dangerous and most profitable are those about which you haven’t the slightest idea.

"You know, if you were a caveman and you had the idea for a wheel, you probably would have invented the wheel…because it would have made things easy. Once you had the idea…you could have the wheel. But until you had the idea…the wheel didn’t exist. Not in reality. Nor in your imagination. You couldn’t possibly calculate the odds of having a wheel, because it was outside the range of imagined events.

"Well, when I gave my talk to the Pentagon people I found that I didn’t have to say a thing. Because it turned out that the casino itself made my case for me. They had insurance against all kinds of things that might happen, of course. But at the time they had a circus playing – a couple of lion tamers, Siegfried and Roy. They had insured against the lions hurting anyone…anyone, that is, except the lion tamers. But the lion attacked the lion tamers. They had to close the show…plus, they had the lion tamer himself in a coma and all kinds of claims they never imagined. In addition, casinos expect trouble from their customers, so they build in all sorts of safeguards. But on that very day they have found someone in the underground parking garage with a car full of dynamite. He had a grudge against the casino and was going to get even. Again, they had insurance against any number of different kinds of claims…but not against someone blowing the place up!

"The fact is, the world is more dangerous than people realize…"

More news, from our currency counselor…


Chris Gaffney, reporting from the EverBank trading desk in St. Louis:

"The GDP numbers to be released Wednesday will probably show that the U.S. economy continues to expand at a faster pace than either Europe or Japan. This will most likely be dollar positive with economists and the media pointing out how the U.S. dollar should be higher given the accelerating growth in the United States."


Bill Bonner, with more miscellaneous opinions…

*** Taleb has spent the last 18 years as a Wall Street trader.

"I bought the fat tails," he explained. Taleb believes investors consistently underprice unforeseen, unlikely events. He doesn’t claim to know when or how unexpected things come about, but he bets that other investors aren’t sufficiently prepared for change.

"Way out of the money…that’s where I always wanted to be. I didn’t have to be right about the events themselves…just about investors’ appreciation of them. People tend to think that whatever is happening right now will always happen. They underprice the fat-tails.

"But only when the event in question is out of the news. When it is in the news, they do just the opposite. It’s a kind of heuristic error. If you ask people to guess about the chances that an airplane will crash – for any reason – they might put the odds as high as 1 in 1,000. But if you ask them to guess what are the odds that a plane might crash in a terrorist incident, the odds might actually go up to 2 in a 1000. Makes no sense. But the terrorist threat is so much in the news, it tends to be overbought. Oil is too much in the news, too, in my opinion."

*** Here at the Daily Reckoning, we like the fat tails too. Give us a nice, fat tail…an outside chance no one else seems to see. We will not be right every time. We won’t even be right half the time. But we don’t need to be. The unrecognized fat tail tends to have very long odds.

What fat tails do we see now? The collapse of the dollar…the rise of gold…recession/depression…a real estate market with no bids…higher real rates of interest with low nominal rates…deflation…bond defaults…personal bankruptcies…an increasing U.S. savings rate…lower consumer spending…

*** "Americans’ fast-food diet catches up to them," says an article in the French press. If the report is to be believed, American life expectancies peaked out at 76 years…and are now headed down, because of widespread obesity. French life expectancies, meanwhile, just surpassed 80 years. But so what if Americans get fat and die? We still have the world’s most flexible and dynamic economy, don’t we?

The Daily Reckoning