On occasion, I’m tempted to apologize for these rants. Not so much for the message, but for the frequency.

Unfortunately, when surveying the landscape on which our hovels rest, the king’s castle looms large in the foreground.

I am not an envious person by nature and so wouldn’t begrudge the king his fine trappings, provided they were honestly earned.

But therein lies Ye Olde Rub.

Ever more frequently these days, the drawbridge comes down and a troop of the king’s finest sallies forth to extort from me more than half of my crops, and to read new royal proclamations whose net result is to add to the daily burden of trying to provide sustenance for family and jobs for workers.

Should I protest, say, by grabbing a pitchfork and telling the soldiers to clear off my land, or refuse to fill their wagons with the best of my crops – each leaf of which represents time and investment on my part – they would grab me by the shoulders, drag me to the king’s dungeon, and confiscate my property.

In fact, all that has changed since the days of yore is that the king’s knights tend to no longer rape, as well as pillage.

To be fair, the annals of history contain rare instances of kind and intelligent monarchs, the sort who understand that overburdening the peasants ultimately reduces crop production, leading to unnecessary and unproductive hardship and, in time, even revolt. Though, by temperament, I resist authority of any description, I suppose I could live comfortably under the rule of a fair and benign monarch.

The problem with that notion, of course, is that the corruptive nature of power leads to the near certainty that Baldash the Not So Bad will be followed by Norbit the Nasty.

And all of a sudden, instead of politely requesting I kick in some reasonable percentage of my crops to help maintain a constabulary, courts, and maybe the highways, Norbit’s men are kicking in my doors and we’re back to ox carts full of my produce being confiscated to provide a new set of gold plates and to pay the cost of invading neighboring lands.

While some among you will protest, there is, I would contend, little difference between a degraded monarch and a degraded democracy. In the monarchy, a single leader directs his minions in their ruinous acts; in a democracy, the directions come from professional politicians, as well versed in gaining and keeping power as any royalty of a bygone era. (Sir Robert Byrd held high office in this nation for 57 years.)

Far from being benign, the nation’s leadership, masters at appealing to the self-interest of an unprincipled voter class, have led us to a perilous situation where the fields are being left unplanted.

And an increasing percentage of the citizenry is now muttering angry curses as the king’s men ride by in their shiny black limo-horses.

For a clear understanding of just how poorly ruled this country has been, look no further than the latest budget projections. In his recent article, “America’s Impending Master Class Dictatorship,” Stewart Dougherty does just that, analyzing the government’s wanton spending and penning some notable, and quotable, words on the topic.

One stark and sobering way to frame the crisis is this: if the United States government were to nationalize (in other words, steal) every penny of private wealth accumulated by America’s citizens since the nation’s founding 235 years ago, the government would remain totally bankrupt.

Recently our stalwart CEO Olivier Garret sent over an insider doc from the Republicans’ Study Committee that provides talking points for candidates to use in the unending struggle for control of the castle. While I think the color of flag flapping over the battlements is at this point almost irrelevant, the document contains some interesting data points.

For instance…

• $13.5 Trillion of New Debt: The president’s budget proposes to increase the national debt from today’s level of $12.3 trillion to $25.8 trillion in FY 2020 – an increase of $13.5 trillion or 109.8%.  The amount of new debt proposed by this budget is larger than the total amount of debt accumulated by the federal government from 1789 to today (even including the $3.6 trillion of new debt over the last three years).

• $2.8 Trillion Tax Increase: The president’s budget submission increases taxes by $2.8 trillion over ten years. This includes allowing many of the 2001 and 2003 tax cuts to expire at the end of this year, such as allowing the top rate (which is often paid by small businesses) to increase from 35% to 39.6%, and allowing the top capital gains tax rate to return to 20%. These tax increases would take effect in an economy that, according to many economists, will still have an unemployment rate around 10%.

• Mandatory Spending: Increases from last year’s level of $2.1 trillion to $3.4 trillion in 2020, an increase of $1.3 trillion or 59.4%. Within that amount: Medicare spending increases from $425 billion in 2009 to $953 billion in 2020 – an increase of $528 billion or 124.2%; Social Security spending increases from $678 billion in 2009 to $1.20 trillion in 2020 – an increase of $523 billion or 77.1%; and Medicaid spending increases from $251 billion in 2009 to $487 billion in 2020 – an increase of $236 billion or 94.0%.

• Interest Payments on the Debt: Increases from $187 billion in FY 2009 to $840 billion in FY 2020 – an increase of $653 billion or 349.2%.

As mentioned yesterday, the projection on interest costs is far too conservative. While the government’s always flawed projections don’t anticipate it, both Bud Conrad and Doug Casey see strongly rising interest rates as a certainty in the foreseeable future. At that point, the debt death spiral begins in earnest, and the whole charade begins to come apart.

But it won’t take soaring interest rates to bring the economy down. That’s just going to accelerate things. And, of course, the worse things get, the worse the monarchy will act – demanding ever higher taxes and further debasing the currency, as they now certainly must.

How can you protect yourself? It really depends on where you are from.

One obvious solution would be to move to a different kingdom, one that treats you and your money better. Or that pretty much ignores you altogether. If you are from the U.S., the king’s tax collectors will follow you wherever you go – but even so, there are modest tax advantages you can gain by expatriation. Ask your tax counsel for details.

If, on the other hand, you live in a kingdom that doesn’t tax foreign-derived income (yet), becoming a citizen of the world can offer serious advantages and is well worth considering. The situation in most of the developed kingdoms, where easy money and quick mortgages greatly exacerbated the levels of debt, is only going to get more dire as the rulers cast a wider and stronger net in the quest for more revenue.

Even if you aren’t in a position to move, however, you’ll benefit from clearly understanding one key point about the king. While he may dress well and speak in dulcet and pleasing tones, he doesn’t actually produce anything. What money he has to spend must first be taken off the productive elements of the peasantry.

But there are limits to how much he and his men can squeeze out of the citizenry. We are nearing those limits.

That means that all that is left to the monarchy is for it to issue IOUs. And given the levels of their debts and ongoing spending, lots and lots of IOUs. Those IOUs are called dollars, or pounds, or pesos, or yen, or….

