Posted on 04/26/2011 7:31:29 PM PDT by sickoflibs
Let's go back to the beginning of the current economic crisis — yes, it is still a crisis for many millions of Americans who lost their jobs, ruined their credit, filed for bankruptcy, lost their homes, and lost their lifestyle. Shanty towns have popped up all over America, though rarely gaining media exposure.
Tens of millions have been ripped from the middle class back down into the poverty from whence their parents or grandparents had climbed.
Make no mistake: it is not capitalism that got us here; it is government interventionism and central banking — the Federal Reserve.
The first two charts we're looking at are the S&P 500 Index (top) and the Effective Federal Funds Rate (bottom). Our current economic state of affairs began with the Internet bubble (the red arrow on the first chart), which itself was exasperated by an earlier easing of the federal-funds rate (the green arrow on the second chart).
After the bubble burst in 2000, Alan Greenspan sought to prop up the "irrational exuberance" against which he himself had cautioned, by dropping interest rates — artificially, of course — from 6.5 percent down to barely 1 percent in 2002 (the orange arrow on the second chart).
The whole idea here was to encourage corporate (and private) spending by lowering the cost of borrowing money. This "cost" was thus much lower than it otherwise would have been in a truly free market, where interest rates are set by the supply and demand of money. Today, a free-market interest-rate environment is simply a dream — it's illusory; it doesn't exist. The Fed, rather, simply creates as much supply as it wants, and then hopes foolish risk takers will take the bait. Indeed, millions did.
Enter the housing boom. Maybe you remember the 1 percent LIBOR interest-only adjustable loans? How completely, unrealistically optimistic (or gullible) did you have to be in order to buy into an adjustable-rate mortgage (ARM) when interest rates were at an all-time low?
In any event, the loose-money policy and low interest rates drove the real-estate market to new, all-time highs, with record low unemployment and a false feeling of risk-free risk taking.
Sure enough, inflation hit, the Fed raised rates, those ARMs adjusted upward, people couldn't sell their house for what they owed, and then record foreclosures ensued. All the while, the banks responsible for the bad loans got bailed out by the taxpayer, and the bank executives got to keep their multimillion-dollar bonuses. Hooray.
But that's not the end of it. Once the housing bubble burst, our masters at the Fed (primarily Comrade Bernanke) decided to drop rates to zero and to inflate the money supply beyond all recognition.
The next chart is the Fed's monetary base. Note the vertical movement during and after the Depression of 2008: an increase from around $800 billion to just over $2.4 trillion.
This is the most worrisome chart I have ever seen. By comparison to what Bernanke has done, take a look at the blip (circled in red) that Greenspan caused just after the dot-com bust in early 2000. This is not the kind of comparison that makes it to CNBC or the front page of the Wall Street Journal.
If 1 percent interest rates and that small Greenspan monetary increase back in 2000 caused the boom and ultimate crash of 2008, then what will be the ultimate result of our current extended course of 0 percent interest rates and a 300 percent increase in the monetary base?
There is an answer, but it's not good. To quote Human Action, by Professor Mises, the economist who actually predicted our current plight over 60 years ago,
There is no means of avoiding the final collapse of a boom brought about by credit [or monetary] expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of the further credit expansion, or later as a final and total catastrophe of the currency system involved.
The end result seems fixed; the only question that remains is what happens between now and then.
Even though the federal-funds rate has been at zero, and even though the Fed has created enormous amounts of fiat money, most of that money remains at the banks. Take a look at the chart below.
This chart represents the amount of money our nation's banks keep on deposit with the Federal Reserve. So you see, the newly created money is being held by the banks, who instead of loaning it out to folks who would like to refinance their houses and businesses that might expand and hire (which is what the Fed intended), they (the banks) just redeposit the free money back with the Fed and earn massive amounts of interest.
What? Are you kidding me? The banks got bailed out from billions of dollars in bad loans that they issued, then they got literally $1.2 trillion (as you can see from the chart above) of free money that they then turned around and invested in Treasuries, the interest on which is one of Obama's biggest line-item budget expenses. Are we living in an Ayn Rand novel? How would you like to get free money to invest, the interest on which is guaranteed by the government's taxation authority (and guns)?
And speaking of the budget, the next chart is the second scariest I've ever seen. It shows the federal deficit, which now surpasses $1.4 trillion annually! Note that the chart is denominated in millions.
