WORLD'S GREATEST PONZI SCHEME

I'm back for one more post. Recent developments are just too significant to be ignored.

Take this Bernie Madoff scandal as an example. Old Bernie has been credited with creating the largest Ponzi scheme in history. Are you kidding me? How can you compare Bernie's puny $50 billion dollar pyramid scheme to the U.S. Government's pyramid scheme involving trillions of dollars?

Since I stopped blogging a few months ago, the total tally for U.S. government bailout funds has gone from roughly $500 billion to over $7 trillion !!!. Essentially the U.S. government has been using its own balance sheet to buy up all of the irresponsible loans from banks and lenders. Add that $7 trillion sum to the existing roughly $10 trillion in Federal government debt and untold trillions of Corporate and Consumer debt and the total debt figure easily climbs north of $50 trillion. Once you add in another $50 trillion for those unfunded liabilities known as Social Security and Medicare and that sum is up to a cool $100 trillion !

The All Important Question
The critical question in all of this, and one that only a few observers seem to be asking themselves, is what will come of all of this debt and how/will it ever be repaid?

The clear and obvious answer of course is that it will never be repaid, simply because the economic fundamentals of the economy are inherently unsound and therefore provide no basis for repayment via normal means (i.e. taxation).

So, that brings up the question of how will the U.S. government eventually get out of repaying all of this money? And to that question, there are only 3 possible answers:

1) Outright default - this means that the U.S. government repudiates its debts and then overnight essentially becomes a third world banana republic. This scenario is highly unlikely however the because the debt is denominated in U.S. dollars, which gives the Fed the option to print our way out of this mess, whereas other banana republics don't usually have that option (e.g. Latin American debts are usually priced in U.S. dollars).

2) Debt monetization (Printing Money) - So far the Federal Reserve has been "sterilizing" all of its bailout operations to prevent outright printing of new currency; however, should the Fed get really desperate, then they could simply credit the U.S. government account with fresh money that could be used to buy back Treasury bonds, hence "printing money".

3) Inflation - This is the most pernicious of mechanisms that can be used to get out of debt. Instead of an overt repudiation of debt, inflation is instead an indirect way of essentially devaluing the dollar such that the debt gets partially repaid but with significantly devalued dollars.

Since option (1) would be politically unthinkable, that leaves options (2) and (3) on the table, and with deflation now spreading inexorably, I believe that the Fed will eventually need to use both options in tandem to relieve the collective debt burden. Monetizing the debt will be the mechanism by which the U.S. government gets itself out of debt. It will also allow Helicoper Ben to make good on his promise of distributing "free" (devalued) money to the masses, which will ultimately generate inflation, hence relieving the consumer debt burden.

How Now Deflation?
So given this recent massive increase in the "money supply", how is it that we could still be heading towards deflation and not inflation? This is the key fundamental question, and one that seems to elude most economists and bloggers. The answer is two-fold. First, as I mentioned above, to date, the Fed has not been printing currency, they have been expanding credit and also sterilizing these operations to prevent outright inflation. The second part of the answer is that contrary to most belief, credit is not "money", credit is debt and whereas in a normally functioning economy the expansion of credit is inflationary, in an asset-impaired economy the expansion of credit has no impact i.e. lenders won't lend and borrowers won't borrow - out of lack of confidence, lack of collateral etc.

Bear in mind that Bernanke is a dedicated Monetarist. He believes in a credit (debt) based economy. He also thinks that he has learned the lessons from the Great Depression and can take steps to avoid the same deflationary spiral. Bernanke and other Monetarists believe that the Fed of the 1930s caused the Depression by allowing the money supply to contract (i.e. as banks failed). However, comparisons between then and now are completely specious, because at that time the U.S. was on the gold standard. That means that the Fed was physically limited to the extent that it could increase the money supply by the amount of gold reserves. So while yes, the Fed did less to expand credit after-the-fact in the 1930s, keep in mind that the money over-supply going into the Great Depression was likewise much more constrained than what we are facing now, due to the disciplines imposed by a Gold standard. Therefore despite Bernanke's interventions, there is no reason to believe that economic fallout from the catastrophe that we are now facing won't be as great or greater than what was faced during the Great Depression.

Careful what you wish for
And of course the Misian pollyannas are out in full force telling us that deflation is not something to be feared but something to be embraced.

Unfortunately, there are actually two types of deflation. There is the "cinderella deflation" that the Noveau Misians speak about, as characterized by responsible fiscal and monetary policy, a fixed money supply (based on the gold standard) and ever-increasing productivity.

Then, there is what I call "Frankenstein" deflation which is precipitated by 30 years' of reckless fiscal/monetary policy leading to out of control debt accumulation; characterized by widespread asset price destruction and precipitating a rapid uncontrolled economic collapse the likes of which not even an Ivory Tower Misian hiding behind 20 foot walls could embrace i.e. "are those the neighbour's kids eating out of my garbage can?".

In short, unless you are an end times Militia freak living in a bunker in Montana surrounded by crates full of M16s and 5.56mm, I don't think it's going to be a fun time...

