Ponzi Economy

Money is disappearing, and that’s not good for stock prices, home prices – or what’s left of the Mogambo’s sanity.

My hands were shaking as I looked for the latest report of Federal Reserve data, especially Total Fed Credit. This is always an awkward moment for me, as I know that I am going to hate the news, no matter what it is. And my family hates it, too. That is why they lock themselves in the bathroom in anxious anticipation of this very moment.

If Total Fed Credit is up, then I am angry that the Fed is creating more inflationary credit in the banks. If Total Fed Credit is down, on the other hand, I am not happy either, since this means that credit is not being created, which means more money won’t be created, which is (as we professional economists refer to it in our scholarly research papers), The Big Freaking Bloodthirsty Horseman Of The Economic Apocalypse (TBFBHOTEA) when you are operating (as we do) a Ponzi economy (financed by inflation in money, prices and debt) and a Ponzi system of governments (financed by increasing debt, size, taxes and spending), based on a derivative currency (electronic digits) that is, in itself, based on a mere fiat/paper currency, with a banking system that allows itself an infinitely low reserve ratio (zero retained cash on hand as reserves against additional deposits or loans).

This brings up the embarrassing fact that in last week’s exciting issue of the Mogambo Guru, I made a Big Mogambo Mistake (BMM) as was tactfully pointed out by several readers, which was (as embarrassing as it was), actually a delightful change of pace from the usual e-mails from readers (e.g. "You’re stupid! I hate you!").

Well, what was this big mistake? I inadvertently used figures for loans and deposits of New York banks, and not the total for U.S. banks. The real figures, in December 1996, are bank credit was $2,769 billion, and savings was $2,214 billion. Now, in the here-and-now, July 2006, loans and leases are $5,738 billion and savings is $5,457 billion.

The interesting thing, which was (and is) the whole point, is that also in December 1996, required reserves were $48,935 million. Today, 10nyears later, and with twice as many loans and twice as many deposits in the banks, required reserves are only $44,139 million, down about five billion bucks!

This means that every dime of debt and money created by the banks for the last 10 years was literally created out of thin air, as there is no fractional-reserve backing (in cash) as a rainy-day fund for one thin dime’s worth of the doubling of loans created, or the liability created by doubling of deposits! Zero reserves! In fact, reserves are about 10% less than they were 10 years ago!

But this is not about how I make mistakes due to chronic laziness, inattention to details, or slovenly work habits, but about Total Fed Credit and how it creates the credit, which creates the debt, which creates the money that creates the bubbles. And not only do they create bubbles, but actual spending cash, as we learn from Stephen Church, of Piscatasquaresearch.com, in his essay at PrudentBear.com entitled: "Consumer Crunch Update." He writes, "The latest 2005 economic statistics show that consumers depended on new debt for more than 90% of their cash flow during 2005. Most new consumer cash flow now comes from new debt."

Intrigued, I urge him to go on. He does so by saying, "Consumer liquidity has resumed its downward trend. Liquidity has fallen to 3 weeks of funds on our preferred measure. Consumer money supply now flows backward."

I’m thinking to myself, "Hmmm! I wonder what this ‘money supply now flows backward’ thing means? And, more importantly, will I have to do actual work to find out?" Luckily, Church immediately went on to explain: "Historically, household incomes were sufficient to generate a cash surplus after consumption and debt service. Now, households have a large cash deficit."

But I have stalled looking at Total Fed Credit long enough that out of the corner of my eye I can see that my wife and family are timidly peeking around the bathroom door, wondering if it is safe to come out. With a chuckle I fire off a couple of quick shots from my .45 ACP out through the window. They immediately duck back inside, slamming and locking the door. I can hear them praying to Jesus to protect them. That ought to hold them for another 20 minutes or so.

So, imagine my conflicting emotions upon seeing that Total Fed Credit was actually down by $1.1 billion last week. I look at the chart. I note that in 2000, Total Fed Credit, astonishingly, also stopping growing, admittedly for a little longer time than this. But it caused the stock market to crash, and the S&P500 lost about half its value over the next couple of years. There have been a couple of other short times since 2000 when Total Fed Credit stopped growing, and the stock market was not pleased, but it did not actually crash. Mostly because, I assume, all the other central banks and "investors" were taking up the slack

But things are a lot different now. There is a growing consensus that global liquidity may be drying up, just like it seems to be doing in our own Federal Reserve.

