The Daily Reckoning
It is amazing how many things have NOT happened.
Probably most incredible is that the dollar has NOT collapsed. It has lost ground, and was trading at $1.43 per euro on Friday, but no one laughs at you when go to exchange dollars…or offer to pay in dollars rather than the local currency.
For the last 10 years, the money supply in the United States has expanded at roughly twice the rate of GDP growth. And the Fed doubled its balance sheet in just the last 18 months. This last bit of information is stunning. It took the central bank nearly 100 years to build a balance sheet of $1 trillion. Then, under the leadership of Ben Bernanke, it added another $1 trillion in just a few months.
What does that mean, exactly? It means they bought a lot of debt from US agencies and the financial sector. It means also that they “monetized” this debt…transforming it into cash by paying for it with money especially created for that purpose. It also means that the whole financial sector has a bigger financial base against which to lend. The Fed lends against its balance sheet to member banks. These banks then lend to other banks who lend to business and consumers. So the amount of potential credit – as well as the amount of actual cash – has gone up.
There is an iron law in economics. Quality and quantity vary inversely…which is another way of saying that when you add more of something…each unit is worth less than the unit that preceded it (assuming everything else remained unchanged.) Certainly, this is true of money. The more money in a financial system, the less each unit of it is worth. Add enough new money – as Zimbabwe proved recently – and each unit becomes worthless.
But so far, the dollar has not collapsed. It has fallen, but gently…
Meanwhile, the inflation rate has NOT gone up. Instead, it’s gone down. Go figure. You add that much monetary inflation and you’d expect to get a boost in the CPI. Nope. Not yet.
On the other hand, we’re already a year-and-a-half into a major recession/depression. You’d think you’d get deflation. That hasn’t happened either. Prices are down. But not as much as you’d expect, given the scale of the downturn.
Related to both the dollar and inflation is the bond market. Even more surprising is that the bond market has NOT fallen apart. Let’s see, a huge input of monetary inflation; that ought to kill the bond market. Then too, the biggest sales of Treasury bonds in history – needed to cover a $1.7 trillion deficit this year. That ought to kill the bond market too. And on top of it all is a projection from the White House telling us that the feds will add $9 trillion to US debt over the next 10 years. And that assumes a full recovery in the economy! Now, that ought to kill the bond market for sure.
Not at all! Bond yields have risen…but the 10-year T-note still only gives you 3.4%.
Of course, you say, it’s a depression. Bond yields always go down in a depression.
But if it’s a depression, how come commodities are up? And stocks are up? Above all, how come Chinese stocks are up? Everybody knows China earns its money selling products to Americans and other non-Chinese. If the rest of the world is in a depression, who is China going to sell to? How come China isn’t in a depression already? But there you are – there’s another thing that hasn’t happened. Chinese stocks haven’t collapsed.
And getting back to commodities, they’re all up. Commodity prices don’t go up in a depression; everybody knows that. They go down. But commodities are NOT in a bear market. Go figure.
And, of course, there’s gold. The metal gave up a dollar on Friday, but it’s still just $4 short of the $1,000 mark…and just a shadow below its all-time high. Gold is a commodity…but it’s also money in its purest, more reliable form. Commodities go down in a depression. Money goes up. But since gold is an alternative to paper money, it tends to go up only when paper money goes down. As explained above, the dollar has NOT collapsed. So why is gold going up? It should be going down, reflecting the effect of a recession…
There are two possible answers.
First, maybe the iron laws of economics have been repealed.
Or, second…maybe the iron laws just haven’t caught up to the market – yet.
Unemployment is at 9.7%. It will probably rise above 10% this month. The economy is supposed to be recovering. Now, The New York Times is talking about a “jobless recovery.”
You’ll remember the phrase. It came out in 2003. Then, the economy was allegedly recovering from a micro-recession. Economists were surprised that there were so few new jobs created.
What was really happening was that there was no genuine recovery. Consumers just decided to go deeper and deeper into debt – egged on by the feds. A regional governor of the Fed actually urged consumers to “go out and buy an SUV.” So Americans bought more products from the Chinese…on credit…and the Chinese enjoyed a boom.
And now the boom is over. Americans are paying down their debt. And unemployment is getting worse. This time the feds are pumping trillions into the system. This time, it’s not the consumer who is willing to go further into debt; it’s the government. And once again, few new jobs are being created.
Without jobs, the recovery is an impostor…a phony…a fraud. Without jobs, people have no extra spending power. So they can’t buy – except by going deeper into debt. They were willing to go further into debt in ’03-’07. But not this time. They’ve reached their limit on debt. Besides, with house prices falling, who would lend to them?
No new jobs = no new income. No new income = no new sales. No new sales = no new profits = no new jobs.