The Deflationary C(r)ash economy
John Maynard Keynes called it "The Paradox of Thrift". If one person saves his money, he makes himself wealthy. If everyone saves their money, the economy collapses. That paradox which is occurring as we speak, combined with the deflation in the credit markets and the corresponding unwillingness to borrow and lend fully explains why we are heading towards extreme deflation and eventually a cash-based economy. Imagine a cash based economy, where individuals hoard physical cash, because they can't trust their banks and where they are unwilling to borrow to buy consumer durables such as cars, homes, appliances etc. In other words, in a cash economy, economic activity falls drastically and the circulation of money (liquidity) falls correspondingly. That gets us back to options (2) and (3) above, wherein the Fed will get desperate and unleash hyperinflation to get the economy moving again and at the same time de facto wipe out all prior debts (think Weimar Republic, circa 1923). As I indicated above Bernanke won't give up on the credit markets overnight, but once he eventually capitulates and reaches for the nuclear option (printing currency), then all financial assets (stocks, bonds etc.) will be destroyed and the 40 year Class Warfare of Monetary policy will come to its predictable end.

What of this nascent stock market rally?
As I predicted this past August, the stock market had another major leg lower. Despite the fact that I am still extremely bearish in the longer-term, one must bear in mind that markets, being discounting mechanisms, do not fall or rise in a straight line. As I have pointed out here, I believe this market decline is markedly similar in shape and form to the crash of the 1930s. So if in fact we are following a script similar to that of the early 1930s, then we are currently in the retracement rally that started in late 1929 which should see the market lurch unevenly higher back towards the downtrend line at which point it will again rollover and head inexorably down towards oblivion. If you haven't sold your stocks yet, but are looking for a chance to do so, I think you will get the opportunity in the coming weeks/months, however, be realistic about your price target (i.e. S&P 500 between 1000-1050 seems to be a reasonable target)...

And yes, as I predicted several times, volatility did eventually explode to unprecedented levels with this last stock market decline and by all accounts those hedge funds that were net sellers of volatility were in fact decimated. Ironically in this economy, it's going to be hard for these guys to just get their old jobs back at Starbucks...

Gold
Despite the fact that gold (@ ~$840) has been holding up better than most markets, it is still lower than the peak of $1000 hit last spring. As I have said many times before, gold will be the ultimate asset to own when attempting to hide from the inevitable hyperinflation, but until we get to that point, and especially as we transition through the "cash economy" phase described above (brief though it may be), then gold will not be a good place to hide. I can't predict exactly what price gold will become a "buy" but I imagine it will be closer to $200 than to $800 where gold resides currently. So, as I see it currently 2-3 year treasuries (e.g. via SHY ETF) are the only safe haven in the short-term, with a longer term eye towards migrating towards gold with a "dollar cost averaging" strategy using wide "scales" (i.e. allowing for a large decline in gold).

The Economy
What of the economy? The eight year Bush Fantasy economy is gone and it's never coming back. The reason I am not optimistic about the future is because we can't solve a problem if policy-makers can't acknowledge the root cause of it. Most economists seem to think that if we bail out the banks, give out some free stimulus checks, change some regulations and wait a few months then we will get back to normal again. Unfortunately, what everyone seems to be overlooking is that this past 30 years hasn't just been a colossal financial disaster, much more importantly it has been a phenomenal economic/industrial disaster as well. As I have pointed out, this country has (in a relatively very brief period of time), outsourced its entire manufacturing, R&D, and engineering base, and all of the associated intellectual capital that goes along with it, to foreign countries. Those millions of manufacturing jobs that went overseas took with them hundreds of years worth of accumulated industrial intellectual capital, turning this country into a front office marketing and finance agency. Once the sound and fury from all of the credit crisis starts to quiet down, then it will finally dawn on everyone that the country's industrial seed corn has been eaten. There is no long-term engine for job creation, as the temporary jobs from the Bush era (mortgage finance, construction, bar tending) will have all long evaporated. In short, decades of greed-motivated industrial arbitrage (aka. outsourcing) has permanently hollowed out and impoverished what once was (and no longer will be) the middle class.

This entire era has been a grand failed experiment in the so-called "Anglo-American" economic model, premised on wide open markets as prescribed by the Ricardian model of comparative advantage and the modern day reincarnation of Supply Side ("Let them eat cake") Economics. Apparently Ricardo didn't envision what would happen when an open trade based nation like the U.S. goes up against dedicated export mercantilists such as Japan and China; however, I am sure he was smart enough to guess the inevitable outcome...

Judgement Day

Judgement Day is near at hand, the signs are everywhere, you just have to open your eyes. Except it isn't going to be just one day, it's going to be an extended period of years that for most will seem to last forever.

The only ones who don't see the inevitable collapse of the global pyramid scheme are those who don't want to see the collapse of the global pyramid scheme. In other words the majority in the West are fully invested in the current world order and don't care how many others on this planet have to suffer in order to propagate their consumption-oriented lifestyle. Therefore, in order to see that the decline WILL occur, it's first necessary to believe that the decline SHOULD occur. Those, like me, who believe in moralistic determination, also understand that this current consumption-oriented system which ignores the needs of the majority on this planet, is doomed to fail and was always doomed to fail. The West won the Cold War but far from spending the peace dividend to raise the standard of living for the Rest of the World, instead went about the fevered task of consuming the remainder of the planet.

