Financial panics seem to be caused by productivity disruptions

As a newbie to economics, I observe what seems to be much bickering going on, over periods of decades or centuries, between some supposedly very bright people. Perhaps economists are spending too much time studying money, and not enough time studying the basics of production and consumption, such as the changes over time in the availability and costs of labor, commodities, transportation, retail product delivery and information processing.

It's as if those trying to understand Global Climate Changes (warming, cooling or whatever) spent too much time studying thermometers, and not enough time studying the thermodynamics of the Earth and the Sun.

For examples:

1. The Depression that began in 1873 might be said to have been caused by the disruptions resulting from the more efficient farming in the American heartland coming online, disrupting agricultural production in Europe.
2. The Depression that began in 1929 might be said to have been caused by the disruptions resulting from the more efficient industrial capacity in the American heartland coming online.
3. The Depression that began in 2007 might be said to have been caused by the disruptions resulting from the more efficient (lower labor costs) manufacturing capacity in the Far East (Japan, Korean, then China) coming online.
   
4. The American Civil War certainly involved in part disruptions in the cost of labor due to the waning of slave labor, which had been an essential element of the economy of the American Southern States.

There are likely other examples, such as wealth to the British Isles from their Empire in the 1800's, increases in information processing capacity from the Computer Revolution to which I just spent my last 30 years contributing, the impact of Railroads and subsequently Eisenhower's Interstate Highway system on American Transportation, the world-wide buildout of the Internet this last decade, the abundance of petro-energy from the Middle East and other places this last half century, ... There seems to be a Panic associated with many of these examples.

In many, not all, of the above examples, enormous new capacities at lower costs came online. Typically, to enable the buildout of these new capacities and to facilitate their consumption, great amounts of credit are extended. For example, the Chinese bought U.S. debt paper by the trillions, so that their factories would have customers.

This can result in a world economy awash in too easily gotten capital, that promotes an escalation of greed and corruption and pyramiding financial schemes, until the bubble collapses into a depression. After a period of time, that depression not having really destroyed the broken structures, but rather just left them sputtering and broken, leads to a great war, which destroys the broken and gives birth to a new structure.

Wealth that is not disciplined by those who have a stake in it turns sour. Nations, as children, can be spoiled rotten. Perhaps even human civilization can be so spoiled?

As Mises studies the mechanisms by which excess money turns sour, so also must we study the means by which excess productive capacity turns sour.

Depressions caused by resource misallocations

On reading the first few pages of Garet Garrett's "The Bubble That Broke the World" (1931), available at
http://www.mises.org/store/Bubble-That-Broke-the-World-The-P437.aspx
or full text in .pdf format at:
http://www.mises.org/books/bubbleworld.pdf

it occurs to me that the primary cause of the three greatest depressions (beginning in 1873, 1929 and 2007) are all the same - a misallocation of resources due to a dramatically more efficient producer of essential goods coming on line.

In 1873, America's midwest farming, thanks to railroads and steam ships, could deliver food to Europe more economically than ever before. Leading up to 1929, America's industrial capacity delivered credit and goods to Europe more economically than ever before. Leading up to 2008, the far west (Japan, Korea and most recently China) are delivering manufactured goods to Europe and America more economically than ever before. In each case the new low cost producer, in order to have a customer able to consume all they produce, sells on credit.

This results in a world economy awash in too easily gotten capital, that promotes an escalation of greed and corruption and pyramiding financial schemes, until the bubble collapses into a depression. After a period of time, that depression not having really destroyed the broken structures, but rather just left them sputtering and broken, leads to a great war, which destroys the broken and gives birth to a new structure.

Wealth that is not disciplined by those who have a stake in it turns sour. Nations, as children, can be spoiled rotten.

As Mises studies the mechanisms by which excess money turns sour, so also must we study the means by which excess productive capacity turns sour.

A Wolf Pack runs our money.

[Originally posted on iTulip.com, to describe the nature of the Money Masters, aka Banksters.]

I suspect that a key organizing element of the Money Masters (and other such power brokers) is the tribe, the family (as in the Mafia), the team, the wolf pack, ...

A small group of like minded men, long used to working together and sharing much common background and viewpoints, but with flexible boundaries as people come and go over time and a definite sense of who is similar minded and can be trusted.

