Archive for the ‘Economics’ Category

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

With those words, John Maynard Keynes–the inventor of the “prime the pump,” economic stimulus theory employed by both FDR and Obama–tells you everything you need to know about current U.S. monetary and fiscal policy.  And while he said this as an attack on inflation, it is ironic that his policies have–in some people’s minds–led to high levels of inflation right here in the United States.

American Endgame has already touched upon inflation in fleeting terms.  We have discussed the idea that inflation is the rate at which a particular currency loses its value.  For example, a 2% rate of inflation will leave a dollar with 25% of its buying power after about 75 years.  A 6% rate of inflation will accomplish the same in just over 20.  But one thing we have not discussed is how inflation may be purposely being employed by the U.S. Government–and governments around the world–to both buy this economy more time and to establish a solution to America’s “there’s no way we can pay off our debt” problem.

The mechanics of inflation are fairly straightforward.  Assuming a fixed supply of currency, businesses will accept the fact that there is a finite amount of money to be “earned,” and prices will stabilize around a strategy to maximize a business’ ability to get the largest chunk of that pot as possible.  By way of example, if there were $1,000,000 in the U.S. economy, an intelligent businessman would recognize that there are $1,000,000 in circulation and “up for grabs” among the workers.  Some of these dollars would be given to the workers through paychecks, while others would be made available through bank loans, credit card borrowing, etc.  This intelligent businessman would also recognize that, on average, each American has access to $1,000,000/x, with x being the number of workers in the country (this is dramatically simplified, but bear with me).  After factoring how much of that money must go to basics needed to survive, a businessman makes a calculation of how much they will charge for their good or service to entice workers to spend a portion of their $1,000,000/x dollars on their product to maximize their profit.  Conversely, as a worker with only $1,000,000/x dollars available to spend, one must carefully determine how much they must spend to survive, buying food and clothing, paying rent and utilities, before going out to buy other goods.  Every purchase results from a calculation that goes approximately like this: “I have $1,000,000/x, so I can still afford to buy…”

Now, what would happen if the U.S. Government made arrangements to introduce an extra $1,000,000 into the economy?  This could be done through various methods, including physically creating more currency or by lowering the amount of money banks must hold in reserve, thus allowing them to fractionally lend greater amounts of their deposits.  Either way, let us say that now the U.S. economy consists of $2,000,000, and the amount of money available to workers is $2,000,000/x, on average.  Of course, this increase will come almost entirely from bank lending and credit card borrowing, since no one is going to advocate doubling a worker’s pay in America–not even in our hypothetical scenarios is that anywhere near realistic.  So, now the intelligent businessman recognizes that there are two times as many dollars out there to get his hands on.  In this way, prices would rise in all sectors because people are now “twice as able” to buy the products they’ve been buying all along.  And while the original intent of the government introducing more currency would have been to get people to buy “extra” stuff with their “extra” money, the effect is almost always different: people will end up buying the same stuff at an “extra” cost.  The effect is highly detrimental, and not stimulative at all.

One doesn’t have to be a prize-winning economist to see that this set of circumstances is not only happening today, but very dangerous indeed.  After all, if I make a fixed amount of money, and prices continually rise because more money is available to use, this is highly problematic.  My purchasing power drops continually as my slice of the overall pie continues to dwindle as I sit helpless.  If, in order to keep up, I do what so many Americans do and borrow money from banks or use credit cards to fill the gap, I am doubly in trouble.  How will I ever pay it back on a fixed, finite amount of pay? (I say “fixed” and “finite,” and I use those terms in a relative sense.  A 3% payraise–unimaginable for most of us–is not “fixed,” but might as well be for the purposes of taking on inflation, since the numbers we see suggest inflation is somewhere near 9 or 10%.)  So why does the U.S. Congress and the Federal Reserve continue to make more money available?  Consider the alternative.  Should the Federal Reserve end its policy of introducing more currency into the system on a fairly constant basis–this introduction is easy because U.S. Dollars, as we’ve learned, are fiat and have no real value–people will be forced, finally for the first time in probably 30 years, to live within their means.  “Living within their means” scares the Hell out of Congress.  Without more money always being introduced into the system, the United States would experience a highly deflationary event.  Americans would quickly begin to conserve and spend far more preciously the currency they possess in order to survive.  Without additional availability of credit, we would see money spent on food, utilities, gasoline to get to and from work, clothing, and other basics.  Goodbye, Channels 2-300…  Goodbye, trips to the movies for a family of four…  Goodbye new cars that can’t be paid for from savings…  You get the picture.  While the uber-rich would probably be fine, the 99% would vastly reduce their spending, and this would cause a massive collapse of the United States’ economy for want of customers.  Layoffs would ensue, and a deflationary spiral–where prices would fall to keep up with spending habits, which would lead to layoffs, which would lead to businesses shuttering, which would lead to catastrophe–would be almost certain.

