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Thursday, June 11, 2009 Honey Hun joins Professor Punchy in a grapplefest... Everyone's waiting to see what happens next... How simpleminded economists really can be... Dr. Marc Faber on creating inflation...and more! ----------------------- Special Offer ------------------------- It's taken 15 years, but the secret's finally cracked! A Forex profit tool you can use to 'grab' an average 22 'profit pips' per day in just your spare time... Go here to grab an easy $550-$2,200 each week - as a part-time Forex profit raider! --------------------------------------------------------------- Economic Mud Wrestling by Bill Bonner London, England It's the Ultimate Fighting Event - Worldwide Economic Mud Wrestling! See it now! First, the Honey Hun...German Chancellor Angela Merkel... took on a whole pack of central bankers and economists, charging that they were going to make the situation worse - by spending money they didn't have...and causing inflation. Then, historian Niall Ferguson - Professor Punchy - took a jab at the meddlers in the pages of the Financial Times. His point was simple enough; that the feds were spending trillions of dollars without really knowing what they were doing. If they borrow money to stimulate the economy they are just taking money out of the private economy and diverting it to public spending. There's no gain in that, he said. Watch out Niall...! The Nobel Knucklehead - economist Paul Krugman - hit back. We'll return to this grapplefest. But first, let's take a look at what is happening outside the arena... Nothing! Yesterday, for the third day in a row...not much happened in the markets. The Dow fell 24 points - hardly worth mentioning. Gold held steady at $955. Oil rose a dollar - to $71. And the dollar itself remained about where it was - at $1.39 per euro. It is as if everyone were waiting to see what happens next. Let's see... We've seen the biggest stock crash in history... ..the biggest property crash in history... ..the biggest deficits in history (four times the previous record!)... ..the biggest bailouts in history (we can't even count that high)... ..the biggest bankruptcies in history... ..the auto industry and the finance industry have been largely nationalized... ..the president of the United States of America is now making financial decisions for formerly private industries... What's left to see? Oh yes...the depression...and hyperinflation. And...now's the time to protect your investments from these dreadful consequences... with the strategies outlined here. "Get ready for inflation and higher interest rates," warns Art Laffer in the Wall Street Journal. Remember him? Creator of the 'Laffer Curve.' But don't worry about inflation, adds Harvard professor Gregory Mankiw, also in the Wall Street Journal: Inflation is just what we need. "In the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative..." to force people to get rid of their money as fast as possible. Over in the bond market, investors are finding out what a little bit of inflation - or even hints of inflation - can do. People bought US Treasuries during the panic of '08 for safety purposes. Now, they're getting what we predicted. Alas, yes, they are getting what they deserve, not what they expected. Our friend Chuck Butler points out that prices of 10-year Treasuries have come down from $110 as recently as 5 months ago to just $94 this week. How's that for safety - a 15% loss! What they were fleeing from was the uncertainty and risk of the big wide world of investing. When Lehman Brothers went broke foreign investors took the first available plane out of India, for example. But now, our friend Ajit Dayal reports that they're coming back. We're working with him now to develop an international report on investments in the BRIC countries, with ace editors on the ground in each. As soon as the report is ready we'll give you first crack at reading it here. Because right now things are looking up on the sub-continent: "What a month! "The 36% surge in client portfolios after the election results in India have brought the value of the client holdings back to where they were before the Lehman bankruptcy in September 2008. "We see this as a base for a possible assault on a new peak by June 2010. "That is the good news. "The bad news is that many of the lessons learned in the implosion of capital markets in the year 2008 may be forgotten. Memories are short - in fact they may not exist." Memories? Here at The Daily Reckoning we've got all the memories you could want. We may not be able to remember what we did with our car keys, but we remember that fateful day - August 15, 1971 - when Richard Nixon 'closed the gold window.' It's been downhill ever since... Now...more news from Ian Mathias in Baltimore... "The bond vigilantes have spoken," reports Ian from today's 5 Min Forecast. "They've cried in a powerful chorus, 'Ehhh... we're a little annoyed.' "The much hyped 10-year note auction Wednesday got a lukewarm reception from global buyers. As you can see, when the auction began at 1 p.m., investors quickly demanded a 4bps hike in the underlying yield - according to Morgan Stanley, the biggest markup at an auction's outset since May 2003. "That helped bump the yield on the 10-year as high of 4.0%, its highest since October. Traders definitely made themselves heard - worries about debts and deficits in the US are back in the spotlight. But we wouldn't say it was in re-engage vigilante fashion. 