Friday, September 5, 2008

Why Are These Guys So Scared?

I asked a similar question below in Drying the Tinder for the Bonfire of Revolt - a rather dramatic title for some observations that boil down to - why are the "elites" apparently so scared at the moment?

Why are we seeing policy proposal after policy proposal that is stupid, at least from the perspective of rational economics or long-term health for the U.S. What in the hell is going on?

When I say elites, I'll re-emphasize that I don't always mean it as a pejorative. A culture, a society, a nation is only as strong as the political, military, business and academic elites that it nurtures and holds up as its leaders and guides. That's why I get very concerned by the following news items:

...This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time. Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami. Central bankers, of course, adopting the cloak and demeanor of firefighters or perhaps lifeguards, have been hard at work over the past 12 months to contain the damage. And the private market, in its attempt to anticipate a bear market bottom and snap up “bargains,” has been constructive as well. Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for “they are all underwater...” - Bill Gross, Managing Director, PIMCO and all-around stud of the investment world.

Mr. Gross then goes on to say "if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury – not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A."

My first instinct is to wrinkle my brow in confusion. Isn't that exactly what the old USSR was all about? How did that end up for them? Isn't that how we got the housing bubble in the first place - Fannie and Freddie flaming the fires of speculation in vinyl-siding-and-stucco investment vehicles, driving them to higher prices than fundamentals allow, encouraging overbuilding and now resulting in a devastated house market? But he wants more of that?

My second thought is, maybe he really does think we are on the brink of a failure of the entire system and he is panicking for any solution he can find. This is not a dumb guy by any means.

And of course there was the post from earlier in the week mentioning that the super-rich are moving to cash. The are the smart money for a reason...

The "Big Three" U.S. automakers are looking for a huge bailout as well. Well, I guess when you are spending $10 billion a month in Iraq, $50 billion in loan guarantees here at home doesn't look so painful. Assuming the Chinese, Japanese and Koreans keep buying all that juicy Treasury Debt and if you lose two of those three automakers, the follow-on effects to suppliers and other manufacturers would be catastrophic, so instead of taking the pain now, they opt to keep these companies alive, putting too much production out into the market and not allowing the weak to fail (do you hear me, Chrysler LLC?) and make room for Ford and GM to have a chance a survival.

Then there is this story from the New York Times, a paper of the elites if there ever was one, describing how Given a Shovel, Americans Dig Deeper Into Debt. This has got to scare the living hell out of economists all over North America. If the consumer stops being that - a consumer, and goes back to what made this country great - being a producer and a saver, then the current system of finance and every business model from restaurants to nail salons to money management implodes.

The Common Thread

I have two possible theories on what has the elites so spooked. Maybe all this talk of inflation is a smokescreen and what is really going on is credit, and eventually price, deflation. If we get a full-blown credit deflation in the U.S. the debt defaults would litter the country, the tax base would shrivel to nothing and the fractional reserve banking system itself might evaporate into the fraudulent smoke that is its philosophical basis.

Remember, in a fractional reserve banking system, you extend lot's of credit based on a thin layer of capital assets that is held in reserve. Well, maybe it is worse than the media are letting on. Maybe that asset base is evaporating as badly as PIMCO's Gross indicated above. Maybe it is even worse than is being discussed.

When lenders can't lend and, gasp, must even call in existing loans to rebuild the capital base, then the inflationary dynamics we've lived with all of our lives also end. When banks can't lend, the consumer society is dead. The tax base built on sales taxes and property taxes dries up. Life as we know it ends. A new society has to be built up on the ashes. Not something the current power brokers and elites want to contemplate, so I guess they figure if they throw enough money at the problem, it will eventually go away.

Here's hoping they are right, because if they are wrong, we are all hosed.

The other competing theory is that the upper echelons in power know the earth is going to be smashed by an asteroid or something like that in a few years and so they are encouraging one last party to keep us all happy. That's about the only thing I can think of that would explain Vice President Cheney's famous line: "deficits don't matter." These are not dumb people. They know what the debt and deficits will do to the long-term strength of the U.S.

Don't they? I mean, they all took economics, didn't they?

We shall see. I still say October is going to be bad, in my opinion. Get your stuff together my friends and get your head wrapped around the idea that very soon the markets may just correct to reflect the reality being fretted about by the elites.

UPDATE: Gary North reports on some remarkable statements from the U.K.'s Chancellor of the Exchequer Alistair Darling. Another freaked out elite.

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