Financial Sense "The Tragedy of Busted Myths" by Jim Willie, CB 09/01/2006

THE TRAGEDY OF BUSTED MYTHS
by Jim Willie CB
September 1, 2006

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Mythology is powerful. Just a few thousand years ago, men would go to war over strange beliefs about gods and goddesses, or make decisions of state, or act upon the fate of cities and hamlets, or enter into big trade agreements, or embark on grand voyages, or agree to marriage, all after consulting the oracles. They were the gurus of their day, replaced today by economists from many corners. Budget advisors, brokerage analysts, government spokesmen, and academic charlatans are the modern soothsayers, hardly ever correct, always revered, never understood. It seems whenever things are about to go badly, we face more economic myths in the process of being shattered, and are soon subjected to new ones. In their failed wake, we install more controlling (corrupting) mechanisms like the Plunge Protection Team after crises like the 1987 Black Monday and the 2000 Tech Telecom bust.

Once again the motive in promoting silly myths is the same, or at least the nucleus motive is the same. Domestically, that is to deceive the hapless ignorant hopeful public to continue to trust the leadership out of Washington DC and New York City, to continue to remain invested in the Wall Street game, to continue to participate in the consumption game, to avoid a panic and head for exits before the losses mount. On the foreign front, the motive is to encourage other nations to continue to send their hard earned savings into the Great Black Hole that is the USEconomy, to continue to supply and satisfy its desperate credit needs, to continue to pay for the entry fee for selling in its vast marketplace. The unspoken motive is to enable the aristocrats to continue to churn their machinery, to ply their trade of exploiting the great paper game, to further the squeeze on the middle class. In fact, the middle class is the greatest loser from inflation�s impact and heavy cost.

INFLATION WRECKAGE

Inflation has its hidden costs. Writers, analysts, and pundits catch the easy victims, like savers who are robbed of the stored value from the drip drip drip of erosion. Like small-time participants who shun the opportunity to grow big. Rising wages, which at first seem like an advantage from a steadily inflating economic system, have turned on the masters of the inflationary machinery. Job outsourcing to Asia has ripped the manufacturing foundation of the USEconomy clean off its mooring and capstone, deprived it of legitimate wealth generation. Consequently, the participants of our mfg-less society have been deceived into believing that consumption within retail chains can stand in its place. It offers the benefit of cleaner air, less sweat, and more fun. What�s not to like? Let's go shopping, the great medication for the depressed. Instead of factories belching out smoke, noxious fumes, and rendering its workers musclebound but with damaged bodies from chemical intake, we have clean tidy shopping malls, nifty prevalent consumer retail chains, really cool electronic stores, and nice smelling furniture marts. Complimenting the networks of consumer havens are our homes, the veritable piggy banks. Who needs to save anymore, so pass�? We have mutual funds and trading accounts. So we have suffered a deadly transition from making products in an industrial setting, wherein added value is gained from human labor with the aid of sophisticated machines. We now stand with one foot in the financial credit spin cycle replete with mortgages and car loans and vendor financed sales, not to mention the world of stocks and bonds, and the other foot in the service collage known to keep our devices and grounds in working order and looking spiffy.

Is this progress? No way! It is a tragedy in the making, fully denied. We crossed the Rubicon ten years ago, maybe as long ago as the 1971 date. At that time, we both abrogated the Bretton Woods gold standard for the USDollar, and embraced the USGovt social & military contract. The dual pact often called �Guns & Butter� committed to provide a vast social safety net (despite claims we are not socialist) and to wage war wherever we can. The Medicare plan is the latest socialist plan passed under the current Administration is certain to worsen the national bankruptcy condition, fully fingered by the St Louis Fed this summer. So since 2001 we have a grand scheme identified by Nationalism & Socialism, the former brandished proudly, the latter quietly engrained more deeply, all against a backdrop of growing fear, withering civil liberties, and wider war. My concept is that military actions represent the ultimate in fixed business investment, although with as much cleared paths for trade benefits on the positive side as global backlash on the destructive side. Whereas the multiplier effect reaps benefits in six to seven steps from trickle down in commerce, military and defense spending reaps benefits mainly to the contractors in an abrupt one to two steps as some degree of destruction results. On rare occasion, military contract engineering has civilian benefits, however far more being evident in NASA space research.

