The Magic of 'Product Substitution'

What’s driving The Mogambo crazy this week? Well, dear reader, his anger and fear are equally spread across the topics of the Birth/Death model, price inflation and food prices. Let’s hope it doesn’t get in the way of his tireless pursuit of the Nobel Prize in Economics – which he is oh-so-close to stealing.

John Williams of shadowstats.com is quoted in an interview by Kevin Phillips in Harper’s magazine, which was re-printed in the St. Petersburg Times newspaper under the title "Hard Numbers" with the subtitle "Think the economy’s bad? It’s worse than you know; blame a half century of presidential Pollyanna Creep."

I did not know that John Williams had cleverly coined the phrase "Pollyanna Creep" to describe how the White House, the Congress and the repugnant Federal Reserve, starting with John Kennedy circa 1960 and continuing unabated, and worsening, all the way through to Bill Clinton where Mr. Phillips’ chronology ends, continuously came up with one stinking lie after another to disguise the horrendous inflation in prices, and rise in unemployment, that resulted from the egregious fiscal and monetary performances.

The article goes into such frauds as "imputed income" (such as the "value" you receive from living in your own home, or the "value" of your free checking account), the total of which Mr. Williams calculates was 15% of total GDP (!) in 2007! Wow! "Imputed income" was 15% of GDP? Hahahaha! We’re freaking doomed!

Such laughable duplicity continues into the description of the phantom jobs conjured up by the "Birth/Death Model" (which assumes that new businesses are being formed, and employees being hired, which are too new for anything to show up in the data), and the six separate calculations of unemployment, of which one of the most inclusive shows unemployment at a terrifying 9%! Nine! One out of eleven people in the work force in unemployed! Yikes!

Then, finally, we get to how to magically reduce inflation with "product substitution" in the consumer’s shopping basket ("if flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon"), continuing with the lunacy of the inflation-reducing scam of "geometric weighting" of the items still in the shopping basket ("goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption"), and concluding with the infamous "hedonic adjustment", (which even the author says is "an unusual computation by which additional quality is attributed to a product or service").

It is this last fraud that has been used to such success by Mogambo Inter-Planetary Industries (MIPI), by which we commit an as-yet legalized extortion by utilizing the word "improved". The basic premise was outlined in the MIPI business plan, which is cleverly explained in our corporate motto, namely "Crappy products made out of cheap materials with shoddy workmanship, and passing the savings on to you!"

But before we ship anything a stupid customer ordered, we send a letter saying that the order cannot be fulfilled per contractual price since the product they ordered was "improved" before their stupid check cleared, and therefore the new price should be higher because of the hedonic adjustment for the increase in quality, and if they had some "problems" with that, then you could take it up with Alan Greenspan and the Federal Reserve, ya freaking moron, which is who first came up with this silly crap, and if they still wanted their "Mogambo Ultra Blow-Up Doll" with the optional appendages and pendulous breasts, then they should send another $15.95 in cash, which is their cost for the extra quality inherent in saying "improved" without having to prove anything! Hahaha!

The business plan assumes that sometimes there will be people who will actually send the extra $15.95, whereupon we send them another letter demanding another $15.95. Hahaha! Suckers!

But, as per the business plan, we are sure that they will all eventually give up and demand their stupid money back, like THAT is going to happen (see Section Two of the MIPI Business Plan: "Skipping Town: The Fun Part", which I cheerfully title "Starting over again, but with a lot of money this time!").

The point is not that P.T. Barnum was right when he said, "There’s a sucker born every minute", or that my first girlfriend’s father was right when he said, "You’ll never amount to anything other than a Worthless Piece Of Mogambo Crap (WPOMC)!", but about how we got to be such suckers to let the Federal Reserve and the Congress (except Ron Paul) do this "lying about inflation" crap to us, and how people being ignorant stupid suckers is so very vital to the success of Mogambo Enterprises, Inc.

Where these people came from has always befuddled me, but which has now been explained by Junior Mogambo Ranger (JMR) Rob H., who writes:

"Dear Mogambo, I have long believed that people, in general, over time, were getting stupider and now have a ‘grand unified stupidity theory’ equation that I think can serve as the axiomatic equation for future theorist to expand upon. If true, this equation is very disturbing, especially if you add a time element into it and the associated exponent." He notes, "This may explain why we are where we are in the world."

My finger poised over the "Delete" button as my eyes drifted down over the few equations he provided, and through the rising glaze of incomprehension of math or anything that even LOOKS like math, I still knew enough that I could probably use this to get one of those elusive Nobel Prizes in economics (and that luscious cash prize of millions of dollars!).

