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EJ
10-15-07, 06:52 PM
http://www.itulip.com/images/mcolbert.jpgA Mock Columnist, Amok (http://www.nytimes.com/2007/10/14/opinion/14dowd.html?_r=1&ref=opinion&oref=slogin)
October 14, 2007 (MAUREEN DOWD NYTimes)

I was in my office, writing a column on the injustice of relative marginal tax rates for hedge fund managers, when I saw Stephen Colbert on TV.

He was sneering that Times columns make good “kindling.” He was ranting that after you throw away the paper, “it takes over a hundred years for the lies to biodegrade.” He was observing, approvingly, that “Dick Cheney’s fondest pipe dream is driving a bulldozer into The New York Times while drinking crude oil out of Keith Olbermann’s skull.”

I called Colbert with a dare: if he thought it was so easy to be a Times Op-Ed pundit, he should try it. He came right over. In a moment of weakness, I had staged a coup d’moi. I just hope he leaves at some point. He’s typing and drinking and threatening to “shave Paul Krugman with a broken bottle.”

AntiSpin: The only serious journalism I'm reading these days is done by comedians. Maureen Dowd is already funny, but when Stephen Colbert does her column it's like Mad Max turning on the nitro while chasing gasoline thieves in the last of the Interceptors.

Speaking of gasoline, oil continues to make new highs, today breaking the 86 bonar (http://www.itulip.com/glossary.htm#B) barrier for the first time. AP reports (http://biz.yahoo.com/ap/071015/wall_street.html): "Stocks pulled back sharply Monday as news that major U.S. banks will set up a fund to help bail out the credit markets stirred concerns about bad debt and as oil prices surged to $86 per barrel for the first time. The Dow Jones industrial average lost more than 100 points."

http://www.itulip.com/images/oil.jpgThere you have it in one sentence, the real conundrum: Oil and Debt. A clever means of producing credit without inflation was eventually to lead us to have to choose between one or the other. More on that, below.

We North Americans tend to obsess too much about our little war, oil, inflation, and recession problems. Let's turn briefly out to Germany where one of our now more than 4,000 members, Christoph von Gamm (http://itulip.com/forums/member.php?u=214), President and Founder of Interenterprise.eu and Senior Manager at IBM Corp., reports from Zürich, Switzerland.

We asked Christoph how Germany is holding up in the wake of the US housing market crash and piles of junk mortgage securities dumped on unsuspecting 33 year old European pension fund managers.
A good picture. Much better than two years ago, but mixed. The glass is half-full.

The economy is strong and rebounding. Germany is still the number one Net exporter world wide, before China, despite its relatively small size.

Inflation still is reportedly low yet signs of increasing inflation are going up. Unemployment has become quite low to German measures. It was 25% less than two years ago. The Energy Price surges are still not an issue as the Oil has been quite stable, as measured in Euro.

With of course having a certain export sensitivity to the US, the declining value of the US dollar also affects German exports.

Real estate in Germany is seen by international standards as undervalued, also caused by cautious lending after a 1992-1999 real estate bubble in East Germany after the reunification.

Technically speaking, the German stock market DAX is again near its all time high measured in Euros with 8050 points at the moment. From a technical perspective, I expect a triple top formation–one on 28 March 2000, one in July 2007, and a third now–indicating a major reversal.

The credit crisis has affected several German banks which lost in total more than €30 billions on CDOs and MBSes, such as Sachsen LB, IKB Bank, West LB, Deutsche Bank, Bayern LB etc. so far. Sachsen LB therefore has been bought off by Baden-Württembergische Landesbank (LB BW), Bayern LB and LB BW are considering a merger.

It is reported that loan reversals have become more difficult for SMB companies, but the facts are not reported in a consistent way but rather snippets, so it's hard to say.

The tendency for wage raises to increase with demands–now from railway trainchiefs asking for a 30% salary increase–put Germany on a rail strike, halting the public transports, essentially.

