Who Is Lying: The Federal Reserve Or… The Federal Reserve? And Why Stalin "Lost"


When one thinks of the early 1950’s, things that often come to mind are fries and milkshake, muscle cars, Little Richard, and greased hair. Things that rarely come to mind are that the US and China were openly at war over a little piece of land called Korea, that the Treasury market did not exist, that short and long end rates were “fixed” by the Fed at 0.125% and 2.5% respectively, even as inflation was at the highest it has ever been in the post war period at over 20%. What absolutely never comes to mind, is that on March 3, 1951, the world as we know it changed forever, after a little noted event known as the Fed-Treasury Accord of March 3, 1951 took place, and mutated the role of the Federal Reserve, which set off on a path that would ultimately lead to the disastrous economic state the world finds itself in today.

Oh and another thing that never comes to mind, is that while the current iteration of the Fed, various recent voodoo economic theories, and assorted blogs, all claim that excess bank reserves are never an inflationary threat, it is precisely two Federal Reserve chairmen’s heretic claims that reserves will light an inflationary conflagration, that forced then president Truman to eliminate not one but two Fed Chairmen, and nearly result in the “independent” Federal Reserve being subsumed by the Treasury to do its monetization and market manipulation/intervention bidding. Which then begs the question: who is telling the truth about the linkage of reserve accumulation to inflation – the Fed of 1951, or every other Fed since, now firmly under the control of the Treasury-banker syndicate. Because they cannot both be right.

Why is March 3, 1951 such an important date? Because, more than anything, the confluence of events that led to the “Accord” signed on this day have extensive parallels to our current situation, as the attached paper by the Federal Reserve of Richmond shows in exquisite detail, yet 100% in reverse.

In a nutshell what happened in the late 1940s and early 1950s was that in the aftermath of WWII, and the outbreak of the Korean war, America found itself in a very odd situation… one never really encountered until today. The country had soaring inflation – as in real inflation, not just core inflation measured by hedonic adjustments and excluding all those thing that actually do go up in price. More importantly, it had the 1950’s version of ZIRP – only then it was called a peg, in this case of 0.375%, and subsequently 0.125% on short end Treasurys, and 2.5% on long-dated paper. In other words, the monetary situation in 1951 was one where both the short and long end of the curve were artificially boosted (think ZIRP and Twist), just so holders of Treasury paper (at that time only insurance companies as banks were not allowed to invest in TSYs) did not experience losses and get further “demoralized” in addition to the war that Truman was currently waging.

In fact, the following quote from none other than Truman is as idiotic, yet as valid today, as it was 61 years ago:

[T]he Federal Reserve Board should make it perfectly plain… to the New York Bankers that the peg is stabilized….I hope the Board will…not allow the bottom to drop from under our securities. If that happens that is exactly what Mr. Stalin wants. (FOMC Minutes, 1/31/51, p. 9)

And this:

The FOMC met with President Truman late in the afternoon of Wednes- day, January 31.17    Truman began by stating that “the present emergency is  greatest this country has ever faced, including the two World Wars and all the preceding wars.… [W]e must combat Communist influence on many fronts.… [I]f the people lose confidence in government securities all we hope to gain from our military mobilization, and war if need be, might be jeopardized.”

This is arguably the earliest recorded iteration in modern history of a “the world will come to an end unless you don’t do what I tell you” type of threat uttered by a member of the administration (ahem Hank Paulson) to a governing body. We will skip commenting on the supreme irony that according to Truman, Stalin would win if the US did not engage in the same central planning that ultimately brought the Soviet empire down. 

Yet what is so very different about this date in history, is that while it was the Treasury pushing tooth and nail for endless bond pegging by the Fed (apparently nobody had thought of QE back then yet, because it would have been all the rage), the body warning about the potential threat of runaway inflation from a surge in reserves, as well as the dangers associated with central planning was… The Federal Reserve.

Huh !!??

The same Fed that can not withhold its exuberance in encouraging ZIRP, Twist, LSAP, selling of Treasury Puts, and every other form of market intervention known to man, warning the president these very same actions would lead to ruin? And not only that but Truman being forced to get rid of not just Fed veteran Marriner Eccles (after whom the building in which centrally planned schemes are hatched every single day in yet another supreme irony), but also his successor Thomas McCabe who also refused to follow the precepts of central planning… who in turn was replaced by a Treasury muppet, or someone who will gladly monetize US debt whenever needed, at which point the scene for the final outcome was set.

That is impossible you say. Oh, not only is it impossible but it gets much better.

Because not only did the two veteran Fed chairmen warn against the state’s incursion into central planning, but they explicitly said something which the Fed, or at least its modern versions, have rejected over and over, especially during congressional committees: that a build of bank reserves is the surest way to spark hyperinflation.

But….but….but…. this is what fringe tin-foil hat blogs allege…. not Fed chairmen who between them have over 20 years of tenure.

Well, here are the facts:

“We have marched up the hill several times and then marched down again. This time I think we should act on the basis of our unwillingness to continue to supply reserves to the market by supporting the existing rate structure and should advise the Treasury that this is what we intend to do—not seek instructions” (FOMC Minutes, 8/18/50, p. 137).

 

[Fed member] Sproul would state the idea that a central bank controls inflation through the monetary control made possible by allowing market determination of the interest rate: “[T]he Committee did not in its operations drive securities to any price or yield….[M]arket forces had been the determining factor, and that only in resisting the creation of reserves had the committee been a party to an increase in interest rates. That…was the result of market forces, and not the action of the Committee. (FOMC Minutes, 3/1/51, pp. 125–26)”

In response to Truman’s ceaseless demands for pegging interest rates even as inflation was spiking over 20%, NY Fed president Sproul said that…

…this “would make the Federal Reserve System a bureau of the Treasury and, in light of the responsibilities placed in the System by the Congress, would be both impossible and improper” (FOMC Minutes, 1/31/51, p. 23).

In other words, pegging (i.e., ZIRP, Twist, LSAP)… is “impossible and improper”… is unconstitutional another word for it?