So, if you have forgotten The Infallible Mogambo Market Indicator (TIMMI), it is that if Total Fed Credit is going up and keeps going up, then stocks and the economy will go up. If Total Fed Credit is not going up and keeps not going up, then stocks will not go up. They will, instead, go down, just like everything else when money is withdrawn from any overheated, highly inflated, grossly overvalued, monstrously over-indebted market.

Now, combine that Classic Mogambo Sign (CMS) with the dismal fact that the Fed only bought up a miniscule $52 million in government debt last week. And then, combine that with the ugly fact that foreign central banks only put a stinking, piddly $830 million into buying more U.S. government and agency debt.

Money is suddenly disappearing, and this is not good for stock prices, housing prices, or my wife’s natural homicidal belligerence toward me when she realizes that some of her money has, likewise, disappeared from her purse because she stupidly left it unguarded on the hall table. I mean, I was just standing there. I see the purse. I see she is nowhere around. I notice that neither she nor my tattletale daughter can see me. I have no impulse control. So, who is the real victim here?

But this is not about what my wife believes versus what she can prove, but about how the lack of new money means that the Ponzi-stock market, the Ponzi-bond market, the Ponzi-real estate market, and the Ponzi government program market are going to be too, too, too starved for funds to continue rising in price.

Except gold, which will soar when people (by which I mean those whose retirement funds were stupidly entrusted to these markets) will be panicky and desperate to make up for their losses as they realize that all their other stupidly inflated stock assets, and stupidly inflated bond assets, and stupidly inflated real estate assets are almost all destined to fall mightily in price from their current hugely inflated prices.

Everyone will look around for someplace safe to put their money, and they will eventually look at gold and silver. They will discover, just as all other people have discovered through time and space, that there is no other asset that has ever performed like previous metals. Nothing has even come close.

Soon, gold and silver will be rising, rising, rising, because all the rich and smart people will cash out of stocks, bonds and real estate to buy gold and silver, making the price rise and rise, month after month, year after year.

And as we slower, intellectually impaired, low-level, gutter Mogambo-type trash (if you know even who The Mogambo is, that is you) will also look around for someplace, anywhere, anything, to make a lot of money fast, because nobody will be hiring. In agony, we real morons out here accidentally get sober enough to realize that we have watched other people constantly making big profits in gold and silver, and now we want in, too. The rush will become a stampede, as the stories of the fortunes made in gold and silver will fill the newspapers, airwaves, newsletters and popular magazines.

And that, my Adorable Mogambo Darling (AMD), is how gold and silver will have a spectacular bull run. That’s why you should buy gold and silver now.

Until next we meet…

The Mogambo Guru
for The Daily Reckoning

Mogambo sez: The way that the gold lease rates have just collapsed tells me that the gold market manipulators are going to try to manufacture a sell-off in gold. Get ready to do some bargain buying! Whoopee!

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 to heap disrespect on those who desperately deserve it.

Poor Ben Bernanke. The man is running from pillar to post – from Stamford Bridge to Hastings, fighting Vikings first, and then Normans…inflation here, and deflation there. Yes, he is fighting on two fronts.

Publicly, his big battle is with inflation. Rates went up another quarter of a point a week ago…for the 18th time in a row. And now, the papers are telling us that he’ll take another swing at inflation next month. And we believe it, but for completely perverse reasons, which we’ll explain.

"By August, the Fed will be thinking about lowering rates," says old-timer, Richard Russell.

Russell is usually right. And we admit to a certain amount of confusion here at The Daily Reckoning. But what war is Bernanke really fighting – against inflation or against deflation? Which is the bigger threat?

Looking carefully at a chart of bond yields, we come to the conclusion that the great bull market in bonds is over. It ended three years ago. What this means to us is that credit is becoming more expensive, not cheaper. And if we’re right, this trend cannot be stopped by pulling levers and turning knobs at the central bank. Too many people are too far in debt. They need to pay down their debt, write it off, and work it out. That’s what must happen before a new round of credit inflation can begin. But that process can take years. A whole generation of big spendthrifts has to learn an important lesson: that spending money won’t make you rich. It’s not a lesson that is learned the easy way, or overnight. In fact, it would be surprising if it didn’t take a decade or more. In the meantime, you can expect a lot of grumbling.

