A Day off from the Liquidation

Gold stocks, and the stock market at large, were up nicely today. I asked Dr. Janice Dorn, the trading doctor, why gold stocks were getting particularly hammered last weeks and she said that there was a lot of forced liquidation from hedge funds. A fair number of hedge funds had taken large positions in gold stocks and as that market dropped, many of them were forced to liquidate. That is the problem with massive amounts of leverage: even if you’ve might the correct long term bets, you can still get washed out in a short-term leg down.

Market Technicians, formerly called chartists, like to study the price movement of charts and make predictions based on how the chart is moving. In his book The Misbehavior of Markets Dr. Benoit Mandelbrot said that markets could not be predicted this way; that market data was chaotic but would seem patterned. Doug Wakefield, of Best Minds Inc, has been in the business for years and feels that Mandelbrot is wrong on that particular point.

No one knows the truth. I can tell you that I got a unsolicited email three weeks ago telling me that it was a great time to buy gold. Then last week I got another unsolicited email from the same service telling me to short gold. As I mentioned in a prior post, I believe that the gold market is intentionally manipulated by the central banks in order to discourage people from owning the stuff. They know that people follow trading methodologies based on what the chart looks like, and they are therefore able to knock the gold market around in order to paint a picture that tells the world to sell.

For me, I think that the market is as Warren Buffet said, “A voting machine in the short run, a weighing machine in the long run.” Gold has a wonderful future ahead of it, and I believe that’s why gold stocks rallied over 10% today. I’m crossing my fingers hoping that today marks the end of the forced liquidation of gold stocks but who knows. I was just happy to see a lot of green in my account today. 

I do know that if world leaders keep making noise about going back to some form of the “Bretton Woods” agreement that gold is going to go crazy. For any country to return to Bretton Woods it would have to acquire a fair amount of coin to back it’s currency, not to mention that value of the dollar would fall significantly as it was displaced as the global reserve currency.

Bailout Question from Bill

Bill, a relative of mine that recently got in touch with me through the internet, has started reading my blog and emailed me this question:

HELLO Preston,

    I just ordered a copy of your book. Reading your blog, I really like
your writing style so I’m sure I will enjoy the book.

    I really don’t know very much about economics, I wish I did. I took a
course in Agriculture Economics in college but about all we talked about was
the commodity market. I have been reading everything I can find here lately
about credit default swaps and collateralized dept obligations — OH MY GOD,
Did anyone think this <stuff> would really work??

    I don’t know very much but I recognize a Ponzi scheme when I see one.
How in the world did they get away with it for this long??

    I think our government does one thing better than anyone else. They
play “don’t look over there, look over here”. Every time something happens
that they don’t want to explain they use all their powers to get us looking
in a different direction. They are blaming this on sub prime loans but it
looks like we were headed like lemmings to a cliff even if the loans had
been good.

    In the 1980’s Ronald Reagan sent the Marines to Lebanon and many of
them were killed in a bombing. I remember a politician talking about the
Marines going before the bombing. He said “if they are sending them to fight
they are not sending enough, if they are sending them to die, they are
sending too many”. That always stuck with me. I seems to me that if they are
spending 700 billion to pay off bad loans they are spending to much, if
they are trying to cover the hedge funds and derivatives they are not
spending near enough. Is there enough?????? 

Bill

Bill asks a good question. Is there enough money to pay for the bailout. As with all things in our modern economy, questions involving money can be a bit confusing. The simple answer is “Yes there is enough money for the bailout” because, as Ben Bernanke has so astutely observed, “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” So, as our illustrious central banker has pointed out, the government can simply run the printing press to generate the needed cash to pay for the bailout. Problem solved. 

Or maybe not. For one thing, $700 billion is a lot of money to pull from thin air. And since it’s a purchase from banks, it would show up to the banks as “high powered money” or money that they could then loan against. In a fractional reserve banking system, $700 billion in high powered money could be loaned out to borrowers who then deposit it back into the banking system in the form of checkbook money which can then be loaned out again. In this way, the money can be pyramided many times over. Using the reserve requirement of 10% as a guide (which I believe is the correct figure for the United States) an injection of $700 billion in high powered money would result in $7 trillion dollars of new money injected into the economy by the time all that lending was done.  As you can figure, $7 trillion is a huge wall of money to hit the economy, and it doesn’t take a genius to see that we would see runaway inflation. 

Now, were the US government to borrow the needed $700 billion, then it wouldn’t show up as high powered money so the immediate impact wouldn’t be quite so inflationary. The question is, of course, who exactly is going to loan us this money, and that’s the question few people seem to be asking. Currently the other nations of the world seem to be fighting their own problems in this economic downturn, and I’m not sure how readily they are going to want to part with $700 billion dollars of new US Government bond issues. I’m predicting that the interest rates needed to attract this kind of cash are going to be higher than the government would like.  Higher interest rates will show up in higher mortgage rates, which will further exacerbate the housing downturn. 

