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The Daily Reckoning | Monday, July 2, 2012 The Argentine government gets creative with its mortgage market... A compelling case for a return to good sense... Plus, Bill Bonner on rotten economies and the governments that spoil them... ------------------------------------------------------- Only 62 People Know Exactly Why These Four Companies Could Change the World Now you’re #63 “on the inside” — and you’re on the verge of raking in lasting wealth. This could go down in history as the story of our era.  Click here for all the details.   An Economy Ablaze How Government Spending Continues to Add Fuel to the Fire   Bill Bonner Reckoning today from Paris, France... “France is rotten,” said a friend yesterday. “I don’t know why you came back. Half the people are broke. The other half are crazy... “...and you foreigners still come here, pay $1 million for a hole- in-the-wall apartment...and walk around the city and step in dogsh*t.” Yes, dear reader, that is a fair description of France circa 2012. The new president, Francois Hollande, says he won’t wait for the private sector to create jobs. He will do it himself. He’ll hire more teachers. Never mind that the payback on educational spending is zero — or less. It sounds good to the lumpen-voters. And how will he pay for these new teachers? This week, he is expected to raise taxes on the rich. The top marginal rate, he says, will go up to 75%. And the wealth tax will go up too. In short, the elites who control France will soon control, directly, more of it...and more of the rich will move to Switzerland, England or Belgium. Rotten...rotten...rotten... But here at The Daily Reckoning, we like rotten countries. For example, in a state of even more advanced decay, there is Argentina, where president Cristina Fernando de Kirchner has just announced a solution to the housing problem. We pause to give dear readers a quick résumé of how housing got to be a problem south of the Rio Plata. In the ’80s, the generals who ran Argentina tried to pay their bills by printing money. This led to consumer price increases of more than 1,000% per year. They had to throw out one currency, start a new one, and then throw that one out too. And then there was the war with England. Eventually, people got sick of it and threw the generals out. Then, President Carlos Menem promised a “hard” currency for Argentina, which he would achieve by tying the peso directly to the dollar.  No one is more persuasive than an Argentine when he is trying to borrow money. And since the currency risk was eliminated — or so investors thought — the Argentines soon were able to borrow more money than they could possibly repay, which led to the biggest default — about $100 billion — in world history. The official inflation rate is now still in single digits. But the actual inflation rate — which is apparently illegal to report — is near 25%. This — combined with the fact that when you lend Argentines money they don’t pay it back — greatly reduces the availability of credit...and housing. People have to pay all cash...or nearly all-cash...to buy a house.  Well, you can imagine what America’s housing market would look like if people had to save money before buying a house. There wouldn’t be so many houses. And that’s why there aren’t so many houses in Argentina. And many of those that were built in the past are not in great shape. So, in comes Cristina. Rather than give any hint that her predecessors and her own political party bear any responsibility for the housing problem, she offers another crackpot solution. We will come to that in just a minute. We just want to point out that this situation is classic. Government causes problems. It then offers solutions that make them worse. On a macro level that is what is happening in the US. The feds created a credit-based economy, increasing the supply of credit 50 times in the past 50 years. This huge swell of credit swamped the entire world...leading to (among other things) the explosion in factory output in China...the bubble in housing in the US...the big increase in wealth for the ‘rich’...the blow up in ’08-’09...high unemployment...and little real growth.  But rather than recognize that, they set the house on fire...the feds arrive on the scene like firefighters, pretending to put it out. Trouble is, they keep adding tinder — more credit! The feds have added $4.39 trillion to the national debt since Obama moved into the White House. On an accrual basis, they’ll add $20 trillion by the end of this year.  And that’s the fiscal side. Over on the monetary side, the Fed has been doing its part. It has added $2 trillion to its balance sheet (the foundation of the US money supply) since the crisis blew up in ’08-’09. Even with all that gasoline and dry sticks, they’ve had trouble keeping the fire going. Consumers...and households...have been a wet blanket. They’re trying to de-leverage. That is, they want to get rid of credit, not add more.  