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Tipping point-ville!

Richard Daughty
...the angriest guy in economics
The Mogambo Guru
Sep 27, 2006

-- Total Fed Credit was up a couple of billion bucks last week. Not too bad, but not too good, but more bad than good, as I am, like Goldilocks, always 100% dead-set against anything that doesn't perfectly suit me personally.

Unlike Goldilocks, however, I not only take lots of loaded large-caliber weapons with me when I go snooping around in the houses of bears, but I also extrapolate beyond mere porridge temperature and bed softness to lots of other things, including inflation, which should always be zero. And if inflation is greater than zero, then inflation is much more terrible than some unarmed bear. And if it is NOT zero, then it should be falling gently below zero, so that prices are actually drifting softly down, increasing everyone's standard of living the whole time.

This "increasing standards of living" thing is the now-broken promise of the whole "productivity revolution" that was supposed to "more than offset" the horrors usually produced by anyone attempting the monumental stupidity of the fiat currency/ fractional-reserve banking/ monetary and fiscal insanity of the last few decades. Hahahaha! Wrong, as it turns out! Hahaha!

Any increase in Total Fed Credit, like any increase in expansion of my arrogant, autocratic, cruel-yet-dictatorial domestic rule eventually leads to unexpected bad, bad things (UBBT). For example, some of these bad things are sudden "tipping points", like when you stand up, slowly lean over, farther and farther until, suddenly, you lose your balance and fall on your face.

Or how I would typically come home from a typical hard day of playing typical golf and playing typical drinking games with my typical friends in the typical clubhouse, but then one day, un-typically, out of nowhere, as I pull up in front of the house, strewn over the front lawn are all my clothes and stuff, and standing on the front porch is my wife and her hateful lawyer, laughing at me! Somewhere, somehow, in some way, some little thing has changed, I don't know what, but like the straw that broke the camel's back, wham! Tipping point-ville!

Similarly, increases in Federal Reserve creation of money and credit produces UBBT that one day reach a "tipping point", too, and driving us relentlessly towards that is price inflation, which continuously produces more economic dislocations and civil unrest because people don't like it when they must continually consume less and less goods and services, and the lessening of consumption of goods and services means less production of goods and services, and so people are laid off, which decreases their incomes, which means they can consume even less goods and services, which decreases production, which means less consumption, and then less production, and then less consumption, less production, less consumption, less production, less less less, until your head is whirling around and around and you think you are going to puke.

And perhaps as proof, a release known as the "Philly Fed Index" suddenly "plunged", as Chuck Butler of EverBank.com puts it, to "a negative -.4 from a previous reading of 18! Any number below zero," he explains, "indicates contraction in manufacturing for the region. WOW!"

Tom Sullivan, in his "Current Yield" column in Barron's, opines that it was "an unnerving report on the manufacturing sector."

We professional economists call this process the Slow, Horrible Spiraling Death Of An Economy By Inflation Syndrome, but more commonly by its acronym, SHSDOAEBI Syndrome. In the early stages, it can be temporarily delayed by using savings to plug the gap between stagnant income levels and rising spending levels, which resulted from prices rising so high, and so fast.

In the later stages, however, after the "Steal the kids' piggy banks!" and "Intercept birthday cards from their grandparents!" stage, now with no savings remaining, the onset of economic death can be temporarily forestalled, one last time, with increased borrowing. This is Late Stage SHDOAEBI Syndrome.

And we are already in this advanced stage, if you listen to Martin Weiss of the Safe Money Report, who says "According to Federal Reserve data, the typical American family today has a balance of only $3,800 in cash in the bank, has no retirement account whatsoever, owes $90,000 on their mortgage, and owes $2,200 in credit card debt."

And the supposed Big Financial Savior, the ubiquitous 401(k) retirement account, after decades of saving, only has about $27,000 in it, on average! Hahaha! The average 401(k) "investor" has, thanks to the higher prices of everything, rising relentlessly year after year, managed to merely accumulate enough to buy a nice new car! Hahaha! You think you can retire in customary comfort for 20 years for the price of a new car? Get real! Hahahaha!

