Analysis: U.S. Supreme Court Campaign Finance Decision

Is it not remarkable, dear Reader, that mere days after Republican Scott Brown upsets the U.S. Senate special election (and Obama Administration referendum), that the U.S. Supreme Court made a landmark ruling, rolling back campaign finance and anti-corruption efforts? The case was two-fold, as far as we can tell, in its implications: first, it holds time-based bans upon corporate political advertising and politicking (namely, preventing those interests from advertising too near an election day); second, it frees corporations and other such interests to make direct contributions to political candidates, rather than filtered through special interest groups. The decision was leveraged upon the First Amendment of the U.S. Constitution, suggesting that restricting corporations from doing the aforementioned activities was impinging upon freedom of speech.

This actually does have coherence, as we understand it: corporations are considered an individual under corporate law, legally on par with an actual living human being, such as yourself. So, in essence, yes, a corporation does have just as much of a right to contribute and politick for its candidate of choice as you; that they have vastly more money to throw around than you is really trivial. At least, it's trivial to the Supreme Court. The full implication of the decision perhaps did not sink into justices' thoughts as cast their votes. Let us explain:

Consider the organisation known as Goldman Sachs, everyone's favourite vampire squid. As a financial institution, Goldman can borrow an effectively unlimited amount of money from the Federal Reserve, and then turn around and invest that money into something which pays a guaranteed return. At present, much of that would seem to be Treasury Bills; in essence, Goldman Sachs permits the Federal Government to borrow from itself, but make it look otherwise, and make a profit at the same time. This cozy little arrangement, along with all the other cozy little arrangements Goldman has, seems to make a lot of people very angry. Now, let's say that a vociferous group of contenders for Congress run on a "let's shut down all the big banks" platform, and experience massive support from across the U.S.

The Lord's work would seem to be in jeopardy, no? At that point, is it not a good investment to borrow, say, $25 billion from the U.S. Treasury, and invest that in supporting the candidates who are on the "let's keep Wall Street bonuses flowing" platform? The 'return' off of that 'investment' is not necessarily quantifiable, but it is indeed qualifiable: Goldman Sachs continues to survive. That, perhaps, is the best investment that Goldman could have made with someone else's money.

We point out there is no longer any reason whatsoever that Goldman cannot do this exact manoeuvre during the 2010 Congressional elections. Nor, indeed, does anything prevent JPMorgan Chase from doing the same thing, or Citigroup, or Wells Fargo, and the rest of the too-big-to-fail crowd. Heck, the Federal Reserve System itself could start running advertising if it wanted to! Call us alarmist? Please feel free. But remember that there is nothing which will prevent this from happening.

If anyone notices how momentous this decision was, we have no doubt there will be efforts of dressing it up as a good thing; consider this hatchet piece from the Atlantic. However, in our opinion the Court has simply handed over near-total political control of the U.S. Government to large corporate interests on a silver platter. That situation is perhaps nothing new per se - consider Goldman Sachs' apparent ownership of the U.S. Treasury - but it is much, much more of the status quo, and additionally set in concrete. Going forward, we fear there will forever be a shrinking ability of small interests (e.g. individuals, small entrepreneurs, et cetera) in getting their message to their supposed representatives in Government. That could change, as an aside, if the apportionment lawsuit in Mississippi is actually successful, but the outcome of that case is far from certain.

What is certain is that the large corporations which will exploit this Supreme Court ruling will do so to the hilt, because the Depression puts their very survival at stake. Without even the most ineffective of legal restraint on their politicking, we would not be the least bit surprised if more and more high-level officials in the Government come from super-huge banks and large corporate interests, like the defence industry and healthcare, et cetera. Put simply, the sovereignty of the United States has been transferred, de jure, from the American Citizenry, to the largest and most powerful corporations. The Government must and will respond accordingly.

What this will mean for American Citizens trying to scrape their way through the Depression is fairly easy to predict. The average American will feel the pain, because he or she will be forcibly squeezed of their wealth, for the benefit of these corporate interests. The U.S. Government will continue to everything it can in order to reinforce the existence of those institutions which ethically should be left to die. The cost of these corporatist heroics will come in the forms of more bailouts, more Government largesse, higher taxes, higher inflation, and more destruction of the non-corporatised economy.

Housing Price Report for December

Our North American Housing Price Index registered a 6.46% drop from November, which likely would have been much deeper if we had not seen a sharp uptick on the top of the housing market. The drop from May - when we started the Index - is now 15.86%, representing a massive fall in the North American housing markets, and likely correlated by a similar drop in the valuation of bank mortgage portfolios. On an annualised basis the Index suggests the market is down 27.18%, a truly staggering loss.

That 27.18% drop strongly suggests the stimulus effect of the US Government's tax credit has worn off. Record low rates for conventional mortgages seem to be little help as few applicants qualify for the new, stringent requirements. All in all, we declare that the housing crash appears to have resumed.

