Wall Street Admits That A Cyberattack Could Crash Our Banking System At Any Time

Posted on September 5th, 2014

CyberattackBy Michael Snyder

Wall Street banks are getting hit by cyber attacks every single minute of every single day.  It is a massive onslaught that is not highly publicized because the bankers do not want to alarm the public.  But as you will see below, one big Wall Street bank is spending 250 million dollars a year just by themselves to combat this growing problem.  The truth is that our financial system is not nearly as stable as most Americans think that it is.  We have become more dependent on technology than ever before, and that comes with a potentially huge downsideAn electromagnetic pulse weapon or an incredibly massive cyberattack could conceivably take down part or all of our banking system at any time.

This week, the mainstream news is reporting on an attack on our major banks that was so massive that the FBI and the Secret Service have decided to get involved.  The following is how Forbes described what is going on…

The FBI and the Secret Service are investigating a huge wave of cyber attacks on Wall Street banks, reportedly including JP Morgan Chase, that took place in recent weeks.

The attacks may have involved the theft of multiple gigabytes of sensitive data, according to reports. Joshua Campbell, supervisory special agent at the FBI, tells Forbes: “We are working with the United States Secret Service to determine the scope of recently reported cyber attacks against several American financial institutions.”

When most people think of “cyber attacks”, they think of a handful of hackers working out of lonely apartments or the basements of their parents.  But that is not primarily what we are dealing with anymore.  Today, big banks are dealing with cyberattackers that are extremely organized and that are incredibly sophisticated.

The threat grows with each passing day, and that is why JPMorgan Chase says that “not every battle will be won” even though it is spending 250 million dollars a year in a relentless fight against cyberattacks…

JPMorgan Chase this year will spend $250 million and dedicate 1,000 people to protecting itself from cybercrime — and it still might not be completely successful, CEO Jamie Dimon warned in April.

Cyberattacks are growing every day in strength and velocity across the globe. It is going to be continual and likely never-ending battle to stay ahead of it — and, unfortunately, not every battle will be won,” Dimon said in his annual letter to shareholders.

Other big Wall Street banks have a similar perspective.  Just consider the following two quotes from a recent USA Today article

Bank of America: “Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future.”

Citigroup: “Citi has been subject to intentional cyber incidents from external sources, including (i) denial of service attacks, which attempted to interrupt service to clients and customers; (ii) data breaches, which aimed to obtain unauthorized access to customer account data; and (iii) malicious software attacks on client systems, which attempted to allow unauthorized entrance to Citi’s systems under the guise of a client and the extraction of client data. For example, in 2013 Citi and other U.S. financial institutions experienced distributed denial of service attacks which were intended to disrupt consumer online banking services. …

“… because the methods used to cause cyber attacks change frequently or, in some cases, are not recognized until launched, Citi may be unable to implement effective preventive measures or proactively address these methods.”

I don’t know about you, but those quotes do not exactly fill me with confidence.

Another potential threat that banking executives lose sleep over is the threat of electromagnetic pulse weapons.  The technology of these weapons has advanced so much that they can fit inside a briefcase now.  Just consider the following excerpt from an article that was posted on an engineering website entitled “Electromagnetic Warfare Is Here“…

The problem is growing because the technology available to attackers has improved even as the technology being attacked has become more vulnerable. Our infrastructure increasingly depends on closely integrated, high-speed electronic systems operating at low internal voltages. That means they can be laid low by short, sharp pulses high in voltage but low in energy—output that can now be generated by a machine the size of a suitcase, batteries included.

Electromagnetic (EM) attacks are not only possible—they are happening. One may be under way as you read this. Even so, you would probably never hear of it: These stories are typically hushed up, for the sake of security or the victims’ reputation.

That same article described how an attack might possibly happen…

An attack might be staged as follows. A larger electromagnetic weapon could be hidden in a small van with side panels made of fiberglass, which is transparent to EM radiation. If the van is parked about 5 to 10 meters away from the target, the EM fields propagating to the wall of the building can be very high. If, as is usually the case, the walls are mere masonry, without metal shielding, the fields will attenuate only slightly. You can tell just how well shielded a building is by a simple test: If your cellphone works well when you’re inside, then you are probably wide open to attack.

And with electromagnetic pulse weapons, terrorists or cyberattackers can try again and again until they finally get it right

And, unlike other means of attack, EM weapons can be used without much risk. A terrorist gang can be caught at the gates, and a hacker may raise alarms while attempting to slip through the firewalls, but an EM attacker can try and try again, and no one will notice until computer systems begin to fail (and even then the victims may still not know why).

Never before have our financial institutions faced potential threats on this scale.

According to the Telegraph, our banks are under assault from cyberattacks “every minute of every day”, and these attacks are continually growing in size and scope…

Every minute, of every hour, of every day, a major financial institution is under attack.

Threats range from teenagers in their bedrooms engaging in adolescent “hacktivism”, to sophisticated criminal gangs and state-sponsored terrorists attempting everything from extortion to industrial espionage. Though the details of these crimes remain scant, cyber security experts are clear that behind-the-scenes online attacks have already had far reaching consequences for banks and the financial markets.

In the end, it is probably only a matter of time until we experience a technological 9/11.

When that day arrives, will your money be safe?    (my emphasis)

By Michael Snyder for Economic Collapse

By permission Economic Collapse Blog

http://theeconomiccollapseblog.com

http://theeconomiccollapseblog.com/archives/wall-street-admits-that-a-cyberattack-could-crash-our-banking-system-at-any-time

For St. Patrick’s Day — The Value of Irish Humor

Posted on March 17th, 2014

St Patricks Day Wish

By Tom Purcell

With the world in such a tizzy these days — with so many people ready to shout and argue and poke each other in the eyes — I can’t think of a better time to embrace the Irish spirit.

It’s my great good fortune to be a fellow of Irish descent. I share my good fortune with a quarter of all Americans, who can also trace their heritage to the rolling, green hills of Ireland.

As a lad, I remember my father sitting on the back porch on Sundays. Uncle Mike would sometimes visit for a couple of beers, and few things gave the two more pleasure than swapping Irish jokes.

Such as the one about the fellow who was touring the Irish countryside. Hungry, he stopped at a farm and asked for refreshment. The lady of the house served him a bowl of soup. There was a pig in the house that kept running up to the fellow.

“That is the friendliest pig I ever did meet,” he said to the woman.

“He’s not friendly at all,” said the woman. “That’s his bowl you’re using.”

I know that I’m not really “Irish,” but an American through and through. I know, too, that I’m also of German descent, and, though my father refuses to accept it, my great-grandmother on his side turned out not to be Irish, but 100 percent French.

Still, in my family we celebrate what it means to be Irish. Being Irish means to laugh easily, never to take yourself too seriously, to be cautious of getting stuck in the narrowness of your own point of view.

Which reminds me of the one about the German spy who is sent to Ireland during World War II. The German is instructed to meet an Irish spy named Murphy and confirm Murphy’s identity by saying, “The weather could change by Tuesday.”

After the German parachutes into Ireland, he sets off for town. Along the way, he asks a farmer where he might find a man named Murphy.

“Well, sir, it all depends on which Murphy,” says the farmer. “We have Murphy the doctor, Murphy the postal carrier, Murphy the stone mason and Murphy the teacher. As a matter of fact, I, too, am Murphy, Murphy the farmer.”

The German gets an idea.

“The weather could change by Tuesday,” he says.

“Aye,” says the farmer, “you’ll be wanting Murphy the spy.”

James Thurber, one of my favorite humorists, says the wheels of humor are set in motion by the damp hand of melancholy. Aristotle wrote that comedy and tragedy are close cousins. The Irish have long known that humor and laughter are our chief weapons for combating sadness and pain.

Which reminds me of the time a young Irishman tells his mother he’s in love. Just for fun, he brings home three girls and asks his mother to guess which of the three he has chosen to be his bride.

After his mother interviews all three, she says, “Your fiancée is the one in the middle.”

“That’s amazing, ma. How did you know?”

“Because I don’t like her.”

British academic and joke theorist Christy Davies says a good joke can help clarify and express complex feelings. A good joke can cut to the heart of the matter better than any speech or law or government policy.

If only everyone held such a point of view. These days, with all the conflict and disagreement going on, we could surely profit from a better sense of humor.   (my emphasis)

Which reminds me of the time Pat explained to Mike why his valiant effort to scale Mt. Everest fell short.

“I would have made it to the top,” says Pat, “had I not run out of scaffolding.”

By Tom Purcell

By permission Cagle, Inc.

©2014 Tom Purcell. Tom Purcell, author of “Misadventures of a 1970′s Childhood” and “Comical Sense: A Lone Humorist Takes on a World Gone Nutty!” is a Pittsburgh Tribune-Review humor columnist and is nationally syndicated exclusively by Cagle Inc.

This is excerpt from Tom Purcell’s new book, “Comical Sense: A Lone Humorist Takes on a World Gone Nutty!”

One Speech Too Many

Posted on February 3rd, 2014

Tuning Out Obama

By Alan Caruba

I didn’t take notes while President Obama gave his State of the Union speech. There was no need to.

There was a time when the SOTU was a just a letter sent to Congress, but in the era of radio and television, Presidents took advantage of the opportunity to be seen and heard laying out their priorities and asking Congress to fulfill them.  Since then they have become little more than laundry lists and rarely memorable.

More people will watch a sporting event than tuned in to listen to Obama. In five years he has probably given more speeches than several previous Presidents combined. His first term felt like an extension of his election campaign with one speech following another and soon enough his reliance on a Tele-Prompter became a joke.

Suffice to say that Obama has given one speech too many. Or is that one hundred speeches too many?