There are some who dare suggest that this type of event is inevitable and necessary to fix the problem we’ve created by allowing too much debt to accumulate in the system.  After all, $55 trillion is a lot of debt, and like any massive debt, it will save a lot of money in the long-term were it paid down or paid off.  The devil is in the interim.  The contraction of such an overinflated economy would most likely feel like something between the Great Depression and the Dark Ages.  And as we’ve seen this year in Greece, when the government reduces its spending–ending favored social programs, reducing benefits, lowering minimum wages, and potentially increasing taxes–ain’t nobody gonna be happy.  The problem then becomes not only an economic problem, but a major social problem and a political problem.  And Congress and the White House don’t have the stomach for an American Spring, which is what they would be looking at if they make the necessary changes.

I am of the mind that we are definitely going to experience this “something between the Great Depression and the Dark Ages” event–you could probably tell by the title of this blog.  The question is not whether a major credit crisis will occur.  The questions are “when will it occur,” “how do we mitigate the impact on our society,” and “what do we owe to our progeny?”  If our generation could shoot for the Great Depression–an event which we survived–and take that on, it would be a great contribution to our nation’s future.  This would be far better than the Dark Ages scenario.  However, we grew up in a society so focused on material gain, selfish behavior, and instant gratification, that we may not have the mental fortitude to take this on.  The alternatives are dire.

One way or another, this event is unavoidable unless we make changes to our spending now.  The selfish path leads to our annihilation.  The selfless path–where Medicare, Social Security, low taxes, and military omnipresence are sacrificed–may get us out of this mess in the next 50 or 60 years.  I am simply not yet convinced we as a people have the foresight and strength to recognize the need for these changes and make them.  Even if our Congress sees the need and tries to save us from ourselves, we will probably “unelect” them or riot in the streets.  Either way, the outcomes will most likely be the same and we’ll have an interesting lifetime to look forward to.

~ DS

“If enough bondholders do not accept the bond swap offer, Greece would be deemed to be in outright payment default”

~ Standard & Poor’s Rating Agency

Anyone out there shocked to find that no Greek bailout has taken place yet?  Anyone flabbergasted that zero dollars have flowed into Greek coffers?  Well, if you are, you haven’t done your homework.  After all, several sources, including our friends at ZeroHedge and The Slog, as well as this very site, have stated in recent weeks that no “deal” is done until money flows from the ECB to Greece.  Thus far, nothing of the sort has taken place.  And while several people were laughing at us last week when the European leadership notified the world that a deal had been agreed to, and yesterday when the Bundestag agreed to send German tax dollars to Greece, this morning we wake up to read that Greece is on the verge of default as noted by the Standard & Poor’s rating agency, one of the three organizations who are paid by the issuers of bonds to rate a debtor’s creditworthiness.  In other words, people paid by Greece to rate Greece’s credit say they are incredibly close to defaulting on their debt.  Enjoy this statement, as reported by Tyler at ZeroHedge this morning:

Greece Ratings Lowered To ‘SD’ (Selective Default)

Rating Action

On Feb. 27, 2012, Standard & Poor’s Ratings Services lowered its ‘CC’  long-term and ‘C’ short-term sovereign credit ratings on the Hellenic Republic  (Greece) to ‘SD’ (selective default).

Our recovery rating of ‘4’ on Greece’s foreign-currency issue ratings is  unchanged. Our country transfer and convertibility (T&C) assessment for  Greece, as for all other eurozone members, remains ‘AAA’.

