Over a year ago, I wrote about China threatening to stop buying US Treasuries.

According to an article in the New York Times, it now looks like China is losing it’s appetite for US debt :

In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.

But now Beijing is seeking to pay for its own $600 billion stimulus – just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.

All the key drivers of China’s Treasury purchases are disappearing – there’s a waning appetite for dollars and a waning appetite for Treasuries, and that complicates the outlook for interest rates, said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland.

By itself, this is a concern for our government. Recently, it sold billions of 3 year treasuries at a 1.2% yield! But when the demand for treasuries eventually dries up, yield should start jumping higher. But to make matters worse, the government will start a slew of public works projects and bailouts, for which we will have to borrow even more money. At some point the demand will simply fall short of the supply.

Here’s an interesting note by James Quinn on

As the politicians scurry to “save” capitalism through the use of communist measures, more Americans are becoming disheartened. The definition of communism according to Webster’s is:

A system in which goods are owned in common and are available to all as needed.

George Bush, Henry Paulson and Ben Bernanke have decided to seize money from the vast majority of Americans who lived within their means, utilized debt sparingly, and worked hard to get ahead, and give it to the most appalling failures in our society. They have shoveled billions to banks that operated their businesses like gambling parlors. They have shoveled hundreds of millions to people who bought houses with no money down, interest only mortgages and fraudulent loan applications. They are now rewarding automakers who made the wrong vehicles, pay 30,000 workers per year to not work, and have only been able to “sell” cars by giving them away with 0% financing to any schmuck who could sign on the dotted line. These acts fit the definition of communism. We are now more communist than China.

So what are the repercussions of our monetary policy? According to Chuck Butler of (which I highly recommend):

US government will have to ratchet the yield on these bonds up so high to attract investors… OR… Allow a general debasing of the dollar to allow those purchases of Treasuries to be made at a discounted clearing price.”

A lot of people will disagree, but during these economic times, we’ll see inflation and not deflation. And gold will continue to be a store of value and a hedge against inflation. Even though its quite popular to bash gold and call it a lousy investment, the fact remains that gold has been one of the best performing assets during the past decade. I’ve been buying gold coins since 2005 and while the price of gold is up around 50% since then, the premiums on gold and silver coins has increased more than twice that. (Premium is what you pay over the spot price of gold). This shows an increasing demand for gold coins.

Gold and silver coins will be the next bubble! The bubble has barely started and should take 2-3 years to play out.

According to to the WSJ, Dr. Panarin, a Russian former KGB analyst, predicts that the US will disintegrate by summer of 2010. He actually made his prediction back in 1997 when this scenario really sounded ludicrous. Now its simply improbable!


Before you dismiss him as another crazy, check out his credentials. “Prof. Panarin, 50 years old, is not a fringe figure. A former KGB analyst, he is dean of the Russian Foreign Ministry’s academy for future diplomats. He is invited to Kremlin receptions, lectures students, publishes books, and appears in the media as an expert on U.S.-Russia relations.”

Here’s the gist of his argument:

Mr. Panarin posits, in brief, that mass immigration, economic decline, and moral degradation will trigger a civil war next fall and the collapse of the dollar.

He based the forecast on classified data supplied to him by FAPSI analysts, he says. He predicts that economic, financial and demographic trends will provoke a political and social crisis in the U.S. When the going gets tough, he says, wealthier states will withhold funds from the federal government and effectively secede from the union. Social unrest up to and including a civil war will follow. The U.S. will then split along ethnic lines, and foreign powers will move in.

California will form the nucleus of what he calls “The Californian Republic,” and will be part of China or under Chinese influence. Texas will be the heart of “The Texas Republic,” a cluster of states that will go to Mexico or fall under Mexican influence. Washington, D.C., and New York will be part of an “Atlantic America” that may join the European Union. Canada will grab a group of Northern states Prof. Panarin calls “The Central North American Republic.” Hawaii, he suggests, will be a protectorate of Japan or China, and Alaska will be subsumed into Russia.

Interest in his forecast revived this fall when he published an article in Izvestia, one of Russia’s biggest national dailies. In it, he reiterated his theory, called U.S. foreign debt “a pyramid scheme,” and predicted China and Russia would usurp Washington’s role as a global financial regulator.