A second term, according to the political pundits, is usually a more subdued time as a President seeks to get a few “legacy” pieces of legislation passed and, by then, most people have taken their measure of the President, either liking or disliking him. A President’s popularity or approval ratings usually decline.

Obama’s refusal and failure to work with Congress, combined with the disaster of Obamacare that was passed with only Democratic Party votes and, even then, required Chicago-style bribery and pressure, has seen not just his approval begin to slip away, but it includes the whole of Congress.

Obama’s assertion that he will use executive orders to get his way is simply an admission that he has failed to work with Congress and intends to continue as his second term shapes up to be one of increased resistance. Earlier presidents faced with a Congress whose power was held by another party used persuasion and compromise, but Obama uses neither.

In late January a Gallup poll revealed that “The enduring unpopularity of Congress appears to have seeped into the nation’s 435 congressional districts, as a record-low percentage of registered voters, 46%, now say that the U.S. representative in their own congressional district deserves re-election. Equally historic, the share of voters saying most members of Congress deserve re-election has fallen to 17%, a new nadir.”

It’s worth noting that the 17% who say most of Congress deserves re-election is well below the roughly 40% that has been around for decades and Gallup says “Typically, results like these have presaged significant turnover in Congress, as in 1994, 2006, and 2010. So Congress could be headed for a major shake-up in its membership this fall.”

There’s a history lesson in the 1994 election which occurred when Bill Clinton was President. It marked the greatest victory of the Republican Party since 1980. The GOP picked up 54 seats in the House of Representatives and 8 seats in the Senate. The issue that drove this change was Clinton’s advocacy of a change in the nation’s healthcare system. The Democrats did not learn anything from that defeat and Obama doubled-down on it.

While the media naturally focuses on the President, many Americans appear to have made a shift to Republicans because, at present, there are 30 Republican governors in America. Since Obama took office, Republicans have picked up a net nine governorships. In 24 of those States, Republicans control the legislatures. Democrats have similar power in just 12 States. So, at the State level, voters have already demonstrated their preferences.

A Wall Street Journal-NBC poll published on January 28, the day of the SOTU speech, revealed a nation “increasingly worried about (Obama’s) abilities, dissatisfied with the economy, and fearful for the country’s future.”

Large majorities of respondents said they want the White House and lawmakers to focus on job creation and early-childhood education, and a slimmer majority favored increasing the minimum wage.” Just over half expressed an interest in “reducing income inequality.” Obama is appealing to the “low-information” voters these days, but the majority understands that only a growing economy can address the need for more jobs.

The survey found that just over half of Americans disapprove of the President’s performance, with 43% approving, a trough that remains little changed since the early summer. Nearly six in 10 say they are uncertain, worried or pessimistic about what he will do with the remainder of his presidency. Disapproval for Congress, too, is near its all-time high.”

The midterm elections in November are likely to change Congress by adding many more Republicans in the House and enough in the Senate to give the GOP control of Congress. That will eliminate the chokehold that Harry Reid, the Democratic Senate Majority Leader, has exercised to kill more than a hundred and fifty pieces of legislation sent by the House to repair the nation’s stagnant economy. It will likely override the President’s veto power.

Obama’s SOTU will receive a cascade of political analysis, but if the polls are any indication, the public is far less interested in another Obama speech than they are in getting the kind of change the nation really needs to grow its economy and address its problems  (my emphasis)

By Alan Caruba for Facts Not Fantasy

By permission Alan Caruba

Alan Caruba writes a daily post at http://factsnotfantasy.blogspot.com

© Alan Caruba, 2012

Obama: Bumbling Incompetent…or Bumbling Marxist?

Posted on November 12th, 2010

Thanking Obama by Eric Allie, Caglecartoons.com

Welcome to “the Teleprompter Depression.” Each Time Obama Steps in Front of a Teleprompter, Another Business Dies.

CLASSIC COMMENTARY! EDITOR’S NOTE:  This article was written prior to the recent mid-term election, but the comments are still very appropriate!

By Wayne Allyn Root

As a common-sense small businessman, I have a front row seat to a slow motion economic Armageddon that will be written about, discussed and debated for decades to come. Big shot economists don’t listen to guys like me. They scoff as I keep predicting in commentary after commentary that small business is suffering a catastrophe of epic proportions– leading this nation towards levels of unemployment and economic crisis that will rival or surpass the Great Depression. Just last week, the Bureau of Labor Statistics quietly reported that the labor force dropped by roughly one million people during just the last two months. If those numbers were added into the unemployment numbers, it would shock and terrify the American people.

I do not believe the tragedy that is unfolding before our eyes is a mistake, coincidence, or due to incompetence. I believe my old college classmate Obama (Class of ’83 Columbia University) is a Marxist purposefully trying to destroy capitalism, by overwhelming the system, thereby creating a distraction giving him cover to redistribute America’s wealth to his voters (those who create no jobs, pay few taxes, depend on government handouts for survival, or work for government or unions). As a bonus, he gets to bankrupt the groups that contribute virtually all the money to his political opposition. This is truly a “Marxist Triple Play.”

Consider a few highlights of Obama’s reign of destruction:

#1)  The biggest income tax increase in the history of America will take effect on Jan 1st, 2011. The new tax increase falls almost 100% on small business owners and high-income taxpayers (whose contributions happen to fund Obama’s political opposition). As a result, many more jobs will be lost and more businesses closed.

#2)  A dramatic 60% capital gains tax increase (from 15% to 23.8% effective rate, including new universal healthcare taxes) will accompany the big income tax increase above. More jobs will be lost, more businesses closed.

#3)  Taxes on dividends will increase from 15% to 39.6%, and then another 3.8% by 2013 for Obama’s new healthcare taxes. Stocks will be crushed and older Americans will be devastated (because they live off dividends, investments, and bank interest). More lives ruined, more jobs lost.

#4)  New taxes on income, investments, and even tanning bed users soon take effect to pay for Obamacare. Worse,18,000 new I.R.S. agents will be hired to enforce these taxes (at a cost of billions annually in new government employee salaries, pensions and benefits). More jobs lost.

#5)  The pending Cap and Trade legislation threatens dramatic new taxes on anyone who owns a business, owns a home, owns an auto, or buys products manufactured or delivered through the use of energy. Once again, the more you own, the more you’ll be taxed. More jobs will be lost, more manufacturing jobs sent overseas, more homes foreclosed.

#6)  The pending financial reform bill threatens onerous new rules, regulations and taxes on banks and Wall Street. More jobs will be lost (and more banking and financial jobs sent overseas).

#7)  The pending new jobs bill threatens gigantic new taxes on every Sub Chapter S corporation in America. More jobs will be lost and more small businesses ruined.

#8)  The threat of a gigantic new national sales tax (VAT) on everything manufactured, bought and sold in America looms large. Fewer jobs, reduced consumer spending, more businesses closed forever.

#9)  Obama is pushing for the reduction or elimination of tax deductions (such as mortgage or charitable contributions) for high income earners (mostly small business owners). More jobs lost, reduced charitable contributions, and the real estate industry damaged beyond repair.

#10)  The threat of bans or restrictions on offshore oil drilling being put permanently into place. More jobs lost (and more jobs sent overseas where drilling is welcomed). As a bonus for Obama, he gets to ruin the Texas economy.

#11)  All signs indicate that Obama will soon propose to take the income cap off FICA (Social Security) taxes. If this were to happen, a successful small business owner (if there are any left) could see his or her FICA taxes alone go from an already bloated and burdensome $15,000 per year to an unimaginable $150,000 (or more). In U.S. history, no taxpayer has ever seen a TEN TIMES tax increase in one year. This devastating nightmare will wipe out small business and cause people that Obama calls “rich” to lose their homes and businesses.

#12)  A new I.R.S. law (with the passage of Obamacare) requires business owners to file thousands of new I.R.S. forms each year documenting virtually every expenditure made by their business. As a result of this blizzard of new paperwork, small business faces ruin.

#13)  Let’s not forget the gigantic tax hikes on the state and local level for income taxes, sales taxes, property taxes and new taxes disguised as “user fees.” Local taxes are already at levels that taxpayers and small businesses can no longer afford to pay.

#14)  Finally, Obama refuses to consider lowering the 2nd highest corporate tax rate (40%) in the industrialized world. As a result, more businesses will choose to leave the U.S. (and more jobs will be sent overseas).

And you wonder why there are no jobs? You wonder why there is no recovery? This is the “Teleprompter Depression.” Every time Obama steps in front of a teleprompter another business dies.

Each of these taxes and proposed taxes is a job killer. Taken together, the Obama regime’s policies are the equivalent of General Sherman’s march to the sea- leaving a tragic path of destruction in its wake. Obama has launched an unprecedented, overwhelming, death-by-tax assault on the groups that fund fiscally conservative causes and candidates: taxpayers and business owners.

There are only two reasonable explanations. Obama is executing a bumbling Marxist scheme to destroy capitalism, expand government to Soviet-like levels, and turn Americans into dependent serfs begging for government to save them, clothe them and feed them. “Bumbling” because the plan never works- eventually Obama will run out of taxpayers to rob, thereby bankrupting his own programs and bringing down his government. Or the other choice is that he is truly the most incompetent bumbling President in modern history. I’ll leave it to you to decide. (my emphasis)

By permission Wayne Allyn Root

www.rootforamerica.com

CLASSIC COMMENTARY: Rent Seeking and the Flight of Capital

Posted on October 4th, 2010
Wall St Driving by Pat Bagley, Salt Lake Tribune
By Ron Hera
©2010 Hera Research, LLC

The productive elements of the US economy are caught between powerful financial interests, e.g., banks seeking speculative gains, political constituencies seeking entitlements and government entities at all levels whose budgets and deficits are too large compared to their revenues. All three factions are competing for the same economic resources and all three are net consumers of wealth. The triumph of any one faction or of any combination thereof, promises to erode capital and to encumber production and economic growth in the future. As a consequence, capital can be expected to flow away from the United States to other parts of the world.