So, for the official record, my completely original work that I came up with all by myself, and I declare under oath that I never even heard of anyone named Rob, especially one named Rob H., and that I have, personally, alone, proved that "one half-wit multiplied with another half-wit = a quarter-wit", which is expressed algebraically as 0.5 X 0.5 = 0.25 wit (a "quarter wit"), which soon becomes 0.25 X 0.25 = 0.0625 wit (a "one-bit wit").

But the irrepressible JMR Rob looked at this halfwit breeding thing and came up with the brilliant Zen koan "Therefore: Etc." Hahaha! Perfect! Hahahaha! So we can share credit! Hahaha!

Until next week,

The Mogambo Guru
for The Daily Reckoning
May 5, 2008

The Mogambo Sez: I admire the sheer bravado and raw guts of people who look around them and don’t immediately think to themselves, "This is freaking crazy! I gotta get out of stocks and bonds, and get some gold! Lots of it!"

I hope this little compliment of mine about their bravery pleases them and gives them comfort when their whole world turns to ashes and crap, although I prefer the proven comforts of gold, probably because I am such a coward who prefers not starving in the dark and cold streets.

But, to each his own! Hahahaha!

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.

The papers are so full of claptrap and humbug this morning…we don’t know what to laugh at first.

There is Hillary’s proposal for a ‘Gas Tax Holiday,’ for example. The initiative is so absurd that even trained economists can see through it. Alice Rivlin, Bill Clinton’s former budget director said she was "appalled" at what "looked like pandering." One hundred economists signed an open letter criticizing the proposal – pointing out the obvious, that it would increase driving and divert money now going to the U.S. government to the governments of Arab oil exporters.

Obama has an advantage; Paul Volcker is advising him. So, we can expect a little better. But little better is what we get. Obama proposes a cut in the payroll tax (which finances Social Security) – up to $1,000 – to help families "offset the cost not only of gas, but of food."

As we have said many times, we never met a tax cut we didn’t like. But what troubles us is: where are the cuts on the other side of the ledger? If Social Security has less money, how will it keep up with baby boomer retirements?

The weekend press tells us that people are beginning to worry about whether they’ll be able to retire at all. The middle class counted on rising house prices. But now house prices are going down. What are they going to do?

They’re going to start saving, is the answer. "Consumers to the sidelines," says a Wall Street Journal headline. "Americans cutting back for Mothers’ Day," says a headline in the Los Angeles Times.

You will recall why stocks were certain to go to the moon, dear reader. It was "Dow 36,000" for sure – because the baby boomers had to put money in stocks so they could retire. When that mirage disappeared, they turned to residential real estate. People figured that they could buy an extra house at the beach. They would enjoy it on weekends and holidays…and then, when the time came to retire…they could sell the main house and live off the proceeds. That strategy too was fine – as long as prices were rising.

And now the boomers find them themselves with no easy way to finance their golden years. (They should have bought gold when we first suggested it!) What can they do? They have to resort to the old-fashioned, tried and true method – thrift and savings.

Here, we will spell it out:

You take the total amount of income, after tax. Then, you subtract the total amount you spend. If the result is a positive number, at least you are headed in the right direction. If it is a negative number, we suggest you apply for a job in government…maybe with the Council of Economic Advisors or the Congressional Budget Office. Besides, the federal retirement system is the most generous one around – outside of Wall Street.

Yes, dear faithful reader…the economy is getting a nip on the derriere. The consumers who spent what they didn’t have are now forced to save the little they do have. Result: the consumer economy is slowing down. The bubble has sprung a leak…and the feds desperately try to keep pumping it up. (More below…)

But forget the math…forget the ledgers…there’s an election to be won…and faint humbug n’er won fair voter. No, the way to win is to go all out…tell the biggest lie possible…promise the moon…and pretend to be something you are completely and emphatically not.

George W. Bush, for example – son of a CIA Chief, Vice President and then U.S. president, educated at Andover, Yale and Harvard, from one of America’s richest, most elite New England families – passed himself off as a straight-talking yahoo in a cowboy hat. Now, both Obama and Hillary are trying to pretend that they feel the working classes’ pain. Hillary appeals to the redneck instinct for toughness; she will "obliterate" Iran if it lays a hand on Israel, she says.

(Why the yahoos from Kentucky should care what goes on between Israel and Iran has never been fully clarified…but in the final days of imperial grandeur no sparrow can fall anywhere in the world without setting off sensors in the Pentagon…and eliciting a rapid response from the military/industrial/political complex!)