While there will be no straight line up or down for any asset class in the unsettled times we will live through, using periods of weakness to build your exposure to tangible assets – most notably gold, whose primary and best use is as sound money – is the only way to protect yourself from the Great Debasement that’s coming.

Regards,
David Galland
Casey Research
for Whiskey & Gunpowder

April 21, 2010

Government Is Still Just Like an Overtaxing King was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In the simplest of terms, every closed system will ultimately degrade toward a state of maximum entropy.

I’ll use the current political system of the U.S. as a convenient example. When American democracy was first shoved out of the nest by the founding fathers, it was new, fresh, and energetic. It took the world’s breath away at its boldness and unlimited promise, and set the wheels turning on tangible change across much of the world.

Before the ink dried on the Constitution, however, the degradation began. From the beginning, the country’s political operations fell into the hands of a strictly limited number of parties, which quickly coalesced into just two. Since then, they have essentially shared power, with only minor differences in policies between the two. Simply, absent a disruptive external force, the closed political system quickly matured into an institutionalized “sameness” that all but assures no serious challenges — leading, ultimately, to the certainty it will degrade to only a shell of its former self.

It was, perhaps, because of his own understanding of natural law that Thomas Jefferson was heard to remark, “The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants. It is its natural manure.”

That doesn’t mean I am advocating revolution — just pointing out the fact that any closed system, no matter how well constructed, will degrade. To expect the United States of America to avoid this fate is to expect the impossible.

Switching to a corporate example, I used to be a regular buyer of Toyota cars. They were well made, innovative, and suited my changing needs over the years. And I wasn’t alone — in 2007 they became the world’s largest automobile maker, with a global manufacturing and distribution system that made them appear dominant. Behind the scenes, though, entropy was at work.

In 2008, when the time had come to lease a new car, I reflexively headed over to the local dealer fully expecting to drive off with yet another Toyota, just as I had done several times over the previous decade or more. But as I walked around the showroom, it was impossible not to notice that the company had lost its edge. The cars on offer were not only more expensive than the competition, but even the newest models had that “so yesterday” look about them.

Surprising even myself, I walked out and ended up leasing from another company. I remember vividly at the time saying to my wife that we should short Toyota’s stock. Of course we didn’t — but if we had, it would have been a good play, as you can see in the chart of the company’s stock price here. Note that Toyota’s share price peaked in 2007, almost concurrently with it becoming the world’s largest car company.

As I said at the onset, you can see entropy at work in virtually every closed system. Consider the U.S. dollar, which became the world’s de facto reserve currency as a result of Bretton Woods. What an amazing advantage for the United States — this unique ability to provide the world’s central banks with their primary reserve component! And to have all the world’s commodities dealt in dollars. In short, the dollar became the centerpiece of the global economic system.

It was, of course, damned to entropy, with Nixon’s ending the dollar’s gold backing just being part of the natural progression. And if he hadn’t done it, one of his successors would have — due to some “emergency” or as a “temporary” measure, or some other flimsy political cover. Regardless, the degradation of the currency gained speed and, systematically, it’s been all downhill since.

You may also want to think about entropy when pondering the Chinese miracle. No question, China is having a heck of a run. As James Quinn writes in his article “Is China’s Recovery a Fraud?” in the February edition of The Casey Report, in 1970 that country’s GDP was just $92 billion. Today it is $4.9 trillion!

“Unstoppable!” cheers the punditry. The Chinese leadership, whose capable hands are very much on the levers of the macro-economy, are cut from special cloth, they add.

In answer to that, Quinn points out that despite China being an export-based economy, purpose-built to supply goods to a U.S. population engaged in a mad rush to spend themselves into debt and default — which is to say, an economy now only a memory — there is currently 30 billion square feet of commercial real estate under construction in China.

I’m not sure if bowling is popular with the Chinese, but with all that spare space, some enterprising individual might want to consider promoting it as the coming thing. Roller rinks? Indoor laser tag centers?

Meanwhile, back in the U.S., we the people are no longer content with a free-market system that embraces periodically burning down the house in order to rebuild stronger and better — a system which has been proven to create wealth, and lots of it. Instead, we are hell bent on adopting the closed economic system of a socialist model where everything and everyone is tightly controlled.

On that point, a recent article in the Wall Street Journal titled “No Exit in Sight for U.S. as Fannie, Freddie Flail” sheds light on the continuing degradation in the free market that used to underpin the nation’s hugely important housing sector…

Fannie and Freddie, for their part, remain at the core of a housing-finance system that inflated a dangerous housing bubble. After prices collapsed, sending shock waves around the world, the federal government put America’s housing-finance system on life support. It has yet to decide how that troubled system should be rebuilt.

On Dec. 24, Treasury said there would be no limit to the taxpayer money it was willing to deploy over the next three years to keep the two companies afloat, doing away with the previous limit of $200 billion per company. So far, the government has handed the two companies a total of about $111 billion.

(Full story here.)

Can’t you just smell the entropy? The results are not just predictable, they are evident — just look around.

As investors, it is, I would contend, important to understand the notion of entropy — and to watch for it in your portfolio companies, in your bureaucracies, and, on a more personal level, your relationships and your health. On that last point, the human body is very much a closed system and so, as we all are too painfully aware, will degrade until it ceases to exist.

You can slow the degradation by taking care of yourself. But it’s also worth remembering that it’s a one-way slope, so enjoy yourself while you are fit and able to.

Regards,
David Galland, The Casey Report
for Whiskey & Gunpowder

March 10, 2010

Entropy, or Why the World as We Know It is Dying was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

My interest in Andy was due to the fact that he has been singularly successful in pretty much all aspects of the real estate market, including financing and developing large projects — such as shopping centers, apartment communities, office buildings, and warehouses — from one end of the country to the other. His expertise has also allowed him to build an impressive business providing assistance to large financial institutions that need help in dealing with problem commercial real estate loans. As you might suspect, business is booming.

Back in 2007, however, what most intrigued me about Andy was that he had been almost alone among his peer group in foreseeing the coming end of the real estate bubble, and in liquidating essentially all of his considerable portfolio of projects near the top. There are people that think they know what’s going on, and those who actually know — Andy very much belongs in the latter category.

In fact, he initially refused to speak at our event, only agreeing very reluctantly after I had hounded him for several months. The reason for his refusal, I later found out, was that he had spoken at several industry events before the real estate collapse and had been all but booed off the stage for his dire outlook.