Given the huge shadow inventory of foreclosed houses, the impending wave of Alt-A defaults, high unemployment, and falling income across the board, there is essentially no hope the housing market will find 'a bottom' any time in the foreseeable future. Additionally, the 8.9% rise in housing starts reported by Forbes will only add to the pain of existing housing stock, as new - and difficult to move - houses come into the market and further drive down already distressed property.

We expect the bottom, when it comes, will be shockingly low. We boldly predict a real price decline somewhere in the neighbourhood of 90% on average, peak to trough. In some places, such as Las Vegas, we expect a decline of 100% as the whole urban field there becomes indefensible. Attractive urban centres will fare the best, but it will be grim consolation.

Price declines may be obfuscated by inflation, if that should arrive. Given the devastation banking elites would suffer in a true deflation, we suspect the 'powers-that-be' will attempt to engineer a burst of high inflation to save the banks. On the other hand, such efforts may be unsuccessful, as it would be exceedingly difficult to discern the optimum amount of money-printing. As powerful as banking elites are, they may be sacrificed on the altar of the Almighty Dollar.

U.S. Monetary Policy Does Not Make a Strong Dollar

U.S. Secretary of Treasury Timothy Geithner recently stated that: "Given the dollar’s role in the international financial system and the significant impact of the U.S. economy on global economic conditions, we fully recognize that the United States has a special responsibility to play... The policies of the United States are designed to lay the conditions for a strong dollar and more stability in the international monetary system."

Say what, Mr. Secretary?

There is a serious disconnect in Mr. Geithner's reasoning in this statement. Although it is true that the U.S. Dollar has been comparatively strong in recent days, we hazard to say that this is probably a temporary state of affairs. As ShadowStats.com shows, the Dollar has experienced a relative peak, but is is, as of July 6th, in a steep decline. Additionally, deflationary trends to the tune of about 2% has apparently developed, rendering every dollar in circulation slightly more powerful as time goes on.

However, we posit the exchange strength of the Dollar is liminal; the currency markets are probably changing their minds about the relative value of the Dollar. More telling, though, is the continuing growth of the M1 Money Supply - physical cash and currency in chequeing accounts. That section of the Money Supply is increasing at a whopping 18% annualised... and shows no sign of slowing.

It is that growth which will, eventually, kill the U.S. Dollar, and destroy the wealth of any holders of Dollar-denominated financial instruments (be they savings bonds or Treasury Bills). The Federal Reserve is desperate to prevent any deflation whatsoever, as deflation makes debts all the more painful to the indebited - think the U.S. Government. So, the Fed is pumping up M1 as fast as the printers can press new currency, in the attempt to stoke inflation and thus lessen the pain for the indebited.

We have faith in the Federal Reserve. They may be bumbling and rather silly, but we believe they'll get this stoking-inflation thing down pat. The question, in our minds, is not if, but when. When will the inflation rate rise to once again destroy purchasing power at a rate the Fed finds agreeable?

When that finally happens, and happen we think it shall, Mr. Geithner's "strong dollar" talk will at last be seen as the hot air it really is. We suspect that many investors in U.S. Government debt will see the handwriting on the wall at some point, but there will be many, many investors who will be horribly damaged by the looming inflation. We also suspect those investors will be none too happy with the United States, nor with Mr. Geithner. Hopefully he has his ranch in Argentina already bought and paid for...

Inflation Coming Soon?

We hold up USA Today as the ultimate sign of what is not, in fact happening. If the rag says to do one thing, we know it's a bad idea; if it says that something is happening, we know it isn't. Which is, as an aside, how we expect to know the bottom of the 2007 Depression is in: USA Today will be screaming that the end is near and everyone is going to die... metaphorically speaking.

That is all a bit arch, of course, but you get the idea. As a for-profit company of popular persuasion, USA Today and other information sources have to amend what they publish in order to maintain mass appeal. The public at large does not want to read or hear especially gloomy news, which is probably why our Depression Gazette will never hit the big time. USA Today, as long as enough people feel it provides the desired style and quality of information, will continue to limp along.

Limping along, however, does not make what the company prints actually accurate. And in that vein, we present this article from USA Today, which spews some very impressive fallacies about the nature of inflation. We recommend reading the article with popcorn, as it is quite a laugh, but we'll take on some of the most egregious errors.

"If inflation does hit, it won't be this year, barring a major jump in oil prices or a drastic change in government philosophy." We wonder how oil prices cause inflation. Additionally, according to ShadowStats.com, the Federal Reserve is printing physical money (i.e. growth in the M1 Money Supply) with abandon. That trend is about as iron-clad a guarantee of inflation, at some point in the future, as one can get. Indeed, the USA Today writer himself writes "The ultimate cause of inflation is an unwarranted increase in the money supply."