There is no doubt in my mind that we easily could have solved the world's poverty issues, but we never seriously wanted to, for fear that it would affect our consumption-oriented lifestyle. Any serious attempt to actually solve the issue of poverty has met with the inevitable obfuscating debates around capitalism vs. socialism, which conveniently redirected energy and resources away from the underlying problem at hand. Those economists who say that poverty will be solved under the current globalized (pyramid-scheme) system, are both cynical and callous (not to mention soon-to-be-bankrupt for drinking their own Kool-Aid). The current globalized pyramid scheme is seriously broken and we can't afford to wait another several decades only to realize the situation hasn't gotten any better. Whatever improvement in poverty these past decades, if any, has come at such a glacial pace that only the most hardened or cynical of observers could take heart in the progress to date e.g. The Economist . And sorry Jeffrey Sachs, China is not a model of economic success, it is an environmental, forced labour, and human rights catastrophe of historic proportions. Calling China's unevenly distributed economic rise a miracle, only proves the saying that (even the "best intentioned") economists know the cost of everything and the value of nothing.

Most people on this planet are producers, but they are not consumers. Through hard work and sheer attrition, they literally put their blood, sweat, and lives into the globalized pyramid economy, and they receive a nominal wage in return. The surplus between what they give and what they receive is captured in the wealthy economies in the form of excess return on capital and cheap goods. In other words, our Westernized lifestyle is predicated on exploiting people who are compelled to give their labour (to survive) in return for a sub-human wage - a system most commonly known as slavery.

Forced labour trap
Modern economics is based upon the supply/demand equilibrium model. According to this classic model, supply is shown as an upward sloping line, running from left to right i.e. the greater the price, the more will be supplied. Therefore, according to theory, the higher the price of labour, the more labour will be supplied and the lower the price/wage, the less will be supplied. Unfortunately, this theory is entirely predicated upon the notion that a given 'supplier' (labourer, independent farmer etc.) has sufficient alternate income that she has the choice as to how much of her production she will bring to market i.e. as wages fall, she can choose to withdraw her labour from the market. Clearly, in the real world, poor people don't have this theoretical choice of working less, just because wages have fallen. To the contrary, as prices fall, a labourer or farmer is actually forced to bring MORE supply to market in order to simply survive i.e. at a lower wage, an individual will work more hours just to maintain a bare minimum survival income. Worse yet, as each individual labourer/independent producer brings more supply to market, this leads to a downward collapse in wages/prices. This price trap is in full exhibit across the developing world (and has been forever), having drawn wages and prices BELOW their long-term replacement rate. Wage rates below the long-term replacement rate means that workers are sacrificing their health and long-term well-being by working brutally long hours at ultra-low wages; not to mention, forcing them to accept highly adverse/unhealthy working conditions, just to make ends meet.

As mentioned, this is highly prevalent behaviour observed throughout the developing world - and parts of the developed world as well (Read: Nickel and Dimed: On (Not) Getting By in America), and yet economists cling to their text book supply/demand theories. In other words they have no way of explaining this type of "irrational" behaviour, so they just pretend this behaviour does not exist or if it exists, it's deemed aberrant. Far from being irrational or aberrant behaviour it's typical depression-era mentality which sacrifices long-term sustainability for short-term survival. This same over-supply phenomenon also explains the widespread environmental degradation occurring throughout the developing world as farmers and other independent producers compete to bring as much supply to market by any means possible just to survive.

But then we are quickly reminded that those with jobs are the "lucky" ones. After all, the rest are forced to beg, steal or sell themselves just to survive. So, clearly we are really doing those underpaid workers a favour by exploiting them (apparently it's better to die slowly, rather than quickly...). We are told, and desperately want to believe, that this globalized catastrophe is the best possible economic system ever conceived -irrefutable proof that we are truly a godless species with no value to this planet.

I don't have every answer, and I fully understand that solving poverty will require all of us to significantly downsize our lifestyle. Just as luck would have it though, a forced downsizing is already upon us, so we should take advantage of this coming depression to produce a more equitable distribution of resources. Unfortunately, I have no doubt that this contractionary "retribution" phase will be somewhat acrimonious (to say the least) and will not solve anyone's problems around poverty - far from it.

The fact remains that the poverty issue will never be solved on a worldwide basis until there is a humane minimum worldwide labour and environmental standard. We implement and enforce worldwide/multi-lateral trade agreements all the time, so why can't we implement a global minimum wage and environmental standard? No single developing country can implement its own unilateral labour/environmental standard, because that country would be priced out of world markets; therefore, the standard would have to be enforced by a centralized trade authority and/or the individual Western nations procuring the goods/services from the developing nations. I know, there are always those pesky multinationals to consider, with their penchant for moving their factories around to exploit the next cheaper pool of labour and resources, but I think with enough collective coercion (boycotts, trade sanctions etc.) we could force them in line - if we really wanted to...

Build your own Ark

For those who want to protect themselves from the impending collapse, you need to build your own "ark". Noah had an ark to protect his family from the Deluge. You need a figurative ark to protect yourself and your family from the coming depression. God himself could not have devised a more devastating calamity than the one mankind has brought upon itself.