But what about the government? The feds are still willing to borrow. How come federal borrowing can’t create a new boom – even if it is a phony one – like the one in 2003-2007?
Federal borrowing, spending, bailouts and monetary inflation are not helping the real economy. But they are making a lot of money available for speculation. That’s why so many things are NOT happening. Investors are speculating on commodities, gold and Chinese stocks – for example. And US bonds.
But this is not a durable, reliable trend. And it’s not laying the foundation for a genuine recovery. Borrowing by the feds is different from borrowing by individuals. Private households can go broke. But they can’t take the dollar down with them. When the feds borrow, they pledge the full faith and credit of the United States – and its currency – as security. So, as they borrow more…the value of the US currency comes into doubt…then, into play…and then into jeopardy.
Investors eventually sell off dollars and US bonds…then,what should happen finally does.
Caution: what has to happen does eventually happen. But it doesn’t have to happen when you think it should. The big surprise might be how long it takes before these things happen. If we were Mr. Market, for example, we probably would not take gold much higher – not just yet. We’d let deflation take gold down for a while – long enough to separate the speculators from their money. Then, we’d let investors get used to falling prices – before bringing inflation back.
And, as promised on Friday, the answer to ‘What was the SEC doing?’
Recall that last week,we reported the latest news on the SEC. Investigators wondered why the agency had let Madoff run billions in suspicious trades without ever checking them out. The SEC responded by saying it lacked sufficient resources. Then, New York Senator Schumer said he would propose a measure to increase the agency’s spending power by 75% – by allowing it to shake down the financial industry directly, rather than going to Congress for a budget allocation.
Which still leaves open the question of what the SEC was doing when it should have been making Madoff do the perp walk. We have the answer: the SEC was harassing us.
Yes, hard to believe that they would target your poor, innocent editor. And they didn’t, not directly anyway. Instead, they targeted one of our colleagues. This was a couple of years ago…when Bernie Madoff was at the top of his game.
We haven’t mentioned it in this space…on the advice of our lawyer. Judges don’t like it when you “try a case in public.” And the case still isn’t settled.
But we won’t discuss the merits of the case…only the circumstances around it.
This will help us understand what the SEC is really up to…and why the hope of regulating fraud out of existence is as vain and futile as trying to clear out a bar by using foul language.
Here’s what happened. One of our researchers discovered what he thought was a great investment opportunity. He called the target company and spoke to a VP in charge of public relations. What he heard convinced him that he was on to something, so he published a recommendation, sending a copy of it immediately to the company.
He got no response from the company. But a few months later, the SEC knocked on our door. What was their beef? That we had misled investors. How so? In our report, we told readers what the VP had told us. We carefully called it “insider” information…putting the word in quotes to let readers know it wasn’t the same as the forbidden ‘inside information.’ Anyone could have found out the same thing if he had just called the company, read the published reports, and put two and two together.
Our caution was lost on the SEC. They didn’t see the difference between “insider” information and inside information. What’s more, the fellow at the target company denied he had said what he had said. Curiously, he made no objection when the report was published; the objection came after the SEC started snooping around.
The SEC wanted blood. They thought they could get an easy win against a little guy in Baltimore. They wanted us to turn on our own associate…to stop defending him and cop a plea. Obviously, we couldn’t do that. We stood behind our man.
Then came a quirky turn of events. Both the researcher and your editor’s company were charged with what was effectively a new crime – a federal case, no less. The SEC, remember, is supposed to be protecting investors from stock fraud, manipulation, and ‘insider trading.’ But there was never any allegation of manipulating a stock or insider trading. Instead, the agency charged us with NOT having inside information. We never traded in the stock at all…or manipulated it in any way. So the feds alleged that we did not have any inside information to trade on…and that therefore our representation – of having “insider” information (in quotes!) – was a kind of fraud.
And the whole case turned on a telephone conversation between a stock market analyst and a public relations guy in a company. One said one thing; the other said another thing. Reporters make mistakes all the time; so do their sources. But this was the first time the government made a federal case out of it.
We believe our analyst. The SEC believed the other guy and spent millions trying to prove that our fellow lied. No one who bought the research report on the stock complained, let alone threatened a lawsuit. Prior to any SEC probe, refunds were issued to anyone who asked (most did not). Yet the SEC, protector of the public interest, spent years…and millions…on the case – while Bernie Madoff was stealing billions from his clients.
Case against your editor’s company: judges ruled that we were innocent.
Case against our colleague: still undecided at the appeals court.
Case against SEC: guilty of negligence, dereliction and humbug.
The Daily Reckoning
The Daily Reckoning
This Recovery is an Imposter was originally published in the Daily Reckoning on 9/7/2009