In retrospect perhaps we were a little too rought on Mr. Martin, who despite being a Treasury puppet, had these words to say:

In his speech accepting an appointment to the Board of Governors, Martin (1951, p. 377) said:

 

Unless inflation is controlled, it could prove to be an even more serious threat to the vitality of our country than the more spectacular aggressions of enemies outside our borders. I pledge myself to support all reasonable measures to preserve the purchasing power of the dollar.

There are those who claim the Fed has become the bankers’ puppet. It was not always so. In fact, the bankers loathed the Fed… Until the “Accord”

The banking community contributed to the Fed’s isolation by refusing to support its position. On February 2, the Board had met with the Federal Advisory Council, which represents the views of large banks. At that meeting, Eccles accused bankers of a lack of “courage and realistic leadership” (Board Minutes, 2/20/51, p. 389).

 

The Executive Committee refused to withdraw the FOMC’s letter to the President. Furthermore, it wrote a defiant letter to Senator O’Mahoney. The initial substantive paragraph began with the famous quote from John Maynard Keynes: “[T]hat the best way to destroy the Capitalist System was to debauch the currency” (FOMC Minutes, 2/14/51, p. 87).

It just gets better, as Marriner Eccles puts it into overdrive:

“We favor the lowest rate of interest on government securities that will cause true investors to buy and hold these securities. Today’s inflation. … is due to mounting civilian expenditures largely financed directly or indirectly by sale of Government securities to the Federal Reserve.… The inevitable result is more and more money and cheaper and cheaper dollars.” (FOMC Minutes, 2/7/51, p. 60)

Yet punchline #1:

[We are making] it possible for the public to convert Government securities into money to expand the money supply….We are almost solely responsible for this inflation. It is not deficit financing that is responsible because there has been surplus in the Treasury right along; the whole question of having rationing and price controls is due to the fact that we have this monetary inflation, and this committee is the only agency in existence that can curb and stop the growth of money.… [W]e should tell the Treasury, the President, and the Congress these facts, and do something about it….We have not only the power but the responsibility….If Congress does not like what we are doing, then they can change the rules. (FOMC Minutes, 2/6/51, pp. 50–51)

And #2 and final:

Governor Eccles and Representative Wright Patman, who was a populist congressman from Texarkana, Texas, went head-to-head:

 

Patman: Don’t you think there is some obligation of the Federal Reserve System to protect the public against excessive interest rates? 

 

Eccles: I think there is a greater obligation to the American public to protect them against the deterioration of the dollar. 

 

Patman: Who is master, the Federal Reserve or the Treasury? You know, the Treasury came here first. 

 

Eccles: How do you reconcile the Treasury’s position of saying they want the interest rate low, with the Federal Reserve standing ready to peg the market, and at the same time expect to stop inflation? 

 

Patman: Will the Federal Reserve System support the Secretary of the Treasury in that effort [to retain the 2 1/2 percent rate] or will it    refuse?… You    are    sabotaging    the    Treasury.    I    think    it    ought    to    be stopped. 

 

Eccles: [E]ither the Federal Reserve should be recognized as having some independent status, or it should be considered as simply an agency or a bureau of the Treasury. (U.S. Congress 1951, pp. 172–76)

And there you have it folks, clear as daylight, every aspect of the tension of the “independent” Fed brought to the surface. Because the few men who dared to stand up against Truman,  the doctrine of central planning, “pegging” Treasury prices,  and the banking cartel whose sole prerogative has always and only been cheap and easy money, all got their just deserts:

Fed president #1:

Eccles also reported in his memoirs that shortly before this event he had completed a letter of resignation to the President. He then decided to postpone his resignation. Eccles had been Chairman of the FOMC from its creation in 1935 until 1948. He did not intend to leave Washington with the Federal Reserve under the control of the Treasury. According to a Truman staff member, Truman had failed to reappoint Eccles as Board Chairman in 1948 to show him “who’s boss” (Donovan 1982, p. 331).

And Fed president #2

While in the hospital, Snyder conveyed to Truman the message that he felt he could no longer work with McCabe. Without a working relationship with the Treasury, McCabe could not function as Chairman of the Board of Governors. McCabe sent in a bitter letter of resignation, but resubmitted a bland version when asked to do so by the White House. McCabe, however, conditioned his resignation on the requirement that his successor be acceptable to the Fed.

As a reminder Snyder was the Secretary of the Treasury.

And whom did Truman replace McCabe with?

On March 15, the President appointed William McChesney Martin to replace McCabe.

Martin was undersecretary of the Treasury: the same institution that wanted all objectors to central planning scrapped. His position? Quote the Fed:

Truman and Snyder were populists who believed that banks, not the market forces of supply and demand, set interest rates. Truman felt that government had a moral obligation to protect the market value of the war bonds purchased by patriotic citizens. He talked about how in World War I he had purchased Liberty Bonds, only to see their value fall after the war.

Yet by keeping bonds pegged at ridiculously low prices during the late 1940s, and early 1950s, inflation exploded.

And that is what marked the beginning of the end, as while the Fed may have gained its independence, the US presidency, acting on behalf of the banks and populism (to keep capital losses to a minimum) made it all too clear anyone who steps out of line would be fired.

Call it a Stalinist putsch.

Actually hold on, did we say Stalin lost? Perhaps we may need to revise that. And while we got closure on that, we are still confused: is the real seed of inflation in reserves?

“Forced by the rate peg issue to make a stand on the role
of a central bank in creating inflation, Eccles expressed the nature of a
central bank in a fiat money regime.
 It was not private
speculation or government deficits that caused inflation, but rather
reserves and money creation by the central bank.” [The Treasury-Fed Accord: A New Narrative Account, Richmond Fed, Robert L. Hetzel and Ralph F. Leach]

Ok, now we get it.

And should we listen to the Fed or the… Fed?

Read the full absolutely must read Rchmond Fed narrative of the 1951 accord here. We can only hope someone in Congress can ask Bernanke for his take on the allegations made by the man responsible for the name of the current Fed headquarters.

The Treasury-Fed Accord – A New Narrative Account

Presenting The US Government’s Infographic Of Its Own Insolvency

Here’s a fun way to cap off your week.

The Congressional Budget Office has just released three very telling infographics which, unintentionally, spell out a pretty dreary picture of US government finances.

The first graphic shows US federal revenue, both in raw numbers ($2.3 trillion in 2011) and expressed as a percentage of GDP (15.4%).