Within that group, some will have more power than others, and if push comes to shove, one man likely makes the call. But these are strong men, used to being in charge of major organizations and imposing their will. They are not underling staff who have to check with their Boss on every detail. There appears to be some definite picking and choosing of good future prospects, grooming and facilitating their development up the ranks.

Consider for example Timothy Geithner, who is Obama's choice for Secretary of Treasury, to replace Hank Paulson. Quoting from The Weekly Report by Mick P:

What of the US Treasury Secretary nominee Mr Geithner? Currently serving as the 9th President of the New York Fed, has he come from a background that would bring change? After he finished an MA in Failed Keynesian based International Economics he went to work for Henry "King maker" Kissinger at Kissinger and Associates in Washington, followed by a stint at the US Treasury, culminating as Under Secretary of the Treasury for International Affairs until 2002.

He then moved onto the Council on Foreign Relations joining the International Economics department before being appointed to his current role in 2003, becoming the Vice Chairman of the Federal Open Market Committee as well as the President of the New York Fed. He is also the Chairman of the committee on Payment and Settlement Systems with the Bank for International Settlements.

Not bad for a man who is only 47 years old. He's one of the trusted Money Masters, or as they seem to be called here at iTulip, the Banksters.

Geithner also played important roles in the takeover of Bear Stearns by JPMorgan, and in the decision to let Lehman Brothers collapse. I suspect that these two events accelerated the Panic of 2008, which in turn improved Obama's victory margin. However my further tin foil hat "old fart republican rumblings" (to borrow friendly_jacek's nice turn of phrase to describe another post of mine) on that turn of events would be inappropriate to discuss in this forum.

The debt behind our money became a Fuel-Air Explosive

[Originally posted on iTulip.com, in response to someone asking "Where will all the capital flight go to?" ]

Our capital is debt-based money, which is a gas, not a liquid. That is, it compresses and expands dramatically.

Debt based money monetizes future income streams, such as the tax collections of a government or the mortgage payments of a home "owner." When those income streams seem to be increasing, then the quantity of "money" expands. This happens when individuals, corporations and governments increase their debt.

When moreover we allow serious degradations in the quality of those monetized income streams (such as NINJA home loans - "no income, no job, no assets"), then the quantity of this "money" expands further and faster.

This expansion is inflationary. Ordinarily, in a closed economic system with honest and competent financial leaders, this inflation would be recognized as such and could be resisted.

But thanks to the Far East coming on line, taking up the manufacturing of the worlds goods with much cheaper labor over the last 25 years, and thanks to using a corrupted Consumer Price Index rather than a measure of all debt paper (and derivatives and swaps and other crap thereon) to guide our Federal Reserve Open Market operations (which attempt to throttle the creation of some of this debt based money), our Illustrious Financial Leaders missed seeing (or refused to see?) that inflation. They watched California housing prices double, and Wal-Mart prices halve, and thought we needed more fiat paper. Meanwhile, they turned a blind eye to the massive, stunning, outlandish, outrageous growth in derivatives and swaps and secularized debt piled in a Grand Pyramid on top of these NINJA mortgages. We were no longer just monetizing real income streams and fantasy income streams, but we were also monetizing the continuation of falling interest rates, rising asset prices, falling dollar exchange rates, stable economies and low debt default rates.

It resembles how one sets off a Fuel-Air Explosive [FAE]. Disperse an air cloud of fuel and ignite it.

So my opening analogy of a compressing gas is the wrong analogy. This is not merely an expansion and contraction of a compressible substance, but the transformation of liquid petrol into gaseous petrol into burnt carbon dust.

The final gas cloud dispersal occurred during roughly the years 2002 to 2007. The cloud has now ignited. Wealth is being burnt at a horrific pace, world wide, with no end in near sight.

That's where your nice liquid capital is going. Ouch.

The iTulip position - the Dollar goes Poom

[Originally posted on iTulip.com as a summary statement of the iTulip position.]

We have built a Great Inverted Pyramid of financial "wealth".