But the government comes to the rescue with more student loans, housing loans, bailouts, subsidies, free bread at home...military circuses abroad. And Paul Krugman, Joseph Stiglitz, Larry Summers et al urge the feds to do even more! In our view, they’ve done enough damage already.  Not that we’re complaining. It’s all very entertaining and instructive.  But today’s note is about rotten economies. And while the US is developing large brown spots and a sticky-sweet smell...it’s not nearly as ripe as some others. For example...Argentina. Here’s Cristina’s solution to the housing problem; if the private sector won’t make mortgage loans, the government will: She’ll take money from pension accounts (that she seized 2 years ago) and then lend it to homebuyers at one-tenth the rate of inflation! Gee, you’d think that people would line up around the block to get that kind of money...which is exactly what they do. So, how do they decide who gets a loan? By lottery! Here’s the report: Argentina Denies Runaway Inflation Subsidizing Loans: Mortgages By Camila Russo June 29 (Bloomberg) — Argentines are lining up at banks again. This time, they’re leaving with loans. Veronica Cajal, who wants to move out of her mother’s house, is among 1.4 million Argentines who applied for subsidized home- construction loans in the first week they were offered as part of a program designed to ease a chronic housing shortage and help revive growth in South America’s second-biggest economy. The plan calls for the national pension agency to lend about 20 billion pesos ($4.4 billion) for new homes at rates as low as one- tenth the pace of consumer-price increases. The government is trying to foster home building as private banks balk at issuing long-term loans amid inflation that economists estimate at 24 percent a year, a legacy of government policies that followed a $95 billion default in 2001, when Argentines queued at banks to buy dollars before a currency devaluation. The program calls for making 100,000 loans by the end of 2013. Recipients will be chosen randomly from all eligible applications. Why didn’t you think of that, Mr. Market? You dumb-bell. All you can think of is tired old formulas — protecting the value of the money...then letting willing buyers and sellers work out for themselves how much credit they want...and at what price. Bo...ring! C’mon, Mr. Market...use some imagination...!   External Advertisement Washington’s Dirty Little Secret Social Security: TERMINATED.  Medicare: CANCELLED.  Our cities: SUBJECTED.  Our families: COMPLIANT. Startling new video evidence that Washington is preparing to confiscate your wealth and abolish many of your most cherished personal liberties... Click here to watch... The Daily Reckoning Presents The Path to $10,000-an-Ounce Gold   Dan Amoss There’s a plausible path to $10,000 an ounce gold. And it doesn’t require a breakdown in civil society... Speculators see central bankers as modern-day superheroes, able to push markets around with a single phrase. In the minds of most investors, Ben Bernanke, Mario Draghi and Masaaki Shirakawa might as well be wearing tights, masks and capes. These superhero central bankers continuously swoop down into the financial markets to defend them from downticks...and to insure that they always deliver capital gains. The reality, of course, is that these superheroes are frauds. They have no superpowers...other than the power of mass delusion. The powers of Mario Draghi and the other central bankers in Europe are waning. Excess debt is like kryptonite: Each new wave of printing has less impact on markets. As the popular phrase goes: “This is a solvency problem, not a liquidity problem.”  In other words, new money supply cannot restore health to sick loans and government bonds. The only way to restore solvency to the system is to deflate the economy or slash the amount of debt in the system through mass bankruptcy. Or is there another way? Is there a “reset button” that central bankers can push (with the approval of political leaders) that would restore balance to the system? We know central bankers would never want to deflate the economy or crash the value of debt, which would destroy the banking system. So how about inflating the money supply to dilute the value of debt? All in one fell swoop? Right now, central bankers are diluting the value of debt very slowly by pushing interest rates below the rate of inflation. Some call this “financial repression.” It’s an unspoken policy that has many negative consequences. What is an alternative, since all attempts to “fix” the current system with more borrowing and printing