The Vicious Cycle

Mogambo on Monday! In this week’s episode, our fearful hero starts at the Fed and follows credit and cash whither it goes…sloshing from bank to bank, country to country…and back into the arms of the almighty American consumer.

Last week was pretty weird everywhere I looked.

The Fed was not called upon to issue any credit, and they only dabbled in monetizing existing Treasury debt, the usual $202 million or so, which is literally turning government debt into money by printing up the money to buy the debt, and then throwing the debt into the shredder. Which is such a blatant fraud that I am embarrassed by the ineptitude of the media who, although they like to run their mouths about everything, cannot recognize a blatant fraud when it is happening right in front of their eyes.

Uh-oh! It looks like I am ranting! Sorry.

Deflation: Yet Another New Record

But the big action was in the banks, as almost all line items changed pretty dramatically. I was especially enthralled by the revelation that they sucked up, like a huge, demented vacuum cleaner, a $20 billion wad of government and agency debt. The Treasury Department itself only issued another $6 billion in new debt last week, taking us, once again, to another new record, although I have been reporting this "new record" thing for so long that I am beginning to sound like a broken record broken record broken record.

"The banks have buried themselves in government debt certificates," explains Gary North. "They have bought government bonds. They have bought what economist Franz Pick called ‘certificates of guaranteed confiscation.’ Eventually, the debt will be repudiated. There is a universal long-run law of all government debt: creditors eventually get skinned."

And, as far as the Treasury acting like profligate children goes, it is not their most egregious effort by a long shot. And speaking of egregious efforts, as I write this the national debt has bumped up to $7.043 trillion, which is up another $29 billion, and the week is just getting started. "2003 will enter the financial history books," wrote Marc Faber in the Daily Reckoning last week, "as the year in which all asset classes – including equities in developed as well as emerging markets, government as well as any kind of corporate bonds, industrial commodities, precious metals, real estate, and art – increased in value."

To be fair, although he used the term "value," nothing actually increased in intrinsic value as far as I am concerned, because assigning value to something involves individual judgment about "worth." And then when people hear we are talking about "worth," then that inevitably brings up how worthless I am as a human being, and I get so tired of hearing that over and over, day after day. But I gotta admit that all those things he mentions certainly increased in price. But if that is how you measure value, then, okay, they all increased in value according to Mr. Faber, and increased in price according to me.

And isn’t the popular definition of inflation, and I am asking you instead of actually looking it up in the dictionary, something about how prices go, umm, up? And so how come this blistering inflation in prices was not enough to get the Fed to increase interest rates? How come the year-after-year double-digit increases in house prices, or stock prices, or the prices of oil, or commodities, or the rapidly rising prices of anything, is not enough to get the Fed to try and cool down the white-hot asset sector?

Deflation: The Fed Is a Bunch of Clueless Weenies

The answer is obvious, once you remember that this Fed is the most inept, corrupt, ridiculously pompous and smugly arrogant bunch of clueless weenies in U.S. history. They are worried about deflation, which is now defined as when something, even things that are already so grossly overpriced, goes down in price. Like stocks. And bonds. And houses. You know: Everything that that is currently waaayyyyy overpriced.

And why do they want to prevent this deflation in preposterously overpriced things? Wouldn’t the U.S. consumer, namely you and me, be better off if things were cheaper? Wouldn’t it be a big benefit to us pathetic bozos out here in the real world when our paltry incomes buy a bigger basket of things on payday? Without waiting for your answer, I answer my own question and say, "Yes, it certainly would be a benefit!" But Greenspan does not WANT us to be better off. Why? Because the whole U.S. economy is now totally dependent on things NOT going down in price. In fact, the whole U.S. economy is now dependent on overpriced things being more and more and MORE overpriced!

Namely, stocks, bonds and real estate. Weird, huh?