All of this ignores your other question as to whether the $700 billion price tag is realistic. The true answer to that is, as you already suspect, unknowable. As we say with Japan, bailing out banks that have lots of bad debts on their balance sheets tends to transform an painful collapse into a long slow death. I sincerely doubt that the $700 billion dollar price tag will be the last we see of this, but that’s assuming that we ever get that far. Raising this these funds is going to be the real test of whether our economy is allowed to suffer on a bit longer or whether we start to see an implosion of value as the dollar loses values and interest rates escalate. 

Should be interesting. I’d say that the next few months will provide you with all the education in economics that you’re going to need.

European Leaders Speak of Return to Bretton Woods

There is a saying on Wall Street that “markets make opinions.” That means that when markets are trending higher, there is talk about how innovation and technology have made us prosperous as a people; when markets are falling, we talk of how we have lost our competitive edge. It’s similar to Vegas gamblers. When they are winning, they have a system. When they are losing, they are unlucky. 

When the inflationary boom is raging, politics love to talk about how the people deserve this newfound prosperity they are experiencing. When the deflationary contraction comes, we talk of lost virtue. The market becomes a drought in everyone’s mind and the politicians become the priests of the Rain God come to tell us we must repent. So I can’t say I’m particularly surprised to see that British Prime Minister Gordon Brown and European Central Bank President Claude Trichet have recently been calling for a return to the first Bretton Woods agreement. As those of you know who have read my book, Bretton Woods was the agreement reached after World War II whereby the United States would redeem gold at $35 an ounce and the rest of the world would use the US Dollar as their reserve currency. 

Ah, the excesses of paper money. I guess when the wheels come off the wagon, it’s suddenly cool for Trichet to say that, what the world really needs is “”discipline: macroeconomic discipline, monetary discipline, market discipline.” That’s akin to a drunk saying in the midst of his hangover that he really needs to stop drinking. Yes, the world does need monetary discipline, but it does not possess the world power to impose it on itself and the central bankers of the world are happy to oblige it along it’s merry way. Although it is possible that there is more here than just giving a nod to virtue in the aftermath of the credit orgy; it is possible that this may be the early murmuring of an actual move away from the US Dollar and towards a new financial order. As I mentioned in this blog on October 13th, a move away from the Dollar is inevitable at some point, and it’s possible that the European leaders would like to stop the death of 1000 cuts that is propping up the dollar. Perhaps they’d like to be rid of the current system sooner rather than later. 

Wouldn’t it be a coup for the Euro if it became redeemable in gold? That would assure it that it would become the next reserve currency in the world. Such a move would spell the end of the US empire, because we could no longer print the money needed to run it and traditionally the Europeans have wanted the US to be strong as a protection from Russia. But they may see the writing on the wall and figure that the US Dollar is going to collapse anyway and that Russia is not nearly as strong as it once was. Perhaps they are considering a move towards become great powers on their own merits once against rather than merely a protectorate of the United States. 

It certainly would be, as the Chinese curse says, “interesting times” indeed.

How I Took On Chase Credit Card — and Won

Currently, I have two checking accounts and a credit card with Chase. That may not seem all that unusual to you, but it came as a surprise to me since I never actually opened any accounts with them.

I had two checking accounts with Washington Mutual, (WaMu) but they went bankrupt after doggedly pursuing a business model of loaning money to people who couldn’t afford to pay it back. That WaMu went bankrupt came as no surprise. I knew it was in trouble a week before the FDIC. See, I was randomly accosted by a stranger who, when spying the WaMu header of my checking account transactions printout, told me, “you’d better take your money out of there. They’re about to go bankrupt.”

I wasn’t worried about the few thousand dollars I had in the two accounts; It was FDIC-insured, and, if the FDIC couldn’t make good on the money, then all my gold investments would suddenly catapult to being worth far more than the electronic dollars I had lost. That’s the nice thing about gold, it gives you security. Gold ownership is a bit like having children: people that aren’t parents can’t understand the joy of parenthood. Likewise, people who don’t own gold don’t understand the simple security that the yellow metal brings.

Needless to say, I just left my money in there to see what would happen. And sure enough, a week later, I was a JPMorgan Chase customer.

Now, the credit card situation was a bit different. I signed up for a Quicken credit card under the mistaken notion that it would somehow simplify my bookkeeping; but, I never mastered how to download the transactions, and eventually stopped using the service altogether. The credit card was issued through Citibank who, back in ’05, made me an offer to loan me money at a locked-in interest rate of 2.99% for the life of the loan as long as I stayed current. At the time, I had a student loan balance of just under $10K from my college days at Southern Methodist University and was paying 8.5% on that. Seemed like a good move to me, so I paid off the balance with a balance transfer check and signed up for automatic deductions from my then WaMu account so I’d never be late. It seemed like a win-win. I got a loan at a rate below inflation and Citigroup immediately bundled up my loan and sold it to investors through Smith-Barney.

