The Dog that Didn't Bark

Mogambo on Monday! In today’s episode: How did we get here, our hero wonders? From whence came "the current Fed idea of massive and irresponsible increases in Fed credit"…and how could the Fed, chaired by a former gold bug, get it so very, very wrong?

The Fed has screwed up, massively. And the result is, the United States is headed down the path to economic ruination.

If you want a good explanation why, then look no further than the Wayne Angell article in the Wall Street Journal last Thursday, entitled "The Rubin Recession." This Angell character was a member of the Fed Board of Governors from 1986 to 1994. So you would think that he would have a pretty good idea what he was talking about when he is talking about economics. But then you’d be wrong, sort of.

The first sentence of the article sets the tone, as Angell blames the recession that started in "the third quarter of 2001" on – and hold onto your hat because it is going to comically jump up off of your head when you hear this – "the Clinton administration’s attempt to pay down the federal debt."

This is the first I’ve heard of that! And if you have been paying attention to the accumulation of government debt, then this will no doubt be a surprise for you, too!

So I know that this where I have to do a little research, because I’m sure that you are not going to take my word for it, as Angell is a former Fed governor and a big shot, writing in the Wall Street Journal and advising important rich people, and I am just an angry, crazy man writing with a crayon on the wall and begging for spare change from people going into the mall, even though I am pleading, "Please take my word for it! Please!"

So I grudgingly get up off of my big, fat butt with a lot of whining and complaining, and I trudge over to where I keep some graphs, still whining and complaining, and I dig around in there awhile, and then I get tired and after awhile I forget why I am there. Then I come back and sit down and read what I wrote, and then I remember why I went over there in the first place, and then I do a little swearing and then, with a little more whining and complaining, go back, and finally, finally, I locate the graph of Treasury debt. I blow the dust off of it and hold it up to the light.

Wayne Angell: No One Paying Down Anything

Okay, admittedly from about 2000 until the third quarter of 2001 the accumulated debt does not go up that much. But it did not go down, and only slightly trended up for a few months, but that is a long way from the glib characterization that anybody was paying down anything. And Angell should know that.

Furthermore, this lack of borrowing was due, in the greater part, to the fact that the government was taking in bigger, more gigantic loads of money via the expedient of higher taxes, especially the Social Security/Medicare tax, which was tragically boosted to a mind-shattering 15.3% of gross income, where it sits today.

But that "third quarter of 2001" is infamous for other things. That is the exact moment when two things simultaneously happened, 1) the debt really started to explode, going from $5.8 trillion to today’s $7.1 trillion and 2) something else. And for all I know, there was a third thing that happened, too, because these kinds of things do not happen in isolation.

Then Angell goes on to castigate former Treasury Secretary Robert Rubin et al, declaring that they did "not understand the first principle of macroeconomics." I can tell by the way your head snapped around that you are as curious as I am about this fabulous "first principle." I love this "first principle" thing, as it makes me think of Sir Isaac Newton, or "Izzy" as I call him, because his Principles of Physics are easy to comprehend, and there is never anybody saying things like, "Well, before we can get started we need a quick little review of the topographical hexadecimal mathematical system in N-space."

Wayne Angell: The First Principle of Macroeconomics

This First Principle According To Wayne Angell is, and I know you are going to love this as much as I did, "Output growth is not sustainable without a growth of total credit and debt." I say "huh?" I gotta tell ya that I have read a lot of things in my life, although lately it is mostly letters from collection agencies demanding that I send them some money real fast or they will take stronger action, but I have never, ever heard anybody tell me that "Output growth is not sustainable without a growth of total credit and debt." And especially never has anybody told me that it was some basic principle! Because I am here to tell you that if you want a Basic Principle that you can really take to the bank, output growth can be sustained by profits alone! And it usually was, all the way through the history of mankind! And at the beginning of production, output growth it can be started with savings alone! As it usually was, similarly all the way through the history of mankind.