"...Unemployment... [is] 9.4% now and widely expected to break above 10% this year."Again according to ShadowStats.com, unemployment is cooking at well over 20% and rising sharply. We personally expect to see 25% unemployment be a reality sometime very soon, if that level has not been hit already. That's not to say that particular non-fact is necessarily the writer's fault, though: it's an artifact of the purposefully inaccurate and under-reporting nature of Government statistics.

The best part, though, was this:

If you're worried about inflation rearing its ugly head soon, relax... You don't get inflation in an economy that's as slack as this one... Inflation just isn't going to happen in this economy.

"A lot of the worries about immediate inflation are examples of financial illiteracy," says David Wyss, chief economist for Standard & Poor's. "You won't get inflation until the economy gets back, and that's at least five years out."... To get to inflation... you need a humming economy, and the [U.S.] economy is barely breathing.

Oh, where do we start, dear Reader? How do we assail such a monument to stupidity? To say that inflation cannot happen except in a 'humming economy' is like saying... oh gods, we don't know! Words fail us utterly!

So instead, we would like to take a trip to reality for a moment and provide an example: Zimbabwe. Zimbabwe's economy has not been truly 'humming' since it was a colony of the British Crown (pre-1965). In fact, it has been in negative 'humming' since 2000 (source), and official unemployment in the nation is now a horrifying 94%. Yet this nation is experiencing an inflation rate so high it is effectively meaningless: 231 million percent annualised. It is lunacy - or perhaps misinformation - to say that inflation requires a 'humming economy' to take place. Zimbabwe is chilling proof of the total untruth of such an assertion.

These errors we've expounded upon, plus a few more, are shockingly out of character with the rest of the article, which is fairly sober and accurate. The writer seems to be going out of his way to drive home his fallacious definition of inflation, and we can only wonder why. Whatever the case, though, we take this as a sign for the contrarians: inflation this way comes. And soon.

Mistaking Economic Depression for Deflation

There is a great debate raging in the blogosphere at present, over whether or not the United States is undergoing deflation. It is a question to which there is no easy answer, as systems like the United States' economy are incredibly complex. We personally feel that the U.S. is undergoing deflationary trends, which will almost certainly turn into significant inflation at some point in the future, but we don't think that deflation proper is underway.

Let us explain what we mean by deflationary trends: certain things are getting cheaper. We've been seeing some great deals on meat and meat 'products' recently, and our local grocery is carrying organically-raised medium eggs for 97 cents a dozen. Some other food products have also gotten cheaper, like the roasted almonds we are partial to, but for the most part our food bills have remained relatively stable.

In short, deflationary trends are scattered drops in price within a broader niche of the economy, but not the entire niche experiencing overall drops in prices. In proper deflation, one could expect all prices within an effected niche to experience reductions, caused by a concurrent rise in the purchasing power of one's currency. Although our perceptions of the situation are indeed limited - as we are but one person - we have not seen evidence of an across-the-board increase in the purchasing power of our U.S. dollars.

What we expect the 'deflation' that commentators see is the effects of the 2007 Depression. Those eggs we mentioned are probably not getting 'cheaper' per se, but rather the company which owns the chickens which lay the eggs are selling said eggs at liquidation prices. We posit the same goes for meat and meat 'product' producers as well.

To put the situation in more general terms, the 2007 Depression is exerting enormous pressure on the entire economy, and certain companies are moving faster than others in order to liquidate excess products. This will create the appearance of honest-to-goodness deflation, when the situation is perhaps more along the lines of a liquidation of certain niches or industries. Muddying the waters, as it were, are the concurrent bursting of various bubbles (such as housing prices, automobile manufacturers, et cetera), the products of which are dropping rapidly in value.

To conclude, the U.S. economy is cratering, pure and simple. The prices which one may expect to find on products one wishes to buy may fall to some degree or other, but we don't expect to see full-on deflation in this Depression. Rather, and as long as the economy catastrophises faster than money creation by the Federal Reserve, we posit that prices will stay relatively the same. The exciting part will come sometime in the future, when the economy completes its face-plant; it will be at that point when the Fed's money-printing will come home to roost.

Expanding Government, Declining Economy

USA Today reports "Benefit Spending Soars to a New High". 'Benefits' being the euphemism for 'Welfare', now that there is no shame in being on the dole. In any case, state and federal welfare payments are now one-sixth of Americans' income.

As the Depression grinds on, there will be considerable pressure from all sides to maintain and expand 'benefits'. These 'benefits' will have to come out of taxpayer pockets, one way or another. Since visible taxes will probably not be raised enough to cover the swollen 'benefit' roles, there will be some of that hidden tax coming down the pike - inflation.