Everyone was happy. That was, until Citibank sold the Quicken card to Chase, which immediately discontinued the automatic deductions. I wasn’t paying any attention to the mail I was getting from them because they regularly flood my mailbox with marketing material anyway — often deceptively tagged to look like I had an account with them.

So, you can imagine my surprise in suddenly discovering that, not only did I not have an account with Citibank anymore, but I now had an account with Chase — AND they’ve declared it past due, thus immediately moving my balance up to close to 20% or so, after tacking on a $39 fee

I immediately called Chase and asked them to reset the account to its condition prior to their taking it over. After all, how could they penalize me for not keeping up on an account I didn’t even know I had? Despite what I felt was a strong argument, I got absolutely nowhere. They refused to budge; even refused to refund the $39 late charge. I asked to speak to management. Got someone who told me the same thing. So, I informed her that if this was the official position of Chase that I would take them to court. She would have none of it.

Oh, well. If it was litigation they wanted …

I filed suit in the local small claims court: total cost, including mail service, was $32, and for my $32’s worth of effort, I got everything I asked for and more. My settlement agreement with Chase does not allow me to put the specifics, but I was very pleased with the result. Incidentally, I also have a foolproof section of getting credit cards to refund those pesky $39 late fees that doesn’t involve litigation in my book in anyone is interested. 

I do, however, want to recount here the details of how I did it, in case anyone out there in cyberspace needed the advice on what to do if this kind of thing happens to you.

Now, I know the perception of taking on a large bank is intimidating. I recently learned a story of a friend who had lost $1K out of his checking account (also with WaMu) due to fraud that was in no way his fault. The bank took the position that it was his problem; he decided to just eat the $1K, figuring that there was no way a small individual could fight a mammoth institution like WaMu.

But that’s where he’s wrong.

This is one of the weird places where the small individual has a large advantage over a corporation, and I’m hoping that more people might realize that by reading this story.

Okay. The first step towards bringing suit against a large corporation is to find out their exact legal name. This can be tricky, because there’s no one “Chase Credit Card, Inc.” to go after. Instead, modern institutions are broken up into bunches of smaller, related corporations, so, the first clue is to look at your statement and check for the institution’s name and state where they’re incorporated. Chase was a Delaware Corporation. With that information, I was able to go to the Secretary of State of Delaware’s website. (Insert the name Chase and there are over 500 entries. I narrowed it down by trying different combinations of Chase and either ‘credit’, ‘card’, or ‘bank’.) I then came up with a couple of corporations titled ‘Chase Credit Card Master Trust’, but, while seeming close to the correct company, were actually separate corporations that took the notes from the credit cards and sold them out as CDO bonds: essentially the same things that happened to mortgages, except with credit cards.

By the way, if you’re wondering what the next shoe to drop is in regards to our banking system, I’ll give you a hint.

What actually cinched the corporate name for me was actually the customer service operator for Chase. I called in and told her that I was intent on suing her employer and that I needed to know what the corporate name was. She told me that it was “Chase Credit Card Services”. I searched the State of Delaware’s database for that name, and came up with “Chase Bankcard Services Inc.” It wasn’t exactly the name the operator gave me, but it was close enough.

I took down the address which, for those of you in the audience looking to sue their Chase credit card, is:

The Corporate Trust Company
Corporation Trust Center
1209 Orange Street
Wilmington, DE 19801

Note: This is not the actual address for Chase, but rather for the company that they have established as their “agent”- meaning that they’re there for the express purpose of being served for lawsuits.

Next, I had to file the claim.

Small claims are filed at the local Justice of the Peace Court (called JP courts by those in the legal profession). I turned to Google and found the closet JP court, went down and filled out the forms. As previously mentioned, it cost a total of $32. Including the cost of sending the suit certified mail.

About three weeks later, I got a call from a Dallas attorney who had been appointed to represent Chase in my suit against them. There is a natural inclination towards antipathy on the part of many people who are now talking to an attorney who had technically been hired to take the other side, but that’s not my style. My ex-wife was an attorney and I knew that she didn’t particularly agree with the clients she represented, so instead of being spiteful, I was instead very cheerful with her. As fate would have it, she had not yet passed the bar, and couldn’t even represent Chase when the case came to trial. Believe it or not, I actually think I had more litigation experience than she did.

Long story short, I represented my case in a very reasonable tone and emailed her what my terms were to settle the case. She said she’d get back to me after speaking to her client. Well, she got back to me today — and told me that Chase had agreed to settle the case for terms even more generous than I had asked for in writing — which felt good.

Now, if I could just get my gold stocks to go up, my financial life would be in order.

Strange Days in the Gold Market

The Dow and NASDAQ were both down some 7-8% respectively. Today, they’re up roughly 5%.

As I mentioned previously, volatility begets volatility.