Right now, the largest floors, near the top, constructed from the leveraged debt of individuals, businesses and local governments, are in raging flames. People are racing from those floors to the next floors down, constructed from the debt of sovereign nations. This confuses our understanding, for it is the rent on these "soverign debt" floors (especially the U.S. Treasury floor) which backs the currency we use as the metric (the 'unit') of wealth on most of the other floors. Suddenly space on the "soverign debt" floors has become valuable, lowering the Dollar denominated pricing of most everything else. This pricing distortion will last only as long as the raging fires of financial collapse on the higher floors dominate the pricing.

It is likely that the raging fires of this deflating wealth will not stop at the floors of private debt, but rather continue down, into the "soverign debt" floors. I don't expect total destruction of the Dollar or of other sovereign currencies around the world. I do expect alot of FIRE damage, and some rebuilding using a wider mix of local and regional currencies based on various sovereign, regional (e.g. Euro), and IMF debt.

Of late, our esteemed American financial leaders have been building extensions to the Fire Break, in an effort to stop the raging flames before they destroy the Banks of their favored colleagues (of course, their sole motive is to protect the wealth of the banks customers .) Unfortunately, they build weak structures using paper thin woods, in bizarre formations. This so called Fire Break should burn nicely, if one is alert to watch it, for it could burn very very fast.

In the previous century, as America inflated the Mighty Dollar to its current position as the world's dominant "unit" (its reserve currency) of financial measurement, it first severed the domestic connections with the previous "unit" (gold) under FDR, and then later severed the international connections between the Dollar and gold, under Nixon.

As the Mighty Dollar now loses its esteemed status as the world's only reserve currency, we will work in reverse order. First the international status of the Dollar will fallback, later the domestic.

Already we are seeing the volume of international trade of both commodities and finished goods collapsing. Soon the global demand for U.S. Dollars and short term T-Bills from panicing deleveraging hedge funds and banks will slacken. Foreigners will scorn America's Golden Treasuries. We're talking the worlds most liquid, most watched markets here. The action will likely not be that of a gentle spring rain, but rather more like that of Colliding Worlds.

Americans will import less, and pay more. The laborers, diggers and farmers elsewhere in the world will lose their best customer (and worst "investment" .) Treasuries will partially default by having their terms unilaterally restated or just by having their prices fall (yields rise) to levels not seen since Paul Volcker. Sensible American investors are already abandoning long Treasuries.

Domestically, within America's borders, the Dollar will remain the undisputed currency. It probably will not massively collapse in the manner seen in the German Wiemar Republic (3 billion marks for a pound of bread in November 1923) or currently in Zimbabwhe. The Dollar has too much inertia, is too deeply embedded into the large American economy, for such hyperinflation to be a near term risk. Nor do I expect to be prying loose my gold teeth to bribe the border guard to allow my passage to Canada or Mexico.

Nor am I of the school that if we just abandoned fiat paper currency and fractional reserve banking, returning to "real" money that "is no one's liability" and that "has never gone to zero value", then all would be well. The Romans mucked up their metal currency just as thoroughly as us Americans are mucking up our debt-based currency. I invest in Gold neither as a short term trade (though I do what I can to time my gold trading to my advantage) nor as an ultimate survival currency, along side my guns, whiskey and cans of survival food. Rather I invest in Gold as an insurance policy, hedging unforseeable failures of my other investments. At times, gold has also been a nice medium term investment, as various asset classes rotate in and out of favor.

Though the Dollar will not die, it will once again grow weaker. Domestic American inflationary price increases, caused by the rising Dollar denominated prices of the imports on which America is now so dependent, will seep through American society.This will lower the value of pensions, savings and Social Security payments. This will lower the standard of living of most Americans. Stubborn and widespread unemployment of millions of former workers in various financial, service, real estate, construction, automobile, and other businesses will further lower the American standard of living. Many Americans are going to have to learn the hard way the merits of downsizing and frugal living and hard work at unpleasant labor.

I doubt that Americans will be receiving many sympathy cards from the rest of the world in the coming few years. The rest of the world will have their own burdens to bear,and the opportunities for blame are abundant and in some cases well deserved.

Advancing senility has so weakened the minds of the few remaining members of The Greatest Generation of Americans that they will let this new state of the worlds affairs pass with little complaint. They were never ones to beg for sympathy in any case. If any of them who are still left with clear minds are reading here today, I say a heartfelt Thanks.

