My Two Cents - "Top Stories of 2008"

12/24/2008

2008 will likely go down in history as the year when all those dire predictions made by Austrian thinkers over the past few years finally came to pass. Decades of excesses finally caught up to America, and in traditional fashion, those in authority tried valiantly to negate those excesses with even more of the same. So, to conclude the year, we’ll dig into some of the top stories of 2008. Next week we’ll discuss the top stories of 2009 and how they are likely to shape our country and world moving forward.

#4 – The Fed blows up yet another bubble

Conventional wisdom said that the Fed was out of bubbles to blow up once the housing market fell apart (and continues to do so). True, the home was probably the most convenient way that people could be cajoled into borrowing money on ‘equity’ that in fact never really existed to begin with. However, the Fed properly understands the relationship between debt and economic growth in a fiat monetary system. As such, Fed governors know that the American public must continue to borrow money. They also know that the US government, like consumers, is flat broke and needs to borrow money. So the Fed is now using its member banks to indirectly monetize debt. Put simply, the Fed creates money from nothing, then exchanges it for bad assets on the balance sheet of its member banks. The banks get rid of the toxic assets, then take the Fed’s new money and buy US Treasuries. The government ends up with the fresh money, and you the taxpayer have not only the responsibility to pay the principal back, but also to make interest payments to the Fed (vis a vis its member banks) in the meantime. In doing this, the prices of US government bonds have gone parabolic, and correspondingly, yields are now scraping against the ocean floor.

The net result of this is that savers are further punished by near zero or even negative rates of return on short-term money market instruments and other debt that as recently as a year ago were paying north of 4% interest. On the consumer side of things, mortgage rates have dipped significantly. The idea here is to stimulate borrowing by creating (once again) artificially low interest rates. Doesn’t this sound familiar – a la 2001? One problem is that banks are not lending like they were in 2001. Ironically, they are invoking lending standards again even though the Fed has almost completely eliminated risk from the equation! While money is available, it is generally available to only those with the best credit at the lower rates. The rest it seems need not apply. On the other side of the ledger, consumers are in much worse shape overall than they were in 2001. In many cases, mortgages are underwater, there is no ‘equity’ to be tapped, and credit card balances are higher than ever. In addition, the one means of supporting a debt lifestyle (employment) is being yanked out from under many people as weekly unemployment claims and monthly job loss numbers continue to mount at an alarming rate.

#3 – Energy price whiplash

From the perspective of energy prices, 2008 was a tale of two cities. For the first six months of the year, the headlines were about rising oil prices, potential shortages, and record gasoline prices. The second half the year featured a complete 180 degree turn with the entire move from January 2007 through July 2008 being erased and then some. As I pen this article, prices are threatening the $35/bbl level for crude oil and $5.50 for natural gas. In typical fashion, the financial media once again missed the real story here. The post-election revelation that the US has been in a recession since at least late 2007 was no real surprise to many of us, but underscored one of the points we have tried to establish all along in these weekly commentaries. Inflation is a monetary event, not an economic one. The fact that the largest run-up of oil prices in history came at a time when the US was in a recession throws water all over the idea that increasing prices are caused by economic growth alone. As has now been proven rather nicely this past year, that assertion could not be more wrong.

However, the real story behind the violent gyrations in oil prices and the markets in general is two-fold. First, the gyrations are indicative of a dying monetary system and rampant misinformation as ‘investors’, under the influence of mainstream media race first in one direction, then in another in a frantic attempt to predict the next bubble. These are the dynamics that have caused massive dislocations in bonds, stocks, currencies, and commodities over the past year. The fiat foundation is shaking beneath us. Secondly, the dynamics of petroleum supply are fragile, and such violent price swings and false market signals will have dire consequences moving forward. This issue will be discussed in greater detail next week, but in simple terms, we will see petroleum shortages because of this mess – likely in the next year to 18 months.

#2 – Congress – Out to lunch

If Congress’ approval rating was at an all time low going into this mess, it will be interesting to see what its approval rating is coming out of it. In our experience, it is very difficult to find two people to rub together who feel Congress has done a good job for the American people. Whether it is the financial industry bailout, the auto bailout, energy policy, Congressional raises, or a myriad of other issues, 2008 has been a year where Congress has earned it self a big, red F- as public servants. Congress’ actions this year are not a cause for much optimism moving forward. There is no doubt now that we are facing a crisis unlike anything seen in the last 100 years. There is little doubt amongst most of us that we are in no way ready to deal with it. We’re certainly able, but not ready.

Unfortunately, when it comes to getting common sense policy, don’t look towards Congress. Common sense policy would require a significant degree of economic pain for Americans. Congress is in the business of appeasing, not causing economic pain, and as such is impotent when it comes to solving any of our problems – financial or otherwise. Any decisions made by the 534 (minus Ron Paul because he knows what needs to be done) will be an attempt to further postpone the inevitable, and ultimately, will end up making it worse. While the ineffectiveness of Congress is not a story in and of itself, nor should it be a surprise, it serves as a confirmation of the belief that in a crisis, Congress almost always does the wrong thing.

#1 – Banks stay silent on bailout and Fed money

Thankfully, this is a story that the mainstream financial press is actually starting to pay some attention to. A few weeks ago, Bloomberg news filed a Freedom of Information Act request for full disclosure by the Federal Reserve for the trillions in loans it has given out. It must be remembered that these trillions are totally separate from the $700 Billion authorized by Congress in early October. The flimsy excuse given by the Fed for telling both Bloomberg and the American people to fly a kite was that they didn’t want to cause ‘anxiety’ in the markets. If people knew who got the money, then they might actually be able to make informed decisions regarding the health of those companies. Can’t have that, can we? So instead, the Fed has maintained a cloak of secrecy, which has served the purpose of spooking the entire market. This lack of transparency is partly responsible for getting us into this mess. Of course, even more of it will get us out of the mess. That seems to be the prevailing logic at work these days.

But there is more to the story.On 12/22/08, The Associated Press, to its credit, released a story about what is going on with regard to the more widely understood $700 Billion financial rescue package. At least in the case of this money, we have an idea of who got what. Unfortunately the transparency stops there. Here are some notable quotes from banking executives regarding TARP funds:

"We have not disclosed that to the public. We're declining to." Thomas Kelly – JP Morgan Chase – rec’d $25 Billion from the TARP

"We're not providing dollar-in, dollar-out tracking." Barry Koling – SunTrust – rec’d $3.5 Billion from the TARP

"We manage our capital in its aggregate." Tim Deighton – Regions Financial – rec’d $3.5 Billion from the TARP

This is the attitude that the big banks have towards you, the taxpayer, who saved their jobs, their billion dollar bonuses, and their companies. The frightening thing about this situation is that the hubris of the financial industry as a whole has continued to mount despite the fact that they are constantly having to beg Congress for more of your money. Where has this money gone? At this point, the only valid assumption, in the absence of disclosure by the banks, is that the money is being stolen. The increasing likelihood that we are witnessing the biggest bank robbery of all time makes this story a dead wringer for #1.

Please accept our most sincere wishes for a joyous Christmas season and a healthy New Year – from all of us at Sutton & Associates and “My Two Cents”.

Disclosures - None

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.