 

There are a lot of interesting things about this graphic. Check out the massive downward swing of payroll tax receipts starting in 2009… coinciding not only with the dismal rate of employment in the country, but also the demographic trend of having fewer and fewer baby boomers paying in to the system.

It’s also interesting to note that, by comparison, 2011 US tax revenue is roughly twice what is was 20-years prior. Yet over the same period, the federal debt has ballooned nearly five-fold.

The next graphic is mandatory spending– essentially Social Security, Medicare, federal unemployment, and federal retirement programs. Note: this doesn’t include things like defense, interest on the debt, etc.

 

At $2.0 trillion, these mandatory entitlements comprise a massive 87% of all taxes collected. Put another way, they constitute 13.6% of America’s 2011 GDP. Incredible.

The last graphic shows ‘discretionary’ spending– another $1.3 trillion. The bulk of this is defense ($699 billion), itself nearly 5% of GDP. The rest of it goes to child molesting TSA agents, government-administered education, and all the legions of three letter agencies.

 

At the very bottom corner is a most disingenuous statement that says ”Net Interest not included.”  In other words, they didn’t bother to include the $454,393,280,417.03 (nearly half a trillion dollars) that the US government spent on interest last year.

To put this number in perspective, the US paid more in interest last year than the entire GDP of Saudi Arabia, or the combined GDPs of the smallest 82 economies in the world. Not exactly a trivial number… unless you’re Tim Geithner.

A few days ago, Geithner quipped on NBC’s Meet the Press that there is ”no risk” of the US turning into Greece over the next few years due to such extraordinary fiscal imbalances.

This is the same guy who said there was no risk of the US losing its AAA credit rating, and that inflation on a global level is “not high on the list of concerns…”

Whether it’s lies, ignorance, or arrogance is irrelevant at this point. The situation is what it is. It’s not going to go away just because the political leadership denies it.

Each one of us has a choice. We can either bury our heads in the sand, just like they’re doing… or embrace reality and take control of our own financial futures.

NSA Whistleblower Speaks Live: "The Government Is Lying To You"

 

Just a month ago we raised more than a proverbial eyebrow when we noted the creation of the NSA’s Utah Data Center (codename Stellar Wind) and William Binney’s formidable statement that “we are this far from a turnkey totalitarian state”. Democracy Now has the former National Security Agency technical directorwhistleblower’s first TV interview in which he discusses the NSA’s massive power to spy on Americans and why the FBI raided his home. Since retiring from the NSA in 2001, he has warned that the NSA’s data-mining program has become so vast that it could “create an Orwellian state.” Today marks the first time Binney has spoken on national TV about NSA surveillance. Starting with his pre-9-11 identification of the world-wide-web as a voluminous problem since the NSA was ‘falling behind the rate-of-change’, his success in creating a system (codenamed Thin-Thread) for ‘grabbing’ all the data and the critical ‘lawful’ anonymization of that data (according to mandate at the time) which as soon as 9-11 occurred went out of the window as all domestic and foreign communications was now stored (starting with AT&T’s forking over their data). This direct violation of the constitutional rights of everybody in the country was why Binney decided he could not stay (leaving one month after 9-11) along with the violation of almost every privacy and intelligence act as near-bottomless databases store all forms of communication collected by the agency, including private emails, cell phone calls, Google searches and other personal data.

There was a time when Americans still cared about matters such as personal privacy. Luckily, they now have iGadgets to keep them distracted as they hand over their last pieces of individuality to the Tzar of conformity.

 

Part 1 – Exclusive: National Security Agency Whistleblower William Binney on Growing State Surveillance

William Binney’s shocking facts start at around 15:00…

 

Part 2 – Detained in the U.S.: Filmmaker Laura Poitras Held, Questioned Some 40 Times at U.S. Airports

The Academy Award-nominated filmmaker Laura Poitras discusses how she has been repeatedly detained and questioned by federal agents whenever she enters the United States. Poitras said the interrogations began after she began working on her documentary, “My Country, My Country,” about post-invasion Iraq. Her most recent film, “The Oath,” was about Yemen and Guantánamo and follows the lives of two past associates of Osama bin Laden. She estimates she has been detained approximately 40 times and has had her laptop, cell phone and personal belongings repeatedly searched.

 

 

Part 3 – “We Don’t Live in a Free Country”: Jacob Appelbaum on Being Target of Widespread Gov’t Surveillance

We speak with Jacob Appelbaum, a computer researcher who has faced a stream of interrogations and electronic surveillance since he volunteered with the whistleblowing website, WikiLeaks. He describes being detained more than a dozen times at the airport and interrogated by federal agents who asked about his political views and confiscated his cell phone and laptop. When asked why he cannot talk about what happened after he was questioned, Appelbaum says, “Because we don’t live in a free country. And if I did, I guess I could tell you about it.” A federal judge ordered Twitter to hand over information about Appelbaum’s account. Meanwhile, he continues to work on the Tor Project, an anonymity network that ensures every person has the right to browse the internet without restriction and the right to speak freely.

 

 

Part 4 – Whistleblower: The NSA is Lying–U.S. Government Has Copies of Most of Your Emails

National Security Agency whistleblower

William Binney reveals he believes domestic surveillance has become more expansive under President Obama than President George W. Bush. He estimates the NSA has assembled 20 trillion “transactions” — phone calls, emails and other forms of data — from Americans. This likely includes copies of almost all of the emails sent and received from most people living in the United States. Binney talks about Section 215 of the USA PATRIOT Act and challenges NSA Director Keith Alexander’s assertion that the NSA is not intercepting information about U.S. Citizens.

Why "Unexpected" Is Back, Right On Schedule

Before even taking into account the aftermath of the “unexpected” NFP result, it has been amazing to see over these past few months the number of experts, especially those that reside solely within the “science” of economics, proclaiming a successful engineering of the long sought-after recovery.  That this has been the third such claim in as many years is lost in the noise of confusing “headwinds” that are somehow beyond the control of those that now control most everything within the financial arena.  Stock speculators are beneficial components to the healthy financial transmission mechanism into the real economy (even when all they are supposed to do is provide liquidity 20,000 times per second), but anybody that dares speculate in the far more vital energy sector (or any real commodity) is the pure incarnation of evil.  That these two apparently disconnected speculative classes are really one and the same shows just how obtuse (not always intentionally) economists and the pandering classes really are.

