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Trading Lessons

The Establishment Train Is Going Off a Cliff

Politics / US Politics Apr 16, 2011 - 12:42 PM GMT

By: Gary_North

Politics

Diamond Rated - Best Financial Markets Analysis Article"A billion dollars doesn't go as far as it used to." – Bunker Hunt, 1980

That was Mr. Hunt's comment on his losses – at least $2 billion – in his attempt to profit from the silver market, which peaked at $49.50 in January 1980. The price fell by 75% over the next few months. Win some, lose some. At the time, he was regarded as the biggest financial loser in modern history. This was accurate, since seven years earlier, Mohammar Gadaffi had nationalized his oil operations in Libya. At the time, Hunt was the richest private citizen on earth. When Gadaffi got away with this in June of 1973, OPEC caught on and tripled the price of oil in October. That led to a worldwide recession in 1974-75. Win some, lose some.


The pundits are saying that the Democrats will spend a billion dollars to get Obama re-elected in 2012. That means that the Republicans will do their best to raise a billion dollars to get their candidate elected. One of them will lose.

Think about this. One of them could become the first billion-dollar loser in American political history. He (or she) will not be the last.

The cost of electing and not electing members of Congress will no doubt approach the cost of electing and not electing the next President. But the loss of a billion dollars has a certain ring to it. Someone is going to make history, either in 2012 or 2016, depending on when that billion-dollar figure appears.

The magnitude of a losing campaign that squanders a billion dollars is considerable. It is so huge that even conceptualizing it is difficult. The real cost is the opportunity cost: the cost of the highest value item or items foregone. Here, people debate. What is the highest-value item? There is no agreement.

There are a hundred million households in the United States. A billion dollars is $10 per household. Put this way, it doesn't sound like much. I looked for examples on Google, but there are not many sites devoted to describing what a billion dollars would buy. One site mentioned these items.

Pay the annual salaries of 25,800 Americans
Pay the annual taxes for 103,400 Americans
Pay for two days of the wars in Iraq and Afghanistan

Before I consider the meaning of a billion-dollar loser, I want to consider the billion-dollar winner.

"AND THE WINNER GETS. . . ."

The winner of the 2012 election will get to oversee a Federal deficit of something in the range of $1.5 trillion per year. Maybe it will be less, but not much less. Maybe it will be more. But the round number of $1.5 trillion would have been inconceivable as recently as 2007.

Here is an unsustainable situation. The ability of the United States government to sell its debt at anywhere from six one-hundredths of a percent (90-day T-bills) to under 3.5% (10-year T-bonds) is chronologically limited. It can do this today. No one thinks it can do this for half a decade – not with the balance of payments deficit at $500 billion a year and the on-budget, admitted deficit of $1.65 trillion for fiscal 2011.

There are two American wars in progress. One is in Afghanistan, with no end in sight. The other is in Iraq, where there are 47,000 uniformed troops plus 100,000 mercenaries of various kinds. Secretary of Defense Gates recently said that there is no timetable for withdrawal, which President Obama said in 2009 would take place by December 31, 2011, a fact that the dutiful mainstream media have dropped down the memory hole.

Secretary Gates said that withdrawal will take place when the Iraqi government asks us to leave. That means the twelfth of never.

The winner of the 2012 election will get to take the heat for the economy of 2013-16. All those who are associated with the victor's politics will get to be the targets of electoral blowback in 2016.

Debts must be paid. The alternative is default. The U.S. government's debts cannot be paid. Yet voters cannot bring themselves to face the reality of default. There has always been a way to delay the day of reckoning. There has always been another central bank rabbit to pull out of the fractional reserve hat. There has always been a way to move the decimal points to the right on the asset side one more time, and move the liabilities off budget. There has always been a way to persuade lenders to lend the drunken government enough money for another night on the town.

ENRON'S ACCOUNTING METHODS

What Enron did unsuccessfully, the Federal government has done for a generation: move the liabilities off-budget. Enron eventually got caught.