Unless Congress cuts spending dramatically (which I doubt will happen), the Fed will continue to buy Treasuries to fund our deficit with money that is created out of nothing, just like the Weimar Republic did after World War I. The end result must be a collapse.
Not to throw more fear on the fire, but recently the "Godfather of Bonds," Bill Gross, who manages over $1 trillion, sold every single Treasury his firm owned because, according to a shareholder letter he recently published,
Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies — inflation, currency devaluation and low to negative real interest rates.
I would venture to say it has already begun.
"So what can we do about it? And how does this affect me and my money?" Did I just hear you ask that? Well, good question. Because I don't have the space or the time to go into detail here, suffice it to say that booms and busts are easy to understand and predict if you reject the currently prevalent Keynesian School of economics and look to the Austrian School.
Most people have heard of the "wheelbarrow inflation" of the Weimar Republic in Germany. History has been down this very same road many, many times, and the result is always the same.
Thus, we can learn from the Austrian economists' reasoning — which reflects realism and historical facts, and not flights of academic fancy. Though I run the risk of dramatically oversimplifying the investment method, essentially you want to be more aggressive in a monetary expansion phase and more conservative in a monetary contraction phase. It sounds easy, huh? In reality, it is impossible to time the market to the day or even the month, but our experience in 2000 and 2008 has shown that it is possible to be correct to within a 12- to 18-month period. The key is knowing what signs inevitably show themselves — and taking heed.
As a prime example, one of the chief indicators we monitor in addition to those above is the velocity of money. This can vaguely be analogized to how quickly a dollar moves from one hand to another, but it is much more than that.
Every time you deposit a dollar into your checking or savings account, your bank can then lend that dollar out to ten other people, essentially creating ten more dollars out of your one dollar deposit. This is called the Mandrake mechanism, and it is part of the problem of expanding credit, because your dollar is leveraged ten to one. This exponential expansion of money in the banking system creates vast profits for the banks, but also vast losses when a run ensues. (The true reason the Federal Reserve System was created was to bail out the banks.)
So here's a recap:
1.The Fed has tripled the money supply and reduced interest rates to zero.
2.A stronger economy is trying to get off the ground but can't because all the newly created money is being retained by the banks in reserve.
3.Eventually the banks will start lending again, and the velocity of money will increase.
4.When that occurs, inflation will begin to show signs that even Bernanke can't ignore, and he will respond by raising rates.
5.Eventually, increased velocity, inflation, high oil prices, and interest rates will conspire to crash the market again. And we start the whole thing over again — if we can.
With the tripling of the money supply, cold mathematics would imply that eventually prices will likewise triple — once the new money has made it out into the economy. Thus, $3.50 gas becomes $10.50 gas. Clearly the math is not as easy as that, because really no one (especially Bernanke) can predict what will happen; but if history is any guide, then all of a sudden, $7 gas seems like a deal.
“Where’s the outrage at obama at gas prices?
Seems to me that when Bush was in office that when gas made a little blip up, the MSM was screaming bloody murder.
Gas is now higher than ever and still going up and what do we hear?
crickets........”
Democrats have previously established that the price of gasoline is the responsibility of the sitting president - so I have “a right” to complain about it. Loudly.
This is in the heart of Dupage County, IL, among the most affluent in the country. The headline was a front page banner in the print edition this morning ... well yesterday morning, 4/26.
It won't have to get to $7/gal to kill his re-election. $6/gal would do it. At that price, trucking would come to a screeching halt, literally. Then, the crap would truly hit the fan...
the infowarrior
$3.50 gas becomes $10.50 gas.
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I’d be willing to see that happen if it would get Barack Hussein Obama out of the White House.
I'd be willing to see it happen if it puts Obama on trial for the crimes he's commmitted as President, and puts a supermajority of Conservative Republicans in all 3 branches of government.
On the Stimulus and economy Boehner did exactly the right thing, he went on show after show for two years 2009-2010 and repeated :”The American people want to know, Where are the jobs?” over and over. It was simple and obvious and to the point. Republicans are not doing as good a job at that this year. They havent come up with something similarly simple and to the point to repeat for gas prices(How hard can that be???). .
On the other side Democrats have a series of poll tested talking points they repeat over and over on the talk shows and congressional Republicans sound unprepared to respond to them when asked on camera. I saw this again at another Ryan WI town hall meeting yesterday , audience members one by one hit him with pre-scripted poll tested Democrat political positions like :"Pay for my medicare by taking away big oil tax cuts".