Your ark should be minimalistic: Hold on to whatever job you have as long as you can, as now is not a good time to start foraging for a new career. Protect your banks deposits - no more than $100k at any one bank. Eliminate as much debt as possible and free up cash flow for necessities - food, clothing, shelter and ammunition. Those who stubbornly hold on to their materialistic lifestyle will suffer in direct proportion to their level of greed and gluttony.

Over and Out (This is my last post)

When I first started this blog back in late 2006, the problems I was predicting were still largely in the future - sure the housing market was in decline, but subprime was not yet an issue, the stock market was still strong, commodities were soaring, and the Fed was in hibernation. Fast forward to today and, as you can see from the news - we've come a long way Baby!

So, there isn't much more for me to say at this point that you can't read about in the newspapers. Reality has finally caught up with fantasy and will soon overtake the lead. So, the sooner you embrace reality the better off you will be, as I am fully certain that everything I have predicted in this blog will come to pass in its own due time.

Good Luck.

So Far, So Bad

The ongoing financial meltdown is working its way towards the acceleration phase. So far, it's been a lurching affair that has kept everyone complacent, including the Mainstream Media who are still debating whether or not we are even in recession!!! The acceleration phase will begin with widespread collective acknowledgement that the crisis is deepening and Government is absolutely incapable of stopping it - a realization that will lead quickly to wholesale panic.

The sequence of events I predicted here are unfolding exactly as I had expected, although some of the near term dates have been missed thanks to Bernanke's numerous Wall Street bailouts -we now have a perfect system of crony capitalism where risks are public (socialized) but the profits are private. It's a great system, if you are one of the .0001% of ultra wealthy Americans who benefit from it.

Notwithstanding Bernanke's desperate measures, the inevitable collapse is more or less right on schedule (+/-) a few weeks.

Here is an update of how things are going so far, along with some updated survival advice:

1) Stock market collapse: So far, the market (S&P 500) is down roughly 20% from the top and I believe another leg down should begin fairly shortly. This next leg down will be the wake up call that shakes the general public out of its drunken stupor once and for all...

In the coming years the stock market will lose 90%+ of its value. I base this prediction on the experience from the Great Depression, the devastating economic impact of credit deflation, and lastly based on Elliot Wave Analysis from EWI.

Position your stock market assets accordingly. If you are serious about surviving the coming Depression, you need to read Prechter's Conquer the Crash.

2) Credit market seizure: This process is well underway and due to accelerate any time now. The acceleration phase will be brutal and I expect hundreds of banks to fail within weeks of each other. Unknown to many, there are literally trillions of dollars of uninsured assets at banks throughout the country. This is primarily because people either have too much money at any given bank (>$100k), or because they own a money market account that is not insured (most money market accounts are not insured).

If you haven't already moved your money around to protect your deposits, then I recommend you do so, post haste. Once the doors close, it will be too late...

3) Fed panics and drops rates to near zero: Been there, done that. The Fed Funds rate is already at 2%, as a result of the largest and most rapid decline in interest rates in U.S. history. The Fed, despite numerous interventions, has run out of ways to prop up the debt-inflated financial markets. The worldwide financial markets are several orders of magnitude larger than the U.S. Federal Reserve, so the Fed is like the Dutch boy with 10 fingers in the dike. To date, the Fed has wasted $500 billion (half of all Fed assets) buying up bad mortages and other bad debts to prop up the banks. Make no mistake, these bailouts are not to benefit average citizens, they are intended to bailout the wealthy lenders who made risky loans. The average citizen who is upside down in his mortgage is best served by simply walking away from his house and handing the keys back to the same corrupt bank that lent the money in the first place.

If you have zero or negative equity in your home, then you need to walk out the door and never look back. You don't owe some corrupt bank a dime considering they just wanted your business up front with no concern as to how you would pay after-the-fact. Don't keep throwing good money after bad thinking the housing market is ever going to come back. The housing bubble we just went through was a once in a 100 years event. The housing market will eventually lose at least 50% or more in value and IF it rebounds it will be only because the Fed is eventually successful in generating massive inflation, which means in "real" (inflation adjusted) terms housing will just keep going down.

4) Commodity market collapse: As predicted, this is already well underway. Oil gave up the ghost last week and staged its largest decline in history. Gold is still lingering above $900 due to geopolitical concerns (Israel/Iran), but I have no doubt the deflationary spiral will pull gold down eventually as well. Gold will ultimately be THE asset to own, but first it needs to correct its massive rise from $250 - $1000 dollars. I expect this 'correction' to be a deep pullback that will make most gold bulls question their long-term gold strategy. Oil will go much higher longer-term due to the peak oil crisis and geopolitical instability, but short-term it could pull back well under $100 as demand falls due to the global depression.

5) Liquidity Trap: Credit deflation is already well underway. As expected the M2 money supply is declining rapidly and is on the verge of accelerating to the downside. Deflation along with bank failures will bring about an inevitable liquidity trap wherein no one is willing to lend and no one is willing to borrow. The lack of credit will decimate the real economy.

6) Bank Failures: Only 8 so far this year, but we are nearing an inflection point where there will be a nationwide bank run...

7) Mass Layoffs: The job market has been slowly caving in and is on the verge of a rapidly accelerating decline. Hold on to your current job as long as you can. This is about to turn into a real world version of "musical chairs" where jobs are the chairs and they keep disappearing by the thousands. If you don't have a job now going into this economic hurricane, chances are you are never going to get one...