Redistributing income, up to a point, may have some merits. But if the productive elements of society - most of whom are having a fairly rough time of it lately, too - are overburdened with increasing taxes, there will be further decline in economic activity.

As we have discussed repeatedly before, there is a range of government spending in an economy which is optimal, and spending below or above that range is destructive. At present, government spending at all levels (according to the helpful folks at usgovernmentspending.com) is a 45.2% share of the economy as a whole. This is up from a 37% share in the last fiscal year.

The rate of increase in the share is a whopping 22%! If the share were to increase at that rate for just another two years, the USA would end up two thirds of its economy (mis)managed by the State - a comparable level to Eastern Europe in the Soviet era. And probably with similar results.

Of course, the Nation's leaders are emphatically stating that since recovery is around the corner, there will be no need for further increases. We beg to disagree on the recovery part. Recovery is not around the corner. Whatever spin may be being put on 'the numbers' - they are in fact truly terrible.

In the face of Great Depression II, Mr. Obama's administration will not be able to resist expanding 'benefits', as well as bailing out and nationalising banks, insurance companies, car makers, airlines, airplane makers, and God-only-knows who else.

We believe, with some confidence, the deeper Uncle Sam dives into the economy, the worse the economy will perform. Since the leadership seems infected with some sort of intervention mania, we also anticipate that the lack of recovery will promote ever-larger bailout and 'recovery' schemes. These in turn will hurt the economy even more. We can't anticipate how long these destructive cycles will continue, but probably long enough to turn the USA into a dramatically poorer nation.

This Week's Herbert Hoover Award

Today, we will give the Herbert Hoover Award to the individual most obviously lying through their teeth. Without further ado, onto this week's winner! Presenting (drum roll):

U.S. Secretary of Treasury Timothy Geithner

Recently in China, Secretary Geithner had the gall to inform the students of Peking University that he "believe[s] in a strong dollar," and that "Chinese [dollar-denominated] financial assets are very safe." Apparently the Secretary hasn't been informed that the term "strong dollar" is now a punch-line. Additionally, reviewing the excellent graphs of John William's Shadow Stats, we notice several disturbing things.

First is the value of the U.S. Dollar: it appears to be taking another little dip. We would like to draw your attention to the last high in the power of the Dollar, as it was in 2002 or so. The recent 'strength' of the U.S. Dollar only reached the purchasing power of 2006 Dollars... nothing to write home about.

Secondly, and this is the more damning graph, is the money supply; more precisely the M1 money supply (i.e. coin, paper money, and the deposits in chequeing accounts). As a general rule of thumb, increases in M1 usually correlate with inflation. So, if M1 is increasing at 16% or so, and the trend continues, one can reasonably expect inflation to be cooking along at a respectable 16% or so. We do hope the Chinese will do more than just laugh at the Treasury Secretary's bold-faced lie... perhaps they might use all their dollars to buy industrial and precious metals?

Congratulations, Mr. Secretary. Your trophy will be on your desk by Friday.

***

Runner-up in for the Award this week was Vice-President Joseph Biden, for stating the painfully obvious. "We know some of this money is going to be wasted," he said recently, referring to the Federal Government's bailout plan. Thank you, Mr. Vice-President, we already figured that one out.

As runner-up, Mr. Biden will receive a red origami crane.

An Index is Born

Today we have created a housing price index for ourselves that covers diverse cities in Canada and the USA. We do not claim it will be completely representative, just that it will be completely honest and not subject to manipulation by government authorities or commercial interests.

In one month's time, and monthly thereafter, we will update our index and let you know if housing prices are rising or falling as we measure them. We are naming the index The Frugal Scotsman's North American Housing Price Index.

We suggest you set up some indexes of your own for the costs of things that are important to you. Don't rely on official measures of inflation or deflation to tell you where prices are going. There is too much 'riding' on official numbers to trust them.

Las Vegas, NV: Bellweather of Doom

Our co-writer made a post a while back, laying out a brief case for the collapse of present valuations of American housing stock. He forecasted (and still forecasts) an estimated 87% drop in value for desirable, non-redundant living space, along with almost every mortgaged houseowner ending up 'under water.'

According to the basic number we've seen bandied about, approximately two-thirds of all houseowners have mortgages. We can surmise, without too much imagination required, that if house prices do indeed plummet 87% or so, almost all of these mortgaged houseowners will be 'under water,' and will likely default on their debt. This will of course create an enormous glut on the real estate market, and devastate the debt-addicted banking system of the United States, and indeed the world.

Our co-writer is now partly vindicated, by the original Icon of Sin: Las Vegas, Nevada. In a recent Wall Street Journal article, a study shows that 67.2% of all homes in Las Vegas have "negative equity;" or, in the common tongue, the owners owe more on their mortgage than the house is presently valued. We point out that 67.2% is right around two-thirds of all houses (and thus virtually every owner with a mortgage is 'under water'); Las Vegas is now the bellweather of the United States housing collapse.