Obama, meanwhile, can pretend to be a man of the people too. He drinks beer, when the occasion calls for it… and shoots hoops with the locals. Of course, neither politician would probably give the blue collar workers the time of day were it not for the fact the yahoos are likely to vote tomorrow.

Yes, dear reader, tomorrow is now the big day…the showdown between the two democratic candidates. If Obama wins big…he can say goodbye to Hillary. If the Clintons win big, they could still win the nomination…and probably, the election. At least, that’s what the pundits say…

And so we see how democracy really works…by flimflam and bamboozle.

*** We have set up shop in a café near Auteuil in Paris…copy of the International Herald Tribune in hand…and someone’s wifi connection at our fingertips. It is a delightful spring morning in Paris…the chestnut trees are in flower…birds sing, the sun shines, and beautiful women amble along the sidewalk.

We had a café crème and a croissant…and then, we were enjoying the view so much, we ordered another. The waiter brought a check – the damage was just $15, very reasonable, under the circumstances.

The relevant circumstance is that the price of food is soaring everywhere. The grains are selling near record prices…and so is oil. This is no laughing matter. Food is a relatively minor part of our own family budget; the rising prices are only a nuisance. But a news report from Reuters tells us that 20% of Asians live on less than a dollar a day. Many are farmers with their own local supplies of cheap food. But more and more of them live in cities and pay global prices for their daily bread.

Rising food prices are producing famine-like conditions for many of these poor people. For others, they are wiping out years of financial progress, creating what Reuters calls a "Poverty Time Bomb."

But who should we thank for these remarkable events – a price induced famine…a poverty ‘time bomb’? How could these things be happening in the 21st century – nearly two decades after the fall of the Berlin Wall…more than a century after the invention of the mechanical reaper…and 95 years after the creation of America’s central bank? Ah…there’s the funny part.

Prices are twice as high as they were two years ago. Is the weather twice as bad? Are people suddenly eating twice as much? No? Then what happened? What has happened is that the central bank has created bubble-like conditions in the commodity markets.

An update from Kevin Kerr:

"Many are saying that the commodities bubble is bursting and that all will be well. I don’t think so, but all of this selling will certainly give us at Resource Trader Alert a better chance to buy back in at cheaper levels, especially in the metals, although not yet.

"We are seeing crude oil pull back, and it seems that sugar is along for the ride. I expect sugar to pull back even further, but then turn around after summer – maybe even before.

"As far as the grains go, it’s a completely different story. The weather in the Midwest has been awful, and farmers are getting itchy. Rain – even snow – and very cold ground temperatures continue to hinder farmers. This market remains very, very choppy, so be prepared for some wild swings. However, come harvest time, I think both our beans and corn will leave our RTA portfolio smiling."

If you aren’t yet an RTA subscriber, now is the time. Kevin is offering 3 FREE months of this elite trading service – but only until midnight on May 12.

*** "Fed moves to loosen tight credit," begins a story in the New York Times this morning.

A related article – in the LA Times – tells us that the crunch in subprime is now grinding down on cash-out refinancing, investment property and vacation homes.

But the Fed makes haste to the rescue. Two days after cutting rates down to 2%, the Bank of Ben Bernanke announced – without much fanfare, hoping it would be ignored – that it would accept credit card debt, student loans and even car loans as collateral. Student loans are now being traded on private markets at discounts of about 25%. But the Fed takes them at full value…and charges only 2% for the loan, about half the rate of consumer price inflation.

What kind of way is that to run a bank, you might ask? Don’t bother…

The bubble has sprung a lead…the Fed is doing all it can to keep it pumped up.

*** Meanwhile, Warren Buffett has gone into the business of insuring municipal bonds. His competitors don’t deserve their triple A rating, he observed last week. AMBAC, for example, watched its stock price tumble from $96 to $4 in the space of a year. Its credit is so bad it has to pay 14% to borrow money. Buffett says he’s never before seen such a company rated AAA.

*** And the art market is preparing for a big test. So far, the very peak of the socio-economic pyramid has been relatively immune from pain. The rich are still getting richer, as near as we can tell. Occasionally, the papers speak of problems among the "rich." But the people they are talking about are not really rich. Often, they have two large incomes…two large houses…and two large mortgages – along with all the expenses of living high on the hog, circa 2008 – including private schools, club memberships, ski vacations, and so forth. At the end of the day, they don’t really have much capital to protect them from rising prices or adverse economic trends. But the truly rich are truly different. They don’t have mortgages. They don’t depend on their incomes. And they often have sources of wealth beyond the dollar.