Americans hope President-elect Barack Obama “can work miracles,” he wrote. “But when spring comes, it will be clear that there are no miracles.”

While I agree that the Federal Reserve is running the world’s largest Ponzi Scheme and that Obama may have a tough time working any miracles, I doubt that will necessarily result in complete disintegration of the US.

The US Dollar might lose its status as the world’s reserve currency and we might see a period of high inflation. The average American might also see a contraction in his or her standard of living, which is more of a regression back to living within one’s means since the days of excess spending are over. But so what if we become a little poorer or our standard of living drops a little. Poor people in the US still live better than poor people everywhere else.

And if, like Dick Cheney, you diversify your investment holdings into foreign currencies & bonds and buy some gold & silver coins you’ll be able to hedge yourself against any collapse in the US dollar or financial system.

The media has been going on and on about deflation. Long-term bond prices have also been trending up and long term yields have been dropping, which means that the market thinks there will be long-term deflation. Even the Consumer Price Index numbers that came out claim that inflation is under 2% annually!

(Of course, if you’re one of the unlucky 533,000 people who lost their jobs last month, you really couldn’t care less about deflation).

Let’s first look at the Government reported numbers.

                      May   June  July  Aug.  Sep.  Oct.  Nov.   ended     ended                      
                             2008  2008  2008  2008  2008  2008  2008 Nov. 2008 Nov. 2008

All items..........    .7   1.2    .9   -.2   -.1  -1.2  -2.1     -12.9        .7

Food and beverages    .3    .8    .9    .6    .6    .3    .2       4.2       6.0
Housing...........    .5    .5    .7    .0   -.2    .0   -.1       -.8       3.1

Apparel...........   -.2    .0    .8   1.0    .0  -1.2    .2      -3.9        .2
Transportation....   2.1   4.0   1.8  -1.7   -.7  -6.0 -10.9     -52.1     -10.4

Medical care......    .1    .2    .1    .3    .3    .1    .2       2.7       2.7
Recreation........    .0    .2    .4    .5    .2    .0   -.1        .8       1.9

Education and
  communication..    .3    .5    .5    .2    .0    .2    .2       1.6       3.4

Other goods and
  services.......    .5    .6    .5    .2    .2    .3    .1       2.4       4.4

Special indexes:Energy............   4.5   6.8   4.0  -3.2  -1.7  -9.0 -17.8     -70.8     -14.3

Food..............    .3    .8    .9    .6    .6    .3    .2       4.1       6.2
All items less
food and energy    .2    .3    .3    .2    .1   -.1    .0        .1       2.0

Lets start with the largest expense for most people, housing.

Yes, house prices have decreased. However, if you’re already a home owner or a renter then you’re probably not seeing any benefit. The only people who’re benefiting are those people who can actually qualify for a home loan and have enough cash for a down-payment. The 100% financing loans have disappeared as a result of the tightening of the lending standards. As I mentioned in the last post, it’s not the cost of credit, buts the availability of credit that is important.

Energy prices actually have dropped down from $147/barrel to around $40/barrel in the past 5 months. However, I heard billionaire T Boone Pickins on the radio today say that OPEC is going to keep cutting production until oil is back up at $75/barrel. In the long run, I agree with him. While a global recession might reduce the demand for oil, there are 3 billion people in Asia who are getting a little richer every day and want air conditioning, cars, motorbikes and other luxuries that consume oil. Without alternate energy sources, oil prices have to rise. The current price drop is likely to be short-lived.

According to official numbers, education costs have only gone up 1.6%-3.4% in the past year. However, my MBA program has seen a much higher percentage increase in tuition than last year, and it might see another increase next year (according to a letter I received from the Dean of my Business School).

Likewise, medical costs have also gone up only 2.7%, but my health premiums and medical costs seem somehow higher than that.

And while food and beverage prices have only seen an official 4.2-6% inflation, prices of food items that I consider my staple diet like Tyson Chicken Wings and Sirloin Steak Burgers at Costco have gone up about nearly 50% in the past 2 years.

Meanwhile, the Federal Reserve is printing money like its going out of style. (And at this rate, it actually might). In theory, increasing the money is inflationary. That’s one reason why a house that cost $30,000 in the 70’s costs $300,000 today. More money in circulation means every existing dollar is now worth less. At least thats the theory. Increases in productivity and technology have managed to improve our standard of living despite this inflationary pressure, but there must be some point at which you start seeing inflation. Maybe we’re at that point now.