Rationale

We lowered our sovereign credit ratings on Greece to ‘SD’ following the Greek government’s retroactive insertion of collective action clauses (CACs) in the documentation of certain series of its sovereign debt on Feb. 23, 2012. The effect of a CAC is to bind all bondholders of a particular series to amended bond payment terms in the event that a predefined quorum of creditors has agreed to do so. In our opinion, Greece’s retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what we consider to be a distressed debt restructuring. Under our criteria, either condition is grounds for us to lower our sovereign credit rating on Greece to ‘SD’ and our ratings on the affected debt issues to ‘D’.

What does all this jargon mean?  Simple.  Because Greece has retroactively and unilaterally created new conditions for when and how they will pay back their creditors to their own advantage, making it easier for Greece to force a larger “haircut” onto its lenders, (ZeroHedge and others have done a good job of covering this, and perhaps we can revisit this topic in another post) S&P is stating that it is within its right by its own definition to find Greece is in a state of default.  After all, what is a default but a failure to repay a loan based on the original conditions of said loan?  In essence, S&P is stating that Greece is already in default.  The term “selective” seems to be applied here to indicate that the default is of Greece’s own making, which may be used as a way to avoid triggering Credit Default Swaps.  This is absolutely another conversation for another time.

Let it suffice to say today that we are in uncharted territory here.  The Slog has treated this topic today with the article “When Will Enough Be Enough for the Credit Agencies?” and ZeroHedge has their article here.  As it turns out, March 23 is closer now than it was last time we covered Greece, no money has made its way to the Bailout Fund, and with news like this being circulated in the U.S., what are the odds that Europeans (read Germans) are going to want to chase a nation already in technical default with their own taxes?

He who laughs last laughs best, but will any of us be laughing when Greece goes under?  Three more weeks until we find out…

~ DS

Today is a busy day at the Smith homestead, so this might be a brief piece, but will cover an important topic we will definitely be hearing more about in the weeks and months ahead.  We can’t go too far down this rabbit hole without touching on precious metals, primarily gold and silver.  Some of you probably know a ton about this–even more than me.  Others may have no idea about the wealth-preserving nature of these metals.  It is this second group that I’m hoping to reach with this post.  Enjoy…

One of the things we learned in a previous post discussing the nature of money creation (please see “How The Federal Reserve Creates $$ Out of Thin Air”), and one thing we know from Chris Martenson and his Crash Course video series, is that the process by which any government or central bank can create money is relatively simple.  In fact, it doesn’t even take an act of Congress any more…  Through a process the Federal Reserve likes to call “Quantitative Easing,” or QE, the Fed essentially creates more Dollars electronically (they don’t physically print more money these days–that’s so Weimar Republic!) by buying financial assets from banks on paper and paying the banks in Dollars as part of this quid pro quo.  Usually, the swap involves the Fed buying long-term maturity paper of some kind in exchange for cash.  This only makes sense when the Fed’s interest rate (the price it charges for banks to borrow money) is near zero, which it is right now.  In any event, the Federal Reserve has already employed this technique multiple times, and with predictable outcomes.  For a time the economy is stimulated, but eventually prices rise and inflation ensues.  The Fed knows this happens, and understands that really all they’re doing is making things worse in the long run, but they almost certainly see themselves as having no choice.  Its a choice, using a poor medical analogy, between taking years off the end of the patient’s life or having them die right there on the operating table at that moment.  Hence, Quantitative Easing.

The only problem with QE is that it leads to your Dollars being worth less.  The simplest way to explain this is to say that if there were twice as many Dollars in the world, each Dollar would be half as scarce, or half as precious.  People, therefore, have to work half as hard to get ahold of one Dollar, making every Dollar half as valuable.  This is a major oversimplification, but it will do for now.  In any event, therein lies the major issue with fiat currency, as we discussed in previous posts: when your money has no actual intrinsic value–when your money is linen and fiber–its value is subject to an increase in the supply, which, as we stated above, is very simple to achieve.  That is precisely why the Federal Reserve and the U.S. Government use such currency as their tender.  It is easily manipulated.