The rich can afford to hold gold, for example, even though the yellow metal provides no yield. They don’t need to rely on it to pay for their retirement…so they can take a longer view. They can invest differently because they don’t need current income. And they are often more concerned with protecting or enjoying wealth than with making more. But they are human, just like the rest of us…and just like the rest of us; they are gullible, credulous, and moronic. The last time we looked, Manhattan apartments were selling at record prices. Luxury airplanes and yachts are still selling well, too. And so are works of ‘art.’

Here we add a little detail that we think may be important. Recent sales at Sotheby’s and Christie’s have set records for Chinese and Russian art. You won’t have to think long or hard to figure out why. The Chinese and Russians have a lot more money than they used to.

The rich in the West have more money too. But so far, the art market has been doing a good job of separating them from it.

The test of prices on Western art is coming in three weeks, when the big auction houses have $1.8 billion on sale. In recent years prices have swollen to bubble levels. Many works have little or no real merit – they are merely gaudy, sensational, or pure gimmicks. Still, investors felt clever paying extraordinary sums for these things…and then, even cleverer when they went up in price.

The works of Richard Prince, for example, were put together just a few years ago. Kenny Schachter, an art-critic friend of Marc Faber’s, described his oeuvre as "consisting of large silkscreens on canvas, of purloined covers of pulp fiction novels involving a series of books with nurses in the titles…" such as "Wayward Nurse," or "Surfing Nurse," and so forth. In 2003, you could have bought one for $75,000 to $150,000. Two years later, prices topped $1 million. A year later, one was sold at auction for $2.5 million. And in 2007, one of the nurses hit $6 million.

"What is the inherent value of these works?" asks Mr. Schachter.

About as much as a dot.com without a product or a business plan, is our guess. But what will addled buyers pay? We don’t know…it depends on how eager they are to get rid of their money.

*** A note from Addison on the Maryland Film Festival:

"When Dick Cheney told Paul O’Neill deficits don’t matter," we found ourselves explaining to the audience after Saturday night’s screening of I.O.U.S.A. at the Maryland Film Festival, "he didn’t mean that they don’t matter economically. Of course, deficits matter in economics. What he meant is politically, politicians don’t get punished by voters for running deficits."

In the movie, former Treasury Secretary Paul O’Neill tells the story about the day Cheney said, "deficits don’t matter" to him in a cabinet meeting. He also talks about the day he was fired from the Bush Administration for "a difference of opinion."

"Well," said a gentleman in the second row "let me explain things from the policy makers point of view…"

"Uh ho," Patrick, the director of the film said. He was standing next to me at the front of the theatre. "Are we in trouble?"

The gentleman went on at some length about the "political coalescence" that had take shape in the 1990s, whereby both parties agreed, that despite their differences, keeping the nation’s finances sound should be a priority for everyone.

But that all flew out the window in 2002 when you had the third of the three consecutive tax cuts go into effect at the exact same time that self-imposed "pay as you go" spending laws expired. The nation’s revenues dried up. But spending exploded. For the first time this year, we’ve seen a $3 trillion dollar budget proposal. The deficit is expected to reach beyond $500 billion.

The gentleman, it turned out, was Paul Sarbanes, the former Senator from Maryland whose name gives the willies to corporate legal and accounting firms across the civilized world. Sarbanes co-authored the much-rued Sarbanes-Oxley corporate transparency law. And, now retired, had some extra time on his hands to come and instruct us on the subject of our own movie.

Patrick, a Chicago born, recovering Union supporter was impressed and took the time to raise the issue of disparity of wealth in the country. We were a little more subdued. This is exactly the crux of the problem with I.O.U.S.A. – the film, the project and the nation. Once you get down to brass tacks and start talking about specific solutions you run into two sides of an economic argument that are equally entrenched.

On the one hand you have the Arthur Laffer, supply-side zealots, of which the current president is one. On the other you have the died-in the wool New New Dealers who see government programs – most notably social security and medicare – as the bedrock of their parties’ existence. Their current arguments sound like this:

Neo Lafferites: "Let’s keep the tax cuts permanent"
New New Dealers: "The nation needs universal health care."

Neither the twain shall meet. If we’re successful in getting I.O.U.S.A. into theatres this August and as part of the "national conversation" in time for the political conventions…this is the crux of the problem. With these two sides entrenched, Washington and the political system is broken. And you are the victim. "If we do nothing," David Walker likes to point out "the national debt alone rises by $3-$4 trillion a year. That’s if we do nothing."

Which is exactly what we’re doing now. Nothing.

Unfortunately, it won’t be the Paul Sarbanes or the Arthur Laffers of the world who have to pay the price. It will be you and your family.

*** Tomorrow…more on the coming revolution (yes…you heard that right)…

Until then,

Bill Bonner
The Daily Reckoning