The government has committed to more money on financial bailouts than its ever spent in its history. According to an article in the SF Gate, the Financial Bailout may end up costing the taxpayer $8.5 trillion dollars.

According to an article on CNBC, that’s more than the cost of almost everything else the US government has spent on even adjusting for inflation!

Here are estimates for the major US government expenditures (all figures inflation-adjusted):

Hoover Dam: $782 million

Panama Canal: $7.9 billion

Gulf War: $98 billion

Marshall Plan: $115.3 billion

Louisiana Purchase: $217 billion

Race to the Moon: $237 billion

Savings & Loan Crisis: $256 billion

Korean War: $454 billion

New Deal: ~$500 billion

Iraq/Afghanistan/War on Terror: $597 billion

Vietnam War: $698 billion

NASA Budget since inception: $851.2 billion

World War II: $3.6 trillion

Total = $7.63 trillion

I thought this was the most interesting section of the SF Gate article:

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said [That’s Diane Lim Rogers, chief economist with the Concord Coalition, not Jim Rogers!]. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

In the past 10 years gold is up 300%+. That’s about 300% better than the return on the S&P500 over the same time period! This is not an indication of deflation.

And what does veteran investor Jim Rogers think about this? In a recent Bloomberg interview he predicted that the dollar is “going to lose its status as the world’s reserve currency,” adding, “It will be devalued and it will go down a lot. These guys in Washington, they want to debase the currency.”

“They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term,” said Rogers.

Paul Watson of the Prison Planet states:

The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer. Strauss-Kahn’s comments echo those of others who have cautioned that civil unrest could arise, specifically in the U.S., as a result of the wholesale looting of the taxpayer and the devaluation of the dollar.

How long will it be before Americans realize the looming specter of hyperinflation spells disaster for their life savings? How long will it be before we see rioting in the streets on a par with the scenes witnessed in Iceland over the weekend, where the Icelandic krona has lost half its value in a matter of weeks?

I’m not buying the deflation argument. In fact, I wouldn’t be surprized to see 10-12% inflation for the next several years. I’ve been buying gold coins since gold was $500/ounce and I’ve adding to my position on pullbacks. Maybe in a few years time, $850 gold and $12 silver may look like a bargain!

Check out this 12 minute video from 60 Minutes. There’s another wave of mortgage defaults on the way, this time from Alt-A & Option-Arm (also called Negative-Amortization or Neg-Am) loans. As opposed to the subprime loans which were worth almost $1 Trillion, these two groups make up nearly $1.5 Trillion.  According to Amhurst Capital, they expect a 70% default rate on the Option-Arms based on the current default rate which is occurring at 3% interest rates!

Right now there’s a 3-5 year overhead supply of housing inventory on the market. Along with these coming defaults and the fact that 10% of Americans are behind on their mortgage, you should expect house prices to be depressed for a very long time. I’ll think we’ll have more clarity when home prices actually hit bottom, which might be another 12-24 months from today.

I’m sure glad I sold my condo in summer 2005! The bank now owns and I’m thinking of putting in a very low-ball offer. An offer so low, it’ll cashflow well and at least break-even if rents drop 50%!
(Check out these cheap real estate deals).

If you’ve been reading the news, you know that at yesterday’s FOMC meeting, Bernanke dropped the interest rates to an unbelivable 0.25% (a cut of 75 basis points). Apparently he thinks that cheap credit will solve the problems facing the US economy right now. Unfortunately, its not the cost of credit but the availability of credit that is the issue. Credit is drying up and making it cheaper isn’t going to make any difference.

Last Monday, the Treasury was able to auction $35 Billion worth of 3 month T-bills at 0%, which means there’s a demand for liquidity and safety. Return of principle is more important than return on principle!

However, the government is using this money (and another few hundred billions) to bail out bankrupt financial firms, insurance companies, and auto manufacturers. It is running printing presses around the clock creating pictures of dead presidents and is inflating the money supply at a 17% annual rate. This is inflationary in the long run and will cause the devaluation of the dollar.

In the long term, Bernanke (or Bernie for short) is more worried about saving the economy than fighting inflation. (He’s not really concerned about the devaluing dollar either). And while the price of everything may increase, he’s hoping that real estate prices will stay flat instead of tanking, and that’s how he’s going to engender “a soft landing for the real estate market”.