The happy ending of this story is that Andy’s speech at our Summit was a rousing success, and he enjoyed it so much that he has now spoken at several, and has kindly agreed to sit for periodic interviews to keep our readers up to date on the latest developments in this critical sector. So far, Andy’s real estate forecasts continue to come true. 

As you’ll read in the following excerpt from my latest interview with Andy, who now spends considerable time each day helping the nation’s biggest banks cope with growing stacks of problem loans, he remains deeply concerned about the outlook for real estate.

David Galland

No one has been more right on the housing market in recent years. So, what’s coming next? Some of the housing numbers in the last few months look a little less ugly. Could housing be getting ready to get well?

MILLER: I don’t think so.

For all intents and purposes, the United States home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the U.S. were made with federal assistance, either through Fannie Mae and the implied guarantee, or Freddie Mac, or through the FHA.

If it’s true that most of the financing in the single-family home market is being facilitated by government guarantees, that should make everybody very, very concerned. If government support goes away, and it will go away, where will that leave the home market? It leaves you with a catastrophe, because private lenders for single-family homes are nervous. Lenders that are still lending are reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage. So when the supply of government-facilitated loans dries up, it’s going to put the home market in a very, very bad place. 

Why am I so certain that the federal government will have to cut back on its lending? Because most of the financing is done via the bond market, through Ginnie Mae or other government agencies. And the numbers are so big that eventually the bond market is going to gag on the government-sponsored paper.

The public doesn’t have any idea of the scale of the guarantees the government is taking on through Fannie, Freddie, and FHA. It’s huge. If people understood what the federal government has done and subjected the taxpayers to, there would be a public outrage. But you can’t get people to focus on it, and it’s very esoteric, it’s very hard to understand. But it’s not something the bond market won’t notice. The government can’t keep doing what it has been doing to support mortgage lending without pushing interest rates way up.

Refinancings of single-family homes are very interest-rate sensitive. Consumers have their backs against the wall. They have too much debt. Refinancing their maturing mortgages or their adjustable-rate mortgages is very problematic if rates go up, but that’s exactly where they’re headed. So anyone who’s comforted by current statistics on single-family homes should look beyond the data and into the dynamics of the market. What they’ll find is very alarming.   

On that topic, recent data I saw was that something like 24% of the loans FHA backed in 2007 are now in default, and for those generated in 2008, 20% are in default, and the FHA is out of money.

MILLER: Fannie Mae had a $19 billion loss for the third quarter of 2009, and they are now drawing on their facility with the U.S. Treasury. We have all forgotten that Fannie and Freddie are still being operated under a federal conservatorship. On Christmas Eve, the agency announced that they were going to remove all the caps on the agencies.

So what about commercial real estate?

MILLER: When I saw what was happening in the housing market, I liquidated all my multifamily apartments, shopping centers, and office buildings. I liquidated all my loan portfolios, and I’m happy I did.

Then it occurred to me in 2005 and 2006 that the commercial world had to follow suit. Why? Because it’s a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value. And when consumers hit the wall with spending and debt, that’s going to have an impact on retailers that pay for commercial space.

Furthermore, the financing for retail properties had gotten ludicrous. The conduits were making loans that they advertised as 80% of property value when they originated them, but in reality the loan-to-value ratios were well over 100%. And I say that to you with absolute, categorical certainty, because I was a seller and nobody knew the value of the properties that I was selling better than I did. I had operated some of them for 20 years, so I knew exactly what they were bringing in. I knew what the operating expenses were, and I knew what the cap rates were. And, you know, the underwriting on the loan side and the purchasing side of these assets was completely insane. It was ludicrous. It did not reflect at all what the conduits thought they were doing. They were valuing the properties way too aggressively.

I became very bearish about the commercial business starting in late ‘05. In fact, I think I was in Argentina with Doug Casey, sitting on a veranda at one of the estancias, and he and I were lamenting what was going on in the real estate business, and I said there was going to be a huge adjustment in the commercial market.

Beyond the obvious, that the real estate market has taken pretty significant hits and some banks have been dragged under by their bad loans, what has really changed in real estate since the crash? 

MILLER: I think the first thing that changed was that people learned that prices don’t go up forever. Lenders also saw that underwriting guidelines for commercial real estate loans, especially in the securitization markets, were erroneous. They realized that some of their properties had been financed too aggressively, but still, I don’t think even at the fall of Lehman, anybody was predicting a wholesale collapse in commercial real estate.

But they did see they should be more circumspect with loan underwritings. In fact, after the fall of Lehman, they completely stopped lending. I think they realized we had been living in fantasy land for 10 years. And that was the first change — a mental adjustment from Alice in Wonderland to reality. 

Today it’s clear that commercial properties are not performing and that values have gone down, although I’ve got to tell you, the denial is still widespread, particularly in the United States and on the part of lenders sitting on and servicing all these real estate portfolios. People still do not understand how grave this is.

Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you’ve been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?

MILLER: It’s an educated guess, and it hasn’t changed. I still think that it’s second quarter 2010.

The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there’s some alternative in place, it’s going to be a very hideous picture for the bond market and the banking system.

The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well – not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I’ll give you an example.

In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn’t have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.

That’s very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they’ll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that’s horribly destructive.

Just to be clear on this, let’s say I own an apartment building and I’ve been making my payments, but I’m having trouble and the value of the property has fallen by half. I go to the bank and say, “Look, I’ve got a problem,” and the bank says, “Okay, let’s work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we’ll shake hands and smile.” Then, even though the property’s value has dropped, as long as we keep smiling and I’m still making payments, then the bank won’t have to reserve anything against the risk that I’ll give the building back and it will be worth a whole lot less than the mortgage.

MILLER: I think what you just described is accurate. And it’s exactly a Japanese-style solution. This is what Japan did in ‘89 and ‘90 because they didn’t want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses. 

And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it’s not going to sell them. 

Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.

Wouldn’t banks know that ultimately the piper must be paid, and so they’d be trying to build cash — trying to build capital to deal with the problem when it comes home to roost?

MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it’s digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it’s going to be. I can tell you that because I’m out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices — all the foot-dragging allows the fundamental problem to get worse. 

In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you’re clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?