It is difficult - if not impossible - to put a time-frame on this collapse, but we are confident that said collapse is both in progress, and cannot be halted in real terms. However, the Federal Reserve's attempts to rekindle inflation will likely succeed, and when that day comes some of these 'under water' houseowners will at least have the succor of having their nominal property values resume an upwards march. That will be a phyrric victory, but we suspect that realisation will take some time to dawn on the average American citizen.

Unemployment versus Contraction

We were reviewing the statistics at Shadowstats - a service that reports relatively honest economic data for the USA - and noticed a 19% unemployment rate (ouch!) and a 4% rate of GDP contraction (bad, but not that bad). Two points immediately leapt up: one, there is a fairly wide divergence; and two, this is divergence in an opposite direction from the Great Depression.

The divergence points to the chronic unemployment and underemployment that exists in the US. Even at the peak of the economy in 2000, approximately 12% of the workforce was redundant. If GDP is to contract in this Depression as much as in the Great Depression (50%), and unless there is to be 60% or more unemployment, more currently employed workers are going to have to take reduced hours or rates of pay.

The nation is faced with a highly problematic scenario. At some point in the not-too-distant future, the Federal Government will have exhausted its borrowing power to maintain welfare payments and its own operations. We have discussed in prior posts how both welfare payments and government salaries will have to be cut. We expect these to be cut through price inflation.

Many private sector organisations will be facing the task of whether to cast redundant workers into a fraying social safety net, or 'sharing the pain' by cutting hours accross the workforce. Self-employed persons will be facing involuntary 'part-time' status. Price inflation will also deliver pay cuts to the private sector.

The course the nation takes to adjust the population to lower economic output will have a decisive impact on how orderly the adjustment is. The more desperately 'turf' is defended and groups attempt to clutch onto their income, the greater the polarisation of income and the potential for social disruption. If there is a consensus to 'share the pain' - even if through inelegant methods such as inflation and higher taxes on the remaining productive elements - there is less potential for acute stife. Unfortunately, the more coercively the pain-sharing is achieved, the more long-term harm is done to the economy: inflation distorts investment decisions, and taxation inhibits productivity.

Clearly, the nation is still sufficiently affluent to handle some economic abuse - but there is a limit to how much. We are not optimistic that there is any collective will to institute a sounder basis for economic development. Alert individuals, on the other hand, will find even in a less benign environment adequate possibilities of prosperity.

The Dark(er) Side of Raising Taxes

As our co-writer noted in yesterday's post, raising taxes during a recession is a bad idea. Raising taxes during a depression is a very, very bad idea. President Herbert Hoover raised taxes during the 1929 Depression, and thereby helped dig a deeper pit for the American economy.

As President Obama's new tax regime is cranked up, it will turn a problem into a crisis. When -- if we are correct -- the U.S. dollar is devalued significantly, it will turn a crisis into a disaster. Let us explain:

According to the President, 'rich' is now classified as a couple making $250,000+ a year. At present purchasing power, only about 1.5% of all households are making that much money. So, by the numbers, these people are apparently 'rich.' Tax them!

But wait... what about all those bank bailouts, car-maker bailouts, insurance funds, synthetic CDOs, pension funds, hedge funds, ad infinitum? Surely the top 1.5% of households by income cannot support such largesse on the part of the government... so the money's got to come from elsewhere. We turn to Messrs. Ben Bernanke and Gideon Gono, as they know the answer: the printing presses.

With money flowing magically into being from the sky, those little financial concerns disappear in a puff of inflation. The question is how much inflation will happen: we posit a nice, comfy ten-times devaluation. In that scenario, today's dollar coin is tomorrow's dime.

Also in that senario, today's $250,000 is tomorrow's $25,000. Feeling a cold chill, dear Reader? We do. We'll work hard to preserve our modest lifestyle, but that means we'll be making more and more money -- nominally -- in order to keep up with inflation. At some point, we see no reason why we won't slam headlong into the 'rich' tax bracket... even though we're far from the classic definition of 'rich.' What's your income, Reader? And what tax bracket would you be in if you tacked another zero at the end of it? If you're not careful, you may become rich without even knowing it!

Fire Up the Presses!

The Year of our Depression 2009 hasn't yet ended its second month, yet already a great sea of red ink is bathing the bailout-happy nations of the world. Japan's exports tanked 46% year-over-year in January; the Royal Bank of Scotland is haemorrhaging pounds like nothing else in British banking history; Fannie Mae put her lil' ol' hand out for more money after losing another $25.2 billion in fourth quarter of 2008.

