VIX plunges under 14. Mr. Market banishes all thoughts of bear.

This has been an extremely dramatic decline, from 22 to 13.9 in one trading week.

Previous drops under 14 in recent years have been followed by limited upside in stocks and an increased incidence of significant declines.

This week’s action seems to be based on relief that Congress has come to terms on the budget. Never mind that taxes are going up for everyone (payroll tax “holiday” ends), and that no progress was made on spending, not even so-called “cuts” to the rate of growth.

Side note on the budget:

High inflation remains baked into the cake for the coming years, just as it appeared in the later years of the secular bear markets of the 1910s, 1930s-40s, and 1966-1982. This is not just because the government is running trillion+ deficits without end, because the Fed has tripled its balance sheet and the monetary base in just four years.

When enough bad debt has been written off for lending to start back up in earnest, the upswing of the multi-generational interest rate cycle will have severe repurcussions for the budget. The effects will be greater because the US Treasury is not taking advantage of low long-term rates, but issuing mostly shorter-term notes.

Note that I was a rare bull on Treasuries going into the last debt crisis. That is no longer the case, but I’m not necessarily bearish on them just yet.

Is the Yen making a giant top?

Deflation has kept a bid under the Yen for 20 years, since the huge load of bad debt denominated in that currency creates demand. The Japanese government took advantage of that bid and ridiculously low long-term rates and has issued unpayable quantities of debt, squandering the nation’s current and future wealth on government jobs and bridges to nowhere, when all they had to do instead was turn their backs on the banks that enabled the 1980s Rising Sun bubble.

Now that sovereign defaults are finally looming on the public consciousness, export markets are shrinking, and the ratio of workers to retirees is still shrinking, it would make perfect sense if the market started to tack a risk premium on all things Yen.

Technically, you can see the weakness of each advance against the USD for the last two years:


USD and US T-bond bears take note: the Japanese are a generation ahead of us in the Kondratieff / credit cycle, and theirs may foreshadow our own experience in winter.

Treasuries could have a lot of strength left.

Take a look at this spike in the long bond yield in late 1979 and early 1980 (charts from Yahoo! Finance):

It must have been a real shocker at the time, and when yields returned to near pre-spike levels, it must have seemed as though the event were an anomaly. Well, it was part of a generational bottoming process for bonds that lasted a few more years:

Now take a look at recent history:

I’m just sayin’…

Real credit vs. fake credit.

The essence of why bailouts will only deepen our problems is that real credit cannot be created out of thin air. This counterfeit operation is what caused the bubble to begin with, and by trying to put out a fire with gasoline, Bernanke, Congress and Obama are going to burn down the whole city.

Frank Shostak, the Chief Economist at M.F. Global, knows a thing or two about economics, which is not something you can say about many of today’s economists. The Mises Institute website publishes this essay of his on credit, which illustrates the critical identity between savings and investment, and the proper role of banks in an honest system.

Central-bank policy makers have said that the key for economic growth is a smooth flow of credit. For them (in particular, for Bernanke) it is credit that provides the foundation for economic growth and raises individuals’ living standards. From this perspective, it makes a lot of sense for the central bank to make sure that credit flows again.

Following the teachings of Friedman and Keynes, it is an almost-unanimous view among experts that if lenders are unwilling to lend, then it is the duty of the government and the central bank to keep the flow of lending going. …

It is true that credit is the key for economic growth. However, one must make a distinction between good credit and bad credit. It is good credit that makes real economic growth possible and thus improves people’s lives and well-being. False credit, however, is an agent of economic destruction and leads to economic impoverishment.

Good Credit versus Bad Credit

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit); and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (bad credit).

Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers. To understand why, we must first understand how good credit comes to be and the function it serves.

Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one week’s time. Note that credit here is the transfer of “real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.

Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.

Note that the saved loaves of bread provide support to the shoemaker, i.e., they sustain him while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is a path to real economic growth.

Money and Credit

The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend those dollars to the shoemaker. With eight dollars, the shoemaker can secure either eight loaves of bread (or other goods) to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things includes eight loaves of bread that the baker has produced. Note that without real savings, the lending of money is an exercise in futility. …

The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. …

Despite the apparent complexity that the banking system introduces, the act of credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.

Now, when the baker lends his eight dollars, we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully “backed-up” dollars so to speak.