One of the most curious developments lately has to be the market for gold and gold mining stocks. The demand for gold bullion’s gone through the roof in the past couple of months as the financial system has fallen apart — so much so, that bullion dealers are simply out of stock on most coins. German bullion dealers have stopped taking orders because they’re so swamped and have no product to offer. The US Mint itself has suspended production on the Gold Eagle and Buffalo coins; they simply can’t get the gold on the open market at a cheap enough price to profitably make the coins at the prices for which they’re currently offered.

Which just begs the question: why doesn’t the US Mint just raise the price on the coins?

I’ve discovered that this is a rabbit hole question — the more you study it, the more questions you come up with. When you finally do manage to piece together an answer that makes sense, you’ve arrived at the conclusion you’re looking at the result of some kind of conspiracy.

Now, I realize that conspiracy theories regarding gold are the stock of Libertarians everywhere — not to mention, the kind of thing that makes traditional people regard us as freaks. But — I’ve come to believe that that is exactly what’s going on.

Here are the facts that are difficult to explain without invoking some form of conspiracy:

  • WHY … has the US MInt suspended the sale of gold coins rather than just raise the prices on the coins they offer?
  • WHY … had the electronic market of gold futures come about with a “spot” price of gold (that’s fallen quite a bit lately — 5.1% today) at a time when gold bullion dealers haven’t been able to keep the stuff in stock?
  • WHY … is Barrick Gold (ticker symbol: ABX), one of the world’s largest gold miners with a solid balance sheet, a good pipeline of new mining projects, and more production coming online next year, trading at a Price-to-Earnings ratio of 11.5 today — down over 10% today alone?

What on Earth is going on here?

Well, the COMEX (Commodity Exchange) is the marketplace where futures contracts for gold and silver, and what is traded are paper claims to the metal. Very little actual metal is delivered in all of this paper trading of gold and silver on the COMEX exchange.

In days of old, a large portion of the paper claims to gold and silver were ultimately backed by “forward selling” based upon mining operations. In other words, there were paper claims floating around to gold and silver that were backed by nothing more than the promise of a mining operation to deliver it at some point in the future. That makes some sense, but given that some mining operations were selling up to 10 years in the future, it’s not hard to see how this could be used to create the illusion of an abundance of gold when the actual precious metals themselves are quite rare.

Consider the recently settled lawsuit brought against Morgan Stanley.

Morgan Stanley was charging clients a service to store physical silver in their vault for them. The problem was, there was no actual silver ever stored. Eventually, the clients caught on and sued them for fraud.

Their defense? That it was merely carrying out “industry standard” practice.

Since the paper claims to gold and silver are for precious metals that are supposed to be stored in bank vaults, Morgan Stanley has since let us know that it’s the banking industry’s “standard practice” to claim they have gold and silver that they actually don’t. Is it such a far fetched idea that the COMEX paper market has attempted to “create” gold out of paper by inflating more physical claims to paper than actually exist? If the COMEX spot prices for gold and silver are truly representative of the actual demands for the physical metal, then why can’t the US Mint buy the gold it needs to fill its orders? Instead, since bullion dealers have stopped taking orders, Ebay has become the main exchange for gold and silver coins — which are trading at far higher prices the COMEX says it should.

This situation represents a vast fraud perpetrated against global investors seeking to protect their wealth against inflation. The Morgan Stanley lawsuit in particular shows how callously “industry standard” practice treats its clients. The fiat money game is all about how the banking industry can pervert the free market system and siphon off wealth to themselves. Apparently, out and out fraud is not against their interpretation of the rules, and that just goes to show you, as far as they’re concerned, this is war — a war they certainly fight aggressively.

Dr. James Conrad wrote regarding this issue:

“At any rate, you initially issue a lot of claims to fake metal, and so many futures contracts are written, in a very short time period, that they flood the market on exchanges like COMEX and the London Metals Exchange, where almost all the transactions are on paper, and real metal rarely changes hands.  Meanwhile, if you are the big bullion bank, you know what you are doing.  You issue just enough subsidized precious metal paper to automatically trigger stop-loss orders.  The price starts going down as the sell orders are filled.  That triggers yet more stop-loss orders, and the process becomes one of dominos, falling one after another, until the price collapses.  If the operation is successful, and the collapse is big enough, market confidence is destroyed, on a wide scale.”

I believe that we are clearly witnessing yet another attempt to destroy confidence in gold and silver as a hedge against inflation.

Further evidence for this: as discussed in the video of the Gold Antitrust’s Gold Rush 21: A Historic Gold Conference Exposing the Manipulation of the Gold Market, the gold market has declined at many times of high political tension, such as when Iraq invaded Kuwait.

Why would the price of gold decline when you would expect people to increasingly demand it except that the banks of the world flood the market with false paper claims in order to drive the price down to discourage people from looking at precious metals as a safe haven at all? The financial market is falling apart and the price of gold fell 5% today. Yet, there’s not enough physical gold to go around?

Beware, dear reader. Something is very rotten in the state of Denmark.