Having lived through three financial devaluations through the last 100 years–1919, 1923, 1948 and the Euro introduction in 2002–a rather big group of Germans is still amongst the most sensitives on inflation and therefore hear the fleas coughing more than many others in Europe.
A lot of folks forget that Germany is a real economy that makes real things for export that real people buy. They also have intellectual property, management skills, transparent financial markets, and all of which are the usual excuses for why the US doesn't stoop to making things and exporting them, too, but instead makes capital goods for consumption by foreign central banks.

The US, like Germany, also has a high unemployment rate, but isn't reported that way. Anyone who works at MacDonald's manufacturing hamburgers counts in the manufacturing sector, and anyone who has even had a thought of working or, paradoxically, has given up looking for work for six months is "employed" or "not counted as unemployed" respectively.

Grateful we are in the US that the 33 year old pension fund managers bought the mortgage paper. The boyz are not doubt busy trying to figure out what to sell them next.

Fleas coughing, for those of you who aren't familiar, refers to the fabled Eastern magician who in addition to hearing the fleas cough can see the grass grow. Recently, one of our other members, impatient from watching financial Armageddon grow as slow as grass, started a thread to ask, "Where is the crash? (http://itulip.com/forums/showthread.php?t=2196)"

Several of our members have provided their typically insightful responses, showing where we are in the process (http://www.itulip.com/forums/showthread.php?t=1797). For an expert report, we are interviewing Dr. Peter Warburton, author of debtanddelusion, next week.

Here's the single customer review of the book from the sole reader brave enough to tackle this technical, not to mention expensive, book.
Published in 1999, the work rapidly went out of print but has since become a cult classic among financial contrarians. Although not written from an Austrian point of view, the argument parallels an Austrian view of money and banking in many aspects.

Its central premise concerns the lessons learned from the 1970s when the developed world flirted with hyper-inflation. Warburton's story begins in the aftermath of Volker's triumph. The conundrum facing governments at the time was: how to enable governments to continue to live beyond their means, without suffering inflationary consequences?

What follows is a very plausible explanation about how, "Central bankers offered a program to solve this dilemma, the centerpiece of which was a change in the method of financing government debt. Deficit finance bonds would be sold to private investors through existing financial markets. This would place the bonds in the hands of investment funds, rather than on the books of commercial banks as would have been the case had they returned to the old style of monetization. The subsequent explosion in the size and breadth of bond markets is illustrated by a few snapshots of gross issuances: less than $1 trillion in 1970; $23 trillion by 1997 and nearly $43 trillion by 2002."

The conundrum, as Warburton wryly noted:

"Periodic bouts of price inflation, the tell-tale signs of a long-standing debt addiction, have all but vanished. The central banks, as financial physicians, seem to have effected a cure... Few have bothered to ask how the central banks have accomplished this feat, one which has proved elusive for more than 20 years. As long as inflation is absent, who really cares exactly what the central banks have been up to.

The solution to this puzzling anomaly is to identify the source of demand for government bonds. For this, we must examine "what the central banks have been up to."

Debt and Delusion argues that the institutional changes... have confined the price adjustments resulting from monetary expansion to the financial system. The character of the 80s and 90s inflation differed from that of the 70s. In recent decades, price changes following money quantity changes have been in stocks and bond prices, rather than wages and consumption goods prices.
While more mysteries of the FIRE Economy are revealed by Warburton, my first question to Peter might be, "I bought the first edition of your book in 1999 for $35. Now a used first edition sells for more than $90. The appreciation is nearly exactly the same as for gold over the same period. Coincidence?"

No, I'm not really going to ask that. But the fact that a stack of his books did as well as a stack of gold coins says something good about both.