I have come to the opinion that in politics the caving(compromising) is just the formality, the actual loss is not being able to keep control of the message. To win requires anticipating the other sides talking points and responding with specific poll tested responses.
There are radio talk show host that will tell you that we win if congressional Republicans do what they say is right(ram something through) , even if public opinion is 3 to 1 against it. But that is equivelent to Pelosi-Reid-Obama ramming through Obama-care Spring 2010. Public opinion is still sour on that and they lost the House. (a shame we cant tie that to gas prices.)
What I think is going to happen is that gas will get extortionately high, and then obama will work some *miracle* to drop gas prices significantly in time for the election and get the credit for it somehow. That will convince a whole bunch of idiots who forget that he made this mess to begin with, to vote for him.
I think that's the strategy.
Ironically two Democrats have told me that gas prices will go down before the presidential election claiming they always do. I cant remember why they went down in fall 2004 temporarily but in late 2008 they went down because of world economic collapse, and it didnt help Republicans (until now.)
I find hard to imagine, short another world economic dive like the EU crisis, how oil prices will go down by next year.
The evil one(s) will figure out some way to do it.
I’m convinced that this is all fixed anyway. Oil is not at it’s record high, and yet gas prices are way higher than ever.
If gas followed oil prices, oil should either be through the roof, or gas should be much cheaper.
I wouldn’t put it past Soros to stockpile oil now, jack up the price, and then dump it during the election. Pump-and-dump. Make some money and support the left. That’s Soros.
Interesting thought. That would be a good time to buy if true
I don’t really know. There is a fee for storing oil [even for speculators], but if Soros purchased or leased storage capacity, you would have a good lead. He’d wwant to buy quickly before the price goes up and then sell quickly before the price drops.
That was a very popular argument in 2008 when gas prices went through the roof and consumers were in a tizzy about it. Another one I used to hear was :”I know the station is price gouging because I saw them change the price sign and there was no delivery truck there.” In fact once again Democrats are investigating those prices.
There are a number of things to consider before you accept a simple model like that:
1) Gasoline is not oil, it has to be refined and mixed lots of expensive additives like wasteful ethanol. A worst case example is Iran, they have a flood of oil but gasoline shortages, or 'not a drop to drink'.
2) Gasoline refinement and distribution is completely independent of oil prices. Before ethanol you could pipe gasoline, now it must be trucked long distances.
3) The gas stations will raise their prices to make the most money. That may or may not track their current cost of gasoline and it can include anticipation of future price increases if they are doing good enough business.
4) because of 1-3 any local shortages of gasoline can cause price jumps as happened when ethanol first was mandated, and happens typically before summer.
If a simple rule like the above was valid(gas price=oil price+), we could have a Soviet style centralized economy with Obama setting the prices of gas everyplace.
I appreciate you giving me the opening here :)
They started down a day or two after W started going through the motions of making it easier to produce oil in the Gulf.
Eventually the banks will start lending again, and the velocity of money will increase.With respect, No, they won't. The savings rate is so low because interest rates are low. This came about as a consequence of two things -- first, Greenspan basically blackmailed Congress into bringing the budget into balance; second, rates had been deregulated, ending the era of the 5% passbook rate.
I believe what he is saying, consistent with posts I have done with Shiff, Faber, Rogers and Mises is that as soon as any economic activity or confidence rises inflation will take hold(I doubt houses will inflate soon). He is talking about inflation not a real recovery.
Now what is possible is that inflation, or Feds efforts to stop it, stalls the economy again which avoids hyperinflation but gives us stagflation kind of like now. That was always my theory.
Your comments seem consistent with Austrian theory wrt low savings and capital formation..
” I wouldn’t put it past Soros to stockpile oil now, jack up the price, and then dump it during the election. Pump-and-dump. Make some money and support the left. That’s Soros. “
Very possible, as a matter of fact!
“What I think is going to happen is that gas will get extortionately high, and then obama will work some *miracle* to drop gas prices significantly in time for the election and get the credit for it somehow. That will convince a whole bunch of idiots who forget that he made this mess to begin with, to vote for him.”
I’m not concerned about this; he has been extremely light in the miracle department so far.
As was pointed out to me a couple of years ago, not only do gas stations need to make money on gasoline, they also have to pay for the next tank of gasoline.
It’s all well and good for a gas station to make $.50 per gallon on a tank that cost them $3.00/gal to fill. But, if the next tank costs $3.75/gal, it’s going to be a problem.
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