The evil energy speculators go part and parcel with the angelic stock speculators since they are only different sides of the same coin.  Yet mainstream conventional economics continues to miss or ignore this.  But this demonstrable ignorance is really a curiosity in that in every other case economics makes absolutely no distinction whatsoever amongst various types of activities.  The “evolution” (devolution, in my opinion) of economics, especially as it has moved further and further away from qualitative analysis, favors simple quantity calculations.  Lost in that transformation is the real process of real economic recovery, and modern economics will always be befuddled in this search process so long as it ignores differentiation in more important arenas.

I don’t think there is much doubt that Keynes and his intellectual contemporaries solidified the focus on quantity.  The very notion of aggregate demand is essentially a statement that any and all economic activity is a perfect substitute for any and all other economic activity, regardless of “how”, “when” or, more importantly, “why” it was derived.  Quantity is all that matters in aggregate demand.

Every mainstream economic strain follows this basic canon.  As much as monetarism and Keynesianism proclaim and try to be at odds, often positioning themselves as the only two paths for economic and monetary policies, they are really just close ideological cousins.  Keynesians seek to “create” real economy activity through the public sector, largely financed by debt.  Monetarists seek to do the same exact thing, only through the private sector.  But at their philosophical roots, both of these strains adhere to that pernicious notion of quantity as a perfect (or near perfect) substitute.

The monetarism that now lies at the heart of central banking and the soft central planning that has taken over the margins of the global real economy, depends on one formulation to achieve its substitute, quantity-based ends.  Working primarily through the private sector, rather than the public sector where ends can be forcibly accomplished relatively easily through political processes, central banks cannot explicitly force the public to engage in activity.  Of course, central banks operate on the premise that they know better how to “manage” the economic

 affairs of society (beginning with the application of the self-righteous, so-called fallacy of composition which bears no resemblance to actual logic , so it follows for monetarists that there are times when economic actors should not be “allowed” to set their own course.  Aggregate demand is detached from the traditional notion of economics as the aggregation of individual self-actualization, so the “greater good” sometimes demands economic or financial self-immolation.

That means monetary policy has to cajole and coerce (these are not words that describe something that is “free”) the “correct” actions out of economic actors, regardless of their own tendencies and preferences.  The “bunker mentality” that comes with every downturn in the business cycle (regardless of where the business cycle might actually originate) has to be defeated with monetary measures that make “safety” expensive.  It matters very little how much of that bunker mentality is actually beneficial on the individual level, aggregate demand must be filled by something, and a population that cuts back on spending to save or pay down debt is following the “wrong” path.  Therefore, every means or financial vehicle that promotes this antithetical process has to be financially countered by monetary measures.

Monetarily, destroying savings and dampening the desire to save is easily accomplished through ZIRP and a negative real rate of interest.  Those evil oil speculators were not so evil in the early days of QE 2.0 when the Fed was trying to stoke inflationary “expectations” to try to generate “modest” negative real interest rates.  In addition to making savings unappealing, ZIRP also, in the minds of central bankers/planners, increases borrowing activity (the trope that low interest rates are stimulative is still widely circulated and believed despite now years of empirical evidence to the contrary).  Finally, there is the “wealth effect” of rising asset prices through the enhanced speculation that I mentioned in the beginning.  Each of these measures is undertaken with the expressed understanding that they will “stimulate the economy”.

But each and every one of those monetary means to the quantitative ends are financial economy measures.  There is no direct pipeline into the real economy.  Philosophically, these central measures are dependent on the idea that financial risk-taking leads to real economy risk-taking.  It is an unquestioned pillar of modern economics and monetary science that encouraging “risky” behavior in the financial economy encourages and promotes “risky” behavior in the real economy.  Again, risk in the financial economy is believed to be a perfect (or near perfect) substitute for real economy risk.  By getting people to act on these financial impulses, getting money to flow in the financial economy, it is believed that this will eventually lead to real economy activity.

To a certain extent, that idea is correct.  Financial economy activity can and does create activity in the real economy; there are real effects of monetary engineering.  But not all activity is the same, and there is no perfect substitution of generic real economy activity.  It really should not be such a surprise that activity founded on financial risk is not a good substitute for organic growth.  And that is where this entire philosophical construction falls apart.

In reality, promotion of risk-taking in the financial economy actually cannibalizes risk-taking in the real economy.  There is no doubt that financial economy risk-taking leads to activity in the real economy, thus satisfying the quantification needs of aggregate demand, but it is the wrong kind of activity.  A healthy economy is based on activity that is both sustainable and efficient.  Real economy activity based on engineered financial economy risk-taking is neither (especially when the process of price discovery and systemic price of financial risk are heavily manipulated).

For example, the real economy needs a steady supply of entrepreneurs willing to take on the real risk of starting, owning and operating a productive business.  But entrepreneurs are humans that respond to incentives in the same way as everyone else (not mathematical formulations that conform to “logical” interpretations).  During periods where heavy applications of monetary largesse are providing asset inflation, therefore “stimulating” the “wealth effect”, we see entrepreneurialism skewed toward that asset inflation rather than any other real imbalances or opportunities in the real economy.  People chase returns, whether they are presented in the real economy or the financial economy.  During the housing bubble, how many people started small businesses or speculated to take advantage of real estate prices?  Marginal economic activity in the last decade was centered on real estate and construction.  People became real estate speculators (even the portion of the labor force that shifted toward real estate because that was where the money was being made, to the point that such labor not only oriented its skill in that direction, it also moved physically to the locations that provided the most money) rather than real economy innovators.  Instead of starting businesses in the real economy as monetary practitioners intended, economic actors concentrated on the financial economy that was producing what was mistakenly perceived to be the best financial returns. 