Perhaps to top it all off, yesterday President Obama unveiled his $3.5 trillion budget, featuring $989 billion in new taxes. Oh, all these numbers are making our eyes bleed, dear Reader! We see a great tsunami of red ink barrelling down upon the economic landscape, and we hope to keep our head above all the mess.

Imagery aside, the implications of all these massive problems is severe: a great deal of pain and misery is required, if a society wants to honestly work its way back to fiscal health. That, however, isn't very popular with the average American, or Briton, for example. It's also political suicide to suggest such a thing: people do not want to work hard, to pay off the national bar tab, or all the gambling debts.

No, the only expedient way out of this mess, the one that is relied upon time and time again, is inflation. These debts will be inflated away into nothingness; President Obama's bloated budget makes this clear. He is only getting started with his spending spree, since he has to make up for the Baby Boomers and their underwater finances.

In summation, we turn to no less a sage that Ernest Hemingway:

The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.

Don't Take the Bait

The bait we are referring to is the 'improved' tax credit for house buyers that was included as part of the USA stimulus program. Look at it like a different shade of lipstick on a pig. Almost everyone who used previous versions of this credit is underwater on their mortgages, or at least looking at some pretty serious depreciation on their house value - much greater than the value of the tax credit. As a rule, taxpayers who attempt to take advantage of this credit will suffer the same fate.

Apparently a lot of people are buying houses - though not nearly so many as a couple years ago. They must think they are getting a good price. While a few of them may be, most are not. Housing prices in general have a long way to fall yet. The only thing that will arrest the decline will be runaway inflation.

Even after the inflation hits, house prices will probably not rise as fast as most goods and services. If you can find a house you like that is priced to be cheaper than renting after you factor in all the costs, then go for it, if you can pay cash or lock in a long-term fixed rate mortgage. That should be your only criteria, tax credits notwithstanding.

Think the Fed is Out of Ammo? Think Again

The Federal Reserve has been publicly clamouring about how they've used up their "conventional monetary firepower." It seems that the media is rather confused about the situation: they apparently think that interest rates, quantitative easing, and balance sheet debauchery are the only tricks that the Fed has to play with. Oh, how wrong they are. There are "still arrows left in the quiver."

At this point, we'd like to assure you, dear Reader, that if what we write about seems familiar, it is. Mr. Gideon Gono of the Reserve Bank of Zimbabwe has played with most of them... but not all. He didn't use every little trick, because he was trying to contain inflation. The Federal Reserve, on the other hand, is desperate to stoke the flames of buying power destruction.

In May 2003, Federal Reserve Bank of Dallas Vice President Evan Koenig and Senior Economist Jim Dolmas wrote a piece titled Monetary Policy in a Zero-Interest-Rate Economy. Read it, and read it well, dear Reader. This will be the game plan of the Federal Reserve in the future... perhaps even the near future.

We will glide over the more pedestrian methods that Messrs. Koenig and Dolmas list, and instead focus on two of the most powerful tools they discuss: taxing bank deposits, and making currency have an expiry date. If and when the occasion arises, we posit that the two tools will be applied simultaneously. The why is easily demonstrated:

Would you, dear Reader, keep your money in a bank account if your savings and chequing accounts suffer a -1% or -2% monthly tax? No, you'd pull your money right out of those accounts and stuff them in a mattress, the same as every other citizen or business. However, the physical money you get from the bank will have a little stamp on it, saying something like 'legal tender until July 1st, 2011.' You're damned if you keep your money on account at a bank, and you're damned if you sleep on $100 bills at night.

So... the only thing you can do is spend, spend, spend. The Fed will see the velocity of money shoot to the moon, and everything will seem better - for a while. But these policies -- along with all the other ones the piece listed -- are ultimately destructive beyond belief. The economy would be gutted, the U.S. Dollar would become worth more as a heat source than as a currency.

But hey! At least Mr. Ben Bernanke can get his inflation. Unfortunately, he will get far more than he bargained for.

The Problem of Financing the US Federal Debt

There are countless misconceptions about where the money comes from to finance the US Federal Debt. One reads constantly in the financial press something like "the U.S. must have a sound fiscal policy, or the Chinese [or Japanese, or Arabs, etc.] will not fund the deficit." This is actually just silly.

Foreign trade partners have money to invest in US Government debt because they run trade surpluses with the USA. Debt is bought with funds left over after they have bought whatever they might want (if anything) that the USA has to sell them. The amount of debt they buy is incidental to their trading activities. Internal US policy (interest rates, inflation rates) has little impact on the process.

For a while it was a great deal for citizens of the USA. They got to buy stuff from abroad, and when the money was recycled back to the Federal Government, they got to spend it again! Things are changing, though. Foreign trade surpluses with the US are crashing. This is because foreign trade is crashing (see a previous post).