False Credit Is an Agent of Economic Destruction

Trouble emerges however if, instead of lending fully backed-up money, a bank engages in fractional-reserve banking, the issuing of empty money, backed up by nothing.

When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality, however, nothing has been saved. So when such money is issued, it cannot help the shoemaker, since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. But, since the printed money masquerades as proper money, it can be used to “steal” bread from some other activities and thereby weaken those activities.

This is what the diversion of real wealth by means of money “out of thin air” is all about. If the extra eight loaves of bread aren’t produced and saved, it is not possible to have more shoes without hurting some other activities — activities that are much higher on the priority lists of consumers as far as life and well-being are concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.

Rather than facilitating the transfer of savings across the economy to wealth-generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation. It has to be realized that banks cannot relentlessly pursue unbacked lending without the existence of the central bank, which, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn’t cause banks to bankrupt each other.

We can thus conclude that, as long as the increase in lending is fully backed up by real savings, it must be regarded as good news, since it promotes the formation of real wealth. False credit, which is generated “out of thin air,” is bad news: credit which is unbacked by real savings is an agent of economic destruction.

Fed and Treasury Actions Only Make Things Worse

Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings. …

If the pool of real savings is still growing, then doing nothing (and allowing the interest rate to reflect reality) will allow the recession to be short lived and economic recovery to emerge as fast as possible. (At a higher interest rate, various bubble activities will go belly up. As a result, more real savings will become available to wealth generators. This in turn will work towards the lowering of interest rates.)

We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.

By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.

If Princeton and the rest weren’t run by fools and knaves, this is the kind of thing they would be teaching, not Bernanke’s brand of institutionalized theft.

I recommend reading Shostak’s whole essay. Click around the Mises site while you’re there. It is a wonderful resource for real economics, the kind that can make you money. The Rothhbard and Mises files would be good places to start.

Greenspan was Framed! Blame bankers’ moral hazard, not their lackey.

Source: The Johnsville News

Source: The Johnsville News

The Cover Story

It has become commonplace to lay blame for the greatest of asset bubbles on the inflationary policies of Sir Allen Greenspan and his employer. A typical critique goes something like this: For the last 20 years, every time the market started to liquidate bad debts and malinvestments (the junk bond bust, the crash of ’87, the early ’90s recession, the LTCM blowup, and dot-com crash), Greenspan just turned on the money spigot and made it all better again with lower rates. Because he so encouraged borrowers and lowered or eliminated reserve limits for lenders, we avoided the necessary catharsis and let bad investment pile upon bad investment, with ever increasing asset prices and debt levels, until we reached the stratosphere last year. By then the system had become so saturated with debt, and asset prices so high, that mass bankruptcy and liquidation was inevitable.

The Real Killers

This history is correct, but not complete, and it lays no blame on the true evil at the heart of the age-old problem of the credit cycle. In any analysis of historical events, one must sift through dunes of BS, and the best way to do that is to ask, Qui Bono? (“as a benefit to whom?”). The answer of course, is bankers and their perennial sidekicks, politicians. The latter designation includes the ‘Maestro,’ whom, while valuable for his mastery of obfuscation, could have easily been replaced had he not played ball. Bankers have no qualms about overextending credit, because they, more than any other party, control the government. Politicians and the bureaucracies they create have always worked for money, and bankers have always been the highest bidders.

The Means

The primary mechanism by which bankers steal from the public is fractional reserve lending, which is enabled by the socialization of losses through FDIC insurance and the Federal Reserve’s monopoly over currency.  FDIC absolves commercial bankers from responsibility for their client’s deposits, and the Fed and Treasury lock the public into the rigged system.

The Motive

Within FDIC limits, depositors have no incentive to seek out banks that employ sound lending standards. Because banks are all equally safe from the depositor’s point of view, bankers have no incentive to be cautious. They have a strong disincentive to be so, because the more credit banks extend (the higher their leverage), and the shakier the enterprises to which they lend (at higher interest), the higher their rate of return during the credit expansion (inflation) phase of the cycle. The name of the game is to grow your balance sheet as fast as possible, with little concern as to reserve ratios or collateralization.

The Opportunity

Once the bust arrives, bank executives have already collected so much in salary and bonuses and sold so much stock to an ever-credulous public, that it isn’t very painful for them if their bank fails, since they have become rich. But once a bank gets big enough (remember, the name of the game is to expand your balance sheet), it is easy for its now powerful executives to ‘convince’ politicians that failure would be so damaging that the Treasury (i.e., public) must assume its debts for the greater good.  At critical times, it may be desirable to cut out the middle man and place a trusted member of the cartel directly in the federal executive.