If banks dominate over government, for example, ever larger shares of tax revenues will likely flow to banks as a consequence of interest payments and taxes will certainly rise despite inevitable austerity measures. If government triumphs at the expense of banks, setting aside questions related to bank failures, bailouts or sovereign defaults, there is no reason to believe that government entities will become fiscally responsible or that the pattern of government expansion, as a percent of GDP, will reverse in the foreseeable future. The banking and financial services industries also represent a disproportionate share of US GDP. Political constituencies seeking entitlements are, in part, a reaction against and a consequence of disproportionate growth of government and of the banking and financial services industries. In advocating for or against any of the above factions, what seems to be ignored is where sustainable economic growth will come from in the future.

Surrounded on all sides are entrepreneurs and private capital, which are the historical engines of US economic growth. As the nation struggles to recover from the unprecedented global recession and the financial crisis that began in 2008, the competition between banks, government entities and political constituencies seeking entitlements represents a diversion of wealth and future production into economically unsustainable pursuits, such as bank profits, government stimulus or social welfare programs. In economic terms, the relationship of banks, government entities and political constituencies seeking entitlements to the productive elements of the economy can be described as one of rent seeking.

Rent seeking is a relationship where an individual, company or other organization seeks income by capturing the production of others through manipulation or exploitation of the financial, legal or political environment, rather than through ordinary market participation or the production of wealth. Analogous to parasitism in biology, rent seeking means obtaining an economic gain at the expense of others without any reciprocal benefit. Common examples of rent seeking include tariffs sought by industries for no purpose other than to boost profit margins and efforts by special interest groups to redistribute wealth in their favor by shifting tax burdens or government spending where there is no reciprocal benefit to any other group in society.

Businesses that produce physical goods, i.e., real production, along with labor and existing capital derived from past production surpluses are the targets of rent seeking strategies. The central question for economists is whether rent seeking is sustainable as an economic paradigm, i.e., as the dominant form of economic relationship in an economy. If so, spending by those who successfully gain control of wealth will stimulate economic activity in a sustainable way and the economy will return to genuine growth.

For example, economic growth might return as bank profits trickle down through the economy; or as government borrowing and spending or expansion stimulate the economy and create jobs, e.g., government jobs; or as social entitlements, such as guaranteed retirement incomes or medical care, prove to be more efficient and less costly to society when provided by government and funded by tax revenues rather than by private industry.

If it turns out, however, that rent seeking is not a sustainable economic paradigm, then the future of the US economy will be characterized by an erosion of capital and an absence of sustainable economic growth. One question that might arise in the latter scenario is whether capital will stay in the US or migrate to other parts of the world. The answer to this question lies in the nature of capitalism, as well as in the historical origins of American capitalism.

Property and Liberty

In terms of both economics and political philosophy, there are links between rent seeking where government is involved, the fundamental relation of individual citizens to the institution of the state, and macroeconomic developments in the US particularly since 1971. These links became increasingly clear since the start of the global financial crisis that began in 2008.

History bears out that capitalism, compared to other economic systems, has created more wealth, raised the living standards of more people, and has increased individual liberty to a greater extent. The reasons for the success of capitalism lie not only in economics but also in philosophy. The historical innovation and entrepreneurship and the immense industrial production of the United States in the past occurred both in the context of capitalism and in a social and legal framework established by the US Constitution.

Going back to the American Revolution and before, the ownership of an individual person of their own body and of the labor that it can produce literally distinguished a free person from a slave. This concept is the common root of private property and of capitalism. The natural right of a person to the fruits of their labor, i.e., to own property, is, therefore prerequisite to other rights. In his seminal book, The Road to Serfdom, F. A. Hayek explained the interdependence of private property, the division of labor and freedom.

“… [T]he system of private property is the most important guaranty of freedom. It is only because the control of the means of production is divided among many people acting independently that we as individuals can decide what to do with ourselves. When all the means of production are vested in a single hand, whether it be nominally that of “society” as a whole or that of a dictator, whoever exercises this control has complete power over us. In the hands of private individuals, what is called economic power can be an instrument of coercion, but it is never control over the whole life of a person. But when economic power is centralized as an instrument of political power it creates a degree of dependence scarcely distinguishable from slavery. It has been well said that, in a country where the sole employer is the state, opposition means death by slow starvation.” – F. A. Hayek, The Road to Serfdom (1944)

Of course, a human being is much more than an economic unit and the natural rights of individuals do not end with the absence of slavery, thus private property can be viewed as the keystone of all human rights. In fact, provisions of the American Bill of Rights, such as the prohibition against unreasonable search and seizure are an elaboration and enumeration of private property rights vis-à-vis the rights of government. Interestingly, the American Bill of Rights contains broad prohibitions against actions by government, rather than positive rights, such as the right of an individual to a particular social benefit.

In the modern world, private property and, therefore, other rights are not threatened directly by violence and coercion as they were prior to the American Revolution, but they are threatened today by excessive growth of government, by private concerns pursuing rent seeking profit strategies and by political constituencies seeking entitlements.

Taxes levied on privately owned businesses or on private individuals for the purposes of social welfare programs function as a proxy for rent seeking in that they affirm a positive right to an economic benefit for one group at the expense of another group that receives no reciprocal benefit. For example, the establishment of a legal right of a person with no means to pay for it, to obtain medical care, takes precedence over the property rights of individuals who have the means to pay for medical care on their own behalf. In the example of medical care, it is likely that those upon whom the financial burden falls have little or no objection to the arrangement because a majority of individuals probably believe that their contribution is for a worthy cause, but the precedent of government intervention over volunteerism is a dangerous one from the standpoint of individual rights.

While one group bears the economic cost, even if the only cost is reduced access to medical care or reduced quality of care, there is a more broad cost to society in terms of the erosion of individual rights. In a rent seeking economic relationship where government is the agent of wealth transfers, it is not only exploited groups that loose rights but, in fact, all citizens. When wealth is transferred or redistributed by government, rights removed from exploited groups are not transferred to groups that receive the resultant economic benefits but rather accrue to the government itself, thus diminishing the rights of all and expanding the power of government, i.e., the power to claim the wealth of it’s citizens for whatever purposes are deemed worthy.

“The preservation of freedom is the protective reason for limiting and decentralizing governmental power. But there is also a constructive reason. The great advances of civilization, whether in architecture or painting, in science or in literature, in industry or agriculture, have never come from centralized government.” – Milton Friedman, Capitalism and Freedom (1962)

While wealth transfers may be undertaken with the best intentions, over time, the eventual consequence is an aggregation and concentration of power in government at the expense of individuals. Among other things, a precedent is established whereby rights are granted by government to citizens and not the reverse. Wealth transfers by government, therefore, result in the expansion and centralization of economic and legal power in the government at the expense of the rights of individual citizens.

In the extreme, the flow of rights from individuals to government may eventually result in a totalitarian state structure where rights per se no longer exist, or exist in name only, replaced, in practice, by privileges granted by government at its sole discretion. In terms of political philosophy, a constitutional republic aims to prevent totalitarianism (historically referred to as tyranny) by establishing that the people are sovereign and that the limited rights of government are granted to it at the sole discretion of the people. In contrast, an economic system, based on government redistribution of wealth, is ultimately incompatible with a structure where the people are sovereign, i.e., a constitutional republic, simply because wealth redistribution requires that the rights of government take precedence over the property rights of individuals.

There’s been one underlying basic fallacy in this whole set of social security and welfare measures, and that is the fallacy – this is at the bottom of it – the fallacy that it is feasible and possible to do good with other people’s money. That view has two flaws. If I want to do good with other people’s money, I first have to take it away from them. That means that the welfare state philosophy of doing good with other people’s money, at its very bottom, is a philosophy of violence and coercion. It’s against freedom, because I have to use force to get the money. In the second place, very few people spend other people’s money as carefully as they spend their own. The real problem with government is not the deficit. The real problem with government is the amount of our money that it spends.   – Milton Friedman

There’s been one underlying basic fallacy in this whole set of social security and welfare measures, and that is the fallacy – this is at the bottom of it – the fallacy that it is feasible and possible to do good with other people’s money. That view has two flaws. If I want to do good with other people’s money, I first have to take it away from them. That means that the welfare state philosophy of doing good with other people’s money, at its very bottom, is a philosophy of violence and coercion. It’s against freedom, because I have to use force to get the money. In the second place, very few people spend other people’s money as carefully as they spend their own. The real problem with government is not the deficit. The real problem with government is the amount of our money that it spends.

If the basic economic rights of individuals are undermined and government power expands, becoming more centralized, then controlling government spending may be problematic, particularly if doling out entitlements is central to the political goals of the regime in power, e.g., remaining in power. As has been seen in Europe, government spending for the purposes of expanding entitlements is constrained only by the capacity to borrow and to service debt, which is a pattern that can lead to economic collapse.

“A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefits with the result the democracy collapses because of the loose fiscal policy ensuing, always to be followed by a dictatorship, then a monarchy.” – Scottish historian Alexander Fraser Tytler, Lord Woodhouselee (1747-1813), unverified attribution.

Totalitarianism: Public or Private?

Wealth redistribution is not the exclusive domain of government. Inflationary policies by the US Federal Reserve erode the value of money and dilute the share of wealth held by those who depend on the monetary system while transferring wealth either to banks or to those who first receive newly created money. The institution of central banking is itself a form of rent seeking where governments borrow their own currencies into existence from private banks passing the burden of repayment with interest on to taxpayers, e.g., as a value added or income tax, rather than maintaining the national currency as a public facility.