Where do the precious metals come in?  Gold and silver are the two main precious metals that people deal in, although platinum is also somewhat common.  These metals are also a form of currency.  They, in fact, better meet the traditional definition of a currency than the USD: a true currency must have intrinsic value, must be scarce enough to maintain its value, and must be easily transferable as part of a currency transaction.  So, depending on what form you hold your precious metals in, the “easily transferable” part might be difficult.  I’d personally feel awkward trying to buy a mansion with a 100 kilo brick of gold bullion.  Of course, these metals come in all sizes and denominations.  In any event, the first two criteria are met by PMs head on.  There is almost always more demand for gold and silver than there is production, and this kind of production can’t happen at a printing press or a bank of computers.  The intrinsic value of gold or silver is really a discussion for a philosophy class, but silver itself has significant industrial uses and is, I would argue, intrinsically valuable for its uses as a part of manufacturing.

These metals are Kryptonite to the Fed’s QE plans.  Think about it this way:  If you buy an ounce of gold today for $1700, and tomorrow the Federal Reserve created–out of thin air–another $1 trillion in currency, and massive inflation ensued as it usually does, and the price of gold rose as a result of this inflation to $2000 an ounce, you just made money.  Of course, you must be careful (DON’T MAKE ANY PURCHASES OF ANY PRECIOUS METALS ON MY ADVICE–I AM FAR FROM AN EXPERT ON PRECIOUS METALS–I SPEAK FROM MY HEART AND SPEAK THE TRUTH AS BEST AS I CAN, BUT I AM NOT A FINANCIAL ADVISOR) because today there are paper precious metal exchange mechanisms called ETFs, which trade the “paper” value of gold or silver like stocks or mutual funds, and the price is subject to wild fluctuations in the short term.  To be clear, the wealth-preserving properties I am discussing relative to precious metals only apply to actual physical gold and silver, not gold or silver funds that you buy on E-Trade.  So, your $1700 today might become $1400 tomorrow.  But, over time, as more Dollars are printed, the physical asset you bought in the past is worth more and more Dollars, in theory. Its something that most people use, not as a way to get rich–although some people who figured this out 30 years ago are swimming in it now–but as a way to preserve your wealth in an era when savings accounts yield something like 0.25% and stocks against inflation often lose money.  Hell, governments are now charging investors to loan them money in some countries.  With PMs, you have a means of protecting and preserving your assets if and when (hyper)inflation ramps up.

That’s enough for today.  We’ll get WAY more into this topic in future posts, but for now, knock yourselves out doing research on this stuff.  There are dozens and dozens of websites out there that talk PMs, but I would start at TF Metals Report or Silver Doctors.  In the meantime, enjoy your Monday.  Silver and gold are already doing battle this morning, and if this is the first week you ever get into following this stuff, you picked a wild one–should be fun.

Peace out girl scout.

~ DS

“There are few problems which have greater potential to quickly unsettle the North American public and strain essential services than suddenly being denied access to fuel.” ~ Rick Munroe

Imagine, if you can, that there is a resource everyone likes to use.  They like to use it for convenience: it lets them go places, have neat things, eat the foods they want no matter what time of year it is…  And imagine this item was in total abundance, as if the world might never run out of it.  Imagine how fast people would use this resource…  Probably as fast as they possibly could, right?  And imagine it was really easy to access it, and that in certain parts of the world you could simply drill a hole in the ground and this resource would flow right to you.  Life would be fantastic!

Now imagine, if you can, that this resource begins to become scarce.  Imagine that the world could not discover any new supplies of this resource, nor could they produce it any faster.  Imagine this was because the “easy” supplies had already been used, and now the more difficult to reach supplies were economically disadvantageous to access…  What would happen to the supply of this resource?  It would dwindle.  And what would happen to all the items that were made from it?  They would rise in price.  And what would happen if the resource became so scarce that not everyone could have it?  How would people react?  Would they adapt and move on with their lives?  Would they go to war to protect their resource?  Would there be civil unrest when people couldn’t afford the resource or have the things they wanted?

While those questions may seem difficult to answer in the abstract, we are currently being treated to a real-life experiment along these very lines.  That is because such a resource exists today in the form of oil, and we are watching the world decide what to do about the reality that less oil is available for more of us every day.  The concept of “peak oil”–that the world is now beyond the peak of oil discovery and production–is one that few of us have been treated to, but is probably the most important economic and geopolitical problem facing us in 2012.