Dr. Steve Sjuggerud, also writing in the Daily Reckoning, pointed out that because of these price rises, there is a dearth of places to put money where there was a good possibility of making some profit, instead of having a good probability of losing your shirt and ending up in the gutter begging money to buy stale bread or another shirt. Sjuggerud quotes Jeremy Grantham: "Today we have substantially the worst prospects for long-term global investment returns of my 35-year career when all asset classes are considered, particularly for U.S.-centric investors." This is because things are all so overpriced, and this should not come as a surprise to you if you had been paying the least bit of attention to me, and don’t feel bad if you have not, since nobody else does, either. And when things are overpriced, there is usually not a good chance that they will get MORE overpriced, which is where your profit should come in.

But how and why did they all increase in price? Because the Fed increased the amount of dollars in the system, and the Congress borrowed and spent those dollars. And so the system was flooded with more dollars, but the amount of goods and services did not increase. Ergo – and don’t you just love it when I use the word "ergo?" – the value of each dollar went down.

And don’t worry if you do not understand this concept right away. The Federal Reserve has never understood it either, and they think they are smarter than all of us put together. They are not. In fact they are much more stupid than we are, QED. They just think that they are smarter.

Deflation: Those Lovely Mountains of Dollars

Anyway, that flood of dollars sped hither and yon through the economy, and ended up in somebody’s pockets, who spent the dollars on imports, which flooded foreign economies with dollars. But those foreign exporters did not want dollars, but instead they want their own currency, because their wives want to spend money, and the places where they shop do not want to go through the hassle of converting U.S. dollars into their own currencies. So the exporters were prone to dumping those dollars to get their own currencies with which to fill up the pocketbooks of their wives, and then the banks ended up with all the dollars. But the banks do not want the dollars either. So then the foreign central banks printed up some big wads of their own currencies, and bought up the U.S. dollars from the banks, who do not want, as we have seen, dollars. And then the boss of the central bank comes to work one day and wants to know who in the hell has been piling up all these dollars in the lobby and making such a big mess, and issues an order to get them out of here and get this placed cleaned up! So all those dollars, those lovely mountains of dollars that in the aggregate add up to more than a half a trillion dollars a year, were used to buy U.S. debt.

Which the U.S. government spent, continuing the viciousness of the cycle. And then they went into people buying things, like stocks, and bonds, and houses, and imports. And prices went up. And then, the next year, they went up some more. And then, the next year, they went up some more. And then the next year, they, but this is getting real boring, so to save time, we will hop into Professor Peabody’s Time Machine and fast forward a decade or so, and when we step out of that time transporter we notice that I am still intoning, "And then the next year, they went up some more."

Then we are all happy that we are back in the present, and have finally stopped that "and then next year…" crap.

And sure enough, there is Jeremy Grantham saying that "today we have substantially the worst prospects for long- term global investment returns of my 35-year career when all asset classes are considered, particularly for U.S.- centric investors," which gives me an eerie feeling of déjà-vu, but is quickly explained by the fact that I just cut-and-pasted his original quote, but that doesn’t change the facts.

And it is a truism that the mechanism of inflation is that the beneficiaries of excess creation of money and credit will be those guys who are first to get in line for it, and who buy the things that will soon go up in price. And it is another truism that after this initial bunch of winners will come another bunch, who will get in the parade and do the same thing, and prices will go up some more. And it is another truism that more and more people will take notice of the profits being made, and then they will get into the swing of things, too, and then, finally, at the end of the parade, come the guys who think that they can arrive late at the party, and they will be buying those assets that are so high in price that there is nobody left to take the bag from them, and so they will be left holding the bag.

The big question (BQ) is: is anybody holding the bag yet? Yes. Lots of them. In fact, the whole American economy is now composed of people holding bags. Big bags (BB). Big, BIG bags (BBB). And the Other Big Question (OBQ) is: Is there another bunch of people who are willing to pay money to take the bag? Ahhhh. That’s the REAL question (RQ)!

And the way to entice people into buying something that is ludicrously overpriced is to, and here we see the beauty of Modern Fiscal Policy, give everybody their money back! Yes! That’s right! And how do we do that? Through the Tax Credit section of the 1040! The government will pay you back if you spend your money the Government Approved Way (GAW)!