4% is a point of historic buying support for the 10-year... it'll capture our interest again when that level is tested. "And what a coincidence... the very day of this highly anticipated bond auction, Russia and Brazil both announced they'd soon be selling $20 billion in US Treasuries in exchange for IMF bonds. "It's a smart move... each nation gets to diversify out of the dollar (the IMF will pay these bonds back with a basket of global monies) and send a clear signal to the US government. But their leaders can hide behind altruistic intentions: "This support is important to help end the international financial crisis," said Brazilian finance minister Guido Mantega. Since the money will go to the IMF's emergency fund, Brazil and Russia get to look like generous, globally cooperatave players... even if their only intention is to get the hell out of US Treasuries. "Coupled with India and China's recent call to sell US bonds for IMF paper, that's $80 billion in US debt to be sold... just what the struggling bond market needs." If you want to make sure you get Ian's insight from The 5 - in its entirety every Monday through Friday - you can...by subscribing to one of Agora Financial's paid publications. One such fortune-building read is Wayne Burritt's Easy Money Options...available here. And back to the Ultimate Fighting Event... In his blog, Krugman accused Ferguson of "living in a dark age of macro-economics, in which hard-won knowledge has simply been forgotten." The "hard-won knowledge" he referred to was Keynes' "proof" that extra government spending was indeed a plus to the economy - as long as there was not full employment. Once full employment was achieved, things changed, he said. Then, government borrowing just "crowded out" private borrowing. We don't expect Daily Reckoning readers to be deeply interested in these squabbles; you've got better things to do. We just bring it up to make a point. The world's governments - led by the United States of America - are spending trillions to head off what they believe could be a terrible depression. Yet the theory on which they hang their reasoning is such a thin string, some of the world's leading thinkers can't seem to hold onto it. Merkel thinks the theory is wrong; Ferguson thinks it's wrong. Heck, we even think it's wrong. Not that that proves anything. We could be wrong. But we're not spending trillions of dollars based on an idea that is the subject of hot dispute. It's a dangerous plan... Fortunately, you can defend your family finances with this strategy. "Keynsian revolution was not a triumph of good science, but of good judgment," says the FT's headline from yesterday. Ha ha...that's a good one. They're right, of course. There was no science in Keynes' oeuvre. It was all guesswork. But good judgment? Not much of that either. As for Keynes' "proof," it is defective. He argues only that when the feds borrow and spend in a recession they can't "crowd out" private borrowing without also increasing economic activity - which he takes as a gain. Which reminds us how simpleminded economists can be. Imagine a town where people borrowed and spent too much. Faced with unemployment and a slump, the mayor borrows money to build a new town hall - thus putting "idle" resources back to work. He doesn't "crowd out" private activity, because private citizens are hunkered down, trying to pay off their debts. They save. They lend to the mayor. Private borrowers have no better use for the money. That is the theory of it. On the surface, it appears that the mayor's stimulus plan is a big success. Pretty soon, people are working again. Money is changing hands. The new city hall is going up. But what has really happened? The citizens will have a new town hall. But it's a building they hadn't particularly wanted when the good times were still rolling. And now they have their share of the debt the mayor incurred to build it. Yes, it may look as though the town is more prosperous - with people employed on the new town hall, collecting paychecks and spending money. But the prosperity is phony. Citizens got not just one thing they didn't want, but two - a new town hall and more debt. And somehow, sometime in the future...other spending plans will have to be shelved so that the town hall can be paid for! That's what Angela Merkel was saying in her attack on the central banks. When all is said and done, 10 years from now we'll be back to where we are now. And, if we're looking at a return to the worse parts of where we've been, you might want to look into this strategy to bail yourself out. This morning, we got a call from a reporter. "How long do you think this rally will continue," she asked. "Why do you think it won't last?" "As to the first question, we have only an intuition...based on very few historical precedents. When you get a crash as big as we had until March...you can expect a rebound for 3-6 months after. The current rebound is now almost exactly 3 months old. By our guess it could run 3 months more...which takes it to September. But it's very dangerous. If you're playing this rally, be sure to use tight trailing stops...the next leg down could be worse than the first. Remember, after the Crash of October '29 the market rallied until the following May. Then, it went down. And it didn't bottom until 1932. "As to the second question...why can't the rally become a real boom?...the answer is very simple. Debt is either expanding. Or it is contracting. When it gets to an extraordinary high...it tends to go down. Because it can't go up any more. That's where we are now. Since consumer debt can't increase - and since consumer incomes are definitely not increasing...especially not in Britain and America - there is no way that a consumer economy can expand. Since it can't expand, it must contract. You can't have a boom in a consumer economy when consumer credit, consumer incomes, and consumer spending are all going down. Forget it." Until tomorrow Bill Bonner The Daily Reckoning ----------------------- Special Offer ------------------------- The Anti-Stock Market was up 71% in 2008 ... were you? It's averaged 56.3% gains every year since 2002... And, just cashed in another 100% winner! Sign up by Thursday, June 18th and These Gains Are