Once again, we will turn to Chris Martenson and his Crash Course video series.  This is where the concept was explained to me, and if you want to get it, no one explains it better.  This is Chapter 17a (yes, there a lot of chapters) on Peak Oil:

If you weren’t able to watch the whole 18 minutes at once, I understand.  Please come back to it–this is a really powerful concept.

For those of you who want the down-and-dirty version, here goes:

  1.  Global oil discoveries peaked about 40 years ago.  Since then, no major new high-energy oil or oil-based sources have been discovered (I know, I know, tar sands–those are in the low-energy-return category).
  2. Global oil production peaked within the last few years.  We now produce less oil every year than the year before for the first time since oil was discovered in the 1850s.
  3. Global oil demand continues to climb every year.  Countries like China and India are witnessing massive oil demand as their middle classes grow and the desire for gasoline powered vehicles and creature comforts like electronics, CDs, etc., increases.  Also, energy demand for electrified homes and heat is continuing to climb.
  4. Nations who were recently exporters of oil are also seeing increased domestic demand for oil, and are quickly becoming net importers of energy.  This concept is REALLY important.  For example, Mexico, the U.S.’ third largest oil supplier, is about to begin importing oil to meet its own energy demands.  When that happens, the United States will lose its third-largest oil supplier and then begin competing with Mexico for the dwindling global oil supply.
  5. The sources of oil and oil-based energy we continue to use (including tar sands) cost more to produce and offer less energy per unit.  In other words, we have already extracted and used the cheap, high-energy stuff.  We are now using the expensive, low-energy stuff.
  6. All this to say that between lower supply, higher demand, more nations competing for less oil, and higher production cost per energy unit produced, the cost of oil-based energy (and every other form of energy when you consider that less oil means greater demand for every other way we make energy, including solar, wind, water, LNG, coal, etc.) is going to continue to climb, probably exponentially.

So what?  This is problematic on two levels.  The first level is very obvious.  More of my paycheck going to heat my home and get to work, not to mention buy my groceries (which are shipped by truck) and clothes (ditto), is going to push America’s fragile economy to the brink of Depression (in my opinion, we’re already there, but that’s another post).  What good is a payroll tax cut of 2% when energy costs go up 20%?  The second level is far more disturbing.  Consider the massive, exponential growth of every yardstick by which we measure human development: industrial output, standard of living, quality of life, access to technology, access to communication, GDP, etc.  Consider that these rapid advancements have coincided–although it is not coincidental–with the availability of oil.  If you saw a timeline on a chalkboard that covered the last 200 years, and were asked to mark the board with a line signifying when you believed American society was “at its peak,” meaning at its best, its most prosperous, its most balanced and its happiest, where would you mark it?  I would venture to say that many of us, if we are mature and honest enough to handle this exercise appropriately, would look at the period of the late 1950s to early 1960s and say, “oh yeah, those were the good years.”  And I would agree with you.  If you feel that way, consider how little stood in America’s way during that time.  Sure, we were in the midst of a heightening Cold War, but domestically, the world was our oyster, and development and growth were commonplace and rampant.  And it is my assertion that this period of prosperity was due almost entirely to the abundance and availability of inexpensive, high-yield oil-based energy products.  When there is a ton of oil, and you can get it for almost nothing, any country can be great.  It is, as Chris says, the lifeblood of a developed economy.  With it, a nation can take on all comers and grow its industrial, commercial, and technological sectors with abandon.

However, without a cheap and abundant supply of oil, I am afraid our nation is headed for difficult times.  Could it really get that bad, and how bad would it be?  That is what Peak Oil is all about.  I’ve thrown the term at you, now you get to go learn more, if you choose.

In another post I hope to explore Zbigniew Brzezinski’s important work, The Grand Chessboard.  This book, written post-Cold War, explained the importance of the United States both a) maintaining control of the Middle East for resource purposes and b) not allowing a “Eurasian challenger” to grow powerful enough to threaten American global hegemony.  I think that is an area where the Peak Oil discussion becomes relevant, and I think combining Brzezinski’s work with a post-peak production would goes a long way to explain why we are about to go to war with Iran.  But that, as I like to say, is for another post.

~ DS