The Mogambo Guru,
for The Daily Reckoning
February 19, 2004

P.S. In a related vein, the IMF, given that they are as brain-dead as our own Fed, which is understandable since the Fed is the biggest of the creditors of the IMF, decided to give Argentina some more loans. I left off the exclamation point there, although normally that would rate at least one exclamation point. But I am cleverly setting you up for the punch line, to show you that the Mogambo has a humorous side, which I call the Mirthful Mogambo, with which to offset his dangerously angry and trigger-happy side.

The IMF gave them more money even though Argentina is pretty honest and blunt about saying that they are in pretty bad shape, and they are going to keep defaulting on loan payments! I put that last exclamation point in there to indicate the fact that this is the punch line, and now you should laugh heartily – Ho ho ho! – and say, wiping the tears of laughter from your eyes, "No! Really? No! What is the joke, oh Mighty Mogambo?"

The joke, and you are going to love this for all its cosmic ramifications, is that it is no joke. That is what really, really happened.

Now, anybody who knows me immediately deduces, correctly, that all of this is just too, too spooky for me, and I am grinding my teeth so hard that the friction is sending out a radio signal that is jamming radios and government communications for blocks around. I know this from looking outside my window and watching the government’s Super Secret Agents spying on me as they try to talk to each other on their cell phones over the loud static I am producing, and I sneer at them "Chumps! This is one of those ‘unintended consequences’ from your reign of terror against me, the Magnificent Mogambo!" And, to give the government agent credit, he was fast on his feet when he replied, "Huh? Look, Mister, I’m just here to read the water meter! Honest!"

Well, I think that is what he said, but my Super Duper Central Computer System was activating a Perimeter Defense, Repel Boarders-type action, and what with all those machine guns cocking, and shells being loaded, and sirens blaring, it was pretty loud, and the super-powerful Klieg lights were illuminating the Fire Control Zone with a blistering glare and neighborhood kids were falling to their knees crying "My eyes! My eyes!" and he was in a hurry to leave. But he was one of them, all right. Trust me on that one.

Mogambo Sez: I wish I weren’t so lazy, and then I would take the time to go back through precious issues of the MoGu and identify the guy who said that buying gold was an investment that was obvious, riskless, and a bunch of other swell things, all of which added up to suggesting, in the strongest of terms, that you ought to take a break from downloading pornography off the Internet, and go out and buy gold.

I shall merely paraphrase, and you must look deep into my eyes to discern my utter seriousness, when I tell you to quit trying to download pornography off the Internet and go out and buy gold right now. If not sooner. You’ll thank me later when the investment pays off in spades, and you can hire somebody else, who did NOT look deep into my twinkling blue eyes and who did NOT buy gold as per my suggestion, to do the downloading for you, and then project it onto the giant plasma screen TV on the wall of your lovely beachside villa.

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.

Eric is back after a trip to Brazil. Addison is back after a visit to London. As Porter Stansberry reports, below, insanity is back on Wall Street.

Adam Smith described market conditions such as these as a ‘kids’ market.’ It has been a good time to be a teenager with an on-line brokerage account, with no fear, no experience, and not much sense. If you were reckless enough, you could have made a fortune.

"Sometimes you make more money on fake stuff than on really valuable pieces," said an antique dealer over the weekend. "You won’t believe this, but on a recent magazine cover from the auction house, I saw a large vase that was said to be 14th century, Moorish, from Spain. I just looked at the picture and I could tell that there was something wrong with it. But it was exhibited at the Louvre…and then sold at auction for $2 million.

"But it was a fake. Well, not an intentional forgery…I mean, it was just a copy done on the 19th century. You know, in the 19th century, they copied everything antique. They had recently rediscovered some of the great art of the past and, naturally, they admired it and reproduced it. But these copies are not especially rare, nor very valuable. Unless, of course, you can pass it off for the real thing. I bet that some of the people selling that vase knew that it was not real. But so what…as long as they could sell it. I think the buyer was a rich Arab."

The moral of his story was that you can make a lot of money on things that are really not supposed to be worth very much. We don’t deny it. But it takes more nerve, more brains, and more luck than we have.