SHDOAEBI Syndrome on the macroeconomic level, in case you were wondering, is always fatal in the end. However, on the microeconomic level, the entire economic history of mankind has shown that if you wisely bought gold and silver to bet against the success of the government pulling off this kind of silly monetary and fiscal crap WITHOUT killing the economy with inflation, then you always did very, very well.

And since it is true that it is an ill wind that doesn't blow somebody some good, one of the more pleasurable good, good things (PGGT) from all of this economic ugliness and misery is the guaranteed increasing wealth of people who own, as I have been screeching about until my voice is hoarse and raspy, gold and silver, as those two metals always (eventually) soared in price when a "creation of excess money and credit boom" hits the skids. As they always have. And always will. Because they always must.

But this is not about how people who own gold and silver will do very, very well, but about how production falters as consumption falters because of inflation in prices and the inflationary dilution of the buying power of wages and interest, and how the government responds by creating more inflationary problems by trying to spend its way out of the inflationary problem caused by it previously trying, over and over, to spend its way out of its inflationary problems, and how the Federal Reserve accommodates them by creating more and more money, and more and more debt, from low-priced credit, which increases the money supply, which makes prices go up some more, which was the original problem. I sigh.

But all this new money created by the banks isn't even ours (meaning you and me, as in the collective "us") anymore, as we learn from Bloomberg when we read that international reserve assets are now up to $4.59 trillion! About 10% of the GDP of the entire world! And the really surprising thing, beyond the horrifying sheer size of the world's governmental accumulation of assets, is how fast they are growing; 18% since January 1, and up 16% since this time last year (12 months ago)! So not only are reserves growing like some hideous cancer, but growing faster and faster, like some REALLY hideous cancer!

I gulp in horror, as my heart is pounding at the revelation. I try to calm myself by remembering that, to be fair, it is not just the lowlife American central bank that is creating this excess money and credit, as lowlife central banks around the whole freaking world are doing it, too. I note, for the record, that it was not as calming as I thought it would be.

Surprisingly, M2 (seasonally adjusted) was down $32 billion last week, which seems like a lot to me, and M1 (seasonally adjusted) was down $39, which also seems like a lot to me, too, and neither of them are good economic news.

-- Paying a dollar for a single McDonald's hamburger seems like a lot to me, since I can remember when you could get a McDonald's hamburger for 15 cents in 1966.

So, class, put down your books and take out a clean sheet of paper for today's Mogambo Pop Quiz (MPQ). The question is, "If in 1966 I had started to save for my retirement, how much money would I need to save, per day, to buy one hamburger, per day, in the future, knowing that the hamburger is currently selling for 15 cents, but would cost a dollar in 40 years?"

Since everyone in the class is moaning and whining and scratching their heads, I kindly provide the hint "Firstly we note that inflation in the price of the burger has been 670% over 40 years. That's comes out to 4.9% inflation, per year, compounded."

Uncharacteristically forsaking my usual unhelpful, vengeful and insulting pedantry, I announce that I will magnanimously "Assume that inflation and expenses equals net capital gains."

I foolishly thought that would be enough to enable them to solve the problem, but with my Mogambo Super Hearing (MSH) I can hear them whispering into their little cell-phones to each other "What in the hell is this Mogambo idiot talking about?"

I make a mental note that since the government is tapping all of our phones now, I can simply have FBI give me a list of exactly who was talking to who in my class, and maybe get a transcript of their little conversations, so that I can take my calculated revenge with their final grades.

Having done that, I put a big, false smile on my face so that they would not suspect anything, and I go on to helpfully hint, "If you had saved up your retirement in cash, you actually lost 'money', as your money lost its buying power at the rate of 4.9% per year." Again I paused, expecting to see their young, fresh little faces light up at the sudden comprehension. But nothing! If anything, their faces were even MORE blank, and they were even MORE stupid than they were a minute ago. And then they wonder why I hate them so much!