Central banking is associated both with economic rent seeking insofar as private interests successfully influence the central bank in their favor, and with political philosophy where the rights of individuals are concerned, e.g., monetary inflation deprives savers of the right to spend tomorrow money obtained in exchange for labor today at a value consistent with the terms of the exchange. In the latter case, the central bank produces a de facto breach of contract that is technically legal. As John Maynard Keynes famously said, “By a continuing process of inflation, government [or private interests that control the central bank] can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

In this regard, one can see the extent of the powers abdicated by governments to central banks. Central banks have the power to redistribute wealth and can do so either at the behest of government or, more importantly, in the service of private concerns.

The advent of bank bailouts, amounting to roughly $4 trillion in the US officially, but perhaps as much as $23.7 trillion, during the global financial crisis that began in 2008 was remarkable for two reasons other than the danger of systemic collapse thus averted and the amounts of money involved. First, it became apparent that large banks, and central banks, had more influence over governments than their own citizens. In fact, a majority of Americans opposed bank bailouts.  Second, the power of central banks to transfer wealth was laid bare by the Federal Reserve’s purchase of mortgage backed securities which traded newly created money for what most observers agree was little more than worthless paper in an attempt to render otherwise bankrupt financial institutions solvent again.

The independent actions of the US federal government and Federal Reserve produced record profits and bonuses in the banking sector while, at the same time, household wealth in America fell significantly, creating the popular impression that Wall Street was somehow looting Main Street. The mechanism of wealth transfer, however, was actually the Federal Reserve, which had then been in place for 94 years prior to the crisis and during which, arguably, a similar process of wealth transfer had taken place gradually on a smaller scale.

The arbitrary and sweeping nature of the emergency actions taken by the federal government and Federal Reserve in response to the financial crisis revealed the extent to which the powers of both the federal government and Federal Reserve had quietly expanded and become more centralized over a period of less than 100 years to a point of near absolute control over the wealth, i.e., the property, of US citizens. The roots of these developments, however, lay not in the economic bubbles leading up to the financial crisis that began in 2008 but in the 1913 Federal Reserve Act and in the New Deal that followed the resulting Great Depression.

“Legal plunder can be committed in an infinite number of ways; hence, there are an infinite number of plans for organizing it: tariffs, protection, bonuses, subsidies, incentives, the progressive income tax, free education, the right to employment, the right to profit, the right to wages, the right to relief, the right to the tools of production, interest free credit, etc., etc. And it is the aggregate of all these plans, in respect to what they have in common, legal plunder, that goes under the name of socialism.” – Frederic Bastiat, The Law (1848)

After World War II, the United States had embraced labor unions and social programs partly in response to the ideological struggle between the US and the Soviet Union, which was a totalitarian state, but the US, while fighting totalitarianism, planted the seeds of totalitarianism in its own backyard. Following decades during which social welfare programs expanded, and during which both the federal government and the financial sector grew dramatically as percentages of US GDP, the centralization of power revealed in 2008 indicated a largely unrecognized shift in political philosophy toward a totalitarian state structure.

A Monetary Empire in Decline

Perhaps every empire in decline witnesses a transition from surplus production to excess consumption and that is precisely what happened in the United States in the 1970s, marked first (after the establishment of the US Federal Reserve and then of a welfare state by President Franklin Delano Roosevelt) by the final abandonment of the gold standard in 1971 then by the 1975 shift from trade surplus to trade deficit. Both events were a consequence of spending in excess of real wealth production.

These events ushered in the era of offshoring in the 1980s and of outsourcing to foreign firms in the 1990s. The idea was simple: exchange higher domestic costs for lower costs abroad and sell virtually the same products to the same domestic customers at higher margins, lower prices to gain market share, or simply hold prices at competitive levels by cutting costs. Under the banner of free trade, and later of globalization, the US government did virtually nothing to curtail these trends and the US economy appeared to expand as US dollars flooded the world in an unprecedented period of monetary expansion. As the accompanying deindustrialization of the United States progressed, two developments, in addition to the then accumulated capital in the US, mitigated the impact of declining US industrial production: (1) growth in service industries and (2) a combination of asset appreciation and increased consumer borrowing and spending (eventually reaching an unsustainable 70% of GDP), but both were fundamentally linked to monetary expansion and neither proved to be sustainable.

Replacing industrial production with a service economy was a flawed concept because as domestic production fell, it was, in fact, debt expansion that replaced the creation of real wealth, thus the US trade deficit soared. As factories closed and as jobs departed US shores for Taiwan, China, India and elsewhere, the selling of equivalent foreign-made goods and offshore services to Americans into a domestic market that included a growing number of displaced workers, became less and less plausible. The idea that displaced American workers would eventually embark upon new, service industry careers and, therefore, maintain their spending levels, in retrospect, was plainly wrong.

While perhaps viable in a perfectly balanced global economy, it is difficult to imagine a sustainable domestic economy, in itself, comprising a majority of services since it would have to rely on material goods from abroad, i.e., it would suffer a chronic trade deficit. The answer for American businesses was to expand into global markets but this did little for the domestic economy, thus the US service economy failed to replace declining industrial production. What happened, in reality, was that the percentage of the total US population in the work force simply declined, flooding welfare roles and producing a growing political constituency favoring wealth redistribution.

Chart courtesy of the Federal Reserve Bank of St. Louis

One way to characterize the sequence of events in the US is to say that a paradigm shift took place where the US economy moved from production to consumption; from an industrial economy to a (so-called) service economy; from wealth creation to wealth extraction; from increasing living standards to wealth redistribution; from a nation of citizens and workers to a nation of “consumers,” all the while transitioning from the largest lender in the world to the largest debtor nation in the entire history of the world.

In terms of US government spending, unsustainable growth in entitlements and pork barrel politics became business as usual in Washington D.C., while Wall Street shifted from investing, in order to participate in dividends and capital gains resulting from production and value creation, to trading based on technical indicators; a competition where participants seek to extract wealth from investors and other traders in what amounts to a casino game, i.e., a rent seeking structure. Flash trading using automated trading systems and high-frequency trading algorithms, for example, is pure rent seeking in the garb of high technology.

Other advanced economies, in varying degrees, have followed the American example, resulting in the emergence of rent seeking as the dominant economic paradigm of Western countries. To make matters worse, rent seeking by private concerns has become confused with capitalism.

The Flight of Capital

In the past, capital and individual entrepreneurs flowed into the United States from around the world because it represented two related things: freedom and economic opportunity. The post bailout world is one where large banks have, to some degree, hijacked the emergent totalitarian powers of governments in a model where perpetual sovereign debt represents a virtually unlimited flow of wealth from the subjects of totalitarian states to the banks that, through the institution of central banking, exert considerable influence over each nation’s government. The post bailout economy seems to be a veritable frenzy of rent seeking activity by banks, governments and political constituencies seeking entitlements. In all three cases, individual liberty, e.g., the right to own property is an impediment and the success of any of the three factions promises to encumber or to prevent entirely future economic growth.

It makes little difference to individuals if the fruits of their labor are confiscated by inflation, by taxes to fund unsustainable government expansion, or by taxes to fund social welfare programs. In all three cases, the impetus toward entrepreneurship and the incentives for putting private capital, i.e., private property, at risk in new business ventures are reduced or eliminated.

Regardless of which rent seeking faction wins, capitalism, which has created more wealth, raised the living standards of more people and which, because of its intrinsic compatibility with private property, has increased individual liberty more than any other economic system in the history of the world, is set to lose.

Capitalism, rather than ceasing to exist, will obviously adapt, thus capital will migrate away from economies characterized by rent seeking, i.e., by the consumption of wealth, to parts of the world characterized by the production of wealth. Capital may also be driven into black markets as seen under the former Soviet Union. All other things being equal, the next decade is likely to see a massive flight of capital from the United States to countries where property rights are respected (or where government is simply smaller) and where the values of investments are less vulnerable to the ravages of excess monetary expansion, counterproductive taxation and sovereign debt risk or redistribution by government in the service of political constituencies seeking entitlements.

Within the latter constraints, China and emerging economies that are rich in natural resources and that produce commodities or physical goods will surely become the new bastions of capitalism.

By permission Ron Hera Research
www.heraresearch.com

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US Government and Financial Elites Deceive Us

Posted on September 17th, 2010

Truth Lies RoadsignNOTE: This article exemplifies exactly some of the goals of What Am I Missing Here?. Ron Robins very thoughtfully discusses how “The US government and financial elites are in many ways deceitful,” and adds that “The deceit comes in many guises.”

He concludes by saying “Welcome to the Land of the Free where deceit is alive and well in the US government, the Federal Reserve and on Wall Street.” We are in total agreement with his comments, but would add that the mainstream media is also very involved, and remains very active in this deceit, misinformation and propaganda.

I should also mention that this article was featured at alrroya.com, which is an Arabic and English Middle East newspaper, located in Dubai Media City. Interesting that only a couple of U.S. blogs picked up this story.

By Ron Robins, Founder & Analyst – Investing for the Soul

The US government and financial elites are in many ways deceitful. Directly and indirectly, they promote debt and consumption as a drug dealer promotes cocaine. Drugged by manipulated and low interest rates, Americans believed the messaging of the US government, the Federal Reserve and Wall Street propaganda that affluence was forever and that all they needed was a credit card and stocks for a heavenly life. From massive hidden government debt and massaged statistics to Enron style bank accounting and securities’ frauds, these institutions deceive us.

The deceit comes in many guises. One of the greatest deceits is the masking of huge future financial problems associated with US government debt. Professor Laurence J. Kotlikoff, Professor of Economics at Boston University, says the US, and even IMF data, reveal that the US is already bankrupt. That is due to its unfunded Medicare, Medicaid, Social Security, defense and other liabilities totalling $202 trillion, or over fourteen times the annual US gross domestic product (GDP) of a little over $14 trillion.