Paul Krugman Gets a Funny Kind of Prize

For those of you who don’t know, Paul Krugman, Economics Professor and NY Times columnist, has recently been named recipient of the 2008 The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. This blog may be one of the only places you see it expressed in this fashion because most media outlets just say he got the “Nobel Memorial Prize in Economic Science” or, even more simply, the “Nobel Prize in Economics.” There’s only one problem with this, and that is that there simply is no Nobel Prize in Economics. 

Alfred Nobel was the chemist who invented dynamite and made a fortune manufacturing explosives. One day he was reading the paper and came across his own obituary. It was sobering for him to read that the major work of his life was viewed as a “merchant of death” and this motivated him to want to improve his name and legacy. So his will set up for annual prizes to be awarded for significant achievements in five fields: Medicine, Chemistry, Physics, Literature, and Peace. The first group of prizes were given in 1901. Economics was not among them. 

Then the central Bank of Sweden in 1968 decided to donate money and give away it’s own prize “in memory of Alfred Nobel.” It is not a nobel prize, and that’s according to the Nobel Foundation itself. But people call it that, and that’s because the Bank of Sweden wanted to cash in on the prestige of the Nobel name. It’s a bit like me giving out a prize for best blogger “in memory of Alfred Nobel”. It’d be interesting to see if we could get the press to pick up on it and start saying “this years Nobel prize for blogging was awarded to…”. You have to give it to Economists, they understand the importance of controlling people’s perceptions more than anyone else. It is rather fitting then that their prize is only prestigious because they did such an excellent job confusing people into thinking of it as a Nobel Prize, given that one of the main contributions of the “science” has been confusing people into thinking that fiat money has intrinsic value or that inflation adjusted “real earnings” per hour worked are only down 2.5% from a year ago. As I discuss in my book, the whole “science” boils down to little more than conjecture expressed in mathematics too sophisticated for the majority of people to understand.

So what is it that Dr. Krugman won the prize for? He came up with a theory that industrialized nations tend to trade a lot of the same goods back and forth. No, I’m not joking. You can read the NY Times story for yourself if you don’t believe me. Krugman came up with a theory that corporations develop in different countries that specialize in slightly different versions of the same goods and that different consumers in different countries will develop a preference for some of those particular variations. Therefore, international trade will show a lot of nations shipping similar stuff back and forth; the article gives the examples of Fords and Volkswagens being shipped across the Atlantic.

Wow. Well I suppose congratulations to Dr. Krugman are in order. The Nobel may be phony, but the prize money is real. And his theory has clear application… but I’m not quite sure how or to what. The theory that he was correcting was David Ricardo’s defense of free trade which supposed that nation’s would specialize in goods where they had a competitive advantage. That we did not necessarily see this represented in the flow of goods (e.g. Japan doesn’t make all the world’s cars) was to me not as important as whether rich nations, where capital has been invested in plants and technologies, should trade with poor nations which have only cheap labor to offer. Ricardo demonstrated through math than any 8th grader could do that allowing free trade between these nations would be beneficial to both countries because the high labor cost goods would start to be made where the labor was cheaper and vice versa (which we do still observe today). That Mr. Krugman has instead theorized that industrialized nations trade a lot of the same goods back and forth does not even seem relevant to me. So I suppose it’s good for him I wasn’t on the selection committee. 

So we have a committee set up for a central bank that set up this “prize” more or less as a public relations exercise. Presumably they figured that if “Nobel Prizes” were awarded then people would think it was a real science, and they probably aren’t wrong. I remember when A Beautiful Mind came out, I don’t remember encountering anyone who did not feel that John Nash had not been awarded a genuine Nobel Prize. You would expect that the winners of this “prize” tend towards being people who favor theories which feature strong central banks, for instance, and that is exactly what we have with Krugman. To quote Dan Klein’s review of all the columns that Krugman has written, “Krugman has almost never come out against extant government interventions, even ones that expert economists seem to agree are bad, and especially so for the poor.” 

Let’s call this ridiculous prize what it is, a sham. Alfred Nobel did not establish this prize, the central Bank of Sweden did. And it has given awards to Economists such as Merton and Scholes for their theory on options pricing that is widely viewed as producing option prices that don’t work. As if to prove their critics point for them, Mr. Scholes has gone on to lose a spectacular amount of money with it with the meltdown of Long Term Capital Management, which you can read all about in Roger Lowenstein’s book When Genius Failed. 

Economics is a graveyard of failed theories that are still paraded about as validated truths. Keynesian Economics has been dogmatically followed by both the United States and Japan in efforts to get out of depressions, and it has failed spectacularly. Yet we still see Keynesian theory and the government intervention it (and Dr. Krugman) recommend as the savior that we now need to embrace in the face of our new credit crisis. When we will ever wise up?