The Fed is Just an Accomplice

In the meantime, the Federal Reserve is called upon to extend cheap credit to banks in general, which often entails the printing of new paper or digital money. The lower base rates that ensue help banks to get off their feet again by encouraging the public to borrow more than is warranted by economic conditions. (Note: The above is how things worked before we reached Peak Credit last year, and the bankers and Fed are trying with all their might to inflate again, but they will be continually confounded. The game is now over, because nobody wants or can afford any more debt, and banks are finally so impaired by defaults that they cannot lend. Also, at $50 trillion in total private debt, the entire mess is now too big to bail, given the Fed’s mere $900 billion balance sheet.)

A Long History of Offense

So that is it in a nutshell: a completely corrupt monetary system. It is nothing new. We have had episodes like this since before Andrew Jackson abolished the first national bank. So long as a national bank has a monopoly on money creation and legal tender laws obligate the public to use fiat currency and not an alternative such as gold, bankers will retain a lock on the economy and the boom-bust cycle will continue, at great expense to our security and quality of life.

Can They Help it? Isn’t it Just Human Nature?

The credit cycle is a natural phenomenon, yes, but so is war. And just as right-thinking people oppose that other means by which the public is exploited by the oligarchy, so they should oppose fractional reserve lending and the institutions that support it: the Federal Reserve system, the FDIC, and legal tender laws.

Hard Currency? Hardly. The Swiss Franc is the Euro.

That’s what the market thinks anyway, and yours truly is feeling like a dope for not checking out some long term charts before trading dollars for Francs last spring. Here they both are against the dollar via CurrencyShares ETFs (Euro in red, Franc in blue):

Click for larger view. Source: Yahoo! Finance

Here’s a 10-year shot (courtesy of Index Mundi. Ignore the spikes, must be a data feed error):

The market can barely tell them apart. From ’02 to ’07 the Euro dashed up about 50 US cents, but it only gained 20 Swiss cents, since the Franc was rallying too. Now that the European economy has turned and lower rates loom, a great reversal may be underway. But Switzerland never ran very hot, its real estate only appreciated by low single digit compound rates, and its bond rates have been puny for years, so there is no gap to be closed with the dollar. On the contrary, dollar rates have fallen to meet those of the Franc, so one would expect the scales to tip the other way.

So much for rewarding the prudent. Americans bring ruination on themselves but the ensuing deflation drives a powerful rally in their inherently worthless and ultimately doomed script. It will be very interesting to see how far this goes. Sentiment is still very anti-dollar, so we could easily get back to parity with the Euro in 2-5 years.

So here I have fallen victim to the rule that the market inflicts the maximum pain on the maximum number. In my haste to get out of a horribly flawed currency, I ran to the Franc on its reputation as the paper that has best held its value in the decades since the end of gold convertibility. I like the Swiss, and I still think they play the fiat game better than anyone, but currencies are all just slips of paper in the winds of public opinion, and public opinion doesn’t often follow the ‘fundamentals’ of financial analysis. It has its own natural patterns, which are not so easily formulated as interest rate differentials and purchasing power parity.








Now we know what the strong dollar policy is

Paulson meant that he was waiting for the US-lead depression to catch up with the rest of the world and bring down rates in Pounds, Euros, Yen and Australian dollars. He’s a genius after all. It’s working:


Even gold, that running vote of confidence in paper money, has backed well off the disconcerting 4-digit level:


How could people suddenly have such a preference for the dollar again? Don’t they know that it, like the Constitution, is just a goddamned piece of paper? Well, Paulson won’t admit this part of the policy, but you may have heard lately about people and companies going broke. Broke means no money (such as dollars). Since dollars accounted for a huge share of the bad loans made in the bubble, the implosion of that debt is akin to a shortage of dollars.

The dollars were never really there, just debt, but when you get a loan, it sure feels and works like money. And when it comes time to pay it back, money is what you need. Right now, nobody seems to have much of it, so those who do are getting the sense that they should hang onto it. That means a slower velocity of money (the pace with which it changes hands), which is deflationary by even by mainstream economists’ definition (M V = P Q).

So, who wants to guess how much longer Peter Schiff can hold out with his inflation case?