The Dollar is not a fiat currency; it is debt based.

[Originally posted on iTulip.com, in response to a post from Lukester referring to the dollar as 'fiat'.]

You've noted, more than once I believe, Lukester, that the dollar is fiat.

I would disagree. Dollars can always be converted to Treasuries,either way, in one of the most liquid markets in the world. Treasuries have inherent value, as their dividends are a reliable claim on the income stream collected as federal taxes from Americans. This income stream has been "as good as gold" for the better part of a century now.

Rather, I would agree with those here who have described the events in the financial markets of the last few months as a short covering rally, on the dollar. One way or another, in increasing amounts (explosively exponentially increasing, in the case of mortgage backed securities and related derivatives and swaps) the world has been flooded with dollar denominated paper.

Every dollar denominated asset that could be purchased in sizable quantity from a computer station has had its price run up over the last few years. Even a few such asset classes that required "hands on" extraction, such as mortgages in California, Florida and a few other states were run up, in that case using a newly hired army of mortgage brokers.

Dollars came in one door, and were spent on anything for sale out the other door.

For another example, the big runup in gold and gold mining was between 2001 and 2007.

Everyone sold dollars short and bought other dollar denominated assets long.

Well, everyone except perhaps the Japanese, who sold the Yen short and bought Treasuries long.

This is unraveling, dramatically, to the great delight or pain of participants, depending on which side of this crash they got caught on.

I'm fairly optimistic, in that the worst of this house of paper that is burning down around us was built in the last few years. So I trust that there is the financial base for a solid economy, underneath that burning paper, which we have a decent chance of partially rediscovering, without causing the End of Western Civilization.

Sometime in the next one to six months, I expect to see the Dollar reverse, and start back down again, in the Foreign Exchange market. I sold my California real estate and all my stock last year, and have been sitting almost entirely in Treasuries, Dollars and cash equivalents this year. I've downsized my life style from the high flying, debt burdened, Silicon Valley style that I've enjoyed the last two decades to one that has zero debt, cash in the bank, and costs less than one-tenth per month than before, for ordinary living expenses, in North Texas.

When I see the dollar solidly reverse (no big hurry, don't need to jump the gun) I will look for asset classes which are getting some wind in their sales ... perhaps energy related stuff, and stuff that does well in inflationary times. We'll see.

No ... the dollar is not a fiat currency. However, if we increase the national debt sufficiently, perhaps while our economy weakens in a serious recession, the incredible lowering of Treasury rates from 18% to 2% in the last 25 years will reverse. Obviously that 25 year trend must reverse, sometime in the next year or two, if not sooner. It cannot go below zero.

As the rates we must pay for Treasuries starts to rise, higher and higher, this will start to make the burden of these interest payments increasingly onerous on the American tax payer. An increase from 3% to 6% would double our burden paying these dividends. The pain in a long term reversal of these rate trends will be serious.

Given that, along with the unfunded liabilities of Medicare and Social Security, and along with the near certainty that our politicians will continue to be corrupt Socialist fools, we have the makings, over the next five to twenty years, of some very interesting headlines in the news.

The Panic of 2008 is a deliberate banking consolidation

[Originally posted on iTulip.com]

May I suggest it [the current banking crisis] is both a runaway disaster, and an orchestrated consolidation.

I imagine that after that famous asteroid hit the Yucatan peninsula 65 million years ago and wiped out the dinosaurs (if that's what happened) that shortly thereafter, the fastest, most ferocious raptors were feasting on the carcasses of their weakened comrades.

Presently, I figure that the debt-based money system of the Rothschilds, Rockefellers and Morgans, which lives on in the financial institutions of JPMorgan Chase, Goldman Sachs, the New York Fed and the U.S.Treasury, inter alia, has achieved its final, greatest, climax.

The asteroid of such excessive leverage that an even greater bubble can no longer be constructed has hit planet earth. The king raptor, JPMorgan, is feasting. Raptor steak is momentarily the coin of the realm.

The main event is a runaway disaster. Credit based money tends to do that. However in this case, Western Civilization had a few centuries of magnificant glory, and terrible wars, in the process.

But the king carnivores are doing their best to herd the weaker animals into killing pens during the chaos.