Abruptly losing my patience, I leap atop a desk and scream out "If you had invested the money into assets on a buy-and-hold basis, year after year, it looks like you made money, doesn't it?" Frightened, they all nervously nod their heads up and down. Enraged, I go on, shouting, "But after you pay capital gains taxes, income taxes, miscellaneous other taxes, fees, expenses and commissions, and maybe some state income taxes, and after all THAT you then deduct from that pitifully diminished 'gain' the vast diminution of your wealth caused by persistent, grinding inflation, you ain't really earned squat! Hahaha! Squat! In fact, you lost wealth, you little twits! Hahaha! You are worse off than when you started! Welcome to ugly economic reality, you stupid, halfwitted morons!"

Still they sat there, perplexed and apparently paralyzed with fear for some reason. Tiring of this game, I give them the answer, "Mathematically, with real (inflation-adjusted) net gains of zero, to get a hamburger in the future, you have to save a hamburger today."

A murmur runs through the class! I have finally connected with these little boneheads! Excitedly, I quickly go on to say "Extrapolating, if you want to have a retirement lasting 20 years, after working for 40 years, and to do so with a retirement income equal to the buying power of 100% of your current income, then, adjusting for inflation and taxes, you have to save 50% of your income per year, every year that you work, for the whole 40 years! Hahahaha! Fifty percent!"

At that, they all jumped up, screaming, and ran from the class in horror, so I never got the chance to tell them that it gets worse if you are only 20 years away from retirement, because then you have to save (hahaha!) 100% of your income today!

The point of all of this? According to my Daily Lesson Plan, I was teaching that it is very, very ugly (VVU) out here in the real world of Stark Mogambo Reality (SMR).

And all of this misery is because of inflation in the monetary aggregates by the Federal Reserve, which has to show up as inflation in prices as all this new money floods through the economy. And it, sadly, does. And thus it erodes the value of you, your money, and your pitiful little retirement account that is so pathetically inadequate that I laugh in scorn (LIS).

And in that regard, what did not get (in my opinion) adequate media coverage was the release of the Leading, Coincident and Lagging Indicators. The only trusted news outlet really raising a fuss was the Mogambo True Patriot Monetary News Service, located at 1776 on your radio dial, and available everywhere, except where the government is jamming the broadcast signal in an attempt to silence The Mogambo, preventing His Mogambo-ness from spreading the news that you can "Kiss your fat, stupid butts goodbye, American morons, because you ignored the Constitution and let your money be nothing but paper and electronic accounting balances, and as a result the government and the banks went nuts with creating and spending too much money, and now you are all freaking doomed by the inflation in prices and the hell of an economy composed of government spending! Hahaha!"

Anyway, for those of you who were prevented by government censors from hearing that important, important broadcast, what happened was that the Leading Indicator (which, as advertised, indicates future profits) went down 0.3. Bad enough. The Coincident Indicator (again as promised, the indicator of current economic activity) went up by the smallest increment possible, 0.1. Worse enough, if I may be permitted to coin a phrase.

The really horrifying news was that the Lagging Indicator (which is the indicator of inflation) zoomed (relatively) by 0.4! Worst enough!

If you look up that curious combination of things in the "Risk/Reward Matrix" section of your Mogambo Handy-Dandy Desk Reference (MHDDR), you will notice that it is far, far, far into the Doom Zone, which is sort of like the Twilight Zone, in that things are pretty weird and twisted, except that in the Twilight Zone everybody is usually still alive at the end of the episode, whereas in the Doom Zone everybody dies a horrible death by being eaten alive by inflation, with lots and lots of screaming in pain and fear, and the episodes always end with silence and something burping, instead of the cool, dulcet tones of Rod Serling saying "Thus little Bobby learned the true meaning of Christmas, in the Twilight Zone."