Everybody likes a credit boom. They all believe they have more money. This is the dirty little secret of modern central banking. It only works by stealth and fraud – silently debauching the currency so that people make mistakes. The businessman believes there is more demand for his products than there really is. The consumer believes he has more purchasing power than he really has. The lender believes the borrower is a better risk than he really is. All these mistaken judgments lead to spending, investing and lending – which look at all the world like a bona-fide boom.

But it is an ersatz boom, a public spectacle, founded on fraud, expanded into farce, and ending ultimately in disaster. Eventually, everyone gets too stretched out on credit. Then, the bubble finally finds a pin somewhere, and the air wheezes out. That’s the part that no one cares for, because, it is when people discover that they’ve made mistakes, that they’ve over-reached, and that they’ve been had.

If, as we believe, we’re at the beginning of the disaster stage, the Fed’s real enemy is not inflation at all; it’s deflation. Typically, a credit contraction shrinks everything down with it. Earnings go down. Consumer spending is reduced. GDP growth falls…or even goes negative. And prices for most financial assets dive.

Both Bernanke and Greenspan recognized the deflation enemy, and raised rates – not to fight inflation (although that is what they appeared to be doing), but to "reload the gun." They had to hike rates in order to be able to cut them to fight deflation. Now, with 525 basis points from here to zero, at least the Fed has a new round of ammunition.

But what will get them to pull the trigger? The most likely signal of deflation is a slowdown in consumer spending. Since consumer incomes are either flat or falling, consumer spending depends on the real estate market continuing fat and flourishing. And for that, the housing market must be propped up like a corpse at a viewing. The Fed must try to keep house prices from collapsing – at any cost! But, the housing market depends on long rates, not short rates. Mortgages are long-term debt. And long-term lending rates depend largely on lenders’ views on inflation. If they think they have a real inflation fighter at the Fed, they are most likely to lend at low rates. If, on the other hand, they see the Fed’s knees weakening, or its hands toiling over a white flag, they’re likely to want higher rates.

This explains why the Fed is still raising rates, even though it sees deflation as the biggest threat. It explains why Ben Bernanke may raise rates again in August, even though it is deflation he really fears. He is merely trying to keep mortgage rates low so the real estate market won’t fall apart.

Now we see the Bank of Bernanke’s strategy more clearly: it must crush inflationary expectations, while preparing to fight deflation as soon as it appears. When U.S. asset prices crack – that is, when stocks, bonds, and real estate begin to collapse – you will see another rush to cut rates.

It worked so well last time, from 2001-2004, it surprised us. Too bad it’s not the sort of trick you can pull over and over.

More news from our currency counselor…


Chuck Butler, reporting from the EverBank world-currency trading desk in St. Louis:

"The euro and the yen have not taken a piece of news from Japan very well, and have backed off even more overnight. Japanese Prime Minister Koizumi announced that he is studying the legitimacy of striking bases in North Korea."

For the rest of this story, and for more insights into today’s currency markets see: The Daily Pfennig


And more views:

*** We’re spending the summer in France. We took the train back to France on Sunday. The Eurostar just came out of the tunnel when news came that France had scored a goal against Italy in the World Cup soccer championship. "Hooray," the cheer went up.

Then, about 15 minutes later the loudspeaker announced that Italy had scored. The game was tied, one to one, proclaimed the conductor.

It was still tied when we arrived in Paris. The whole nation must have been watching, because the subway was empty. The streets were empty. Everything was quiet…except when France nearly missed a goal, whereupon a huge groan of agony seemed to rise up from the city.

The match ended badly for France. The star of the French team was removed from the game after he head-butted an Italian player. And then, with him missing from the line-up, the French missed a decisive penalty kick.

All night long, from our hotel window, we heard the French arguing and cursing in the bar across the street.

*** Yesterday, we went to hear our favorite priest – Peter Mullen, chaplain of the London stock exchange.

Elizabeth enjoys Mr. Mullen’s sermons as well. We both listened intently as he warmed to his subject, which was, what is expected of us as churchgoers.

Now, Elizabeth has a marvelous talent – she can fall asleep readily, at any time, anywhere. In theatres, at movies, on trains, plains, automobiles. She nods off quickly, quietly.