The most reckless and irresponsible phase change has been the overdue dependence within the USEconomy on the inflated equity of the entire housing sector. Indeed it sustains the system to a great degree. Americans have not saved actively since the mid-1990 decade, when Greenspan endorsed irrational exuberance by warning about it, but continuing to feed the destructive damaging condition. Several years later, Greenspan actively shocked the world by claiming that gains in home equity suddenly realized should be regarded as legitimate wealth. This is unprecedented in the modern era for a central banker. Worse still, in 2005 Greenspan added insult to injury by stating that �People who took on too much debt were desirous of financial harm.� He urged the housing bubble stampede, then stepped out of its path on political fallout. The central question should be �Will the Greenspan legacy be directly linked to the upcoming crisis in housing and the USEconomy, which is of his own making?� Given the utterly imbecilic na�ve confounded lack of comprehension of economic matters, blame is likely to go to the current USFed Chairman Bernanke by the present public and current leaders alike.

The entire nation has been dumbed down on all matters economic, at least on the macro level. The crisis will happen on Ben�s watch. It is not preventable. Its pathogenesis was designed and laid out carelessly but meticulously by Mr Greenspan. He split town to leave Bernanke with the headache, and likely blame. Without a doubt, Ben was selected to become the bagholder. Poor Ben has less charisma than Alan, perhaps equal ability to explain and confuse, but he tragically has no more available bubbles to engineer like Alan did. Housing is the last bubble. Well, to be more clear, the commodity bull is the final bubble, but it is of a cost nature.

CITATION OF CURRENT MYTHS

The present situation is overflowing with falsehoods, nonsensical beliefs, indefensible notions being actively promoted when required. As they are pressed into forefront usage, they are almost all discussed, analyzed, and countered in my Hat Trick Letter. There are so many current chapters to today's mythology. Several key heretical notions will be listed below, but not dismantled here and now. Many beliefs have been discredited in public articles. The latest monthly issues to the HTL and the upcoming September issue (always published midmonth) address several listed myths at work, each thoroughly invalid, untenable, and inexcusable, but each highly important, each integral, each serving a key bonding purpose for the system like band aids or chewing gum or bailing wire. It is inconceivable to me how any sane, well educated, competent academic Economics professor of repute could defend a single listed item. Yet the great majority of this corrupted profession do precisely that, defend and promote and carry on the great game. The corruption is of thought process. An economic system dependent upon inflation requires the associated cancerous defensive thought to complement the cancerous policy itself. A certain level of cheerleading is also necessary to keep the public bought in.

Almost all current myths will soon unravel in tragic fashion. Do not expect apologies when they do. Expect instead blame to be put on speculators, blame to be put on the mortgage industry (maybe even Fanny Mae & Freddie Mac), blame to be put on reckless consumers, blame to be put on past administrations, blame to be put on Congress, blame to be put on outsourcing corporations, blame to be put on the Chinese. Do not expect much blame to be put on the high priests Greenspan or Samuelson or Friedman. They are untouchable. Give better than 50-50 odds that sufficient blame will be lodged on Bernanke, to the point that he might be dismissed and shown the door before all monthly calendar pages of 2007 are turned.

Here is a cornucopia of current crazy myths at work, the underpinnings for each to unravel in tragic fashion. Steadfast belief in them would be funny if not so tragic in doling out misery. The list could fill volumes, but in the interest of time and space, only the major prominent myths are cited. The authors and proponents to each myth should feel shame, but they do not, at least not publicly. My guess is that privately, they might offer derision and contempt for the public who accepts their spun claptrap silly beliefs which hold the system together and keeps the caste structure in place. This list is simply mindboggling.