Everything I Need to Know I Learned from a Shock Jock

For those of you who don’t know, I listen to some pretty salty radio. Specifically, I listen to both Howard Stern and Bubba the Love Sponge on Sirius Satellite radio and, while I can’t specifically recommend shock radio for everyone, I can say that both shows have, in addition to a lot of material many would find objectionable, a healthy amount of intelligent dialogue. Both shock jocks have gotten increasingly more political over the last handful of years as both were targeted by George Bush’s FCC chairman Michael Powell with the largest fines in radio history. Having both found their home on sensor free satellite radio, they now both routinely comment on the absurdity of the “War on Terror” as well as favoring Barrack Obama in the Presidential race.

Having been so financially touched by the latest administration, politics has become personal issue for them. I find the politics of the Bubba show particularly interesting as he is not a traditional Democrat but rather someone like myself who has developed a Democratic sympathy out of utter dislike for the policies of the Republican party. Yesterday on the Bubba show, the topic of the housing crisis came up. Specifically they were discussing John McCain’s recent proposal that the government simply buy up all of the troubled mortgage’s and have the government renegotiate better terms with the home owners so as to keep everyone in their homes. Brent, the producer, pointed out that he had reread Ron Paul’s A Foreign Policy of Freedom and that the book had predicted both the housing crisis as well as the government’s bailout of it. Bubba then went on to say words to the effect that:

If they want to stabilize housing prices here’s what they need to do. Stop all this bailout <stuff> and just lower the price. Eventually, the price will get lower to those of us that have some spare change will go out and buy the house as an investment property and fix it up. Crisis solved.

This reinforced in my mind the utter simplicity of classical economic theory because Bubba, who did not even go to college, was doing a wonderful job as describing the effects of Say’s Law. Jean-Baptist Say (1767-1832) was a French economist who attacked the Mercantilist notion that recessions were caused by a shortage of money. Instead, Say argues that money is merely a medium of exchange and one can not actually buy anything without first supplying something else (i.e. a worker must first supply his labor in order to get its money’s worth to then buy goods) that it is not money that is in short supply but other goods. According to Say, a generalized over-production was simply not possible, while a specific overproduction of one given good certainly was. Thus Say’s solution was to allow the markets of goods and services to find their own clearing price and that that would quickly bring an economy back to stability and further help orient the markets production of goods and services towards what the society actually valued. 

Say’s law was attacked by Keynes who theorized that a generalized over-production was not only possible, but that it would tend to be persistent unless the government took action. It is Keynesian theory that lies behind John McCain’s plan, but Keynesians will quickly admit that if Say’s law is correct, that all of Keynes’s theories will fall apart. William Hutt’s A Rehabilitation of Say’s Law points out the how Keynes seemingly intentionally misstated Say’s Law in order that he might then attack it and how Keynes’s misstatement still seems to be accepted by most modern economists as the law itself when it, in fact, is not. 

Say’s law is obvious. So much so that it was unintentionally state by Bubba when describing the John McCain’s housing plan. To allow the economy to quickly realign itself with the actual wants and needs of society, we need to allow the value of housing, bank stocks, and collateralized debt obligations (CDOs) to find their own price rather than have the government move in to buy these products. Do not believe the argument that the “credit markets are frozen” and that no one will buy CDOs at any price. That is simple nonsense. I guarantee that if CDOs are allowed to fall enough in price, eventually they will find a market clearly price and the market will unfreeze itself. The problem is that this market clearing price is probably far below where the banks have it marked on their balance sheets. So you see, the problem is a political one, not a defect of the market itself. 

All in all, I think we would do well to follow the simple logic of Bubba and his crew. Allow the market to find it’s own market clearing price, and let the chips fall where they may.

Volatility in the Dow

The Dow is up a breathtaking 11.08% today (936 points at close). For me this is another reminder of Benoit Mandelbrot’s The Misbehavior of Markets. Mandelbrot is the mathematician who discovered chaos theory as well as fractal geometry. In that book he examines the stock market for mathematical patterns: a task that many mathematicians have tried to do and failed. Mandelbrot discovered that the market is far wilder than finance theory takes it for, and he also made some other interesting observations. 

For one, he discovered that volatility begets volatility. If one day had a wild swing up, the next day would tend to have another wild swing. It might be up, or (more likely) it might be down, but it would tend to be of far greater magnitude than the average market return. This disproves one of the tenants of the Efficient Market Hypothesis which assumes that each day is independent from each other day, and it is a principle that we are seeing in action today. Mandelbrot proved that, as he puts it, “markets have memory.” He further proved that markets are a bit like elephants in that they never forget. 

Last week the Dow was down far more than it ever had been in any one week period regardless of whether you measured it in percentage or nominal points. So I had figured that today at least we would probably see a large move to the upside, and what a move it was. As a betting man, I’d say that tomorrow might bring a rather large move to the downside, or it could be up again. But either way, the magnitude of the move should be much higher than we say the market moving just a few weeks ago. Volatility begets volatility and vice versa. Right now the movements of the Dow more closely resemble those of a high flying tech stock in the 99-00 market than that of the 30 most solid blue chip companies in America; I should point out that the Dow lost one of its member companies with AIG had to get a government bailout, so being a Dow Jones company is no guarantee against suddenly going bankrupt in this economy.

