The Fed Prints, The Government Borrows: Welcome to Planet Death Star

Down, down, down they go. But are stocks cheap as we begin the first week of March? “They are cheap looking back,” says our friend Eric Fry in California, “but they still might be VERY expensive looking forward.”

Ah yes, the future. What does it hold? Well, apparently more lay-offs and CEO pay raises. Judging by Sol Trujillo’s $20 million goodbye handshake and the actions of the board at Pacific Brands (giving themselves raises while sacking workers) it looks like there are some people out there doing their level best to run the good name of their corporation into the ground.

Don’t they know that’s bad for business?

Kevin Rudd is headed over to America this month to speak with Barrack Obama about climate change, the global financial system, and other ways to save the world and improve on human nature. Perhaps he might ask him if America’s US$1.75 trillion annual deficit for next year should cause global investors to worry about America’s credit quality.

Again from Eric, “The cost of buying a five-year credit default swap (CDS) to insure against the possible default of U.S. Treasury bonds reached 100 basis points for the first time yesterday. In English, the price of insuring $10,000,000 worth of Treasury bonds for five years now costs $100,000 – up from just $5,000 one year ago.”

We’ve said before it’s nearly impossible to default on your debt when you can print the money to pay it back. But what this normally does is send interest rates up on new short-term borrowing, of which there is a lot lately in America.

Keep in mind, the Obama budget includes about US$3.5 trillion in Federal spending, much of it to be financed with short-term borrowing. In fact, this week the U.S. Treasury is selling $94 billion in debt. The Treasury is even bringing an old-friend back from the dead. The seven-year Treasury note (which had been discontinued in 1993) will be reissued beginning with an auction of $22 billion worth today.

Can you see how government borrowing needs begin to crowd out lending to the private sector? Can you see also how we are speeding into an era where more of national cash flows are redirected to central governments for redistribution and/or the service of interest payments to foreign lenders? Can you see how directing national cash flow toward wealth re-distribution does not lead to more capital formation and wealth generation?

Ron Paul is still the only man in Washington who can see all this. He made a great point the other day that no one wanted to listen to. “Credit is not capital,” he told Ben Bernanke. You can’t recapitalise the banking system by printing new money or extending credit.

Credit comes from available savings. That’s why a high savings rate is essential the formation of future capital. We’re not making it up. It’s even the first sentence of the Treasury White Paper on the Capital Assistance Program.

“The financial system plays the critical role of channeling funds from savers in the economy to the investors with the ideas and ability to turn those funds into productive economic resources,” the paper begins. This is exactly how recessions prepare the way for the future boom. As households reduce consumption they increase savings.

Banks can become solvent again by retaining earnings (cutting dividends like ANZ did earlier this week) and increasing their depository base (and, of course, writing down bad investments and making more prudent loans). Or, the bad banks go belly up and the good banks are able to come in and scoop up the remaining assets.

Losers fail. Winners win. Or, as Rothbard puts it, an increase in savings reflects an increased desire for cash from consumers. This is actually good for banks in the long run. But we won’t run on and on about it below, although we’ve provided a fuller quotation for you below.

Incidentally, as we expected a couple of weeks ago, the gold price (in U.S. and Aussie dollars) has given up some of its ground after streaking ahead. But we wouldn’t be too worried.

One last quote for the day from Eric Fry on the matter, “The credit crisis does not study technical charts or read investor sentiment indicators. It does what it does. And what the credit crisis does best is destroy credit-based enterprises…and reward the buyers of non- credit-based assets like gold.”


Still with us? Good! How about a quick revisit of the “baseline” and “more adverse” assumptions that are embedded in the CAP plan (son of TARP) released yesterday by the U.S. Treasury. The table listing the assumptions is below. But let’s give you the analysis first: crrraaaaaazzzzy!

After reading it, you’ll be more convinced than ever that falling stock and house prices this year are going to be followed by a blizzard of paper money that will send inflation soaring.

Government Assumptions That Guarantee Inflationary Disaster Ahead


How about some analysis? First, the GDP assumptions are for-at worst-a 3.3% contraction this year and a recovery in 2010. It’s probably more realistic to expect a GDP contraction of between 5 and 10% this year (based on the cliff diving GDPs of Asia and Europe) and a smaller contraction of 2-5% in 2010. Although either could be much worse, as the fourth quarter GDP figure in the U.S. was already a little fishy to begin with.