But it gets better, as we now see where the current Fed idea of massive and irresponsible increases in Fed credit comes from, as Angell concludes that since the private sector has loaded up on debt, "this household debt burden continues to require both low interest rates and rising household wealth from real estate and the stock market to avoid deflationary pressures." In other words, the private sector has now gotten itself so loaded up on consumer debt, real estate debt and total reliance on the stock market, that it is now necessary to continue to force interest rates down, and down, and down, down down down, downdy down down de down down, so that the idiots who got themselves into that kind of bankrupting mess can be saved from their own folly. And not only that, but everybody thinks it will work! Hahahaha!

But the really troubling thing about the mess the Fed has gotten us into is that its chairman, the honorable Sir Alan, knows better. I had lunch the other day with two guys who are also scribblers about economics, Bob Wood and Steve Heller. Over our meals, we all wondered aloud why it is that Greenspan, an erstwhile gold-bug/sound money/Austrian-type dude, and therefore recognizably one of the more intelligent of our species, has apparently given up the faith. Why is this Greenspan guy, who not only knows better, but has actually proved that he knows better by writing one of the better defenses of gold and the utter refutation of fiat money, doing this to us? Why?

Wayne Angell: Teaching by Bad Example

Steve Heller thinks he is doing it on purpose. For Greenspan so loves mankind that he is deliberately proving to the people of the planet that you MUST have gold as money, and proving the profound wisdom of the Founding Fathers, who were so careful to write into the Constitution – the very Constitution itself! – that money shall only be silver and gold. And he is teaching this Grand Lesson to us via the brilliantly simple expedient of doing literally everything that a central bank can do, to every excess, when unencumbered by the strictures of gold, to ensure a boom. Including enlisting, through the global financial system, the cooperation of almost all foreign central banks on the globe, to do the same things! Gaaaahhhhh! Uh-oh! I feel one of my "spells" coming on.

The purpose of this deliberate boom-bust cycle, with the emphasis on "bust," is to prove to the primitive savages, namely you and me, once and for all that when the inevitable bust comes, so that there will be nooooOOOooo doubt in anyone’s mind, that you cannot have a monetary system that uses a fiat currency, especially one in which you have fractional reserve banking, and DOUBLY especially when you allow such leverage inside the banking system on such an absolutely massive scale, and TRIPLY especially when the expansion is accompanied by bigger government and an economy receiving huge money transfers, which is the government literally handing out money.

You don’t need a big brain to see what is coming. All you need to do is stop drinking heavily, lay off those prescription medications that have a mind-altering component, and take a look at some of the other times in history when people did what we, and I am talking about us Earth creatures again, are doing. And the one thing that you would notice, if you were paying close attention with your magnifying glass, snooping around looking for clues as to what is going on around you, is what you did NOT see. It is another famous case of the Dog That Didn’t Bark.

Specifically, you never read about a time when people used a fiat currency to expand government and its spending, multiplied by a massive fractional reserve system of banking, where everybody ended up rich and fat and happy. Instead, what you always read, and lots of times there are really neat pictures and photos with captions to make it a more interesting read, is how all the fiat-currency people went broke and died of starvation in utter poverty at the end of the boom-bust cycle, usually involved in some disastrously expensive and destructive war.

I shiver at the thought.

Regards,

The Mogambo Guru,
for The Daily Reckoning
April 5, 2004

— Mogambo Sez: In response to overwhelming demand for a way to hold gold, an asset that has been doing very well and is guaranteed to do well for years to come, such is the demand for shares of the Central Fund of Canada, which is now so huge and popular that they are now selling their shares on the American exchanges. Apparently there is a big enough American demand for aggregated gold and silver bullion ownership that does not want to go through the Canadian exchanges, and be subject to all of that cross-border, cross-currency hassle. So this is a way for Americans, using dollars, to directly own gold in its most highly liquid form: actual vault bullion that sells as shares on an exchange. So why don’t you tell me again how gold is such a barbarous relic, and how nobody is buying it?