8) Real Economy collapses: Due to factors 1-7 this is inevitable and already well underway. As mentioned many times, the Western economy is predicated on credit. Without credit, the economy is going to collapse like a cheap tent and stay collapsed. Many jobs that were a function of the debt inflated pseudo-economy are going to go away and never come back (i.e. Middle Management) .

9-11) Deflation turning to "Flat Tax" and Hyperinflation: As mentioned, deflation is now underway, and when M2 bottoms out, hyperinflation will take over as Bernanke churns out dollar bills. Exact timing impossible to predict, but I think the deflationary phase will be absolutely brutal, yet relatively brief (12-24 months). At the point at which deflation turns to inflation, you need to move your assets to gold and silver.

12) Crime and Anarchy: It's starting now with property crime, but will eventually turn into violent crime...

Stock Market Con Game

The stock market is the biggest con game on the planet.

As of this week, the stock market (S&P 500) is at the same level it was 10 years ago. That means even cash bank deposits yielding 1% have outperformed the market.

They call it the "secondary market" for a reason, the stock market exists to allow company insiders to sell their shares to the general public. That money you've been plowing into your 401k these past 10 years? That was used to buy shares from insiders who have taken hundreds of billions of dollars out of the market in the past 10 years, while your money has gone nowhere. The common man has been brain washed into a "buy and hold" strategy by Wall Street who need a steady supply of suckers to buy out the insiders. And when I say "insiders" I include those in "buy side" firms such as Hedge Funds who get their information from investment banks long before the public ever hears about it. Reg. FD (Full Disclosure) is a total joke that only washed out a handful of the really bad traders. The fact that hedge funds routinely pay commissions well above what I pay as a measly retail "Active Trader" is all you need to know that the insider trading game is alive and well i.e. inflated commissions are "payment in kind" - thank you very much.

Meet the Country Club
The stock market is just another Ponzi scheme based on cheap and easy growth at all cost. The CEOs of major companies are vastly overpaid and have little or no accountability. After Enron, we were told things would get better, but things have only gotten much worse as Bush & Co. basically neutered the SEC the day they (Bush & Co) took office. Just look at examples such as Charles Prince whose company (Citigroup) lost ~$18 billion which got him fired with a "modest" $42m in severance (see this article from USA Hooray) - poor fella. Similarly at Merrill Lynch, writedowns there have totalled some $19+ billion dollars (to date), as Merrill Lynch just took down another $5 billion in losses this week. Yet last fall, CEO Stan O'Neal was "let go" and given a "mere" $160m in severance for doing such a bad job. These guys are all part of the global country club - this is a cohort of Poser CEOs who made their way to the top not through entrepreneurship or innovation, but strictly through their country club and frat boy connections. George W. is the quintessential example of a guy with zero talent who just bullshitted his way to the top. Every major company in America is now riddled with these pretenders, and this past 8 years has given them the perfect venue in which to succeed at their con game. Their methods are largely all the same, take an existing business and leverage it up to the maximum extent possible, temporarily manipulate the stock price higher based on ephemeral and inflated earnings, cash out, and then walk away, leaving the general public as the bag holder.

If you still have money in the stock market, then I highly recommend you make an honest assessment as to YOUR role in this cash out scheme, and adjust accordingly. Those who would tell you that the stock market outperforms less risky asset classes over the long-term, left out some important details. For example, after the 1929 market peak, the Dow lost 90% of its value in 3 years and then took 25 years to get back to the 1929 peak. If you are planning to retire sometime in the next 10-20 years, ask yourself if you can take that kind of pain. I know I can't. And don't kid yourself that it can't happen again. The current lineup of morons running this show (economy) are the least competent group of policymakers since the founding of the Republic. They are the Country Club Idiocracy and you are their meal ticket.

Wake Up Call: The End of Credit

People often ask me why I think this recession will become a depression when we've had many recessions in the 70 years since the Great Depression i.e. what's different this time? The fact is that nothing's different. What's different for a guy who has been living an unhealthy lifestyle for 30 years and eventually has a heart attack? The answer is nothing. Complex systems are often able to absorb substantial "adverse stimuli", but eventually they reach a critical tipping point that ends in disaster. Contrary to human optimism, the passage of time does not lessen the likelihood of an adverse event, it only increases the probability of an adverse event. When the tipping point occurs, it's not because of a "Black Swan Event", it's because of a "Dumb Swan Event".

In the case of our economy, the negative factor that's been building up all of this time isn't cholesterol, it's credit. Not to say that all forms of credit are bad, but just as with cholesterol, there is good credit and bad credit. In the case of our economy, our figurative "arteries" are clogged with "bad credit" also known as non-self-liquidating credit. This "nsl" credit refers to money borrowed to pay for consumption as opposed to self-liquidating credit which is is debt used to invest in productive assets (factories etc.). Borrowing for consumption imposes a negative burden (debt service) on future consumption, whereas productive investment creates a future source of income that (usually) more than offsets the cost of the debt service.