See also today's iTulip Select news Part I: The Blow-Up (MIT Technology Review) (http://itulip.com/forums/showthread.php?t=2213).

iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032): The Investment Thesis for the Next Cycle™
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rzero
10-16-07, 01:16 AM
So fundamentally, what this funneling of inflation into "good" places is doing is creating the greater and greater potential for "bad" inflation to manifest, which would occur if people decided to start selling stocks and bonds. Correct?

EJ
10-16-07, 09:59 AM
So fundamentally, what this funneling of inflation into "good" places is doing is creating the greater and greater potential for "bad" inflation to manifest, which would occur if people decided to start selling stocks and bonds. Correct?

"[Starting in the early 1980s] central bankers offered a program to solve this dilemma, the centerpiece of which was a change in the method of financing government debt. Deficit finance bonds would be sold to private investors through existing financial markets. This would place the bonds in the hands of investment funds, rather than on the books of commercial banks as would have been the case had they returned to the old style of monetization. The subsequent explosion in the size and breadth of bond markets is illustrated by a few snapshots of gross issuances: less than $1 trillion in 1970; $23 trillion by 1997 and nearly $43 trillion by 2002."

"Debt and Delusion argues that the institutional changes... have confined the price adjustments resulting from monetary expansion to the financial system. The character of the 80s and 90s inflation differed from that of the 70s. In recent decades, price changes following money quantity changes have been in stocks and bond prices, rather than wages and consumption goods prices."

It has created asset bubbles and fueled the rise of the FIRE Economy. Since Warburton wrote his book in 1999, when private investors stepped back from the US bond market in the early 2000s, foreign central banks stepped in.

The questions are, 1) What happens if the private and foreign public bond market is no longer able to absorb new bonds at a sufficient rate to cover past debts (corollary question: how much of the approximate $50 issued since the start of the process needs to be rolled over every year)?), and 2) What happens if new bonds needed to fund the government and for other purposes, such as balancing the currency account deficit, can no longer be absorbed by the bond markets? The answer that the US experiences a debt deflation. What can stop it? Two possibilities: 1) The Fed and Treasury succeed in ramping the bond market going again or 2) government debt has to be monetized the old fashioned way: inflation.

Throw into the equation a surge of inflation due to the need to print more money to pay for a lower supply of oil as the US Congress inadvertently gave Turkey the green light to invade Kurdish Iraq, and the second possibility increases.

jk
10-16-07, 11:43 AM
The questions are, 1) What happens if the private and foreign public bond market is no longer able to absorb new bonds at a sufficient rate to cover past debts (corollary question: how much of the approximate $50 issued since the start of the process needs to be rolled over every year)?), and 2) What happens if new bonds needed to fund the government and for other purposes, such as balancing the currency account deficit, can no longer be absorbed by the bond markets?

isn't warburton's argument that these problems can never arise as long as financial institutions can borrow cheaply enough to make their bond purchases a profitable arbitrage?

rzero
10-16-07, 04:37 PM
What happens if new bonds needed to fund the government and for other purposes, such as balancing the currency account deficit, can no longer be absorbed by the bond markets? The answer that the US experiences a debt deflation. What can stop it? Two possibilities: 1) The Fed and Treasury succeed in ramping the bond market going again or 2) government debt has to be monetized the old fashioned way: inflation.

Thank you. I have been focusing on all the repatriated dollars we would have to deal with if the T-bond market stalled, and was overlooking the fact that the Fed would also have to start monetizing debt to keep the government afloat. So the Fed response to either a Japan/Mish-esque deflation threat, or a T-bond market stall would be the same: good old printing.

rzero
10-17-07, 04:02 AM
So, not to harp on this point, but this t-bond monetization is an implicit part of the "Final Poom", right? This isn't mentioned in the official (http://www.itulip.com/kapoomtheory.htm) decriptions (http://www.itulip.com/retrospective2006.htm) of Ka-Poom I am familiar with. I guess it is self-evident though. So the response to a dollar/t-bond selloff would be base money inflation by buying t-bonds, thus possibly creating even more price inflation and possibly an even weaker bond market. Sounds like fun.