Or a borrower who is sitting on a suburban office property — he’s got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don’t think so. So the problems get bigger.

Why would the owner bother going through a workout with the bank if he knows he’s so deep underwater he’s below snorkel depth?

MILLER: It’s always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you’re a borrower who’s guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there’s always a little hope that values will turn around. So there is no reason to hurry into a default. None.

So that’s from the borrower’s standpoint. But wouldn’t the banks want to clear these loans off their balance sheets? 

MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone. 

So here we are, we’ve got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They’ve taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?

MILLER: Well, obviously nobody knows, but I can guess at what’s coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.

I think they’re going to contrive something to help assist commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. It’ll resemble what they did with housing.

They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire U.S. residential mortgage market has in effect been nationalized, but there wasn’t any act of Congress, no screaming and shouting, no headlines in the Wall Street Journal or the New York Times about “Should we nationalize the home loan market in America.” No. It happened right under our noses and with no hue and cry. That’s a template for what they could do with the commercial loan market. 

And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.

But it won’t really be a solution. In fact, it will make the problems much more intense. 

Don’t these properties have to be allowed to go to their intrinsic value before the market can start working again?

MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We’re going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem. 

Do you think the U.S. will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?

MILLER: I know this is going to make you laugh, but I’m actually an optimist about this. I’m not optimistic about the short run, and I’m not optimistic about the severity of the problem, but I’m totally optimistic as it relates to the United States of America.

This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.

Regards,
David Galland
The Casey Report
 
Andy Miller is the co-founder of the Miller Frishman Group (MillerFrishman.com), which includes three companies serving different sectors of the real estate market – from mortgage brokerage and banking, to the building, management, and marketing of commercial real estate across the United States. His firm is currently deeply involved in the distressed real estate business, assisting lenders across the nation with their growing portfolios of non-performing loans.

February 10, 2010

An Insider’s View of the Real Estate Train Wreck was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Lawmakers Propose ‘War Surtax’ to Pay for Troop Increase in Afghanistan

Two top Democrats say they want to impose a new tax on the wealthy to finance any increase in U.S. troops for the Afghanistan war.

Rep. David Obey, D-Wis., chairman of the purse string-controlling House Appropriations Committee, is calling the idea a “war surtax.” He said that just as the federal government is expected to pay for its proposed intervention in the health care sector with new taxes, any escalated involvement in Afghanistan should come with a payment plan.

“If we have to pay for the health care bill, we should pay for the war as well … by having a war surtax,” Obey told ABC News in an interview that aired Monday. “The problem in this country with this issue is that the only people that has to sacrifice are military families and they’ve had to go to the well again and again and again and again, and everybody else is blithely unaffected by the war.”

Readers of my free missive, Casey’s Daily Dispatch, know I’m vehemently opposed to the doomed adventure in Afghanistan. On that front alone, the idea of a war tax is like a shard of glass in my eye.

But it’s even worse than that. It shows just how degraded this country has become — picking the pockets of the productive is now pretty much the only remaining source of funding the administration and its allies can imagine.

Just to be sure we keep this in perspective: At this moment, if you earn more than $250,000 a year (which isn’t what it used to be, given the steady erosion of inflation over the last 30 years), you will pay federal income taxes of about 35%, no estate taxes, and a 15% capital gains tax should the money you put at risk in the market return a profit.

As soon as next year — if the government moves up the expiration of the Bush tax cuts, as I very much expect them to — the top tax bracket will go to 39%. On top of that, the current healthcare legislation will add a 5.4% surcharge. Then, add in the Democrats’ proposed 5% war tax. So straight up we’re talking 49%.

Then there’s a near doubling of capital gains taxes, from 15% to as high as 28%. And, of course, the return of the estate tax.

But that’s just for starters, because everywhere you look states and municipalities are raising taxes and fees, and attorney generals, taking a page out of Caligula’s playbook, are casting about for their next deep-pocketed victim.

At the end of the day, the top tax rate in the U.S., starting as early as next year, will soar way over 50% of income. While further number crunching is required, it is a very safe assumption that top income earners will soon be paying over 65% of their income in taxes.

Which is to say, if you are in a top tax bracket, every penny you earn between January 1 and August 25 will go straight into the coffers of one layer of government or another.

And this while more than 40% of Americans pay no income taxes at all.

This is just another symptom of the single biggest problem now facing the U.S. (and for that matter, the world): the ballooning size and cost of government. And there are no speed bumps in sight.

Even so, endless complaining won’t really do anything other than raise the blood pressure. So, what can we actually do about it? Some ideas:

1. Buy gold. Unless and until there is an angry upwelling of popular discontent at the growing size of government — and it has to be far more substantive than just a few vocal talk radio jocks, or even 100,000 or so people peacefully gathering on the Mall in Washington DC — the government will continue to grow, or even just keep running at current levels, which means the destruction of the dollar. Many tangible assets will do well, but their intrinsic value as money means gold (and silver) will do best.

As I write, gold has again broken to a new, non-inflation-adjusted high. As with all markets, it will fall back now and again, but the trend is very much up.

2. Buy gold shares. The leverage in the high-quality gold shares can boost your returns by a factor of 2X to 10X, and more. Again, there will be setbacks, but shares in the right companies with the right projects will trend higher and higher until the Mania phase kicks in, and then things will get really interesting.

3. Be smart about taxes. Keep an eye on Pelosi’s tax trap — if you have appreciated assets that qualify for long-term capital gains, consider selling them before year-end to lock in the lower capital gains tax. Likewise, if you run a business and you can pull any income into this year, versus next, consider doing so.

4. Diversify globally. Why do it? The short version is that it’s a big world out there, and there are a lot of places that are incredibly beautiful, safe, and unbelievably inexpensive. For many non-U.S. citizens, expatriating means you’ll pay no income tax, but even if you are a U.S. citizen, there are substantial tax benefits in moving offshore. And what you can save in cheaper everyday living allows you to live like royalty, for a fraction of the cost. Which means you can save more.

Personally, I favor Argentina. Some years ago I went on a three-year quest to find paradise on earth, and Argentina was ultimately the hands-down winner.

5. Recognize the bureaucracy for what it is. These are not “public servants” but rather an entrenched interest group that is actively engaged in a systematic effort to look after itself, with no regard for the damage it’s doing to your family finances and to the country.