Americans are also deceived by the reported US government budget deficits. The 2009 deficit was advertised as $1.417 trillion. But John Williams at shadowstats.com says the US government’s own figures show that using the same accounting methods that businesses are required to use reveals an enormous $4.3 trillion 2009 deficit. That is the real accounting deficit and equal to about 30 per cent of US GDP. To cover it would mean an immediate doubling or more of US taxes!

Professor Kotlikoff says what America urgently needs is financial and policy ‘heart surgery,’ and not the Band-aid solutions recently passed on healthcare and financial reform. Otherwise, he says, hyperinflation will eventually rule. But the US government and their Wall Street cohorts continue to ignore such insightful calls to action, thereby continuing to deceive the public of the seriousness of the issue.

Most government statistics are somewhat deceitful too. Every US government in recent times, whether it was the administrations of Bill Clinton, the Bush’s or Barack Obama, has allowed the US Bureau of Labor Statistics (BLS) to massage its statistics that, funnily enough, after revisions, almost always show the US economy to be doing better than before. One wonders if it might also have something to do with the head of the BLS always being a political appointee.

The consumer price index (CPI), unemployment rates and gross domestic product (GDP), undergo almost continual ‘refinement’ making comparisons with previous periods often impossible. I wrote about these problems in my alrroya.com column of August 3, “Unethical Statistics Lead us Astray.”

Another deceit of the financial elites is the valuing today of some bank and financial assets at virtually whatever the banks feel they are worth. How would you like to up the value of your home from $500,000 to $800,000 because the software you wrote for your computer model said it was ok to do so? Welcome to Bank Finance 101.

US Congressional leaders and banks in April 2009 effectively forced the Financial Accounting Standards Board (FASB)—which governs US accounting reporting standards—to adjust its rules on how some bank assets are valued. The resulting changes to FASB’s rules gave banks the ability to value certain assets however they wanted to. This meant they were able to revise the values of some assets higher. Subsequently and miraculously, bank stocks rose and banks showed big profits after previous huge losses.

But residential and commercial foreclosures continue to grow and real estate asset values are either stagnant or again falling. Hence, due to the FASB ruling and other government actions—too many to detail here—the real asset value of most banks is probably somewhat lower than reported. Therefore, they are fictional and probably deceitful. The US government, financial elites, and many astute investors know this too.

The Federal Reserve (or Fed) likes to make statements that help guide the direction of individuals and businesses’ economic actions. For many years, their intent or remarks were akin to real estate sales people saying that it is always a good time to buy. Individuals and businesses believing in the Fed’s infallibility—and luring them with ultra low interest rates—purchased homes and expanded their businesses, only to later realize that they had been led down the path to major losses. In fact, evidence could suggest they were sacrificial lambs in order to maintain an appearance of economic growth that the Fed was desperate to create. Thus, the Fed is probably guilty of deceit too.

Wall Street seems guilty of many major deceits. Even though firms such as Goldman Sachs knew of the enormous potential losses associated with mortgage backed securities (MBS), they continued selling them anyway. Furthermore, with such massive and recognized possible fraudulent MBS and related securities involving Wall Street and the banks, where are the prosecutions? Is deception involved here too?

The Securities Exchange Commission (SEC) and the US Justice Department might be just a little deceitful as well by being too close to Wall Street operators and thus minimising sentences to those on Wall Street found guilty of financial crimes. Three judges implied this in their recent remarks in cases involving Wall Street shenanigans. (See “US Judges Sound Off on Bank Settlements,” The New York Times, August 23.)

Increasingly, Americans and people all over the world are realizing that the US government and its financial elites have been deceitful in many ways. The deceit includes: masking the reality and consequences of an unsustainable government debt spiral; statistical adjustments that make the economy look better; accounting standards changed to make banks appear solvent when they may not be; promoting excessive debt as the salvation for the populace; and probably unprecedented, unprosecuted, financial deception by some Wall Street elites.

In the US democracy does not always equal honesty and integrity. Financial dealings are not all truthful. Fraud seems to go unpunished and punishment does not fit the crime. Welcome to the Land of the Free where deceit is alive and well in the US government, the Federal Reserve and on Wall Street. (my emphasis)

By permission Ron Robins
And by http://english.alrroya.com/
http://english.alrroya.com/node/56426

CLASSIC COMMENTARY: The Law? How Quaint! The Law Be Damned.

Posted on September 16th, 2010

Immigration Policy by Gary McCoy, Cagle Cartoons

By Victor Davis Hanson

We are well into revolutionary times, but perhaps not in the way we traditionally think of political upheaval. Instead, insidiously, the law itself is becoming negotiable — or rather, it is becoming subservient to what elite overseers at any given time determine is a higher calling of social change.

Of course, progressive federal judges have been creating, rather than interpreting, law for decades. Yet seldom in memory have we seen such a systematic attack on our framework of laws as the present assault from the executive branch.

Federal immigration statutes mandate a clearly defined American border, which aliens may not cross without authorization. Yet the Obama administration not only does not fully enforce those statutes (in this regard, it is not behaving much differently from the prior administration), but also is preparing to sue the state of Arizona for implementing enforcement that follows the intent of neglected federal laws on the books. Apparently, the president believes that enforcement of existing law is a bargaining chip that can be used to obtain “comprehensive immigration reform” — a euphemism for blanket amnesty.

Other states and even cities are now marching in lockstep to boycott Arizona. Meanwhile, the president of Mexico recently blasted Arizonans from the White House Rose Garden, no less, apparently counting on the president of the United States to go along with this demonization of one of his own states. All this is eerie; it has a whiff of the climate of the late 1850s, when the federal government was in perpetual conflict with the states, which in turn were in conflict with one another, and which often appealed to foreign nations for support.

Recently, as if on cue, the secretary of labor, Hilda Solis, produced a video advising workers to contact her office should they feel that they have been shorted wages by their employers.  Fair enough.  But then she goes on to explicitly include workers who are not documented and to promise them confidentiality, i.e., de facto federal protection for their illegality:  “Every worker has a right to be paid fairly, whether documented or not.”

“Undocumented” is part of the current circumlocution for breaking federal law and residing here illegally.  In short, although Solis is a federal executive sworn to uphold existing federal law, she has decided which laws suit her and which do not. She rightly promises to pursue lawbreaking employers, but quite wrongly not to pursue lawbreaking employees.

Yet when we become unequal before the law, the entire notion of a lawful society starts to erode. If Secretary Solis has decided that lawbreaking aliens can in confidence count on her protection, then can those who don’t pay their taxes (perhaps citing some sort of prejudice) likewise find exemption from Treasury Secretary Geithner?  Can citizens pick and chose their particular compliances — run red lights, but still want shoplifters arrested?  Break the speed limit, but insist that cars stop at crosswalks?  Do questions of race, class, and gender determine the degree to which the federal government considers enforcing existing law?

Recently in Port Chester, N.Y., a federal judge made a mockery of the concept of one man, one vote.  Apparently the magistrate felt that Hispanics in Port Chester needed help to elect someone with whom they can identify along racial lines.  So, to ensure the election of an Hispanic to the village Board of Trustees, the judge created a system of cumulative voting.  Each voter was given six votes, and the explicit hope was that Hispanics would give all their votes to Hispanic candidates, voting on the basis of race rather than policy.  Now we hear this may well become a precedent that the federal government will use to ensure diversity elsewhere.

When an “Hispanic” was duly elected as one of the six trustees, the judge and other observers were pleased that Hispanic voters had achieved the intended result.  There was no thought, of course, about what constituted “Hispanic.”  Does it require three-quarters Hispanic blood?  One-half?  One-quarter?  One-eighth?  Does Puerto Rican count, but not Spanish?  Mexican, but not Portuguese or Basque?  There was also no thought about whether such racial pigeonholing was good for the country.  After all, focusing on race, while violating the cherished notion of each citizen enjoying one — and only one — vote, might also conjure up some disturbing memories from our not-too-distant past.

BP has acted in derelict fashion in the Gulf. But that does not justify the Obama administration’s decision — without a court order and without legislation passed by Congress — to ignore past legal precedent capping oil-company liability.  Instead, this administration promises to “kick ass” and put a “boot on their necks” until BP coughs up, say, $20 billion in reparations.  If a president by fiat can demand $20 billion from a corporation to create a payout fund, why not $30 or perhaps $100 billion?  Or better yet, in South American style, why not simply nationalize BP altogether?

We saw something like this before from the Obama administration, when it bailed out the bankrupt Chrysler Corporation and by executive order overturned the legally determined order of creditors. “Senior” creditors were to have been, by contract, the first paid, while junior creditors waited in line. But the latter group included union workers.  So Obama derided the senior lenders as “speculators” and simply put his own constituents and campaign donors in front of them.  The first sign of a debauched society is that it does not honor contracts, but reinterprets them according to perceived political advantage.

Now there is talk of an executive decree from the Environmental Protection Agency to implement provisions of cap-and-trade legislation that Congress will not pass.  Republican senators are already worried that the administration will likewise simply begin to grant amnesty to illegal aliens en masse, without introducing such a proposal to Congress, which alone has the right and responsibility to make our laws.  And the recent executive order to ban all offshore drilling in the Gulf clearly circumvented the legal process.  (Does the government have the right to shut down every flight if one airplane crashes, or to mothball all nuclear plants should one leak?)  Instead of putting a moratorium on the sort of deep-drilling procedure and pipe fittings that BP used, the Obama administration simply issued a blanket ban on all offshore drilling — as if the real intent was not to allow the crisis of an oil spill to go to waste in the larger environmental effort to reduce carbon emissions.