"It is not enough to come to church," explained Reverend Mullen, raising his voice. "You have to pay attention and think about what is going on here. Sunday used to be a day unlike all the others. The shops were closed. The streets were quiet. There were no football games on the television and we even had special Sunday clothes. But now, Sunday is not much different from any other day – except for the time you spend here," he declaimed, pounding the podium to make his point.

"This is not like going to the cinema," he wound up. "You can’t just sit there and doze off."

At that moment, we turned to see what Elizabeth’s expression might be. But instead of listening carefully, her head was already hanging down. She had gone asleep.

We tapped her discreetly as we whispered, "Wake up."

"I wasn’t sleeping," she replied, groggily. "I was praying."

*** A Dear Reader writes:

"I was recently reading the Daily Reckoning of the 07/03/2006 in which the author introduced the concept of ‘change at the margin.’ I quote the relevant passage:

‘Readers will say we exaggerate. We don’t deny it. There are plenty of Englishmen in London and plenty of foreigners in Paris. But everything happens at the margin, as economists say. At the margin, Paris is a French city; London is an international one. Paris is an attractive capital city.

London is a great one.’

"I am writing this e-mail hoping that someone at The Daily Reckoning might be good enough to suggest a book or other resource that explains this concept."

We can’t think of any good explanation, so we offer one of our own. Reading through history, we often note how many close calls there are. It is amazing how many decisive events could have gone in the opposite direction, had it not been for one small thing: battle plans are used to wrap a cigar and discovered by the enemy…someone arrives too late or too early…it rains…it doesn’t rain…a crucial vote is swung by a single vote.

At the Battle of the Bulge, the Germans were undone when one of them, pretending to be an American and speaking with a perfect accent, asked for "benzine" instead of gasoline.

The Archduke Ferdinand was shot because his driver took a wrong turn.

Hitler probably would have smashed the English air force had not a German pilot made a mistake and dropped a bomb on London. The English retaliated with a raid on Berlin, which prompted Hitler to switch to bombing civilian targets, giving the hard-pressed air-force crucial time to recover.

Harolde might have prevailed at Hastings, but he had heard a prophecy and believed he was doomed. As a result, say some historians, he failed to control his men and lost the battle.

Do you see? Things happen "at the margin." Important things.

But the expression ‘at the margin’ has a special meaning in economics; in economics it is at the margins that everything happens. There are millions of holders of a particular stock, for example, but the price of that stock is not determined by all of them, rather by the marginal few who are buying or selling. Markets are always in a state of dynamic equilibrium. They are tipped…by small, marginal actions. There may be millions of homeowners in America, for example. But all it would take would be a relatively few desperate sellers, and the value of all the real estate in America could be cut by trillions of dollars. Only one house in an entire subdivision may be sold, but the price of that house largely determines the value of all the other houses in the area.

The margins tend to be under-appreciated, in our opinion. We noticed a woman on the train. She was a mature woman, and a very attractive one, with blonde hair gathered up on the back of her head. She was well dressed, and well put together. A young woman can be pretty, sexy…casual…like a cheerleader on a weekend trip. But an older woman must shoot for something different. She must aim for elegance, a kind of dignified formality that makes her attractive. But this woman was chewing gum. It was a small thing, but it undermined her.

The margins are everything in all parts of life. Because those are the only things we have any control over. The woman was what she was. She could not change her age. She could not change who she was or what she was. She could only remedy the marginal things: the way she dressed, the way she spoke, the way the carried herself. She could be attractive…or not; it was a marginal thing.

Likewise, a general is not likely to win a battle against a much superior army. There is not much he can do. But against an evenly matched enemy, the battle will be won or lost "at the margin."

So are elections. We noticed an article in the weekend press that described the election in Mexico as a "cliffhanger." And as you may have remembered, there are a lot of election results that hang over a cliff. George W. Bush won his first term – if at all – by a tiny handful of voters.

Why? Because political parties operate like market economies…competing for the marginal voter, right in the middle of the electorate, who will decide the issue. Parties do not operate on the basis of principles. They would be out of business if they did. Instead, they seek power, and they know they can only get it by getting the votes of those decisive marginal voters, the "swing voters" in the middle. Positioning and repositioning themselves for the competition, the two sides usually end up fairly evenly matched. And so, if the election is to be decided at all, it must be by the marginal voters who could go either way.

Markets, politics – even personal lives – all rest in states of delicate balance, until something (often something small) comes along and tips them over.

Everything happens at the margin.

The Daily Reckoning