Now, there are two schools of thought as to how you deal with the bureaucrats. My dear friend and partner, Doug Casey, would tell you to take every opportunity to let the bureaucrats know you hold them in low esteem. For example, by asking airport security personnel how old they were before they realized they wanted to make a career out of pawing through people’s underwear.

The second approach is to accept that the bureaucrats, backed by the voting masses, hold most of the cards at this point. Poking at them with a stick risks unnecessary aggravation and worse. So, keeping a low profile and going about your business is certainly a rational choice.

Of course, there’s no better way of maintaining a low profile than moving to another country where you’ll be welcomed as a visitor and not viewed as a serf.

Is there no hope? One obvious scenario is for the Democrats to lose control of either the House or the Senate come next November’s elections, thereby returning the nation to some form of political gridlock. The best of all worlds, in my view. And the way things are heading, this is now a certainty.

But before you get overly excited about the prospects of a political solution, don’t forget the role the Republicrats have played in bringing the nation to this sorry state over the past several decades. If you’re holding out for an outbreak of capitalism or other signs of fiscal sanity once Republicans regain some modicum of political power, you are delusional. They may package their programs in different-colored paper, but when you rip away the wrappings, you’ll find the same statism and the same promises of a chicken in every pot.

Look after yourself — no one else is going to do it for you.

Regards,
David Galland
Casey Research

December 4, 2009

How the Government Tries to Fleece You and What You Can Do About It: Buy Gold, Diversify was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Some analysts now contend that China can no longer afford to let the gold or silver price slump. The rationale behind that contention is that with the Chinese government now telling the general populace to buy precious metals, it would be highly problematic should gold and silver subsequently take a nose dive.

In many cases, what a government wants and what ultimately occurs can be wildly different, due to unintended consequences rarely foreseen by officialdom, and because once the masses get it into their heads to break one way or another, government’s desires are largely ignored.

“You shall not smoke marijuana,” says the government. “Roll me another,” says John Q. Public.

But in the case of gold, interestingly enough, the Chinese government has the means at its disposal to actually do something about prices. Namely, at $1,000 an ounce, the total value of all the gold ever mined comes to about $5 trillion.

Of that amount, less than $1 trillion is held in official reserves, the rest under mattresses, in jewelry and family heirlooms, and in various ETFs – GLD being the biggest, by far, holding about $34 billion worth of gold.

Against these totals, China has foreign reserves in excess of $2 trillion. In other words, more than enough to push the tiny gold market around in any way it wishes. Given that much of its reserves are now denominated in fragile U.S. dollars that it would sorely love to replace with something more tangible, and that China is the world’s largest gold producer, the country’s involvement with gold is something more than just a passing fancy.

Simply, there is a new gorilla in the room in global gold markets. The extent to which the broader market hasn’t yet figured this out is the extent to which you as an early mover can ultimately profit. Especially in the more leveraged gold stocks, which continue to be strong even as the broader markets show weakness.

That all of this comes before the dollar hits the wall it must hit, or before the inflation that is now baked in the cake arises, lends a lot of credibility to the idea that when the gold bubble begins to expand, it could reach all the way to the moon.

No need to chase gold at these levels, as opposed to buying on dips. But buy.

Regards,
David Galland
Managing Director, Casey Research

September 18, 2009

Could China Push Gold to the Moon? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Howe and Strauss have written many books on how generations determine the course of history and how they will shape America’s future. Their forecasts on a wide variety of indicators have turned out to be amazingly accurate. They were among the first to predict (back in the late 1980s) the rise of Boomer-driven culture wars and the simultaneous rise of Gen-X-driven free agency and distrust of government. And they were completely alone back then in predicting, for the post-X “Millennial Generation” (a label they coined), a decline in youth crime and risk taking and an increase in youth civic engagement that would first become apparent around the year 2000. Guess what? For the last ten years, everyone has been noticing exactly these trends among teens and 20somethings.

Howe and Strauss also made extensive predictions, based on generational aging, on how America’s entire social mood would likely change, in dramatic fashion, during our current 2000-2010 decade. To quote Doug’s prescient 1997 article, which was reprinted in Outside the Box late last year…

“… an excellent case can be made the U.S. is approaching another time of secular crisis, a Fourth Turning, with an expected due date of 2005 – seven years from now – plus or minus a few years in either direction.

“The Stamp Acts catalyzed the American Revolution, the election of Lincoln catalyzed the Civil War, the Crash of ‘29 catalyzed the Depression/WW II era. What might precipitate the elements now floating in solution? The answer is practically any random event that’s sufficiently traumatic. Any of the theses of current disaster/action novels and movies will do nicely. Perhaps the accidental or intentional release of a super plague vector. The crashing of an airliner into the Capitol during a joint session. An all-out assault on the IRS computers by an armed group – or perhaps the computers just melting down due to the Year 2000 Problem. Perhaps a financial disaster that cascades into the Greater Depression. In any of these, or a hundred other scenarios, the federal government would almost certainly act precipitously and with a heavy hand, which would bring on a whole other set of consequences.

“There’s no way of telling where the Crisis will lead, or how it will end. That’s going to depend not only on exactly who’s in control, but what they do, who they’re up against, and a hundred other variables we can’t even anticipate.

“One thing that seems certain is that real crisis brings out strong leadership. Because of its age and size, it will come from the Boomer generation, and it will be in the mold of Roosevelt or Lincoln – both very dangerous precedents. The boomers in elderhood will be dogmatic, harsh, puritanical, and quite willing to burn down the barn in order to destroy whatever rats they see. Admix that attitude to a time resembling the Revolution, the Civil War, or WW II, overlain with today’s ethnic strife, urbanization, financial overextension, and powerful, compact new weaponry in the hands of foreign fanatics out to teach the Great Satan a lesson and it’s a real witch’s brew.”

As eye-opening as Doug’s predictions were, they brought us only to the onset of the current crisis. Consequently, we thought it both timely and important to check back with the source of much of the research he relied on. And so it was that I spent several hours talking with Neil Howe, co-author of the seminal work on generational cycles, The Fourth Turning, and, just recently, the subject of the DVD “The Winter of History.” Howe is not just an historian, but also a Washington DC-based economist and demographer. While our conversation covered a great many topics, the overriding focus was on how things are likely to unfold from here.