No clear connection can be made between a slump in the asset markets (primarily the stock market, but also the housing sector) and an economic recession. In fact, the stock link to slowdown was exhibited in 2001, whereas the housing link is believed by sane experts to contain twice the impact on spending. Worse still, an asset-based economy is undoubtedly the most risky and unstable of all types, since inflation corrections threaten with deep recession.
A slower USEconomy will slow demand for commodities, and thus cool down the commodity bull market, including that for energy prices. In fact, demand is drawn from numerous corners. Jobless still scamper around looking for work, and burn energy in homes. All standing homes and offices and plants will use commodities and energy. Businesses continue to hum with the majority of workers still on the payroll. Foreign economies like Asia have a degree of regional integrity and autonomy. And lastly, war consumes commodities and energy at a great measure.
The consumer will hand off responsibility for leadership within the USEconomy to the corporate sector, as households yield to the business sector in the lead for spending. In fact, if businesses forecast slower consumer demand, they might cut back in supply, the other half of the price equation. A tapped out consumer is not the candidate targeted by corporate outlays, which are doing ok for now.
The housing sector can be cooled down with higher interest rates, with an end to lax lending, and less speculation, without an outright decline in housing, i.e. a bear market. In fact, a vicious cycle has begun which is highly likely to be worse than previous declines. As wild as gains were registered, as lax as lending occurred, the reversal will be just as powerful and damaging. What artificially rose will judiciously decline.
A rate cut by the US Federal Reserve can stop any housing decline in its tracks. In fact, momentum has a cold hand in itself to unwind which cannot be sustained. Lower housing prices lead to new sellers, and the vicious cycle continues. With 20% of all mortgages written in 2005 being with 0% down payment, the march to negative equity is quick, often inducing a �for sale� sign. With corrupted appraisals and home inspections came purchases which should not have occurred. Those last two types will provide the initial downward momentum in sales.
Higher interest rates are an exercise in tightening of credit, reducing systemic debt. In fact, this is an abuse of labels. Debt growth in the USEconomy has actually risen by over 50% in the two years of rate hikes. That aint tightening. It helps to check the data. Interest rates are indeed rising globally, but money supply growth is too.
The inverted Treasury Yield Curve no longer signals an economic recession. In fact, it still does, even as it reflects something equally lethal. The hemorrhage that is the US trade deficit comes back to subsidize our own federal debt load. This represents an indirect monetization shot with a foreign abandonment risk chaser.
The enormous growth in foreign held US Treasury Bonds is not a problem, not in need of resolution, since the owners are all trade partners. In fact, some of the biggest creditors are not so friendly at all. China and Islamic nations are at odds politically if not militarily with the United States. Russia has become the spearhead to fracture the Petro-Dollar, enforced by their military, a unique situation. Watch conflict with China and Russia rise inexorably.
Gold is a commodity with no yield payout, a dead asset. In fact, most growth assets pay no dividend, like high flying tech stocks in the 1990 decade, like even Google today. Ever heard of capital gains? Gold has risen from $265/oz in 2001 to over $600 today, much like a growth stock. Dividends and yields pale by comparison to capital gain.
The oil cost can be neutralized and monetized via inflation, as in printed money, without harm. In fact, with China in the picture, higher wages are not occurring. New money injected into the system is more likely to chase commodity assets such as energy, than to build new plants with new workers, or offer higher paid current workers. Energy investments are excellent hedges against both monetary inflation and geopolitical risk.
Speculation demand has kept energy prices high for three years. In fact, a war premium has proven justified, given all the violence, bandit actions, contract dishonor, supply disruptions, and geopolitical strains. A global war for energy, pursuing security of supply is perhaps the central motive for the Iraqi War. With war comes inherent risk, and speculators have been eager to bid up the risk premium, since it is real.
The USEconomy is the engine of growth for the world system. In fact, an engine would pay for its bills rather than issue increasingly worthless IOU�s in return. A credible argument can be made that the US is actually a parasite on the global economy, or a debtor green bourgeois which brandishes bountiful weapons.
The USEconomy is stronger than that of the European Union. In fact, Europe has not fostered a deep dependence on inflated housing assets, not drawn home equity in the process, and not spent recklessly. The EU bilateral trade surplus with the USEconomy has run between $9 and $12 per month for the last two years. Europe does not lie about almost every conceivable economic statistic, like the US does.
A devalued USDollar will eventually remedy the US trade deficit. And conversely, an upgrade in the Chinese yuan currency valuation will assist in the same remedy. In fact, the US trade deficit is structural. It cannot be fixed in any meaningful manner without a return of the manufacturing sector to US shores. Let me know when that occurs. Distress in the carmaker sector should provide a good forward indicator for actual solution. A lower USDollar since 2001 has gone hand in hand with record setting trade deficits, a forecast of mine in 2003, which was met with mockery to me in direct emails and phone conversations.
Productivity has created profits, with benefits reaped by corporations and households alike. In fact, one should direct attention to where the direct investment has taken place. It is in Asia. So the benefits have largely gone to Asian economies, corporations, and households, as their economic strength has markedly increased, and their standard of living has risen markedly. US wages have fallen three years in a row. Outsourcing and equipment deployment result in shed workers.
The military industrial complex works to keep the nation safe, even financially. In fact, inefficiency and chronic costly military adventures have been the outcome. Add to the mix the erosion in representative government mechanisms, whereby lobbyists have greater access to legislators than constituents. Defense contractors have profited greatly, decade after decade. Cost overruns, waste, fraud, and ineffective weapon systems are commonplace. Wars like Vietnam and Iraq and Afghanistan might have secretive motives. They surely add to the national federal debt, with uncertain benefit.
The Iraqi War will pay for itself. In fact, this was more political hokum than myth, but surely worthy of mention in this parade of charades. The civil war rages, fully denied, a common trait of myths. Now $300 billion spent, with 50 Iraqis being killed per day, the shock & awe is on its failure. How loudly to the contrary must its status quo go before failure is admitted?
It will result in a �Soft Landing� this time, whatever �it� is. In fact, we have never experienced a soft landing in any claimed area in three decades, no exception. Like with denied alcoholism, a prevalent usage of the term or engagement of the question indicate the present condition, imminent occurrence of the opposite. The more we hear of �Soft Landing,� the more closely the contrary takes root.
Job growth continues. In fact, the August Jobs Report cited 128 thousand new jobs today, but it relied a bit much on the fantasy known as the Birth-Death model. The convenient fallacious B-D model provided 121 thousand of those jobs. That is right, 94.5% of the new jobs were from a suspicious indefensible model directly out of a mythology book, but without pictures. See the �Anatomy of Jobs Fraud� from last week.
The casino gambling gaming sector contributes to the USEconomy. In fact, it is as productive as any other addiction such as drinking, smoking, or narcotic drugs. The benefits are superficial and fleeting, while the costs are staggering, ongoing, and cause widespread wreckage. Let's not overlook the misery.
To lose weight, just join a diet plan. In fact, it takes work, sweat, discipline, and energy. Too many people jump from one diet plan to another, deceiving themselves, wasting money and time. Try exercising steadily and changing bad eating habits. French fries and burgers, be gone!
Good hitting overcomes bad pitching in Major League Baseball. In fact, pitching is of paramount importance. Case in study should be the implosion of the Boston Red Sox, stacked with great hitters. May their 2006 season rest in peace.