It was not just entrepreneurs either.  Marginally, economic participants derived more and more purchasing power from financial means rather than real economic means.  Whether that meant “cashing in” equity in growing real estate prices or just accumulating consumer debt because of the psychology of asset inflation, none of that marginal activity was based on the real economy.  In fact, this bend toward consumption fueled by debt actually skewed the real economy away from efficiently allocating scarce real resources into sustainable, long-term productive endeavors (such the millions of houses and condos that never should have been built, the production capacity that was created to serve that construction effort, and even the parallel production capacity that was created to serve the level of consumption the financial economy enlargement alone provided, i.e., the productive capacity devoted to consumer electronics such as big screen TV’s), including and especially labor resources.

We saw the same exact process in the dot-com bubble era as well.  Instead of starting productive small businesses that were sustainable, marginally a significant segment of the workforce shifted its productive attention toward speculative activities such as daytrading (how many people quit productive jobs to focus on stock trading, preceding the class of real estate flippers that would follow?).  Even business itself was shifted unproductively toward the easy money of asset inflation.  Rather than the marginal creation of businesses that could become sustainable and add real productive value (and thus real wealth) to the real economy, entrepreneurs and others focused on creating or expanding businesses dedicated to some segment of the tech or internet sector whether it was needed or not (whether they actually had a real business plan or not) because that was where all the money was flowing, where the easy financial gains of artificially engineered financial risk-taking were skewing the entire system.

 Throughout this entire experimentation period of monetarism (essentially the past forty years, but really since 1989) the nature of business itself has changed in response to these intentional monetary expeditions into financial risk.  We have seen the rise of the age of unrelenting stock repurchases, where companies buy back shares, using scarce cash resources, to further engineer asset inflation.  Building upon the base of the central bank’s efforts to create a wealth effect, these companies respond to these central incentives and invest their funds first in financial projects (including M&A) rather than real economy capital expenditures.  It started out at the margins, especially in the 1980’s during the junk bond bubble, but since 2003 it has become an all-consuming focus.  Businesses, regardless of their internal situations, will divert resources to stock repurchases, even resorting to borrowing money to fund them.  Stock price over productive value is the name of 21st century business, and the real economy suffers for it.

Rather than leading to a self-sustaining recovery process where financial economy risk-taking leads to beneficial real economy processes, the enlarging financial economy, with its “easy” money returns, draws more and more resources into each bubble, away from where those resources would be far more useful and sustaining.  Financial engineering just does not compliment the real economy as intended.  In reality, asset bubbles are far more like vortices than bubbles.  They draw in more and more formerly useful material and leave destruction in their wake, and a system that can afford less and less the imbalances that these vortices inevitably lead to.

For the purposes of central banks dedicated to aggregate demand, however, the fact that economic actors are engaging in any economic activity is counted as a success.  When quantity is all that matters, these distinctions are unnecessary complications.  Anyone with a modicum of common sense can differentiate economic activity and see that economic quantity that is increasingly based on artificial financial risk and its attendant asset inflation will always be wholly dependent on those characteristics, and thus fully susceptible to reverse.  And reverse is always the end result since, at some point, this mistaken monetary course will always be convinced of its own success once generic activity rises to some level of quantification.  At that point the prime monetary forces are removed, crashing the entire artificially constructed and distorted economic system.  We have even seen this play out after each unique episode of monetary expansion ends just in this recovery/reflation period.

There are enough unambiguous historical examples that provide ample evidence to discard this entire theory of quantification, but ideology prevents unbiased readings of the evidence.  This kind of monetary activity toward quantification can be called reflation since it is almost always heavily applied in the aftermath of some downturn in generic activity (there is very little effort in describing the full processes of said downturn other than generic deference to a purportedly natural business cycle; I suppose that makes these kinds of massive mistakes easier to hide when it is camouflaged within something that conventional wisdom holds to be the natural course of economic events).  The housing bubble/vortex itself was nothing more than reflation out of the dot-com bust.  Once the monetary “stimulus” was turned off in 2005 & 2006 (not just in the US, Japan ended its experimentation with quantitative easing) because central authorities believed they had achieved the correct quantity of activity (mathematically described by the “output gap”), the whole thing came crashing down because the financial economy had cannibalized so much of the real economy disaster was inevitable.  The greater the imbalance of financial  economy over real economy (and the imbalance over speculative, financial risk-taking over investment, real economy productive capacity), the less able the entire system is to absorb the very real price of undifferentiated aggregate demand.  Taking a longer view, 2007 was not all that much different than 1937, including the fact that some lessons are never learned.

In the end analysis, monetarism has the entire process backwards.  The demand for money and credit should be as a result of success in the real economy, not the method for creating activity there.  Consumption itself should be an offshoot of economic success, not the goal of generic activity.  Indeed, the entire financial economy has become displaced from its proper role as real economy compliment.  Intermediation is supposed to be a tool where the real pool of savings is matched to the most productive and sustainable uses for scarce resources, enhancing the real economy through increasing the productivity of money.  The modern financial economy, and the 21st century definition of intermediation, is to create any and all activity in any and all places (see Greece).  This is the opposite of productivity and efficiency.

Yet it is no surprise that central banks and their financial economy, bank-first system continues in the face of so many continuous failures.  The alternative is to return and revert to a complimentary, secondary (or even tertiary) role in the economic system.  The bureaucracy and ideology of the financial economy, especially since it has taken on this primacy, is not really set up for returning economic power to the organic processes of true capitalism, so an ideology has been created to justify this bank-centric schematic (“if the banks fail, the economy fails”).  As long as generic activity and aggregate demand rule the philosophical mainstream roost, intellectually crowding out all other real capitalist, decentralized and free-market alternatives, the case will be made to manage the “greater good” and supersede even the most basic individual actions.  That there exists this fundamental flaw (among many others) of quantification of generic activity, and thus the impossibility of long-term prosperity, is lost in the obfuscation of ideological self-preservation.  So “unexpected” will once again return to the headlines of nearly every economic news item, like clockwork, after each and every independent reflation effort.