Many bullish readers won’t be thrilled to hear Howe’s latest findings about the future, but given his predictive track record, dismissing them out of hand could be a costly mistake.

The summary outlook, according to Howe, is that we are in the very early stages of a 20-year period of economic and institutional upheaval – an era denominated by a crisis during which we’ll likely witness the tearing down and reconstruction of many aspects of society as we know it.

As individuals, understanding Howe’s views and taking some reasonable precautions makes a lot of sense. As investors, those views also have the potential to make us a lot of money.

Following is my high-level recap of my long conversation with Neil Howe, along with some general thoughts on the investment implications of a 20-year bear market.

Remember the Sixties?

If you’re old enough — or possess even a rudimentary sense of history — think back to the 1950s, with roller-skating waitresses, crew cuts, and nuclear families of the sort represented by the iconic Leave it to Beaver. Fathers worked, while many mothers stayed home. Life had a certain predictable quality and, as far as anyone knew, would continue along the same lines for time immemorial.

But then something happened… the 1960s. Literally no one saw it coming. It was as if someone had flipped a switch that electrified America and, quickly, the world. Most everything changed, and a society accustomed to conformity was blown away with a fierce individualism expressed with long hair, sex, drugs, and rock and roll, topped off with civil disobedience and bloody riots in the streets.

What happened?

According to Neil Howe, in the mid-1960s, generational change pushed society around a dramatic corner as idealistic, individualistic young Baby Boomers (born 1943 to 1960) rebelled against the midlife leadership of their G.I. Generation parents (born 1901 to 1924).

These periods of transitions are part of a larger cyclical pattern made up of four distinct eras, or “Turnings,” each lasting approximately 20 years. It can be helpful to think of the four turnings as you might think of the four seasons, repeating predictably in their own natural rhythm. A full cycle of turnings takes place over a period of about 80 to 90 years — roughly the span of a long human life. A new turning begins as a new youth generation comes of age, bringing a new social ethic that compensates for the excesses of the midlife generation then in power.

While we don’t have the space here to go into the full details of Howe’s research, it’s important to the topic at hand that we quickly recap the Four Turnings.

The First Turning is referred to by Howe as a High. As this follows a period of crisis, one of the hallmarks of a First Turning is a heightened sense of community and collective optimism, driven in part by the fact that the society has just come through a difficult and challenging time. Consequently, during First Turnings, societal institutions tend to be strong while individualism is weak. The post-World War II “High” of the mid-1940s through early ‘60s is the most recent example of a First Turning.

The Second Turning, called an Awakening, typically starts out feeling like the high tide of a High, with signs of progress and prosperity everywhere. But just as everything seems to be going along swimmingly, large swaths of society begin to chaff under the social conformity of the High, beginning to gravitate to more individualistic pursuits and demanding that their personal interests come first. You may recognize the “Consciousness Revolution” of the mid-1960s through early 1980s, correctly, as the Second Turning.

Next up, the Third Turning, which Howe calls an Unraveling, is much the opposite of a High. To wit, individualism dominates, while institutions are increasingly weak and discredited. Quoting Howe on the Unraveling…

“This is a time when social authority feels inconsequential, the culture feels exhausted, and people feel bewildered by the number of options available to them. It is a time of celebrity circuses and a tremendous amount of freedom and creativity in our personal lives, but very little sense of public purpose.

“The most recent Third Turning began in the mid-‘80s with Morning in America, and continued through the ‘90s. Previous periods of Unraveling in American history were also decades of cynicism and bad manners. Think of the 1920s, the 1850s, the 1760s. And history teaches us that the Third Turnings inevitably end in Fourth Turnings.”

Finally, there is the Fourth Turning, called a Crisis. The recent Third Turning appears to be winding down, and we are currently on the cusp of a Fourth Turning. This is a time of great turmoil, when society’s basic institutions are torn down and rebuilt, and seemingly insurmountable problems are addressed. During Fourth Turnings, America engages in a struggle for its very survival and redefines its identity as a nation. Large wars are often a part of this process. The American Revolution, Civil War, Great Depression, and World War II were all features of past Fourth Turnings.

In sum, Howe’s research has shown that, with remarkable predictability, history is not a straight line extending toward a better and brighter (or increasingly awful) future, but rather a repeating cycle of the four distinct social eras. These four turnings have recurred with remarkable consistency throughout Anglo-American history, as Neil Howe outlines at length in Generations and The Fourth Turning. It is therefore no accident that America has experienced great cataclysms or “Crises” about every 80 years. Travel back eighty years from Pearl Harbor Day, and you land in the middle of the Civil War. Eighty years before that takes you to the Revolutionary War. If the rhythms of history hold, America is now poised to enter another Fourth Turning.

Bad News, Potentially Good News

You don’t need me to tell you that the United States and in fact the world are now facing a plethora of intractable problems. The world’s former powerhouse economy, the U.S., is now the world’s largest debtor nation – and by a wide margin. The nation has trillions in unpayable liabilities coming due on Social Security and Medicare, to name just two of many broken government programs weighing on the country. And our much vaunted democracy is increasingly dysfunctional – rotten to the core, truth be known – thanks largely to entrenched special interests and a voting public clamoring for their own piece of the pie, while trying to hand the bill off to somebody else.

Meanwhile, the economy – despite rigorous jawboning by the government and its many friends in the large banking institutions — is in serious trouble, with the housing market buffeted by tsunami-like waves of defaults, foreclosures, overvaluations, historic levels of personal debt, and tight credit that has left the U.S. government as the sole lender in many markets.

Bernanke and his ilk may see green shoots, but what they’re really seeing is the deep, green sea rising up once again to bury the economy. That’s the bad news.

The potentially good news, if you credit Howe’s research, is that the Crisis we’re now entering will change pretty much everything. While this change will entail a great deal of pain and a reduced standard of living for a large number of people, by the time the Crisis subsides, society will have pretty much remade itself in ways that no one can predict at this point.

Put another way, today’s intractable problems will be solved… one way or another.