What do all these ends-justify-the-means examples portend? Mostly, they reflect an effort by a technocratic class to implement social change through extralegal means if it finds that its agenda does not meet with public approval.  In some sense, the Obamians have lost all faith that our democracy shares their vision, and so they seek to impose their exalted will by proclamation — as if they are the new Jacobins and America is revolutionary France throwing off the old order.

In late 2008, the liberal hope was that an elected President Obama, with large Democratic majorities in both the Senate and the House, could do just about whatever he wanted.  But then a number of obstacles arose, from occasionally recalcitrant Democratic legislators to bothersome things like filibusters.  In response, Obama was not content with achieving his liberal ends, but sought to change the very means of obtaining them; even New York Times columnists suddenly resented the calcification of American politics, and pointed to the ease with which dictatorial China can simply impose green change.

Note the logic of all this.  Federal officials determine a supposed good and then find the necessary way to achieve it. The law be damned. “Diversity,” unions, environmentalism — any of these anointed causes trumps the staid idea of simply following the letter of the law.

The final irony? It was law professor Obama who campaigned on respect for the rule of law as he serially trashed elements of the Bush administration’s war on terror — almost all of which he subsequently kept or expanded.  Note how what was deemed illegal before 2009 has suddenly become quite legal and worthy of emulation and indeed expansion. (my emphasis)

As Obama’s polls continue to erode and congressional support for his agenda further dwindles, expect his cabinet to continue to seek ways around the enforcement of existing law. You see, in the current climate, the law is seen as retrograde, an obstacle to the advancement of long-overdue social change — which is to be implemented by a law professor and a past fierce critic of George Bush’s supposed constitutional transgressions.

While the media still rail about fanciful threats to constitutional stability from right-wing Tea Party types, we are getting real usurpation — but with a hope-and-change smile.

By permission of Victor Davis Hanson

www.victorhanson.com

CLASSIC COMMENTARY: PRESERVE & PROTECT Mapping the Tipping Points

Posted on August 25th, 2010

Summer Camp by Jeff Parker, Florida Today

By Gordon T. Long

The economic news has turned decidedly negative globally and a sense of ‘quiet before the storm’ permeates the financial headlines. Arcane subjects such as a Hindenburg Omen now make mainline news. The retail investor continues to flee the equity markets and in concert with the institutional players relentlessly pile into the perceived safety of yield instruments, though they are outrageously expensive by any proven measure. Like trying to buy a pump during a storm flood, people are apparently willing to pay any price.  As a sailor, it feels like the ominous period where the crew is fastening down the hatches and preparing for the squall that is clearly on the horizon. Few crew mates are talking as everyone is checking preparations for any eventuality. Are you prepared?

What if this is not a squall but a tropical storm, or even a hurricane? Unlike sailors, the financial markets do not have the forecasting technology for protection against such a possibility. Good sailors before today’s technology advancements avoided this possibility through the use of almanacs, shrewd observation of the climate and common sense. It appears to this old salt that all three are missing in today’s financial community.  Looking through the misty haze though, I can see the following clearly looming on the horizon.

Since President Nixon took the US off the Gold standard in 1971, the increase in global fiat currency has been nothing short of breath taking. It has grown unchecked and inevitably has become unhinged from world industrial production and the historical creators of real tangible wealth.

Do you believe trees grow to the sky?

Or, is it you believe you are smart enough to get out before this graph crashes?

Two Inflection Points

Apparent synthetic wealth has artificially and temporarily been created through the production of paper. Whether Federal Reserve IOU notes (the dollar) or guaranteed certificates of confiscation (treasury notes & bonds), it needs to never be forgotten that these are paper. It is not wealth. It is someone else’s obligation to deliver that wealth to the holder of the paper based on what that paper is felt to be worth when the obligation is required to be surrendered. It must never be forgotten that fiat paper is only a counter party obligation to deliver. Will they? Unfortunately, since fiat paper is no longer a store of value, it is recklessly being created to solve political problems. What you will inevitably receive will be only be a fraction of the value of what you originally surrendered.

In the chart above, we see that just when the exponential expansion seemed to have run its course during the dotcom bubble implosion, we subsequently accelerated even faster. Cheap central bank money; the unregulated, off-shore, off-balance sheet increase in securitization products; a $617T derivatives market; and the domination of the credit producing Shadow Banking system then took us to even greater levels. Bubble after bubble continues to propel us, as more recently the Bond Bubble replaced the Real Estate bubble.  Similar to trees not growing to the sky, something always happens which creates a tipping point, a moment of instability or a critical phase transition. Suddenly what worked no longer works.

I have written extensively in a series entitled “Sultans of Swap” and another series entitled “Extend & Pretend” the growing and clearly evident tipping points that are unquestionably now on the horizon. You can ignore them at your peril, but when the storm swells hit, don’t say you were never warned and no one saw this coming. 

Evolving Transition

Consolidating the trends and distortions outlined in these two series, we arrive at the following ‘large brush’ death spiral leading to a failure of fiat based currency regimes.

Consumer Lending Crisis

The above cycle is well supported by recent and still unfolding developments. These have been mapped onto the cycle.

Fiat Currency Structure Failure

MAPPING THE TIPPING POINTS

Let’s now list the Tipping Points which have become abundantly evident over the last few years and which are continuously expanded on our web site Tipping Points.  We track each of these on a daily basis on the site.

SEQUENCE & TIMEFRAMES

We can never be sure of the sequence and time frame of any particular Tipping Point. Like a house of cards you never know which one, or what movement will precisely bring the house of cards down. What you know however, is that it will happen – you just need to be patient and prepared. Unfortunately few have the patience or think they can time it for even more profit. The greatest trader of all time, Jesse Livermore, wrote after a life time of trading, that his best gains were made when “he bought right and sat tight!”

Our current analysis on Tipping Points reflects the following:

Techtonic Shift

DETERMINING MORE GRANULARITY – We are in the 2010-2011 Transition Phase

 Evolving Transition 2

In my articles EXTEND & PRETEND: A Guide to the Road Ahead  and EXTEND & PRETEND: A Matter of National Security I outlined even more granularity to the virtuous cycle turning vicious spiral.

The Road Ahead

We can now overlay the Tipping Points onto this map. We arrive at the following.

 A – EXIT FROM ECONOMIC CRISIS STAGE

  • Commercial Real Estate – Finally forced to account properly for mark-to market valuations.
  • Housing Real Estate – Option ARMS come due and FHA / FNM / FDE / FDIC are seen as insolvent.
  • Corporate Bankruptcies – Unfunded Pension impacts and debt loads (gearing) on reduced revenues.
  • State, City & Local Government Financial Implosion – Non Accrued Pension Obligations, falling tax revenue and years of accounting gimmicks come home to roost.
  • Central & Eastern Europe – The ‘sub-prime’ of Europe will soon erupt on the EU banking network as evidenced recently by Hungary and the Baltic States.

TRANSITION: 

HIGHER INTEREST RATES

Significantly Increasing Interest Rates – A Major Global News Focus

A $5T Quantitative Easing (QE II) Emergency Action

It will likely be triggered by a geo-political event or false flag operation.

B – ENTER POLITICAL CRISIS STAGE

  • Entitlement Crisis –  The unfunded and underfunded Pension charade ends
  • Credit Contraction II – Credit Shrinks Violently
  •  Banking Crisis II – Banking Insolvency no longer able to be hidden through Extend & Pretend.
  • Reduced Rating Levels  – Falling Asset Values and Collateral Calls on $430T Interest Rate Swaps
  • Government Back-Stopped Programs –  FHA, Fannie Mae, Freddie MA, FDIC go bust

C – HITTING ‘MATURITY WALL’ STAGE

  • Lending ‘Roll-Over’ – Game Ends

CONCLUSION

A recent Zero Hedge contributing author summarized the current environment nicely:

“There is an entrenched insolvency problem in the United States, and a picture is worth a thousand words. Insolvency is not illiquidity; insolvency is about income that can’t service debt burden. Notice where things fall off the cliff: I believe we are getting close to this point. Just need a catalyst. Sequential bond auction failures here, a sovereign default there, massive liquidity drain all around, worse… whatever. The fumes running the engine (QE, or credit easing) are dwindling.”

Chasing Waterfalls

There is an old sailor’s saying:

Red sky at night, sailors delight.

Red sky in the morning, sailors take warning!

Every morning the next batch of economic numbers is released and the indications are consistently red. Of course the market initially drops, and then miraculously rises on no volume. Since 2007 we have potentially constructed the largest head and shoulders topping formation we have ever seen.

This doesn’t mean the markets are imminently headed down. What it does mean is you should be meticulously battening down your financial hatches and checking your options for every eventuality.

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

Follow daily Tipping Point developments at Tipping Points

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By permission Gordon T. Long  Tipping Points

Mr. Long is a former senior group executive with IBM & Motorola, a principle in a high tech public start-up and founder of a private venture capital fund. He is presently involved in private equity placements internationally along with proprietary trading involving the development & application of Chaos Theory and Mandelbrot Generator algorithms.

Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, you are encouraged to confirm the facts on your own before making important investment commitments.

© Copyright 2010 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or recommendation you receive from him.

Classic Commentary: The Great Inflation

Posted on August 11th, 2010

Inflation MagnifiedBy Jason Tillberg, President of Tillberg Capital Management, Inc.

The title of my article is the title of a book I recently got from the library. It was written in 1975 by William Guttmann and Patricia Meehan and is about the period in Germany from 1919 – 1923.