As I’ve stated before and in my book, the Dow will continue to lose ground against gold. It did well for itself today, but the long term trend is clearly for it to continue to lose against the yellow metal. The only money to be made off of these huge moves in the Dow is for traders: this kind of volatility is a traders dream come true, provided he or she is on the right side of the move! For all others, I’d encourage all readers to seriously reconsider leaving their money anywhere near the American stock markets. The worse is yet to come.

The Endgame Begins

Despite the fact that I’m an avid gamer, my Chess game is pretty horrible. There was a one point in my life where I thought I might devote some time to it, but that never came to be. I do know through my limited reading on the subject that serious students of the game divide Chess into three parts: opening, midgame, and endgame. Because the game has so much history, and because the number of opening moves are very limited, much of the opening tends to follow historical convention of various “opens.” But the open only goes for the first handful of moves. Before too long, the game has broken from the predictable opening to the midgame where the players have now gone from “following the script” to making moves as best they see fit on their own accord. The midgame is where the players are forced to begin making entirely their own decisions, but the situation is also so dependent on the opening that an experienced player can look at a game in progress and reliably predict what opens both players used.

Then after most of the pieces have been taken, the endgame begins. In terms of moves, the endgame can be the longest part of the game. If played out to its conclusion, it can take quite a few moves to advance a pawn to the other end of the board, regain a queen, and checkmate the opposing king. But often good players will simply concede when they see that that is where the game is going. There are no specific markers that delineate opening from midgame from endgame. It’s more a subjective judegement that people can make when reading over the games moves, but there is, to my knowledge, no textbook definition upon which one can say “Ah, with this move, the endgame has begun.” And yet, it is something that experienced players can recognize immediately. In that way, Chess is a bit like global markets.

When compared to a game of chess, the current financial order can be said to have started back in 1944 when John Maynard Keynes led the Western Allies to agree upon a new financial system near Bretton Woods New Hampshire. As discussed in my book, the Bretton Woods agreement set about a new monetary order by which all of the currencies of the world would maintain pegs to the US Dollar which in turn would be fully redeemable in gold. In this way, all of the world’s currencies were indirectly redeemable in gold. More importantly to the United States, the US Dollar became “as good as gold” to the powers of the world. This is how the “game” of our current financial system opened, and the opening moves were indeed predictable. 

The US Dollar became the strongest currency in the world. It was readily taken everywhere and all nations worked to develop a positive trade balance with the United States so that they could begin saving this new version of paper gold in the vaults of their central banks. The currencies of the world did not vary much against each other as each was pegged to a given amount of dollars. All appeared stable and predictable. But as the game advanced, the situation developed to where their became a strain on the gold reserves of the United States. The United States had enjoyed the ability to, in essence, print paper that others took as gold upon demand. No nation can be expected to not abuse such a monumental privilege. Particularly not when there was a Cold War going on. The 1960s say a huge inflationary expansion of the US Dollar as both LBJ and Nixon expanded social spending while financing an expensive war in Southeast Asia. Various nations of the world, particularly France, began presenting their dollars to the US Treasury and asking for gold. Either the United States would have to stop all of this spending or it would have to cease redeeming in gold. In 1971, Nixon chose the later and the midgame began. 

As mentioned, in the midgame, the players have more ownership in their own decisions rather than following a pre-planned set of moves. Now the currencies of the world were free to “float” against each other. The conversion ratios between one nation and another fluctuated daily. Currency traders and not central bankers increasingly began to determine what a given currency was worth in terms of all other currencies. The US Dollar was now going to have to compete on the world marketplace, but because of how revered it had been at the start of the system, to many of the world’s central banks had too large a stake in it to allow it to collapse; remember, the opening has a huge influence on the development of the midgame. There were some scary times at the end of the 1970s where it seemed like the US Dollar was going to collapse, but ultimately it was simply too pervasive a currency and the economic and military power of the United States too strong to allow its currency to be treated like that of a banana republic- even if there was an amazing similarity between the policies of the two. 

But eventually the midgame ends. After most of the pieces have been taken, the players try to surmise who has the advantage and plan accordingly. In our little game, the pieces have been falling all in a row lately. Whether its the housing market, the stock market, or commodities, one pieces after another has been taken off of the board as a safe place to put your money. Lately even the banking system itself, the equivalent of the king in our allegory, has been in danger of getting captured. The endgame is starting. The players of the world are looking at the board and have realized that the financial order of the last six decades is about to collapse. They are starting to plan accordingly. On October 10th, Italian Prime Minister Silvio Berlusconi announced that the world leaders were considering closing the financial markets of the world so that they would have time to “rewrite the rules of international finance.” He would later say that he was just speculating about a rumor, but one does have to wonder whether he was forced to recant by the other world leaders who had wanted more secrecy maintained around their meeting. 

