The Bailout

I hate to write about negative events and problems. I would prefer to write about happy things, like my Grandchildren, the joy of Italian Food, and NY Giants making the Super Bowl. I always have preferred a Bull Market to a Bear Market, and a healthy, and happy Economy. The problem I have is that we have big problems. We have some real Economic and Financial Problems that need to be addressed. No doubt, in time, all the problems will be resolved in the long run, but (as John Maynard Keynes said) we eat in the short run. Here are some of the problems we confront for this year:

In the past five years, Wall Street has created yet another derivative-namely, “Credit Rate Swaps”, whereby “bets” are placed between two parties that a given debt will default or make good. The market is about $45 Trillion, which is equal to all of the Deposit’s in the Banks around the World. A Party for a price assumes the value of an “insurance” contract that rises or falls with perceptions of risk. Some players buy them just to speculate. A financial institution, hedge fund, or other player can make unlimited bets on whether loans will either strengthen or go sour. If they default, everyone is supposed to settle up with each other. Even if there isn’t a default, if the market value of the debt changes, parties in the swap may be required to make large payment to each other. Many of the contracts are leveraged. Warrant Buffet says” you are essentially counting on the reliability of strangers to pay up on their contract. The rate swaps are largely unregulated, and the derivatives are off-balance sheet transactions. Who’s going to bail out these transactions? Taxpayers? Who’s watching the store, and what are these instruments worth? Nobody knows!

The lowering of the Fed Funds Rate twice in a matter of weeks excited Wall Street. Yet the Stock Market has not had any significant rally so far. Could it be that this is a credit crunch and not an interest rate problem? No doubt the lowering of interest rates will help the helpless, hapless Banking System and some Reset Mortgages coming due over the next 9 months, but remember, the Mortgage Obligor must now pay higher rates and at the same time make principal payments.

Mammoth infusions of Capital into the US Banking System from Foreign Soveirgn Wealth Funds (Saudi Arabia, Korea, and China) have bolstered Bank Capital, but the Banks are paying 15% to 18% interest on the “loans”. The US Dollar is recycled. We pay foreigners buying Oil and Consumer Goods, and now Foreigners give us the money back.

The US Dollar is in free fall. A nations currency value measures the wealth of a country. If a nation’s currency goes lower, it indicates the lower purchasing power of that currency for World Wide Goods and Services. The US Dollar versus all currencies was 121.29 in June 2001. It now stands at 74.48, a 38.50% decline in purchasing power. Factor in the inflation rate, and our populace has given up over 42% in value in 7 ½ years.

As our we go from “Bubble to Bubble”, The Federal Reserve and Congress keep bailing us out (we pay for it) by lowering interest rates and providing funds to prevent a Recession. In the Great Depression, this was a very good idea. However, in the current economic environment this strategy poises several major problems, namely:

1. Interest Rates cannot go to zero percent (can they?),
   
2. it takes greater and greater infusions of liquidity to prevent a Recession (inflationary). This process is very much like narcotics addiction. Each injection does not create the desired high, so the addict injects more narcotics trying to capture the original high. This process cannot go on,
   
3. the whole process assures a penalty free atmosphere for those that created irrational and inefficient processes, In fact, Wall Street calls this the “Federal Reserve Put”, meaning that any half-baked scheme will be “bailed out”.
   
4. We (taxpayers) pay for the mess made by others,
   
5. Our Economy goes from one bubble to another bubble. We already had the Dot.Com bubble, and the Housing bubble. With cheap money and borrowing rates at all time low’s, the tendency is for investors to borrow and bid asset prices up. The question is what asset class will investors buy next?
   
6. As other Foreign Currencies go up against the dollar, Foreign Central Banks are motivated to keep their trading advantage. To do this, they print more money to prop the US Dollar up (thus selling their currency). We then have an expansion of all Currencies that is inflationary for the World.

The Gold Reserves of the United States have not been full and independently audited for half a century. Our Gold Reserves are being used for the surreptitious manipulation of the international currency. The Treasury Department acknowledges that their Exchange Stabilization Fund has undertaken gold swaps. Barrick Gold Corp acknowledged that the mining company was the instrument of Central Banks in shorting the Gold Market. Now our Government is fooling with our Gold Reserves.

There are two opposing economic possibilities confronting the US Economy. Deflation or Inflation If the Credit crunch gets out of control, we will have a deflation (collapse of credit). If the Politicians and Federal Reserve keep up their advertised cures, we will have inflation. Either extreme is not satisfactory. My bet is we will have increasing levels of inflation, which makes Gold and precious metals viable candidate’s for the next Bubble. Cash is King and Gold glimmers.