The U.S. Federal Government (and indeed any national government that has been running chronic trade deficits) will be losing a critical source of funding in the years ahead as international trade declines. It is highly unlikely that interest rates will be raised to attract funds as this would exacerbate the economic contraction. Instead, the loss of recycled trade deficits will be made up for by just that much more 'printing'.

As we have been hinting darkly, the USA is coming to the point where its economy simply cannot service the debt load it has placed upon itself. Given the way policy has been going lately, the outcome will be the quasi-default of runaway inflation.

The Scale of the Crash

Yesterday, Japan reported a 35 percent drop in exports from a year ago. This, coupled with the stock market crash, the housing market crash, millions around the world becoming newly unemployed each week, gives one a pretty clear sense that the world economy has fallen off a cliff.

The world has clearly not only entered a depression, but a great depression. Time will tell if it is worse than the 1929-1939 Depression. In any case, things are bad and getting worse.

In a previous post we said, "A halving of income for citizens of the 'Developed Countries' may well be baked into the cake by now." We ought not to have been so provisional. It is almost certain that incomes will be falling on this order. The question arises: will they fall further?

Unfortunately, the answer is probably Yes. It appears the whole credit-based model of economic activity is suffering a fatal, or near-fatal crisis. Remember, gentle readers, the financial architects of the global system gave us an economy that can only grow when people and organisations borrow and spend. When the borrowing stops, the growth stops.

Unfortunately for the model, at present borrowing can no longer grow. Incomes and revenues are falling, so debt burdens are becoming more onerous to households, businesses, and governments alike. Dropping interest rates to near zero is little help since the principal payments alone are the culprit.

Defaults do little to help the situation as they shock and injure the investors. It is looking more and more like gradual monetisation of debt and resultant inflation will be the only way out in the short term. That will be a frying-pan-to-fire operation, though. It will probably take a bit more time for leaders to employ that strategy effectively, as they hope against hope that the economy will fix itself (via consumer attitude adjustments perhaps?), or in response to feeble 'stimulus' programs.

In the meantime folks, prepare for the worst and hope the storm passes quickly.

The Trauma of Making Money in Hyperinflation

As we were working today, eking out our honest dollar, a thought occurred to us: how will we get that dollar when hyperinflation hits? Sure, we'll be making something, but as the people in Zimbabwe have discovered, that something might not be worth a whole lot by the time one gets to the store.

Let's look at a simplistic business model: buy inventory at price X, sell at price Y, lock in profit at a comfy 7%. What happens when the inflation rate in the time between the purchase and sale is 7%, or -- especially -- 14%? Not being able to replace the inventory for less than it sold for, one loses on every sale (but makes up for it in volume, we suppose).

A similar thing will occur in wages; one may indeed make $25 an hour, but by the time the paycheque is cut and the tasty eats (extra fries, hold the mayo) from McBurger Kong costs $25, the apparently higher pay is pointless.

We like our eats, and our apartment, 'n stuff, and we cheerfully work to keep all that going. Right now, with inflation relatively 'stable,' it's easy to budget our expenses as a percentage of our income. It'll be a different story, when inflation is burning through cash faster than Bernard Madoff. Contracts, rent, interest, profit margin... all these things will become very, very different in the coming year. And we are very, very worried about that.

You should be too, dear Reader.

Painted into a Corner

Mr. Henry Paulson, Jr., has had $350 billion burning a hole in his pocket since October. It's a terrible thing: he had far more money than he knew what to do with. He's been passing out the bucks willy-nilly, handing off bags of cash to friends, former co-worker, and former employers. Even so, it took him awhile to burn up the taxpayer's hard earned dollars: the last of TARP's initial $350 billion are set to roll out from the Treasury's loading dock. Now Mr. Paulson has pockets filled with lint; it is within his powers to now request the second $350 billion immediately... but he's making no moves to break open that piggy bank. 'Tis strange, we think: it's the season of giving, and he looked like he was having a ball of a time.

His compadre, Mr. Ben Bernanke, is having an even better time: $1.388 trillion worth of goodness, to approximate from the Fed's inscrutable balance sheet. We've looked at the Fed's latest excuse for a report... good luck making headway into its decipherment. Bloomberg has apparently sued the Fed for more information about the central bank's various lending programs... but the Fed may fall back to its legal trump card: the Federal Reserve System is a private bank, and therefore doesn't fall under the Freedom of Information Act.

We put ourselves in the shoes of these two men, and we can't help but feel... nervous.

Let us explain: the Treasury wants to keep the bailouts rolling, and the incoming Obama Administration is planning on spending trillions. At present the Treasury's bailouts are funded by investors buying Treasury debt... but when the cost of make-work programs start rolling in, these investors will be swamped. They just don't have enough money.

Enter the Federal Reserve, which can create a theoretically infinite supply of money. The Fed wants to prevent deflation by any means necessary, and buying up Treasury debt on the open market is just the thing for stoking inflation. The Treasury gets its money, the Fed gets its inflation and liquidity.