Back on Wall Street, while nervy kids were getting rich, the so-called ‘smart money’ has been selling this rally. Insider sales-to-purchase levels have been far above normal. Templeton, Grantham, Soros, Faber, Rogers, Buffett – almost all the sage old pros warn stock market investors to play it safe. And now comes Bill Gross with this advice: watch out for bonds, too.

The pros have been timid; they know there is something wrong. Stock prices are too high; they never fully corrected after the Dow peaked out in March of 2000. And what is wrong with the economy? Two and a half million jobs have been lost since the recession ended. Friday’s employment report showed no change in the pattern. The dollar fell; gold rose over our target price of $400. (We wonder: will we ever seen gold below $400 again?)

It’s not supposed to work that way in a real recovery. Job growth normally allows people to spend more money. Without more jobs and real income, consumers have had to pretend. They mortgage their homes – adding to their debts and depressing their real wealth – in order to continue spending at the rate to which they’ve become accustomed.

Woe to them all – investors, consumers, homeowners – if current trends should ever come to an end. Higher interest rates would put the kibosh on the whole make-believe prosperity. But for the moment, at least, all is well in fantasyland. Even the money supply is once again bubbling up, after a worrisome slump in the fall. In the last 4 weeks, M3 has increased at an annual rate of $1.5 trillion – or about 10 times faster than the increase in above- ground gold.

"As for gold," our antique dealer friend continued, "people my age [he is only about 30] don’t know anything about it. You have to explain. They don’t understand why it doesn’t shine, for example. They think the real stuff is fake; and the fake, glittery stuff…they think it’s real. And none of them buys gold as an investment. At least, not yet."

And now we go to our New York correspondent…tanned from the beach at Ipanema…rested from a week-long holiday…ready to samba on Wall Street, Eric Fry:


Eric Fry, back on the pavement in New York…

– "The bolsa is volatile," observed Brazil’s President Lula last week, after his country’s stock market tumbled more than 5%. "But I am calm," he reassured the lumpeninvestoreiras. Evidently, the locals believed their president, as the Bovespa Index rebounded 4% on Friday.

– The New York stock market was also volatile last week. But your New York editor was calm…very, very calm. He spent the entire week sitting on a Brazilian beach – or rather, a variety of Brazilian beaches. This sort of extreme, sun-baked inactivity is not for everyone. But some of us can tolerate a tropically induced torpor for brief periods of time.

– While lying on the sand, your editor tried to think of nothing at all…and usually succeeded. But he could not suppress his professional inclinations entirely. He could not help but notice, for example, that the Brazilian currency – the real – is very, very weak, even though the local economy seems to be quite strong. And he could not help but imagine that the U.S. dollar could go the way of the real, but for the grace of foreign investors.

– Five years ago, one real fetched one dollar. Today, a Brazilian must scrape together three reals to buy one dollar. Perhaps, your editor imagined, the dollar and the real will again achieve parity – either because the Brazilian national finances continue to improve or because the U.S. national finances continue to degrade, or both. Interestingly, almost no one can imagine that the real and dollar would ever achieve parity again. And yet, interestingly, the real is one of the very few currencies in the world to have APPRECIATED against gold over the last two years.

– Brazil’s official statistics show an economy that is improving only marginally. But anecdotal evidence is far more compelling. The shopping malls are crowded, the bars and restaurants are full (at least on the weekends) and the entire state of Sao Paulo seems to be "under construction."

– New buildings and houses are going up everywhere. The evidence of private enterprise at work is particularly visible along the beach towns of the Sao Paulo coast. New condominium projects dot the landscape like bougainvilleas. The construction activity does not seem to be crazy or bubble-like, merely steady. Meanwhile, the Sao Paulo government is spending much of the money it doesn’t really have on infrastructure projects, like widening highways and renovating the capital’s beautiful old train station.

– One of the main trends powering the economy’s resurgence is Brazil’s thriving export trade with China. Brazil supplies the resource-hungry Asian nation with iron ore, wood products and myriad other natural resources. Brazil’s trade surplus with China stands in stark contrast to America’s multi-billion dollar trade deficit with China.