Looking at the dollar index over the past few days, the dollar has started showing signs of weakness. Now that the interest rates in the US are even lower than in Japan, maybe people will start using the US Dollar as the new currency of choice for the carry-trade!

You could sell the US Dollar and buy the Australian Dollar or the New Zealand Dollar, both of which have a much higher yield than the US Dollar. (Note: this is not a recommendation, just an example of how to execute the new carry-trade). I bought some Australian Dollar ETF (FXA) yesterday morning in anticipation of a rate cut for my retirement account. The yield on FXA is currently 8%! It’s up nearly 5% since then and I’m happy to say my retirement account is down only 4% for the year – if only all my investments had fared so well this year!

Anyway, with interest rates close to zero I’m reminded of an 80’s song called “Turning Japanese“! Enjoy.

Happy Thanksgiving! Here’s an interesting cartoon on the topic.

[Thanksgiving In Washington]


There’s certainly one group of people who have a lot to be thankful for this Thanksgiving: The white-collar criminals in Washington who are looting the U.S. Treasury and stealing trillions of dollars from taxpayers.

That’s what this financial bailout really is, of course: A grand, desperate swindle that seeks to wring every last cent out of the U.S. dollar before the coming currency collapse. A collapse of the value of the U.S. dollar is coming soon. Just do the math: The end result is obvious. It will either be runaway inflation that leaves dollars virtually worthless or the abandonment of the dollar by the U.S. government and the adoption of a new currency (the Amero?) at confiscatory exchange rates that will wipe out the savings of most Americans.

You are witnessing the downfall of the American empire, and the Federal Reserve — a private bank that was stupidly handed the power over our nation’s money supply — is heaping new debt onto old debt, sending the U.S. into a tailspin of bad money from which it will never emerge. Consider this: It took the United States over 230 years to accumulate $5 trillion in debt. That national debt has now roughly tripled in the last 60 days. Officially, the national debt is now about $10 trillion, but with the Fed just announcing another $7 trillion in bailout money, we’re talking about a $17 trillion national debt that nobody even has a clue how to pay back.

The very idea that we can pay off bad debt with more bad debt is so utterly stupid in the first place, it could have only been dreamed up by politicians. It makes as much sense as paying off one credit card by taking out a cash advance on another credit card. That’s not a financial bailout; it’s more like a financial tar pit. But it’s exactly what the United States of America has decided to do.

Read the rest of the article here.

I got into a lively debate yesterday with a fellow student about the bailout of the auto-industry. He said the social ramifications of letting them fail were too high. The impact on the local communities would be too high and so they should be bailed out by the tax-payers.

I said they were not cost-effective and there wasn’t enough demand for their cars to keep them in business. Even if the government gave them $25 billion, they’d plow through it and be back at the door asking for another handout. The government, too ashamed to admit it had wasted the first $25 billion would probably hand them another $25 billion. (This is called the Concorde effect, after the failed Concorde partnership between England and France which was a financial disaster).

I read some articles with also drew similar conclusions, but with different viewpoints.

In 2006, the average hourly wage of a person with a high school diploma was $13.46 per hour. For those fortunate enough to receive insurance and other forms of compensation, the average was $17.50 per hour in total compensation. These averages encompass all age groups.

However, if you are a Detroit auto worker with a high school diploma, your total compensation comes to: $67.78 (Ford), $70.43 (GM) or $72.59 (Chrysler) per hour.

That’s right, it cost Detroit 4-5 times more to hire unskilled labor! I think it’s the auto unions who are driving the US car manufacturers out of business.

I think its said that someone who spent 4 years in college and graduates with a student loan has to work for about $20-$25/hr while an unskilled worker makes more than that. Even grocery baggers in California supermarkets used to make $27/hr after working there for 7 years because of their union deal! That’s a pretty sweet deal if you can find it.

But moving on…

All of this brouhaha about bailing out the auto industry and how destructive it will be to the country – sounds a lot like the moans and groans of the steel industry (and steel unions) a few decades ago when the Japanese and Koreans were killing the U.S. companies with low prices for bulk steel. The biggies, like U.S. Steel and Bethlehem, went under.