Yours - GUARANTEED. --------------------------------------------------------------- The Daily Reckoning PRESENTS: In the conclusion of Dr. Marc Faber's two-part essay, we pick up where we left off yesterday: with an unveiling of Dr. Faber's simple solution for creating inflation. Read on... The Frame of Mind of American Economic Policymakers, Part II by Dr. Marc Faber Hong Kong, China In his 1,200 page History of Economic Analysis, Joseph Schumpeter mentions Gesell just twice and just en passant - in one instance when explaining that Keynes himself acknowledged in the General Theory of Employment, Interest and Money that Gesell had a much larger influence on him than Hobson. (Keynes called Gesell a "non-Marxian socialist".) Keynes noted in the General Theory that, according to Gesell's proposal, "currency notes (though it would clearly need to apply as well to some forms of at least bank-money) would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office. The cost of the stamps could, of course, be fixed at any appropriate figure. According to my theory it should be roughly equal to the excess of the money-rate of interest (apart from the stamps) over the marginal efficiency of capital corresponding to a rate of new investment compatible with full employment." And although Keynes found "the idea behind stamped money sound", he nevertheless conceded that there would be difficulties in the implementation of this scheme: But there are many difficulties which Gesell did not face. In particular, he was unaware that money was not unique in having a liquidity-premium attached to it but differed only in degree from many other articles, deriving its importance from having a greater liquidity-premium than any other article. Thus if currency notes were to be deprived of their liquidity-premium by the stamping system, a long series of substitutes would step into their shoes - bank-money, debts at call, foreign money, jewelry and the precious metals generally, and so forth...there have been times when it was the craving for the ownership of land, independently of its yield, which served to keep up the rate of interest; though under Gesell's system this possibility would have been eliminated by land nationalisation. (John Maynard Keyes, General Theory, London, 1936, Chapter 23) I briefly discussed Gesell's ideas because his books would make excellent bedtime reading for Comrade Obama. I doubt, however, that the Commissar can indulge in much reading time since he has embarked on micro-managing the economy. Also, as Keynes himself admitted, there are enormous problems associated with the "stamping system", as well as with the "hat system" explained above by Mankiw, because savers would turn to other forms of "money" such as precious metals, non-ferrous metals, diamonds, paintings, stamps, cigarettes (see also below), metal coins, ecstasy pills, cocaine, prepaid cards, etc. But back to Mankiw! Mankiw: If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates - interest rates measured in purchasing power - could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend... Yes, real interest rates could be strongly negative, as was the case in the 1970s, which generated high inflation and high nominal GDP growth rates but a collapse in bond prices (see Figures 1 and 2). Currently, Mr. Mugabe maintains in Zimbabwe by far the lowest interest rates in the world in real terms. But who is lending him money? What about capital spending and consumption in Zimbabwe? Go and look for yourself, Professor Mankiw! But there is no need to travel that far. After all, it is far too uncomfortable for an academic at Harvard. Closer to home - in the US - there is sufficient evidence that consumption as a percentage of the economy fell in the inflationary environment of the late 1960s and 1970s when interest rates in real terms were mostly negative. Mankiw: Ben S. Bernanke, Fed chairman, is the perfect person to make this commitment to higher inflation. [MF: I am in full agreement on this point.] Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative... I have a far simpler solution for creating inflation (for which I should obtain a Nobel prize in economics) than the half-baked measures proposed by Gesell, Mankiw, and his students, in order to create "more demand for goods and services, which leads to greater employment for workers to meet that demand". The government could issue to each US man, woman, and child free vouchers for different goods and services, which would have a three or six months' expiry date. There are 310 million Americans. The government could issue 310 million vouchers to be exchanged for a new car, 100 million vouchers to be exchanged for a $500,000 home, a billion vouchers for a visit to an amusement park, a trillion vouchers each for Prozac and attendance at a sporting event, and so on. AIG and Citigroup would be in charge of making a market in these vouchers, so if someone didn't wish to buy a car he could exchange the "Closer to home – in the US – there is sufficient evidence that consumption as a percentage of the economy fell in the inflationary environment of the late 1960s and 1970s when interest rates in real terms were mostly negative." car voucher for cigarette vouchers or any other voucher. But since these vouchers would have an expiry date they would unleash a huge consumption boom, which would temporarily lift the prices of everything and, therefore, achieve the objective of the US economic policymakers of creating inflation and negative real interest rates. (An even simpler solution would be to remove all taxes for two years, or simply to send each American a cheque for a million dollars, but the impact on spending would not be as powerful as with my voucher system.) With my voucher system, the current interventionist government could even target the bailout of some specific industries that are