Non Amortizing debt
There is an even worse form of credit that the Government uses, which is non-amortizing credit. As opposed to a mortgage or even revolving credit, the Government's favourite debt instrument, Treasury bonds, does not require periodic payments on principal. Government bonds only require interest payments, so for example, on a thirty year bond our Government can defer paying back principal for the entire time to maturity (30 years). And when these "long bonds" do eventually expire, what does Government do? They of course issue a new long bond to pay off the old one and hence extend the time for repayment by another 30 years. Needless to say, this is an extremely handy way of shifting the repayment burden from one generation to the next. So, not only does Government run up obscene amounts of debt, they've even found a great way of paying the least amount possible in the current period against the debt. This is equivalent to an interest-only mortgage where you basically never pay off a dime against your house.

Why Now?
So then people ask me why do I think we are reaching this critical point now? I first came to realize that we were facing the first depression in 70 years when I observed the response of the Government and Federal Reserve to get us out of the last recession (2001-2002). In the end, the Fed had to lower interest rates from the 6% range all the way down to 1% in order to revive the economy. In addition, we had the massive fiscal stimulus caused by the war in Afghanistan and the war in Iraq AND the Bush tax cut. That for me was the wake up call. What that told me right there, is that monetary policy is losing its effectiveness. Fast forward 6 years to today and we've been borrowing steadily throughout this expansion and now we face yet another recession, this time much more leveraged thanks to all of the additional debt that's been incurred in the meantime. Add to that the recent evidence that the long-awaited "deleveraging" process is already well underway, to wit, the extreme turmoil and massive writedowns we've seen across the credit markets to date. And, as I wrote recently, (Fed Funds) rates are all the way back down to 2% and yet Fed policy is now trapped between the Scylla of inflation and Charybdis of bank failure.

Debt Addiction
The real story is how the hell did we get here? As I've indicated before, coming out of the 1970s, the U.S. was incurring structural fiscal and balance of trade deficits, indicating that the economy was no longer competitive. That's when the "neo" Supply Side Economics movement came along and convinced us that we could have our cake and eat it too, we just had to get used to taking on a little bit of debt. Or as Cheney put it "Reagan proved that deficits don't matter" (which makes as much sense as eating a Big Mac and declaring cholesterol doesn't matter). The other insidious element of SSE is the relentless drive for growth, because growth hides a lot of underlying problems - in the short-term. Stated GDP is never adjusted for debt levels which means that recent years' GDP is massively overstated relative to historic GDP.

The End of Credit
Our economy represents a 30 year bubble in credit. As the bubble expanded, our sponsors (China, Japan, Saudi Arabia) were more than willing to lend to us, in the belief they would be paid back with interest. More importantly, our current level of economic activity is predicated upon continued and growing access to credit. Credit is extended based on confidence in the likelihood of repayment. Once lenders' confidence is lost, it will go away for a long time and it will take with it the biggest part of our economy.

In short, it's wake up time folks. There are signs everywhere that we are at or near the all important "tipping point", you just have to be willing to look for them. Paraphrasing from Robert Prechter (EWI), it's better to be a year early, than an hour late when it comes to preparing for financial calamity. For those reading this near the time of writing, you must take steps to protect yourself, your family and your assets before it's too late.

Goodbye Fannie and Freddie, we hardly knew ye

The meltdown started late last spring with the implosion of a few lesser-known financial firms such as New Century Financial. Then in March of this year, once-venerable investment bank Bear Stearns basically evaporated overnight after 85 years of business and having weathered the Great Depression. The company was bought for $2/share by JP Morgan (w/Fed backing), after falling from $150/share in less than 9 months.

Moving on up, we are just now witnessing the nationalization of Fannie Mae (FNM) and Freddie Mac (FRE), the two companies chartered to provide liquidity to the U.S. mortgage market. Just this past Friday, the Federal Government stepped in and indicated they will "make good" on the implicit Government guarantee to backstop these companies financially.

I have no doubt that the Government will do whatever it takes to keep these companies from failing outright, because these companies now underwrite roughly half of the $12 trillion U.S. mortgage market. But to be sure, equity (stock) holders will be wiped out in the process and the cost to taxpayers could run north of a trillion dollars [unofficial guess]. Further to the point, in reaction to the news, U.S. Government bonds sold off sharply, based on genuine fear that through this action the U.S. Government may be at risk of losing it's AAA bond rating as a Sovereign borrower. As indicated here, major rating agencies were quick to clarify that a downgrade of the U.S. government, is not an immediate concern; however, the mere fact that a Sovereign downgrade is even on the table is beyond disturbing, and portends badly for the future. These bond rating agencies (Moody's/S&P) have been so incompetently behind the curve on their ratings relative to the market reality, that their reassurances basically have no value at this point.

That these two companies have lost 90% of their equity value and now are on the verge of massive failure, can come as no surprise. One would be hard pressed to find two companies more leveraged to the Global Ponzi scheme than these two. Both companies were chartered to bring liquidity to the mortgage market by buying up mortgages from local banks, thus providing local banks with fresh cash to originate still more loans. The FNM/FRE portfolios were typically leveraged 30:1 (you read that right), meaning for every dollar of equity, these companies held $30 of debt. What this means is that only a 3% decrease in value in the portfolio wiped out all of the equity. In other words, these companies had become massive call options on the U.S. economy, that worked great when the economy and housing market were growing, but have now since "expired" - and "out of the money", I might add.