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.

Let’s see, where were we?

Oh yes…on the Road to Ruin…

And what a pleasant drive it is! The jobs are finally beginning to show up – 308,000 of them, says the Labor Department. Stocks rose on the news… Everything is beautiful in its own way – even the road to ruin. It is like admiring the beautiful mountain views from a convertible, just before you drive off a cliff.

Let us not go there just yet. First, we turn our faces to the stars. If we cannot trust them, what hope is there?

Our friend, Veronique, publishes an investment newsletter based on astrology. Her recommendations are up nearly 300% over the last 19 months, she tells us.

Reading her latest issue, we find that we are entering a new cycle:

"The period from April 4th to August 4th might be less attractive for stocks than it has been since March of ’03…The end of the month [of April] will be volatile; it is difficult and dangerous to guess in which direction prices will go. In effect, we have two cycles, both positive and negative, in the medium term. One is as vigorous as the other."

The twinkling stars give the sailor a sure course, but alas, the investor has to make his way the best he can. His skies are always cloudy. So, let us try to remember how we got on this road in the first place. We recall Minsky’s dictum: stability breeds instability. So safe and secure have Americans felt, they saw little danger in spending money – especially not when their most revered economists told them that spending was good for the economy. Over the last 50 years, they have built such a proud tower of debt that it is likely to fall over at any time.

If that were all there was to it, our Day of Reckoning would be a picnic. But there are other things to reckon with.

Our favorite columnist, Thomas Friedman, hardly lets a week pass without touting the benefits of democracy, nation building and the empowerment of women. We would normally dismiss these notions as hollow words from an empty mind. But the fact that Friedman is so insistent about them makes us wonder. Maybe they are not as harmless as they seem – maybe they are just signposts on the road to ruin.

"It’s all very well to talk about empowering women," said a neighbor over the weekend. "But when women go out, get jobs, and stop raising children, the whole society seems to fall apart. Crime, divorce, social problems…we’ve seen all these things in France since women’s roles began to change. And the worst of it is that the birthrate falls. The only nation in Europe – and it is barely in Europe – that produces enough children to remain at replacement level is the Ukraine. Fat lot of good it is to empower women if the result is that the whole race disappears."

In the paper last week, scientists speculated that the world was going through a period of mass extinction, similar to the Ice Age, when thousands of species are said to have died out. We doubt the human race, or Europeans, will be erased. But we can’t help but wonder.

While women in the West slack off, those in China, India and dozens of smaller countries are adding new citizens as if they were cell phones coming off an assembly line. That these new proletarians will take more and more of the world’s decent-paying jobs seems almost inevitable. Relatively speaking, incomes in America and Western Europe should fall – just when Americans most need money to repay their debts and pay for their retirements.

At the very same time, public retirement systems depend on an influx of new workers to pay the living expenses of the geezers.

"We’re trapped," said our friend. "France has had several waves of immigration – from Germany, from Poland, from Russia and from Italy. All these immigrants integrated themselves quickly. But these immigrants from Africa…both the muslims from the North and the blacks from the South…don’t integrate very well. They seem to make social problems worse. But because we don’t have enough children to keep the system solvent, we depend on these immigrants to pay for our retirements. If we don’t let them in, our economic system falls apart. If we do let them in, our society is destroyed."

Growing old…in debt…facing the greatest competitive threat since the advent of the Industrial Revolution, with bankrupt retirement programs and mass immigration from strange cultures – you’d think that would be enough. But wait…there’s more.

"Oil production is going down," said an executive from the French oil giant, Total, on Friday. "It looks like your Mr. Hubbert was right, after all. Oil production worldwide seems to be peaking out. Yes, you can get more out of the ground, using modern processes. But it is much more expensive. And it doesn’t make up for the easy oil we’ve been pumping for the last 50 years."