And you know what? Small, progressive and aggressive steel companies arose in the U.S. – not for the cheapo junk steel, but for the better grades, for alloys and for hi-tech steels. And in a few decades, the industry bounced back better than ever. The U.S. was THE place to buy the good stuff. The Far East was where you bought the cheap bulk stuff. Did it ‘hurt’? Yeah, for a while, but you know, we got over it and came through it all the better. We just forgot what we learned.

How many innovative car companies do you think will start popping up in the U.S. when the dinosaur Big 3, and their fat-assed dinosaur management, are finally gone? I don’t think that innovation is completely dead in the U.S.; it’s just been shut down in favor of huge management bonuses paid for killing industries through blind stodginess. Let’s see, how many U.S. car companies were still trying to crank out SUV guzzlers when gas prices were scaling Everest? Let the dead die so that the living can grow.
Sorry, unions and union members, but the day is over that a dumb back can command a sizeable (read uncompetitive) wage and benefit package just for showing up to do a job that, in many cases, a monkey could be trained to do. Better get some education. The new companies will be high-tech – there will be plenty of jobs for those with a reasonable education and training. Dumb backs will get to clean toilets at a commensurate wage.

Hear that Fed and Treasury and Congress? Don’t waste money trying to resurrect dinosaur corpses. Put the money into opening up investment in new technologies, good products and well-run companies. Put the money toward training a labor force that can be part of competitive industries. And start the ‘do it or fail’ philosophy in the schools. First-grade would be good.

This reminds of an excellent book I read a few years ago called God Wants You to Be Rich: How and Why Everyone Can Enjoy Material and Spiritual Wealth in Our Abundant World. The author states the example of automated farming techniques introduced in the early 1900s, reducing the workforce required for producing food from 30% of the population to the 3% we have today. Did those people starve to death? No, they went on to find other jobs. I think society, (and by society I mean the US taxpayer) is better served by having an overpaid segment of society go find some other work to do.

And lastly, if the economics isn’t enough, lets look at how poorly managed these companies are.

The execs for the Big Three automakers each took private jets to their testimony before Congress yesterday. Average cost for the flight from Detroit to Washington? $20,000… Northwest had flights available that day for $288 coach, $837 first-class.

“It’s almost like seeing a guy show up at the soup kitchen in a high hat and tuxedo,” Rep. Gary Ackerman, a Democrat from New York, said of the dynamic trio. “Couldn’t you have downgraded to first class or something, or jet-pooled or something to get here?”

Maybe they should have driven?

The southern states make cars like Honda, Acura, and Nissan. They don’t have the high labor rates and are actually profitable car companies. Obviously they’re opposed to the bailout because it use’s their tax money to help the competition.

So what do you think of the car industry bailout?


What’s the difference between a pigeon and a Wall Street banker?

The pigeon can still make a deposit on a Porsche!

Meanwhile, in what looks like a stunning display of stupidity, the Federal Reserve recently hired someone to “assess the safety and soundness of domestic banking institutions.” The new employee is none other than Former Bear Stearns chief risk officer (from 2006 to 2008) Michael Alix. Unbelievable! The Fed hired the guy who let Bear go bust.

Regular readers know that I’ve been saying the US government is broke for a while now. As if our national debt and unfunded future debt obligations weren’t enough, Henry Paulson proposed spending $700 billion to buy mortgages and other toxic “assets” from banks. Well, not only does the Treasury now want to spend bailout cash on all kinds of financial companies (from banks to bond insurers to specialty-finance firms like GE Capital) it’s becoming more and more obvious that the government didn’t actually have $700 billion lying around. The Treasury has borrowed $600 billion since mid-September, and it wants to borrow a record total of $550 billion during the fourth quarter of 2008 to help stabilize the financial sector.

In July, the Treasury estimated third-quarter borrowing would be $171 billion. It actually borrowed $530 billion, $300 billion of which was for its Supplementary Financing Program, launched in September, to keep Wall Street from melting down.

While people may argue that this was the best thing to do (of course you should bail out your buddies on Wall Street!), the fact is that this level of government borrowing and spending will have an inflationary affect. It’s still not too late to buy some gold coins and hedge against it.