The title of Chapter 1 is “A license to Print Money” and starts off with a quick story from a play written a century prior called “Faust” by a famous German Poet named Goethe. In his play, there is a scene where the Emperor, who sold his soul to the Devil, Mephistopheles, is lacking money and asks the Devil to create it. The Devil accepts this task and a prototype note is created and multiplied a thousand times by magicians overnight. The Chancellor then gives the Emperor the note that has turned an ill into a good.

The authors go on to write on pg. 42 from this book:

It is fitting that licence to print money should have originated with a spirit akin to the Devil, the father of lies. The currency of Germany during the inflation years was a gigantic lie, which the nation recognized for what it was only in the last stage. (emphasis mine) The road to inflation, like the road to hell, is paved with good intentions, and it was to turn “ill into good” that the German government gave the licence to print money.

I can’t help but recall the speech our Federal Reserve Chairman, Mr. Ben Bernanke, gave in November of 2002, known as his Helicopter Speech, in which he stated:

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.

I’m in no way suggesting any of our members of Government or Federal Reserve have made any deals with the devil. Although the lesson is that the intentions may well be benevolent, to turn ill into good, i.e. cut taxes and run massive deficits to provide long unemployment benefits (99 weeks), free healthcare, food stamps for 1 in 7/8 citizens (non citizens?), etc., the future ramifications may well be disastrous and lead to ruin. Whether or not we’re on the road to hell is to be seen, but we’re more or less playing our cards, moving our pieces in this game that has that particular outcome if not played right.

Ron Paul puts it this way: (Sic) Money does not grow on trees for if it did, it would become as leaves do, either bagged up and thrown away or chopped up and used as mulch.

The Germans didn’t realize that until 1923 (ultimate collapse was in November of 1923) when in fact, the money was bagged up, burned to heat the home and used to wallpaper walls. Believe it or not, in the summer of 1922 in Germany, unemployment was less than 1%. (pg. 26) Since the mark was so weak, demand for German exports was very strong, thus taking advantage of cheap German made goods. Ill of unemployment turned good.

The German hyperinflation experience is one we can all learn from. Investing or even preserving our wealth is serious business and demands a fierce objective analysis.

We’ve already seen the massive explosion in the Fed’s monetary base (the ultimate measure as best I know, I could be wrong, of how much printing our Fed is willing to do) and there is no telling how much higher or when the printing will resume as there are many ills out there, from state budget deficits to unfunded pensions to a broke FDIC, under-funded Fannie (FNM) and Freddie (FRE), 30 million working age Americans either unemployed or underemployed, etc.

BASE

I’d like to remind Americans that in 1792, our Coinage act, (http://www.ft.com/indepth/lehman-brothers) section 19 had a strict law that the debasement of coin was punishable by death. Founding Fathers knew of the evils of debasement of currency.

Fast forward nearly 200 years, since we have been off the gold standard August 15, 1971, the US (via Congress) has more or less given the Federal Reserve the license to print money – with benevolent intentions of low unemployment and stable prices.

I’ll let you draw your own conclusions about whether we’ll see more deflation from credit contraction or inflation from money printing disbursements via more Government Transfer Receipts (social security, medicare, food stamps, unemployement benefits, etc.). See 2 charts below.

Total Loans and Leases at Commercial Banks

Total Personal Current Transfer Receipts

PCTR

But, if we are on the road to hell and we’re destined for a stage when it turns out our currency was a big lie, like Germany’s, then there are ways to perhaps increase chances of preserving one’s wealth.

In Germany’s hyperinflation road to ruin, there were winners and there were losers.

From this book, there is a chapter on the winners and a chapter on the losers. I’ll summarize briefly, the winners and the losers.

Winners in Germanys’ hyperinflation:

Anyone who either had foreign currency, gold, silver, or earned incomes in foreign currency. One example is foreign students in Germany who had been receiving their allowance in Swiss francs or British pounds, found themselves rich and able to buy German Real Estate at highly depressed prices in their native currencies as well as increase their standards of living by staying in the best hotels, attracting the prettiest girls, etc.

Importer/Exporters who had access to foreign currency and could hold those currencies for a few days extra before converting to German Marks to profit from the exchange rate change.

Bankers/Money Changers exploited this situation for their own gain by trading in the currency markets and using to their advantage the time before converting back to marks in their trades. (Those folks were later highly resented.)

Renters: Rent control kept rents of flats (a great majority of German people were renters) down, making rent payments by 1922 constituting less than .5% of total household incomes, next to nothing. (Landlords of residential buildings lost out greatly as not only were rents low but fixtures and anything else of value in many cases were stolen to be used to barter for food.)

Those that were privileged to have taken great advantage of Germany’s poor state of money, particularly those with access to foreign money or able to borrow foreign money, were able to buy Germany’s best assets, mines, real estate, factories, etc. or simply live the life of luxury on the cheap during the times of the weakest Mark. The key factor is simply having foreign capital. Again however, the German people didn’t quite realize what was happening to their currency until it was too late.

Owners of agricultural land and industrial premises.

Artists: Physical items that would hold value were in high demand, so top German artists works were in high demand.

Those with debts: The debts were simply inflated away. (Don’t get any ideas because this road is a road to ruin. However, there is no easy choice out of the current state of US debts, both public and private, and inflating it away is unfortunately one means of ridding ourselves of all our debts and starting over; preferably without an evil dictator ruling over us as a consequence.)

Losers in Germany’s Hyperinflation

Losers were ultimately the German people. Much of the German middle class was destroyed. (pg. 122) When you debase currency, you debase civilization. History proves that over and over again and again.

Those most affected and least able to provide for themselves included the many who were living on pensions or received income expressed in fixed money values, like life insurance policies, state securities, municipal and other bonds, war bonds and mortgages. Those who had claims against debtors basically.

Those who worked for the Government, be it civil servants, judges, teachers, scientists, academics, etc. who received wages of ever increasing marks, but not enough to maintain the standards of living they were accustomed to.

The key takeaway from this very brief summary of this book I highly recommend reading, is that when you have a license to print money, you are doing dangerous work that may well lead to ruin, so great caution must be taken, to prevent us from going the way of Germany.

Diversify into asset classes that stand to do well in the event of further debasement of fiat currencies. Ideally, gold and silver are one way. I own Central Fund of Canada for clients (CEF) and Silver Standard Resources (SSRI) as one way to hedge if that printing press goes into further overdrive. (my emphasis)

Think about owning physical assets like art, antiques, farmland, industrial premises and in the worst case scenario, if you’re on a fixed income from the Government for example, learn to raise chickens for laying eggs. On page 172, there is a picture of a barber accepting eggs as payment for a shave and a hair cut. Shave = 2 eggs, haircut = 4 eggs. A hen can lay an egg a day by the way.

We simply don’t know how our Fed will steer our currency. It’s ultimately in their power to determine the cost of money (interest rates) as they have a near monopoly on that front . Congress has the power to determine spending (quantity of money available). We know the Fed has a printing press that can create money at essentially no cost (no cost, right).

In the end, I agree with Goethe and Ron Paul, printing money is the devil’s work (Goethe) and will lead to a collapsed currency and state of ruin (Ron Paul). Debase the dollar and you debase America, one could argue. We may get a brief period of strong exports, like Germany in the summer of 1922, but that’s a one trick pony.

Disclosure: Long SLV, SSRI and CEF for myself

By permission Jason Tillberg

valueinvestingclass.com

CLASSIC COMMENTARY: Some Thoughts on Deflation

Posted on August 3rd, 2010

Recession Is Over by Bob Englehart, The Hartford Courant

By John Mauldin

The debate over whether we are in for inflation or deflation was alive and well at the Agora Symposium in Vancouver this this week. It seems that not everyone is ready to join the deflation-first, then-inflation camp I am currently resident in. So in this week’s letter we look at some of the causes of deflation, the elements of deflation, if you will, and see if they are in ascendancy. For equity investors, this is an important question because, historically, periods of deflation have not been kind to stock markets. Let’s come at this week’s letter from the side, and see if we can sneak up on some answers.

Even on the road (and maybe especially on the road, as I get more free time on airplanes) I keep up with my rather large reading habit. This week, the theme in various publications was the lack of available credit for small businesses, with plenty of anecdotal evidence. This goes along with the surveys by the National Federation of Independent Businesses, which continue to show a difficult credit market.

Businesses are being forced to scramble for needed investments, generally having to make do with cash flow and working out of profits. This is an interesting quandary for government policy makers, as 75% of the “rich” that will see the Bush tax cuts go away are small businesses.

There was a great graphic (that I now cannot find) showing that all net new jobs of the past two decades have come from small businesses and start-ups. And yet as of now, when structural employment is over 10% (if you count those who were considered to be in the work force just a few months ago), we want to reduce the availability of revenues to the very people we want to be hiring new workers, and who are cash-starved as it is.

It is not just that taxes will go from 35% to just under 40%. It is the increase in Medicare taxes coming down the pike, too. We are taking money from private hands, where it has the potential to increase productivity, and putting it into government hands, where it will do nothing for growth of the economy. There is no multiplier for government spending. And tax increases reduce potential GDP by a multiplier of at least 1 and maybe 3, depending on which study you want to cite.

I understand that taxes have to go up. I get it. But we would be better off having a discussion of where we want to tax dollars to come from before we risk hurting an economy that will barely be growing at 2% in the 4 quarter, and may be well below that. It is the increase in taxes that has me concerned about a double-dip recession.

That being said, the announcement by several prominent Democratic senators that they think we should extend the Bush tax cuts is significant. As I said a few weeks ago, we should not experience a double-dip recession absent policy mistakes. A slow-growth world, yes. But an actual double dip is rare.