Second, the unemployment projections appear to have been generated on Planet Fantastic, where the laws of gravity and reality do not apply. Has anyone generating these U.S. statistics taken a look at the economy lately?

Or are these statistics pure propaganda and fabrication, designed to obscure from ordinary Americans (and Westerners) everywhere that real wages have been falling for thirty years and will continue to do so as global production shifts to low-wage labour markets?

Finally, how is it no one in the media picked up on the fact that the Treasury’s “baseline” forecast is for an 18% decline in house prices over the next two years (under rosy assumptions about GDP growth and unemployment)? Or that the “more adverse” forecast has house prices falling 29% in the next twenty-four months?

And here’s a question…how could house prices fall and unemployment continue to rise without having a further massively negative effect on bank loan books?

If TARP and CAP are designed to shore up bank capital by taking some a snapshot of how banks will perform under certain scenarios, then the plans are almost certain to fail if those scenarios fail to account for increased default and foreclosure rates in residential and commercial real estate that would come in the next two years (not to mention poor performance in securitised credit cards, student loans, and auto loans…all of which would deteriorate as unemployment rises.)

And how is simply raising taxes and transferring money to the newly unemployed going to solve this again?

All we can think of now is a supernova. In the rush to repair the broken financial system (which was broken by the explosion in credit and the enormous misallocations and distortions it caused) liberals and conservatives and professional politicians of every stripe (without brains or spines) are launching every conceivable spending plan they can think of. Their goal is to tag the culpable private sector for all the blame, shift the burden for losses on to the public balance sheet and future generations, and replace the private sector with the government as the prime mover of economic life in the modern world.

Or have we missed something?

A supernova, of course, is the death of a star. It unleashes a giant amount of light, heat, energy, and radiation in one brilliantly beautiful moment of destruction. But let’s not forget it’s a moment of death, as pretty as it might be.

Perhaps that’s where we’re headed. Instead of seeing a recession as the method of re-establishing the efficient allocation of an economy’s resources and capital, the banksters and pollies are going to give us an even bigger global system of paper, as Ron Paul suggests.

With the dollar-standard in tatters, the only place left to go in the artificial evolution of paper money is a global fiat standard on top of the dollar standard. We have no idea what it would look like. But you can bet there are some other folks who’ve been thinking long and hard about it and are more than willing to use the current crisis as an excuse to inflict it upon you.

Finally, the last (and longish) word from Rothbard on why booms require busts.

“The ‘boom,’ then, is actually a period of wasteful mal-investment. It is the time when errors are made, due to bank credit’s tampering with the free market. The ‘crisis’ arrives then the consumers come to re-establish their desired proportions.

“The ‘depression’ [ed. note, Rothbard uses the word ‘depression’ in place of ‘recession’] is actually the process by which the economy adjusts to the wastes and errors of the boom, and re-establishes the efficient service of consumer desires.

“The adjustment process consists in rapid liquidation of the wasteful investments. Some of this will be abandoned altogether (like the Western ghost towns constructed in the boom of 1816-1818 and deserted during the panic of 1819); others will be shifted to other uses. Always the principle will be not to mourn past errors, but to make the most efficient use of the existing stock of capital.

“In sum, the free market tends to satisfy voluntarily-expressed consumer desires with maximum efficiency, and this includes the public’s relative desires for present and future consumption. The inflationary boom hobbles this efficiency, and distorts the structure of production, which no longer serves consumers properly.

“The crisis signals the end of this inflationary distortion, and the depression is the process by which the economy returns to the efficient service of consumers. In short, and this is a highly important point to grasp, the depression is the ‘recovery’ process, and the end of the depression heralds the return to normal and optimum efficiency.

“The depression, then, far from being an evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom then requires a bust.”

Some people don’t want a return to normal. Bankers don’t want it because it means a lot of them would be out of business for good. Investors in credit-backed bonds don’t want it because it means taking losses. And politicians certainly don’t want it because the sense of continual crisis is the perfect mechanism for the relentless expansion of government power in private life.

The only who want things to be normal are normal people. And they are stuck right now living on Planet Death Star; a spaceship captained and crewed by a bunch of morons who will be the financial death of us all. Or are we just whistling a bizarre Dixie?

Dan Denning
Australian Daily Reckoning

March 2, 2009

The Daily Reckoning