I do not expect the fall from such heights to be as disastrous as befell the dinosaurs. But looking back on the present from a century in the future, it might look like the decline of the British or earlier Spanish empires. I am optimistic that civilization has well enough integrated into the fabric of everyday human life all over this planet that the fall will not be anything as serious as the Fall of the Roman Empire, relative to the size of the known world.

[Originally posted on iTulip.com]

On the other hand, if you're in a conspiratorial mood, check out Jim Willie CB's latest GoldenJackass.com piece "WALL STREET MONSTERS & MEAT (YOU)" over at http://www.gold-eagle.com/editorials...lie101608.html .

By his reckoning, we should have Nuremberg trials for Hank Paulson and Jamie Dimon, and we can expect the dollar collapse, and other spectacular fireworks this year, perhaps even this month, maybe even this week.

One interesting theory he raises is suggesting that the continuing lowering of Treasury rates is a JPMorgan & Associates manipulation, to starve other banks of the capital they need to survive. Recall, as I noted in a post above, that continuously declining interest rates harms existing capitalized firms, just as it benefits those lending to or investing in them.

JPMorgan is able to survive in this rarefied air by periodically feasting on the butchered carcasses of other banks, herded their way by the compliant FDIC, after stripping the carcass of any toxics, to be covered by us generous American taxpayers. Jim Willie further suggests that over the last few years JPMorgan entered into massive quantities of Interest Rate Swaps with other banks, allowing the other banks to offload their rate risk some. This further fattened up the victim banks, kept them alive as their capital structure further deteriorated and made it easier for JPMorgan to control when to pull their plug and harvest their bankrupt carcass.

It is difficult to read a Jim Willie piece with stopping after every third paragraph to log into ones accounts and press the Buy Now button on yet more gold.

[Originally posted on iTulip.com]

Some more thoughts on the present situation, after reading the article:

http://www.safehaven.com/article-11601.htm

October 18, 2008
The Mechanism Of Capital Destruction
by Antal E. Fekete

Address at the Annual Dinner of the
Committee for Monetary Research and Education, CMRE
on October 16, 2008
New York City

The above article explains how the falling interest rates over the last 28 years have been generally destructive of capital based businesses, including industry and banking, and the banking cartel known as the Federal Reserve.

Borrowing money to capitalize your business at rates that turn out to be higher than the subsequent prevailing rates is a money losing proposition.

A key element of the $700 Billion bailout, notes this article, is that the Treasury passed the new Treasury notes directly to the Fed, bypassing the Open Market, which is a direct act of monetizing debt not seen since World War II. Not only were GM, GE, AIG, JPMorgan, and a host of other major banks and businesses worldwide bankrupt. The Fed was bankrupt as well. We bailed out the Fed.

As this article further explains, in different terms, this is the curse and the blessing of using a convertible currency that depends on interest rates, rather than on precious metal.

The blessing is that the base for the worlds reserve currency the last half century or so, essentially monetizing the tax income stream from the American worker, has been able to grow faster than the worlds mined gold reserves, while remaining "as good as gold." A world prosperity unlike any ever seen before in civilization has been funded on the back of this currency.

One (not the only) curse is what the above article terms the "wrecking ball" of interest rates. Unlike the quantity of mined gold available to Western Civilization, which is "rock solid" (ignoring such times as the Spanish conquest of the New World), interest rates can swing back and forth. Declining rates hurt those who have already borrowed, while they help those who have already lent. Rising rates do the reverse.

A near three decade decline in rates has wrecked great damage on, and embedded great distortions within, the capital base of America's economy. This will be reversed when the secular trend in rates reverses. This should be fun to watch.

Those capital businesses that can:

1. Survive the depression,
2. Adapt to a lower, world competitive, wage base,
3. Survive serious inflation and dollar damage, and
4. Avoid the burdens of excessive socialist regulation,

will make great investments over the next decades.

Hmmm ... I wonder what those businesses might be.

[Originally posted on iTulip.com]

Our dollar is not a simple fiat currency. It is not just monopoly money that Parker Brothers can print by the truck load for the cost of wood pulp, printers ink and rental time on the printing press.