"The Apple Conundrum": Why One Fund Is Not Buying The iKool-Aid

Looking at the parabolic rise in AAPL shares in the past 3 months one would imagine that the company’s product line up, so well telegraphed over the past several years, has changed, or at least has found a way to cure cancer, while expanding margins, and also providing loans to cash-strapped US consumers to buy its products exclusively. Truth is nothing substantial has changed – we have merely seen a ramp as every hedge fund and asset manager jumps on the Apple bandwagon (we fully expect at least 250 funds to hold Apple as of March 31: atleast 216 were in the stock as of December 31 and then even Dan Loeb jumped in after) which is fun and games on the way up, but pain and tears when the bubble finally does pop. Many have attempted to warn the public about the latest manic phase of Apple expansion, but few have succeeded – such as the the reality of bubbles: they pop when you least expect them. Yet giving it the old college try, here is Obermeyer Asset Management’s John Goltermann with an extended commonsensical approach to his perspective on the company with two main growth products, and why unlike everyone else, he is not buying the iKool-Aid.

Some excerpts from the letter:

Most members of the Obermeyer Asset Management team use Apple’s products and highly respect the company and its achievements. We recognize that it has built a cult-like following of both technophiles and ordinary users who aspire to own its latest and greatest gadgets. We recognize the elegance of its platform, the ease, convenience and life-enhancing attributes of its apps, the effortless delivery of media content and how it has even transformed entire industries. We recognize the style element of owning Apple devices, we recognize the status that people derive as Apple users and we understand the mystique the company possesses in the way it operates.

 

Given our shared appreciation for Apple as a company, why aren’t we making a place for it in client portfolios? We generally separate current and prospective investments into three broad categories: Yes, No and Too Difficult. In the case of Apple, we see this investment as Too Difficult. Let us explain:

 

With a market value of $550 billion, Apple now comprises 4.4% of the S&P 500 index and, all by itself, is larger than the entire utilities industry. With 932 million shares outstanding, every dollar move in Apple’s share price represents nearly $1 billion in net new capital flowing to its shares. For context, the median company size of those in the S&P 500 is $12 billion, so a 2% move in Apple’s stock is the equivalent of adding a whole new company at the median value to the index.

 

Since December 31st, Apple’s market value has increased by $172 billion, which is roughly the size of Johnson & Johnson, a large, well-established, innovative healthcare and consumer products company with a 125-year history. Johnson & Johnson has enjoyed many successes, has reinvested high levels of profit and is investing to expand its divisions, products and businesses. Apple attracted the same amount of investor capital in two and a half months that Johnson and Johnson attracted in its entire 125-year history.

 

 

Apple launched its first iPad in April 2010 and is now on its 3rd version, so the iPad has about a two-year shelf life for the company (it might milk a few more years out of each version, but the company’s business model is to continually launch new product iterations and slash prices on the older versions). Though it’s not disclosed in the financials, a guess would be that the new iPad will sell 26 million units its first year and 14 million in its second. If each version of the iPad earns $260 per unit, then Apple investors can expect somewhere in the range of $10 – $15 billion in total pre-tax profit for this newest version of the iPad. Unless investors thought Apple’s stock was way too cheap before the new iPad announcement, they seem to be expecting much more value to be delivered to shareholders from the iPad launch than can be reasonably be delivered by sales of the iPad device itself. The $172 billion increase in the company’s value far exceeds the approximately $15 billion that will come from the iPad, so it will have to come from something else. We don’t know yet what that “something else” is.

 

When we look at our cash flow models, assuming Apple can maintain its current operating margins (a heroic assumption in the face of increased competition in the tablet market), to justify the current stock price, it appears to us that Apple will have to sell about $2.6 trillion worth of total products and services over the next ten years. Last year’s revenues (for the fiscal year ending 9/24/11) totaled $108 billion. If Apple’s margins shrink, it will have to sell a lot more. This level of Apple product sales will make up almost 1.5% of U.S. GDP (of course it  also sells products outside of the U.S.). That means that with the average GDP per capita in the United States being around $50,000, each person must spend $750 on Apple products and services annually (since 30% of sales are domestic, this means that about $225 per U.S.  citizen would go to Apple every year). Since not all 310 million people in America use Apple, those who do need to spend a lot more and the vast majority of those sales will need to be on devices because iTunes sales do not bring much profitability.

Like we said: no stories here. Just common sense.

The Fed Is Losing The "Race To Debase"

As we pointed out about a month ago, in “While You Were Sleeping, Central Banks Flooded The World In Liquidity” as the world was focused on headlines whether or not the Fed would step up as it always does when the market is sliding, and unleash the monetary floodgates, it was not Ben Bernanke, but eveyrone else that hit CTRL+P and took the place of the Fed, of note the primary central banking peers among the Final Four – the ECB, the BOE and the BOJ. And why not: after all the hope was that since electronic money is electronic money, and can be moved from point A to point B at the push of a button, it would be used primarily to reflate stocks around the world, but mostly where the path has least resistance – the US. What was not accounted for was that money would also be used to inflate commodities such as oil – a key factor when delaying further US-based easing in an election year. However, more than even record for this time of year gas prices, there was one even more important outcome from this chain of events. As the following chart from Willem Buiter shows, in its fake attempt to show monetary restraint, the Fed has gone straight into last place in the “race to debase.” Needless to say, in a world with $25+trillion in “excess” debt (debt which would need to be eliminated simply to reduce global debt/GDP to a “sustainable” 180% per BCG), last is a very bad place to be…

Of course, our frequent readers will note that this is the same chart that we have presented, however in the form of the main correlation chart for 2012 as we have dubbed it – i.e,  the ratio between the size of the ECB and the FED vs the EURUSD. What is probably also quite disturbing is that the Fed is “losing” even after expanding by a massive 232% in the past 5 years, a number that is only topped by the Bank of England. To quantify, the Fed is now responsible for “only” 20% or so of US GDP, compared to 30% for the ECB and BOJ. To further quantify, to get back to first place in the race to debase, the Fed will have to do at least another $1.5 trillion in QE.

Also, having become a buyer of last reserve for credit money, it is easy to see why one should be outright skeptical of US GDP “numbers” – from 6% of US GDP, the Fed now accounts for a whopping 19% – this is “growth” that would not have happened unless the Fed, via debt monetization would have allowed it. Said otherwise, net of Fed deleveraging (if it ever unwinds its balance sheet of course), US GDP would be a 13% lower

Not only that but as the chart above shows, global GDP has about $6 trillion in “one-time, non-recurring” growth factored in.

… Only, and let’s not fool ourselves here, it is not one-time, and certainly not non-recurring.