Whether the meeting was real, or whether it isn’t it does beg the question of when one is going to happen. I say when, because I just don’t see how the powers of the world are going to sit by and watch this deflationary collapse unfold without a fight. Confidence has become shaken in the banks of the world, and part of the reason for this is because the banks of the world have far more liabilities than they have assets when the market actions of the past year have been taken into account. A new plan whereby a large block of nations pledged a significant portion of assets to back their banking system would restore confidence in that banks structure and that nation might thereby gain an advantage in prestige over the other nations of the world. A new economic order to replace the now defunct Bretton Woods agreement must be in the works somewhere; if nothing else, it would be needed as a contingency against further collapse of confidence. 

This all spells the end of the dollar. Like a chess game, the players of the world know that its just a matter of time (a matter of moves) before the once almighty dollar is reduced to far less than the paper its printed on. We are about to once again discover the words of Ludwig von Mises who wrote that “”Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”

Why Gold?

Nat posted this question:

Really, as an investment right now, any commodity is a good buy. I would say gold, guns and bullets are pretty valuable. So your second question is really the one i am asking about. Why should we peg the dollar to gold and not some other natural resource? Gold has no true value. Its pretty, is used in some manufacturing, has a history, but other than that, useless.

I would again recommend that anyone who has this question read Murray Rothbard’s essay Case for the 100% Gold Dollar. It succinctly answers this very question. So as to not just rehash what Rothbard argues, I’d like to make this a hypothetical exercise. 

Pretend for a moment that the government had no power to issue money or to declare legal tender. A lot of people have a hard time with this because they feel that money inherently comes from the government, but they are wrong. As I say in my book, money is a self-organizing principle of a community. So at the beginning we would see various communities using different commodities as money. Perhaps the East Coast would settle on using gold as their money, but let’s say Nevada preferred Silver, except for this one town in Nevada which has decided to use cigarettes. 

So we had those three commodities being used as money in three different places. That may seem crazy, but it’s not in any way different that the situation we have today with different countries standardizing on different fiat monies with no backing whatsoever. When I go to Canada in a couple of weeks I an going to exchange some of my American Dollars for some Canadian Dollars; returning to our hypothetical example, if you were visiting the East Coast, you would exchange your silver currency for gold. In this way, the free market would determine both the exchange rates of all of the commodities used as money. In addition, each person in a given community would be allowed to chose what form they wanted to store their wealth in. 

So you can think of this hypothetical exercise as a grand social experiment regarding money. As the communities began to trade more and more with each other, there would be a tendency to standardize on one particular money so that trade could be normalized across more communities. Whatever this grand money would have to be would have to meet certain criteria:

1. People would need to value it. 
2. It would need to be scare. (So oxygen is out until the air is so polluted we can’t breathe it anymore).
3. It would need to be easily transported.
4. It would need to be rendered into standardized units.  
5. It would need to be a store of value across time. So it would need to not be easily perishable. 

Ok, let’s come back from the hypothetical experiment for now. In this thought experiment we learned that money is a self-organizing principle and that as communities traded with each other there would be a tendency towards adopting the same money as your trading partners.

Now here’s the kicker. This experiment has been run already- more than once. Precious metals always seem to become the desired money upon which communities settle. I can’t tell you why it is that humans value precious metals, but we do. So the reason I’m saying we should return to gold now is because it the money that societies have always gravitated towards for at least the last 4000 years or so.

Now I’m not saying that gold will be the money of the human race for the next 4000 years.  Perhaps in the future we will develop a Star Trek fabricator that, in addition to piping hot Earl Gray tea, will render as much gold as you could possibly ask for. The commodity of choice in the Star Trek Universe might be Dilithium crystals or antimatter, because that’s what makes society go. But that world won’t evolve over night, and if and when it does evolve, gold will be tradable as a commodity for these dilithium crystals right up until we technology got to the point where we had complete control over all matter. 

In the meantime, if you are still not convinced that gold should serve as our money, and Article I, Section 10 of the US Constitution which reads that “No state shall… emit bills of credit; make anything but gold and silver coin a tender in payment of debts” still hasn’t convinced you, then know that I as a free market person respect your right to call for any form of money you wish. We can it is conceivable that we could always start the experiment over and allow all communities to start trading in their own money, but I’d be prepared to put a heavy wager on precious metals coming out on top. 

In terms of the world we live in today, you are correct in saying that any natural resource can conceivably be used as a money to back a currency, but bankers are still partial to things they can put in their vault. Even in today’s world, where every effort has been made to demonetize gold, every central banker in the world will still show and accept it to be shown on a balance sheet as asset. That’s saying something. So if gold is still used as a money amongst central bankers today, despite all of the efforts to the world’s governments to deny it’s use as money, then that’s really saying something.

The one final thing I want to point to is that virtually all commodities in the world are lower today than they were a year ago, except gold. It is the commodity that people have fled to as they have lost faith in the system. So much so that many bullion dealers haven’t been able to keep gold coins in stock. What do you think the odds are that people are going to suddenly stop valuing it?

So, my question to you is, “Why not gold?”