Our dollar is a convertible currency. Gold certificates were convertible to gold, and held value so long as the Kings store of gold was not near depletion. Dollars are convertible to Treasuries, and hold value so long as the burden of interest payments on those Treasuries is not so honerous on the American tax payer as to be put in doubt.

Total debt, public and private, on the American taxpayer is two or three times GDP, which is starting to get up there, but still not presenting immediate risk.

What is collapsing now is the massive bubble of finanicial paper built on top of this currency, including domestic and foreign debt, derivative, stock, bond and asset valuations.

Yes, that collapse of bubble paper can take "seven years", though gloomy me tends to expect that collapse to be harder and faster, with a long depressing bottom.

It seems, from what we are learning now, that so long as the dollar remains strong (Treasuries are the preferred "safe" store of wealth), then the collapse of the financial bubble built on top of the dollar is good for the dollar. This is to be expected, now that I think about it. When bubbles collapse, the underlying "safe" currency becomes more valued.

What will drive gold up is the recognition of a serious threat to the underlying "coin of the realm", the worlds reserve currency, the dollar.

One cannot anticipate the timing of such a gold boom by looking at how much longer it will take the financial derivative bubble to burn out. The dollar could start to collapse while we're still shredding the financial derivative bubble paper, or it could collapse later on,due to other strains.

Just as one looks to see how much gold remains in the Kings treasure to estimate how near the threat of collapse is to gold certificates, similarly one must look to how soon the convertible base of dollars, the reliable interest income on Treasuries from the taxes on American taxpayers, is at risk of depletion or collapse, if one is to determine when the dollar starts melting down, and gold becomes much more valuable.

Predicting runs on the bank, which in this instance would be a spiralling collapse of confidence in Treasuries, is not easy. The events can be sudden, and involve the extremes of human emotion. The events will certainly involve massive, deceptive, almost inescapable (for us little people) actions by the largest holders of Treasuries, as they decide, one way or another, to rid their coffers of Treasuries.

I'd first look for Treasury rates to reverse their long term (since early 1980's) decline in yield, which will cause holders of existing Treasuries to start to lose, rather than gain, profit on the principal value of their Treasuries, and start to escalate the burden of the interest payments on the American tax payer. This is rather like noticing when your Credit Card company starts raising the interest rates it offers you, as you become a less worthy credit risk. If you are rolling over your credit card debt, as we are our American Treasury debt, rather than paying it down, this can be a good sign of the beginning of the end.

The unfunded liabilities of Social Security and Medicare payments to Baby Boomers, the increasingly outrageous corruption and profligacy of our political representatives, the costs of bailing out the bankers, the costs of a Military that would make the Roman Empire jealous and of wars past and likely future, the direct and indirect costs of a massive and corrupt federal bureacracy, and the lowering of GDP due to a serious depression (seemingly imminent) all look to put Treasuries under further strain, as paying the interest on them becomes an increasingly large proportion of American cash flow.

[Originally posted on iTulip.com]

My simple minded take on the situation is as follows.

First of all, nevermind that various countries, currencies, crooks, congressmen and companies are involved.

We (us economically active humans on planet Earth) have a world financial system that currently stands atop U.S. Treasuries. Mind you, Treasuries are --not-- simply fiat Monopoly Money (Parker Brothers board game). Rather Treasuries are based on the monetized income stream from us good old American taxpayers. Treasuries are "good as gold" because the world's strongest economy for over the last half century pays interest on Treasuries from its tax collections.

Now we (economically active humans) have built a flaming house of cards of credit, debit and a**wipe paper atop these Treasuries, which is now in a big time old fashioned Panic. Actually it's kinda fun being able to see such a Panic up close and personal, while I have the means and ability to realize some of what's happening. But perhaps I say that because I sold all my stock, and my overpriced house in California, last year.

Anyhow, as with any panic in leveraged or less secure assets, the underlying asset becomes sought after, as the fallback. If the underlying "strong" currency is seashells, gold or Treasuries, it doesn't matter. When a bubble of overpriced or overleveraged or risky assets is built atop that strong currency, the strong currency becomes in great demand again when the bubble collapses, as people unwind their failed "investments" and hoard the strong currency.

It's time to trade in the Trash for Treasuries, and their more convenient, (very slightly) less profitable, alter egos, dollars.