If Congress were to extend the Bush tax cuts for at least a year, until the presidential commission on taxes is done with its work and THEN have the debate, it would make me far more optimistic. And it would be quite bullish for stocks, I think. Businesses would know how to plan, at least, for a year, and the economy would be given more time to actually recover. I am not ready to channel my inner Larry Kudlow, but from what we see this summer it would make me more optimistic and reduce the chances of a double-dip recession significantly.

Some Thoughts on Deflation

Inflation in the US is now just below 1%, whether you look at the CPI, the Cleveland Fed’s measure, or the Dallas Trimmed Mean CPI. The Fed’s favorite, the PCE, is also approaching 1%. The Dallas numbers are a little behind, but they are at all-time lows.

Chart PCE Inflation

The classic definition of deflation is an economic environment that is characterized by inadequate or deficient aggregate demand. Prices in general fall, and normal economic relationships start to fall apart.

The Super-Trend Puzzle

I am a big fan of puzzles of all kinds, especially picture puzzles. I love to figure out how the pieces fit together and watch the picture emerge, and have spent many an enjoyable hour at the table struggling to find the missing piece that helps make sense of the pattern.

Perhaps that explains my fascination with economics and investing, as there are no greater puzzles (except possibly the great theological conundrums, or the mind of a woman, about which I have only a few clues).

The great problem with the economic puzzles is that the shapes of the pieces can and will change as they rub against one another. One often finds that fitting two pieces together changes the way they meld with the other pieces you thought were already nailed down, which may of course change the pieces with which they are adjoined; and suddenly your neat economic picture no longer looks anything like the real world.

(Which is why all of the mathematical models make assumptions about variables that allow the models to work, except that what they end up showing is not related to the real world, which is not composed of static variables.)

There are two types of major economic puzzle pieces. The first are those pieces that represent trends that are inexorable: they will not themselves change, or if they do it will be slowly; but they will force every puzzle piece that touches them to shift, due to the force of their power. Demographic shifts or technology improvements over the long run are examples of this type of puzzle piece.

The second type is what I think of as “balancing trends,” or trends that are not inevitable but which, if they come about, will have significant implications. If you place that piece into the puzzle, it too changes the shape of all the pieces of the puzzle around it. And in the economic super-trend puzzle, it can change the shape of other pieces in ways that are not clear.

Deflation is in the latter category. I have often said that when you become a Federal Reserve Bank governor, you are taken into a back room and are given a DNA transplant that makes you viscerally and at all times opposed to deflation. Deflation is a major economic game changer.

You can argue, as Gary Shilling does, that there is a good kind of deflation, where rising productivity and other such good things produces a general fall in prices, such as we had in the late 19th century. And as we have experienced that in the world of technology, where we view it as normal that the price of a computer will fall, even as its quality rises over time.

But that is not the kind of deflation we face today. We face the deflation of the Depression era, and central bankers of the world are united in opposition. As Paul McCulley quipped to me this spring, when I asked him if he was concerned about inflation, with all the stimulus and printing of money we were facing, “John,” he said, “you better hope they can cause some inflation.” And he is right. If we don’t have a problem with inflation in the future, we are going to have far worse problems to deal with.

Saint Milton Friedman taught us that inflation is always and everywhere a monetary phenomenon. That is, if the central bank prints too much money, inflation will ensue. And that is true, up to a point. A central bank, by printing too much money, can bring about inflation and destroy a currency, all things being equal. But that is the tricky part of that equation, because not all things are equal. The pieces of the puzzle can change shape. When the elements of deflation combine in the right order, the central bank can print a boatload of money without bringing about inflation. And we may now be watching that combination come about.

The Elements of Deflation

Just as every school child knows that water is formed by the two elements of hydrogen and oxygen in a very simple combination we all know as H2O, so deflation has its own elements of composition. Let’s look at some of them (in no particular order).

First, there is excess production capacity. It is hard to have pricing power when your competition also has more capacity than he wants, so he prices his product as low as he can to make a profit, but also to get the sale. The world is awash in excess capacity now. Eventually we either grow the economy to utilize that capacity or it will be taken offline through bankruptcy, a reduction in capacity (as when businesses lay off employees), or businesses simply exiting their industries.

I could load the rest of the letter with charts showing how low world capacity utilization is, but let’s just take one graph, from the US. Notice that capacity utilization is roughly in an area that we associate with the bottom of past recessions (with one exception).

Chart Capacity Utilization

Deflation is also associated with massive wealth destruction. The credit crisis certainly provided that element. Home prices have dropped in many nations all over the world, with some exceptions, like Canada and Australia. Trillions of dollars of “wealth” has evaporated, no longer available for use. Likewise, the bear market in equities in the developed world has wiped out trillions of dollars in valuation, resulting in rising savings rates as consumers, especially those close to a wanted retirement, try to repair their leaking balance sheets.

And while increased saving is good for an individual, it calls into play Keynes’ Paradox of Thrift. That is, while it is good for one person to save, when everyone does it, it decreases consumer spending. And decreased consumer spending (or decreased final demand, in economic terms) means less pricing power for companies and is yet another element of deflation.

Yet another element of deflation is the massive deleveraging that comes with a major credit crisis. Not only are consumers and businesses reducing their debt, banks are reducing their lending. Bank losses (at the last count I saw) are over $2 trillion and rising.

As an aside, the European bank stress tests were a joke. They assumed no sovereign debt default. Evidently the thought of Greece not paying its debt is just not in the realm of their thinking. There were other deficiencies as well, but that is the most glaring. European banks are still a concern unless the ECB goes ahead and buys all that sovereign debt from the banks, getting it off their balance sheets.

When the money supply is falling in tandem with a slowing velocity of money, that brings up serious deflationary issues. I have dealt with that in recent months, so I won’t bring it up again, but it is a significant element of deflation. And it is not just the US. Global real broad money growth is close to zero. Deflationary pressures are the norm in the developed world (except for Britain, where inflation is the issue).

Chart Global Real Broad Money Growth

Falling home prices and a weak housing market are one more element of deflation. This is happening not just in the US, but also much of Europe is suffering a real estate crisis. Japan has seen its real estate market fall almost 90% in some cities, and that is part of the reason they have had 20 years with no job growth, and that the nominal GDP is where it was 17 years ago.

In the short run, reducing government spending (in the US at local, state, and federal levels) is deflationary in the short run.

Martin Wolfe, in the Financial Times, wrote the following last week (arguing that that the move to “fiscal austerity” is ill-advised):

“We can see two huge threats in front of us. The first is the failure to recognize the strength of the deflationary pressures … The danger that premature fiscal and monetary tightening will end up tipping the world economy back into recession is not small, even if the largest emerging countries should be well able to protect themselves. The second threat is failure to secure the medium-term structural shifts in fiscal positions, in management of the financial sector and in export-dependency, that are needed if a sustained and healthy global recovery is to occur.”

Finally, high and chronic unemployment is deflationary. It reduces final demand as people simply don’t have the money to buy things.

Deflation that comes from increased productivity is desirable. In the late 1800’s the US went through an almost 30-year period of deflation that saw massive improvements in agriculture (the McCormick reaper, etc.) and the ability of producers to get their products to markets through railroads. In fact, too many railroads were built and a number of the companies that built them collapsed. Just as we experienced with the fiber-optic cable build-out, there was soon too much railroad capacity, and freight prices fell. That was bad for the shareholders but good for consumers. It was a time of great economic growth.

But deflation that comes from a lack of pricing power and lower final demand is not good. It hurts the incomes of both employer and employee, and discourages entrepreneurs from increasing their production capacity, and thus employment.

That is why it will be important to watch the CPI numbers even more closely in the coming months. The trend, as noted above, is for lower inflation. If that continues, the Fed will act. I did a summary of Bernanke’s 2002 speech on deflation a few weeks ago. For those who didn’t read it, here is the link.

If the US gets into outright deflation, I expect the Fed to react by increasing their assets and by outright monetization, buying treasuries from insurance and other companies, as putting more money into banks when they are not lending does not seem to be helpful as far as deflation is concerned. More mortgages? Corporate debt? Moving out the yield curve? All are options the Fed will consider. We need to be paying attention.

One final thought before I hit the send button. Recessions are by definition deflationary. One of the things we learned from This Time is Different by Rogoff and Reinhart is that economies are more fragile and volatile and that recessions are more frequent after a credit crisis. Further, spending cuts are better than tax increases at improving the health of an economy after a credit crisis.

I think we can take it as a given that there is another recession in front of the US. That is the natural order of things. But it would be better to have that inevitable recession as far into the future as possible, and preferably with a little inflationary cushion and some room for active policy responses. A recession next year would be problematic, if not catastrophic. Rates are as low as they can go. Higher deficits are not in the cards. Yet unemployment would shoot up and tax collections go down at all levels of government.

That is why I worry so much about taking the Bush tax cuts away when the economy is weak. Now, maybe those who argue that tax increases don’t matter are right. They have their academic studies. But the preponderance of work suggests their studies are flawed and at worst are guilty of data mining (looking for data that supports your already-developed conclusions.)

Professor Michael Boskin wrote today in the Wall Street Journal:
“The president does not say that economists agree that the high future taxes to finance the stimulus will hurt the economy. (The University of Chicago’s Harald Uhlig estimates $3.40 of lost output for every dollar of government spending.) Either the president is not being told of serious alternative viewpoints, or serious viewpoints are defined as only those that support his position. In either case, he is being ill-served by his staff.”

As noted at the beginning of this letter, I find it very encouraging that there is a movement among Democrats to think about at least postponing the demise of the Bush tax cuts until the economy is in better shape. Those who advocate letting them lapse are in effect operating on our economic body without benefit of anesthesia. If they are wrong, the consequences will be most severe.

We need to think any tax increase through very thoroughly. (my emphasis)

By permission John Mauldin Copyright 2010 John Mauldin. All Rights Reserved

www.frontlinethoughts.com

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