Today, Social Security is running a deficit. The FICA taxes do not pay for the costs of the program. The surplus in FICA taxes for over 40 years have been counted as assets, with the IOUs to Social Security counted as off-budget liabilities. The game cannot go on unless there is a hike in FICA taxes. Medicare has been in this condition for several years.

Enron is a model of phony accounting gone bad. The documentary, The Smartest Guys in the Room, is a devastating look at what bad accounting and personal arrogance can do. The smart guys were fools. This is the message of the documentary.

With Social Security, the smartest guys in the room for 70 years have gotten away with it. When Enron went bust, it took down the pension fund dreams of the trusting employees who believed Ken Lay's assurances that everything was fine. When Medicare goes down, taking Social Security and the Federal government with it, who will be tried and convicted? No one.

Who will be tried an convicted in the court of public opinion? That will depend on the skills of the non-Establishment groups that have sounded the warning. It will depend on which of today's losers wins.

Yet there are at least a dozen people who want the opportunity to preside over what is clearly going to be a train wreck. "Let me be the engineer!" they cry.

I would like to get off the train. But there are no stops between here and the burning trestle.

LOSE NOW, WIN LATER

Admittedly, I can see the logic of running. I am in direct-response marketing. I am also in the field of education. The idea of developing a mailing list for the post-election train wreck would be tempting – just so long as I had no chance of winning. Think of the web traffic I could generate. Think of the donations. I could use the donations to build the mailing list. Then, after the election is over, I would hire people to produce a comprehensive plan of education. This would include the following:

  1. A K-12 on-line curriculum, which in 9-12 would allow these options for specialization: social sciences, natural sciences, humanities, and small business.
  2. A program of political education: how to organize and elect people in county government
  3. A program on using digital media: social networking, YouTube, WordPress, podcasting, screencasting, and similar free methods of digital communication
  4. On-line course on central banking: what it is and how it has led us onto the train
  5. An on-line course in political theory, showing that the politics of plunder has led us onto the train

In other words, I would use the enthusiasm of national politics in 2012 t create the basis of a localized resistance movement in 2013.

After the train goes over the trestle, there will be a brand-new market for post-Keynesian approaches to political economy. There will be lots of competing groups with all kinds of solutions, most of them hopeless and most of them based on politics as the correct means of social healing. That outlook got us all onto the train.

Digital technology is ideal for decentralization. This is the great advantage possessed by those whose idea is to shrink the state rather than expand it. As time goes on, there will be more voices from the Remnant. The ability of small groups to get a message of decentralization and de-funding the state is increasing. The gatekeepers of Keynesian orthodoxy are finding it more difficult to block the message of tax reduction and deficit reduction.

MORAL HAZARD II

The term "moral hazard" applies to banking. When commercial bankers know that the big banks will be bailed out by the central bank, and their CEO's will suffer few negative consequences personally, they choose high-risk, high-return investments. This cause-and-effect pattern has been known since the mid-1800s.

Here is one of many examples. Chuck Prince, the former CEO of Citigroup, made his now-legendary observation in July 2007: "As long as the music is playing, you've got to get up and dance." He added: "We're still dancing."

He retired the following November, due to low returns. In December, the recession began. Prince is now a laughingstock. But he is a rich laughingstock. We read on Wikipedia,

Prince left with vested stock holdings valued at USD$94 million and the roughly $53.1 million salary he received over the four years in the position. . . . He is still a consultant with Citigroup.

As long as the Federal Reserve is there to bail out banks, along with help from the U.S. government, the people at the top of the pinnacle of money will not fall to earth. They may get replaced, but they will not be wiped out. They will in fact clean up. How? With our productivity. We foot their bills when they lose. They clean up on us when they win.

This is an asymmetric economic relationship. "Heads, I win; tails, I win." It produces disastrous results.

What is not widely recognized is that this same moral hazard phenomenon applies to all areas of the American political Establishment. This is why the same faces come in and out of government in the top advisory positions. Presidents come and then depart for high-income retirement, never to exercise influence again, but their senior advisors rarely depart permanently.