Addison Wiggin at Agora Financial sat down with Warren Buffett for an interview. He published that interview in his brand new book, I.O.U.S.A – One Nation. Under Stress. In Debt. On the whole, Buffett seems pretty optimistic. Here’s an excerpt:

On our national debt problems…

We’re transferring small bits of the country – ownership of the country, or IOUs – to the rest of the world. But our national pie is still growing.

We’re like a very, very, very, rich family that owns a farm the size of Texas, and we have all this output coming from the farm. Now, because we consume a little more than we produce, we’re selling bits of that farm daily, a couple billion worth. Or we’re giving a small mortgage on it which we don’t even notice, but it builds up over time.

So even though we own a little less of the farm, or we create these IOUs against it, our equity in the farm actually increases somewhat. That’s why people will benefit over time. But they won’t benefit as much as if they hadn’t given the IOUs or sold off little pieces of the farm.

On gold…

Over time, people have dug up gold from the ground in far remote areas and then they’ve shipped it thousands and thousands of miles. And they’ve put it in the ground over here and hired guards to stand over it. So the real utility of gold is not that high. It’s been something that people turn to, but it has not been a very good investment.

On China and globalization…

In 1790, there were about 4 million people in the U.S. and about 290 million in China. They were just as smart as we were. They had a climate that was about the same as ours. And yet we did enormously well over the next 217 years… as compared to China.

Now, why did we do that? Well, we had a market system, a rule of law, and equality of opportunity… and that system unleashed the potential of citizens in the United States to an extent far greater than in many countries including, up until recently, China.

About the risk of default of U.S. government bonds…

The U.S. government bond is absolutely certain to be paid. It’s just total nonsense when people talk about the U.S. going bankrupt. I mean, the U.S. government will always pay its debts. The purchasing power of the dollar you receive is likely to be less than the dollar you invested, so you have purchasing power risk… But you should not be afraid of government bonds in terms of being paid.

The unique situation in the U.S. now…

Many years ago, when we lent a lot of money to various emerging countries and were having trouble getting paid back, somebody said that they found it very hard to imagine some Philippine or Thailand worker spending a couple of extra hours every week in the hot sun merely so Citicorp could increase its dividend twice a year. At a point, people say, “To hell with it.”

It’s much easier just to inflate your way out of it. If you’re a South American or Asian country that owes money in dollars, it gets very binding to pay back in dollars. But if you owe it in your own currency, you just print more currency. And we have the ability to print currency. We can denominate debt in our own currency, whereas many countries can’t because people don’t trust them.

On government economic policies and crises…

We came fairly close to the whole system imploding in the 1930s because of economic conditions. People became very responsive to communism… When people are scared about economics, they’ll listen to whoever is the most persuasive… One thing I don’t like about the consequences of sustained large trade deficits is I think it makes the potential for demagoguery and really foolish policies more likely over time.

When you think about the history of this country, our economic policies have been pretty darn good. I mean, any country that delivers a seven-for-one increase in per capita living in a century has done an awful lot of things right. It’s never happened before in the history of mankind.

What the right policies are…

You want a system where Mike Tyson is fighting for the heavyweight championship and Jack Welch is running General Electric. But you don’t want Mike Tyson to be running General Electric and Jack Welch in the heavyweight championship. Government allocation of resources has tended, too often, to misallocate, and I think a market system does a pretty good job of allocating.

Wrapping up…

It’s been a marvelous time to be alive. It wasn’t really a whole lot better to live in the fourth century BC than the fourth century AD. But it’s been a lot better to live in the year 2007 than it was in the year 1807.

…Even those on the low end are doing far better than people on the high end were doing 100 years ago. There’re many, many things that a person earning a normal wage in this country can do and enjoy that John D. Rockefeller couldn’t do and enjoy. So a rising tide has lifted all the boats… The average American is going to live better 10 years from now, 20 years from now, and 50 years from now.

Not too long ago, the Federal Reserve could only buy Treasuries. If it injected any liquidity in to the financial markets, it was limited to reserve bank credit. Nowadays, it can give generous cash gifts to investment banks, mortgage lenders, money market funds, consumer finance companies and any other financial company it feels like bailing out.

In essence the Federal Reserve has turned into a hedge fund. It still owns some Treasuries and gold, but a lot of its assets now include agency debt, repurchase agreements from various financial companies, pieces of Bear Sterns and AIG debt, and foreign currency paper. Pretty soon, it’ll include actual mortgages and consumer debt! After all, the American consumers are the only group that hasn’t been explicitly bailed out yet.