currently ailing. For instance, it could issue 310 million vouchers, each of which could be exchanged for the purchase of a new car; whereas it would not issue vouchers for goods where demand remains strong - namely, for guns, cocaine, ecstasy, prostitutes, and porno magazines. And if some protectionist flavour was desired - since this would really stimulate domestic capital spending and employment - the government could issue a disproportionately larger quantity of vouchers for the purchase of domestic goods than for foreign goods. And who would pay for the vouchers that businesses would receive from consumers? Nobody! The Treasury Department could issue bills, notes, and bonds to pay businesses for the tendered vouchers, and have the Fed buy them all. But would nobody really pay for my voucher system? The objective of my voucher system would be fulfilled, which is to create inflation, but at the cost of a tumbling US dollar and collapsing bond prices, as was the case in the 1970s (see Figures 3 and 4). I may add that a collapsing dollar might lead to a "little too much inflation"-even for the Bernankes and Mankiws of this world! The astute reader will naturally ask what will happen when the economic stimulus arising from the vouchers ends, since they are issued with an expiry date. The answer is very simple: the same thing as occurred after 2007 when the stimulus from easy monetary policies and strong debt growth (inflation) ended: demand collapsed. But that should be of no great concern to the Mankiws of this world. The government could then issue new vouchers with a higher face value and in higher quantities. So, whereas my initial voucher program would have issued 310 million car vouchers with a face value of $40,000 each, the government could now issue 400 million car vouchers with a face value of $100,000 each. Now, some of my readers may think that I have lost my mind, but macroeconomically there is very little difference between my voucher program, which guarantees to stimulate demand and bring about inflation immediately, and the way the Treasury has recently expanded the fiscal deficit and the Fed has increased its balance sheet (see Figure 5). My vouchers stimulus runs out when the vouchers expire, and the Treasury's and the Fed's stimuli run out when these esteemed institutions stop increasing them! But my point is that if a government is determined to create inflation and negative real interest rates, there is really nothing standing in the way of its doing so. Naturally, both voucher and money stimuli lead to enormous economic and financial volatility. In this respect, I urge my readers to read R.A. Radford's "The Economic Organisation of a P.O.W Camp", in Paul A. Samuelson, John R. Coleman, and Felicity Skidmore (eds), Readings in Economics (McGraw-Hill, 1952). (For those people who have little time to read, this is a superb book about economics and contains brief contributions by economists such as Malthus, Marshall, Boehm-Bawerk, Taylor, Hayek, Tobin, Friedman, Samuelson, Schumpeter, Ricardo, Bastiat, Rostow, Kuznets, Burns, Eckstein, Keynes, and Kindleberger, and many more.) Radford describes how in a prisoner's camp during the Second World War cigarettes became the principal "currency" and how prices compared to cigarettes fluctuated widely. The Red Cross would make weekly deliveries of cigarettes to the P.O.W. camp and prices would subsequently fluctuate largely as a function of the quantity of cigarettes delivered. When plenty of cigarettes were delivered the prices of other goods would increase; conversely, when the supply of cigarettes was scarce, prices would deflate. Radford concluded that "the economic organisation described was both elaborate and smooth- working in the summer of 1944. Then came the August cuts [in the delivery of cigarettes by the Red Cross - ed. note] and deflation. Prices fell, rallied with deliveries of cigarette parcels in September and December, and fell again. In January 1945, supplies of Red Cross cigarettes ran out and prices slumped still further: in February the supplies of food parcels [to a lesser extent, food also was used as medium of exchange - ed. note] were exhausted and the depression became a blizzard. Food, itself scarce, was almost given away in order to meet the non-monetary demand for cigarettes." Radford never won a Nobel Prize for his observations about the economics of a P.O.W. camp, but they taught me far more about relative and absolute price movements than did economists at Ivy League schools. When supplies of cigarettes (money) increased relative to food items, prices for food rose more than for cigarettes; and when supplies of cigarettes fell, food prices fell more than prices of cigarettes. In other words, the successful P.O.W. camp hedge fund traders had to constantly adjust their investment position between cigarettes (money) and food (assets), depending on their relative supplies. This is the investment environment I expect for the foreseeable future. Regards, Dr. Marc Faber for The Daily Reckoning Editor's Note: Your opportunity to catch Dr. Faber speaking live, in person, is at this year's Agora Financial Investment Symposium in Vancouver, British Columbia. This year's event promises to be the best on record, and is already 70% sold out...so secure your ticket now. Get all the information you need here: Agora Financial Investment Symposium - July 21-24 Dr. Marc Faber, an Asian-equities sleuth and the original bear on Japan, is the editor of The Gloom, Boom and Doom Report. Dr. Faber has been headquartered in Hong Kong for nearly 20 years, during which time he has specialized in Asian markets and advised major clients seeking down-and-out bargains with deep hidden value - unknown to the average investing public - and immense upside potential. Dr. Faber is the author of the bestseller Tomorrow's Gold. Get your copy here.