The policies of the Treasury and the Fed seem to be forcing them into an inflationary corner. Surrounded by seas of financial red ink, they have nowhere to turn but to the presses. They are playing with fire: sooner or later, all that paper money is going to start burning - first, in the people's pockets; and second, in their furnaces.

The Reality of Peak Minerals

An idea which is gaining traction in the mainstream is Peak Oil, the inevitable maximum level of world oil production. The idea of limits to growth is not a happy one for most, so we will sidestep the argument of whether or not scarcity of energy can be overcome with technology. Instead, we merely point to the facts: all major oil producers have peaked, and indeed world oil production (excluding ethanol, tarsands, and other such silliness) peaked in 2005.

But what of other minerals, the stuff that oil rigs and cellphones are made of? Their futures are no different from that of oil. In fact, many minerals have already peaked: the fertilisers potash and phosphate rock both peaked in 1989; industrial metals lead and cadmium peaked in 1986 and 1989 respectively;... and we hear rumblings that peak copper has recently been reached.

If peak minerals were to have occurred absent peak oil, the increasing scarcity of minerals might not have been as bad. However, the world is facing both increasingly-difficult-to-mine minerals, and increasingly-difficult-to-drill oil. Quite simply, this means that the prices of anything that requires oil and minerals will be going up in price - if not nominally (i.e. increased purchase price), in any case in terms of affordability (i.e. lowered personal income).

It seems to us that this is just about everything. Although some may say that improved technology will help alleviate the pressures of scarcity on supply and cost, we respectfully disagree. The pressures of scarcity will be made even more painful with the 2007 Depression. Falling incomes will make one poorer, inflation will burn up the purchasing power of what money one gets, and one's stuff will be more costly to buy... one will be feeling triplely poorer.

What is Deflation?

There is, at present, a raging debate in the blogosphere and elsewhere as to whether the economy has entered a period of inflation or deflation. The conflict is not helped by the fact that there are no generally accepted definitions of these two concepts. We will attempt to create a definition that will provide a framework for analysis of various viewpoints.

First of all, the most useful definition of inflation and deflation would explain them as two sides of the same proverbial coin. A naive definition would call inflation, rising prices; and deflation, falling prices. Unfortunately in the real world, the prices for all sorts of things rise and fall continuously for a wide variety of reasons. Many analysts attempt to reduce their definitions to narrow, easily observed phenomena, i.e. official defined money supplies, or indices of consumer prices. Much of the contention arises over what is being observed.

Inflation and deflation could be said to be something that is hard to define but, like pornography, we know it when we see it. In that spirit, we define deflation as pervasive, structural falling of costs as measured by the currency across a broad range of economic activity; and inflation as its inverse.

By pervasive, we mean costs therefore do not just refer to retail prices, but also asset prices, wholesale prices, producer prices, and most critically wages and rents (including profits and interest). By structural, we mean that economic activity is inherently complex. Making money has many costs embedded within it, and what one pays out axiomatically ends up as many multiple others' income. This aggregation of costs, wages, interest, and so forth we call the structure.

Is deflation happening in the 2007 Depression? What costs have fallen so far? Obviously, the cost of many securities, houses, and commodities. Not so obviously, the cost of interest on national debts (with some notable exceptions, such as Iceland), and corporate profits. What about costs that are rising? The U.S. minimum wage went up in 2008 by 12 percent, and in 2009 will be going up a further 11 per cent; U.S. Postal first class stamps; and, as a personal example, our water and sewer utility service.

The picture is once again, conflicting trends. Over time, one of these trends will emerge the 'winner'. In the mean time, falling prices of certain things might be called 'deflationary', but that is very conjectural. For example, if the price of a commodity falls so much that it is unprofitable to produce it, the fall will simply be what is known as a price spike down. The price will then have to rise again, if people want to continue using the item. This is hardly deflationary.

Likewise, incomes will likely soon be shown to be falling, and some may call that evidence of deflation, but it might just be people becoming poorer. If what people want to buy does not also become more affordable, then there is no deflation.

It is our opinion that the 2007 Depression will probably not be deflationary. Two significant factors are at work to ensure that outcome. First, it is the stated objective of monetary authorities everywhere to prevent deflation. Second, many costs (such as minimum wages or social security benefits) are fixed by law, and even more costs, contractually over long periods of time.

It is also our opinion that the 2007 Depression will probably be, overall, strongly inflationary, if not even hyperinflationary. We believe that the overhang of money, and money-like securities (bonds, CDs, money market funds, etc.) from the bubble years combined with central bank efforts to prevent deflation will create a surplus of currency chasing a quantity of goods and services which is declining due to contracting production. In other words, when more money chases fewer goods, the outcome is inflation, not deflation.