But it was inflation we were talking about, because that is all I ever talk about, and that brings up the news about how the drought has severely reduced this year's crops of things that we eat, such as wheat fields, soybean bushes, corn stalks and pizza shrubs. For example, from Bloomberg we learn that "The continental U.S. endured the hottest summer since the Dust Bowl of the 1930s, and the second-warmest since recordkeeping began more than a century ago."

And this almost certainly has something to do with the El Nino region of the Pacific Ocean that is, again this year, very big and very warm and commensurately more influential of the weather. For example, from FreeMarketNews.com comes the item "John Ing, of Maison Placements Canada, in a post on gold-eagle.com takes the inflationary side, noting that the anchovies have once again gone missing off the Peruvian coast."

What do anchovies have to do with anything? Well, before I can explain how this reduced supply of anchovy protein and rising global demand for protein spills over into the supply/demand dynamics of alternative sources of protein, they rudely interrupt me by saying "The last time this happened soybeans rose to record highs, carrying precious metals prices along with them."

-- From Doug Noland we get a lot of very interesting news, like this bit about how "China Mobile Ltd., the world's largest cell-phone operator by users, added 4.42 million subscribers in August, taking its total number of customers to 282.7 million." That is equal to, roughly, the entire population of America, counting every man, woman and child! One Chinese cell-phone company has more subscribers than our entire population!

Or how about how the Chinese are doing smart things, too, like road building, which is a guaranteed producer of economic growth? Sure enough, Mr. Noland notes that Bloomberg reports "China's Guangdong province, which has the largest economy in the country, will spend 290 billion yuan ($37 billion) expanding its roads and ports, as it seeks to win to further investment from overseas companies."

-- Barb at 321Gold.com keeps track of Federal Reserve Bank Temporary Reserves, known as the repo market, which are merely the interaction between (theoretically) somebody who needs some very short-term money for some reason, and a bank making a short-term loan against the collateral of some securities that this "somebody" owns, with the agreement that the loan will be re-paid in a few days.

Or the Federal Reserve is creating, and paying out, lots of money to soak up government securities, flooding the system with liquidity. And thus the banks, eager to get this sudden new money "working", drive interest rates down to entice people to borrow the money to buy assets, making asset prices go up, generating lots and lots of tax revenue to the government, and everybody is happy happy happy.

In case you were wondering, the name "repo" comes from the Latin "re", which means "in reference to" or "appertaining to, and the word "po", which is an obscure Hawaiian colloquial expression for "dog excrement", as in "Don't step in that big pile of fresh po, Mogambo! Oh, God! You did it anyway! What a stinking mess!"

And considering what the Federal Reserve is trying to do with all this repo stuff, the literal translation is about as appropriate as you can get.

But this is not about how the Federal Reserve is a horrible bunch of lying, thieving bastards who are stealing the purchasing power of our money by printing up so damned, damned, damned much of it that I wake up in the middle of the night, bathed in sweat, screaming in fear at the inflationary bonfire that is building, but about repo activity, and how for months and months now, seemingly day after day, we saw $10-$20 billion a day in repo activity. Suspicious and weird!

And then, suddenly (cue flash of lightning and blast of thunder to signify ominous significance), nothing! Things abruptly calmed down to the range of "eerie", which I will soon signify with a mysterious wolf howling in the distance when the, you know, thunder stops echoing. In fact, on two days last week, there was a notation on the Fed site that I have never seen before, which read "No operations today"!

But this central banker desperate desire and need to loan money plays right into the subject of derivatives and debt, which are the focus of a special report titled "In the Shadows of Debt" in this week's Economist magazine, where they write "Egging borrowers on are bankers, who sometimes admit to lending amounts, as a multiple of underlying cashflows, that are against their better judgment." One reason that they do it, they say, is because the "competition to provide credit is so fierce, however cheap it is!" Hahahaha!