are failing? How about the classical gold standard, which stands out as the least flawed of all the systems we’ve tried. Each nation could choose to peg its local currency to gold at a price that allows for enough growth in bank reserves to greatly reduce the burden of public- and private-sector debts. Re-pegging a currency like the US dollar to gold at the current price (about $1,550) has its pitfalls. Most notably, it would not deleverage an overleveraged banking system. But re-pegging the dollar to something like $10,000 an ounce might do the trick. Hedge fund managers Lee Quaintance and Paul Brodsky from QB Asset Management wrote a fascinating outline on the potential reintroduction of gold into the monetary system, while simultaneously implementing what one might consider a debt jubilee. I recommend reading the entire outline. Zero Hedge posted it at this link. QB explains the mechanics of how it could work in the US: Using the US as an example, the Fed would purchase Treasury’s gold at a large and specified premium to its current spot valuation. The higher the price, the more base money would be created and the more public debt would be extinguished. An eight-to-10-fold increase in the gold price via this mechanism would fully reserve all existing US dollar-denominated bank deposits (a full deleveraging of the banking system).” Below is what the remonetization of gold would look like in chart form. The yellow line would rapidly approach the blue line. And the blue line will keep rising as we see further growth in the money supply. QB’s “Shadow Gold Price” divides the US monetary base by official US gold holdings. Policymakers, who always feel the need to manage something, would appreciate that this is the same formula used during the Bretton Woods regime to peg the dollar at $35 per ounce. In other words, the Shadow Gold Price is the theoretical price of gold after the Fed inflated the supply of dollars to a level that would cover systemic bank liabilities and then re-pegged the dollar to gold. Behold the path to $10,000 gold: This path would weaken the economy-sapping effects of debt created since President Nixon closed the gold window. It would transform a debt-based currency into an asset-backed currency. No longer would one ask the unpleasant question “What backs the dollar?” and come away with even more questions (and a headache). Right now, the dollar is backed by Treasuries held on the Fed’s balance sheet, which are in turn backed by dollars, which are in turn backed by faith in fiat money — i.e., nothing! QB’s monetization scenario would impose losses on certain parties as the reset button is hit, but unlike most of the policy prescriptions we’ve seen lately, it seems to solve more problems than it creates. Most notably, politicians could argue that this reset would involve “migration of value, in real terms, from leveraged assets to unleveraged goods, services and assets.” Wage earners would be winners relative to asset owners, because “stable to higher nominal asset prices would require even higher nominal wage and consumable pricing looking forward.” This scenario argues for holding some shares in producers of physical commodities (especially gold miners), even if it feels like we’re in a deflationary environment. A gold standard, after a one- time debt monetization, would make for a more-balanced, efficient global economy less prone to violent booms and busts. As an added bonus: Central bankers would no longer be viewed as superheroes! Just meager servants, pegging the money supply to gold and letting the free market determine the price of money. After all, when in history has central planning worked better over time than the free market? We can hope the central bankers of the world stumble their way to a solution like that proposed by QB Asset Management before they inflict even more damage to the foundation of the global economy. Unfortunately, conditions may have to get much worse in financial markets, banking systems and economies before such “outside the box” ideas are considered. A defensive portfolio with exposure to gold and other real assets seems like the right mix in today’s environment. Regards, Dan Amoss for The Daily Reckoning Editor’s Note: We like it when things make sense, fellow reckoner. And at a time when those in charge of the world’s money seem to have little of it themselves, we’re increasingly happy to have gold on our side. As Dan points out above, there are numerous reasons why a gold-backed currency simply makes sense, and after seeingthis presentation, we can tell he’s in good company. Click here to discover a long-lost gold “bible” penned by none other than Congressman Ron Paul...and how you can snag a copy for yourself. ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor atjoel@dailyreckoning.com