ONE PAST EXAMPLE & A KUDO

A walk through recent history was provided in a past article entitled �Economic Mythology� in Sept 2004. In it a sequence of pathological belief systems was described, one with the Reagan Administration, another with the Clinton Admin, and the current chapter with the Bush II Admin. To be fair, the Clinton and Bush II myth chapters were written by Greenspan, who deserves full attribution, credit, and responsibility as the system unravels. The Reagan chapter had chief authors in David Stockman, Art Laffer, and others who attempted to put to practice theories of Nobel Prize Winner Paul Samuelson. Yes, even our icon prize winners are party to the colossal charade. Although not a complete portrayal of nonsensical notions, the above article at least offered a broad review. More specifically, it made a basic description of something so extraordinarily silly on its face, that it must be pulled out once more, if for no other reason than for a good laff (sic). In it was said two years ago:

The Laffer Curve expects higher tax revenue from higher tax rates in a direct response with no reaction. It also expects higher tax revenue from much lower tax rates in an exercise in powerful elasticity. In other words, tax collection receipts benefit regardless, have the cake and eat it too. How incredibly silly, but widely accepted. Budget Director David Stockman was a certain charlatan, as he sold the idea, later changed his numbers, but Reagan used an erroneous numbers anyway in an historically hilarious Keystone Cop event.

This week, a highly unusual debate took place on CNBC which elicited both laughter and dismay by me. It was between Peter Schiff of Euro Pacific Capital and Art Laffer, the charlatan who penned the absurd �Laffable Curve.� Heck, the Laffer Curve is even more boldly ridiculous than the Phillips Curve, which attempted to tie a given threshold level of unemployment with price inflation. After viewing that five minute interview on Monday afternoon, I wrote Peter a brief email, moved to the point of feeling compelled. We have exchanged emails in brief fashion in the past. He has been the source of some admiration for several months, as he has taken on numerous financial sector conventional team players. During these snapshot televised debates, he has managed to embarrass each and every one of his legless opponents. The funny part is that his forensic adversaries actually seem to believe their absurdities, unaware of their embarrassment. My eyes have seen numerous such interviews, where opponent points bordered on psychotic, like gigantic foreign trade deficits do not matter, like using borrowed home equity to sustain a heavy consumer lifestyle is not destructive, like an economy founded upon consumption and reliant upon assets without industry is healthy, like inflated homestead worth (home equity) is legitimate wealth, like flexibly funded growing government deficits are not in need of remedy, and like growing foreign debt holdings are not a threat. In my brief email, a well deserved compliment was handed to Peter, along with a slam insult of Laffer who was way way over the top in his arrogant mocking manner, even laughing at Peter with unvarnished condescension, even offering to bet him on future outcomes. Hey, I enjoy taking my shots when the time is right. My note was simple and to the point:

After witnessing that 5 minute interview debate today on Monday afternoon on CNBC, I have concluded Art Laffer is without question the dumbest (expletive) primate I have laid eyes on in several years. No need to itemize his stupid comments, since his entire viewpoint was moronic, delusional, heretical, off-base, condescending, lunatic, illogical. You did very well, making your major fundamental points, the consistently made ones. You also showed tact in not reminding him of the Laffer Curve chapter of mythology. At some point, you might look foolish even debating such a truly lost hack like him.

Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.

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