Back in the 1970s, Susan Huck described the race for the President as competition between Council on Foreign Relations Team A vs. CFR Team B. In the words of Phyllis Schlafly back in 1963, it is an echo, not a choice.

The political Establishment rolls on because it has perpetual guaranteed funding. The financial system has always been sustained by massive theft from the taxpayers and lenders to the Federal government, supported by the Federal Reserve. But the American banking system remains dysfunctional today. The bad debts are still there, even though the commercial banks' accountants are allowed to conceal this through book-value accounting rather than market-value accounting. The international banking system remains dependent on central bank intervention. The economy still rests on monetary inflation, massive borrowing, and men's faith that the trestle is not burning – just smoking a little.

The Establishment cannot get off the train. It cannot get out of senior management. Its man is the engineer. It has paid the traffic routers. It has failed to repair the trestles. It has deferred the day of reckoning. It has adopted the strategy of state and local governments with respect to potholes: "patch and pray."

The train is clearly not being managed correctly. The $1.65 trillion deficit cannot be hidden. Yet interest rates are at historic lows in the post-Great Depression era. The lenders are turning their money over to the Federal government because it is AAA-rated. Yet the companies that offer this rating are the same firms that offered AA-ratings to the banks that were profiting from the subprime loan market in 2007.

There is no sense of urgency. The interest rate structure reflects this. The accountants see what is coming, but they think the day of reckoning can be extended. For short-term investors, political deferral is the same as government solvency.

There is no sense of urgency because of an asymmetric allocation of responsibility. The senior politicians believe that the central bank can solve every major economic problem. The senior investors who run the funds believe that the central bank and the government can solve every major economic problem.

BERNANKE'S POSITIONING

The central bankers, as represented by Ben Bernanke, generally think that fiat money can solve every problem but one: $1.5 trillion deficits. Bernanke has repeatedly told Congress that Congress must someday – he does not say when – reduce the deficit. In January, he told the Senate Banking Committee that the trestle is on fire.

It is widely understood that the federal government is on an unsustainable fiscal path. Yet, as a nation, we have done little to address this critical threat to our economy. Doing nothing will not be an option indefinitely; the longer we wait to act, the greater the risks and the more wrenching the inevitable changes to the budget will be.

He then added the obligatory statement that there is still a way out, if only Congress takes – you will not believe this – effective and decisive action.

By contrast, the prompt adoption of a credible program to reduce future deficits would not only enhance economic growth and stability in the long run, but could also yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence.

What did he mean, "credible program"? He offered this example:

Plans recently put forward by the President's National Commission on Fiscal Responsibility and Reform and other prominent groups provide useful starting points for a much-needed national conversation about our medium- and long-term fiscal situation.

The National Commission was set up so that no recommendation from it would have to be considered by Congress. A majority vote could not do this; it had to have a 78% majority, which the President knew it could not get. It got 61%: 11 of 18. "Sorry, But thanks for playing." The commission's report, "The Moment of Truth", was published in December 2010. That moment has now passed, as has truth.

Bernanke knew this in January. Bernanke is positioning the Federal Reserve as the main Establishment institution that sounded the warning, despite the fact that he knows full well Congress will pay no attention. "I did my best!" The FED supplies some of the loans the Treasury needs, to keep the train moving rapidly toward the burning trestle, but he is making noises as if he is preparing to pick up the pieces after the train goes over the collapsed trestle. You can read his full testimony here.

CONCLUSION

Someone is going to be a billion-dollar loser in November 2012. He or she will be the lucky one. The textbooks will barely mention his or her name. Someone else will be the billion-dollar winner. His or her reputation will not be reclaimed by the textbooks. It will be "Herbert Hoover and X" from 2017 on.

When will you jump from the train? It's not going to stop, but maybe it will slow down briefly as it heads around a curve.

Gary North [send him mail ] is the author of Mises on Money . Visit http://www.garynorth.com . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

http://www.lewrockwell.com

© 2011 Copyright Gary North / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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