Lastly, and almost forgotten in the excitement over FNM/FRE, IndyMac went bankrupt last week and was taken over by the FDIC. This was the third largest bank failure in U.S. history - so far...

(Bear) Market Update

Since I subtly indicated here last May, that the stock market was carving out a multi-year double-top, the market soon after topped out in October and has declined 20% from the top.

Below is the current updated view of the S&P 500:

Granted my market calls have been early, and cynics might say that's because I am overly zealous about anticipating the "end of the world". To which I say, mea culpa. In reality, I should really refrain from making time-based predictions, even though it's a lot of fun, especially when I am right. And in all fairness to me, who knew that Bernanke would have been so *creative* in attempting to keep the Global Ponzi Scheme alive. By all accounts, he has come up with some historically novel ways of handing tens of billions of dollars to big banks and brokerage houses to make sure they don't suffer from their own greed and stupidity. Regardless, the man from Oz has only postponed the inevitable and taken the Federal Reserve basically out of the picture. With the Fed Funds rate at a mere 2% and inflation running at the highest level in decades, the Fed really has neither the option to cut nor to raise interest rates - if they cut, then inflation will accelerate killing consumers; if they raise, then banks will fail. The next option that Bernanke has hinted he might take is to "buy" long-term U.S. government bonds aka. monetize the debt, which is tantamount to "printing money".

Regardless of my calls being early, the trajectory and velocity of the current stock market decline thoroughly validates my overall thesis. We are still very early in this overall market decline and with each step lower, more and more of my longer-term predictions will be validated.

As for the commodities market, oil is hanging in there valiantly (~$140/barrel as of today). Paradoxically, despite being a big believer in Peak Oil Reality, I think the next major move in oil will be to the downside. I base this on demand destruction from high prices, weak overall economic fundamentals and over-supply from speculators who took oil out of the markets and will be puking it back onto the markets as the decline accelerates. I am clearly not among the current cohort of deceivers trying to convince everyone that speculation plays no role in commodity prices. If you believe that, then there's this bridge over here...

Also to date, contrary to my predictions here and here, and despite the fact that this has been the most volatile market in years, the major options put sellers have seemingly not yet shit the proverbial brick. however, I suspect that this past two times that the VIX touched 30, these guys had some serious nicotine stains in their underwear. As for the full scale filling of drawers, in my opinion that event is only a matter of when, not if. After all, stupid is as stupid does, and selling puts into a decline is like selling house insurance when the house next door is already on fire.

Desecration

We've desecrated the Blue Planet.

This one, unique, gorgeous gift from God - for all we know the only hospitable planet that exists in the universe or at least within say a hundred million light years - and we've done our level best to destroy it.

Vanishing species, desertification, polluted land, air and waterways, depleted ozone and unprecedented climate change.

We've taken billions of tons of hydrocarbons that took hundreds of millions of years to form underground and released it into the atmosphere in less than 100 years. And now like a bunch of stunned dunces we stand around asking ourselves "I wonder if that caused a problem". One plan that's been put forward to slow global warming, is to pump carbon back underground i.e. take atmospheric gas that was converted from dense liquid oil and pump the expanded gas back into the ground - BRILLIANT! Let's put Exxon and the Saudis to work on that plan...

We've created myriad religions that put us at the center of the universe and rationalize our pathetic existence because we do not have the capacity nor courage to understand how insignificant we are in the context of the universe. We study holy books full of gibberish written hundreds (thousands) of years ago by people who were even more ignorant and backward than we are (hardly seems possible), to give ourselves the short stories we need to put ourselves to bed each night. The books all say we own this planet, so we can do what we want with it. To "worship" or admire anything that's natural or to find God's beauty in anything that's natural is deemed "Pagan". After all, religion, like all businesses, hates competition. Nothing can compete with such a deceptively alluring and self-serving way of thinking - science can't, logic can't, commonsense - no chance. Somehow God appeared a few thousand years ago to part the Red Sea and punish the Egyptians, but since then no one has seen hide nor hair of him - even as half a billion children evaporated from the face of this earth in the last century alone. I guess he was on his lunch break. The Book also says the Hebrews were punished for worshipping a golden calf, to which I say our entire consumption-oriented way of life including the pseudo religions that tell us to embrace it - are all one giant golden calf - a false idol.

Then I ask myself, how can we expect the average person to ever care about this planet when we are so busy stuffing our own bodies full of fast/factory food toxic waste? Logic dictates that guys like Dick Cheney who eat beef at every meal and have had 5 heart attacks, aren't worried about the fact that yogourt containers aren't recyclable.

The one true God gave us the greatest gift - our home - and we threw it away. This is desecration of the highest order and it shows more than anything what we think of God...and I have no doubt before it's all said and done, God is going to show what he thinks of us.

Don't Blame Bush

President Bush's popularity is falling faster than the stock market and the anti-Bush chorus gets louder each day.

But don't blame one man for everything bad that you see going on around you. After all, (almost) half the electorate of the U.S. voted for Bush, not once, but TWICE if you can imagine!!! Worse yet, the second time they voted for him, the "War" (occupation/fiasco/etc.) in Iraq was already well underway.