What’s Next

When discussing what’s likely to follow next, Neil Howe turns to his generational profiles and points out that the rising societal power today belongs to the generation he calls the Millennials, individuals born between 1982 and 2004. They are a “Hero” generation, just like the G.I. Generation that coped so well with the turmoil of the Great Depression and World War II — the last Fourth Turning. Coddled as children, the G.I.s were ultimately called upon to help society through a dark and dangerous period and rose to the occasion. Again, quoting Howe on the Millennials…

“These are today’s young people, who are just beginning to be well known to most Americans. They fill K-12 schools, colleges, graduate schools, and have recently begun entering the workplace. We associate them with dramatic improvements in youth behaviors, which are often underreported by the media. Since Millennials have come along, we’ve seen huge declines in violent crime, teen pregnancy, and the most damaging forms of drug abuse, as well as higher rates of community service and volunteering. This is a generation that reminds us in many respects of the young G.I.s nearly a century ago, back when they were the first boy scouts and girl scouts between 1910 and 1920.”

Unlike the Baby Boomers, who are largely individualistic and anti-establishment, the Millennials are good team players. We hear a lot these days about working together for a common cause, volunteerism, and the need for stronger government institutions, largely because these are the new priorities of the Millennial Generation.

As you may recall, out of the devastation of World War II, a spate of transnational political and economic institutions were born, including the United Nations, the World Bank, the World Health Organization, and the International Monetary Fund. By the time the current Fourth Turning is over, expect more of the same — but probably even bigger and more ambitious.

What Does This Mean to You?

Most importantly, if Howe is right, this crisis is far from over. In fact, when I asked him where we are today on a scale from 1 to 10 — with 10 representing as bad as the crisis will get — he replied that we are at either 2 or 3. In other words, the worst is very much yet to come. And, per above, he expects this period of turmoil to take 20 years to play out. Thus, if nothing else, you may want to continue approaching matters of personal finance cautiously.

Secondly, if you’re the type of individual that tends to get steamed up by larger and more intrusive government programs, you may want to take a few deep breaths and resolve yourself to the fact that this phenomenon is likely to get far worse before we see a return to celebration of individual rights. (And the cycle shows that we will see such a return — about 40 to 50 years from now, when the next Second Turning comes around.)

If it is any consolation, the Millennial Generation places a great deal of weight on teamwork and the notion of doing things “smart.” That doesn’t mean, of course, that the various programs that are kicked off in an attempt to fix the many problems now confronting society will in fact turn out to be technically smart. But they will almost certainly be better thought out than some of the numbskull initiatives we’ve seen over the last 20 years.

You can also take some comfort in the fact that Millennials are builders, not destroyers. By contrast, the individualistic Boomers that dominate today’s aging political class are world-class dissenters, radio talk show aficionados always ready to scrap it out for their beliefs. Millennials want to skip the philosophical debate and get straight to fixing things.

Other insights about Fourth Turning periods gained from my conversation with Neil Howe…

• Government grows powerful, and sweeping new legislation is enacted. The old 1990s rule was: just compete and stay off the state’s radar screen. The new 2010s rule will be: better have a presence in Washington so you’re not dealt out of the “new” new deal.  One political party tends to dominate. The Democrats under FDR during the last Fourth Turning offer a good example. While Neil Howe doesn’t think it will necessarily be the Democrats this time around, they are certainly in the pole position at this point.

• While public history speeds up, personal life slows down. Families will spend more time together, like in the old Frank Capra movies. Ever more households will be multi-generational, a trend now spurred by Boomers with large, empty McMansions and Millennials without jobs. There will be a blanding of the pop culture, with the entertainment of the young (put Miley Cyrus or “High School Musical” on fast forward) increasingly regarded as tamer than the entertainment of the old.

• Innovation tends to stagnate, while a few new technologies will be chosen to be adopted on a large scale. We will see the equivalent of canals or railroads or interstates being built across America. To borrow from Carlotta Perez’ four-stage description of technological revolutions, we are moving from the “innovation” to the “implementation” stage.

• New laws and regulations will do less to referee a free market and more to pursue one or another national priority. They will increasingly favor the large producer over the retail buyer, investment over consumption, planning over risk, debt over equity. Businesses will hustle to reposition themselves. Anti-trust will weaken.

• The authority and obligations of community will strengthen at all levels, from local to national and possibly beyond (if our alliances prove durable). Personal reputation and membership will matter more. A “new localism” will reshape town and urban planning. A global slide toward national or regional protectionism will loom as a real danger.

• It is too early to tell whether the crisis will ultimately be inflationary or deflationary, though we at Casey Research come down on the side of inflation for the simple reason that the government possesses the means to inflate. Due to the gold standard, that was not the case early in the Great Depression.

• In the past, Fourth Turning periods have always resulted in the nation redefining who we are in some essential way. That was certainly the case during the American Revolution, when we transitioned from a British colony into a collection of independent states — and the Civil War, when those states were hammered into a single nation. And, again, after World War II, when the U.S. went from being a relatively isolated nation to a global empire. A wild card, for instance a terrorist nuke going off in a city anywhere on the planet, could similarly take the country, and the world, into unforeseeable new directions.

• Baby Boomers will continue to be respected for their cultural achievements (it’s not a fluke of history that Boomer music and other entertainments are still wildly popular among the young), but will be increasingly ignored in the political debate. The term “senior citizen,” already in decline, will disappear entirely. And if push comes to shove, Boomer’s financial interests – including Social Security – will be subjugated “for the greater good.”

• There will be a growing push to rebuild the middle class. The wealthy and the impoverished alike will both come under pressure thanks to new pro-middle class initiatives. If you are a high-income earner, it’s a certainty your taxes are going up, and likely by a lot. If you want to make a fortune, don’t pursue the niche or the “long tail.”  Invent the next big brand that will appeal to Everyman.

Don’t Worry, Be Happy

That is, at best, a sketch of my long conversation with Neil Howe and doesn’t do justice to his research. If nothing else, however, I hope I’ve succeeded in giving you at least some sense of the man and his unique research and encouraged you to think outside the box about the nature of today’s crisis.

A couple of final observations.

First, Neil Howe is not a negative person, nor a professional doomsayer. Rather, he is a social scientist and historian with decades of experience in the social sciences. As you speak to him, you get the sense that he doesn’t view the world through any particular philosophical bias, but rather is simply reporting what his research is telling him about the current players on the global stage, and which act we are currently in.