According to newsletter writer Ed Bugos, people will stop eventually believing Bernanke’s rhetoric of deflation. Massive reinflation efforts are under way and eventually gold prices will start to reflect this. My stock portfolio which is heavily weighted towards Gold and Energy Stocks has gotten massacred in the past 10 days.

So do I bail or do I maintain the conviction that printing money hand over fist leads to inflation and an increase in gold prices? For the time being, I’m going to maintain the status quo, but given that we’ve seen the worst trading week since 1931, its getting tough to stick to one’s beliefs.

Wasn’t it Milton Friedman who said “The markets can remain irrational longer than you can remain solvent“?

Well the $700 billion bailout plan was defeated. Wall Street didn’t like it and the market dropped a jaw-dropping 777 points. Was the bailout that vital to the health of the US economy?

Jim Rogers didn’t think so. Here’s a news report from the 25th of September ago:

Treasury Secretary Henry Paulson’s proposed bailout plan is “astonishing, devastating, and very harmful for America,” internationally-known investor Jim Rogers told The New York Sun.

Rogers says the current monetary climate in Washington reminds him of when then-Fed Chair Arthur Burns refused to let anyone fail.

Rogers insists Washington is making the same mistake again.

“We’re in for the worst recession since World War II, as well as higher long-term interest rates, higher inflation, higher taxes, a weaker dollar, and substantially lower stock prices,” Rogers says.

Even worse, Rogers believes it’s “embarrassing to see how little the presidential candidates know or grasp what’s going on, just like the current administration.”

But what about the almost 779-point boost in the Dow Jones Industrial Average that lasted for two days? “It’s only a matter of time before reality sets in and the market heads down again,” Rogers says.

“I wouldn’t buy now because it’s insane,” says Rogers, who believes investors “were foolishly sucked in by hysteria and a buying panic.”

Rogers, who bought dollars a couple of months ago, now thinks the greenback rally may have come to an end. He’s now buying more Chinese shares.

I’ve been insanely busy with college so I wasn’t even sure how the dynamic duo of Paulson & Bernanke came up with $700 billion. What were the calculations that led to that number? I couldn’t really find anything about it – most reports were rather vague. And if the risk-analysis departments of banks couldn’t figure out the worth of the toxic assets they owned, how did batman and robin figure them out?

A lot of people believe that printing money and turning on the cheap, easy credit spigot will keep the US from experiencing a 30s-style Depression. I really wonder if that is a likely scenario. It doesn’t seem to be working for Japan (although to be fair, they have cultural differences such as their not letting businesses fail, which is probably distorting their business cycle). Also, if its true that excess liquidity and cheap credit caused much of these problems in the first place, how can the solution be the same as the cause?

Here’s what Ron Paul said on the issue over the weekend:

This is Wall Street in big trouble and sucking in Main Street…and dumping all the bills on Main Street. You can’t solve the problem of inflation, which is the creation of money and credit out of thin air, by creating more money and credit out of thin air…

What they’re doing now, they’re propping up a failed system so the agony lasts longer. They’re doing exactly what we did in the Depression.

Saddling the American Taxpayer with an additional Trillion Dollars of Debt doesn’t seem like a good way of boosting the economy. The way things are going, the national debt is set to increase by a Trillion Dollars per year until 2017, after which it should increase by two Trillion a year!

If you still believe that bailing out foolish and greedy bankers is the right thing to do, check out my comments in  a previous post.  It’s a pretty interesting discussion.

So now that the bailout plan failed, is the US economy doomed? I don’t think so. Here’s an interesting article from the Heritage Foundation which suggests that the government is on a partially correct path regarding the financial markets.

And if you want something that’s even more optimistic about the US economy, I suggest reading Reality Check: The Unreported Good News About America by Dennis Keegan. He’s a hedge fund manager and he actually came and gave a speech to my class last week. While I don’t fully share his gung-ho optimism, he’s worth many millions and I’m not, so that should give you a good idea of whom to listen too! But he did say that chaos brings opportunities and people still make money in bad times, which I fully agree with.

And finally, Citi announced that it would be buying Wachovia. Isn’t that kind of strange considering that Wachovia was thinking of buying Morgan Stanley a week or two ago!