Of course they couldn't vote for Gore and Kerry, because those guys were too "boring" - after all, neither one of them has run a company into the ground, or speed balled coke (who knows, maybe one of them did speed ball coke - did anyone think to ask?). Meanwhile, Gore and Kerry both have real-world military experience and now they don't like war anymore - BOO FREAKING HOO! Maybe if they had spent the '60s doing everything possible to avoid Vietnam, they would still have their cajones!!! Worse yet, I heard Bore's house is the size of Rhode Island and requires 15 coal fueled power plants to power it! (Heard that on Fox News - or maybe my hill billy neighbour told me - can't remember which).

So just remember, there are still 62 million people (+/-) out there who voted for Bush TWICE and these people are just lurking in the shadows waiting to plunge us into the next abyss of stupidity and short-sightedness. If you encounter one of these people, run like hell, because reason, logic or reality will not avail you in a confrontation with the almighty BUSH VOTER. As for the future, as long as these people stalk the earth, there really isn't much hope I'm afraid (but if you are reading this, you pretty much already came to the same conclusion)...

Chaos and Anarchy

Don't like Armageddon? How about Chaos and Anarchy? Because long before we get to any crazy end-times scenario, the "thin veneer of civilization" will be stretched to its breaking point and then a whole lot further.

As I've said before, we are now witnessing in real-time, the utter failure of governance at all levels. From the Federal Government to State, Local Governments, the Judiciary, Federal Reserve and all regulatory bureaucracies in-between, they have all become frozen and incapacitated by the unfolding financial crisis. These are bureaucracies that have grown increasingly incompetent over the decades and have no chance of ever becoming effective, well-run institutions.

Democracy has been totally undermined by special interest groups. On the right you have the Military Industrial Complex, the Christian Fundamentalists, Ultra-wealthy tax dodgers, and fanatical gun owners. On the left you have Gays/Lesbians, Abortion Advocates and Ambulance-chasing lawyers looking to sue anyone at the drop of the hat. Some choice.

Obama v.s. McCain? It really doesn't matter. These guys spend 80% of their time campaigning and 20% of their time pretending to make decisions and passing still more useless laws taking away yet more freedoms. Two years of making false promises followed by two years of broken commitments followed by two more years of false promises - an endless cycle of hype and deceit. None of these career politicians (Obama, McCain, Clinton etc.) have any experience actually DOING anything. They are career sales people who have never been on the hook to delivery anything of substance.

The current debate about Iraq (stay in vs. get out) is out of our hands. Historically all governments have had to make a choice between "guns and butter". The Bush Administration chose both guns and butter, which means the next administration won't have the choice of either. Again, the Chinese control U.S. fiscal and monetary policy. All signs (weak dollar, rising interest rates) indicate they are growing weary of sponsoring the U.S. fantasy. Once they pull the funding, the war will be over. Those who think we have a choice in the matter don't understand history, economics or even basic math.

The Government is thoroughly corrupt and untrustworthy. They publish a 4% inflation rate when the true inflation rate is running at close to 10%. They adjust the stated inflation rate because they don't want to pay full benefits that are indexed to the rate of inflation. Also, if they announced true inflation of 10%, that means inflation-adjusted GDP is negative! i.e. We are already in a recession and have been for many months. Thanks to understated price increases we been conned into thinking the economy is still strong.

Crime and anarchy are on the verge of exploding. The social safety net that was put in place following the Great Depression has been whittled down and dismantled. Social Security and Medicare are completely unfunded Ponzi Schemes - IOUs from one generation to the next, based on the assumption that each successive generation can support the previous one. Unfortunately the designers of these programs were not forward thinking enough to predict declining birth rates or baby booms, like the one that occurred almost immediately after the system was put in place. The irony of the situation is that the Baby Boomers need the next few generations to fund their retirement, yet the Baby Boomers have raised the most incompetent, helpless, entitled generation in the history of the planet! How can your kids fund your retirement when most of them are still living at home? Thirty-five year-olds playing with their XBoxes, wondering what they want to be when they "grow up".

Hard-core conservatives will tell us that we need to privatize Social Security i.e. put the money in the stock market. The stock market is the biggest casino in the world. When people are down on their luck, the last thing they need is to have their sole remaining safety net be subjected to the vagaries of the stock market. When the economy is down, people lose their jobs, the stock market collapses and charity dries up i.e. all income streams are 100% correlated to the downside - Does anyone get this? A public Social Security system was SUPPOSED to be non-correlated with the business cycle. Replacing a bad public system with an even worse private one, is the kind of leadership we get these days.

The fact remains that most people are in denial about the crisis unfolding all around them, because they don't want to confront the reality that our entire way of life is a consumption-oriented fantasy propagated by cheap natural resources and massive debt. Hundreds of years ago the developed nations secured early control of Third World natural resources through war, colonization/imperialism, bribery/corruption and exploitation. Now that a few of these countries (China, India) have bootstrapped themselves up to the big table, we are finding out that there just isn't enough to go around. Therefore, it's time for all of us to wake up and downsize our lifestyles to the new reality, before the new reality is rudely crammed down our throats.

As for Chaos and Anarchy, like it or not, those two features are coming soon to a neighbourhood near you, just as sure as God made little green apples and mankind made Hornady 9mm. Batten down those hatches, because here comes Katrina x 100...