Americans use about a quarter of the world’s oil production. All of a sudden, they find they have to compete with foreigners for it. As standards of living rise in India, China and elsewhere…people are going to use more oil.

"This huge increase in the demand for oil comes at the worse possible time," said our friend, "just when supplies are heading down. The economy of the West has depended not just on oil…but on cheap oil. It will be interesting to see what happens when the real price of oil goes up."

Very interesting.

We turn to Eric for more news:

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Eric Fry in Lower Manhattan…

– The "jobless recovery," may it rest in peace…Although our dear departed friend spent a very brief time on this orb, his impact was unmistakable. Thanks to the jobless recovery, interest rates plummeted to generational lows, thereby facilitating simultaneous bull markets in bonds, stocks, housing and…most importantly…debt-financed consumption. We will miss our dear friend.

– Friday morning, the U.S. Labor Department announced that nonfarm payrolls jumped 308,000 in March, well above expectations of 122,000. The job-counters at the Labor Department also "found" another 87,000 new jobs in January and February that they hadn’t noticed the first time around. All told, the economy is 395,000 jobs better off than we thought.

– But all may not be as rosy as it seems. "Here," writes colleague Dan Denning over at Strategic Investment, "is the grisly, income-disinflationary truth: "Average hourly earnings in retail trade for March 2004 were $11.99 – DOWN from February by .05 cents and UP only 0.75% from March 2003. Average weekly earnings in retail trade for March 2004 were $364.50 – DOWN 1% from February of 2004 and UP just .09% from March 2003. Bottom Line: More service jobs, fewer hours worked, anemic if not falling hourly and weekly income levels for those service jobs. And this is GOOD news?

– Yes indeed, the jobless recovery is dead and gone. But investors spent no time in mourning on Friday (he wouldn’t have wanted it that way). Instead, they conducted a kind of national wake – a raucous affair where everyone dumped buckets-full of cash into the stock market.

– The Dow Jones Industrials Average rose 97 points to 10,471, while the Nasdaq Composite leapt 2.1% to 2,057. For the week, the Dow gained 2.5% and the Nasdaq surged 4.9%. Dollar-buyers also partied hearty on Friday, as the greenback soared more than 2% versus the euro to $1.211.

– Despite the celebratory mood on Wall Street, some folks were simply too torn up by the death of the jobless recovery to participate in the merrymaking. Bond investors broke out their hankies as long-dated Treasury bonds plummeted, pushing up the yield on the 10-year Treasury note to 4.14% from 3.89% the previous day. And even within the jubilant stock market itself, the interest-rate sensitive sectors were "hanging crêpe." Stocks like mortgage lender Countrywide Financial and homebuilder Pulte Corp. tumbled 5% or more.

– Gold also tumbled. In a world of job creation and rising interest rates, gold seems to many folks like a luxury they can ill afford. The newly irrelevant metal fell $6.30 Friday to $422.50 an ounce.

– Interestingly, gold seemed extremely relevant to investors just one day before the jobs report. Thursday, the gold price jumped to a 15-year high of $432 an ounce. We suspect we have not heard the last from this contrary precious metal.

– But the main question now before the House is whether Friday’s celebratory mood on Wall Street will yield to angst over rising interest rates. The growth in jobs prompted warnings from numerous economists that the Federal Reserve will rethink its accommodative interest-rate policy.

– "I am more concerned about the implications as regards the Fed," said Peter Boockvar, equity strategist at Miller Tabak. "The Fed is likely to raise rates in August, possibly earlier, and markets don’t rally during rate hiking cycles."

– But Donald Straszheim, president of Straszheim Global Advisors counters, "We will see some upward pressure on interest rates eventually, but not enough to stall the recovery or hurt the gains in earnings. The fed funds rate is at 1 percent. Even if the rate doubled, it would still be low."