In other words, they are saying "I deliberately acted like a greedy, stupid pig because everyone else was!" Hahaha! This is too, too much, and I can't wait to use it myself! Wife: "You and your hoodlum friends ate cheap tacos that some guy was selling out of the trunk of his car, drank an entire case of tequila, you are now desperately sick, smell worse than ever, and you tell me that you did that on purpose?" Me: "Of course I did, you stupid old woman! Don't you know anything about modern banking theory and practice?"

Although the article does not contain any more priceless bits of highly useful information like that, the article did say that "Credit derivatives, which behave a bit like insurance contracts, allow investors to buy or sell cover against default by a borrower, and the price moves depending on perceptions about the borrower's credit worthiness", and that "the notional amount outstanding of credit derivatives rose by 52% in the first six months of the year to $26 trillion."

This is the part that kills me; they go on to write that although $26 trillion is a large number, "That number would be far smaller if banks' positions were netted out for offsetting exposures." Hahaha! I love that! What morons!

The fact is that these "offsetting exposures" did not disappear in some miraculous "netting out". In the aggregate, risk went up and the totals of the derivative bets went up because somebody else's risk exposure went up when they accepted the other side of the banks' "netting out"! And where do you get the money to finance all these new derivatives? Ultimately, by borrowing the money from another bank, or selling it to somebody who goes to the bank to get the money! And then they, in turn, contract for some derivative risk-transference to a fourth party to offset some of that risk!

And then that new guy decides to offset his increased risk by entering a fifth-party derivative contract with someone else, who in turn has to enter a sixth-party derivative contract with someone else to offset some of the risk, and then that person has to enter a seventh-party derivative contract with someone else to offset some of that risk, and then on and on and on, eighth, ninth, tenth, until I am hoarse from screaming at the idiocy of thinking that this is NOT a Ponzi scam! How can it NOT be?

I guess to add a little levity, the article startlingly admits that "Such products, known as 'structured credit', encourage liquidity, partly because they can be created out of thin air." Hahahaha! Gosh! Ya think that the ability to create assets out of thin air would increase "liquidity"? Hahaha! Me, too! In fact, give me a chance to create money out of thin air and I will show you some REAL liquidity increases!

"The problem," the Economist says, "broadly identified by many regulators, is that not a lot is known about how structured-credit products behave in unusual conditions", and that "it is hard to know how they will react when hard times return."

If they had bothered to ask me, I would have told them that the answer is, unfortunately, that the whole freaking system will fall apart and the country will be plunged into utter bankruptcy, as the whole idea of eliminating risk by creating more risk, and then spreading it among a bigger group of people, financed with nothing but minimal margin and borrowing the rest, is insane! Insaaaaaaane! Absolutely insane!

And I am here as a guy who really knows this "insane" business, both by the fact that I have been tested for it so many, many times and passing it somewhat fewer times, and by the fact that I see it every freaking day of my life whenever I merely glance at the monstrous, monetary insanities of the Federal Reserve and the grotesque spending insanities of all the levels of government.

And anyone who thinks that now, for the first time in history, the umpteenth repetition of this stupidity will NOT be calamitous, is truly, truly, truly insane.


****Mogambo sez: Whether or not the current economic and financial weirdnesses are caused by the government trying to keep things up-tempo until the elections, they are surely trying. Remember that ever since Clinton, the mantra is "It's the economy, stupid!"

Their bigger problem is that the big Presidential election is only two years away, so they have to keep this bloated, stinking monstrosity of a world economy afloat for a long, long time yet. Your best-case scenario is that they succeed enough to keep the prices of gold and silver extraordinarily low the whole time, so that you can have two more glorious, fabulous years of accumulating gold and silver at astonishing, historic bargains, multiplying your eventual gain when it all blows apart!

Sep 26, 2006
Richard Daughty

email: RichardSmithGroup@verizon.net
Daughty Archives
Provided as a courtesy of Agora Publishing and The Daily Reckoning

Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the writer/publisher of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it. The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications.

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