Secondly, speaking as a Baby Boomer and someone with a lifelong distrust of government and its meddling institutions, talking to Neil left me feeling oddly relaxed — letting go, if you will, of some of the frustration that has been building within me as I watch the nanny state grow more and more bloated.

That is not to say we won’t continue to speak out against government waste and prolificacy. We will. But it seems increasingly clear that we’re now caught up in a powerful trend toward bigger, not smaller, societal institutions — and that these institutions will, over the period ahead, change the world as we know it.

Of course, being active investors, at the same time we raise our voices in protest, we’ll deal with the reality of the situation by strategically positioning our portfolios to profit from the coming changes.

And so, like the Rockefellers and J.P. Morgan during the Great Depression, we’ll make the trend — to matter how negative — our friend. You may want to consider doing so yourself.

Making the trend your friend is more important than ever, if your assets are to make it through the Fourth Turning intact. The Casey Report discovers and analyzes budding economic trends and turns them into hands-on, actionable recommendations for its subscribers. Read the latest report from Casey Chief Economist Bud Conrad about our favorite investment of 2009… a play on an all but inevitable economic development. Click here to read more.

Regards,
David Galland

July 13, 2009

A 20-Year Bear Market? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Early though it may be, however, it’s not too early to come right out and say what needs to be said: when it comes to the steps being taken to address the current crisis, Obama has no clothes.

Both President Obama and Timothy Geithner, the latest recipient of the Goldman Sachs Chair for Managing the Treasury, are on record as saying that the Japanese experiment in quantitative easing didn’t work. They say much the same about FDR’s New Deal. In both instances, they correctly point out that massive doses of government stimulus had no lasting effect.

If the history lesson stopped there, we could all nod our heads in agreement and go about our business.

Alas, the lips of Mssrs. Obama and Geithner keep moving… telling us with great confidence that the reason the fiscal exertions of Japan and FDR failed was only because in each case government didn’t act quickly enough, or with enough monetary vigor.

Having thus explained the shortcomings in prior adventures in stimuli, the administration promises that “this time it will be different” and wholeheartedly commits itself to acting decisively, quickly, and with stunning amounts of cash. By doing so, we are told, they will shock the economy back to life.

But this argument simply doesn’t hold water — there is zero historical precedent for the notion that applying blunt-force government stimulus will somehow mechanically “shock” an economy back into productivity. A couple of bullet points:

• When FDR came into power in 1933, unemployment in the U.S. had reached a high of about 25%. Despite tripling federal spending on the much heralded New Deal, the best unemployment number achieved was 14%, in 1937. By 1939, however, unemployment was back up to 19%. Now, there is some nuance in those numbers, because the calculations include some number of people on the payrolls of the New Deal’s many make-work programs. Yet, given the fact that those make-work jobs would have come to a quick end if the government had stopped its New Deal spending, the poor results of the FDR stimulus hold up.

• In the Japanese crash, the government spent hundreds of billions supporting banks and businesses, buying U.S. Treasuries in an attempt to keep the yen cheap and so their manufacturing sector at work. As the economic morass dragged on, the government cut interest rates to zero, then eventually accelerated spending in a five-year experiment in “quantitative easing,” which involved funding all manner of public works projects and other targeted infusions of government spending into the economy.

Using the equity market as a proxy for the broader economy, the Nikkei fell from around 38,000 at the height of the bubble in the late 1980s, down to around 7,000. During the five-year period of quantitative easing, 2001 to 2006, the Nikkei rebounded by about 100%, moving back to the 14,000 neighborhood. Importantly, however, the minute the Japanese government stopped the spending, the stock market came tumbling back down to around 7,500, near where it hovers today. Note that at no point did it get anywhere near the bubble high of over 38,000.

In sum, the evidence strongly suggests that there is no permanent benefit to be gained from throwing a lot of money at an economy, though there is one clear negative: a steep ratcheting up in government debt. Of course, because the government doesn’t actually make anything, what we’re really talking about is a steep ratcheting up of your debt… and that of your children… and their children.

So, what’s going on? Don’t you think all the Obama’s horses and all the Obama’s men know this?

Maybe they do.

In earlier editions of this missive, I have commented that President Obama may be the best politician in U.S. history. How else to explain how a virtually unknown black man could, in just a few short years, become president. And do so despite a foreign father and two given names eerily reminiscent of two of the most vilified individuals in the current American ethos? Impossible, most would have said, if asked a few years ago. But here he is… undeniable proof of his political skills.

Not to be cynical, but what if, on surveying the landscape, Obama and his inner circle came to the following conclusions about the possible paths they could take in regard to the dismal economy:

Path One: Stand aside and let Mr. Market put on the leather gloves, pick up the truncheon, and get to work pounding the economic dislocations out of the economy. Or…

Path Two: Observe that, during the period of Japan’s quantitative easing, the economy actually did pick up, albeit on a cushion of growing government debt. Using the same approach, one might push the worst of the economic problems past the next presidential election. Given his political skills, that approach syncs up nicely with what is almost certainly Obama’s most pressing personal goal: to avoid at all costs the ignominy of being a one-term president.

Besides, Team Obama could rationalize, even though the quantitative easing will have no lasting effect other than sending government deficits through the roof (a fact that Obama has been very candid about), it will at least buy the new administration some time to come up with another plan that might actually work.

I sincerely believe that just this sort of calculation has been made, and not for practical economic reasons – but almost entirely political ones. Supporting that contention, a large part of the spending in the latest stimulus bill is slated for 2011, the year before the next presidential election is held. Coincidence?

Then there is the $2 billion earmarked for ACORN in that same stimulus bill. While I tend to dismiss the allegations about ACORN’s purported voter fraud as desperate measures on the part of the failing McCain campaign, what we do know about ACORN is that their primary mission is voter registration, and that they are very friendly to President Obama.

It’s all a big win-win… as in “yes we can” win-win the next presidential election.

The way the current mess will actually get cleaned up is through the adoption of measures that support, or at least don’t hinder, entrepreneurs running or starting businesses and expanding into new markets. What we have instead is yet another experiment in more government.

In this matter, at least, Obama has no clothes.

Regards,
David Galland
Managing Editor, The Casey Report

February 23, 2009

Stimulus, Deficit and Elections: Obama Has No Clothes was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.