As shown here before, the biggest problem for the world right now is the disappearance of “money good” assets, and the redirection of investing capital from worthwhile growth activities such as R&D into shareholder placating pursuits such as dividend issuance (and overall cash hoarding), and job dilution -a practice which as described yesterday may have well killed the virtuous cycle. As such any future global “growth” will be exclusively a function of further “nominal” improvements, achieved only through further currency dilution.

And now that the economy has once again hit a downward inflection point (with 12 of 14 economic indicatorscoming in negative), and since the Fed has some serious catching up to do to get back to the front of the race to debase, it is only a matter of time before it becomes clear that Obama reelection be damned, it is Bernanke’s turn to hit CTRL+P. Because in a world in which only currency devaluation matters, a 10% debt/GDP handicap is most certainly a nominal aggression that will not stand…

Terminated CBO Whistleblower Shares Her Full Story With Zero Hedge, Exposes Deep Conflicts At "Impartial" Budget Office

Earlier today, we suggested that in the aftermath of the Greg “Muppets” Smith NYT OpEd, contrary to assumptions by Jim Cramer, a bevy of potential whistleblowers would step up to tell their tale of fraud and corruption across all walks of life – from Wall Street to, far more importantly, Washington, consequences be damned. This was paralleled by an alleged JPM whisteblower describing to the CFTC the firm’s supposedly illegal activities in the precious metals space, which while we initially dismissed, we now admit there may be more to the story (stay tuned), even though we still have our doubts. What we are 100% certain of, however, is that yet another whistleblower has stepped up, this time one already known to the general public, and one that Zero Hedge covered just over a month ago: we refer to the case of former CBO worker, Lan T. Pham, who, as the WSJ described in early February, “alleges she was terminated [by the CBO] after 2½ months for sharing pessimistic outlooks for the banking and housing sectors in 2010” and who “alleges supervisors stifled opinions that contradicted economic fixes endorsed by some on Wall Street, including research from a Morgan Stanley economist who served as a CBO adviser. As part of the review, Sen. Grassley’s staff is examining whether Wall Street firms or others exert influence that compromises the office’s independence.” As we observed in February, “what is most troubling is if indeedthe CBO is nothing but merely another front for Wall Street to work its propaganda magic on the administration. Because at the core of every policy are numbers, usually with dollar signs in front of them, numbers which have to make sense and have to be projected into the future, no matter how grossly laughable the resultant hockeystick.” As it turns out, somewhat expectedly, the WSJ version of events was incomplete. There is much more to this very important story, one which has major implications over “impartial” policy decisionmaking, and as a result, Ms. Pham has approached Zero Hedge to share her full story with the public.

As we stated earlier, we will present any and every whistleblower’s statement in its entirety, and without editing, and so we will, however we want to bring our readers’ attention to several key aspects of Ms. Pham’s termination from the CBO, because it may have substantial implications over the enacted $25 billion robosigning settlement. The reason for this is that Ms. Pham was fired because of her work voicing skepticism over precisely the same ‘chain of title’ validity issues that snarled foreclosure to a halt for much of 2011, which as Adam Levitin has said present a “potential systemic risk to the US economy” and which have necessitated the recently enacted Robosettlement to avoid massive losses for the banks (and in the process yet another shadow taxpayer bailout for the Too Big To Fail banks).

The bottom line is that the CBO was warned at least by Ms. Pham (and possibly others) over the dangers of precisely the issue that Attorneys General are scrambling to shove under the rug in exchange for a wristslap to all mortgage originators (i.e., the same banks that somehow are now getting bailed out by taxpayers and the GSEs on an annual basis). And just like every other issue that merely gets a cosmetic and very transitory liquidity facelift, nothing ever is actually fixed. As Ms. Pham says: “It is unclear how the recent State attorney generals’ agreement to a proposed yet unpublished terms of the $25 billion robo-signing settlement would repair the chain of title issues that continue to mutate. In January 2011, the Massachusetts Supreme Judicial Court reversed the foreclosure actions of two banks for lacking proof of clear title, followed by a decision in October 2011 that a buyer who purchased a house that was improperly foreclosed upon does not make the buyer the new owner of the house; the sale does not transfer the property.”

While we are confident that even more contract laws will be terminally bent and broken simply to avoid some more balance sheet impairments for America’s already insolvent financial system, the message here is clear: the CBO, and arguably other “impartial” policy advisors, will only focus on the established institutional opinion, preferably that set by Wall Street itself, and retaliate (in some cases with physical force) over anyone who provides a dissenting opinion.

Such as Ms. Pham.

Below is her full story (pdf).

Following the Wall Street Journal story, “Congress’s Number Cruncher Comes under Fire,” I realized that the true nature of the issues would not come out. Therefore, I am making public the letter that I wrote to Senator Grassley (Feb. 23, 2011) regarding circumstances that led to my firing after 2.5 months by the Congressional Budget Office (CBO), particularly my writing about mortgage fraud and its roots in mortgage securitization that CBO sought to deny was a problem.

For clarification, the WSJ did not give proper recognition to some individuals. My “supervisors” was Dr. Deborah Lucas, who was CBO chief economist and assistant director, and is currently tenured professor of finance and economics at the Massachusetts Institute of Technology (MIT). MIT Professor Lucas was called by the President to serve in a leadership role at CBO. Morgan Stanley economist and CBO advisor, is the Vice President of Economics Research at Morgan Stanley, Richard “Dick” Berner, whose policy framework for refinancing stimulus was to be incorporated into my writing. Dr. Lucas also shared with me analyses from Goldman Sachs, also on the CBO’s distinguish panel of economic advisors, on the housing market such as the banks’ limited risks on mortgage buy-backs.