– Meanwhile, up here in the northern hemisphere, the U.S. stock market forged ahead, even though the economy merely muddles along. The Dow jumped 104 points last week to 10,593, but is still 154 points below the January 27th intra-day high of 10,748. The S&P 500 also tacked on 1% for the week, but itself remains 13 points below its January 26th high 1155. The Nasdaq dropped a two points to 2,064.

– The Nasdaq stumbled a bit midweek, thanks to a disappointing earnings report from Cisco Systems. But the buy-the-dip crowd showed up in force, as they so often do, to buy the Nasdaq’s midweek dip and restore it to a very slim loss.

– "The unabated, near-vertical sprint of the Nasdaq ranks right up with some of the most forceful post-bear surges in market history," writes Barron’s. "From the Nasdaq’s low in October 2002 through its recent high on Jan. 26 at 2153, the index had rallied 95% over more than 15 months, computing to an average monthly gain, or velocity, of more than 6%.

– "Comparing the move with 22 other post-bear market rallies in the U.S. and Japan since 1900…the monthly rate of ascent of the present rally has been exceeded by only three, each of them occurring in the Depression following the 1929-32 washout. The average duration of these rallies has been 17.3 months and the average overall gain amount was 69%…

– "Things have been so good for so long," Barron’s concludes, "that they are bound, at least, to become less good before too much longer."


Bill Bonner, back in Paris…

*** Will we see a sharp sell-off in the dollar today? As Addison noted on Friday, currencies traders in Tokyo, Sydney and London were planning to take their breakfast early this morning…in case comments from the G7 meeting in Boca Raton sparked a Soros’ style rush for the exits.

"We reaffirm that exchange rates should reflect economic fundamentals," read the press release from Florida.

"Economic reasons for dollar weakness are still there," added a currency strategist in London.

So far, in early trading, the dollar has lost only half a penny against the euro.

*** Rob Peebles at has retranslated the Fed’s Latin motto as follows: "If you can’t get something for nothing, its not worth having." Rob also tells us of a Longview, Texas woman who struck oil recently…not in her back yard…but in her bathroom. Seems utility workers had mistakenly hooked up an oil pipeline to the woman’s sewer line.

*** "There’s not much better for financial journalists to write about than fools being parted from their money," comments Porter Stansberry. "Such good stories…

"Consider the recent buyers of Redback Network warrants. I won’t go into the history of Redback Networks. (Short version: Using investor’s money, it tried to compete head- to-head against Cisco.) But it finally gave up the ghost late last year, reorganizing by converting its substantial $400+ million in debt into new stock. Holders of the old stock were virtually wiped out, via a massive dilution. They drank the cool-aid, so to speak. Specifically, there was a 1-for-73 reverse split, leaving Redback’s true believers with 1 share for each of the 73 shares they’d bought retail. Or, in other words, what investors once paid nearly $15,000 for would now fetch $8.75 on a good day.

"However…dumb investors are nothing if not resilient. Not content merely to be completely wiped out once by the managers of Redback, its true believers are drinking the cool aid yet again…

"If you held on to your Redback stock through the reorganization and reverse split, you got one new share for each of the 73 old shares you owned, plus you got a warrant. This warrant gives you the right to buy a new share of stock at $5.00. Thus, the warrant has a current intrinsic value of about $3.75. ($8.75 – $5.00). As any options dealer would tell you, there’s some time value here too, because the warrant doesn’t expire for seven years. How much would you pay for this warrant…? I’d be surprised if Redback is in business in seven years. But even if you assume a 100% premium for the time value, that wouldn’t explain why this warrant is trading hands for $10.50 in the OTC market. What does explain it…? The drunks haven’t woken up yet.

*** China is set to become Europe’s largest trading partner next year, reports the Wall Street Journal. We noticed a couple of weeks ago that the Eiffel Tour had turned pink. The edifice was lit up with red lights…through the fog, it gave off a strange pink light, like a nuclear reactor melting down. Now we know why. It was to honor China’s president on a recent visit. Traffic came to a halt all over town, so the official motorcade could make its way around town. News reports tell of one woman who was not allowed to go back to her own home, since it was along the route.