– Then again, maybe the March jobs number was a one-time fluke. At the risk of stating the obvious – a Daily Reckoning specialty – one month’s strong jobs report does not a trend make. We’ll need to see few more "Marches" to get the job engine running in high gear. And clearly, we’ll need to see the job engine humming if we are to have any hope of strengthening our national balance sheet.

– "Some are dangerous illusions; others are welcome," your Paris editor, Bill Bonner, observed in this space in early February. "When your wife tells you she loves you, you might as well believe it as though it were Holy Writ. What do you gain by questioning motives or deconstructing meaning?

– "Every illusion has its price, of course. You will pay as dearly for a chimera of love as for all others…but you will pay in kisses and caresses, a currency better spent than saved. Yet other illusions are far more costly and fatal…

– "At The Daily Reckoning, money is our beat," your Paris editor continued. "And so we focus on America’s leading economic illusion-du-jour: Deficits don’t matter. Here once again, we climb a pile of bones to get a clearer view. This is not the first time a nation has gone head over heels into debt…The British Empire was built on debt…

– "The new system was slow to catch on in America. Thomas Jefferson was against it. In 1789, in a letter to James Madison, he wondered whether ‘one generation of men has a right to bind another.’ His answer was no….Jefferson concluded: ‘No generation can contract debts greater than may be paid during the course of its own existence.’"

– However, subsequent American politicians have adopted a slightly more liberal definition of "existence." The modern attitude toward debt, roughly stated, is that no government should amass debts greater than can be paid before Man’s extinction upon the earth.

– "Budget deficits and debt finance are not an alternative way of financing government expenditures," former Treasury secretary Lawrence Summers said recently. "They are a way of deferring tax increases or subsequent expenditure cuts at substantial cost in interest and ultimately in the allocation of national resources."

– Fiscal probity…may it rest in peace.

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Bill Bonner, back in London…

*** The U.S. added jobs faster than at any time in the last 4 years, says the Labor Department. What to make of this latest development? Are we wrong about everything, dear reader? About stocks topping out…about the migration of jobs to India and China…about debt, the dollar, and America’s economic calamity? Maybe we misread the stars…or the map. Maybe we shouldn’t drink so much. Maybe we’re not on the road to ruin after all. Instead, we’re on the road to glory. Yeah, we’re on the road to glory…and there is no stopping us. Stocks will go up from here to kingdom come. Houses will become more valuable every year, so consumers can continue ‘to take out equity’ for all eternity. And all over the world, people will always want to lend us money…and we will never have to pay it back.

Maybe you can have all boom and no bust…all gain and no pain…all A’s without studying…growth without saving…Resurrection without Crucifixion. Gosh…we hope so.

*** Thomas Friedman is remarkable. No sooner had he solved the problems in Mesopotamia (his advice: more "caring…nurturing" troops, much more money) then he went to India. There, too, he saw the problem and had the same solution: more democracy…reform (a term that seems to work in any situation)…empower women! And today brings yet more advice – this time for Mexico. What does Mexico need to do? We can barely wait to find out.

"Revolution," says Friedman…"a reform revolution." Our breathing stops. We are awed by the monumental imbecility of it. "Reform" we can imagine, dimly. "Revolution," vividly. But we can’t imagine the two together anymore than we can imagine a jellyfish mating with bobcat. What strange and horrible fruit would such a union produce? We read on to find out. But even Friedman is stumped. His words go nowhere. Having put the two creatures in the same cage, he can’t seem to get them to do anything. Lamely, he resorts to his favorite remedy: raise taxes and spend more money.

"It is hard to stay competitive when you collect the lowest percentage of taxes among leading Western economies," he writes. Again, we can hardly draw a breath…We know of no case where raising taxes increased competitiveness. Like ‘revolutionary reform’ and ‘honest politician,’ the ideas seem at odds with each other. ‘Oxymoronic,’ we might say, if we wanted to impress someone. Taxes are a cost. How can you raise costs…while cutting prices? Does he just make this stuff up as he goes along?