As a Congressional senior staffer, financial economist, my initial responsibilities were to write a brief (paper) to Congress on the state of the foreclosure crisis and the alternative policy options, as well as cover banking and housing. Almost to the exclusion of other policy options, CBO Assistant Director Lucas and senior management worked around Morgan Stanley’s policy framework and related ideas to present to Congress as the policy choice (One would be correct to point out that CBO does not make policy). Below are excerpts from my letter to Senator Grassley:

I was repeatedly pressured by the CBO Assistant Director, Deborah Lucas… to not write nor discuss issues in the banking sector and mortgage markets that might suggest weakness in these sectors and their consequences on the economy and households…

CBO: Robo-signing, foreclosure fraud as “hype in the press”

When I wrote about the emerging foreclosure problems in September 2010, CBO Chief Economist Lucas maintained that robo-signing was media “sensationalism,” “the kind of event of the moment where we should be adding skepticism, not just repeating the hype in the press”; CBO wrote that my writing about it “lacks judgment about what is important.” Exploring this further in the letter,

…Issues at the heart of the foreclosure problems pertain to securitization….and the Mortgage Electronic Registration System (MERS), which purports to have legal standing on electronic records of ownership on about 65 million…mortgages… MERS…facilitated Wall Street’s ability to expedite the pooling of subprime mortgages into MBSs by bypassing standard ownership transfer procedures as the housing bubble escalated…

The implications have profound financial and economic consequences that would be of compelling interest to Congress and the public, but the CBO sought to silence a discussion of such risks, that in reality have been materializing. These risks put into question the ability of investors or bondholders to make claims on the collateral (the homes) that underlies trillions of dollars in MBSs, the bulk of which are now guaranteed by …Fannie Mae and Freddie Mac. This affects $10 trillion in residential mortgage debt outstanding, of which $7 trillion in mortgage-backed securities (MBSs)…

The CBO dismissing such issues prevents an analysis of the risks, so that the public may be forced again to shoulder the consequences for which they have not been a given a voice or a choice.

A month later after being told by CBO Chief Economist Lucas to not repeat this media hype, Georgetown University Law Professor Adam Levitin, Special Counsel to the Congressional Oversight Panel and scholar at the American Bankruptcy Institute, raised essentially the same issues in his testimony before the House Financial Services Committee:

“The chain of title problems are highly technical issues, but they pose a potential systemic risk to the US economy. If mortgages were not properly transferred in the securitization process, then mortgage-backed securities would in fact not be backed by any mortgages whatsoever….

These problems are very serious. At best they present problems of fraud on the court, clouded title to properties coming out of foreclosure, and delay in foreclosures that will increase the shadow housing inventory and drive down home prices. At worst, they represent a systemic risk that would bring the US financial system back to the dark days of the fall of 2008.” [Executive Summary, first page]

Essentially, the chain of title on securitized mortgages appears broken, whether or not there is a foreclosure. This would pertain to most homebuyers in the past 10 years as most mortgages were securitized by Fannie Mae and Freddie Mac providing the guarantees, and the largest banks (“The $7 Trillion MBS Problem – Foreclosure Problems and Buybacks”). Recall that these same entities founded MERS, which expedited securitization and purported to have foreclosure authority from its electronic records of ownership on about 65 million mortgages. “Robo-signing” emerged as fraudulent or defective documents were used or created to establish the legal authority to foreclose as MERS faced legal challenges; as of July 22, 2011, foreclosures could no longer be initiated in MERS’ name. At last year’s pace, some figures suggest it could take lenders in New York 62 years to clear their foreclosure inventory, 49 years in New Jersey and a decade in Florida, Massachusetts, and Illinois.

It is unclear how the recent State attorney generals’ agreement to a proposed yet unpublished terms of the $25 billion robo-signing settlement would repair the chain of title issues that continue to mutate. In January 2011, the Massachusetts Supreme Judicial Court reversed the foreclosure actions of two banks for lacking proof of clear title, followed by a decision in October 2011 that a buyer who purchased a house that was improperly foreclosed upon does not make the buyer the new owner of the house; the sale does not transfer the property.

A striking little mention fact of the Massachusetts foreclosure case was that the lenders could not show that the two mortgages were part of the securitization pool. Let’s consider a thought exercise. Others have the raised the question: if the entity that has been taking the homeowners’ mortgage payments is not the real owner, what happens when the true owner(s) of

the mortgage shows up? Are homeowners on the hook again for those ‘missed’ mortgage payments? It was not uncommon for mortgages to be sold multiple times, and it is my understanding that loans were intentionally not given unique identifiers as it moved from origination or purchase through to securitization.
In response to the WSJ story, Director Elmendorf issued a public statement maintaining the integrity of CBO’s work, an excerpt which reads:

“…We have the utmost confidence in the objectivity of our work and devote considerable time and energy to explaining the basis of our findings as clearly as we can to help Members of Congress understand the work that we do.” (Bolded emphasis is CBO Director Elmendorf’s)

In early November 2010, a stunning example was CBO Director Elmendorf’s, a Harvard Ph.D. economist, view that employment growth in housing construction would spur economic growth, in his discussion of inputs into CBO’s macroeconomic forecast model. A question about the assumption was met with Director Elmendorf asking why they were “pessimistic” about such assumptions.

After my termination, Director Elmendorf stated that I should have followed directions from the more knowledgeable and experienced Chief Economist Lucas, taken the opportunity to learn from her. Director Elmendorf saw no ethical issues in her direction, but shifted to perhaps we had a difference of professional opinion. As I understand, Director Elmendorf and MIT Professor Lucas first claimed to Senator Grassley’s office that they could not speak about my termination due to personnel privacy protections, when none exists for Congressional employees. When given full immunity to speak freely to Senator Grassley’s office regarding my termination, they refused to speak.

It has been suggested to not mention these things in polite conversation, but I admit there were oddities following CBO’s termination. After CBO fired me at the end of the day saying “we do not know whether or what you know about economics, economic theory or finance,” I returned to my office to make a phone call. Everyone had left, but there was a silhouette of a man standing in the dark in an office across the courtyard watching me during the 15-20 minute phone call. Later, I came home to find some papers had been moved and could no longer find some important documents pertaining to this case. I attempted to retrieve these documents from my office at CBO, but the power to my office was shut down precisely as the documents from my computer were about to be e-mailed to me; the entire floor and building were unaffected. At about 3 a.m. during a week day, there was sudden a loud crash into my front door followed by complete silence. Perhaps it was just a complimentary early wake-up call.

The truth is still what it is.

As I have come to learn, the issue of foreclosure fraud ‘robo-signing’ seems to be spoken in hushed tones near the powers of Washington D.C. CBO has the ear of Congress and can make or break policies that affect the nation with its analyses.

Who is the CBO serving?

Lan T. Pham, Ph.D.